Canada's Place in the Global Economy

[Edward Campbell]

I agree with you, Brad: spending, all spending, including all sacred cows, must be cut. Where I suspect we part company is on the revenue issue. I don't think spending cuts of sufficient depth are wise, much less politically possible; therefore I think revenue must be enhanced, also. The easiest, but least desirable way to raise more revenue is to raise individual (income) taxes; a much better, but also, I suspect, politically impossible way is to impose a national/federal value added tax, à la our HST, on top of state and local sales taxes. That leaves reforms of the HUGE and HUGELY complex US tax code. My guess is that enough revenue can be found within a few sane, harmless (except to tax lawyers and accountants) tax code reforms to make the spending cuts equally harmless, albeit still painful to many voters.

My other guess is that 99.9% of elected US legislators, Democrats, Independents, Republicans of all stripes, equally, are too frightened or too indebted to the lobby industry to do what good economic sense and simple patriotism require; they will neither cut nor reform until a wholly preventable disaster strikes.

Americans, again of all political stripes, are the authors of their own misfortunes but the world will pay for their willful irresponsibility.

Watch this: it is US specific but the principles, inefficient and ineffective tax regimes, are a global problem and so is too much entitlement spending.

 

[Brad Sallows]

Tax increases are not necessarily the solution.  There are four factors to consider: taxables, tax rates, tax credits (aka tax expenditures), and tax shelters.  The latter two could be lumped together as one for purposes of this discussion.

Too much attention focuses on the simple linear relationship involving taxables and tax rates, and not enough attention on human behaviour.  The "rational economic man" is a myth, the "rational investor" is not.  At the risk of sounding like Noam Chomsky, "no serious person" disputes that increased tax rates encourage tax avoidance (movement of capital into tax shelters) and decreased tax rates remove that incentive.  It is simple investment arithmetic: is the after tax income from the non-sheltered investment greater than the RoI from the sheltered one, or not?

Tax shelters and tax rates act together to distort market signals (risk pricing) and the flow of investment capital.  Those who are able to offer tax sheltered investments can reduce their price (essentially, transfer some fraction of risk pricing to taxpayers - socializing risk, to which most progressives would object if they understood it); those who cannot offer shelter must offer higher rates of return (than the risk would ordinarily warrant) to compete for capital.

In the US, where they have tax-free municipal (and some state) bonds, this is exceptionally pernicious.  Capital is drawn away from more productive investments.  The cost of borrowing, for governments, is cushioned.  It should be clear that this might promote lazy, sloppy, inefficient, imprudent government spending practices.  So reduction of tax rates and elimination of tax shelters would achieve two useful goals: redirect more capital into innovation and production, and force governments to either fix their imbalances or accept a greater cost for not doing so.

Notice I've written nothing about "the rich" spending more and supporting some sort of "trickle down" effect.  "Trickle down" is a strawman created to support objections to tax reductions.  Thomas Sowell has a standing challenge - which AFAIK no one has met - to anyone to find a reputable source which espouses a "trickle down" theory.  The thrust of the counter-complaint - which I believe to be largely valid - is that "the rich" don't spend the money, so nothing "trickles down".  But the follow-up question is never asked: so what do "the rich" do with the reduction in their tax liabilities?  Surely no-one believes they stuff it in mattresses.  And I have already stipulated that they don't spend enough of it to matter, so the objection "oh, they spend it on X" is already null.  Short of burning it, the obvious explanation is that it is invested.  And regardless where it is invested, it means jobs and economic activity (all or most of which will be taxed).  And that is why tax reductions are useful, and why tax reform marrying tax reductions with elimination of tax shelters shows a lot of potential to increase economic activity, and thereby increase government revenue take.  If the reform is revenue neutral or even nearly so, the increased economic activity can be enough to generate a net surplus for government.

 

[ModlrMike]

For the most part Brad I'd agree with your summation. However you'll never convince the "tax the rich" crowd that they can continue to cut thicker and thicker slices from the ham and still feed everybody. At some point you run out of ham; or worse, you run out of pigs.

 

[a_majoor]

Actually, Brad has plenty of empirical evidence to back him up; the various economic booms during times of tax reductions in different times and places, and the increase (sometimes large increase) in tax revenues accrued by the various nations that have implemented a flat or single tax.

The real reason for the various straw man arguments always raised against changes to the tax code (especially broad based tax cuts or elimination of various tax loopholes) has little to do with overall economic efficiency but everything to do with special interests that benefit from one or more tax loopholes or other economic distortions. These are the sort of people who will fight to the last taxpayer to preserve their special benefits and perques.

 

[Redeye]

Actually, Brad has plenty of empirical evidence to back him up; the various economic booms during times of tax reductions in different times and places, and the increase (sometimes large increase) in tax revenues accrued by the various nations that have implemented a flat or single tax.

The real reason for the various straw man arguments always raised against changes to the tax code (especially broad based tax cuts or elimination of various tax loopholes) has little to do with overall economic efficiency but everything to do with special interests that benefit from one or more tax loopholes or other economic distortions. These are the sort of people who will fight to the last taxpayer to preserve their special benefits and perques.

Funny enough, most of that countries that use flat taxes which are proffered to support that argument are countries which have also just undergone massive transformations in their economic system (they're almost all Eastern European/former Soviet states), meaning it's rather hard to argue the benefit because it's anything but clear what caused it. In most cases where flat taxes are proposed, the middle class (which is a pretty vast swath of voters) stands poised to get hit hard, as do poorer people, because they benefit from a number of deductions put in place to accomplish other goals. Things like child care deductions, earning income tax credits/personal exemptions, dependent credits, etc benefit them in proportionally greater ways. That's why such plans generally flop with voters once the ramifications are explained. The upside of them is that they greatly simplify the tax collection system and probably can reduce avoidance.  If pitched with a reasonable individual or household exemption it could gain some traction, and if coupled with consumption taxes (again, exempting a broad range of staple goods to reduce incidence on lower income persons), it'd be interesting to model the impact.

What's most interesting is the optics through which fiscal imbalance are perceived by different groups - or rather, how they are perceived as being perceived. The "rich" are portrayed in America, for example, as being angry that a massive deficit is being run to subsidize "freeloaders". I don't accept that argument, especially, since it's a caricature, just as any portrayal as "the left" as being idle, non-working, "Occupy" folks, when they're not generally, but they do seem to have a legitimate reason to question, in many countries, why they're being saddled with debt to give tax breaks to businesses, or to fight wars abroad, or for any other form of wasteful spending. There's legitimate reasons, in any state or jurisdiction, to not want to run long-term deficits, and to spend government money prudently. I'm watching Nova Scotia's government piss-artists once again hand a bunch of public money to businesses to "create jobs" in economically depressed areas. As soon as those subsidies are withdrawn, the businesses will leave as has happened umpteen times, and one can only wonder what if any benefit taxpayers received. However, it's a problem that will exist in many places - trying to maintain a post-industrial economy.

I'd never considered the perverse incentives created by munis - interesting concept that makes complete sense. The more common one brought up is mortgage interest deductibility and how it impacts housing markets and consumer behaviour with respect to home equity financing in the United States. It's interesting how programs can cause distortion in consumer choices, and I often wonder if they were intended or at least anticipated consequences.

I tend to agree with the argument Roubini makes that government is unable to fix the issue at either extreme - because they're either looking short-term in the context of an election cycle - or their long-term self-preservation interest means they're risk averse and will accept underperformance as a cost of stability. No one, for example, will touch the defense budget in the USA, which is a perfect storm of all the problems - protectionism, waste, etc, because it has consequences at the ballot box. The problem is, there isn't any realistic solution. Our economies are going to wildly change, regardless of policy decisions, because trade, free or not will force them to.

 

[Edward Campbell]

Many American so-called conservatives will, with absolutely no intellectual foundation, describe Joseph E. Stiglitz as a radical socialist ~ that's arrant nonsense of the highest order which tells us a lot more about the intellectual poverty of American political discourse than it does about Stiglitz.

Joseph E. Stiglitz is part of the New Keynesian movement, which I, personally, regard as just as muddle headed as classical Keynesian  economics ~ it's not that Keynes was a bad economist, in fact his theories make good sense, it is just that Keynesian economics is a political impossibility: it is easy to run deficits and spend, Spend, SPEND in a recession; it is hard, too hard, indeed impossible to do what Keynes said and cut spending in good times, to pay off the deficits and pay down the debt. Keynes and the Keynesians, new and old, failed to sqaure that circle, but so do the neo classicists who are all in favour of cuts but cannot manage to tell us where and how.

But, being politically naive does not make Stiglitz a bad economist and his Nobel Prize (2001) suggests that he might be better than anyone teaching at, say, College of the Ozarks which is a favourite of American conservatives.

Anyway, now that that's of my chest, here, reproduced under the Fair Dealing provisions of the Copyright Act from Project Syndicate is Stiglitz on why he believes monetary policy, alone, cannot work:

http://www.project-syndicate.org/commentary/quantitative-easing-3--qe3--and-the-problems-of-the-fed-and-ecb-s-expansionary-monetary-policy-by-joseph-e--stiglitz

Monetary Mystification

Joseph E. Stiglitz

Oct 4, 2012

NEW YORK – Central banks on both sides of the Atlantic took extraordinary monetary-policy measures in September: the long awaited “QE3” (the third dose of quantitative easing by the United States Federal Reserve), and the European Central Bank’s announcement that it will purchase unlimited volumes of troubled eurozone members’ government bonds. Markets responded euphorically, with stock prices in the US, for example, reaching post-recession highs.

Others, especially on the political right, worried that the latest monetary measures would fuel future inflation and encourage unbridled government spending.

In fact, both the critics’ fears and the optimists’ euphoria are unwarranted. With so much underutilized productive capacity today, and with immediate economic prospects so dismal, the risk of serious inflation is minimal.

Nonetheless, the Fed and ECB actions sent three messages that should have given the markets pause. First, they were saying that previous actions have not worked; indeed, the major central banks deserve much of the blame for the crisis. But their ability to undo their mistakes is limited.

Second, the Fed’s announcement that it will keep interest rates at extraordinarily low levels through mid-2015 implied that it does not expect recovery anytime soon. That should be a warning for Europe, whose economy is now far weaker than America’s.

Finally, the Fed and the ECB were saying that markets will not quickly restore full employment on their own. A stimulus is needed. That should serve as a rejoinder to those in Europe and America who are calling for just the opposite – further austerity.

But the stimulus that is needed – on both sides of the Atlantic – is a fiscal stimulus. Monetary policy has proven ineffective, and more of it is unlikely to return the economy to sustainable growth.

In traditional economic models, increased liquidity results in more lending, mostly to investors and sometimes to consumers, thereby increasing demand and employment. But consider a case like Spain, where so much money has fled the banking system – and continues to flee as Europe fiddles over the implementation of a common banking system. Just adding liquidity, while continuing current austerity policies, will not reignite the Spanish economy.

So, too, in the US, the smaller banks that largely finance small and medium-size enterprises have been all but neglected. The federal government – under both President George W. Bush and Barack Obama – allocated hundreds of billions of dollars to prop up the mega-banks, while allowing hundreds of these crucially important smaller lenders to fail.

But lending would be inhibited even if the banks were healthier. After all, small enterprises rely on collateral-based lending, and the value of real estate – the main form of collateral – is still down one-third from its pre-crisis level. Moreover, given the magnitude of excess capacity in real estate, lower interest rates will do little to revive real-estate prices, much less inflate another consumption bubble.

Of course, marginal effects cannot be ruled out: small changes in long-term interest rates from QE3 may lead to a little more investment; some of the rich will take advantage of temporarily higher stock prices to consume more; and a few homeowners will be able to refinance their mortgages, with lower payments allowing them to boost consumption as well.

But most of the wealthy know that temporary measures result only in a fleeting blip in stock prices – hardly enough to support a consumption splurge. Moreover, reports suggest that few of the benefits of lower long-term interest rates are filtering through to homeowners; the major beneficiaries, it seems, are the banks. Many who want to refinance their mortgages still cannot, because they are “underwater” (owing more on their mortgages than the underlying property is worth).

In other circumstances, the US would benefit from the exchange-rate weakening that follows from lower interest rates – a kind of beggar-thy-neighbor competitive devaluation that would come at the expense of America’s trading partners. But, given lower interest rates in Europe and the global slowdown, the gains are likely to be small even here.

Some worry that the fresh liquidity will lead to worse outcomes – for example, a commodity boom, which would act much like a tax on American and European consumers. Older people, who were prudent and held their money in government bonds, will see lower returns – further curtailing their consumption. And low interest rates will encourage firms that do invest to spend on fixed capital like highly automated machines, thereby ensuring that, when recovery comes, it will be relatively jobless. In short, the benefits are at best small.

In Europe, monetary intervention has greater potential to help – but with a similar risk of making matters worse. To allay anxiety about government profligacy, the ECB built conditionality into its bond-purchase program. But if the conditions operate like austerity measures – imposed without significant accompanying growth measures – they will be more akin to bloodletting: the patient must risk death before receiving genuine medicine. Fear of losing economic sovereignty will make governments reluctant to ask for ECB help, and only if they ask will there be any real effect.

There is a further risk for Europe: If the ECB focuses too much on inflation, while the Fed tries to stimulate the US economy, interest-rate differentials will lead to a stronger euro (at least relative to what it otherwise would be), undermining Europe’s competitiveness and growth prospects.

For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending.

The current downturn, already a half-decade long, will not end any time soon. That, in a nutshell, is what the Fed and the ECB are saying. The sooner our leaders acknowledge it, the better.

Stiglitz is right, in so far as he goes: monetary stimulus, by itself, will not work; some sorts of fiscal stimulus are needed, too; but many countries, including the USA, cannot provide any fiscal stimulus until they get their existing budgetary houses in order. So, first, some "short term pain" is necessary: for those (47%?) who are "entitled to their entitlements" and for those who suck, endlessly, at the teat of the "military industrial complex." The, and only then, will it be possible to provide fiscal stimulus. Politically, I think, the two must be made to happen simultaneously: entitlements and the defence budget must both be cut and most of those cuts can, productively, be applied to New Keynesian type fiscal stimulus which we have learned, from every other recession, actually works. What we, Keynesians and classicists alike, must learn is that fiscal stimulus works when it is applied, indirectly, to e.g. public works - maintenance of sewers and bridges, for example - not directly, to entitlements which become too hard to cut.

 

[Edward Campbell]

Part 1 of 3

More pessimism in this interview with Ian Bremmer, president of Eurasia Group and author of The End of the Free Market: Who Wins the War Between States and Corporations? and Nouriel Roubini, professor of economics at New York University's Stern School of Business, who is co-founder and chairman of Roubini Global Economics, which is reproduced under the Fair Dealing provisions of the Copyright Act from Foreign Policy:

http://www.foreignpolicy.com/articles/2012/09/24/fear_premium_roubini_bremmer?page=0,0

Fear Premium
An exclusive conversation with Nouriel Roubini and Ian Bremmer on the hidden economic risks as geopolitical tensions bubble over in the Middle East and China.

INTERVIEW BY BENJAMIN PAUKER

SEPTEMBER 24, 2012

With anti-American tensions simmering across the Middle East and anti-Japanese sentiment flaring across China, the European fiscal crisis all of a sudden seems like yesterday's problem. Not so fast, say Nouriel Roubini and Ian Bremmer, who argue that while the immediate disaster in Europe may have been averted, the fundamental problems haven't even been touched.

In this wide-ranging interview, Roubini and Bremmer see dark omens on the horizon: a "deteriorating" geopolitical environment, a potentially "dangerous" trade war with China if Mitt Romney were to win the U.S. presidency and label Beijing a currency manipulator, and a "fear premium" spiking international markets over what seems like inevitable conflict among the United States, Israel, and Iran.

Foreign Policy: Are we out of the woods in Europe yet?

Nouriel Roubini: The recession is still deep, and it's becoming deeper. The vulcanization of banks and of public debt markets is still ongoing, and therefore the economic side of the crisis is still with us. The positive is that now the Europeans realize that for a monetary unit to be viable, you need a banking union, a fiscal union, and an economic union to provide legitimacy for the transfer of power from national governments to the center. And they've finally put in play a coordinated bond program to provide support to struggling sovereign states. Those are positives, but the fundamental problems of the eurozone remain. The recession is deepening in the periphery, ascribing to the eurozone extreme difficulty in reaching agreements on these elements of a union. Take banking, or the first element of a banking union; if it is supervisory, there is still marked disagreement on how, when, and so on. So the challenges of restoring competitiveness, restoring external balance, restoring growth, are significant, and therefore I still see a very risky road ahead for the eurozone.

Ian Bremmer: George Soros, you probably saw it, came out and basically told [Angela] Merkel that the Germans basically have to support growth or they have to leave the eurozone. And of course, the reality is that Merkel is going to do neither, and that's precisely why Nouriel's downside for continued poor-growth recession, lack of competitiveness across the eurozone, is going to persist, because the desire to fix these long-term structural problems of eurozone governance comes part and parcel with very strong, long-term austerity, which is causing very significant problems across all these peripheral states. As a political scientist, I actually see an interesting problem emerging: I'm quite optimistic, as I have been for some time, that the eurozone stays in place and, ultimately, that governance gets stronger. But what's interesting is that as that occurs, you are weakening national institutions in Europe. And you're not just weakening from the top; you're not just taking sovereignty away from many of these governments in terms of banking regulation and in terms of budgetary authority and fiscal authority; you're also undermining them from below because as you continue with this crushing austerity, you're leading to a situation where every incumbent gets voted out and extremist parties start popping up across Europe who are just disgusted with their national authority. So as you work toward fixing the structural economic imbalances in Europe -- or should I say the structural governance problems -- you may start creating some unsustainable political conflict across the continent.

FP: Where's the leadership going to come from? There's no longer Nicolas Sarkozy in France, and Britain's David Cameron is not interested in playing any sort of a leadership role.

NR: Well, the problem with faith in the eurozone is, of course, that you have 17 countries, 17 governments, 17 coalitions, and sometimes they don't agree even within a coalition, like in Germany, within CDU, CSU, and Free Democrats. So any process that leads to more EU integration, whether banking, fiscal, economic, political, is going to be very challenging and take a long period of time. At the same time, as you suggested, the top leaders, who believe much more strongly in this European integration, are not there anymore. I mean, Angela Merkel comes from East Germany. We'll have to see the views of the French Socialists. Some of them are more pro-European; some of them, like the current foreign minister, Laurent Fabius, who was against the referendum in 2005 in France -- he voted no -- is a little more skeptical. And so, in other parts of the world -- and I spoke recently with [José María] Aznar, former prime minister of Spain, he believes that there shouldn't be a greater union, that Europe should remain a union of separate sovereign states, certainly not the federal system. So there are marked disagreements, and certainly there is no leadership.

IB: And that lack of leadership plays out internationally as well. Historically, the Brits were very interested in having an outsized international diplomacy role. Increasingly, you look at Cameron, you look at [Foreign Secretary William] Hague -- these are folks who really are focused on the economic side of Britain and trying to be part of the global growth story, but not trying to play a significant geopolitical leadership role. Under Sarkozy, France was much more interested in that. That's not true under [French President François] Hollande. Germany is overwhelmingly focused -- yes, they certainly are taking on a great deal of leadership in terms of the way we think about European institutions, but beyond that, if you want to talk from an extra-European position, outside of Europe, as Kissinger said, there's still no address.

FP: What about China? How worried should we be about the economic slowdown there?

NR: In China, there is an economic slowdown in capital spending, infrastructure spending, and in real estate. And the problem of China is to rebalance its growth away from net exports, away from high savings, away from fixed investments (which is now 50 percent of GDP) and facilitate reform that will increase consumption. My concern is that the new leadership is going to come out of China and is going to be a collective leadership with seven or nine members of the founding committee of the Politburo. Some of them are pro-market-oriented folks; some of them are more in favor of civil enterprises; some of them want to accelerate political reforms; but any progress they're going to make in the election of balance in the growth rate of China is going to be slow. It might end up being too late compared to what is desirable enough. And by the mid to late part of next year, a hard landing in China -- meaning growth at 5 percent or below -- becomes a more likely scenario.

FP: Do the Chinese just not realize that keeping Xi Jinping in a box for two weeks is an unsettling thing?

IB: No, they don't, and I think that they are piqued that they have to say anything. They do not feel accountable, certainly not to the New York Times or to the international journalistic community.

End of Part 1

 

[Edward Campbell]

Part 2 of 3

FP: And high officials have blown off Hillary Clinton as well.

IB: That's right. And you saw there were sources close to the leadership that said he had a minor back problem and that he'd be back. I accept that at face value -- or close to face value -- in the sense that if it had been something more serious, we would have seen folks close to Xi Jinping leaving the country and showing up at American consulates, things like that. I don't think there was a significant instability issue.

But the point is that the Chinese leadership has absolutely no desire or intention to provide any level of direct accountability or transparency to the people that they govern. Their perspective is, "Look, we're responsible for improving the social safety net; we showed you our five-year plan. However we do that is really not your issue. This is not a democracy." And the way they handled Xi Jinping shows that. But while it's not a democracy, it is increasingly an informationally empowered society. It's very hard to run a 21st-century economy with a population of 1.3 billion people with a 20th-century government, and the ability of the Chinese to do this is going to come under much greater pressure. And certainly I believe that the breadth of anti-Japanese demonstrations that you've seen across that country over the last couple weeks -- and the Chinese government clearly coordinated and stimulated a lot of them -- it's not coincidence that that comes right after Xi Jinping shows up. We're not going to talk about the "where was the president" issue; we'll talk about our level of distaste for what the Japanese are doing.

FP: It's the old bogeyman game that's worked so well.

IB: And it's interesting that it's focused on Japan. It could have been focused on a lot of things. Japan's an easy one for the Chinese, and the level of Japanese exposure to China is something that should really worry Tokyo at this point.

FP: Nouriel, how concerned are you about the anti-Japanese sentiment in China?

NR: Well, that depends on whether the shutdown of Japanese firms in China is going to be a matter of days or persist over time. The paradox of Japan is that by doing a large amount of foreign-backed investments in China, it is hostage to the fact that political tensions on the issue of the contested islands or whatever can cause a lot of economic damage to Japan. The leverage of Japan is significantly limited.

FP: Ian, in the wake of the recent protests across the Muslim world, are you concerned about the political risk to the United States?

IB: Well, the political risk to the U.S. isn't actually that high. I don't think that anything happening in the Middle East is going to have that dramatic an impact on U.S. elections, nor do I believe that the U.S. is planning to play nearly as significant of a role in the Middle East as it has historically. It's very interesting in terms of Israel. On the one hand, that means the ability of Israel to get the U.S. to set down red lines to stop the Iranians on the nuclear front is very, very constrained. And the Israelis are going to be upset about that, and they're going to bluster about it, and they're going to try and raise the perceived geopolitical risk so that people take it seriously.

On the other side, it's not all bad news for Israel. The willingness of the U.S. to press the Israelis on settlements in the West Bank is also going to decline, so you can play it both ways. But the real point here is what we've seen over the past weeks -- these massive anti-Western demonstrations across the region, the attack on the consulate in Benghazi. If you thought it was going to be hard to stop the Syrian war and remove Bashar al-Assad from power, it just got a lot harder. The U.S. is much less prepared now to countenance support for a relatively unknown Syrian opposition that includes many of the same sorts of Islamic militants that we see as sort of armed paramilitaries in Libya.

The willingness of the Russians or the Chinese to countenance more pressure on Syria has gone down significantly given what's happened over the past weeks. Bashar al-Assad, 18 months in and 20,000 deaths into the war that he's been prosecuting against his own people, actually looks a little more insulated from Western and international pressure than he did a week ago. And that's not just a problem for Syria; that's a problem in terms of the potential expansion of that war into proxy conflict between Sunni-Shiite powers in the region, the refugee crisis expanding into Turkey and Jordan and elsewhere, and the destabilization of Lebanon. This has significant implications, but perhaps fewer for the U.S. than anywhere else, and that's a particular problem given that it's the U.S. that has historically done most of the heavy lifting in this part of the world.

FP: Nouriel, how concerned are you by rising tensions over Iran's nuclear program?

NR: I'm not a geopolitical expert, and I don't know whether the likelihood of a military attack by Israel and/or the U.S. is high or not. Most likely, it's not going to happen before the election. But I would say that the only thing is by next year, sanctions are not going to credibly deter Iran from continuing its project to develop a bomb, and therefore, even short of a military confrontation, tensions are going to rise. Because Israel is going to eventually take action, and just the threat that there is going to eventually be war -- and that Israel, the U.S., and Iran are all going to be involved in it -- could lead to an increase in oil prices. It's already been happening in the last few weeks and months.

Given the slowdown in global economic growth, oil prices today should be 10 percent lower than they are right now. Why are they so high and rising? Because there is a fear premium, and in my view, next year that fear premium is going to be higher. If there is war, oil could go to $200 a barrel for awhile, and that can cause a global depression, but even if there is no war, and oil goes to $130 a barrel because there is a fear premium, that's going to be a negative for all oil-importing countries -- the U.S., Europe, Japan, China, India, and other advanced economies and emerging markets that are major oil importers. So it's a negative even short of an outside military confrontation in the Middle East to cause some damage to the oil market in negative ways for global growth.

End of Part 2

 

[Edward Campbell]

Part 3 of 3

FP: Do you buy Mitt Romney's statement that Russia really is our "No. 1 geopolitical foe"?

IB: That's very funny; you know, [Vladimir] Putin just kicked USAID [out of] Russia, so at the very least, it's going to cost U.S. taxpayers a little less. Maybe Romney will like him more now. I think that it was a little farcical that Romney called Russia the No. 1 geopolitical foe." It implies that he was looking back at the 1980s or the 1970s. But then again, when Obama was asked, he said that al Qaeda was our No. 1 geopolitical foe, and that means he's looking back 10 years.

The reality is that China is the country that we're most concerned about, but you don't want to mention China. It's like Voldemort, you know, on the international stage -- because they can hurt you, and the U.S. is very interdependent with China. So, they've been trying to manage the relationship, but if you look at U.S. foreign policy and you look at the Obama strategy, which has been this pivot toward Asia which includes engaging much more closely and directly with American allies across the region -- whether it's Vietnam or Indonesia, Japan or even Myanmar -- that's a strategy that has paid off quite well, for Hillary Clinton in particular. There's also been a focus on economic statecraft in this administration, which clearly is oriented over concern at the rise of Chinese state capitalism. But if you look at Romney, he's made a lot of statements about Russia, and he's picked on Obama for playing "nice-nice" with [Dmitry] Medvedev, but the reality is that Romney has said that on day one, if he comes into office, he's going to declare China a currency manipulator. Now, I don't believe he would actually do that. But if you take him at face value, I assure you that on day two of a Romney administration, Russia's not going to look like the No. 1 geopolitical foe of the United States.

FP: Nouriel, what would happen if Romney declared China a currency manipulator? Can you play that out, just a little bit?

NR: Well, there are two scenarios. One is that it starts the process that leads to negotiations between China and the United States regarding the trade imbalance; that the two sides, constructively -- in spite of the tension -- sit down and discuss it. But I don't think it would be a positive, and I wish that if Romney gets into power, he won't decide to brand China a manipulator. If he does, perhaps China wouldn't respond that aggressively. But there is a scenario in which both sides eventually escalate the tension, and Congress starts to think about taking preemptive action against China, given that they've been branded as manipulators, and then China could retaliate by imposing tariffs on a number of U.S. goods, and that could escalate, not into a full-scale trade war, but certainly into a trade war that becomes kind of dangerous. So that's the risk.

FP: Should we be worried about increasing protectionism?

IB: I think we should be worried about more fragmentation of the global marketplace -- and certainly that we're not going to be doing global trade agreements anymore. We'll do regional trade agreements, we'll do bilaterals, and that's less efficient for the global marketplace. I don't see a lot more protectionism coming from the United States, and the reason for that is because the legislative process in the U.S., Democrat and Republican, remains dominated by private-sector interest. I mean, back in 1974, 3 percent of congressmen that retired went into private-sector lobbies. Today, that's over 50 percent for the Senate, and it's over 40 percent for the House of Representatives. And that's true whether you're a Democrat or a Republican. And that overwhelmingly is a break on greater protectionism because that has to go through the same legislation. So people can talk a lot of red meat, but that's very different from actually putting it into practice.

FP: Nouriel, in the Mother Jones-leaked video of Romney, he claimed that global markets would welcome his victory. Do you buy this?

NR: Well, I would say that certainly a meaningful part of the business and financial community has been disappointed with Obama and would prefer a Romney victory, believing that -- rightly or wrongly -- Obama has not been as pro-business. So, yes, a Romney election might lead to a certain rally in the stock market. But the reality is that the problems of the United States require a bipartisanship response, because there is gridlock. And therefore, the fundamental problem of fixing the fiscal solvency of the U.S. cannot be addressed by one party alone. I'll give you an example. Say Romney is elected, and he says I want to cut $3 trillion [of] spending on Medicare and Social Security as a form of entitlement. Great, he's not going to have 60 votes in the Senate, and therefore Democrats are going to say, either you have to include $1 to $1.5 trillion worth of tax increases, especially for the rich or corporate environment, or we're going to block this. So in some sense, it doesn't really matter whether Romney is elected or President Obama is reelected. You need some modicum or some degree of bipartisanship in the United States to resolve the fundamental economic, fiscal, and financial issues that the U.S. is facing. So, even if there was a short-term stock market rally, unless he can essentially induce bipartisanship, that's going to fizzle out.

FP: Do you think the U.S. economy is really on the upswing?

IB: I mean, I'm generally an optimist on most things: I believe in American progress; I believe in humanity's progress. When you look at life expectancy, when you look at global health care, when you look at people coming out of poverty, all those sorts of things are good. And the U.S. drives more innovation and entrepreneurship and creates more new things that really matter, game-changers, than any other country in the world. And that's clearly long term very good for the market. I was looking at Apple's capitalization today -- it's higher than the capitalization of all corporations listed in Portugal, Ireland, Greece, and Spain combined, which says a lot. It really says something. But increasingly, that's being done leaving behind very large numbers of Americans. So you can tell me that even if the U.S. gets a deficit that looks more sustainable, even if the U.S. starts putting policies in place that are going to be very promising for foreign direct investment, if larger numbers of Americans are not participating in it long term, that will create more polarization in the system and will undermine the ultimate competiveness of the United States. So I do have a mixed view as a consequence of that.

FP: Nouriel, what are the unforeseen, destructive events that have not been priced into the markets right now?

NR: Well, I think that the risks to the global economy are several. One is that the eurozone crisis gets worse and becomes a train wreck. The second one is that the fiscal cliff becomes severe in the United States and you have a contraction. The third one is that you might have a hard landing in China, and the fourth one is the risk of conflict in the Middle East. I think that each one of them alone could trigger a global economic downturn because they're all systemically important, let alone if several of them were to occur at the same time in a virulent way. So, that's the risk we're facing. Of course, with each one of them, appropriate policy reactions may stem those risks -- for every problem, there is a solution -- but we'll see whether the policy response is going to be adequate, within countries and across countries, because a lot of them imply policy coordination, as in the case of the eurozone. Even without a global perfect storm of crises the next year could be quite bumpy for the global economy and for financial markets.

IB: I think the geopolitical environment is deteriorating. I think America is stable and will continue to look stable; Europe is going to be very disappointing from a growth perspective, but it's not going to fall apart. But the geopolitical environment is deteriorating. We see this particularly across the Middle East, and it's not going to improve. We'll see much more sectarian conflict and -- although I don't think anyone's going to attack Iran or stop them on the nuclear side -- the likelihood of growing interstate, not just intrastate, conflict within the Middle East is growing dramatically. And furthermore, the ability of countries to effectively balance between competing U.S. and Japanese opportunities in Asia is becoming more of a problem. It'll be true under Obama; it'll be true under Romney. We see that with China and Japan. Despite all the attention we've had on the Middle East over the course of the last weeks, the implications of dramatically deteriorating China-Japan relations -- the world's second- and third-largest economies -- are vastly greater for the global economy. We're going to see a lot more of that over the last year.

End of Part 3 of 3


Neither Bremmer nor Roubini is out of the mainstream, neither sees anything bright on the horizon. The Great Recession drags on and on and on and ...

 

[Edward Campbell]

To make matters worse, the Financial Times warns of the "Risk of a US-China trade war". There is scant hard evidence that Huawei engages in corporate espionage, on its own behalf or on behalf of the Chinese government - no more evidence, anyway, than exists on the same charges against say Alcatel (France) or Motorola (USA) - but that has not stopped the US Congress from imposing serious sanctions against it. The US has also imposed punitive tariffs against a Chinese solar panel maker. In both cases some commentators  (e.g. Michael Hlinka on CBC Radio) suggest that this has much, much more to do with US elections than with anything the Chinese companies may have done (probably did to, to be fair). So, in all likelihood, it's business a usual in a US election year, BUT there is also a change of government underway in China and there is a real possibility that signals can be misunderstood with serious consequences for the global economy if China decides to retaliate, in kind, against the USA.

The Financial Times says, "Whatever the merits of the case, the risks of a trade war must be contained." Amen.

 

[Edward Campbell]

Economics professor Danny Quah offers a suggestion for restoring balanced growth to the global economy in this article which is reproduced under the Fair Dealing provisions of the Copyright Act from global policy:

http://www.globalpolicyjournal.com/blog/11/10/2012/small-proposal-rebalance-global-economy-just-let-china-grow

A Small Proposal to Rebalance the Global Economy: Just let China Grow

Danny Quah

11th October 2012

Many take as fact that the current pattern of global imbalances — large and persistent trade deficits and surpluses across different parts of the world, eventually unsustainable — is due to China and the rest of East Asia consuming too little and saving too much. Since the global economy is a closed trading system, trade deficits and surpluses across all national economies must sum exactly to zero always. Therefore, that one part of the world saves too much and thereby runs trade surpluses means other parts of the world — notably the US — must be running trade deficits.

However, just because deficits and surpluses are tightly inter-connected does not mean that trade surpluses in China, say, have been responsible for US trade deficits: absent further information, causality could well have flowed in the opposite direction. Moreover, China’s high savings might be dynamically welfare-optimizing for its citizens — for instance, private enterprise in China might find self-accumulation the only way to generate investment funds — and, at the same time, only minimally if at all welfare-reducing for already-rich US citizens. Finally, it might be that global imbalances should best be viewed not as a bilateral (US-China) problem but instead a multi-lateral one.

Be all that as it may, many US policy-makers focusing on US trade deficits and China’s trade surpluses urge policy actions against China to rebalance the global economy. Those policy actions include punitive tariffs against Chinese imports and tagging China a currency-manipulator — and thus moving it yet further from official free-market status. Some observers remark that without such external pressure, China will find it domestically too difficult to shift away from its reliance on export promotion, infrastructure investment, and restrained consumption towards a more balanced growth path (e.g., Michael Pettis, Nouriel Roubini, Martin Wolf).

The problem: To raise China’s domestic aggregate demand, especially consumption. The difficulty: China’s consumption cannot increase quickly enough to compensate for the shortfall in aggregate demand should both investment and exports decline. The danger: a hard landing for China and the global economy.

I want to suggest that such a re-direction need not be that difficult. My proposal: Let China grow rich as quickly as possible. Why might this do the trick?

First, consumption within China is already rising faster than both income and investment, provided that we look at those parts of China where incomes per head exceed US$8,800 (Figures 1 and 2). Of course, China’s current per capita income overall now is only US$2200, less than 6% that of the US. What this suggests, however, is as China’s income grows, its overall savings rate will naturally fall. The right policy is to encourage growth, not adopt punitive actions that might retard that growth.

Figure 1

(I took Figures 1-3 from a term paper that Daisy Wang wrote for my course Ec204 The Global Economy at the LSE-PKU Summer School, August 2011. The underlying data are from China’s National Bureau of Statistics.)

Second, as John Ross reminds us, investment too is aggregate demand. But, third, continuing to increase China’s investment in, among other things, infrastructure and transportation can help further as it allows those western, poorer regions in China (again Figure 2) better to integrate both nationally and globally, and thus become richer through raising demand and productivity.

Figure 2

While many observers make much of China’s high investment to income ratio, it is useful to note that that ratio is high not just because its numerator is being driven up, but also because the denominator remains so low. The right state variable for dynamic analysis in a neoclassical growth model is capital per head, not capital per unit of income. And here (Figure 3):

Figure 3

we see how China still has a long way to go on the upside.

Finally, Figure 4:

(“The Chinese led the way in the rush to the Boxing Day sales, flocking to department stores to grab designer goods”, The Times of London, 27 December 2011)

However much anyone might doubt those China statistics I used above, auxiliary evidence shows that rich Chinese consumers have no difficulty increasing consumption.

The evidence I’ve described doesn’t of course say that global imbalances can be easily erased through just more economic growth in China. However, the algebraic signs of the required relations seem to me to point at least in the right direction. Careful work to quantify these effects might end up showing that their magnitudes aren’t large enough. But, as far as I know, that calibration has not been done, which makes me wonder why some observers can be so certain that China’s current growth trajectory can only exacerbate global imbalances.

When China becomes rich, that will also dramatically lower inequality in the world — globally, the difference in incomes per head across nations overwhelms that across individuals within a single country. No one I know arguing for a more egalitarian society also says that that push for equality should stop at their nation’s borders and be kept from applying seamlessly across humanity’s 7 billion.

We too often forget that our collective goal is to move from this:

Toronto home, 14 August 1913 (courtesy City of Toronto Archives/SC 244-134).

To this:

A 21st century home on Toronto's Bridle Path

China is in the process of doing that - the shift is by no means complete, to be Churchillian, it is the end of the beginning for China, not the beginning of the end. There is still a lot, too much, of this:

Most of China, now

The next, vital, step up is this:

Some of China, now

But China will not be ready to save more than it consumes until pretty much everyone has this:

Where China needs to be

I have travelled a fair bit in China, including well away from the prosperous, sophisticated East Coast, and I can assure you that there is a lot of productive consumption, probably a full generation's worth of it, before China gets from even Some of China, now to Where China needs to be. Thus I think Prof Quah is on the right track and President Obama and Governor Romney, both of whom say they want to restrain China's growth, are wrong.

 

[GAP]

Oh....they want China to follow the pattern of the West's economics and price themselves out of the market.

Would it not then be Indonesia's turn, then xxxx, then xxxx?

What happens when all these grown economies are all grown up to consume and wither on he vine, production wise?

 

[Edward Campbell]

Oh....they want China to follow the pattern of the West's economics and price themselves out of the market. Yes

Would it not then be Indonesia's turn, then Philippines, then Nigeria? Yes

What happens when all these grown economies are all grown up to consume and wither on he vine, production wise? Russia, which will have declined to Third World status, along with Greece, Spain and Italy, will begin the looooong, loooooooong and painful rise back to prosperity. Don't forget that 500 years ago China accounted for more than 25% of the global GDP, then it sunk to near zero and now it is the second largest economy in the world; in the same 500 years Britain rose from lower middle rank to the very top and has, now, declined back to the middle again. It's all cyclical.

 

[GAP]

Oh....I love cycling clubs.....uh...not the same thing huh?  bummer  ;D

 

[kevincanada]

So much talk about the USA economy, yet no one has even looked at the USA economy numbers.  All these news articles of tax this, do that even the postings on here....  I had look at the Federal reserve balance sheets.  Aside for the obvious cracks in the the system bailouts and such,  looking at the numbers and it hits you in the face why the usa recovery is so slow.

When you take the rises in government spending, lowered income, and the Federal reserve easing up on credit,  subtract out the increase of liquid personal holdings, repayment of debt and increase of corporate holdings.  The numbers balance out.

The trillions of dollars spent over the last 4 years in this recession, has virtually all gone into people holdings and debt payments on those credit cards and mortgages.  All other stuff aside, it explains why it is so sluggish.

Don't believe the media and their tax system reports... Taxes just keep the money flowing is all.

 

[a_majoor]

While repaying debt is virtuous, the real reason the recovery is slow or nonexistent has far more to do with the money being parked in various safe spots or offshore, rather than being invested in wealth creation. (Note politicians use the term "investment" differently from the rest of us; government spending on roads and sewers is "investment"; government spending on hockey arenas is not). Apple Corp is thought to be sitting on an offshore dragon's horde of @ $35 billion dollars alone.

The "Capital Strike" of 1937-38 is perhaps the most recent and clear cut example of what is really happening; business in the United States simply refused to make any investments during the capital strike due to the chaos and uncertainty created by the "New Deal", plunging the United States into the deepest part of the Great Depression since it had started in 1929. The current economy is hamstrung for similar reasons, as business is unwilling to invest in new projects due to uncertainty caused by uncertainty due to the unknown impacts of Obamacare, potential tax code revisions, political demagoguery and the potential to face competition from taxpayer funded crony capitalists. They will know one way or another on election day.

 

[kevincanada]

Yes this is true.  The Politicians and central banks in America and Canada as well have done their job and made the money available.  The issue is as you say is the faith side of the value of money.  It's public faith that you will wake up tomorrow go to work and have a paycheck that allows you to spend money.  When this faith is in a state of hardship as it is now, it has a real and negative impact on the quality of living for everyone in the form of finances.

The election is dire for improvement, as is Europe is dire for improvement.  Even some good news that we have a real solution in order even if it takes a decade to implement.  Simply something worthwhile coming out of Europe would have a positive affect for America and the whole world.  They really are dragging everyone behind in Europe, both directly in raw production and indirectly being the faith/political spectrum.

 

[Edward Campbell]

Some news from the IEA, reproduced under the Fair Dealing provisions of the Copyright Act from the IEA Press Release site:

My emphasis added
http://www.iea.org/newsroomandevents/pressreleases/2012/october/name,32158,en.html

Global map of oil refining and trade to be redrawn over next 5 years, IEA report says

12 October 2012

Profound shifts in the regional distribution of oil demand and supply growth will redefine the refining industry and transform global oil trade over the next five years, the International Energy Agency (IEA) says in its annual Medium-Term Oil Market Report (MTOMR) released today. The IEA expects the global oil market to become somewhat less tight over the medium term than it has been through most of the last decade, as a combination of demand and supply factors will cause OPEC spare capacity to return to more comfortable levels. But it also highlights elevated supply and demand risks.

The MTOMR is the last in a series of medium-term forecasts that the IEA devotes to each of the four main primary energy sources: oil, gas, coal and renewable energy. A companion to the IEA’s authoritative monthly Oil Market Report, the MTOMR offers a bridge between that monthly snapshot of market conditions and the oil section of the annual World Energy Outlook, which has a longer-term focus.

“The oil market is at a crossroads,” said IEA Executive Director Maria van der Hoeven. “On each and every front – technology, geopolitics, the economy – potentially game-changing developments are taking place. This report is an attempt to bring it all together and sketch out what it might all mean for the next five years. It is thought-provoking and while it cannot possibly anticipate everything the next five years have in store, we hope it will help the reader think through the issues and gain a more refined understanding of the broader context in which tomorrow’s surprises will play out.”

The report’s projection of a return to higher OPEC spare production capacity will be welcome news amid rising supply and demand risks, she added. 

Today’s weak economic environment has reduced expectations of oil demand growth for the medium term, yet the reallocation of demand by region and key product, which has been underway for the last 15 to 20 years, is expected to continue. Demand from non-OECD economies is forecast to overtake that in the OECD as early as 2014.  The “East of Suez” region will account for most of the growth, led by Asia, the Former Soviet Union and the Middle East. Distillate demand is also expected to growth much faster than that for other products, so that gasoil and diesel by the end of the forecast period will account for the largest share by far of the demand barrel – a challenge for refiners and end-users alike.

On the supply side, most of the growth will come from the Americas, buoyed by the transformative power of advanced extractive technologies applied to light, tight oil deposits in the US and the Canadian oil sands that has exceeded earlier expectations. Among OPEC producers, Iraq stands out as its production capacity is expected to enter a new growth phase, which may continue even beyond the forecast period. These new supply sources are expected to more than offset decline rates and outages elsewhere as well as the continued impact of international sanctions of Iran.

The report also notes a continued rebalancing of refining capacity, with expansions in Asia and the Middle East more than offsetting continued attrition in the OECD. Internationally traded crude volumes are expected to decline sharply, as rising domestic production reduces North America’s import needs and more Middle East oil is kept at home to satisfy growing regional demand rather than exported. Product trade may grow in both volume and scope, however.   

The report also reviews regulatory changes that will come into play in financial oil markets and surveys the most recent academic literature on oil price formation, including the relationship between oil prices and interest rates, other commodity markets and macro-economic measures such as quantitative easing. 

The Medium Term Oil Market Report is for sale at the IEA bookshop. Accredited journalists who would like more information or who wish to receive a complimentary copy should contact ieapressoffice@iea.org.

_____________
About the IEA

The International Energy Agency is an autonomous organisation which works to ensure reliable, affordable and clean energy for its 28 member countries and beyond. Founded in response to the 1973/4 oil crisis, the IEA’s initial role was to help countries co-ordinate a collective response to major disruptions in oil supply through the release of emergency oil stocks to the markets. While this continues to be a key aspect of its work, the IEA has evolved and expanded. It is at the heart of global dialogue on energy, providing reliable and unbiased research, statistics, analysis and recommendations.

The changes in refining capacity represent the changes in gasoline demand, for automobiles, which is, ever so slightly, falling in North America even as it is, rapidly, growing in East and South Asia.

 

[Edward Campbell]

Interesting and illustrative economic factoid: Heard at 2nd Annual China Consumption Conference in Hong Kong - sales of adult diapers will outsell those for babies in Japan this year!

More

than

is not an enviable economic position.

 

[Edward Campbell]

I'm not sure what this report, reproduced under the Fair Dealing provisions of the Copyright Act from the Sunday Straits Times, means, exactly:

http://www.straitstimes.com/breaking-news/money/story/hk-defends-currency-peg-first-time-2009-20121021

HK defends currency peg for first time since 2009

Published on Oct 21, 2012

HONG KONG - Hong Kong's de facto central bank stepped in for the first time since 2009 to prevent the city's currency from rising against the US dollar, after it touched the upper limit of a range that triggers an intervention, Bloomberg reported on Sunday.

The Hong Kong Monetary Authority (HKMA) said it bought US$603 million (S$736 million) at HK$7.75 per dollar, which is the so-called strong side of the permitted convertibility range of HK$7.75 to HK$7.85 that obligates intervention.

The move, announced in an e-mailed statement on Saturday, was confirmed by spokesman Rhonda Lam who said the HKMA acted during New York trading hours.

"Funds continue to flow into Hong Kong given the monetary easing in the US and Europe," said currency analyst Kenix Lai at Bank of East Asia in Hong Kong. "That's evident by the rising stock market and property prices. I expect HKMA will still have to intervene in the near term as capital inflows continue."

My guess: QE (quantitative easing) really means that Ben Bernanke is printing more and more and more money with nothing new happening in the US economy to give it any real value. Thus the US dollar is 'devaluating' itself against e.g. the HK (and Canadian) dollar and this poses a threat to price stability in HK as the US money leaves America in search of real value elsewhere - e.g. HK real estate. In other words "bad" money flows in and drives out "good" money, if you like Gresham.