The Egyptian Revolt Goes Back to its Roots -- in the Soil

Feb 8, 2011Jon Rynn

egypt-flag-wall-150A change in agriculture, industry and employment must accompany a change in government.

egypt-flag-wall-150A change in agriculture, industry and employment must accompany a change in government.

Egypt, which was once the breadbasket for the Roman Empire, is now one of a growing number of food basket cases. A thriving center of trade and industry centuries ago, it is now marked by unemployment and dependence on tourism. Instead of dealing with these mounting problems, the Mubarak regime has swept everything under the rug and skimmed billions from the country. No wonder the population is in revolt.

Egypt has always been dependent on the Nile river, which was the foundation of what may have been humanity’s most ecologically sustainable agricultural system. In dry regions like Egypt and the Middle East, and even in areas with inadequate rainfall like much of the American West and northern China, irrigation is required to produce a large crop, normally of grains like wheat or rice. The problem, which is becoming more and more ominous, is that irrigation can destroy the soil and water on which agriculture depends. Too much water for too long a period in the wrong kind of soil, and the soil becomes salty, which doomed another ancient center of Middle Eastern civilization: the Sumerians. Or the water for irrigation might use up ancient reservoirs of water called fossil aquifers. This depletion is threatening food production from the American plains to India to China.

The Nile, on the other hand, always flooded the Nile valley annually, thus depositing nutrients and water at just the right time to grow plants but receding at just the right time to prevent too much salt from accumulating. It did this, that is, until the Aswan Dam was built in the 1960s, which prevents the Nile from flooding. The benefit is that the flow of water is dependable, because the Nile would often over-flood or under-irrigate, and the Dam can be used for electrical generation. The problem is that many areas are now becoming salty, the nutrients, or silt, are building up behind the Dam, and now Egypt is dependent on fossil fuel-based fertilizers for its agriculture.

Even with the Dam, Egypt has become the world’s biggest importer of grain, requiring foreign grain for 40% of its needs. Since it doesn’t have much industry, it has to trade tourism and some fossil fuels for this grain, and as a result, even university graduates have a 30 percent unemployment rate and only 3 percent of the population consumes 50 percent of goods. Meanwhile, instead of creating an industrial base that could be used to produce the goods to trade for food, the current regime either takes the money itself or spends it on useless military equipment (although much of that money comes from the US, but that’s another story). Egypt therefore has become dependent on the global economic system for its survival; it needs the food, industrial goods and fossil fuels from the global system, but it has very little to give back. This is one reason that 3 million Egyptians work outside the country, sending back badly needed money to families at home.

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It is quite possible that if the Aswan Dam was actually torn down and a different water storage and drainage system was constructed, and if Egypt took advantage of the massive amount of sunlight that falls on the deserts near the Nile to generate its electricity from solar power, it could create a sustainable economy. It would have to do all of this, just to add another wrinkle, while it created a sustainable plan for the use of the Nile’s waters.

At least 80 percent of the water that reaches Egypt actually comes from Ethiopia, where most of the Nile originates, and most of the rest comes from Sudan. There has been a long and varied history of tension among these nations concerning the use of the Nile’s rivers, as told by Steven Solomon in his book “Water: The Epic Struggle for Wealth, Power, and Civilization”. So an ecological solution to Egypt’s problems requires coordination with its neighbors to the south. On the other hand, if it is to industrialize it would probably be greatly aided if it partnered with Israel and with other Middle Eastern nations, all of which have similar problems. Together, they could all create a Middle Eastern common market, to use a term from the European Union’s past. This idea of an integrated, industrializing Middle East was the vision of Yitzhak Rabin, the Prime Minister of Israel who was cut down by a fundamentalist Israeli.

I don’t think that the current regime can pull off this balancing act. Mubarak’s choice for vice president, Omar Suleiman, has been directing the notorious “rendition” program whereby people that the United States wants to torture are “taken care of." This policy led to the false information that provided the “proof” of an Al Qaeda-Iraq connection; as James Ridgeway explains, “our loyal ally Egypt provided the fake information used by the United States to justify going to war in Iraq." The regime is so accustomed to using force and violence as a means of governing that it hatched the plot that fizzled to have “pro-Mubarak supporters” literally beat the protesters out of Tahrir square. As the New York Times explained, “Hosni Mubarak’s Egypt has long functioned as a state where wealth bought political power and political power bought great wealth." A regime based on corruption and violence cannot pull off the feats of industrializing, spreading the wealth, working with its neighbors, and most importantly, insuring that its unique ecosystems survive. It will require a regime that has real legitimacy, one that is elected democratically.

Egypt is not the only country facing the problem of an ecologically unsustainable path, the need for industrialization, the replacing of fossil fuels, and in many cases, the need for democratization. As Lester Brown has pointed out recently, there is a global food crisis emerging. It is being driven by the abuse of agricultural ecosystems and water; by using grain for ethanol and for livestock; by the inefficient use of water; and oh yes, by climate change. Let us hope that Egypt's example will not only spur change in the Middle East but create change around the entire planet.

Jon Rynn is the author of Manufacturing Green Prosperity: The power to rebuild the American middle class, available from Praeger Press. He holds a Ph.D. in political science from the City University of New York.

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Memo to Obama: Anything but Democracy Now for Egypt is Building on Sand

Feb 7, 2011Tom Ferguson

Food and oil prices are rising as tension in Cairo is soaring -- time to get on board with the people's demands.

Food and oil prices are rising as tension in Cairo is soaring -- time to get on board with the people's demands.

Add Barack Obama to the long list of statesmen who couldn't solve the Riddle of the Sphinx. For a while last week it looked like a miracle was happening: The United States was on the verge of doing right and doing well at the same time. After stumbling initially, the administration openly warned the Egyptian army and government not to slaughter the protesters. It also started lining up behind the Egyptian people's demands for a swift transition to a new, more democratic regime. Neo-con lions like Robert Kagan and Elliott Abrams bedded down with liberal internationalist lambs in a "Working Group on Egypt" that called for reforms and Mubarak's exit, while John McCain and other Republicans offered bipartisan cover for Real Change in the world's oldest civilization.

But by Saturday, February 5, the wheels started coming off. With oil prices threatening the anemic global recovery and commodity prices soaring, the President dialed up leaders of the Persian Gulf states for whom the aging Egyptian leader is Mummy Dearest. As the world watched in astonishment, Frank Wisner, a veteran US diplomat who now works with a major Washington law firm that represents major Egyptian business and government interests, calmly advised the Munich Security Conference that Mubarak should stay on for a while. The hapless State Department responded by being against it before the White House and other NATO leaders all came out for it.

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Now with the whole world watching, Mubarak's American (and Soviet -- the Cold War is truly over) trained intelligence chief now presides over the "democratic transition" as Mubarak holds on.

It's always dangerous if you lose your compass amid the desert sands. But for the White House to lose its moral compass now is potentially catastrophic. The President is already bent on one Mission Impossible in Afghanistan, a land that Alexander the Great couldn't conquer. Now he's trying again in a place that Napoleon couldn't hold.

A foreign exchange crisis lies immediately ahead, as food prices keep rising. If the security police or the army turns Cairo's streets and squares into the Valley of the Dead, the harm to both Egypt and U.S. interests will be incalculable. In the longer run, the confidence the US reposes in the army as a force for stability may also be misplaced. Vertical and horizontal tensions run deep within a fighting force that is now big business. Better supplement it while you can with a free press, an independent judiciary, a real parliament and an end to repression. In a word: democracy.

Thomas Ferguson is Senior Fellow at the Roosevelt Institute and Professor of Political Science at the University of Massachusetts, Boston. He is the author of many books and articles, including Golden Rule: The Investment Theory of Party Competition and the Logic of Money-Driven Political Systems.

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Investment is a Win-Win for the Global Economy and Climate Change

Jan 28, 2011Jon Rynn

earth-150Following Keynes, Joseph Stiglitz proposes solutions that would heal the economy and the environment in one fell swoop.

earth-150Following Keynes, Joseph Stiglitz proposes solutions that would heal the economy and the environment in one fell swoop.

Recently Joseph Stiglitz, the Nobel-prize-winning economist and Senior Fellow and Chief Economist at the Roosevelt Institute, gave a very interesting speech in South Africa concerning climate change and the global economy. He argued that by implementing policies that help to reverse global warming, we can also reverse the global economic downturn. Although he also pointed out many barriers to doing so, he outlined some interesting policy proposals.

For me, the most interesting part of his speech concerned the use of a Keynesian approach, not just for a single country, as is usually done, but for the entire world economy. Keynes pointed out that when the private sector is unable to generate enough demand in the economy, that is, it is unable generate enough spending from consumption and investment, then the government must step in to kickstart spending. Thus in recessions and depressions many now acknowledge that at some point it may be necessary for the government to spend more than it takes in to get the economy moving again. (See numerous articles from Marshall Auerback on this basic idea.)

There are a couple of fine points to what Keynes was saying, however, that are either often glossed over or challenged. First, he asserted that when demand is low, saving can get in the way of recovery. So -- and this is the part that is ignored -- since the rich save more than the poor, their excess income gets in the way of recovery. The horrendous implication, from the rich person’s point of view, is that they should be taxed more. The less direct way to put this, which is the way it is discussed even in much of the progressive media, is that an “unequal distribution of wealth” leads to negative economic outcomes. The important statistic for the US is that while in 1970 the top 1% of households pulled in about 10% of total income, now they receive close to 25%. Not good, from a purely Keynesian perspective.

So what does this have to do with climate change? Since he was speaking in South Africa, it was easy for him to point out that the world distribution of wealth is very unequal. Because of this inequality, it will be much harder for developing countries to create less carbon-intensive economies through large-scale investment than for developed countries. In addition, the poorer countries consume more and the richer countries save more. So an obvious policy approach is to tax financial transactions, which moves money from something that (to be charitable) involves savings into consumption and investment by developing countries. The richer countries could also simply give grants to the poorer countries. Stiglitz claimed that about $200 billion per year would be required to help developing countries make the transition to a less carbon-intensive future, which could be financed from a financial tax.

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The second implication of Keynes’ ideas is that the economy needs more investment when it is in a downturn. We certainly need a good deal of investment to create less carbon-intensive economies, and it so happens that, according to Keynes, investment, particularly in factories, is the best way to pull economies out of slumps. While he famously suggested that digging holes and filling them up again would also do the trick, he clearly preferred doing something useful with investments on the grounds that investment is generally good for a society and that it is a surer way to speed recovery than consumption.

Stiglitz argued that what we have now is an inadequate level of global aggregate demand, which is to say, there isn’t enough consumption and investment for the entire global economy to pull out of the recession. Thus, he stressed, reversing climate change is an opportunity for the economy, not a drag. We need investment for the good of the climate and we need investment for the good of the economy -- therefore what we have is a win-win situation.

But how do we encourage investment? Stiglitz’s answer is to put a price on the emission of carbon, thus stimulating investment into less carbon-intensive technologies. He thinks that eventually carbon will be priced at 80 dollars per ton, which means that it will probably be cheaper to build a wind farm than to build a coal plant. In fact, it might become more economically rational, with a price on carbon, to shut down an existing coal plant and build a new wind farm to replace it. And new wind farms mean new investment, which means increasing global aggregate demand, which means pulling out of the global recession.

Of course, there are roadblocks in the way of this process. For one thing, there is the power of the greatest emitters of carbon, the oil and coal industries, among others. Then there is the expense that a price on carbon would mean for poorer countries -- thus the need for the richer part of the world to subsidize the poorer part. Even rich countries, of course, would not take easily to a price for carbon, as we saw in last year's defeat of lukewarm cap-and-trade legislation. Stiglitz argues that for an international treaty to be effective, it needs to have enforceable sanctions, such as hitting the offending nation's exports with a price increase. But as the managing editor of South Africa’s largest newspaper argued in a generally favorable response to Stiglitz’s lecture, trade sanctions would mean that developing countries would be hurt, thus requiring some more subsidies in order to equalize the playing field.

In all, I think Stiglitz laid out the foundation of a very workable global economic strategy. I would propose another element: encouraging direct investment and construction of infrastructure on the part of governments. While Stiglitz mentioned the idea of regulation and praised mass transit as an adjunct to the general policy of pricing carbon, it was not a focus of his approach. But here is another possibility for a win-win -- if developed countries sold or gave factories to the developing countries to create the wind turbines, electric rail and cars, and solar plants that would allow them to reduce carbon emissions, it would give the developed countries a huge boost economically and the developing countries the capability to become much wealthier in a sustainable way. Think of it as a global Marshall Plan or Works Progress Administration. The developed countries could promise, say, one trillion dollars per year in machinery to the developing countries, which would be a strategic, targeted, Keynesian method for pulling the entire world economy out of its slump. And it would go far to meet what Stiglitz called the greatest challenge we have ever faced: the threat of global climate change.

Jon Rynn is the author of Manufacturing Green Prosperity: The power to rebuild the American middle class, available from Praeger Press. He holds a Ph.D. in political science from the City University of New York.

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SOTU: The Dollar Gap between Rhetoric and Reality

Jan 26, 2011Marshall Auerback

The good, the bad, and the paradoxical in the President's speech.

In his State of the Union address Obama offered a corporate tax cut, a retooling of the tax code and an end to pet spending projects. All good. The tax code has long been used as a political plaything by Washington's mounting corps of lobbyists and special interests, so it will be interesting to see how much resistance the President will encounter if he is serious about ending this insidious form of corporate welfare.

The good, the bad, and the paradoxical in the President's speech.

In his State of the Union address Obama offered a corporate tax cut, a retooling of the tax code and an end to pet spending projects. All good. The tax code has long been used as a political plaything by Washington's mounting corps of lobbyists and special interests, so it will be interesting to see how much resistance the President will encounter if he is serious about ending this insidious form of corporate welfare.

Mr. Obama displayed his usual rhetorical flourishes, outlining what he called "a Sputnik moment" -- a blueprint for spending in critical areas like education, high-speed rail, clean-energy technology and high-speed Internet to help the United States weather the impact of globalization and the challenge from emerging powers like China and India. "We need to out-innovate, outeducate and outbuild the rest of the world," he said.

All true, but these types of things cost money, which at one level the President seems to recognize: "Countries in Europe and Russia invest more in their roads and railways than we do. China is building faster trains and newer airports." He noted at another point that the world's biggest private solar research facility and fastest supercomputer were now in China.

Which suggests that a token $50 billion allocation here and there won't do the trick: Consider the solar industry, which represents a perfect microcosm of the challenges the US now faces in regard to China. Beijing's command economy policy makers are piling subsidy on top of subsidy to make China's domestic market and domestic production the largest in the world. Its state-controlled banking system under government directive is financing capacity equal to a multiple of world demand on lending terms that make no sense for an industry with this much competition and flux.

The Chinese solar industry has been able to drive down solar product prices to levels that are too competitive for the most automated U.S. producers using the most advanced technology. As a result, the U.S. solar industry, including Evergreen, upon which President Obama has placed such high hopes, is departing the U.S. for facilities elsewhere, including facilities joint ventured with favored Chinese companies.

This encroachment by the Chinese into the global market for solar products is not occurring because China has especially low labor costs. It is not occurring because China has more advanced technology. It is occurring because China's command economy can force fixed investment in priority industries through a broad array of non-market means.

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Owing to depletion of China's well of underutilized rural labor, wage costs in China are now soaring. Firms like Foxconn are looking to move their production platforms to lower wage economies. As a result, China is shifting its mega fixed investment more and more into higher tech industries, including capital goods industries.

Armed with massive arrays of subsidies and a willingness to build unprofitable companies in order to reach the technological frontier and global market dominance, China is now entering a new phase in which its mercantilism threatens the last bastion of U.S. manufacturing expertise.

Chinese objectives are as much geopolitical as they are economic.

For the U.S., today's casualty is Evergreen Solar; tomorrow's may well be Boeing. That's the scale of the challenge we now face. Yet the impressive SOTU rhetoric was undercut by the proposed 5 year freeze in non-security discretionary spending which the President said would save the economy, $400 billion from budget deficits over a decade.

It's useful to take any promise of government "saving" with a huge grain of salt. After all, most fiscal expenditures these days are largely non-discretionary and one can hardly predict with any degree of accuracy the "savings" that will accrue. This is because the ultimate government deficit after the spending freeze will reflect the interaction within the economy of the three major sectors: the domestic private sector (including households and businesses), the government sector, and the foreign sector. So unless some other sector is willing to reduce its net or increase its deficit spending (which means the private sector reducing its cash balances and taking on more private debt), then the mere attempt by the government to net save could well reduce overall levels of economic activity and offset the attempted savings brought about via the freeze proposed by Mr. Obama.

Fortunately, the President has decided not to embrace the British government's vicious assault on entitlements thus far. The SOTU gave no indication that the any future spending cuts would apply to the programs such as Social Security and Medicare. In fact, Mr. Obama appeared to reject further cuts, saying, "Let's make sure what we're cutting is really excess weight."

The best way to remove "government excess weight" is to have a growing economy. Full employment means we can enjoy the benefits of globalization; unemployment gives us another reason to fear overseas competition. "Bloated government" is not a significant problem when you have full employment. Just as surpluses precede recessions, large deficits can almost always be expected to result from recessions because of the automatic stabilizers that are in place. That is, budget deficits in the U.S. are largely automatic and non-discretionary: when the economy slides into a recession, tax revenues start falling as economic activity declines. Social transfer payments, particularly unemployment benefits, on the other hand, increase, again automatically, as more people lose their jobs. So recessions create budget deficits. Despite all the conservative uproar against Obama's stimulus plan, the largest portion of the increase in the deficit has come from automatic stabilizers and not from discretionary spending, which also means that his grand trumpeting of a freeze on the non-discretionary parts of the budget is more show than dough.

Finally, I to say something about the President's aspiration to turn the U.S. into "an export superpower." It is becoming clear that not all countries can rely on exports to boost growth and employment; more than ever, they need to give greater attention to strengthening domestic demand. Competition in export markets often leads to domestic policy to keep wages and other costs low -- both to fight the domestic inflation pressures (fueled in part by the processes just outlined) but, more importantly, to compete with other low wage developing nations.

The typical outcome of these dynamics is that the domestic population does not share in the economic growth that is generated by exports. Poverty and social unrest often worsens even as the economy grows. Is this really what the President wants? How has being an "export superpower" worked out for Japan the last 20 years?

The ultimate paradox facing the President -- and the country as a whole -- is that while innovation, education and infrastructure are necessary ingredients for global competitive success, they offer no guarantee. But it is certainly the case that absent the fiscal resources deployed to confront the challenges outlined by the President (rather than continuing to shovel subsidies to zombie financial institutions), failure is certainly guaranteed.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Lesson From Europe: Fiscal Austerity Kills Economies

Jan 25, 2011Marshall Auerback

Following faux-reasonable Rubinite advice will only put Americans further into debt.

There's more evidence that fiscal austerity should never be a government policy objective. The UK has just released its 4th quarter GDP numbers and the results are predictably grim: a -0.5% decline in GDP for the last three months of 2010, versus a market expectation of +0.4%.

Following faux-reasonable Rubinite advice will only put Americans further into debt.

There's more evidence that fiscal austerity should never be a government policy objective. The UK has just released its 4th quarter GDP numbers and the results are predictably grim: a -0.5% decline in GDP for the last three months of 2010, versus a market expectation of +0.4%.

This comes as no shock to anybody who understands basic sectoral flows. Taking income out of the private sector in the absence of any countervailing flows from the government or external sector means lower output, slower growth and higher unemployment. The UK economy's performance is totally consistent with this analysis.

Yet the FT is flooded with articles from the likes of Roger Altman and Robert Rubin. Why let evidence get in the way of a good neo-liberal theory? Neither Altman nor Rubin understand that it would be ruinous for this country if the federal government took their advice and pursued budget surpluses at a time when the external sector is in deficit and the private domestic sector needs to save to reduce its damaging debt levels. They, like virtually all mainstream economists/policy makers, haven't taken the time to understand the sectoral balances. If they had, they would know that they are pursuing a strategy that would force the private sector into further debt. That's precisely what's happening in the UK.

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Mainstream economic theory (which Rubin embodies totally) claims that when private spending is weak, it is because we are scared of the future tax implications of rising budget deficits. This is Ricardian nonsense. As Bill Mitchell has repeatedly noted, "the overwhelming evidence shows that firms will not invest while consumption is weak and households will not spend because they are scared of becoming unemployed and are trying to reduce their bloated debt levels."

We already have overwhelming empirical evidence in the European Monetary Union -- Ireland's government has collapsed as a result of its ongoing embrace of misconceived austerity and the economic crisis has morphed into a fully fledged political and social crisis. But now we also have the UK, which is some six months or more into the period of fiscal austerity even though many of the cutbacks have not been introduced. And the VAT was only recently increased in January! But British households and firms have known since the election in May what was ahead of them and so have had time to make adjustments to their spending and saving patterns to take the expected future into account. It doesn't help when you've got a series of Cabinet ministers saying that Britain faces a "Greek problem" or is "bankrupt," as Chancellor of the Exchequer George Osborne announced shortly after the Tory/LibDem coalition took over last spring.

Now to be fair to Rubin (I can't believe I'm writing this), he's not advocating the cuts right away. But he's definitely still part of the problem, not the solution. And his faux reasonableness is one of the things that has made him so persistently dangerous over the years. We'll probably have more of this nonsense tonight in the SOTU, but President Obama must heed the dangers posed by the British approach, despite the fact that virtually every single mainstream economist and talking head is advocating that the president ultimately adopt the UK's ruinous course of action.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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China’s Emergence as a Great Power Began with FDR

Jan 21, 2011David B. Woolner

Roosevelt historian David Woolner shines a light on today’s issues with lessons from the past.

Roosevelt historian David Woolner shines a light on today’s issues with lessons from the past.

In his remarks at the ceremony welcoming Chinese President Hu to Washington, President Obama took note of "China's rise as a strong, prosperous and successful member of the community of nations." He also observed that at a time "when some doubt the benefits of cooperation between the United States and China, this visit is also a chance to demonstrate a simple truth. We have an enormous stake in each other's success. In an interconnected world, in a global economy, nations -- including our own -- will be more prosperous and more secure when we work together."

With China now possessing the world's second largest economy and with more and more talk of the importance of the "G2 relationship" in the post-Great Recession world, no one would doubt the veracity of the president's statement. China, and the Chinese-American relationship, has indeed become critical to the world's peace and prosperity. Nevertheless, for most Americans recognition of China's status as a "Great Power" is something that has occurred rather slowly and relatively recently, within the last decade or so. But one individual who never doubted that China would play an important role on the world stage was Franklin D. Roosevelt. It was FDR, in fact, who perhaps more than any other world leader first recognized China's potential as a world power.

FDR's interest in China was in some respects linked to the history of his own family, as his maternal grandfather, Warren Delano II, was involved in the China trade in the 19th century. But it was the onset of the World War II in Asia that greatly intensified his interest in the region. The Japanese invaded Manchuria in 1931 and China proper in 1937. It was the US refusal to recognize the Japanese conquest of Manchuria, as well as the former's desire to dominate China (along with US insistence that Japan pull its troops off the Asian mainland), that eventually placed the two countries on a collision course. This led to the dramatic events of December 1941 -- and turned the Second World War into a truly global conflict.

Following the American entry into the war, FDR and a number of his advisors placed great hopes in the possibility that China might serve as America's principle ally in the Pacific. Given China's proximity to Japan, for example, the US Army Air Force hoped to launch bombing raids on Japan from air bases located on the Chinese mainland in areas not under Japanese control. But given the overall weakness of the Chinese nationalist forces (which stemmed in part from their long struggle with the Japanese and in part from their on-again-off-again struggle with the Chinese communists), these hopes were soon dashed. The Japanese were able to put a quick stop to the raids by overrunning the air bases from which they were launched.

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Due to this and other failures, the emergence of China as a major theatre of military operations in the US effort to defeat the Japanese never really materialized. This did not mean, however, that China was not important to the war effort or that FDR had given up on the possibility of her emergence as a Great Power once the war was over. On the contrary -- and unbeknownst to most Americans -- roughly four fifths of the Japanese army was located in China during the Second World War. It was critical, therefore, that China stay in the conflict, if only to keep the Japanese troops tied down.

Moreover, in spite of the difficulties China experienced during the war, FDR never lost sight of her potential. In part out of this belief, and in part to encourage the Chinese nationalists to keep up the fight, FDR began to promote the idea of China joining the United States, Great Britain and the Soviet Union as one of the world's four (later five) policemen that would help keep the peace once the war was over. It is for this reason that China today holds one of the five permanent seats on the Security Council at the United Nations.

There is, of course, something of a paradox in all of this. Having built up China's wartime image through numerous references to the country as a key US ally and as one of the powers who would help maintain the peace after the defeat of the Axis, it is not surprising that the resumption of the Chinese civil war in 1946 and the defeat of the nationalists at the hands of the communists three years later would be regarded as a major blow to US foreign policy and one of the starting points that added to the onset/intensification of the Cold War. In this sense, one could argue that FDR's legacy with respect to China is negative, particularly in light of the oft expressed wartime fear that we might "lose" China as an ally if we did not make a concerted effort to keep her in the war.

But did the nationalists' defeat really mean that we had "lost" China? Certainly in the geo-political sense the answer is no. Once again, FDR's basic assumptions were correct, some would say tragically correct. China -- communist or not -- was indeed more likely to line up with the Americans than with the Soviets in any major showdown among the Great Powers, as Richard Nixon and Henry Kissinger were to discover some thirty years later.

FDR was also correct when he predicted, as President Obama confirmed earlier this week, that China would emerge as one of the world's leading post-war powers. She is a power that we must engage with if we hope to make progress on host of international issues.

David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute.

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Debt, Housing and Currency: Cautiously Optimistic for 2011

Jan 14, 2011Edward Harrison

the-economy-200Some signs are looking up, but there are still plenty of landmines in the economy.

the-economy-200Some signs are looking up, but there are still plenty of landmines in the economy.

It's high time I laid my cards on the table about 2011. So, here it is: I am cautiously optimistic about the US and global economy for 2011. Let me explain both pieces of the puzzle -- the cautious part and the optimistic part -- below. I'll start with the positive first.

Optimistic

Double dip recessions are not the norm; they are the exception. Why? Here's how I put it in September:

Recoveries by definition start from a point of diminished output because recessions are periods of diminishing output. So output in the initial period of any recovery is always lower. That's how the math works -- and also why I continue to stress that this is a technical recovery.

But, the important part to remember is how the business cycle works and how the recency effect creates self-reinforcing declines or recoveries in output.

Increases in income lead to increases in retail sales which lead to increases in output and inventories which lead to more jobs and thus a further increase in income. This is a virtuous circle that defines the upward path of a business cycle.

So, you really need to see powerful secular forces to overcome this self-reinforcing dynamic. Once a technical recovery begins, we should expect it to continue and blossom into a full-blown cyclical recovery. Obviously, I am talking about the medium-term, not the long-term here. But the point is that we have been in recovery for over one-and-a-half years in the US. Odds are that this will continue for some time to come (through 2011 at least).

I see the jobs picture as encouraging. Employment is lagging, as it has in the last two recoveries. So the recovery looks particularly weak. Moreover, there seems to be a skew toward the upper income strata. This makes the technical recovery appear even more sluggish. But clearly, the jobs picture is improving.

What are US jobless claims telling us about recovery? They are averaging about 410,000, down from almost 470,000 a year ago. And since employment is a lagging indicator, we should expect claims to drop even further as GDP has been growing.

Across the board, the economic indicators show a modest but improving economic picture: industrial production, capacity utilization, personal income, retail sales. And I expect this to continue through at least the first half of 2011, probably through the whole year.

Cautious

I am cautious about this outlook because I still believe the US is in a cyclical upturn within a larger depression. The concept that the structural problems of excessive household indebtedness and an over-reliance on financial services and housing can be solved by money printing and fiscal stimulus leaves me cold. My thesis is that these remedies mask problems only due to the cyclical upturn. If the recovery is not used to whittle the problem away, the next recession will be as bad or worse than the last.

That said, policy makers have done a pretty good job of avoiding egregious policy errors so far. I think that gives us enough oomph to get over the hump so the cyclical agents like inventories and cyclical hiring can do their magic. But, here are my lingering concerns.

1. Europe: the sovereign debt crisis refuses to go away. The European periphery is hurting but the crisis has infected the core via Belgium and Italy. I expect the crisis to get worse before decisive action is taken because that's how politicians usually respond. There are three options for the euro zone: monetisation, default, or break-up. The question is whether this -- in and of itself -- deals a fatal blow to recovery in Europe, infecting the global economy. If you had asked me this question early last year, I would have said yes. Today, one year more into a cyclical recovery, it is less clear.

2. US states and municipalities: Meredith Whitney has put this crisis front and center. My take is similar to the one on Europe: The question is whether this -- in and of itself -- deals a fatal blow to recovery in the US, infecting the global economy. Here, I have always felt that the budget issues would only become dire in a cyclical downturn as declining asset prices created public sector pension losses. In an upturn, tax revenue increases, as do accounting gains from asset prices. Costs for supporting the unemployed decrease. To the degree that there are budget problems, the situation is very pro-cyclical -- meaning you have what MBAs call a high degree of operating leverage on municipal and state income statements. Leverage works to magnify cyclical ups and downs. That means that, while I agree with Whitney's alarm on munis, I do not think this is a 2011 event.

3. Housing: House price declines have resumed in the UK and the US. They never stopped in Ireland and Spain. The housing double dip is in progress. Complicating matters, clearly, fraud was a big issue not only in the origination of mortgage loans in the US but also in packaging and foreclosure. There is a real possibility that a systemic legal problem develops on that front in 2011. I don't know how this problem will be resolved. At this point, I see it as the biggest near-term risk for the US in 2011.

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4. Currency Wars: a lot of good is done simply by having economic growth. It takes a lot of political heat off politicians. The currency wars are really a political event because they are caused by a lack of aggregate demand. When the pie shrinks, individual countries feel obliged to implement beggar-thy-neighbour policies to maintain their standards of living by taking a larger share of the pie. The developed economies have felt this ‘pie shrinkage' most acutely. So it is they who are driving the so-called currency wars forward. The emerging markets are merely reacting in kind. I say "First the rate reductions, then money printing, then the currency war, then the tariffs, then..." hopefully economic recovery. But, as with the other problems, unless recovery is used to solve the issue of external imbalances created by our jury-rigged monetary system, the so-called Bretton Woods II, then tensions will return worse than before when a recession hits. Only after a full-blown crisis will the underlying issues be addressed. So, wait for the next crisis for reform of the monetary system.

5. UPDATE: Added this paragraph -- Commodity price Inflation: There is a real threat to recovery from commodity price inflation. We have already begun to see signs of food price riots, food price controls and the like in emerging markets. Additionally, Brent crude is at 27-month highs, closing in on $100 a barrel. Just think back to 2008; this type of commodity price inflation was toxic and sowed the seeds of its own demand destruction.

Conclusions

I may write what I think this means for stocks or bonds in another post. But the quick data dump is that profit margins are cyclically high while P/E ratios are above their long-term levels. If firms staff up, we could see a modest rise in stocks due to an increase in aggregate demand, despite these two factors. Personally, I tend to like large cap value and I think that's the right call for this environment because, while I am optimistic, I am cautious. On bonds, I have been saying for four months that they showed a poor risk/reward skew at these levels. Moreover, duration changes are pretty large when yields are low. That means you can sustain heavy losses if yields tick up. There is no reason to be a hero by moving out the curve and getting long duration. Nor is there any reason to load up on risk, especially in munis and sovereign debt. That is still my view. But US sovereign debt is a lot more attractive today than it was four months ago.

On the economic front, I moved away from a multi-year recovery baseline because of the prospect of policy errors. We avoided those errors in 2010. With the technical recovery poised to become a full-blown cyclical recovery, I think it's time to move back to the multi-year recovery baseline. Let me repeat my oft quoted phrase about the secular leveraging in the developed economies:

The problem I have with the recent history of growth in the United States, the United Kingdom, Spain and Ireland in particular is that the growth was underpinned by high debt accumulation and low savings. As debt is a mechanism through which we pull demand forward, the debt and consumption has meant we have been growing today at the expense of future growth.

Low quality growth can go on for a long time

This dynamic can continue for a very, very long time. In the United States, by virtue of America's possession of the world's reserve currency, an increase in aggregate debt levels has been successfully financed for well over twenty-five years. Mind you, there have been a number of landmines along the way. But, time and again, these pitfalls have been avoided through asymmetric monetary policy and counter-cyclical fiscal expansion.

So, poor quality growth can continue for very long indeed. And it is this fact which allows the narrative of easy money and over-consumption to gain sway.

The boy who cried wolf

A soothsayer who counsels against this type of economic policy, but who warns of impending collapse, will surely be seen as the boy who cries wolf. Think back to 2001 or 2002. Did we not witness then the same spectacle whereby the bears and doomsayers were let out of their holes to warn of impending doom from reckless economic policy? By 2004, unless these individuals changed their tune, they were long forgotten or even laughed at -- only to resurface in 2007 and 2008 with their new tales of woe. Knowing this shapes the psychology of economic forecasting is why missing the turn is disastrous for one's career. Efforts to avoid missing the turn are also part of a very large pro-cyclical psychological force underpinning a cyclical bull market.

The fact is: low quality growth does not lead to immediate economic calamity. It can continue through many business cycles. Even today, it is wholly conceivable that we could experience a multi-year economic expansion on the back of renewed monetary and fiscal expansion.

Marc Faber: "Don't underestimate the power of printing money"

You will recall that I wrote a post at the depths of the market implosion highlighting a phrase by Marc Faber, "Don't underestimate the power of printing money." This quote has stuck with me as asset markets have soared in the intervening time. What Faber was alluding to was the fact that printing money works. It does goose the economy as intended and it can induce a cyclical recovery.

Nevertheless, the recovery is likely to be of poor quality due to significant malinvestment. Debt levels will rise and capital investment will be directed toward riskier enterprises. Look at what's happening in China. Are you telling me stimulus is not working? It most certainly is.

In the west, stimulus is also working. It is designed to stop people from hoarding cash and to consume. It is also designed to get people out of savings accounts and into riskier asset classes. It is doing just that.

But, remember, the developed world has a lot of problems to work through. The origins of the next crisis are already apparent -- and they have nothing to do with cyclical upturns and everything to do with a secular trend of rising indebtedness, now in both the public and private sectors in developed economies. If the developed economies use this cyclical upturn wisely to reduce household debt levels, to increase private sector savings, to clean up the balance sheets of weak banks, and to cautiously normalize fiscal and monetary policy, we will be in a much better position to counteract economic weakness when the next downturn hits.

Edward Harrison blogs at Creditwritedowns.com, where this  piece originally appeared.

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Chinese Trade Policy Must Focus on Social Consequences

Jan 13, 2011Marshall Auerback

Focusing on currency isn't going to cut it for America's workers.

Focusing on currency isn't going to cut it for America's workers.

You have to have a sense of irony to watch the latest maneuvers on trade with China. Obama continues to turn his administration into "Clinton Mark III". (Enter Gene Sperling and Jacob Lew, following the revolving door departures of Peter Orszag and Larry Summers). The president continues to turn to many of the very folks who paved the way for China's eclipse of the US economy. Granting China normal trade status under the World Trade Organization, as President Clinton did during his presidency, facilitated the expansion of China's external sector, which coincided with a big step-up in the ratio of fixed capital formation to GDP. The WTO entry is how China managed to increase its growth rate from 2002 to 2007, using an undervalued currency to cannibalize the tradeables sector of its main Asian competitors and increasingly hollowing out US manufacturing in the process. At this stage, however, despite the ongoing requests by Treasury Secretary Geithner that "China needs to do more" on its currency, a simple revaluation of the yuan won't cut it.

Today, the global economy is characterized by huge trade imbalances. Everyone has focused on exchange rates. That is the wrong focus. China's net business fixed investment now may be equal to two times the combined fixed investment of Europe, Japan, and the United States. That capacity has to go somewhere. Some of it has to go abroad. Some of it has to substitute imports China now buys elsewhere. This will cause even greater trade imbalances, which will be problematic given the political constraints on using fiscal policy to offset the likely deterioration in America's external sector (and corresponding increased threats to employment).

We're now seeing the consequences of our "malign neglect" of China's economic policies: The Chinese are preparing to dominate the higher tech and capital goods areas -- from new Stealth fighters, to high speed railways, to solar, to nuclear. So what happens to the US industrial base when Boeing can't sell abroad because China has the same line of planes and they are cheaper? Oops! There go our military aircraft exports.

This points to the issue of import substitution, which everyone forgets. Exporting into a country with two billion people is a chimera because China doesn't really want American exports; they want total self-sufficiency. Building your plants in the land of the two billion armpits is a chimera as well, because the locals will steal your know-how and then undercut you and carve up the domestic market, which they control against you. Look at what is happening to the Spanish wind turbine company, Gamesa, as a recent NYTimes article illustrated:

Gamesa has learned the hard way, as other foreign manufacturers have, that competing for China's lucrative business means playing by strict house rules that are often stacked in Beijing's favor.

Nearly all the components that Gamesa assembles into million-dollar turbines here, for example, are made by local suppliers -- companies Gamesa trained to meet onerous local content requirements. And these same suppliers undermine Gamesa by selling parts to its Chinese competitors -- wind turbine makers that barely existed in 2005, when Gamesa controlled more than a third of the Chinese market.

But in the five years since, the upstarts have grabbed more than 85 percent of the wind turbine market, aided by low-interest loans and cheap land from the government, as well as preferential contracts from the state-owned power companies that are the main buyers of the equipment. Gamesa's market share now is only 3 percent.

China's capital expenditure as a percentage of GDP has now reached a historically unprecedented 50% of GDP. Throughout economic history, countries with especially high investment to GDP ratios have embarked on inefficient investments. In the 1820s they built too many canals. In the railroad boom in the UK in the 1840s they built three lines between Leeds and Liverpool but the traffic could barely support one. Throughout the 19th century railroad boom after railroad boom led to busts. We saw a repeat of the same across a broad spectrum of industries during the 20th century, right up to the present day. The oil boom of the 1970s led to gluts of rigs and tankers that were idled for a decade. The bubble decade in Japan produced unneeded private investment that, in the two decades since, has been scrapped and replaced. In emerging Asia in the late 1980s and 1990s excesses of residential investment led to gluts that took a decade to work off. In the past decade the US did in residential construction what emerging Asian countries did a decade earlier.

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History, then, is replete with examples of the adverse consequences of bubbles. The fact that China has a fixed investment to GDP ratio of 50% when no country in economic history has had this ratio above 42% -- and then only for a brief moment -- makes it likely that there will be more gluts and more white elephants in China than anywhere else in history.

But the problem for US industry is not just China. The country is now experiencing high wage inflation, and I think they are at the tipping point. Inflation erodes the real value of the currency, but this is not occurring with a sufficient degree of speed to reduce China's massive trade surpluses, particularly with the US. It is possible, therefore, that Washington might ultimately contemplate the type of policy that they have hitherto not dared to consider -- namely permanent taxes on corporations that produce abroad.

Outsourcing, after all, is the creeping source of unemployment and leads to the destruction of our industrial base. One policy response might be a substantial tariff on Chinese imports if Beijing refuses to contemplate a significant revaluation of the RMB. (The RMB has actually been weakening again in the past few months, probably due to inflation problems.) The other possibility is a permanent tax on corporations that produce abroad. Since unemployment is the cause of the extended pay benefits provided by the government, it might consider permanently taxing the source of the unemployment -- US corporations producing abroad.

Huge technological advances have facilitated unprecedented outsourcing by US companies seeking to maximize profits by employing low cost foreign labor. The scale of this outsourcing is only recently possible because of advances in technology. Simply, and as we all recognize, US workers have been semi-permanently replaced by low cost foreign workers. Prior to these great advances, displacement of the current labor force could only have occurred through workers immigrating into the country. You have what Chris Dialynas of PIMCO has called "synthetic immigration." As Chris noted to me in a recent correspondence,

Because of technological advances, today's trade policies are effectively an immigration policy. There are differences to be sure. The US and its municipalities do not benefit from the taxes that would normally accrue to them if the workers were based in the US. Yet the US government, like in old world real immigration, must provide benefits for the displaced workers. Synthetic immigration leads to capital investment in the immigrant's country (China and others) resulting in a greater capital stock there and increased competitiveness.

This process will continue until the US embraces a much more aggressive fiscal policy to promote employment growth (eg. a job guarantee program), highly unlikely given the current political configuration in the US or a political revolution of sorts.

Of course, the difference between normal immigration (which generally means new workers entering the domestic labor force, thereby displacing menial workers) and "synthetic immigration" is that the former focuses on employee displacement, whereas trade policy makers simply worry about consumers obtaining the lowest priced goods possible, regardless of the social consequences. Shouldn't we consider adopting a trade policy that covers the domestic considerations, such as worker displacement and higher unemployment, much as immigration policy currently does?

Policy in the US has to deal with the problem from our end. Something is going to go very wrong geopolitically when the share of industry in the US is half of what it was a generation ago. Much as the "quantitative easing explained" video captured the public's fantasy, this video speaks to many of the same issues in regard to China and its trade policies:


Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Dishonest Debt Ceiling Debate to Further Doom U.S. Economy

Jan 11, 2011Marshall Auerback

How misplaced fear of Greece could lead us on a path more like Japan's.

My best guess is there will be little or no fight over the debt ceiling extension. I think the President will agree to pretty much whatever the Republicans want, and get more than enough Democrats to join him.

How misplaced fear of Greece could lead us on a path more like Japan's.

My best guess is there will be little or no fight over the debt ceiling extension. I think the President will agree to pretty much whatever the Republicans want, and get more than enough Democrats to join him.

Best I can tell, the entire Congress agrees the deficit is a long term problem that absolutely must be addressed. The only arguments against 'fiscal consolidation' that I've see are the 'bleeding heart' arguments which don't cut it when everyone believes that Greek-type insolvency looms -- despite plenty of evidence to the contrary.

Also, the ball is in the Republicans' court, as they can't just be against raising the debt ceiling. So it will be up to them to take the lead and offer terms and conditions for their votes, after which enough Democrats will pretty much agree to it all, including cuts in Social Security and Medicare expenses, of one type or another, current and future.

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All of which dooms the US economy to suffer from a severe lack of aggregate demand for the foreseeable future. As my friend Warren Mosler has pointed out in his book "The 7 Deadly Innocent Frauds of Economic Policy": The actual act of Government spending is NOT operationally limited or in any way constrained by taxing or borrowing. Debt or no debt, our children get to consume whatever they can produce. There is no "intergenerational theft". Government budget deficits add to savings; they don't detract from them. Social Security is not "broken" and government checks don't "bounce". The trade deficit is NOT an unsustainable imbalance that takes away jobs and output, so long as fiscal policy is deployed in support of higher incomes and growth. Jobs are lost because taxes are too high for a given level of government spending, not because of imports. Budget deficits build productive infrastructure, which exerts a positive influence on economic growth.

Meanwhile, budget deficits typically help stimulate investment because they keep aggregate demand from plummeting and thereby help to sustain employment. So any moves to cut spending in order to keep us under an arbitrary, self-imposed legal debt ceiling will simply add to our deficit, because governments can control spending levels, BUT NOT DEFICIT LEVELS.

Bottom line -- believing we could be the next Greece continues to keep us on the path of becoming the next Japan.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

**For more, see Auerback's ND20 posts: "Whatever Happened to Japan" and "Repeat After Me: The U.S. Does Not Have a Greece Problem".

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What Were They Smoking? The 10 Dumbest Stories of 2010

Dec 23, 2010Tim Price

idiotIt’s been an unpredictable year, and if our pundits and policymakers could do it all over again, there are some moments they’d probably love to take back. Unfortunately for them, the Internet never forgets, and the ND20 team has decided to look back over 2010 by counting down the dumbest headlines, decisions, and predictions.

idiotIt’s been an unpredictable year, and if our pundits and policymakers could do it all over again, there are some moments they’d probably love to take back. Unfortunately for them, the Internet never forgets, and the ND20 team has decided to look back over 2010 by counting down the dumbest headlines, decisions, and predictions. There was a lot of dumb to cover, so if you think we missed something, be sure to let us know.

10. One and done: To be a great president, Obama should not seek reelection in 2012 (WaPo)
What's the silliest part of this advice -- the idea that President Obama could achieve more by quitting his job, or the idea that two Fox News analysts have the president's best interests at heart?

9. Heritage Foundation and the "Luck" of the Irish (OurFuture.org)
Conservative economists had a lot riding on their belief that Ireland's austerity measures would save its economy, so it's not surprising that the Heritage Foundation was still touting the Celtic Tiger's strength two years into a deep recession.  That doesn't make it any less funny.

8. The Health Care Bill is Dead (Weekly Standard)
The day after Scott Brown's shocking victory in the special election to fill Ted Kennedy's Senate seat, Fred Barnes declared "The health care bill, ObamaCare, is dead with not the slightest prospect of resurrection. [...] Democrats have talked up clever strategies to pass the bill in the Senate despite Brown, but they won’t fly." To be fair, many progressives agreed with him.

7. Off-Message Watch: "I Don't Know That for Sure" (Economist's View)
Austan Goolsbee brought a lot of good will with him to the Council of Economic Advisers, but when he turned out to be agnostic about the benefits of a bigger stimulus package, it made us wonder if he was off-message or if the entire administration was.

6. Robert Rubin: 'Virtually Nobody' Saw Crisis Coming, Bush Deserves Much Of The Blame (HuffPo)
Like many of the architects of the financial system that collapsed in 2008, Rubin must not have been paying very close attention if he didn't spot any signs of trouble brewing.

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5. The war recovery? (WaPo)
We're always open to innovative economic ideas, but David Broder made us wonder if Martians had invaded his body with this column speculating that war with Iran would boost growth and help President Obama in 2012. But then again, Afghanistan and Iraq have done wonders for us.

4. Christine O’Donnell TV Ad: “I’m Not a Witch… I’m You” (CBS)
Even in the year of Aqua Buddhists and chicken barterers, Christine O'Donnell was an unusual Senate candidate. When Bill Maher revealed that she had once dabbled in witchcraft, she was forced to issue a denial that perfectly captured the absurdity of the midterms and earned a place in our political lexicon.

3. President Obama: Drill, Baby, Drill (ABC)
In one of his signature attempts at bipartisan pre-concession, President Obama decided at the end of March to endorse more offshore oil drilling. Three weeks later, the Deepwater Horizon oil rig exploded, creating one of the worst environmental disasters in U.S. history. Perfect timing.

2. The Politics of Foreclosure (WSJ)
When the foreclosure scandal broke, the Wall Street Journal argued that liberals were making too big a fuss about “the pain that results when the anonymous paper pusher who kicks you out of your home is not the anonymous paper pusher who is supposed to kick you out of your home.” The editorial stated that the good folks at the Journal were “not aware of a single case so far of a substantive error.” We can think of a few.

1. Welcome to the Recovery (NY Times)
Tim Geithner probably didn’t mean for the title of his now-infamous op-ed to sound sarcastic, but as Wall Street’s profits soared and the middle class continued to sink, it was hard for anyone to take it seriously. At least he didn’t mention green shoots.

Tim Price is a Junior Fellow at the Roosevelt Institute.

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