Ireland’s Paradise Lost

For an American tourist weaned on Gaelic kitsch and screenings of “The Quiet Man,” the landscape of contemporary Ireland comes as something of a shock. Drive from Dublin to the western coast and back, as I did two months ago, and you’ll still find all the thatched-roof farmhouses, winding stone walls and placid sheep that the postcards would lead you to expect. But round every green hill, there’s a swath of miniature McMansions. Past every tumble-down castle, a cascade of condominiums. In sleepy fishing villages that date to the days of Grace O’Malley, Ireland’s Pirate Queen (she was the Sarah Palin of the 16th century), half the houses look the part — but the rest could have been thrown up by the Toll brothers.

It’s as if there were only two eras in Irish history: the Middle Ages and the housing bubble.

This actually isn’t a bad way of thinking about Ireland’s 20th century. The island spent decade after decade isolated, premodern and rural — and then in just a few short years, boom, modernity! The Irish sometimes say that their 1960s didn’t happen until the 1990s, when secularization and the sexual revolution finally began in earnest in what had been one of the most conservative and Catholic countries in the world. But Ireland caught up fast: the kind of social and economic change that took 50 years or more in many places was compressed into a single revolutionary burst.

There was a time, not so very long ago, when everyone wanted to take credit for this transformation. Free-market conservatives hailed Ireland’s rapid growth as an example of the miracles that free trade, tax cuts and deregulation can accomplish. (In 1990, Ireland ranked near the bottom of European Union nations in G.D.P. per capita. In 2005, it ranked second.)

Progressives and secularists suggested that Ireland was thriving because it had finally escaped the Catholic Church’s repressive grip, which kept horizons narrow and families large, and limited female economic opportunity. (An academic paper on this theme, “Contraception and the Celtic Tiger,” earned the Malcolm Gladwell treatment in the pages of The New Yorker.) The European elite regarded Ireland as a case study in the benefits of E.U. integration, since the more tightly the Irish bound themselves to Continental institutions, the faster their gross domestic product rose.

Nobody tells those kinds of stories anymore. The Celtic housing bubble was more inflated than America’s (a lot of those McMansions are half-finished and abandoned), the Celtic banking industry was more reckless in its bets, and Ireland’s debts, private and public, make our budget woes look manageable by comparison. The Irish economy is on everybody’s mind again these days, but that’s because the government has just been forced to apply for a bailout from the E.U., lest Ireland become the green thread that unravels the European quilt.

If the bailout does its work and the Irish situation stabilizes, the world’s attention will move on to the next E.U. country on the brink, whether it’s Portugal, Spain or Greece (again). But when the story of the Great Recession is remembered, Ireland will offer the most potent cautionary tale. Nowhere did the imaginations of utopians run so rampant, and nowhere did they receive a more stinging rebuke.

To the utopians of capitalism, the Irish experience should be a reminder that the biggest booms can produce the biggest busts, and that debt and ruin always shadow prosperity and growth. To the utopians of secularism, the Irish experience should be a reminder that the waning of a powerful religious tradition can breed decadence as well as liberation. (“Ireland found riches a good substitute for its traditional culture,” Christopher Caldwell noted, but now “we may be about to discover what happens when a traditionally poor country returns to poverty without its culture.”)

But it’s the utopians of European integration who should learn the hardest lessons from the Irish story. The continent-wide ripples from Ireland’s banking crisis have vindicated the Euroskeptics who argued that the E.U. was expanded too hastily, and that a single currency couldn’t accommodate such a wide diversity of nations. And the Irish government’s hat-in-hand pilgrimages to Brussels have vindicated every nationalist who feared that economic union would eventually mean political subjugation. The yoke of the European Union is lighter than the yoke of the British Empire, but Ireland has returned to a kind of vassal status all the same.

As for the Irish themselves, their idyllic initiation into global capitalism is over, and now they probably understand the nature of modernity a little better. At times, it can seem to deliver everything you ever wanted, and wealth beyond your dreams. But you always have to pay for it.

Ross Douthat, New York Times


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The loan arranger

AMAZON.COM says soon you will be allowed to lend out electronic books purchased from the Kindle Store. For a whole 14 days. Just once, ever, per title. If the publisher allows it. Not mentioned is the necessity to hop on one foot whilst reciting the Gettysburg Address in a falsetto. An oversight, I’m sure. Barnes & Noble’s Nook has offered the same capability with identical limits since last year. Both lending schemes are bullet points in a marketing presentation, so Amazon is adding its feature to keep parity.

Allowing such ersatz lending is a pretence by booksellers. They wish you to engage in two separate hallucinations. First, that their limited licence to read a work on a device or within software of their choosing is equivalent to the purchase of a physical item. Second, that the vast majority of e-books are persistent objects rather than disposable culture.

If you own a physical book, in much of the world you may sell it, lend it—even burn or bury it. You may also keep the book forever. Each of those characteristics is littered with footnotes and exceptions for e-books. We are granted an illusion of ownership, but may read only within the ecosystem of hardware and software supported by the bookseller with sometimes additional limitations imposed by publishers. Witness Amazon’s remote deletion—since abjured—of improperly sold copies of George Orwell’s “1984” and “Animal Farm” in 2009. This Babbage recalls an Apple executive, Phil Schiller, extolling to him in 2003 the virtues of purchasing downloadable music when that company’s iTunes Store launched, and the dominant model was for recurring subscriptions. Mr Schiller described buying a song as owning it. Asked if one could therefore sell the song, Mr Schiller said no. He explained:

I do think of it as ownership, and it really does fit the definition of legal ownership. [There are] certain boundaries on your rights, just as on everything I own. I can own a car but that doesn’t give me the right to speed 100mph in it.

That was as tendentious then as it is now, and applies just as directly to Apple’s current e-book offerings. True, Apple removed digital rights management (DRM) protection from its music when the recording industry decided its best tool to fight Apple’s near-total ownership of digital downloads was to make it possible for music to be played on devices other than iPods. But the licensing terms for music didn’t change, and books and video remain locked down, however ineffective such protection is.

But the reason for restricting lending, even with the sham of offering it in Amazon’s or Barnes & Noble’s form, is to distract people from the fact that buyers are spending real money to buy a book they may read just once. To judge from the information Amazon provides, the long tail applies to e-books as it does everywhere else. Many different titles are flogged, but the most disposable and ephemeral have the lion’s share of units sold. Dan Brown’s epics are rarely re-read, judging by how many copies are available for one penny or given away in free book bins weeks after release. Allowing the loan of “The Lost Symbol” by any purchaser to any other e-book hardware or software user worldwide turns each buyer into a one-person lending library. Publishers don’t much like libraries, either, despite the chin-wagging otherwise. (In the US, the public lending right or remuneration right doesn’t hold; the first-sale doctrine allows library lending of physical media without additional fees.)

With a physical book, the afterlife of a disposable read is to hand it off to another party: a library sale, a friend or relative, or the free bin outside a used bookstore. Such books are also purchased in the millions and sold for one penny plus shipping online partly as a marketing effort by booksellers who can then include their own catalogs with each sale. An e-book, however, lives in limbo. Neither moving on to the next life, nor returning to this one, it can never be freed.

That will change. Just as with music, DRM will be cracked. As more people possess portable reading devices, the demand and availability for pirated content will also rise. (Many popular e-books can now be found easily on file-sharing sites, something that was not the case even a few months ago, as Adrian Hon recently pointed out.) The end-game is unclear. Authors can’t turn to touring to obtain revenue in the way musicians can, though some can charge steep speaking fees. Nor can authors produce their work in 3D, only readable in certain special theaters. (McSweeney’s has a proposal in that regard.)

All is not lost, however. Despite fewer adults reading fewer books, billions are still sold worldwide each year, with an increasing portion being digital. Publishers and booksellers need to get non-readers to pick up a device and buy books, and existing readers to read more. Lowering the risk of purchasing a book that a reader may not like would reduce the friction between considering a title and clicking the buy button.

In fact, Barnes & Noble and Starbucks are experimenting with a sort of loan in their bricks-and-mortar shops. The bookseller allows its Nook hardware owners to read books willy-nilly on its stores’ Wi-Fi networks for up to an hour a day. Starbucks has partnered with several publishers to allow full access to some titles, but only while a browser is in the store. Barnes & Noble’s effort is a year old and Starbucks’ was launched just a few days ago.

In other words, they are finally doing with digital books what they have long practised with the printed sort. After all, most bookshops nowadays let you pick a book off the shelf and read it at your leisure, sometimes providing comfy armchairs. Cafés have been making books and newspapers available to patrons for centuries, to entice them to stick around for another cuppa.

The college-textbook market provides another replicable business model. Students pay through their noses for new textbooks at the start of term only to resell them at the end to other students or back to the original bookshop at a discount. Alternatively, they rent books for a fee while leaving a deposit which is returned when the book comes back to the shop. Creating a legitimate digital resale market along similar lines ought to be possible. If, that is, publishers can be convinced to let what are in effect mint-condition digital copies to go at a lower price.

Introducing either de facto rental (purchase and resell at prices set by the bookseller) or the actual sort (read a book in a set period of time for a lower fee) would expand general and specialist readership alike, while discouraging a turn to piracy by breaking the appearance of immutable, high prices. At the same time, it would enable publishers, booksellers and authors to sidestep the first-sale doctrine of physical media, and to rake in revenue each time a “used” digital copy passes from hand to hand.

The music and film industries fought a decade-long losing battle for the digital realm that only put them at odds with their best customers. The book business may yet be able to avoid recapitulating all that pain and disruption, not least by pinching ideas from the off-line world.


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Which MBA?

Pirate copy

What managers can learn from Somali pirates 

PURVEYORS of management-speak are fond of quoting cod insights from military strategists. According to David James, a professor at Henley Business School, they would do better studying the management styles of some of those the armed forces are fighting, such as Somali pirates. Alongside Paul Kearney, a lieutenant-colonel in the Royal Marines, Professor James has been studying the operations of the pirates, as well as insurgents in Afghanistan and Iraq, to see if they have anything to teach legitimate firms. 

The threat to life and liberty aside, Somali pirates’ business model is impressive. According to the professor, each raid costs the pirates around $30,000. On average one raid in three is successful. The reward for a triumphant venture, however, can be in the millions. 

The organisation behind the pirates would be familiar to many ordinary businesses. For a start, they have a similar backend—including the kind of streamlined logistics and operations controls that would be the envy of most companies. Their success has even prompted one village to open a pirate “stock exchange”, where locals can buy shares in up to 70 maritime companies planning raids.

But Professor James believes that the most important lesson firms can learn is one of strategy. He teaches his MBA class that one reason for the pirates’ success is that they avoid “symmetrical” conflict—challenging their targets head on by, for example, lining up against the Western navies patrolling the waters—battles they would surely lose. Instead, they use stealth and surprise, attacking targets at their weakest point. In this way, with only a dozen-or-so sailors, they wrest control of huge assets, in the form of oil tankers.

This is a lesson that serves smaller companies well as they look to take bites out of larger rivals. It might be foolish, for example, for a start-up to take on one of the traditional banks head-to-head—only another large bank could afford the pyrrhic battle that would ensue from it protecting its market. But by picking a small, localised fight a start-up can make an impression before a bank has had time to react. An example, says Professor James, is It has taken market share by attacking banks’ inflexible lending policies by offering loans for the exact amount and length of time the customer wants. It processes the loans extremely quickly and customers can even get immediate approval using an iPhone app. 

Sometimes such an asymmetrical strike can shift the centre of gravity in an industry. Nintendo, a computer-games firm, was competing, and failing, against two much better-resourced rivals—Sony and Microsoft—in a sector where it seemed the only way to be successful was to win an arms race of processing power and ever more sophisticated technology. Nintendo opened a new avenue of attack based on the idea that consumers would enjoy getting physically involved in video games, using a motion-sensitive controller to control the on-screen action. So, using relatively cheap technology, it invented the Wii, in the process opening up a whole new market for previous non-gamers. 

That smaller, nimble competitors make stealth attacks on larger rivals is a well-known phenomenon. Nonetheless, the way that larger companies can defend themselves against attack is a matter of much debate. Professor James says that the key is to quicken decision making. In his analogy, by the time the captain of an oil tanker has spotted the pirates’ inflatables it is too late; big ships take a long time to turn around. Similarly, once a large business has gone through the traditional process of observing an attack, orientating itself, deciding what to do about it and then acting (what Colonel John Boyd, an American military strategist, called an OODA loop) it is too late, the competition is upon it.

To help companies understand the best way to speed up their reaction times, the professor turned to another unpalatable source: insurgents in Afghanistan. Despite stressing that he believes the outcomes of their strategies to be repugnant, he nonetheless says that he admires the management structures that makes them successful. 

One of the main lessons he learned, and which he teaches companies on his executive-education programme, Corporate Insurgency, is that insurgent leaders don’t micro-manage. Leaders of such movements are, in Professor James’s words, “brand agnostic”—they allow their brand to be adopted by autonomous local cells with little central control. The mistake big business makes is to try to protect the brand by making decisions from its headquarters; better, he says, to allow local managers to respond quickly to local events.

He even goes as far as to suggest that companies set up “commando” forces; small units which work outside the traditional command structure of the company and which have a level of autonomy—“not holding the long committee meetings, not having the extended approval and budgeting process”. If a big business as a whole cannot act as a small, nimble player, these business units can.


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An Age of Creative Destruction

‘Gentlemen: You have undertaken to cheat me. I won’t sue you, for law takes too long. I will ruin you.” Thus Cornelius Vanderbilt writing to business partners who had exploited his absence to gain control of one of his companies. He was as good as his word.

The nature of both ruin and success is the subject of “American Colossus,” H.W. Brands’s account of, as the subtitle has it, “The Triumph of Capitalism” during the period 1865-1900. Mr. Brands paints a vivid portrait of both this understudied age and those industrialists still introduced by high-school teachers as “robber barons”—Vanderbilt, Andrew Carnegie, John D. Rockefeller and J.P. Morgan. Together these men of the 19th century laid the foundations that would allow the use of innovations that we think of as modern, such as trains and automobiles, on a massive scale in the 20th century.

“Colossus” also reminds us of something more subtle: the terrifying difficulty of remaining at the top once one has arrived. Vanderbilt, for example, seemed doomed to be sidelined during his lifetime. He was a “water man” and remained devoted to the steamship even as railroads threatened to relegate river transport to the status of the fax. His hostility to trains was so great he referred to them simply as “them things that go on land.” But the Commodore eventually admitted to himself the looming obsolescence of the river highway—just in time to corner the stock of the New York & Harlem Railroad in the 1860s. Thus did he postpone—albeit only for a few decades—the decline of the great Vanderbilt empire.

Rails to riches: An 1870 cartoon depicting James Fisk’s attempt to stop Cornelius Vanderbilt from gaining control of the Erie Railroad Company

As Mr. Brands relates the tycoons’ stories, he drops some anecdotes wonderfully relevant today. Many Americans these days are buying their first gold shares—but with a certain ambivalence, all too aware that the metal’s price can move suddenly. Mr. Brands reminds us just how suddenly with a description of gold’s gyrations on Friday, Sept. 24, 1869, the day the Treasury signaled the Grant administration’s intention to combat rising gold prices by putting a supply worth $4 million on the market. That day, before Treasury’s move, gold shot to $162 an ounce from $143. Then the government’s gold came online. “As the bells of Trinity pealed forth the hour of noon,” reported the Herald Tribune, “the gold on the indicator stood at 160. Just a moment later, and before the echoes died away, gold fell to 138.”

“Colossus” also reminds us just how colossally wrong bets can be. When New York’s first apartment building, on East 18th Street, was planned in 1869, the reception it received was as cold as a February wind off the Hudson. New Yorkers reckoned that “cohabitation,” as apartment life was called, would fail and that gentlemen would never live “on shelves.”

For all the pleasure that “Colossus” offers in the way of anecdote, two flaws undermine its attractions. First, Mr. Brands frames the book—and indeed all of American history—as a contest between capitalism and democracy. Democracy depends on equality, the author claims, while capitalism needs inequality to function. “In accomplishing its revolution, capitalism threatened to eclipse American democracy,” he writes.

The author’s attachment to a sweeping theme like the democracy-capitalism clash is understandable: It’s the sort of duel that Will and Ariel Durant and other producers of pageant-style history have featured to unify their multivolume works.

Still, this “wasn’t it grand?” mode of writing is imprecise. Mr. Brands laments that capitalism’s triumph in the late 19th century created a disparity between the “wealthy class” and the common man that dwarfs any difference of income in our modern distribution tables. But this pitting of capitalism against democracy will not hold. When the word “class” crops up in economic discussions, watch out: it implies a perception of society held in thrall to a static economy of rigid social tiers. Capitalism might indeed preclude democracy if capitalism meant that rich people really were a permanent class, always able to keep the money they amass and collect an ever greater share. But Americans are an unruly bunch and do not stay in their classes. The lesson of the late 19th century is that genuine capitalism is a force of creative destruction, just as Joseph Schumpeter later recognized. Snapshots of rich versus poor cannot capture the more important dynamic, which occurs over time.

One capitalist idea (the railroad, say) brutally supplants another (the shipping canal). Within a few generations—and in thoroughly democratic fashion—this supplanting knocks some families out of the top tier and elevates others to it. Some poor families vault to the middle class, others drop out. If Mr. Brands were right, and the “triumph of capitalism” had deadened democracy and created a permanent overclass, Forbes’s 2010 list of billionaires would today be populated by Rockefellers, Morgans and Carnegies. The main legacy of titans, former or current, is that the innovations they support will produce social benefits, from the steel-making to the Internet.

The second failing of “Colossus” is its perpetuation of the robber-baron myth. Years ago, historian Burton Folsom noted the difference between what he labeled political entrepreneurs and market entrepreneurs. The political entrepreneur tends to compete over finite assets—or even to steal them—and therefore deserves the “robber baron” moniker. An example that Mr. Folsom provided: the ferry magnate Robert Fulton, who operated successfully on the Hudson thanks to a 30-year exclusive concession from the New York state legislature. Russia’s petrocrats nowadays enjoy similar protections. Neither Fulton nor the petrocrats qualify as true capitalists.

Market entrepreneurs, by contrast, vanquish the competition by overtaking it. On some days Cornelius Vanderbilt was a political entrepreneur—perhaps when he ruined those traitorous partners, for instance. But most days Vanderbilt typified the market entrepreneur, ruining Fulton’s monopoly in the 1820s with lower fares, the innovative and cost-saving tubular boiler and a splendid advertising logo: “New Jersey Must Be Free.” With market entrepreneurship, a third party also wins: the consumer. Market entrepreneurs are not true robbers, for their ruining serves the common good.

Mr. Brands appreciates the distinction between political entrepreneurs and market entrepreneurs, but he chooses not to highlight it. Thus he misses an opportunity to emphasize a truth about the late 19th century that rings down to our own rocky times: The best growth is spurred by the right kind of ruin.

Miss Shlaes, a senior fellow at the Council on Foreign Relations, is writing a biography of Calvin Coolidge.


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The Non-Economist’s Economist

John Kenneth Galbraith avoided technical jargon and wrote witty prose—too bad he got so much wrong

The Dow Jones Industrials spent 25 years in the wilderness after the 1929 Crash. Not until 1954 did the disgraced 30-stock average regain its Sept. 3, 1929, high. And then, its penance complete, it soared. In March 1955, the U.S. Senate Banking and Currency Committee, J. William Fulbright of Arkansas, presiding, opened hearings to determine what dangers lurked in this new bull market. Was it 1929 all over again?

John Kenneth Galbraith (1908-2006), photographed by Richard Avedon in Boston in 1993

One of the witnesses, John Kenneth Galbraith, a 46-year-old Harvard economics professor, seemed especially well-credentialed. His new history of the event that still transfixed America, “The Great Crash, 1929” was on its way to the bookstores and to what would prove to be a commercial triumph. An alumnus of Ontario Agricultural College and the holder of a doctorate in agricultural economics from the University of California at Berkeley, Galbraith had written articles for Fortune magazine and speeches for Adlai Stevenson, the defeated 1952 Democratic presidential candidate. He was a World War II price controller and the author of “American Capitalism: The Concept of Countervailing Power.” When he stepped into a crowded elevator, strangers tried not to stare: he stood 6 feet 8 inches tall.

On the one hand, Galbraith observed, the stock market was not so speculatively charged in 1955 as it had been in 1929 On the other, he insisted, there were worrying signs of excess. Stocks were not so cheap as they had been in the slack and demoralized market of 1953 (though, at 4%, they still outyielded corporate bonds). “The relation of share prices to book value is showing some of the same tendencies as in 1929,” Galbraith went on. “And while it would be a gross exaggeration to say that there has been the same escape from reality that there was in 1929, it does seem to me that enough has happened to indicate that we haven’t yet lost our capacity for speculative self-delusion.”


Reading List: If Not Galbraith, Who?

Maury Klein tells a great story in “Rainbow’s End: The Crash of 1929” (Oxford, 2001), but he also attempts to answer the great question: What went wrong? For the financial specialist in search of a tree-by-tree history of the forest of the Depression, look no further than Barrie A. Wigmore’s “The Crash and Its Aftermath: A History of the Securities Markets in the United States, 1929-33” (Greenwood Press, 1985).

In the quality of certitude, the libertarian Murray Rothbard yielded to no economist. His revisionist history, “America’s Great Depression” (available through the website of the Mises Institute), contends that it was the meddling Hoover administration that turned recession into calamity. Amity Shlaes draws up a persuasive indictment of the New Deal in her “The Forgotten Man” (HarperCollins, 2007).

“Economics and the Public Welfare” by Benjamin Anderson (Liberty Press, 1979) is in strong contention for the lamest title ever fastened by a publisher on a deserving book. Better, the subtitle: “A Financial and Economic History of the United States: 1914-1946.”

“Where are the Customers’ Yachts? Or A Good Hard Look at Wall Street,” by Fred Schwed Jr. (Simon & Schuster, 1940) is the perfect antidote for any who imagine that the reduced salaries and status of today’s financiers is anything new. Page for page, Schwed’s unassuming survey of the financial field might be the best investment book ever written. Hands-down, it’s the funniest.

An unfunny but essential contribution to the literature of the Federal Reserve is the long-neglected “Theory and Practice of Central Banking” (Harper, 1936) by Henry Parker Willis, the first secretary of the Federal Reserve Board. Willis wrote to protest the against the central bank’s reinvention of itself, quite against the intentions of its founders, as a kind of infernal economic planning machine. He should see it now.

Freeman Tilden’s “A World in Debt” (privately printed, 1983) is a quirky, elegant, long out-of-print treatise by a non-economist on an all-too-timely subject. “The world,” wrote Tilden in 1936, “has several times, and perhaps many times, squandered itself into a position where a total deflation of debt was imperative and unavoidable. We may be entering one more such receivership of civilization.”

If the Obama economic program leaves you cold, puzzled or hot under the collar, turn to Hunter Lewis’s “Where Keynes Went Wrong” (Axios Press, 2009) or “The Critics of Keynesian Economics,” edited by Henry Hazlitt (Arlington House, 1977).

—James Grant


Re-reading Galbraith is like watching black-and-white footage of the 1955 World Series. The Brooklyn Dodgers are gone—and so is much of the economy over which Galbraith lavished so much of his eviscerating wit. In 1955, “globalization” was a word yet uncoined. Imports and exports each represented only about 4% of GDP, compared with 16.1% and 12.5%, respectively, today. In 1955, regulation was constricting (this feature of the Eisenhower-era economy seems to be making a reappearance) and unions were powerful. There was a lingering, Depression-era suspicion of business and, especially, of Wall Street. The sleep of corporate managements was yet undisturbed by the threat of a hostile takeover financed with junk bonds.

Half a century ago, the “conventional wisdom,” in Galbraith’s familiar phrase, was statism. In “American Capitalism,” the professor heaped scorn on the CEOs and Chamber of Commerce presidents and Republican statesmen who protested against federal regimentation. “In the United States at this time,” noted the critic Lionel Trilling in 1950, “liberalism is not only the dominant but even the sole intellectual tradition.” William F. Buckley’s upstart conservative magazine, National Review, made its debut in 1955 with the now-famous opening line that it “stands athwart history, yelling Stop.” Galbraith seemed not to have noticed that history and he were arm in arm. His was the conventional wisdom.

Concerning the emphatic Milton Friedman, someone once borrowed the Victorian-era quip, “I wish I was as sure of anything as he is of everything.” Galbraith and the author of “Capitalism and Freedom” were oil and water, but they did share certitude. To Galbraith, “free-market capitalism” was an empty Rotary slogan. It didn’t exist and, in Eisenhower-era America, couldn’t. Industrial oligopolies had rendered it obsolete.

Only in the introductory economics textbooks, he believed, did the free interplay between supply and demand determine price. Fortune 500 companies set their own prices. They chaffered with their vendors and customers, who themselves were big enough to throw their weight around in the market. As a system of decentralized decision-making, there was something to be said for capitalism, Galbraith allowed. As a network of oligopolistic fiefdoms, however, it needed federal direction. The day of Adam Smith’s “invisible hand” was over or ending. “Countervailing power,” in the Galbraith formulation, was the new idea.

Corporate bureaucrats—collectively, the “technostructure”—had pushed aside the entrepreneurs, proposed Galbraith channeling Thorstein Veblen. While, under the robber baron model, the firm existed to make profits, the modern behemoth exists to perpetuate itself in power while incidentally earning a profit. Planning is what the technostructure does best—it seems to hate surprises. “This planning,” wrote Galbraith, in “The New Industrial State,” “replaces prices that are established by the market with prices that are established by the firm. The firm, in tacit collaboration with the other firms in the industry, has wholly sufficient power to set and maintain minimum prices.” What was to be done? “The market having been abandoned in favor of planning of prices and demand,” he prescribed, “there is no hope that it will supply [the] last missing element of restraint. All that remains is the state.” It was fine with the former price controller of the Office of Price Administration.

As for the stockholder, he or she was as much a cipher as the manipulated consumer. “He (or she) is a passive and functionless figure, remarkable only on his capacity to share, without effort or even without appreciable risk, in the gains from the growth by which the technostructure measures its success,” according to Galbraith. “No grant of feudal privilege has ever equaled, for effortless return, that of the grandparents who bought and endowed his descendants with a thousand shares of General Motors or General Electric or IBM.” Galbraith was writing near the top of the bull market he had failed to anticipate in 1955. Shareholders were about to re-learn (if they had forgotten) the lessons of “risk.”

In its way, “The New Industrial State” was as mistimed as “The Great Crash.” In 1968, a year after the appearance of the first edition, the planning wheels started to turn at Leasco Data Processing Corp., Great Neck, N.Y. But Leasco’s “planning” took the distinctly un- Galbraithian turn of an unsolicited bid for control of the blue-blooded Chemical Bank of New York. Here was something new under the sun. Saul Steinberg, would-be revolutionary at the head of Leasco, ultimately surrendered before the massed opposition of the New York banking community. (“I always knew there was an Establishment,” Mr. Steinberg mused—”I just used to think I was a part of it.”) But the important thing was the example Mr. Steinberg had set by trying. The barbarians were beginning to form at the corporate gates.

The cosseted, self-perpetuating corporate bureaucracy that Galbraith described in “The New Industrial State” was in for a rude awakening. Deregulation became a Washington watchword under President Carter, capitalism got back its good name under President Reagan and trade barriers fell under President Clinton. Presently came the junk-bond revolution and the growth in an American market for corporate control. Hedge funds and private equity funds prowled for under- and mismanaged public companies to take over, resuscitate and—to be sure, all too often—to overload with debt. The collapse of communism and the rise of digital technology opened up vast new fields of competitive enterprise. Hundreds of millions of eager new hands joined the world labor force, putting downward pressure on costs, prices and profit margins. Wal-Mart delivered everyday low, and lower, prices, and MCI knocked AT&T off its monopolistic pedestal. The technostructure must have been astounded.

Galbraith in his home in Cambridge, Mass., in 1981

Here are the opening lines of “American Capitalism”: “It is told that such are the aerodynamics and wing-loading of the bumblebee that, in principle, it cannot fly. It does, and the knowledge that it defied the august authority of Isaac Newton and Orville Wright must keep the bee in constant fear of a crack-up.” You keep reading because of the promise of more in the same delightful vein. And, indeed, there is much more, including a charming annotated chronology of Galbraith’s life by his son and the editor of this volume, James K. Galbraith.

John F. Kennedy’s ambassador to India, muse to the Democratic left, two-time recipient of the Presidential Medal of Freedom, celebrity author, Galbraith in life was even larger than his towering height. His “A Theory of Price Control,” which was published in 1952 to favorable reviews but infinitesimal sales, was his one and only contribution to the purely professional economics literature. Thereafter this most acerbic critic of free markets prospered by giving the market what it wanted.

Now comes the test of whether his popular writings will endure longer than the memory of his celebrity and the pleasure of his prose. “The Great Crash” has a fighting chance, because of its very lack of analytical pretense. “History that reads like a poem,” raved Mark Van Doren in his review of the 1929 book. Or, he might have judged, that eats like whipped cream.

But the other books in this volume seem destined for only that kind of immortality conferred on amusing period pieces. When, for example, Galbraith complains in “The Affluent Society” that governments can’t borrow enough, or that the Federal Reserve is powerless to resist inflation, you wonder what country he was writing about, or even what planet he was living on.

Not that the professor refused to learn. In the first edition of “The New Industrial State,” for instance, he writes confidently: “While there may be difficulties, and interim failures or retreats are possible and indeed probable, a system of wage and price restraint is inevitable in the industrial system.” A decade or so later, in the edition selected for this volume, that sentence is gone. In its place is another not quite so confident: “The history of controls, in some form or other and by some nomenclature, is still incomplete.”

At the 1955 stock-market hearings, Galbraith was followed at the witness table by the aging speculator and “adviser to presidents” Bernard M. Baruch. The committee wanted to know what the Wall Street legend thought of the learned economist. “I know nothing about him to his detriment,” Baruch replied. “I think economists as a rule—and it is not personal to him—take for granted they know a lot of things. If they really knew so much, they would have all of the money, and we would have none.”

Mr. Grant, the editor of Grant’s Interest Rate Observer, is the author, most recently, of “Mr. Market Miscalculates” (Axios, 2009)


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Homo administrans

The biology of business

Biologists have brought rigour to psychology, sociology and even economics. Now they are turning their attention to the softest science of all: management

SCURRYING around the corridors of the business school at the National University of Singapore (NUS) in his white lab coat last year, Michael Zyphur must have made an incongruous sight. Visitors to management schools usually expect the staff to sport suits and ties. Dr Zyphur’s garb was, however, no provocative fashion statement. It is de rigueur for anyone dealing with biological samples, and he routinely collects such samples as part of his research on, of all things, organisational hierarchies. He uses them to look for biological markers, in the form of hormones, that might either cause or reflect patterns of behaviour that are relevant to business.

Since its inception in the early 20th century, management science has been dominated by what Leda Cosmides and John Tooby, two evolutionary psychologists, refer to disparagingly as the standard social science model (SSSM). This assumes that most behavioural differences between individuals are explicable by culture and socialisation, with biology playing at best the softest of second fiddles. Dr Zyphur is part of an insurgency against this idea. What Dr Cosmides and Dr Tooby have done to psychology and sociology, and others have done to economics, he wants to do to management. Consultants often talk of the idea of “scientific” management. He, and others like him, want to make that term meaningful, by applying the rigour of biology.

To do so, they will need to weave together several disparate strands of the subject—genetics, endocrinology, molecular biology and even psychology. If that works, the resulting mixture may provide a new set of tools for the hard-pressed business manager.

To the management born

Say “biology” and “behaviour” in the same sentence, and most minds think of genetics and the vexed question of nature and nurture. In a business context such questions of heredity and environment are the realm of Scott Shane, a professor of management at Case Western Reserve University in Ohio. In a recent book*, Dr Shane proffers a review of the field. Many of his data come from studies of twins—a traditional tool of human geneticists, who are denied the possibility of experimental breeding enjoyed by their confrères who study other species, such as flies and mice.

Identical twins share all of their DNA. Non-identical twins share only half (like all other siblings). Despite a murky past involving the probable fabrication of data by one of the field’s pioneers, Sir Cyril Burt, the science of comparing identical with non-identical twins is still seen as a good way of distinguishing the effects of genes from those of upbringing.

The consensus from twin studies is that genes really do account for a substantial proportion of the differences between individuals—and that applies to business as much as it does to the rest of life. Dr Shane observes genetic influence over which jobs people choose (see chart), how satisfied they are with those jobs, how frequently they change jobs, how important work is to them and how well they perform (or strictly speaking, how poorly: genes account for over a third of variation between individuals in “censured job performance”, a measure that incorporates reprimands, probation and performance-related firings). Salary also depends on DNA. Around 40% of the variation between people’s incomes is attributable to genetics. Genes do not, however, operate in isolation. Environment is important, too. Part of the mistake made by supporters of the SSSM was to treat the two as independent variables when, in reality, they interact in subtle ways.

Richard Arvey, the head of the NUS business school’s department of management and organisation, has been looking into precisely how genes interact with different types of environment to create such things as entrepreneurial zeal and the ability to lead others. Previous research had shown that people exhibiting personality traits like sensation-seeking are more likely to become entrepreneurs than their less outgoing and more level-headed peers. Dr Arvey and his colleagues found the same effect for extroversion (of which sensation-seeking is but one facet). There was, however, an interesting twist. Their study—of 1,285 pairs of identical twins and 849 pairs of same-sex fraternal ones—suggests that genes help explain extroversion only in women. In men, this trait is instilled environmentally. Businesswomen, it seems, are born. But businessmen are made.

In a second twin study, this time just on men, Dr Arvey asked to what extent leaders are born, and to what extent they are made. Inborn leadership traits certainly do exist, but upbringing, he found, matters too. The influence of genes on leadership potential is weakest in boys brought up in rich, supportive families and strongest in those raised in harsher circumstances. The quip that the battle of Waterloo was won on the playing fields of Eton thus seems to have some truth.

Pathways to success

Twin studies such as these point the way, but they provide only superficial explanations of what is going on. To get at the nitty gritty it is necessary to dive into molecular biology. And that is the province of people like Song Zhaoli, who is also at the NUS.

One way genes affect behaviour is through the agency of neurotransmitters, the chemicals that carry messages between nerve cells. Among these chemicals, two of the most important are dopamine and serotonin. Dopamine controls feelings of pleasure and reward. Serotonin regulates mood. Some personality traits have been shown to depend on the amounts of these neurotransmitters that slosh around the junctions between nerve cells. Novelty-seeking, for example, is associated with lots of dopamine. A tendency to depression may mean too little serotonin. And the levels of both are regulated by genes, with different variants of the same underlying gene having different effects.

Recent years have seen a surge of research into the links between particular versions of neurotransmitter-related genes and behavioural outcomes, such as voter turnout, risk-aversion, personal popularity and sexual promiscuity. However, studies of work-related traits have hitherto been conspicuous by their absence.

Dr Song has tried to fill this gap. His team have gathered and analysed DNA from 123 Singaporean couples to see if it can be matched with a host of work-related variables, starting with job satisfaction.

In this case Dr Song first checked how prone each participant in the study was to the doldrums, in order to establish a baseline. He also asked whether they had experienced any particularly stressful events, like sustaining serious injury, getting the sack or losing a lot of money, within the previous year. Then he told participants to report moments of negative mood (anger, guilt, sadness or worry) and job satisfaction (measured on a seven-point scale) four times a day for a week, using a survey app installed on their mobile phones.

He knew from previous research that some forms of melancholia, such as seasonal affective disorder (or winter blues), have been linked to particular versions of a serotonin-receptor gene called HTR2A. When he collated the DNA and survey data from his volunteers, he found those with a particular variant of HTR2A were less likely than those carrying one of its two other possible variants to experience momentary negative mood, even if they had had a more stress-ridden year. Dr Song also found that when carriers of that same variant reported lower negative mood, they also tended to report higher job satisfaction—an effect which was absent among people who had inherited the remaining two versions of the gene.

This suggests that for people fortunate enough to come equipped with the pertinent version of HTR2A, stressful events are less likely to have a negative effect on transient mood. What is more, for these optimists, better mood turns out to be directly related to contentment with their job. In other words, it may be a particular genetic mutation of a serotonin-receptor gene, and not the employer’s incentives, say, that is making people happier with their work.

The hormonal balance-sheet

Neurotransmitters are not the only way an individual’s genetic make-up is translated into action. Hormones also play a part. For example, oxytocin, which is secreted by part of the brain called the hypothalamus, has been shown to promote trust—a crucial factor in all manner of business dealings. The stress hormone cortisol, meanwhile, affects the assessment of the time value of money.

That, at least, was the conclusion of a study by Taiki Takahashi of Hokkaido University in Japan. After taking saliva samples from 18 volunteers, Dr Takahashi asked them what minimum amount of money they would accept in a year’s time in order to forgo an immediate payout of ¥10,000 (around $90 at the time). He found those with a lower base level of the hormone tended to prefer immediate payment, even when the sum in question was piffling compared with the promised future compensation.

Then there is testosterone, the principal male sex hormone (though women make it too). The literature on this hormone’s behavioural effects is vast. High levels of the stuff have been correlated with risk tolerance, creativity and the creation of new ventures. But testosterone is principally about dominance and hierarchy. This is where Dr Zyphur’s mouth swabs come in.

When Dr Zyphur (who is now at the University of Melbourne) was at the NUS, he led a study of how testosterone is related to status and collective effectiveness in groups. He and his colleagues examined levels of the hormone in 92 mixed-sex groups of about half a dozen individuals. Surprisingly, a group member’s testosterone level did not predict his or her status within the group. What the researchers did discover, though, is that the greater the mismatch between testosterone and status, the less effectively a group’s members co-operate. In a corporate setting that lower productivity translates into lower income.

Testosterone crops up in another part of the business equation, too: sales. It appears, for instance, to be a by-product of conspicuous consumption. In an oft-cited study Gad Saad and John Vongas of Concordia University in Montreal found that men’s testosterone levels responded precisely to changes in how they perceived their status. Testosterone shot up, for example, when they got behind the wheel of a sexy sports car and fell when they were made to drive a clunky family saloon car. The researchers also reported that when a man’s status was threatened in the presence of a female by a display of wealth by a male acquaintance, his testosterone levels surged.

As Dr Saad and Dr Vongas point out, a better understanding of this mechanism could help explain many aspects both of marketing and of who makes a successful salesman. Car salesmen, for example, are stereotypically male and aggressive, which tends to indicate high levels of testosterone. Whether that is really the right approach with male customers is, in light of this research, a moot point.

Natural selection

Results such as these are preliminary. But they do offer the possibility of turning aspects of management science into a real science—and an applied science, to boot. Decisions based on an accurate picture of human nature have a better chance of succeeding than those that are not. For instance, if job satisfaction and leadership turn out to have large genetic components, greater emphasis might be placed on selection than on training.

Not everyone is convinced. One quibble is that many investigations of genetics and behaviour have relied on participants’ retrospective reports of their earlier psychological states, which are often inaccurate. This concern, however, is being allayed with the advent of techniques such as Dr Song’s mobile-sampling method.

Another worry is that, despite the fact that most twin studies have been extensively replicated, they may be subject to systematic flaws. If parents exhibit a tendency to treat identical twins more similarly than fraternal ones, for instance, then what researchers see as genetic factors could turn out to be environmental ones.

That particular problem can be examined by looking at twins who have been fostered or adopted apart, and thus raised in separate households. A more serious one, though, has emerged recently. This is that identical twins may not be as identical as appears at first sight. A process called epigenesis, which shuts down genes in response to environmental prompts, may make their effective genomes different from their actual ones.

Statistically, that would not matter too much if the amount of epigenesis were the same in identical and fraternal twins, but research published last year by Art Petronis of the Centre for Addiction and Mental Health in Toronto and his colleagues, suggests it is not. Instead, identical twins are epigenetically closer to each other than the fraternal sort. That means environmentally induced effects that are translated into action by this sort of epigenesis might be being confused by researchers with inherited ones.

Still, this and other concerns about the effectiveness of the new science should pass as more data are gathered. But a separate set of concerns may be increased by better data. These are those of an ethical nature, which pop up whenever scientists broach the nature-nurture nexus. Broadly, such concerns divide into three sorts.

The first involves the fear that genetic determinism cheapens human volition. But as Dr Shane is at pains to stress, researchers like him are by no means genetic fatalists. He draws an analogy with sports wagers. Knowing that you have the favourable version of a gene may shift the odds somewhat, but it no more guarantees that you will be satisfied with your job than knowing of a player’s injury ensures that you will cash in on his team’s loss. Indeed, it might be argued that a better understanding of humanity can help direct efforts to counteract those propensities viewed as detrimental or undesirable, thus ensuring people are less, rather than more, in thrall to their biology.

The second set of ethical worriers are those who fret that biological knowledge may be used to serve nefarious ends. Whenever biology meets behaviour the spectre of social Darwinism and eugenics looms menacingly in the background. Yet, just because genetic information can serve evil ends need not mean that it has to. Dr Shane observes that pretending DNA has no bearing on working life does not make those influences go away, it just makes everyone ignorant of what they are, “Everyone, that is, except those who want to misuse the information.”

The third ethical qualm involves the thorny issue of fairness. Ought employers to use genetic testing to select their workers? Will this not lead down a slippery slope to genetic segregation of the sort depicted in the genetic dystopias beloved of science-fiction?

This pass, however, has already been sold. Workers are already sometimes hired on the basis of personality tests that try to tease out the very genetic predispositions that biologists are looking for. The difference is that the hiring methods do this indirectly, and probably clumsily. Moreover, in a rare example of legislative foresight, politicians in many countries have anticipated the problem. In 2008, for example, America’s Congress passed the Genetic Information Nondiscrimination Act, banning the use of genetic information in job recruitment. Similar measures had previously been adopted in several European countries, including Denmark, Finland, France and Sweden.


There is one other group of critics. These are those who worry that applying biology to business is dangerous not because it is powerful, but because it isn’t. To the extent they are genetic at all, behavioural outcomes are probably the result of the interaction of myriad genes in ways that are decades from being fully understood. That applies as much to business-related behaviour as to behaviour in any other facet of life.

Still, as Dr Zyphur is keen to note, not all academic work has to be about hard-nosed application in the here and now. Often, the practical applications of science are serendipitous—and may take a long time to arrive. And even if they never arrive, understanding human behaviour is just plain interesting for its own sake. “We in business schools often act like technicians in the way we conceptualise and teach our topics of study,” he laments. “This owes much to the fact that a business school is more like a trade school than it is a part of classic academia.” Now, largely as a result of efforts by Dr Zyphur and others like him, management science looks set for a thorough, biology-inspired overhaul. Expect plenty more lab coats in business-school corridors.

*“Born Entrepreneurs, Born Leaders. How Your Genes Affect Your Work Life”. Oxford University Press. $29.95


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Aren’t We Clever?

What a contrast. In a year that’s on track to be our planet’s hottest on record, America turned “climate change” into a four-letter word that many U.S. politicians won’t even dare utter in public. If this were just some parlor game, it wouldn’t matter. But the totally bogus “discrediting” of climate science has had serious implications. For starters, it helped scuttle Senate passage of the energy-climate bill needed to scale U.S.-made clean technologies, leaving America at a distinct disadvantage in the next great global industry. And that brings me to the contrast: While American Republicans were turning climate change into a wedge issue, the Chinese Communists were turning it into a work issue.

“There is really no debate about climate change in China,” said Peggy Liu, chairwoman of the Joint U.S.-China Collaboration on Clean Energy, a nonprofit group working to accelerate the greening of China. “China’s leaders are mostly engineers and scientists, so they don’t waste time questioning scientific data.” The push for green in China, she added, “is a practical discussion on health and wealth. There is no need to emphasize future consequences when people already see, eat and breathe pollution every day.”

And because runaway pollution in China means wasted lives, air, water, ecosystems and money — and wasted money means fewer jobs and more political instability — China’s leaders would never go a year (like we will) without energy legislation mandating new ways to do more with less. It’s a three-for-one shot for them. By becoming more energy efficient per unit of G.D.P., China saves money, takes the lead in the next great global industry and earns credit with the world for mitigating climate change.

So while America’s Republicans turned “climate change” into a four-letter word — J-O-K-E — China’s Communists also turned it into a four-letter word — J-O-B-S.

“China is changing from the factory of the world to the clean-tech laboratory of the world,” said Liu. “It has the unique ability to pit low-cost capital with large-scale experiments to find models that work.” China has designated and invested in pilot cities for electric vehicles, smart grids, LED lighting, rural biomass and low-carbon communities. “They’re able to quickly throw spaghetti on the wall to see what clean-tech models stick, and then have the political will to scale them quickly across the country,” Liu added. “This allows China to create jobs and learn quickly.”

But China’s capability limitations require that it reach out for partners. This is a great opportunity for U.S. clean-tech firms — if we nurture them. “While the U.S. is known for radical innovation, China is better at tweak-ovation.” said Liu. Chinese companies are good at making a billion widgets at a penny each but not good at complex system integration or customer service.

We (sort of) have those capabilities. At the World Economic Forum meeting here, I met Mike Biddle, founder of MBA Polymers, which has invented processes for separating plastic from piles of junked computers, appliances and cars and then recycling it into pellets to make new plastic using less than 10 percent of the energy required to make virgin plastic from crude oil. Biddle calls it “above-ground mining.” In the last three years, his company has mined 100 million pounds of new plastic from old plastic.

Biddle’s seed money was provided mostly by U.S. taxpayers through federal research grants, yet today only his tiny headquarters are in the U.S. His factories are in Austria, China and Britain. “I employ 25 people in California and 250 overseas,” he says. His dream is to have a factory in America that would repay all those research grants, but that would require a smart U.S. energy bill. Why?

Americans recycle about 25 percent of their plastic bottles. Most of the rest ends up in landfills or gets shipped to China to be recycled here. Getting people to recycle regularly is a hassle. To overcome that, the European Union, Japan, Taiwan and South Korea — and next year, China — have enacted producer-responsibility laws requiring that anything with a cord or battery — from an electric toothbrush to a laptop to a washing machine — has to be collected and recycled at the manufacturers’ cost. That gives Biddle the assured source of raw material he needs at a reasonable price. (Because recyclers now compete in these countries for junk, the cost to the manufacturers for collecting it is steadily falling.)

“I am in the E.U. and China because the above-ground plastic mines are there or are being created there,” said Biddle, who just won The Economist magazine’s 2010 Innovation Award for energy/environment. “I am not in the U.S. because there aren’t sufficient mines.”

Biddle had enough money to hire one lobbyist to try to persuade the U.S. Congress to copy the recycling regulations of Europe, Japan and China in our energy bill, but, in the end, there was no bill. So we educated him, we paid for his tech breakthroughs — and now Chinese and European workers will harvest his fruit. Aren’t we clever?

Thomas L. Friedman, New York Times


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That ’70s Feeling

TODAY we celebrate the American labor force, but this year’s working-class celebrity hero made his debut almost a month ago. Steven Slater, a flight attendant for JetBlue, ended his career by cursing at his passengers over the intercom and grabbing a couple of beers before sliding down the emergency-evacuation chute — and into popular history.

The press immediately drew parallels between Mr. Slater’s outburst and two iconic moments of 1970s popular culture: Howard Beale’s “I’m mad as hell” rant from the 1976 film “Network” and Johnny Paycheck’s 1977 anthem of alienation, “Take This Job and Shove It.”

But these are more than just parallels: those late ’70s events are part of the cultural foundation of our own time. Less expressions of rebellion than frustration, they mark the final days of a time when the working class actually mattered.

The ’70s began on a remarkably hopeful — and militant — note. Working-class discontent was epidemic: 2.4 million people engaged in major strikes in 1970 alone, all struggling with what Fortune magazine called an “angry, aggressive and acquisitive” mood in the shops.

Most workers weren’t angry over wages, though, but rather the quality of their jobs. Pundits often called it “Lordstown syndrome,” after the General Motors plant in Ohio where a young, hip and interracial group of workers held a three-week strike in 1972. The workers weren’t concerned about better pay; instead, they wanted more control over what was then the fastest assembly line in the world.

Newsweek called the strike an “industrial Woodstock,” an upheaval in employment relations akin to the cultural upheavals of the 1960s. The “blue-collar blues” were so widespread that the Senate opened an investigation into worker “alienation.”

But what felt to some like radical change in the heartland was really the beginning of the end — not just of organized labor’s influence, but of the very presence of workers in national civic life.

When the economy soured in 1974, business executives dismissed workers’ complaints about the quality of their occupational life — and then went gunning for their paychecks and their unions as well, abetted by a conservative political climate and the offshoring of the nation’s industrial core. Inflation, not unemployment, became Public Enemy No. 1, and workers bore the political costs of the fight against it.

Though direct workplace confrontations quickly dropped off, the feelings that had fueled them did not. Analysts began talking of an “inner class war” — more psychological than material, more anxious than angry, more about self-worth than occupational justice.

“Something’s happening to people like me,” Dewey Burton, an assembly-line worker for Ford, told The Times in 1974. “More and more of us are sort of leaving our hopes outside in the rain and coming into the house and just locking the door — you know, just turning the key and ‘click,’ that’s it for what we always thought we could be.”

Johnny Paycheck, a country singer, understood. Throngs of working-class people may have gathered around jukeboxes to raise a glass and chant the famous chorus to his most famous song, but they knew that his urge to rebellion was really just a fantasy: “I’d give the shirt right off of my back / If I had the nerve to say / Take this job and shove it!”

Similarly, in “Network,” Howard Beale, a TV news anchor played by Peter Finch, became famous as “the mad prophet of the airwaves.” But while he and his audiences may have been yelling, “I’m as mad as hell, and I’m not going to take this anymore!” the tag line was more a psychological release than a call to arms. After all, at the end of the film, Beale, already in suicidal despair, is murdered by his employer for meddling with the system.

The overt class conflict of the late ’70s ended a while ago. Workers have learned to internalize and mask powerlessness, but the internal frustration and struggle remain. Any questions about quality of work life, the animating issue of 1970s unrest, have long since disappeared — despite the flat-lining of wages in the decades since. Today the concerns of the working class have less space in our civic imagination than at any time since the Industrial Revolution.

Occasionally a rebel shatters the silence. Like Steven Slater, though, they get more publicity than political traction. Many things about America have changed since the late ’70s, but the soundtrack of working-class life, sadly, remains the same.

Jefferson Cowie, an associate professor of labor history at Cornell, is the author of “Stayin’ Alive: The 1970s and the Last Days of the Working Class.”


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The 1.6% Recovery

The results of the Obama economic experiment are coming in.

To no one’s surprise except perhaps Vice President Joe Biden’s, second quarter economic growth was revised down yesterday to 1.6% from the prior estimate of 2.4%, which was down from first quarter growth of 3.7%, which was down from the 2009 fourth quarter’s 5%. Economic recoveries are supposed to go in the other direction.


The downward revision was anticipated given the poor early economic reports for the third quarter, including a plunge in new home sales, mediocre manufacturing data, volatile jobless claims and even (after a healthy period) weaker corporate profits. Many economists fear that third quarter growth could be negative. Even if the economy avoids a double-dip recession, the current pace of growth is too sluggish to create many new jobs or improve middle-class living standards.

As recently as August 3, Treasury Secretary Timothy Geithner took to our competitor’s pages to declare that this couldn’t happen. “Welcome to the Recovery,” he wrote, describing how the $862 billion government stimulus was still rolling out, business investment was booming, and the economy was poised for sustainable growth.

We all make mistakes, but the problem for the American people is that Mr. Geithner’s blunder is conceptual. He and President Obama and their economic coterie really believe that government spending can stimulate growth by triggering private “demand,” that tax rates are irrelevant to investment decisions, that waves of new regulation can be absorbed by business with little impact on costs or hiring, and that politicians can assail capitalists without having any effect on the movement of capital.

This has been the great Washington policy experiment of the last three years, and it isn’t turning out too well. If prosperity were a function of government stimulus, our economy should be booming. The Fed has kept interest rates at near-zero for nearly two years, while Congress has flooded the economy with trillions of dollars in spending, loan guarantees, $8,000 tax credits for housing, “cash for clunkers,” and so much more. Never before has government tried to do so much and achieved so little.

Now that the failure is becoming obvious, the liberal explanation is that things would have been worse without all of this government care and feeding. The same economists who recommended the stimulus are now producing studies, based on their Keynesian demand models, claiming that it “saved or created” millions of jobs, even as the overall economy has lost millions of jobs. The counterfactual is impossible to disprove, but the American people can see the reality with their own eyes.

The nearby table compares growth in the current recovery with the recovery following the recession of 1981-82, the last time the jobless rate exceeded 10%. The contrast is stark.

Then after three quarters the recovery was in high gear. Now it is decelerating. Then tax rates were falling, interest rates were coming down and the regulatory state was in retreat. Now taxes are poised to rise sharply, interest rates can’t get any lower, and federal agencies are hassling business at every turn. Then business investment was exploding. Now companies are sitting on something like $2 trillion, reluctant to take risks when they don’t know what new costs government might next impose on them.

To borrow a phrase, maybe it’s time for a change.

Editorial, Wall Street Journal


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The Mark Hurd Show

In the CEO’s job, one strike and you’re usually out. The former head of H-P had two.

Mark Hurd is fired as Hewlett-Packard CEO as the upshot of a questionable sexual harassment complaint—and Oracle’s Larry Ellison thinks the proper analogy is to Apple’s ouster, in 1985, of its wunderkind co-founder Steve Jobs. At the time, recall, Apple was consumed in a debate, not about soft-porn actress Jodie Fisher, but about how to adapt to the decisive triumph of the Wintel standard.

You could almost suspect a backhanded Ellisonian genius at work, deliberately drawing an analogy designed to flush out a far more apt analogy. This one too involves Mr. Jobs—and Al Gore. As an Apple director, the former vice president preserved the company’s chief asset by producing a 2006 report to whitewash Mr. Jobs’s role in backdating management’s stock options.

Mr. Ellison, a friend of Mr. Hurd, in his now-famous letter to the media, could not have meant that the H-P board had deprived itself a visionary genius who would go on to invent new industries. If he meant anything serious, Mr. Ellison meant that H-P directors, in firing Mr. Hurd, had thrown overboard a valuable executive to minimize the public-relations risk to their own hides.

This is exactly the opposite of what Al Gore did. He got little credit at the time, and was undoubtedly glad of it, since his mission was successful only if no one noticed it. As an Apple director and head of a three-member panel assigned to investigate the Apple backdating scandal, he had the courage to be unconvincing—excusing Mr. Jobs of everything except naiveté about the finer points of accounting rules for management stock options.

For a CEO, it’s usually one strike and you’re out. The former head of H-P had two.

The two cases are similar enough in the ways that matter. Mr. Hurd was a CEO highly valued by the stock market. His offenses were piddling enough that even now we can’t get a persuasive statement of them. One difference, though, is that this would have been the second time the H-P board had to mount a rescue operation for Mr. Hurd. In the CEO’s job, one strike and you’re usually out. Mr. Hurd has had two.

Let’s recall a little history. H-P in recent years has been a problem child of Silicon Valley, and of this column. We defended Carly Fiorina against her critics, and her strategic gropings have played a role in the company’s relative success in recent years. We’ll defend Mark Hurd too, for his ruthless devotion to efficiency, for executing on what was essentially Ms. Fiorina’s choice to keep H-P together, to get bigger and try to latch on to the convergence of consumer electronics and information technology toward the cloudization of everything.

An early bump in the road, though, was his role in the 2006 scandal in which the company, attempting to quell leaks from its soap-operatic board, employed private investigators to steal the phone records of board members and journalists. You will remember the flaying and humiliation of H-P’s highly reputed board chairwoman, Patricia Dunn, who became the primary fall person.

You are less likely to recall the unconvincing press conference of Mr. Hurd, in which he tried to project an air of “accountability” while simultaneously claiming to have been remote from the shenanigans.

We gave an ironic rendition of his performance here in a column on Sept. 27, 2006. Mr. Hurd admitted what he couldn’t deny, including directly authorizing the seminal dirty trick, namely using an email scam to lure a reporter into exposing her sources. Otherwise, he adopted every minimizing adjective in the book, as did his board, as did the media, all playing along with the company’s strategy of saving Mr. Hurd at the expense of Ms. Dunn.

Today, all the other stuff you hear may be true—that Mr. Hurd was unpopular because he brutally cut jobs, cut costs, cut research spending, imposed discipline, and did so without conspicuously feeling the pain he imposed on others. In other words, a lot of what you hear are the sickly moanings of the vaunted “H-P way”—a set of admirable teamwork principles that nowadays is mostly invoked to resist unwelcome change.

Such mythologies have a way of becoming entrenched just as they’re least useful. Mr. Hurd’s style of wearing himself out against this brick wall of conceit may have been different than Ms. Fiorina’s style of wearing herself out against it. But both were done in by the same thing, essentially, even as each had their successes in moving the company beyond it. We’re guessing the same will be true of the next CEO too.

Holman Jenkins Jr., Wall Street Journal


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The Great American Bond Bubble

If 10-year interest rates, which are now 2.8%, rise to 4% as they did last spring, bondholders will suffer a capital loss more than three times the current yield.

Ten years ago we experienced the biggest bubble in U.S. stock market history—the Internet and technology mania that saw high-flying tech stocks selling at an excess of 100 times earnings. The aftermath was predictable: Most of these highfliers declined 80% or more, and the Nasdaq today sells at less than half the peak it reached a decade ago.

A similar bubble is expanding today that may have far more serious consequences for investors. It is in bonds, particularly U.S. Treasury bonds. Investors, disenchanted with the stock market, have been pouring money into bond funds, and Treasury bonds have been among their favorites. The Investment Company Institute reports that from January 2008 through June 2010, outflows from equity funds totaled $232 billion while bond funds have seen a massive $559 billion of inflows.

We believe what is happening today is the flip side of what happened in 2000. Just as investors were too enthusiastic then about the growth prospects in the economy, many investors today are far too pessimistic.

The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout.

Shorter-term Treasury bonds are yielding even less. The interest rate on standard noninflation-adjusted Treasury bonds due in four years has fallen to 1%, or 100 times its payout. Inflation-adjusted bonds for the next four years have a negative real yield. This means that the purchasing power of this investment will fall, even if all coupons paid on the bond are reinvested. To boot, investors must pay taxes at the highest marginal tax rate every year on the inflationary increase in the principal on inflation-protected bonds—even though that increase is not received as cash and will not be paid until the bond reaches maturity.

Today the purveyors of pessimism speak of the fierce headwinds against any economic recovery, particularly the slow deleveraging of the household sector. But the leveraging data they use is the face value of the debt, particularly the mortgage debt, while the market has already devalued much of that debt to pennies on the dollar.

This suggests that if the household sector owes what the market believes that debt is worth, then effective debt ratios are much lower. On the other hand, if households do repay most of that debt, then the financial sector will be able to write-up hundreds of billions of dollars in loans and mortgages that were marked down, resulting in extraordinary returns. In either scenario, we believe U.S. economic growth is likely to accelerate.

Furthermore, economists generally agree that the most important determinant for long-term economic growth is productivity, not consumer demand. Despite the subpar productivity growth reported for the last quarter, the latest year-over-year productivity growth of 3.9% is almost twice the long-term average. For the first two quarters of this year productivity growth, at over 6%, was the highest since the 1960s.

From our perspective, the safest bet for investors looking for income and inflation protection may not be bonds. Rather, stocks, particularly stocks paying high dividends, may offer investors a more attractive income and inflation protection than bonds over the coming decade.

Yes, we can hear the catcalls now. Stock returns calculated off the broad-based indexes have been horrendous over the last decade. In 2009, the percentage decline in aggregate dividends was the largest since the Great Depression. But remember the last decade began at the peak of the technology bubble.

Those who bought “value” stocks during the tech bubble—stocks with good dividend yields and low price-to-earnings ratios—have done much better. From December 1999 through July 2010, the Russell 3000 Value Index returned 35% cumulatively while the Russell 3000 Index of all stocks still showed a loss.

Today, the 10 largest dividend payers in the U.S. are AT&T, Exxon Mobil, Chevron, Procter & Gamble, Johnson & Johnson, Verizon Communications, Phillip Morris International, Pfizer, General Electric and Merck. They sport an average dividend yield of 4%, approximately three percentage points above the current yield on 10-year TIPS and over one percentage point ahead of the yield on standard 10-year Treasury bonds. Their average price-earnings ratio, based on 2010 estimated earnings, is 11.7, versus 13 for the S&P 500 Index. Furthermore, their earnings this year (a year that hardly could be considered booming economically) are projected to cover their dividend by more than 2 to 1.

Due to economic growth the dividends from stocks, in contrast with coupons from bonds, historically have increased more than the rate of inflation. The average dividend income from a portfolio of S&P 500 Index stocks grew at a rate of 5% per year since the index’s inception in 1957, fully one percentage point ahead of inflation over the period. That growth rate includes the disastrous dividend reductions that occurred in 2009, the worst year for dividend cuts by far since the Great Depression.

Those who are now crowding into bonds and bond funds are courting disaster. The last time interest rates on Treasury bonds were as low as they are today was in 1955. The subsequent 10-year annual return to bonds was 1.9%, or just slightly above inflation, and the 30-year annual return was 4.6% per year, less than the rate of inflation.

Furthermore, the possibility of substantial capital losses on bonds looms large. If over the next year, 10-year interest rates, which are now 2.8%, rise to 3.15%, bondholders will suffer a capital loss equal to the current yield. If rates rise to 4% as they did last spring, the capital loss will be more than three times the current yield. Is there any doubt that interest rates will rise over the next two decades as the baby boomers retire and the enormous government entitlement programs kick into gear?

With future government finances so precarious, private asset accumulation and dividend income must become the major sources of retirement funding. At current interest rates, government bonds will not be the answer. One hundred times earnings was the tipping point for the tech market a decade ago. We believe that the same is now true for government bonds.

Mr. Siegel is a professor of finance at the University of Pennsylvania’s Wharton School and a senior adviser to WisdomTree Inc. Mr. Schwartz is the director of research at WisdomTree Inc.


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Japan as Number Three

Beijing’s rise, Tokyo’s fall and the wealth of nations.

Younger readers may find this hard to believe, but a mere 20 years ago America’s political and academic establishments viewed Japan as the world’s ascendant economic power. “Japan as Number One” was the title of an influential book by Harvard’s Ezra Vogel, and the journalistic fashion was to lament that while Japan had lost to America in war it had triumphed over the U.S. as an economic competitor.

That inevitability has turned to irony on the news that China has now supplanted Japan as the world’s second largest economy. Such a result was hard to imagine a generation ago, and Japan still far outstrips China in per capita GDP and standard of living.

But the relative growth trends are undeniable, as the nearby chart shows. From 1990 through 2009, China grew by an average of nearly 10% a year, while Japan endured a sharp growth deceleration from its postwar glory years to well under 2% a year. As one nation rises rapidly out of poverty, another has at best settled into a prosperous stagnation.

It’s worth pondering the reasons for this Asian reversal, and its implications. One obvious, if too often forgotten, lesson is that the wealth of a nation is not a birthright. Prosperity has to be earned year after year, through sound economic policies that unleash the natural talents of a nation’s people.


For China, the breakthrough event was Deng Xiaoping’s opening to the world and free markets in 1978. First in agriculture, and later in other industries, China became a remarkably entrepreneurial place. As our Hugo Restall wrote in 2008, the government share of GDP shrank to about 11% in the early 2000s from 31% in 1978. China unilaterally cut tariffs, joined the World Trade Organization, and forced state-owned companies to shape up and meet new competition. China is still benefitting from the growth momentum of those decisions.

Japan, meanwhile, was moving in the opposite direction. In 1984, we wrote an editorial, “Japan as No. 21,” which described how Japan ranked 21st at that time out of 23 developed countries in government revenue as a share of GDP: 27%, according to the Organization for Economic Cooperation and Development (OECD). In spending, it was dead last at 26%. No longer. Japan has imposed a value-added tax and government spending as a share of GDP is closer to 40%.

After its property and stock bubbles burst in 1990, Japan also embarked on what may have been the longest and most expensive Keynesian policy experiment in world history. (See “Barack Obama-san,” Dec. 16, 2008.) This has taken debt as a share of GDP to nearly 200% while doing very little for growth. Japan has also failed to reform its own version of perverse government-sponsored enterprise, the postal savings system, among other domestic barriers to competition.

A visitor to Japan will still see an affluent nation, but its relative decline has been striking. Derek Scissors of the Heritage Foundation notes that Japan now ranks roughly 40th in measures of personal income and that the average Japanese is now poorer than the average citizen of Mississippi. A lost generation of growth has compounding consequences.

Another comparative economic question concerns not merely policy but national will. Emerging from defeat in World War II, the Japanese people were bent on rising again, albeit peacefully. Their social cohesion and corporate discipline built some of the world’s great companies, which still contribute to global well-being.

Tourists stop at a clothing shop in Tokyo Monday, Aug. 16, 2010. Japan lost its place as the world’s No. 2 economy to China in the second quarter as receding global growth sapped momentum and stunted a shaky recovery.

Now Japan’s population is aging, and older countries tend to be more risk-averse. Unlike the U.S. or Australia, Japan has never welcomed immigrants who could supply a younger generation of workers. Its political system seems unable to return to a pro-growth agenda.

Today, China is the more dynamic, confident nation, its people striving to make up for lost centuries and reassert themselves as the dominant regional power. China has its own problems with an aging population (thanks to its one-child policy), but the migration of tens of millions from countryside to cities gives it plenty of youthful talent.

The question is whether China can maintain its fantastic rate of growth as it runs up against the limits of one-party rule. Especially since the financial panic tarnished the U.S. economic model, the Chinese are increasingly touting their version of “state-directed” global business champions.

In a recent report for the U.S. Chamber of Commerce, old China hand James McGregor of APCO Worldwide shows how China is moving away from free market policies by sheltering domestic companies in seven key areas from competition. This will lead to less domestic efficiency and innovation, while courting a global trade backlash. Politically directed capital can flourish for a time but it inevitably founders on the lack of market discipline.

The economic rise of China has nevertheless been a great and welcome contribution to global prosperity, much as Japan’s rise was in the postwar decades. By contrast, Japan’s 20-year stagnation has been a tragedy for the world as well as for the Japanese people. Global prosperity is not a zero-sum game, and each nation needs to make its contribution.

Americans can take some comfort that at least through 2008 the U.S. had retained its global economic standing even as other nations rose and fell. The U.S. remains far and away the world’s largest economy, though China is gaining. The way to avoid Japan’s fate is to avoid the same policy mistakes, which means returning to the policies of the 1980s that revived the U.S. after the last Great Recession.

Editorial, Wall Street Journal


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The End of American Optimism

Our brief national encounter with optimism is now well and truly over. We have had the greatest fiscal and monetary stimulus in modern times. We have had a whole series of programs to pay people to buy cars, purchase homes, pay off their mortgages, weatherize their homes, and install solar paneling on their roofs. Yet the recovery remains feeble and the aftershocks of the post-bubble credit collapse are ongoing.

We are at least 2.5 million jobs short of getting back to the unemployment rate of under 8% promised by the Obama administration. Concern grows that we are looking at a double-dip recession and hovering on the brink of a destructive deflation. Things are bad enough for Federal Reserve Chairman Ben Bernanke to have characterized the economic outlook late last month as “unusually uncertain.”

Are we at the end of the post-World War II period of growth? Tons of money have been shoveled in to rescue reckless banks and fill the huge hole in the economy, but nothing is working the way it normally had in all our previous crises.

The Eastbay Works One-Stop Career Center, Oakland, Calif.

Rather, we are in what a number of economists are referring to as the “new normal.” This is a much slower-growing economy that, recent surveys have revealed, is causing many Americans to distance themselves from the long-held assumption that their children will have it better than they.

What was thought to be normal in the context of post-World War II recoveries? One is that four quarters into the recovery, real GDP would expand at an annual rate over 6%. We are coming out of the current recession at a 2.4% growth rate.

We did enjoy a GDP boost from a buildup of inventories anticipating a recovery at normal speed, but it didn’t happen. David Rosenberg, chief economist of Gluskin Sheff, regards it as “frightening” that whereas the “normal” rate of increase in final sales is 4% annually, this time sales have averaged only 1.2%, the weakest revival in recorded history.

At this point after the onset of a recession, employment payrolls have typically exceeded 700,000 jobs above the previous peak. In this recession, we are still down roughly eight million jobs from the December 2007 peak. As for consumer confidence, the Conference Board survey shows an average a full 20 points below the average lows of previous recessions.

There seems to be a structural change in the American economy. The relationship of household debt to income has proven unsustainable. The ratio is normally established somewhere below 100%, but in 2007 the debt ratio hit 131% of income. It has now fallen to 122%, but at this pace it would take another five years to bring it under 100%. The pre-bubble norm was 70%. To get to this ratio again, debt would have to be reduced by about $6 trillion.

In the meantime, we may well be looking at a vicious cycle of defaults that in turn would produce credit tightening and still more economic weakness—compounding the caution among borrowers, lenders and public financial authorities.

The most obvious source of distress right now is lack of payroll growth, and it’s likely to get worse. Real unemployment today is well above the headline number of 9.5%. That number held steady only because 1,115,000 people gave up hope of finding work and left the labor force in the last three months. Otherwise the headline unemployment rate would have been around 10.4%.

Now there are at least 14.5 million Americans still searching for work: 1.4 million of them have been jobless for more than 99 weeks, 6.5 million have been jobless for over 27 weeks. This is a stunning reflection of the longer-term unemployment we are coping with.

The unemployment numbers are worse than reported. Last year the Labor Department admitted it over-counted the number of jobs by 1.4 million. Why? Because they used a computer program that tries to extrapolate how many new companies are being created during each month and then estimates the number of jobs these firms should be creating. They were wrong.

Since April, the Labor Department has counted 550,000 nonexistent jobs under this so-called birth/death series. Without these phantom jobs, the economy this year created virtually no jobs—certainly not the 600,000 the administration has been touting.

The Obama administration projects the unemployment rate will drop to 8.7% by the end of next year and 6.8% by 2013. That is totally unrealistic. It means we would have to add nearly 300,000 jobs a month over the next three years. At the rate we’re going, it will take anywhere from six to nine years to climb out of this hole. The labor market may be improving, but the pace is glacial.

If there is one great policy failure of this recession, it’s that we have not used the crisis to introduce structural reforms. For example, we have a gross mismatch of available skills and demonstrable needs. Businesses struggle to find the skills and talents that are needed to compete in this new world. Millions drawing the dole to sit around should be in training for the jobs of the future that require higher educational skills.

Given that nearly eight in 10 new jobs, according to the administration, will require work-force training or higher education, it furthermore makes no sense that we have reversed the traditional American policy of welcoming skilled immigrants and integrating them into our economy. Because of a recrudescent nativism, we send home thousands upon thousands of foreign students who have gotten masters and doctoral degrees in the hard sciences at American universities. These are people who create jobs, not displace them. The incorporation of immigrants used to be one of the core competencies of our economy. It’s time to return to that successful model.

Higher education is another critical issue. As President Obama pointed out last week in his speech at the University of Texas, we have fallen from first to 12th in college graduation rates for young adults. The unemployment rate for those who have never gone to college is almost double what it is for those who have.

Education may be the key economic issue of our time, Mr. Obama said in his speech, for “countries that out-educate us today . . . will out-compete us tomorrow.” To improve our performance will involve massive increases in scholarship support for higher education, and an increase in H-1B visas for foreign students who get M.A.s and Ph.D.s in the hard sciences.

But if the economic scene these days is daunting, the political scene is downright depressing. We have a paralyzed system. Neither the Democrats nor the Republicans seem able to find common ground to address what is clearly going to be an ongoing employment crisis. Finding that common ground is a job opportunity for real leaders.

Mr. Zuckerman is chairman and editor in chief of U.S. News & World Report.


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Fire and Imagination

The Obama administration seems to be feeling sorry for itself. Robert Gibbs, the president’s press secretary, is perturbed that Mr. Obama is not getting more hosannas from liberals.

Spare me. The country is a mess. The economy is horrendous, and millions of American families are running out of ammunition in their fight against destitution. Steadily increasing numbers of middle-class families, who never thought they’d be seeking charity, have been showing up at food pantries.

The war in Afghanistan, with its dreadful human toll and debilitating drain on the nation’s financial resources, is proceeding as poorly as ever. As The Times reported on Friday, an ambitious operation that was supposed to showcase the progress of the Afghan Army turned into a tragic, humiliating debacle.

And while schools are hemorrhaging resources because of budget meltdowns, and teachers are losing jobs, and libraries are finding it more and more difficult to remain open, American youngsters are falling further behind their peers in other developed countries in their graduation rates from colleges and universities.

This would be a good time for the Obama crowd to put aside its concern about the absence of giddiness among liberals and re-examine what it might do to improve what is fast becoming a depressing state of affairs.

It’s not just liberals who are gloomy. A Wall Street Journal/NBC News poll this week found that nearly 6 in 10 Americans believe the country is on the wrong track and a majority disapproves of President Obama’s handling of the economy. Nearly two-thirds expect the economy to get worse still.

Mr. Obama’s problem — and the nation’s — is that in the midst of the terrible economic turmoil that the country was in when he took office, he did not make full employment, meaning job creation in both the short and the long term, the nation’s absolute highest priority.

Besides responding to the nation’s greatest need, job creation would have been the one issue most likely to bolster Mr. Obama’s efforts to bring people of different political persuasions together. In the early months of 2009, with job losses soaring past a half-million a month and the country desperate for bold, creative leadership, the president had an opportunity to rally the nation behind an enormous “rebuild America” effort.

Such an effort, properly conceived, would have put millions to work overhauling the nation’s infrastructure, rebuilding our ports and transportation facilities to 21st-century standards, establishing a Manhattan Project-like quest for a brave new world of clean energy, and so on.

We were going to spend staggering amounts of money in any event. There was every reason to use those enormous amounts of public dollars to leverage private capital, as well, for investment in projects and research that the country desperately needs and that would provide enormous benefits for many decades. Think of the returns the nation reaped from its investments in the interstate highway system, the Land Grant colleges, rural electrification, the Erie and Panama canals, the transcontinental railroad, the technology that led to the Internet, the Apollo program, the G.I. bill.

The problem with the U.S. economy today, as it was during the Great Depression, is the absence of sufficient demand for goods and services. Consumers, struggling with sky-high unemployment and staggering debt loads, are tapped out. The economy cannot be made healthy again, and there is no chance of doing anything substantial about budget deficits, as long as so many millions of people are left with essentially no purchasing power. Jobs are the only real answer.

President Obama missed his opportunity early last year to rally the public behind a call for shared sacrifice and a great national mission to rebuild the United States in a way that would create employment for millions and establish a gleaming new industrial platform for the great advances of the 21st century.

It would have taken fire and imagination, but the public was poised to respond to bold leadership. If the Republicans had balked, and they would have, the president had the option of taking his case to the people, as Truman did in his great underdog campaign of 1948.

During the Depression, Franklin Roosevelt explained to the public the difference between wasteful spending and sound government investments. “You cannot borrow your way out of debt,” he said, “but you can invest your way into a sounder future.”

Now, with so much money already spent and Republicans expected to gain seats in the Congressional elections, the president finds himself with a much weaker hand, even if he were inclined to play it boldly.

What that will mean in the real world of ordinary Americans is that even if there is a fretful recovery from the Great Recession, millions will be left out of it. Hope has morphed into widespread gloom as widespread economic suffering becomes the new normal in America.

Bob Herbert, New York Times


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End of the Net Neut Fetish

What the Google-Verizon deal really means for the wireless future.

Historians, if any are interested, will conclude that the unraveling of the net neutrality movement began when the iPhone appeared, instigating a tsunami of demand for mobile Web access.

They will conclude that an ancillary role was played when carriers (even some non-wireless) began talking about metered pricing to meet the deluge of Internet video.

Suddenly, those net neut advocates who live in the real world (e.g., Google) had to face where their advocacy was leading—to usage-based pricing for mobile Web users, a dagger aimed at the heart of their own business models. After all, who would click on a banner ad if it meant paying to do so?

Thus Google and other realists developed a new appreciation of the need for incentives to keep their telco and cable antagonists investing in new broadband capacity. They developed an appreciation of “network management,” though it meant discriminating between urgent and less urgent traffic.

Most of all, they realized (whisper it quietly) that they might soon want to pay out of their own pockets to speed their bits to wireless users, however offensive to the net neutrality gods.

Hence a watershed this week in the little world of the net neut obsessives, as the realists finally parted company with the fetishists. The latter are those Washington-based groups that have emerged in recent years to gobble up Google’s patronage and declaim in favor of “Internet freedom.” You can easily recognize these groups today—they’re the ones taking Google’s name in vain.

The unraveling of the net neut coalition is perhaps the one meaningful result of the new net neut “principles” enunciated this week by former partisans Google and Verizon.

While these principles address in reasonable fashion the largely hypothetical problem of carriers blocking content and services that compete with their own, Verizon and Google insist the terms aren’t meant to apply to wireless. Funny thing—because wireless is precisely what brings these ex-enemies together in the first place. They’re partners in promoting Google’s Android software as a rival platform to Apple’s iPhone.

All their diversionary huffing and puffing, in fact, is a backhanded way of acknowledging reality: The future is mobile, and anything resembling net neutrality on mobile is a nonstarter thanks to the problem of runaway demand and a shortage of spectrum capacity.

Tasteless as it may be to toot our own horn, this column noted the dilemma last year, even forecasting Google’s coming apostasy on net neutrality. Already it was clear that only two economic solutions existed to a coming mobile meltdown. Either wireless subscribers would have to face usage-based pricing, profoundly disturbing the ad-based business models of big players whose services now appear “free” to users. Or Google and its ilk would have to be “willing to subsidize delivery of their services to mobile consumers—which would turn net neut precisely on its head.”

Our point was that the net neut fetish was dead, and good riddance. All along, competition was likely to provide a more reasonable and serviceable definition of “net neutrality” than regulators could ever devise or enforce. That rough-and-ready definition would allow carriers to discriminate in ways that consumers, on balance, are willing to put up with because it enables acceptable service at an acceptable price.

Even now, Google and its CEO Eric Schmidt, in their still-conflicted positioning, argue that the wired Internet has qualities of a natural monopoly, because most homes are dependent on one cable modem supplier. This treats the phone companies’ DSL and fiber services as if they don’t exist. It also overlooks how people actually experience the Internet.

Users don’t just get the Internet at home, but at work and on their mobile devices, and they won’t stand for being denied on one device services and sites they’re used to getting on the others. That is, they won’t unless there’s a good reason related to providing optimum service on a particular device.

You don’t have to look far for an example: Apple iPhone users put up with Apple’s blocking of most Web video on the iPhone because, on the whole, the iPhone still provides a satisfying service.

This is the sensible way ahead as even Google, a business realist, now seems to recognize. The telecom mavens at Strand Consult joke that Google is a “man with deep pockets and short arms, who suddenly disappears when the waiter brings the bill.” Yes, on the wired Net, Google remains entrenched in the position that network providers must continue to bury the cost to users of Google’s services uniformly across the bills of all broadband subscribers.

That won’t work on the wireless battlefield, and Google knows it. Stay tuned as the company’s business interests trump the simple net neutrality that the fetishists believe in—and that Google used to believe in.

Holman W. Jenkins, Wall Street Journal


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German Millionaires Criticize Gates’ ‘Giving Pledge’

Negative Reaction to Charity Campaign


Microsoft founder Bill Gates.

Germany’s super-rich have rejected an invitation by Bill Gates and Warren Buffett to join their ‘Giving Pledge’ to give away most of their fortune. The pledge has been criticized in Germany, with millionaires saying donations shouldn’t replace duties that would be better carried out by the state.

Last week, Microsoft founder Bill Gates attempted to convince billionaires around the world to agree to give away half their money to charity. But in Germany, the “Giving Pledge,” backed by 40 of the world’s wealthiest people, including Gates and Warren Buffet, has met with skepticism, SPIEGEL has learned.

“For most people that is too ostentatious,” said the asset manager of one of the billionaires contacted by Gates, adding that many of the of the people contacted had already transferred larger proportions of their assets than the Americans to charitable foundations.

Dietmar Hopp, the co-founder of the SAP business software company, has transferred some €2.9 billion to a foundation. Klaus Tschira, another founder of SAP, has handed more than half his wealth to a foundation.

Peter Krämer, a Hamburg-based shipping magnate and multimillionaire, has emerged as one of the strongest critics of the “Giving Pledge.” Krämer, who donated millions of euros in 2005 to “Schools for Africa,” a program operated by UNICEF, explained his opposition to the Gates initiative in a SPIEGEL interview.

SPIEGEL: Forty super wealthy Americans have just announced that they would donate half of their assets, at the very latest after their deaths. As a person who often likes to say that rich people should be asked to contribute more to society, what were your first thoughts?

Krämer: I find the US initiative highly problematic. You can write donations off in your taxes to a large degree in the USA. So the rich make a choice: Would I rather donate or pay taxes? The donors are taking the place of the state. That’s unacceptable.

SPIEGEL: But doesn’t the money that is donated serve the common good?

Krämer: It is all just a bad transfer of power from the state to billionaires. So it’s not the state that determines what is good for the people, but rather the rich want to decide. That’s a development that I find really bad. What legitimacy do these people have to decide where massive sums of money will flow?

SPIEGEL: It is their money at the end of the day.

Krämer: In this case, 40 superwealthy people want to decide what their money will be used for. That runs counter to the democratically legitimate state. In the end the billionaires are indulging in hobbies that might be in the common good, but are very personal.

SPIEGEL: Do the donations also have to do with the fact that the idea of state and society is such different one in the United States?

Krämer: Yes, one cannot forget that the US has a desolate social system and that alone is reason enough that donations are already a part of everyday life there. But it would have been a greater deed on the part of Mr. Gates or Mr. Buffet if they had given the money to small communities in the US so that they can fulfil public duties.

SPIEGEL: Should wealthy Germans also give up some of their money?

Krämer: No, not in this form. It would make more sense, for example, to work with and donate to established organizations.


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Canada, Land of Smaller Government

Its corporate income tax rate is 18% and falling. America’s is 35%.

When Americans look to Canada, they generally think of an ally, though one dominated by socialist economic policies. But the Canada of the 1970s and early 1980s—the era of left-wing Prime Minister Pierre Trudeau—no longer exists. America’s northern neighbor has transformed itself economically over the last 20 years.

The Canadian reforms began in 1988 with a U.S. free trade pact that would lead to the North American Free Trade Agreement. But change really began to take off in 1993. A socialist-leaning government in Saskatchewan started by reducing spending and moving towards a balanced budget. This was followed by historic reforms by the Conservatives in Alberta, who relied on spending reductions to balance their budget quickly.

In 1995, the federal government, led by the Liberal Party, passed the most important budget in three generations. Federal spending was reduced almost 10% over two years and federal employment was slashed 14%. By 1998, the federal government was in surplus and reducing the nearly $650 billion national debt. Provincial governments similarly focused on eliminating deficits by paring spending and reducing debt, and then they started to offer tax relief.

All government spending peaked at 53% of Canadian GDP in 1992 and fell steadily to just under 40% by 2008. (Government spending in the U.S. was 38.8% of GDP that year.) The recession has caused government spending to increase in both countries. But if present trends continue, within two or three years Canada will have a smaller government as a share of its economy than the U.S.

Canadian taxes have also come down at the federal and provincial level. They were reduced with the stated goal of improving incentives for work effort, savings, investment and entrepreneurship.

Jean Chrétien (a Liberal) won elections in 1993, 1997 and 2000 by promising to balance the books, to prioritize federal spending to ensure that government was doing what was needed, and also to deliver tax relief. Mr. Chrétien’s former finance minister, Paul Martin, became prime minister in 2003, but he lost power to the Conservative Party in 2006, in part because he moved away from some of the Chrétien principles.

Tellingly, the last three Canadian elections have all had key debates on tax relief—not whether there should be tax cuts but rather what type of tax cuts. Beginning in 2001 under a Liberal government, even the politically sensitive federal corporate income tax rate has been reduced. It is now 18%, down from 28%, and the plan is to reduce it to 15% in 2012. The U.S. federal rate is 35%.

Yet much of the tax relief since 2000 has been on personal income taxes. The bottom two personal income tax rates have been reduced, and the income thresholds for all four rates have been increased and indexed to inflation. Canada has also reduced capital gains taxes twice (the rate is now 14.5%), cut the national sales tax to 5% from 7%, increased contribution limits to the Canadian equivalent of 401(k)s, and created new accounts similar to Roth IRAs.

Government austerity has been accompanied by prosperity. According to the Organization for Economic Cooperation and Development (OECD), between 1997 and 2007 Canada’s economic performance outstripped the OECD average and led the G-7 countries. Growth in total employment in Canada averaged 2.1%, compared to an OECD average of 1.1%.

During the mid-1990s, Canada’s commitment to reform allowed it to tackle two formerly untouchable programs: welfare and the Canada Pension Plan (CPP), equivalent to Social Security in the U.S. Over three years, federal and provincial governments agreed to changes that included investing surplus contributions in market instruments such as stocks amd bonds, curtailing some benefits, and increasing the contribution rate. The CPP is financially solvent and will be able to weather the retiring baby boomers.

The one area Canada has been slow to reform is health care, which continues to be dominated by government. However, some provinces have allowed a series of small experiments: a completely private emergency hospital in Montreal and several private clinics in Vancouver. British Columbia and Alberta also are experimenting with market-based payments to hospitals. While these are incremental steps, the path in Canada is fairly clear: More markets and choice will exist in the future. The trend in the U.S. is the opposite.

Most strikingly, Canada is emerging more quickly from the recession than almost any industrialized country. It’s unemployment rate, which peaked at 9% in August 2009, has already fallen to 7.9%. Americans can learn much by looking north.

Mr. Clemens is the director of research at the Pacific Research Institute and a co-author of “The Canadian Century: Moving Out of America’s Shadow” (Key Porter Books, 2010).


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Defining Prosperity Down

I’m starting to have a sick feeling about prospects for American workers — but not, or not entirely, for the reasons you might think.

Yes, growth is slowing, and the odds are that unemployment will rise, not fall, in the months ahead. That’s bad. But what’s worse is the growing evidence that our governing elite just doesn’t care — that a once-unthinkable level of economic distress is in the process of becoming the new normal.

And I worry that those in power, rather than taking responsibility for job creation, will soon declare that high unemployment is “structural,” a permanent part of the economic landscape — and that by condemning large numbers of Americans to long-term joblessness, they’ll turn that excuse into dismal reality.

Not long ago, anyone predicting that one in six American workers would soon be unemployed or underemployed, and that the average unemployed worker would have been jobless for 35 weeks, would have been dismissed as outlandishly pessimistic — in part because if anything like that happened, policy makers would surely be pulling out all the stops on behalf of job creation.

But now it has happened, and what do we see?

First, we see Congress sitting on its hands, with Republicans and conservative Democrats refusing to spend anything to create jobs, and unwilling even to mitigate the suffering of the jobless.

We’re told that we can’t afford to help the unemployed — that we must get budget deficits down immediately or the “bond vigilantes” will send U.S. borrowing costs sky-high. Some of us have tried to point out that those bond vigilantes are, as far as anyone can tell, figments of the deficit hawks’ imagination — far from fleeing U.S. debt, investors have been buying it eagerly, driving interest rates to historic lows. But the fearmongers are unmoved: fighting deficits, they insist, must take priority over everything else — everything else, that is, except tax cuts for the rich, which must be extended, no matter how much red ink they create.

The point is that a large part of Congress — large enough to block any action on jobs — cares a lot about taxes on the richest 1 percent of the population, but very little about the plight of Americans who can’t find work.

Well, if Congress won’t act, what about the Federal Reserve? The Fed, after all, is supposed to pursue two goals: full employment and price stability, usually defined in practice as an inflation rate of about 2 percent. Since unemployment is very high and inflation well below target, you might expect the Fed to be taking aggressive action to boost the economy. But it isn’t.

It’s true that the Fed has already pushed one pedal to the metal: short-term interest rates, its usual policy tool, are near zero. Still, Ben Bernanke, the Fed chairman, has assured us that he has other options, like holding more mortgage-backed securities and promising to keep short-term rates low. And a large body of research suggests that the Fed could boost the economy by committing to an inflation target higher than 2 percent.

But the Fed hasn’t done any of these things. Instead, some officials are defining success down.

For example, last week Richard Fisher, president of the Federal Reserve Bank of Dallas, argued that the Fed bears no responsibility for the economy’s weakness, which he attributed to business uncertainty about future regulations — a view that’s popular in conservative circles, but completely at odds with all the actual evidence. In effect, he responded to the Fed’s failure to achieve one of its two main goals by taking down the goalpost.

He then moved the other goalpost, defining the Fed’s aim not as roughly 2 percent inflation, but rather as that of “keeping inflation extremely low and stable.”

In short, it’s all good. And I predict — having seen this movie before, in Japan — that if and when prices start falling, when below-target inflation becomes deflation, some Fed officials will explain that that’s O.K., too.

What lies down this path? Here’s what I consider all too likely: Two years from now unemployment will still be extremely high, quite possibly higher than it is now. But instead of taking responsibility for fixing the situation, politicians and Fed officials alike will declare that high unemployment is structural, beyond their control. And as I said, over time these excuses may turn into a self-fulfilling prophecy, as the long-term unemployed lose their skills and their connections with the work force, and become unemployable.

I’d like to imagine that public outrage will prevent this outcome. But while Americans are indeed angry, their anger is unfocused. And so I worry that our governing elite, which just isn’t all that into the unemployed, will allow the jobs slump to go on and on and on.

Paul Krugman, New York Times


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Another Dead-End Summit

Going up the garden path, again. Barack Obama accompanied by fellow ramblers Jose Manuel Barroso, Silvio Berlusconi, Angela Merkel at Nicolas Sarkozy during the G-8 summit in Canada on June 25.

Marked by the EU-US divide over the best way out of the crisis, the world leaders at the G-20 summit in Toronto spurned Europe’s proposals to tax banks and regulate markets. The only consensus reached was on deficit reduction, an objective championed by all 27 EU member states. European papers are scathing in their editorials on the G-20 gathering.

“A summit that could just as well not have been held,” writes Poland’s Dziennik Gazeta Prawna, offering its final verdict on last weekend’s G-20 summit. “In Toronto, the G-20 leaders didn’t solve a single economic problem,” the daily adds. “The world’s most influential politicians were unable to agree on anything tangible,” particularly “on the principle of a global bank levy or on the instruments to bolster bank capital.”

Likewise, France’s Libération pronounces “the ‘Gs’ at a standstill.” “The Huntsville G-8 and Toronto G-20 displayed more differences of opinion than progress in getting out of the crisis. The idea of a bank levy or international financial tax has been shelved indefinitely, and everyone pledged to cut deficits, to be sure, but on their own terms.”

Germany’s Frankfurter Allgemeine Zeitung, which advocates liberalizing international trade as the crisis remedy, says the G-8 and last weekend’s G-20 once again proved how ineffectual summits are. “The fact that certain industrialized countries are incapable of listening to emerging countries’ wishes and opinions jeopardizes the future of the G-20,” writes the FAZ, particularly in view of the EU’s attempt to tax financial transactions in the face of opposition from emerging countries that were spared by the crisis.

“Their pique should induce Europeans to wonder whether such taxes make any sense and give up on them,” the German daily opines. “If the point of the G-20 is to sign off on European ideas, we might as well give it up. And if the G-20 is to become a serious international economic forum, it would be a pipedream to imagine that European notions are the measure of all things,” the FAZ editorial concludes.

Every Man for Himself

“The G-20 has ushered in the return of ‘every man for himself’,” bemoans France’s Le Figaro. “The attempt to define a consensus-based economic policy to get out of the crisis proved abortive. Between a Germany obsessed with cutting deficits … a United States that is fretful about hamstringing growth by excessive austerity and a France halfway between the two, a common guideline is nowhere in sight. The G-20, which was created at the peak of financial turmoil, has proved its utility in times of crisis. But the meeting in Toronto also bared its limitations. Global economic governance of one sort or another, which is already so hard to hammer out at the European level, is not about to be put in place overnight.”

In fact, explains Germany’s Die Tageszeitung, “The disagreements within the G-8 and G-20 now force (the conferees) to refocus on matters that can really be changed: For Europeans today, that means Europe.” So, concludes the TAZ, “The best news from this summit is that Merkel and Sarkozy seemed determined to tax financial transactions in Europe — or in the euro zone if London holds out.”

In spite of all, notes the EUobserver, “the statement on halving public deficits by 2013 was hailed as a victory for European politicians.” “By setting that target, the G-20 came to a close under the banner of German-brand rigour,” remarks La Repubblica. “The match played out” in Canada “was not Germany vs. the US,” even if “Angela Merkel might give the impression she won the day,” explains the Italian daily. “After having foisted its doctrine on Europe, Germany is now exporting it worldwide. Barack Obama, the last of the Keynesian leaders, seems to be beating a retreat. He did not convince Berlin of the benefits of states’ spending their way to growth. But appearances are deceiving, and Merkel’s triumph will soon prove a Pyrrhic victory. It serves to assuage the anxiety of the German public,” which favors fiscal rigour, and to “accelerate the marginalization of Europe” by shifting even faster “the geometries of power towards the new dynamics between America, China, India, Brazil and Russia.”


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Published and Perished

Glossy magazines—and parties—for the shiny time before Wall Street’s fall.

If a hustling Candide had told the story of the Great Wall Street Meltdown, it might read something like this book—a not-so-innocent’s chronicle of crafty charlatans and vulpine finaglers who left the hero dazed and diminished in the bankruptcy of his dreams.

Randall Lane’s notion with “The Zeroes” is to use the sad tale of his slick-magazine enterprise, Doubledown Media, as a proxy for the now-familiar story of the financial collapse. Doubledown published giveaway titles aimed at the nouveaux riches spawned by the big bubble. The publications had names like Trader Monthly, Dealmaker, Private Air, Corporate Leader and Cigar Report. The idea was to use other people’s money to leverage them into an international, multi-media publishing colossus that would make the founders as rich as their target readers.

“The Zeroes” was embargoed—until today—by the publisher in a marketing ploy meant to suggest that the sizzling content had to be safeguarded against leaks. But the book’s hot stuff turns out to be mostly lukewarm. The big news: The juiced ex-Mets baseball player-turned-stock-picker Lenny Dykstra supposedly traded access to Jim Cramer, CNBC’s screaming “Mad Money” man, for $250,000 in penny stock; the psychedelic-art hack Peter Max is a wily operator; and Wall Street sharks made even more money and behaved even worse than you imagined as the markets careened toward disaster in the first decade—the Zeroes—of the new century.

Mr. Lane, who started out in journalism helping compile Forbes magazine’s billionaire scorecards, is an ingenuous narrator who likes to remind the reader that he was essentially a schlump living in a fourth-floor walkup while his glossies burnished the egos and tweaked the appetites of Wall Street’s new wildcatters.

As the boom inflates, Mr. Lane teams up with a London-based publishing wizard in 2004 to launch Trader Monthly. Its pitch-perfect slogan: “See it. Make it. Spend it.” Over the next few years, they add editions in London and Dubai and acquire or start other titles. Soon the pair comes under the spell of a business-mag vet named Jim Dunning, who pumps his own millions into the enterprise and spins a vision of tiny Doubledown quadrupling down in a bid to become an international marketing machine stalking the new “working wealthy.”

The hunt for money to grow on puts Lane & Co. on a treadmill to oblivion. Mr. Lane meets with a grotesque assortment of bankers, venture capitalists, merger partners, potential acquirers and other scalawags. Black books and deal sheets are exchanged. Credit lines are dangled and jerked away. At one point his venture is valued at $25 million; at another, $17 million.

Such healthy valuations were strange because as “The Zeroes” goes along it becomes obvious that, while Mr. Lane’s company is churning out a half-million free copies a month, it is really in the business of staging parties. Advertisers and potential advertisers pay Doubledown for the privilege of pouring the latest designer vodka down the gullets of Wall Street’s new aristocracy, peddling $10,000 watches on the wrists of arm-candy models and enticing rich marks into $300,000 Maybach luxury sedans and time-share condos in Las Vegas.

Mr. Lane’s commercial bacchanals are tame compared with the blasts staged by others. One trader tells him of a golf outing where each twosome was assigned its own stripper. “The women would dangle on the back of the cart from hole to hole,” Mr. Lane writes, “and then prostrate themselves, legs open, on the putting greens, providing the traders a target.”

It isn’t until page 171 that the reader learns that all of Mr. Lane’s frenetic activity produced $3 million in annual losses for Doubledown in 2005, 2006 and 2007. The party addiction was so strong that on Sept. 16, 2008—the day the feds took over AIG, 24 hours after Lehman Brothers cratered—Dealmaker magazine gave a party for a thousand shell-shocked Wall Streeters.

Many sketchy types cross our hero’s path, but none can match Lenny Dykstra. The ballplayer nicknamed “Nails” had somehow morphed into Jim Cramer’s stock-handicapping protégé. Mr. Dykstra had just sold his West Coast car-wash business for $25 million and bought Wayne Gretzky’s L.A. mansion; he drove a Maybach, flew in his own jets and had an investment scheme for rich pro athletes called “The Players Club.” As portrayed in “The Zeroes,” Mr. Dykstra (who piggybacked on a pro’s stock tips) seems seriously demented. Among other tics, he likes to stay up for four or five days at a stretch before crashing. He freely admits to Mr. Lane that he used steroids while playing ball. Despite everything, Mr. Lane goes into business with him; it all ends in tears and surreal litigation.

Mr. Lane gets involved with a host of other characters: Henry Hill, the real-life “Goodfellas” turncoat booted from the federal witness-protection program; Jacob the Jeweler, the money launderer for Detroit’s Black Mafia drug gang; a thieving Caribbean prime minister; and Peter Max. The artist signs on to peddle paintings of the Wall Street icons celebrated in Mr. Lane’s magazines. Mr. Max’s ingenious “One-Plus-Three” gimmick is to do his supposedly single portraits as inseparable tetraptychs—and charge the subjects four times his usual rate.

All of this was as doomed as the credit-default-swap lunacy of those days. Despite his familiarity with money culture, Mr. Lane breaks the sacred code: He dumps $283,000 of his own—and $115,000 of his mother’s!— into the sinking ship and spends another $130,000 redeeming his personal pledge for the office lease. Doubledown winds up in Chapter 7 bankruptcy, its titles, contents and lists fetching $50,000 from a newsletter publisher.

He muses that, as in the old days of Wall Street partnerships, he had risked his own stake in his business. He’d lost half a million dollars but bought peace of mind. “Maybe, in that example,” he suggests, “there was a lesson for Wall Street.” Nope. After the bailout, bankers’ and traders’ bonuses for 2009 set a record. “The game played on, timeless and unabated,” Mr. Lane concedes, sadder and inescapably wiser.

Mr. Kosner is the author of “It’s News to Me,” a memoir of his career as editor of Newsweek, New York magazine, Esquire and the New York Daily News.


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Why Friedrich Hayek Is Making a Comeback

With the failure of Keynesian stimulus, the late Austrian economist’s ideas on state power and crony capitalism are getting a new hearing.

He was born in the 19th century, wrote his most influential book more than 65 years ago, and he’s not quite as well known or beloved as the sexy Mexican actress who shares his last name. Yet somehow, Friedrich Hayek is on the rise.

When Glenn Beck recently explored Hayek’s classic, “The Road to Serfdom,” on his TV show, the book went to No. 1 on Amazon and remains in the top 10. Hayek’s persona co-starred with his old sparring partner John Maynard Keynes in a rap video “Fear the Boom and Bust” that has been viewed over 1.4 million times on YouTube and subtitled in 10 languages.

Why the sudden interest in the ideas of a Vienna-born, Nobel Prize-winning economist largely forgotten by mainstream economists?

Friedrich Augustus Von Hayek, ca. 1940.

Hayek is not the only dead economist to have garnered new attention. Most of the living ones lost credibility when the Great Recession ended the much-hyped Great Moderation. And fears of another Great Depression caused a natural look to the past. When Federal Reserve Chairman Ben Bernanke zealously expanded the Fed’s balance sheet, he was surely remembering Milton Friedman’s indictment of the Fed’s inaction in the 1930s. On the fiscal side, Keynes was also suddenly in vogue again. The stimulus package was passed with much talk of Keynesian multipliers and boosting aggregate demand.

But now that the stimulus has barely dented the unemployment rate, and with government spending and deficits soaring, it’s natural to turn to Hayek. He championed four important ideas worth thinking about in these troubled times.

First, he and fellow Austrian School economists such as Ludwig Von Mises argued that the economy is more complicated than the simple Keynesian story. Boosting aggregate demand by keeping school teachers employed will do little to help the construction workers and manufacturing workers who have borne the brunt of the current downturn. If those school teachers aren’t buying more houses, construction workers are still going to take a while to find work. Keynesians like to claim that even digging holes and filling them is better than doing nothing because it gets money into the economy. But the main effect can be to raise the wages of ditch-diggers with limited effects outside that sector.

Second, Hayek highlighted the Fed’s role in the business cycle. Former Fed Chairman Alan Greenspan’s artificially low rates of 2002-2004 played a crucial role in inflating the housing bubble and distorting other investment decisions. Current monetary policy postpones the adjustments needed to heal the housing market.

Third, as Hayek contended in “The Road to Serfdom,” political freedom and economic freedom are inextricably intertwined. In a centrally planned economy, the state inevitably infringes on what we do, what we enjoy, and where we live. When the state has the final say on the economy, the political opposition needs the permission of the state to act, speak and write. Economic control becomes political control.

Even when the state tries to steer only part of the economy in the name of the “public good,” the power of the state corrupts those who wield that power. Hayek pointed out that powerful bureaucracies don’t attract angels—they attract people who enjoy running the lives of others. They tend to take care of their friends before taking care of others. And they find increasing that power attractive. Crony capitalism shouldn’t be confused with the real thing.

The fourth timely idea of Hayek’s is that order can emerge not just from the top down but from the bottom up. The American people are suffering from top-down fatigue. President Obama has expanded federal control of health care. He’d like to do the same with the energy market. Through Fannie and Freddie, the government is running the mortgage market. It now also owns shares in flagship American companies. The president flouts the rule of law by extracting promises from BP rather than letting the courts do their job. By increasing the size of government, he has left fewer resources for the rest of us to direct through our own decisions.

Hayek understood that the opposite of top-down collectivism was not selfishness and egotism. A free modern society is all about cooperation. We join with others to produce the goods and services we enjoy, all without top-down direction. The same is true in every sphere of activity that makes life meaningful—when we sing and when we dance, when we play and when we pray. Leaving us free to join with others as we see fit—in our work and in our play—is the road to true and lasting prosperity. Hayek gave us that map.

Despite the caricatures of his critics, Hayek never said that totalitarianism was the inevitable result of expanding government’s role in the economy. He simply warned us of the possibility and the costs of heading in that direction. We should heed his warning. I don’t know if we’re on the road to serfdom, but wherever we’re headed, Hayek would certainly counsel us to turn around.

Mr. Roberts teaches economics at George Mason University and co-created the “Fear the Boom and Bust” rap video with filmmaker John Papola. His latest book is “The Price of Everything” (Princeton, 2009).


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Five Best Books on American Moguls

T.J. Stiles says these mogul biographies offer rich rewards

1. Andrew Carnegie

By Joseph Frazier Wall

Oxford, 1970

In the past few decades we have seen a sweeping reassessment of the so-called robber barons of the 19th and early 20th centuries. The trend began in 1970 with Joseph Frazier Wall’s “Andrew Carnegie”—a groundbreaking work that remains a pleasure to read. By turns a thoughtful sifter of the evidence, a sharp and amusing portraitist, and a storyteller with real panache, Wall brings a gift for clarity to both historical context and the blow-by-blow of business battles. His tales of intrigue among Carnegie’s partners are particularly vivid. Carnegie wore many guises—he got his start as an entrepreneur through sweetheart deals, proved a ruthlessly efficient steelmaker and aspired to influence world affairs—and this book artfully integrates them all.

2. The Life and Legend of Jay Gould

By Maury Klein

Johns Hopkins, 1986

Jay Gould’s “reputation for being cold and aloof,” writes Maury Klein, “owed much to the fact that he was a shy, reserved man whose emotions registered on so small a scale, such as tearing bits of paper or tapping a pencil, that only initiates recognized them.” Such insight and literary grace explain why Klein’s “The Life and Legend of Jay Gould” remains the definitive work on this controversial tycoon. The author narrates with wry humor and verve such episodes as the corruption-riddled battle among financiers for control of the Erie Railroad in 1868 and Gould’s attempt to corner the gold market in 1869. But Klein’s greatest contribution may be in describing Gould’s later years, when he proved a master corporate strategist, building an empire around the Missouri Pacific railroad.

3. Morgan

By Jean Strouse

Random House, 1999

As America’s leading banker, J.P. Morgan played a role unlike any other business titan of his age, influencing one industry after another. He reorganized the chaotic railroads and forged U.S. Steel and General Electric—in other words, he was the father of the trusts that others set out to bust. “When the federal government ran out of gold in 1895, Morgan raised $65 million and made sure it stayed in the Treasury’s coffers,” writes Jean Strouse in this elegant biography. “When a panic started in New York in 1907, he led teams of bankers to stop it.” Strouse is masterly, whether addressing finance, family, art or the human condition. Her portrait of Morgan’s first rare-book librarian, Belle da Costa Greene—the daughter of Harvard’s first black graduate, she passed as Portuguese—is but one example of Strouse’s literary gifts and appreciation for the importance of secondary characters in a good biography.

4. Fallen Founder

By Nancy Isenberg

Viking, 2007

It is not easy to get a fair hearing when you have killed the man on the $10 bill. But Aaron Burr is treated with scholarly care and writerly sympathy by Nancy Isenberg in “Fallen Founder.” A hero in the American Revolution and the country’s third vice president, Burr founded the forerunner of J.P. Morgan Chase: the Manhattan Co., a water company and bank. He pioneered modern political methods by systematically identifying and organizing voters, contributors and activists. Isenberg offers evidence that Burr was no villain in the 1804 duel that killed Alexander Hamilton. Three years later, Burr was arrested for what his enemies called a conspiracy to set up an independent state in the west; he was tried for treason and exonerated, then went on to become an influential New York lawyer. An astonishing life.

5. Pulitzer

By James McGrath Morris

Harper, 2010

Today’s reporters and media tycoons would do well to study James McGrath Morris’s life of Joseph Pulitzer, the journalist, editor and entrepreneur. A proverbial penniless immigrant (a German-speaking Hungarian Jew), Pulitzer fought for the Union in the Civil War, then moved to St. Louis. There he learned English and the news business. His rapid rise in journalism was interwoven with politics, a natural twist, since newspapers were overtly partisan. He briefly held elected office but found greatness as a newspaper owner. Morris is fascinating on Pulitzer as a working (make that hard-working) reporter and editor who understood how to grab his readers—and saw where his industry was going (or could go).

Mr. Stiles is the author of “The First Tycoon: The Epic Life of Cornelius Vanderbilt,” winner of the 2000 National Book Award and the 2010 Pulitzer Prize, now available in paperback from Vintage.


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Tough on Wrinkles, Soft on Sales

Japanese cosmetics companies are known as some of the most technically advanced in the world, with promises of creams and emulsions that use rare ingredients to stop wrinkles and create a flawless complexion.

But these days, they are finding one problem tough to conquer: the U.S. market.

Shu Uemura, a Japanese beauty brand that’s best-known here for a sophisticated eyelash curler, will soon cease to have a retail presence in America, moving to online-only sales in the U.S. Kanebo, whose pricey Sensai luxury brand featured unusual ingredients such as a rare form of silk, quietly pulled out of 30 retail locations last year and now is sold at only one U.S. store, Manhattan’s Bergdorf Goodman.

Shiseido Co., Japan’s venerable leading cosmetics company, is pushing forward in the U.S., with its recent purchase of the Bare Escentuals brand, but even after 45 years of selling in the U.S., Shiseido still has a relatively minor presence in the market.

The retreat of Shu Uemura and Kanebo represents a surprising comedown for companies that represent an established beauty tradition—Japanese women have long prized ageless, porcelain-white skin—and a national reputation for quality and high-tech prowess. “The Japanese woman is the most sophisticated consumer in the world. These brands are well-respected and well-known in Japan,” says Mark Loomis, the president of Estée Lauder Japan. “When they go overseas, this recognition is not automatic. You have to adjust your strategy.”

The pullbacks come at a time when Japanese and American beauty ideals are closer than they have ever been. The Japanese concept of bihaku, which literally means “beautiful white” and refers to Japanese women’s quest to achieve an alabaster complexion, long carried uncomfortable racial overtones here and was at odds with Americans’ love of tanning.

Recently, however, the aesthetic in the U.S. has shifted, thanks to growing awareness that excessive sun exposure damages skin and causes wrinkles. (Japanese women have always walked around with parasols under the summer sun.) Americans now spend more money than ever on anti-aging products that target wrinkles. And “brightening” products, which have long been popular in Japan, are gaining ground in the U.S. for the purpose of lightening dark spots and evening out skin color.

Japan’s Hits and Misses

  • The Shu Uemura eyelash curler became popular with American women.
  • Future Solution LX is one of Shiseido’s best U.S. sellers.
  • Shiseido White Lucent Brightening Moisturizing Emulsion promises an eventoned complexion.
  • Kanebo Sensai Premier “The Cream” (below) retails for $650.

“The brightening/whitening market is becoming as large as anti-aging” in the U.S., says Tomoko Yamagishi-Dressler, Shiseido’s vice president for marketing in the U.S. Shiseido launched its White Lucent intensive brightening serum in the States in 2005, and since then it has achieved double-digit growth.

Despite the growing U.S. interest in anti-aging and skin-care products and Japanese companies’ reputation as global leaders in this segment, Japanese companies have still had a rough time in the world’s biggest cosmetics market. Through aggressive marketing, including cultivating key relationships with beauty editors at magazines, editorial placement and social networking, Shiseido has become the No. 4 prestige brand in the U.S. Ten years ago, it wasn’t in the top ten.

But in the year that ended March 2009, only about 20% of its sales were from the U.S. market, compared with 45% from Asia and 34% from Europe. “We are still weak in the U.S.,” said its chief executive, Shinzo Maeda, in an interview earlier this year.

To bolster its U.S. operations, Shiseido in January bought Bare Escentuals, a San Francisco-based mineral-makeup line, for $1.7 billion, marking the largest acquisition in its history.

Japanese companies “have amazing product formulations,” says John Demsey, group president of Estée Lauder Cos. But so far that hasn’t been enough. “Japan has been so successful at building up their presence in the U.S. in the electronic and automotive industries. There has been a disconnect on the beauty side,” he adds.

The challenges for Japanese brands in the U.S. are myriad. Consumers aren’t familiar with the brands; on Shiseido’s website, it explains: “Shiseido is pronounced “She-Say-Doe.” Also, Japanese companies have high distribution costs for the products they have to ship from Japan, and operating costs are high, because they tend to sell via department stores, where training sales staff and acquiring counter space are costly endeavors.


Shu Uemura is pulling out of U.S. retail stores after failing to catch on.

This is a tough time for high-end beauty brands of all sorts. Sales of luxury beauty products have fallen in the U.S. since the recession started, as Americans have traded down to drugstore products or simply bought fewer cosmetics.

Also, American and Japanese women still take sharply different approaches to skin care. Though skin-care awareness has increased in the U.S., the amount of money and time the U.S. consumer spends on her regimen is still far lower than that of her Japanese counterpart. The average Japanese woman spends 60% of her cosmetics budget on skin care, compared with 30% for American women.

A Shiseido survey found nearly 69% of Japanese women used cleanser, toner and moisturizer religiously at night, compared with only 17% of American women.

Indeed, Shiseido has documented that the average Japanese woman employs a much larger array of products each evening—as many as six products. First, she removes her make-up with an oil-based product. Then comes cleansing the face. This is followed by a lotion—a toner-like skin softener—and then possibly an “essence,” or serum. Finally, she pats on an emulsion, which is less viscous than a cream, and then a traditional cream. All of this is achieved while performing an elaborate facial massage meant to help prevent sagging and wrinkling.

“The psyche of the American consumer is about a quick fix, and not about prevention,” says Ms. Yamagishi-Dressler of Shiseido. “It’s all about, ‘What can this product do for me now?’ We have to adapt to that.”

Kanebo, which entered the U.S. market in 2000, incurred a loss on its U.S. operations every year, according to its spokesman. Kanebo said the costs of operating in the U.S. were very high, since its only retail channel was department stores. It didn’t advertise in the U.S. much, making it hard to build an image for its Sensai line. In the U.S., “achieving profitability was tough,” a Kanebo spokesman said. The company is now focusing on expanding its presence in Asia.

Shu Uemura had several popular items, such as a cleansing oil, but it was too much of a niche brand to achieve the scale it needed in the vast U.S. market. Its parent company, L’Oréal USA, said in a statement that it wanted “to focus on the strength of its strategic brands including Lancome, Ralph Lauren, Giorgio Armani, Yves Saint Laurent, Kiehl’s Since 1851 and other fragrance brands in its portfolio” but declined to comment beyond that.

Shu Uemura’s fans in the U.S. have mixed feelings. Christina Carroll, 32, an attorney who lives in Arlington, Va., first bought Shu Uemura’s cleansing oil in Japan a few years ago. She loved it but switched brands after about a year, searching for “a lower-cost option,” she said.

But she hasn’t given up on Japanese brands as a whole. “I think there is an implicit perception that Japanese beauty brands are luxury brands by default,” says Ms. Carroll.

“It might also have something to do with the fact that it’s an imported product that comes with certain cultural associations—that Japanese culture, by default, prizes quality, elegance, and minimalism.”

Mariko Sanchanta, Wall Street Journal


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Net-Worth Obsession

NAME Joey Kincer NET WORTH $201,000 INCOME $65,000 AGE 32 DEBT $2,000 RESIDENCE Calif. ASSETS $203,000

Joey Kincer is the kind of guy who likes to keep records. Kincer is a 32-year-old Web developer who lives in San Juan Capistrano, southeast of Los Angeles, and among the things he tracks on his personal home page at are his collection of action figures based on the Mega Man video games (“Not for sale,” the site warns sternly), the piano awards he received as a child (“My mom kept track of them all,” he says) and a photo gallery of female celebrity crushes that he refers to as his Dream Team.

His highest achievement in record gathering, however, is contained in a Quicken file, where he has tracked his personal finances for 16 years, ever since he was in 11th grade. On a recent Wednesday evening, Kincer punched a few buttons on a keyboard and projected his entire financial history onto a giant screen hanging from the ceiling of his bedroom for me to see. There was the $3.38 he spent on chips and dip on March 16, 1996. A birthday card for a friend a few weeks later cost $3.18. Deposits arrived in small amounts every couple of weeks thanks to a job playing piano at church.

This trove of data came in handy a few years ago when Kincer happened upon a Web site called NetworthIQ, which allows people to record their net worths and display the ups and downs for anyone to view. Most people who share their data do so anonymously, but Kincer posts a link to his personal Web site, where he uses his real name. Kincer especially liked that the site allowed him to compare himself with others. It appealed to the Mega Man player in him. “NetworthIQ is kind of a game,” he said. “Can I get ahead of everyone? Can I be up there with the big shots?”

Net worth is the number you get when you subtract what you owe from what you own. You start with things like cash on hand, retirement savings and home value and subtract your mortgage, as well as credit-card, student-loan and other debts. Net worth paints a bigger picture than income; it rewards the saver and reveals the drain that big borrowers put on their finances. And it vividly reminds people who think only in terms of monthly payments that their debts may be with them for a good long while.

Figuring net worth isn’t hard, and programs like Quicken make it especially easy., a popular personal-financial-management service, introduced a net-worth feature in 2008 that links to credit-card, brokerage and mortgage accounts. The real-time, intraday updates allow people to obsessively check in on the microscopic daily ups and downs of their personal wealth.

The net-worth number, as Kincer found, is more appealing when you have someone else’s to compare it with. We tend to have an intense curiosity about our neighbors and friends, especially those who seem to earn about what we do but spend a lot more. Do they skimp on retirement savings or their children’s college funds? Are they not burdened by student loans? Do they have a trust fund? Have they simply maxed out every credit card they can get their hands on? There’s no way to answer these questions without seeing a breakdown of net worth.

So it should come as no great surprise that the curious are turning up at NetworthIQ to see what other people’s money really looks like. “This was our way of making money a little more social,” said Todd Kalhar, one of the founding executive partners at NetworthIQ, which is now part of Strands, an online-media company whose moneyStrands site competes with Mint. “People had been talking about stocks forever. We wanted to add a bit more context. The guy talking about stocks might have been bankrupt 10 times.”

Joey Kincer’s net worth is about $201,000, much higher than the $120,000 median figure for U.S. families from 2007, the last year for which the Federal Reserve Board released household net-worth numbers. Among NetworthIQ users who, like him, earned no more than an associate’s degree, that makes him a big shot. But when he compares himself with all the people his age and all Californiaresidents, he’s just a bit above average.

He earns about $65,000 a year largely as a Web developer but is determined to save enough money for a substantial down payment on a detached house, not merely a condo or a town home. And he wants to live in a particular area of central Orange County, where housing prices, while lower than they once were, are still a bit beyond his means.

And so he lives with his parents, paying $700 a month and sleeping in his childhood bedroom. There is a Garfield clock on the wall, and above a twin bed is a photo gallery of the Dream Team, including photos of Daisy Fuentes and Hilary Duff in their younger days. He recently put much of his Mega Man memorabilia in storage. “I’m trying to make my room look less like a 10-year-old’s,” he said. It is perhaps not an ideal arrangement for a young, single man. But by living at home, he is able to save $1,500 to $2,000 each month, which allows his net worth to grow at a steeper trajectory than it would otherwise.

Most of the hand-wringing we do around money essentially comes down to two basic questions: How am I doing? And, Am I going to be O.K.? Net worth is a pretty good answer to the first question and, over time, it offers hints as to how things might ultimately turn out. It’s an easy number to calculate and satisfies the desire for a single numerical grade.

But does our almost irresistible urge to rank ourselves against others based on any available data serve as a source of inspiration? Or does it lead to endless striving in search of some ever-elusive achievement? “I think this is a profound problem, this aspect of humans in the West,” said Andrew Oswald, a professor of behavioral science at the Warwick Business School in England. “We’re now extraordinarily rich by almost any standard of human history. But because we are creatures of comparison, it’s harder to get happier and happier.”

Eric Mill wasn’t thinking about his happiness when he created a Web site called Ohnomymoney two years ago. He was thinking in part about societal taboos — and how to thumb his nose at them. The site shows five numbers: his credit-card and student-loan debt, his checking- and savings-account balances and his net worth, which is currently about negative $12,400. The site updates most of the figures automatically every day through a feed from Wesabe, another site, like Mint, that pulls data from personal financial accounts.

At the bottom of the Ohnomymoney home page, there are two sentences of explanation in a tiny font size: “This is Eric Mill’s money. This site made against the advice of everyone who loves him.”

What was their advice? “It’s something they don’t understand, so they assume that it’s risky,” Mill, who is 25, says. “My girlfriend. My family. One friend criticized it from a classiness perspective. He thought it was uncouth to display something like this, though at the time I had a net worth of negative $20,000, so it wasn’t like I was flaunting anything.”

What he was trying to do when he began the site in May 2008, he says, was start a conversation. Since March 2009, Mill has worked for the Sunlight Foundation, a Washington-based nonprofit group that tries to make government workings more transparent. His site turns that notion on himself. “The taboo around talking about money is ill-founded,” he says. “When you’re the only person dealing with it, you’re subject to all of the dysfunctions we all have. If we could all be a little less uptight and more communicative and social about it, we’d be getting better advice, and it wouldn’t be the sort of thing that we stress about privately.”

So Mill’s money is laid bare for the world to see. In the fall of 2008, he became a freelance Web developer. The timing could not have been worse. “I had $3,000 and no firm gigs,” he says, adding that at one point a potential client, after telling him that he had seen Mill’s negative net worth online, tried to lowball him on a job, letting him know that he assumed that Mill probably needed the money. “During that time, my emotional well-being was completely tied to the number in my savings account.”

It wasn’t a happy time, but during this period, Mill figured out how to feel comfortable handling his money. Mill now saves a quarter to half of his take-home pay in a savings account in an online bank, but he is not making as many extra payments as he could on the $20,000 or so in student loans he is carrying, nor does he have any money set aside for retirement. “I put a much higher value on flexibility,” he says. “And I feel like the better investment right now is in me. It’s much more important that I have as much freedom and liquidity as I can.”

Net worth is not precisely calibrated with financial freedom. If Mill used all of his savings to pay down some debt, his net-worth figure would remain the same, but he would have no emergency fund if he lost his job. For this reason, he has come to think of the figure as a number that doesn’t really tell his whole story.

Some financial advisers agree. “To me, it’s an irrelevant number,” says Spencer Sherman, author of “The Cure for Money Madness” and a founder and the chief executive of Abacus Wealth Partners. “If people have a billion in net worth and are spending half a billion in a year, they’re really poor.” After all, they’re on pace to be broke in 24 months. (Sherman’s preferred measure of financial health for retirees is a ratio that compares net worth, excluding home equity, with the amount of money people take from their portfolios each year. He generally doesn’t want clients spending more than 4 to 6 percent of their holdings annually.) Mill acknowledges that his philosophy of financial openness has its limits. “This would be hard for me to do if I was totally affluent,” Mill told me. He balked at revealing his salary for this article, even though some of his friends already know what it is. “I don’t want to cause any tension with my co-workers,” he says, allowing only that the figure was at the upper end of the midfive figures.

I talked to one NetworthIQ user, a South Florida woman, who has about $856,000 in net worth. She blogs about her financial life at, but says she would never reveal her name on the site. She worries that doing so would inject tension into her offline life. Her friends might think she was bragging about her frugal habits or implicitly criticizing their spending. Indeed, talking about wealth or good fortune can seem coarse or boastful, and maybe some people don’t want poor relatives to know to what extent they could be helping — and aren’t.

When Stephanie Grant learned a few months ago that a decent-size income-tax refund was coming her way, she had already dropped out of school twice, run up $37,000 in debt from credit cards and student loans and was the divorced mother of 3-year-old twins. Hers is a catalog of the sort of financial pitfalls that can set young adults back for many years.

Rather than spend the tax refund on the Nintendo Wii she wanted, Grant, who is 31 and lives in Edina, Minn., put it toward paying off her debt. Then, she began tracking her net worth in public, in part to shame herself into sticking to a financial plan, and recorded her progress on a blog, She followed the debt-reduction system of the financial coach Dave Ramsey, paying the smallest loans off first to build momentum. And she posted her numbers on NetworthIQ after seeing a link to it from the forums on Ramsey’s Web site.

“I liked the number it came up with,” she says, noting that her net worth includes her $4,000 or so of retirement savings, the value of her car and her $1,000 emergency fund. “My assets actually made a difference. I don’t have much, but the negative number was less negative than it would have been without them.” This is a common revelation for financial novices: you are more than the sum of your debts.

Initially, the idea of laying herself bare on a blog and on NetworthIQ caused a lot of anxiety. “You’re saying I have a secret and here it is for everyone to see,” she says. “But once it’s out there, and especially now that it’s not just a flat line saying ‘negative $23,000,’ and it is moving up a little bit, there’s a sense of pride and accomplishment that goes along with that. I know people are visiting, and it makes me want to pay something else off so I can post another entry that’s something good.” She’s currently putting a third of her monthly take-home pay from her job as a benefits analyst toward debt payments.

All of this has led to some odd reversals in her life. She looks forward to getting her bills in the mail, for instance, because it means it’s time to update her total debt. “Which might be a little bit sick,” she said. “But I know it’s lower than the last month. I know it for a fact.”

Grant often wonders about the people who are far ahead of her in the NetworthIQ standings. Did they get lucky? Are they lottery winners? Or did they get smart about money before she did? She tries not to beat herself up over it. “For people with the same income as me but higher net worth, it tells me that I can get there, too. It just takes discipline,” she says. “I know it has only been a couple of months now, but I kind of feel like I’ve made a life change.”

She admits that some of her pleasure is fueled as much by competition as self-satisfaction. “I’m not that far off from the person right above me” on the NetworthIQ list, she says. “I can probably catch them this month. And maybe next month I can get to the next one.”

That attitude is familiar to Michael McBride, an economics professor at the University of California, Irvine. “We crave information, not just to outdo others but to know how we ourselves are doing,” says McBride, who has studied how people’s well-being is affected when they compare their incomes against those of others. “When I pass out tests, the first thing students want to know is what the mean was. They don’t know how to interpret their score unless they know how well others did.”

Oswald, the professor of behavioral science, says the craving for comparison may be rooted in our biology. “It’s easier said than done to break through two million years of evolution,” he says. “A million years ago, you could watch what others were doing and mimic that to get food and resources. Or if you were high up the monkey pack, you could get the best mates.”

But what, exactly, are we comparing? Numbers like net worth can become inadequate shorthand. “We use it for something it was never intended to be used for: a sense of self-worth and status,” Milo Benningfield, a financial planner in San Francisco, told me. He urges his clients to stop thinking about other people and think instead about what they want and need. “I tell them to think of this as a topography of the choices you’re making about how you’re spending your lives. The only question I have is whether these are the choices you want to be making as you move forward. I think that takes the pressure away from looking right and left to other people around you and focuses it on your own life goals and your own vision of success.”

Joey Kincer, the Web developer who still lives with his parents, has never had a negative net worth. He stayed employed throughout the recession and got a better job near the end of it.

But when the stock market collapsed in 2008 and early 2009, Kincer worried that the holy-grail number he tracked, his net worth, could drop. “My 401(k) was falling,” he says. “It was affecting my net worth, and I didn’t want to see it doing that, so I took other measures to make sure it stayed flat.” He spent less money on eating out, DVDs and electronics in order to keep that public net-worth figure from dipping.

This might seem like a joyless way to live, but Kincer doesn’t see it that way. “I’m social,” he says. “I have friends from all different branches of my life. But I don’t go out that much. If I have the choice to stay home and earn money, I’ll do that. I’ve seen just about every one of my friends struggle financially. They’re killing themselves, and I’m thinking to myself that I’m not going to live like that.”

Ron Lieber writes the Your Money column for The Times and helps oversee Bucks, a blog about personal finance.


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Minds on the Move

A new kind of free trade as universities around the world compete for students and scholars.

A couple of years ago, as the State Department official whose purview included global education, I toured a dust-baked 2,500-acre campus outside Doha called Education City. Rising across the landscape were grandiose outposts of such American universities as Cornell, Carnegie Mellon and Georgetown—all invited by the royal family of Qatar to teach their specialties to the elite of that rich and tiny nation on the Persian Gulf: engineering at Texas A&M-Doha, journalism at Northwestern-Doha and so on. The professors were nearly all Americans, drawn in part by salary bonuses and in part by a pioneer spirit. The presence of American universities in such a far-away place is but one emblem of the globalization of higher education, a trend that is remaking hidebound institutions and moving minds (and ideas) around the world.

Ben Wildavsky, the author of “The Great Brain Race,” has been to Education City. In fact, while researching this comprehensive and fascinating book, he seems to have been everywhere. Formerly in charge of college ratings for U.S. News & World Report and now a fellow at Brookings and at the Kauffman Foundation, Mr. Wildavsky has toured the horizon and conducted dozens of interviews along the way. He reports on American universities, notably NYU, branching out internationally; on foreign governments, like China’s, spending vast sums to improve their own institutions, partly to attract scholars and students from abroad; on for-profit businesses, like Laureate and the Washington Post Co.’s Kaplan Inc., planting campuses in remote global locations; and, perhaps in too much detail, on the attempt to rank international universities. (According to Times Higher Education, a London-based magazine, Harvard is No. 1; Peking University, No. 52.)

Why all this activity? It is the “quest to build knowledge-based economies that has led so many governments to scramble to improve their education systems,” Mr. Wildavsky writes. But there are other reasons, including “the notion that a well-educated person today must be exposed to ideas and people without regard to national boundaries” and, less high-mindedly, “the financial attraction for many Western universities of overseas students who pay full freight.”

From 1999 to 2009, Mr. Wildavsky writes, the number of students studying outside their home countries increased by 57%—to three million. The U.S., with a 22% market share of this group, hosts more foreign students than any other country, but its prominence is threatened by such nations as Australia, where foreign students comprise a fifth of university enrollments, and Germany, which attracts 190,000 Chinese students. Meanwhile, India and China are making multi-billion-dollar investments to improve the quality of their universities, especially in the sciences.

But most impressive are the efforts of countries that in the past had little interest in academic excellence. “Perhaps the most audacious attempt to create a world-class university from scratch is taking place in Saudi Arabia,” Mr. Wildavsky observes. The King Abdullah University of Science and Technology opened its doors in 2009, funded with a donation of $10 billion from the king himself, thus instantly becoming the sixth-richest university in the world. The university’s partners include Stanford, Cambridge, Imperial College London and the University of California at Berkeley. Its new president, a professor of mechanical engineering named Choon Fong Shih, is, Mr. Wildavsky notes, “the emblematic example of this emerging worldwide university culture.” He is the son of a Chinese father and a Malaysian mother; he earned his undergraduate degree in Singapore, his master’s degree at McGill in Montreal and his Ph.D. at Harvard. He led a research group at General Electric, taught for years at Brown University and then became president of the National University of Singapore, before being hired away by King Abdullah.

Of course King Abdullah University will do more than teach a new generation of scientists and engineers. By permitting men and women to take classes together and by receiving international scholars and new ideas, it will be a catalyst for economic and social change in Saudi Arabia and beyond. This is Mr. Wildavsky’s major argument. The globalization of education is producing what he calls a “free trade in minds”—beneficial not only to countries sending their students abroad and countries accepting them but also, through positive externalities, to the broader world.

Some nations, including India and Russia, continue to see education as a zero-sum game and erect barriers to the free flow of students and scholars—much as they put up tariffs against foreign steel. Even the University of Tennessee once established a quota on foreign graduate students (since dropped). But like free trade in conventional goods and services, free trade in minds helps everyone.

“Innovation overseas,” Mr. Wildavsky says, “can actually enhance America’s financial well-being. That is because ideas can’t be contained within national boundaries, meaning that America’s share of the world’s research production matters far less than the proven ability of U.S. entrepreneurs, financiers, and consumers to take advantage of cutting-edge research wherever it comes from.”

Mr. Wildavsky is not completely upbeat about the global-education boom. No university seems to have gotten the model right yet. Some U.S. schools have closed their foreign branches for lack of students, others hesitate to branch out, worried about protecting their brands. The future may lie with private firms like Laureate, but foreign cartels actively try to keep them out. Still, something big is happening. Making the most of human capital—a key to competitiveness and prosperity—is more and more the work of globalized universities competing for the best thinkers and the best ideas.

Mr. Glassman, a former under secretary of state for public diplomacy and public affairs, is executive director of the George W. Bush Institute in Dallas.


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The Goldilocks recovery

Strict financial regulation and a new commodity boom have turned “boring” Canada into an economic star

THEIR economy is so intertwined with their neighbour’s that when the United States plunged into recession, Canadians assumed they would be dragged along for the ride. Newspapers took to illustrating their economic stories with pictures of Depression-era bread lines. Yet whereas the United States has still not officially declared its recession over, Canada is nine months into recovery from its mildest and shortest downturn in recent history. Unemployment has been falling since last August, and proportionately fewer jobs were lost than south of the border.

Jim Flaherty, the finance minister, attributes Canada’s strong performance to its “boring” financial system. Prodded by tight regulation, the banks were much more conservative in their lending than their American counterparts. Those that did dabble in subprime loans were able to withdraw quickly. This prudence kept a lid on house prices while those in America were soaring, but it paid off when the bust hit. The volume and value of home sales in Canada are now at record highs. In some areas the market looks downright frothy: a modest house in Ottawa listed at C$439,000 ($435,000) recently sold for $600,000. “A lot of homes are selling in one day, and often for over the asking price,” says David Cullwick, a local estate agent. Rising prices have bolstered the construction industry and sellers of furniture and building materials.

True to form, the authorities are moving to halt the party. During the recession the Bank of Canada cut its benchmark interest rate (to 0.25%), injected extra liquidity and bought up mortgage-backed securities. At its April policy meeting the bank withdrew its pledge not to raise rates. Analysts expect an increase in June. The government has ended tax credits for first-time house buyers and for renovations, which were granted in 2008 to stimulate demand.

For the other component of the country’s resilience—resurgent appetites for its exports of oil, gas, and minerals—Canadians have to thank policymakers in Beijing more than those in Ottawa. At their low point, prices for Canada’s commodity exports were still 50% higher than in previous recessions. Since then, they have rallied strongly. The impact is illustrated by the fortunes of Teck Resources, a Vancouver-based mining firm. It staggered into the recession loaded with a $9.8 billion debt taken on to buy the assets of a coal-mining company. For a while its survival was in doubt. Last month Teck not only announced that it had repaid the debt but also that it would pay a dividend.

The energy industry is coming back to life, with new investments planned for in Alberta’s oil sands. Last month Sinopec, a Chinese oil company, announced it would pay $4.65 billion for a 9% stake in Syncrude Canada, the largest operator in the sands. Such investments are controversial because of their environmental impact. But they are welcome in Alberta, where the government posted an unprecedented budget deficit last year.

“Our regional economies are so diverse that there is always something leaning against the wind,” says Philip Cross, the chief economist at the government statistics agency. But the combination of commodity revenues and investors seeking safety in Canadian assets has caused the currency to take off. After falling as low as 77 American cents during the recession, the Canadian dollar has now returned to rough parity with the greenback.

That is a tribute to the country’s success. But the central bank warns that a strong loonie, as the currency is known, will slow the recovery. It would be particularly harmful to manufacturing exporters, who were battered by the recession (car production fell by 31% in 2009). That might lead to further specialisation in natural resources. For now, concern about the loonie is muted, because most companies adapted to a stronger exchange rate during its previous run-up in 2007. Many of those that did not went bust. But if the currency continues to rise, the squeals will surely grow.

The government of Stephen Harper, the Conservative prime minister, might have expected to receive more praise for the economy’s robust performance. If it has not, that may be partly because it insisted that the recession was imported from the outside world. Much of the country’s resilience stems from policies—such as bank regulation and sound public finances—which predate Mr Harper. The Bank of Canada can share some of the credit too. But Britons might note that Mr Harper has managed to govern for four years without a parliamentary majority, and that this has not prevented Canada from sailing through the recession.


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The We’re-Not-Europe Party

The bill comes due for a life of fairness at the expense of growth.

One of the constant criticisms of Barack Obama’s first year is that he’s making us “more like Europe.” But that’s hard to define and lacks broad political appeal. Until now.

Any U.S. politician purporting to run the presidency of the United States should be asked why the economic policies he or she is proposing won’t take us where Europe arrived this week.

In an astounding moment, to avoid the failure of little, indulgent, profligate Greece, the European Union this week pledged nearly $1 trillion to inject green blood into Europe’s economic vampires.

For Americans, this has been a two-week cram course in what not to be if you hope to have a vibrant future. What was once an unfocused criticism of Mr. Obama and the Democrats, that they are nudging America toward a European-style social-market economy, came to awful life in the panicked, stricken faces of Europe’s leadership: Merkel, Sarkozy, Brown, Papandreou. They look like that because Europe has just seen the bond-market devil.

The bond market is a good bargain—if you live more or less within your means. The Europeans, however, pushed a good bargain into a Faustian bargain, which the world calls a sovereign debt crisis.

In the German legend, Faust was a scholar who sold his soul to the devil many years hence in return for a life now of intellectual brilliance and physical comfort. In our version of the legend, Europe’s governments told the devil that, more than anything, they wanted a life of social protection and income fairness no matter the cost. Life was good. A fortnight ago, the bond devil arrived and asked for his money.

In the U.S., the Obama White House and the Democrats have decided to wage politics into November by positioning the Republicans as the party of obstruction, which won’t vote for things the nation “needs,” such as ObamaCare. Some Republicans voting against these proposals seem to understand, as do their most ardent supporters, that they are opposing such ideas and policies because the Democrats have pushed far beyond the traditional centrist comfort zone of most Americans. A Democratic Party whose current budget takes U.S. spending from a recent average of about 21% of GDP up to 25% is outside that comfort zone. It’s headed toward the euro zone.

After Europe’s abject humiliation, the chance is at hand for the Republicans to do some useful self-definition. They should make clear to the American people that the GOP is “The We’re Not Europe Party.” Their Democratic opposition could not attempt such a claim because they do not wish to.


British Prime Minister Gordon Brown

The state of Europe can be summed up in one word: stagnation. Jean-Claude Trichet, the European Central Bank president who just agreed to monetize the debt that Europeans can’t or won’t pay, noted in a 2006 speech that “over the period from 1996 to 2005, euro area output grew on average 1.3 percentage points less than in the U.S., and the gap appears to be persistent.”

Angus Maddison, the eminent European historian of world economic development who died days before Europe’s debt crisis, wrote in 2001: “The most disturbing aspect of West European performance since 1973 has been the staggering rise in unemployment. In 1994-8 the average level was nearly 11% of the labor force. This is higher than the depressed years of the 1930s.”

Stagnation isn’t death. Economies don’t die. Greece proves that. They slow down. Europe’s low growth rates allow its populations to pretend that real, productive work is being done somewhere by someone. But new jobs are created slowly, if at all. Younger workers lose heart.

Economic stagnation is a kind of purgatory. Once there, it’s not clear how you get out. The economist Douglass North, in his 1993 Nobel Prize acceptance speech, said that one of the vexing problems of his discipline is, “Why do economies once on a path of growth or stagnation tend to persist?” Japan also seems unable to free itself from stagnation.

The antidote to stagnation is economic growth. Not just growth, but strong growth. A 4% growth rate, which Europe will never see again, pays social dividends innumerably greater than 2.5% growth. Which path are we on?

Barack Obama would never say it is his intention to make the U.S. go stagnant by suppressing wealth creation in return for a Faustian deal on social equity. But his health system required an astonishing array of new taxes on growth industries. He is raising taxes on incomes, dividends, capital gains and interest. His energy reform requires massive taxes. His government revels in “keeping a boot on the neck” of a struggling private firm. Wall Street’s business is being criminalized.

Economic stagnation arrives like a slow poison. Look at the floundering United Kingdom, whose failed prime minister, Gordon Brown, said on leaving, “I tried to make the country fairer.” Maybe there’s a more important goal.

A We’re-Not-Europe Party would promise the American people to avoid and oppose any policy that makes us more like them and less like us.

Daniel Henninger, Wall Street Journal


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The World’s Dollar Drug

Expect the greenback to remain the world’s reserve currency, but that won’t be a sign of U.S. strength.

For all the talk about the problems of Greece and their implications for the euro zone, there is another currency that presents equally profound problems: the U.S. dollar. The dollar is, as everyone knows, the world’s reserve currency, and it widely seen as a boon and an anchor for the emerging global economic system. It is also the only thing standing between the United States and its own moment of reckoning, and that is not a good thing.

The evolution of the dollar as the world’s reserve currency tracked the emergence of the U.S. as a dominant power. The Bretton Woods agreement of 1944 designated the dollar as the currency of last resort because the U.S. accounted for a significant percentage of world manufacturing and held much of the world’s gold in Fort Knox and other depositories. The British at first demurred but were forced to accept the primacy of the greenback in 1946 when faced with a choice between bowing to the dollar or defaulting on their loans because the Americans would not lend to them otherwise.

Bretton Woods obligated participating countries to determine their exchange rates and the value of their currencies in relation to the dollar, with gold as the underpinning. Then, in 1971, President Richard Nixon ushered in the era of fiat currency when he announced that the U.S. government would no longer allow foreign nations to redeem their U.S. dollars for gold.

The move came in response to rising inflation in the U.S. It also came in response to competitive pressures from Germany and Japan, which were beginning to undermine American manufacturing—a decline that has continued unabated since and can only be laid at China’s door by a willful forgetting of the legacy of a host of lower-cost competitors over the past 40 years. By the early 1970s, the U.S. was importing heavily from new manufacturing centers outside America (though not yet running trade deficits) and being forced to redeem ever larger amounts of dollars for rapidly dwindling reserves of gold.

After 1971, currencies began to float against one another. This fiat system is what exists today, with notable outliers such as China, which continues to peg the value of its currency to the dollar. It does so primarily because when Beijing began to liberalize its economy in the early 1980s, the dollar was the most important avenue of access to the U.S., the world’s most vital and dynamic economy.

Over the past decade, the relative position of the U.S. has shifted. It is no longer a creditor to the world but rather a large debtor. It is a net importer of manufactured goods—though its manufacturing sector remains quite large even while employing fewer workers. Its national economy is the world’s largest but is surpassed by the multinational euro-zone. And China’s economy, while still perhaps not much more than a third the size of the U.S., is growing three to four times as rapidly and accumulating dollars at a torrid clip.

Yet the dollar remains the linchpin of the global system. The financial crisis brought global grumblings about the U.S. currency, about the toxicity of the U.S. financial system, and about the need and desire for an alternate global currency. The Chinese were vocal in their desire to find a new anchor, and the Europeans echoed the sentiment along with others. But words are easy. Even the Chinese, who have made moves toward pegging the yuan against a basket of currencies, still find that having tethered their system to the dollar they can’t simply walk away because they would rather things were different.

The dollar’s dominance has clear short-term benefits for the U.S. Unlike Greece or just about any other country, when the American federal government wants to take on additional debt it has the advantage of a world that must buy dollars. Because much of global trade is conducted in dollars, especially Chinese trade, governments and institutions throughout the world have little choice but to invest in U.S. assets. The U.S. government also has the ability to print that global reserve currency when dire straits demand it. That gives the U.S. considerable latitude to spend its way out of a crisis without confronting real structural challenges.

Greece is being forced to adopt more austere government fiscal policies, as are Latvia and many other smaller countries. Having to turn to global markets with cap in hand is a bitter pill but could force reforms that will eventually leave those economies in stellar shape. The U.S. has been able to forestall deep reforms because it has the dollar.

But while the presence of the dollar keeps money flowing in and the system well-oiled, it no longer reflects the world’s economic pecking order. For all the talk of currency manipulation by Beijing, it is equally true that China’s peg to the dollar is currently propping up an otherwise shaky American economy. The Chinese have become the ultimate offshore bank for American capital, and there is no evidence they deploy it to less American benefit than Americans themselves do. The Chinese government invests conservatively in U.S. bonds, and spends heavily on a domestic economy that produces goods for American consumers.

The U.S. government uses its dollars—and the ability to print them and borrow them—poorly. Large amounts of debt fund consumption of goods and health care. While today’s needs are important, without sufficient investment those dollars will dissipate. You’d lend someone money to open a business or invent a new energy source, but not for dinner and a movie. Yet because of the dollar, America tends to get the money it wants. And so the dollar as an anchor of the global system forestalls fiscal crisis in the U.S. while allowing for gradual decay of the American economy.

This can go on for many years. The world needs a reserve currency to reduce costs and allow market players to assess value across different countries and economies. But that need for the dollar shouldn’t be confused for American strength.

India continues to use English as a lingua franca, more than 60 years after the British departed, not because Britain remains a world empire but because India needs a common tongue and English was already in place. The dollar today serves the same purpose for the world. The ubiquity of the dollar allows Americans to believe that their country will automatically retain its rightful place as global economic leader. That’s a dangerous dream, an economic opiate from which we would do well to wean ourselves.

Mr. Karabell is president of River Twice Research and the author of “Superfusion: How China and America Became One Economy” (Simon & Schuster, 2009).


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The Real Euro Crisis

The EU’s bailout postpones the day of fiscal reckoning.

A trillion dollars is a lot of money, even these days, and the European Union has demonstrated that a check for €750 billion ($972 billion) can produce a rally in European debt markets and global equities. Too bad the larger price for Sunday night’s “shock and awe” intervention is likely to be paid in the further erosion of Europe’s fiscal and monetary credibility.

French Finance Minister Christine Lagarde noted Monday’s exuberant market reaction with satisfaction, saying that the “message had gotten through” that Euroland would defend its currency. Yes, creditors no doubt love that governments have guaranteed their high-yield loans to Greece, Portugal, Spain and any other profligate government that comes under bond-market siege. What investor doesn’t like a risk-free loan that pays 9%?

But there is no such thing as a free sovereign bailout, and the EU’s intervention merely transfers those risks from banks and other creditors to taxpayers and the European Central Bank. The real gamble is being made by politicians who are calculating that, by taking the risk of sovereign default off the table for now, they are giving the global economic recovery time to build and making it easier to address Europe’s fiscal woes.

In a sense, Europe has decided to TARP itself. German taxpayers have undertaken to underwrite the spending of Southern European governments, with Greece playing AIG, and Portugal starring as Citigroup. Spain, we suppose, is Goldman Sachs. Perhaps it will all work. But our guess is that Germany and France will have a harder time shedding responsibility for the fiscal policies of entire nations than the U.S. Treasury has had selling shares in bailed-out banks.

There is also the small matter of the rule of law. Such bailouts are expressly prohibited by the 1992 Maastricht treaty, and that promise is now in tatters. In the euro’s first serious test, the political class blinked. The resulting moral hazard will haunt the single currency for years and reduce the incentive for governments to keep their fiscal houses in order.

Most dangerous, the European Central Bank has also been dragooned into this bailout through a program to buy euro-zone bonds in unspecified amounts. The ECB says that it will “sterilize” its bond purchases by selling other assets, so the intervention won’t affect monetary policy. In Switzerland on Monday, ECB President Jean-Claude Trichet also denied that the ECB decision, announced at the same time as the fiscal rescue, was taken under political pressure.

But the timing smacks of a coordinated campaign and so undermines the ECB’s most precious asset—its reputation for political independence and an unwavering commitment to price stability. The bonds the ECB will buy are the sovereign debt of individual nations, which looks to us as if the central bank will directly monetize debt. Mr. Trichet should ask the U.S. Federal Reserve if buying mortgage-backed securities has had no effect on monetary policy. The Frenchman’s assurances are hard to credit.

While the sheer size of the bailout fund impressed investors, it also raises questions about the borrowing capacity of the euro zone as a whole. In 2009, the 16 countries of the euro zone ran collective deficits of €565 billion, or 6.3% of GDP. Every member of the European Union had a fiscal deficit.

That’s understandable in a recession, but the markets have been sending a message that this spending path is unsustainable. Sunday’s “bazooka,” to borrow former Treasury Secretary Hank Paulson’s famous 2008 metaphor, has silenced the bond messengers for now. But if Europe’s political class doesn’t use this opening to shape up, the crisis will return—and there will be no richer nations left to do the rescuing.

The real euro crisis, in short, is one of overspending and policies that sabotage economic growth. Sunday’s shock and awe campaign has merely postponed that reckoning—and at a fearsome price.

Editorial, Wall Street Journal


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The Beijing consensus is to keep quiet

The China model

In the West people worry that developing countries want to copy “the China model”. Such talk makes people in China uncomfortable

CHINESE officials said the opening of the World Expo in Shanghai on April 30th would be simple and frugal. It wasn’t. The display of fireworks, laser beams, fountains and dancers rivalled the extravagance of Beijing’s Olympic ceremonies in 2008. The government’s urge to show off Chinese dynamism proved irresistible. For many, the razzmatazz lit up the China model for all the world to admire.

The multi-billion-dollar expo embodies this supposed model, which has won China many admirers in developing countries and beyond. A survey by the Pew Research Centre, an American polling organisation, found that 85% of Nigerians viewed China favourably last year (compared with 79% in 2008), as did 50% of Americans (up from 39% in 2008) and 26% of Japanese (up from 14%, see chart). China’s ability to organise the largest ever World Expo, including a massive upgrade to Shanghai’s infrastructure, with an apparent minimum of the bickering that plagues democracies, is part of what dazzles.

Scholars and officials in China itself, however, are divided over whether there is a China model (or “Beijing consensus” as it was dubbed in 2004 by Joshua Cooper Ramo, an American consultant, playing on the idea of a declining “Washington consensus”), and if so what the model is and whether it is wise to talk about it. The Communist Party is diffident about laying claim to any development model that other countries might copy. Official websites widely noted a report by a pro-Party newspaper in Hong Kong, Ta Kung Pao, calling the expo “a display platform for the China model”. But Chinese leaders avoid using the term and in public describe the expo in less China-centred language.

Not so China’s publishing industry, which in recent months has been cashing in on an upsurge of debate in China about the notion of a China model (one-party rule, an eclectic approach to free markets and a big role for state enterprise being among its commonly identified ingredients). In November a prominent Party-run publisher produced a 630-page tome titled “China Model: A New Development Model from the Sixty Years of the People’s Republic”. In January came the more modest “China Model: Experiences and Difficulties”. Another China-model book was launched in April and debated at an expo-related forum in Shanghai. Its enthusiastic authors include Zhao Qizheng, a former top Party propaganda official, and John Naisbitt, an American futurologist.

Western publishers have been no less enthused by China’s continued rapid growth. The most recent entry in the field is “The Beijing Consensus, How China’s Authoritarian Model Will Dominate the Twenty-First Century” by Stefan Halper, an American academic. Mr Halper, who has served as an official in various Republican administrations, argues that “just as globalisation is shrinking the world, China is shrinking the West” by quietly limiting the projection of its values.

But despite China’s status as “the world’s largest billboard advertisement for the new alternative” of going capitalist and staying autocratic, Party leaders are, as Mr Halper describes it, gripped by a fear of losing control and of China descending into chaos. It is this fear, he says, that is a driving force behind China’s worrying external behaviour. Party rule, the argument runs, depends on economic growth, which in turn depends on resources supplied by unsavoury countries. Politicians in Africa in fact rarely talk about following a “Beijing consensus”. But they love the flow of aid from China that comes without Western lectures about governance and human rights.

The same fear makes Chinese leaders reluctant to wax lyrical about a China model. They are acutely aware of American sensitivity to any talk suggesting the emergence of a rival power and ideology—and conflict with America could wreck China’s economic growth.

In 2003 Chinese officials began talking of the country’s “peaceful rise”, only to drop the term a few months later amid worries that even the word “rise” would upset the flighty Americans. Zhao Qizheng, the former propaganda official, writes that he prefers “China case” to “China model”. Li Junru, a senior Party theorist, said in December that talk of a China model was “very dangerous” because complacency might set in that would sap enthusiasm for further reforms.

Some Chinese lament that this is already happening. Political reform, which the late architect of China’s developmental model, Deng Xiaoping, once argued was essential for economic liberalisation, has barely progressed since he crushed the Tiananmen Square protests in 1989. Liu Yawei of the Carter Centre, an American human-rights group wrote last month that efforts by Chinese scholars to promote the idea of a China model have become “so intense and effective” that political reform has been “swept aside”.

Chinese leaders’ fear of chaos suggests they themselves are not convinced that they have found the right path. Talk of a model is made all the harder by the stability-threatening problems that breakneck growth engenders, from environmental destruction to rampant corruption and a growing gap between rich and poor. One of China’s more outspoken media organisations, Caixin, this week published an article by Joseph Nye, an American academic. In it Mr Nye writes of the risks posed by China’s uncertain political trajectory. “Generations change, power often creates hubris and appetites sometimes grow with eating,” he says.

One Western diplomat, using the term made famous by Mr Nye, describes the expo as a “competition between soft powers”. But if China’s soft power is in the ascendant and America’s declining—as many Chinese commentators write—the event, which is due to end on October 31st, hardly shows it. True, China succeeded in persuading a record number of countries to take part. But visitor turnout has been far lower than organisers had anticipated. And queues outside America’s dour pavilion have been among the longest.


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The Irrelevant Yuan?

You’re not going to change the balance of China trade by adding 25 cents to the cost of a T-shirt.

To some in Washington these days, adjusting the yuan-dollar exchange rate is the fix for all America’s ills. That single number supposedly determines which jobs stay in the United States and which go to China. It dictates which and how many goods move where. It’s attributed the mystical power to raise or destroy mighty economies by its movements or lack thereof.

Except that the real world doesn’t work that way. Recent conversations with executives responsible for supplying clothes from Asia to American shelves suggest that the yuan case may not be as clear-cut as U.S. revaluationists would have us believe.

Revaluationists argue that the price of Chinese goods expressed in dollar terms is too low because China artificially suppresses its exchange rate, making it possible to buy “too many” yuan per dollar. They want China to make its exports dearer, thus balancing bilateral trade by making Chinese goods unappealingly expensive in the U.S. and American products more affordable in China.

But how “exposed” is the total value of a finished Chinese export to the yuan-dollar exchange rate? To answer that question, you have to examine how often companies have to exchange dollars into yuan or vice versa along the supply chain—for instance, when a U.S. company converts dollars so it can pay factory workers in yuan, or when a Chinese factory receives dollars in payment for an order and exchanges into yuan to pay its electricity bill.

Revaluationists implicitly, and wrongly, assume that the bulk of the value of Chinese products is exposed to the exchange rate. If that were true for any industry, it would be true in apparel where yuan-denominated labor still accounts for a much higher proportion of costs than in more mechanized manufacturing. Yet it ain’t quite so, as an American executive at a children’s clothing retail chain recently explained. (He and the other executive in this piece asked to remain anonymous given the political sensitivity of the issue.)

This executive’s largest expense is fabric, which accounts for roughly 50% of the final cost of a piece of clothing. He also figures in a profit margin of about 15%, depending on the product. That leaves 35% of his cost for labor, utilities and the like—yuan-denominated expenses. As for the fabric cost itself, about half of that (one-quarter of the cost of the finished garment) is cotton, a globally traded commodity priced in dollars. The fabric manufacturer also might take a 15% profit, leaving 35% for yuan-denominated costs.

So take a $10 pair of boy’s summer shorts: $2.50 is cotton, the price of which won’t change with a revaluation. Another $2.50 (perhaps) is profit. That leaves roughly $5 in Chinese labor and other yuan costs that are affected by a revaluation. Subject that portion to the 5% revaluation (that’s at the upper range of current expectations for what Beijing will do) and the shorts now cost . . . $10.25.

That assumption of a surprisingly large profit margin is significant, as a chat with another American businessman makes clear. His company sells a range of brands, from high-end to low-end, and manufactures throughout Asia. When asked about the possible effects of a yuan revaluation, he first observes that his company no longer makes its cheapest products in China anyway. Rising labor costs, higher taxes on foreign businesses and the like have pushed ultra-low-price T-shirts and jeans to the likes of Vietnam or Bangladesh. What remains in China are higher-value-added, more profitable name-brand products.

One implication is that if over the short term companies can’t raise prices on U.S. consumers in the fiercely competitive apparel market they’ll at least have some room to absorb any revaluation-induced cost increases out of their profit margins. Shareholders may ultimately bear some of the revaluation cost. The more important implication is that over the longer term, when China becomes too expensive, manufacturing moves elsewhere in Asia—not back to America.

Indeed, the rising costs of Chinese manufacturing in general are a much bigger headache for some apparel manufacturers than a yuan revaluation would be. Wage increases alone force factory owners along China’s coast to boost productivity by 6% or more each year to stay competitive. Increasing productivity by another 2% or 3% to compensate for a revaluation would be tough, but perhaps not the most serious challenge.

Some apparel companies undoubtedly are more sanguine about the possible consequences of a yuan revaluation than others. They’d almost certainly feel differently if their bread and butter were low-margin cheap T-shirts. But the fact that there’s some diversity of opinion within the apparel industry on the yuan is telling.

Mr. Sternberg, who is based in Hong Kong, edits the Wall Street Journal Asia’s Business Asia column.


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Time to Junk the Corporate Tax

Nobel Laureate Robert Lucas says reform would deliver great benefits at little cost, making it “the largest genuinely true free lunch I have seen.’

President Obama has put tax reform on the agenda, but surprisingly little attention is being paid to fixing the most growth-inhibiting, anticompetitive tax of all: the corporate income tax. Reducing or eliminating the corporate tax would curtail numerous wasteful tax distortions, boost growth in both the short and long run, increase America’s global competitiveness, and raise future wages.

The U.S. has the second-highest corporate income tax rate of any advanced economy (39% including state taxes, 50% higher than the OECD average). Many major competitors, Germany and Canada among them, have reduced their corporate tax rate, rendering American companies less competitive globally.

Of course, various credits and deductions—such as for depreciation and interest—reduce the effective corporate tax rate. But netting everything, our corporate tax severely retards and misaligns investment, problems that will only get worse as more and more capital becomes internationally mobile. Corporate income is taxed a second time at the personal level as dividends or those capital gains attributable to reinvestment of the retained earnings of the corporation. Between the new taxes in the health reform law and the expiration of the Bush tax cuts, these rates are soon set to explode.

This complex array of taxes on corporate income produces a series of biases and distortions. The most important is the bias against capital formation, decreasing the overall level of investment and therefore future labor productivity and wages. Also important are the biases among types of investments, depending on the speed of tax vs. true economic depreciation, against corporate (vs. noncorporate) investment, and in favor of highly leveraged assets and industries. These biases assure that overall capital formation runs steeply uphill, while some investments run more, some less uphill. It would be comical if the deleterious consequences weren’t so severe.

Of course, the corporation is a legal entity; only people pay taxes. In a static economy with no international trade, the tax is likely borne by shareholders. The U.S. economy is neither static nor closed to trade, and taxes tend to be borne by the least mobile factor of production. Capital is much more mobile globally than labor, and the part of the corporate tax that is well above that of our lowest tax competitors will eventually be borne by workers. In a growing economy, the lower investment slows productivity growth and future wages.

There is considerable evidence that high corporate taxes are economically dangerous. In a 2008 working paper entitled “Taxation and Economic Growth,” the Organization for Economic Cooperation and Development concluded that “Corporate taxes are found to be most harmful for growth, followed by personal income taxes and then consumption taxes.” Virtually every major tax reform proposal in recent decades has centered on lowering taxes on capital income and moving toward a broad-based, low-rate tax on consumption. This could be accomplished by junking the separate corporate income tax, integrating it with the personal income tax (e.g., attributing corporate income and taxes to shareholders or eliminating personal taxes on corporate distributions), and/or allowing an immediate tax deduction (expensing) for investment (which cancels the tax at the margin on new investment and hence is the priority of most economists). The Hall-Rabushka Flat Tax, the Bradford progressive consumption tax, a value-added Tax (VAT), the FairTax retail sales tax, four decades of Treasury proposals and the 2005 President’s Tax Commission proposals would all move in this direction.

Reducing or eliminating the negative effects of the corporate tax on investment would increase real GDP and future wages significantly. Junking both the corporate and personal income taxes and replacing them with a broad revenue-neutral consumption tax would produce even larger gains. Nobel Laureate Robert Lucas concluded that implementing such reforms would deliver great benefits at little cost, making it “the largest genuinely true free lunch I have seen.”

Reducing taxes on new investment could help strengthen what is a historically slow recovery from such a deep recession. It would also strengthen the economy long-term. American workers would benefit from more jobs in the short run and higher wages in the long run.

However, if a new tax device is used to grow government substantially, it will seriously erode our long-run standard of living. The VAT has served that purpose in Europe and, while better than still-higher income taxes, the larger-size governments it has enabled there are the prime reason European living standards are 30% lower than ours. Trading a good tax reform for a much larger government is beyond foolish. No tax reform can offset losses that large. Hence, a VAT should only be on the table if it is not only revenue-neutral but accompanied by serious spending control.

Further, the fraction of Americans paying no income taxes is approaching 50%. That sets up a dangerous political dynamic of voting ever-rising taxes to pay for ever-rising spending. We need more people with a stake in controlling spending. Replacing corporate and personal income taxes with a broad-based consumption tax could increase the number of those with “skin in the game.” But some reforms, for example a VAT, might be much less transparent and may not serve this purpose.

Congresses (and presidents) seem unable to avoid continually tinkering with the tax code. A tax reform that is quickly riddled with special features would lose much of its economic benefit. We need a stable tax system that changes much less frequently, so families and firms can more reliably plan their future. Current fiscal policy, loaded with immense deficits, ever-growing debt, and the prospect of higher future taxes, is the biggest threat to such stability. To balance proposed spending in Mr. Obama’s budget in 2015, his Deficit Commission’s target year, will require at least a 43% increase in everyone’s income tax. Thus, spending control is vital to tax stability.

American companies and their workers compete in the global marketplace saddled with a costly, anachronistic corporate tax system. To compete successfully in the 21st century, we will need to reform corporate taxation. There are several paths to doing so, each with its advantages. Unfortunately, tax policy is headed in exactly the wrong direction, raising taxes on corporate source income. Business investment is growing again after the collapse in the recession, which is usual in a cyclical recovery with very low interest rates. But eventually structural drags, from our antiquated tax code to massive public debt, will impede investment and economic growth.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.


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EU Agrees to Prop Up Greece

110 Billion Euro Package

A man sitting outside the Bank of Greece next to graffiti reading “IMF Out.” On Sunday, European finance ministers agreed to a bail-out package for the country.

European promises of solidarity with Greece were not enough. Over the weekend, euro zone finance ministers agreed on a €110 billion package for Athens in return for even more Greek austerity measures. Whether it will be enough remains open.

The German tabloid Bild am Sonntag called it “a fateful day for the euro.” But was it? At the very least, one can say that it was an extremely hectic day for many of Europe’s leading politicians.

In Athens on Sunday morning, Greek Prime Minister Georgios Papandreou announced further deeps cuts in public spending — a package he said which involved “great sacrifices” for the Greek people. In addition to further tax increases — beyond the VAT and luxury tax hikes announced in March — the new package includes further pay cuts for public sector workers, pension cuts and in increase in the retirement age.

In return, the 16 finance ministers from countries belonging to the European common currency area, meeting on Sunday afternoon, finally released a far-reaching aid package for Greece following weeks of disagreement. The deal makes €110 billion available to Greece in the next three years — €45 billion in this year alone. Germany’s share of the aid package is €22 billion, €8.4 billion of which is due in 2010.

The agreement is to be rubber-stamped by European heads of state and government at a special summit on May 7. But Europe has sent a clear signal in response to the pessimism displayed by ratings agencies and the financial markets. The euro is to remain strong is the message from Brussels. And further, Greece has powerful allies.

‘Better for All Europeans’

“It is our mission to defend the stability of the euro zone in its entirety,” German Finance Minister Wolfgang Schäuble said. “The better we do that, the better it is for all Europeans and for Germans.”

It remains to be seen just how the financial markets will react to the weekend deal. On Monday, the euro was down slightly in early trading.

Indeed, past attempts by European politicians to shore up the euro with expressions of solidarity with Greece have proven inadequate. European summits on Feb. 11, March 25 and April 11 all had little impact on rampant speculation against the euro. The inability of Brussels to calm the markets made Sunday’s deal unavoidable.

Emergency Aid Being Rushed Through German Parliament

The governments involved now at least grasp how serious the situation is. The German government too doesn’t want to be accused of any further stonewalling after ratings agency Standard & Poor’s last week downgraded Greece’s credit rating to junk status.

Berlin is hoping to push the necessary legislation through parliament this week — with the same urgency with which it passed the banking bailout package in October 2008. President Horst Köhler is scheduled to sign the law as soon as Friday. The government hopes the speed will be seen as a further sign of strength. The opposition Social Democrats won’t stand in the way of parliamentary approval but haven’t yet declared whether they will vote in favor of the aid. The party wants commercial banks to foot part of the bill.

In terms of German domestic politics there’s a certain irony in the fact that the emergency aid is being passed on the eve of the May 9 regional election in North Rhine-Westphalia. Critics say that is precisely what Merkel had been trying to avoid in recent months in order to keep the sensitive issue out of the election campaign. A total of 56 percent of Germans are against helping out Greece, so the aid could cost the two ruling parties, Merkel’s Christian Democrats and the pro-business Free Democrats, votes in the election in North Rhine-Westphalia, Germany’s most populous state.

Merkel has reason to fear the wrath of voters. She is arguing that it was her stubbornness that forced Athens to get serious about agreeing to stringent spending cuts, and that she made sure that the International Monetary Fund’s hard-as-nails debt professionals were dispatched to keep an eye on the Greeks.

National debt of EU members as a percentage of GDP.

That may be true. But Merkel’s manoeuvring may nevertheless have made matters worse. The bailout of Greece has become more expensive than initially thought because Greece’s borrowing costs have risen dramatically in recent weeks. The market hysteria could spread. That is why even US Treasury Secretary Tim Geithner got involved and urged Berlin to take rapid action.

Success of Bailout Uncertain

It’s unclear how effective the bailout will be. Everything depends on how the economy, the government finances and political sentiment respond. Many people in Greece and around Europe are wondering how radical cutbacks with wage cuts and tax hikes are supposed to revive the Greek economy. Berlin, London and Paris have recently been rejecting spending cuts for their own countries on the grounds that such measures would throttle economic growth.

Hopes that the bailout will work have been fuelled by the surprising speed with which banks have recovered from the biggest crisis in their history. Just one year after the collapse of the financial system in 2008 they are making record profits again — and the governments that nationalized their banks in order to rescue them can now hope for profits when they sell their stakes.

Ideally, that’s also the way things should go with Greece. Germany’s government, at least, is trying to win over its skeptical public with the argument that it could actually make a profit if Greece pays back all the money it is loaned. No one can really say if that will ever happen, though. Some believe it will; others aren’t so sure.

The Banks Are Partially to Blame

One thing, though, is certain: Should Greece go bankrupt any time soon, it would be almost impossible to predict the consequences. Portugal and Spain would be the next ones to feel the heat. Indeed, it only makes sense for European governments to buy some time for themselves and Greece if they honestly expect that the situation will have calmed down in three years.

It makes equal sense to make Greece’s creditors part of the solution. In interviews, Merkel and Schäuble — both of whom belong to the center-right Christian Democratic Union (CDU) — have suggested that they want banks to be part of the aid package for Greece. Other parties have demanded that they be forced to do so. Following the initiative of Deutsche Bank CEO Josef Ackermann, a number of German companies have now openly pledged to chip in between €1 billion and €2 billion euros — in the form of loans and through the purchase of Greek government bonds.

One could call such a gesture “hypocrisy,” as some in Germany’s far left Left Party are doing, because the financial sector made a tidy profit on Greece’s slide into indebtedness. It could also, however, be seen as a pragmatic contribution. More than anything, however, it is a confession that the banks are not blameless in Greece’s misfortune.


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Post-crisis reading

Our reviews of the best books on the financial crisis and its aftermath

THE financial crisis has had many victims but for book publishers it hasn’t been so bad. For a start, the banking collapse, followed by drastic measures to stop it leading to a global depression, have made many standard economics textbooks look dated. So, students and libraries around the world will soon need to stock up on the revised editions that the textbooks’ authors are busy working on.

More important, there has also been a boom (a bubble, perhaps?) in books explaining, dissecting and apportioning the blame for the crisis. Our finance editor discusses them with our books and arts editor in this audio chat, and our Wall Street editor lists his favourites here.

Many of these books have also been reviewed in our pages. Our look at an early batch of credit-crunch books, in June last year, recommended Philip Augar’s “Chasing Alpha” and Gillian Tett’s “Fool’s Gold”, among others, the former a broad, highly readable account of how the crisis developed, the latter focused on the murky world of credit derivatives.

Prophets of doom who foresaw the crisis but mostly were not listened to

Michael Lewis’s “The Big Short” and Harry Markopolos’s “No One Would Listen” are about the prophets of doom who foresaw the crisis but who were mostly not listened to. In Mr Lewis’s book, some of those prophets profited very nicely from putting their money where their mouths were. Mr Markopolis was an analyst who smelled something fishy about the remarkable investment returns of a money manager called Bernie Madoff, who it turns out was running the world’s biggest Ponzi scheme. In “The Road to Financial Reformation”, another Cassandra of the credit crunch, Henry Kaufman—whose constant warnings about debt bubbles earned him the nickname “Dr Doom”—spends 260 pages relishing reminding us how he told us so.

Two Paulsons at the centre of the financial maelstrom

As the world’s financial system teetered in 2008, no one was closer to the centre of the action than America’s then treasury secretary, Hank Paulson, whose book “On the Brink” contains some jaw-dropping revelations and an admirably frank assessment by Mr Paulson of what he did well, and not so well, in the crisis.

Another prominent figure in the crisis and its aftermath is the former treasury secretary’s namesake, a hedge-fund manager called John Paulson, who is the subject of Gregory Zuckerman’s “The Greatest Trade Ever”. This Mr Paulson came from nowhere to make a fortune by betting that the housing bubble would pop. (Unfortunately his lucrative bets made him part of the dramatis personae of the Securities and Exchange Commission’s fraud case against Goldman Sachs.) Our review of Mr Zuckerman’s book also looked at Scott Patterson’s “The Quants”, which described the mathematical whizzes who sought their fortune by means of applying complex modelling to exploit anomalies in the markets. They conquered Wall Street, says Mr Patterson, but nearly destroyed it.

The rise and fall of Lehman

David Wessel’s “In Fed We Trust” focuses on the Federal Reserve and its boss, Ben Bernanke, giving a vivid description of how they fared as the crisis unfolded, starting with the collapse of Lehman Brothers. The rise and fall of Lehman was itself such a sizzling tale that it has merited several books all to itself. “A Colossal Failure of Common Sense”, by Lawrence McDonald and Patrick Robinson, describes the hubris of the bank’s boss, Dick Fuld, who so riled Mr Paulson that the then treasury secretary became determined to let Lehman go bust. In the same review we looked at Carmen Reinhart and Kenneth Rogoff’s comprehensive look at eight centuries of financial folly, “This Time is Different”, which is ideal for anyone looking for a more academically grounded analysis of crises past and present.

“The Devil’s Casino”, by Vicky Ward, contains some fascinating pen-portraits of Lehman’s characters—Mr Fuld and his sycophantic court; Joe Gregory, the bank’s obsessively politically correct president; and the “desperate housewives” who found that they and their husbands were married to the bank. But perhaps the best of all the fly-on-the-wall books giving the inside story of Lehman’s collapse and the broader ensuing crisis is Andrew Ross Sorkin’s “Too Big to Fail”, which is meticulously researched and littered with colourful anecdotes.

Hunting the scapegoats, grinding the axes

A meltdown on this scale was bound to offer plenty of scope for axe-grinding and blame-spreading. Joseph Stiglitz’s “Freefall” and Simon Johnson and James Kwak’s “13 Bankers” both take a potshot at financial policymakers. Mr Stiglitz traces the origins of the crisis to a deregulatory fervour fuelled by the “ideology” of free-market fundamentalism and Wall Street’s influence on politics; he argues for tough action, including the break-up of the biggest banks. Messrs Johnson and Kwak also worry about the excessive influence of an “oligarchy” of American bankers, and reach the same conclusion: banks that are “too big to fail” are too big.

The volcanic ash from American banking’s eruption spread far and wide. Three books on how Ireland’s “Celtic tiger” economy was brought low by the credit crunch dish out plenty of blame to politicians, bankers and property speculators. They all agree that greed and ineptitude on the part of the country’s wealthy and the powerful are to blame for Ireland’s economic crash-landing being more violent than its peers’.

While other authors point accusing fingers, in his book, “Don’t Blame the Shorts”, Robert Sloan leaps to the defence of short-sellers who, as he describes, have long been scapegoated for market crashes, and are being once again in the wake of the recent crisis. The Dutch East India Company was blaming its troubles on them as far back as 1609.

Re-examining the trust placed in markets

A spectacular market collapse was bound to provoke a re-examination of assumptions about the trust that modern societies place in markets. John Cassidy’s “How Markets Fail” recounts the story of America’s housing boom and bust, arguing that its roots lie in the “Utopian” idea that society is best served when individuals are left to pursue their self-interest by means of free markets.

In a similar vein, “The Myth of the Rational Market”, by Justin Fox, argues that the whole crisis was the result of an idea that failed: that markets are rational and efficient. Mr Fox provides a fascinating and entertaining history of how this powerful idea, the efficient-markets hypothesis, inspired a wave of innovative financial products, such as derivatives and securitised subprime mortgages, that believers claimed would let their users exploit the wonders of the market. Then it turned out that the market was not rational after all and trillions of dollars were wiped out.

Reinhart and Rogoff’s book was one among several notable attempts to set the recent crisis into historical context. Another is Harold James’s “The Creation and Destruction of Value”, which illustrates how financial crises provoke a reconsideration of values, not just the value of investments but in a more fundamental sense. At the moment everything from the ethics of debt and the nature of capitalism to the continued dominance of the dollar is up for debate. Past crises, Mr James argues, show that this sort of ferment can lead to changes in political power.

Central bankers and their obsessions

Liaquat Ahamed’s “Lords of Finance” describes how the central bankers of the Great Depression were obsessed with a single idea, rather like their successors today. Then, it was maintaining the gold standard; now, he says, it is controlling inflation at all costs. History doesn’t repeat itself but it does rhyme, and once again the central bankers’ big idea has been so compelling that they have ignored its unintended consequences, in this case the bubbles in the housing and stockmarkets.

After the massive stimulus packages we are all Keynesians now, so it is only natural to expect a clutch of books celebrating John Maynard Keynes and declaring “victory” for his ideas. One of them, Robert Skidelsky’s “Keynes: The Return of the Master”, uses an exposition of Keynes’s insights to argue that much modern economics is bunk.

A novel approach

Some day a great novel will be written about the credit crunch, along the lines of Anthony Trollope’s 19th-century classic, “The Way We Live Now”. In the meantime, those who want to make sense of it all will have to make do with the factual analysis of John Lanchester, a British writer of fiction. His ability to explain complex stuff in a down-to-earth and witty style makes his short book, “IOU: Why Everyone Owes Everyone and No One Can Pay”, ideal reading for financial novices.

So many post-crisis books have now hit the stands that even the most voracious bookworm will have difficulty digesting them all. Which of them is the definitive account? Perhaps none: remember that J.K. Galbraith’s masterly work, “The Great Crash, 1929”, did not come out until a quarter-century after the event. Maybe we will have to wait just as long this time.


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The corruption eruption

Saying “no” to corruption makes commercial as well as ethical sense

IT IS 15 years since Moisés Naím coined the memorable phrase “corruption eruption”. But there is no sign of the eruption dying down. Indeed, there is so much molten lava and sulphurous ash around that some of the world’s biggest companies have been covered in it. Siemens and Daimler have recently been forced to pay gargantuan fines. BHP Billiton, a giant mining company, has admitted that it may have been involved in bribery. America’s Department of Justice is investigating some 150 companies, targeting oil and drugs firms in particular.

The ethical case against corruption is too obvious to need spelling out. But many companies still believe that, in this respect at least, there is a regrettable tension between the dictates of ethics and the logic of business. Bribery is the price that you must pay to enter some of the world’s most difficult markets (the “when in Rome” argument). Bribery can also speed up the otherwise glacial pace of bureaucracy (the “efficient grease” hypothesis). And why not? The chances of being caught are small while the rewards for bending the rules can be big and immediate.

When in Rome, behave like a Swede

But do you really have to behave like a Roman to thrive in Rome? Philip Nichols, of the Wharton School, points out that plenty of Western firms have prospered in emerging markets without getting their hands dirty, including Reebok, Google and Novo Nordisk. IKEA has gone to great lengths to fight corruption in Russia, including threatening to halt its expansion in the country, firing managers who pay bribes and buying generators to get around grasping officials holding up grid connections. What is more, Mr Nichols argues, it is misguided to dismiss entire countries as corrupt. Even the greasiest-palmed places are in fact ambivalent about corruption: they invariably have laws against it and frequently produce politicians who campaign against it. Multinationals should help bolster the rules of the game rather than pandering to the most unscrupulous players.

And is “grease” really all that efficient? In a paper published by the World Bank, Daniel Kaufmann and Shang-Jin Wei subjected the “efficient grease” hypothesis to careful scrutiny. They found that companies that pay bribes actually end up spending more time negotiating with bureaucrats. The prospect of a pay-off gives officials an incentive to haggle over regulations. The paper also found that borrowing is more expensive for corrupt companies, probably because of the regulatory flux.

The hidden costs of corruption are almost always much higher than companies imagine. Corruption inevitably begets ever more corruption: bribe-takers keep returning to the trough and bribe-givers open themselves up to blackmail. Corruption also exacts a high psychological cost on those who engage in it. Mr Nichols says that corrupt business people habitually compare their habit to having an affair: no sooner have you given in to temptation than you are trapped in a world of secrecy and guilt. On the other hand, the benefits of rectitude can be striking. Texaco, an oil giant now subsumed by Chevron, had such an incorruptible reputation that African border guards were said to wave its jeeps through without engaging in the ritual shakedown.

Moreover, the likelihood of being caught is dramatically higher than it was a few years ago. The internet has handed much more power to whistle-blowers. NGOs keep a constant watch on big firms. Every year Transparency International publishes its Corruption Perceptions Index, its Bribe Payers Index and its Global Corruption Barometer.

The likelihood of prosecution is also growing. The Obama administration has revamped a piece of post-Watergate legislation—the Foreign Corrupt Practices Act (FCPA)—and is using it to pursue corporate malefactors the world over. The Department of Justice is pursuing far more cases than it ever has before: 150 today compared with just eight in 2001. And it is subjecting miscreants to much rougher treatment. Recent legislation has made senior managers personally liable for corruption on their watch. They risk a spell in prison as well as huge fines. The vagueness of the legislation means that the authorities may prosecute for lavish entertainment as well as more blatant bribes.

America is no longer a lone ranger. Thirty-eight countries have now signed up to the OECD’s 1997 anti-corruption convention, leading to a spate of cross-border prosecutions. In February Britain’s BAE Systems, a giant arms company, was fined $400m as a result of a joint British and American investigation. Since then a more ferocious Bribery Act has come into force in Britain. On April 1st Daimler was fined $185m as a result of a joint American and German investigation which examined the firm’s behaviour in 22 countries.

Companies caught between these two mighty forces—the corruption and anti-corruption eruptions—need to start taking the problem seriously. A Transparency International study of 500 prominent firms revealed that the average company only scored 17 out of a possible 50 points on “anti-corruption practices” (Belgium was by far the worst performing European country). Companies need to develop explicit codes of conduct on corruption, train their staff to handle demands for pay-offs and back them up when they refuse them. Clubbing together and campaigning for reform can also help. Businesses played a leading role in Poland’s Clean Hands movement, for example, and a group of upright Panamanian firms have formed an anti-corruption group.

This may all sound a bit airy-fairy given that so many companies are struggling just to survive the recession. But there is nothing airy-fairy about the $1.6 billion in fines that Siemens has paid to the American and German governments. And there is nothing airy-fairy about a spell in prison. The phrase “doing well by doing good” is one of the most irritating parts of the CSR mantra. But when it comes to corruption, it might just fit the bill.


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The Recovery So Far

Growth is about half as strong as it was after the last deep downturn.

President Obama yesterday hailed the first quarter growth rate of 3.2% as “an important milepost on the road to recovery,” and let’s hope he’s right. From our own current vantage point, the first quarter numbers reveal a respectable cyclical recovery, though one that is so far less robust than we’d expect after an especially deep recession.

Which is not to say the growth isn’t welcome. The quarter is the third in a row in which the national supply of goods and services expanded, after an entire year of contraction, and the report contained some good news. The American consumer, who was supposed to have gone on strike, increased spending by 3.6%, the most in three years. Americans are recovering their spending confidence. Inventories also continued to rebound, accounting for 1.57% of the 3.2% growth total, another sign of a normal upward turn in the business cycle.

On the down side, fixed investment in the likes of capital goods and buildings added little to growth. This is surprising given buoyant corporate profits, though perhaps investment will pick up as residential housing and commercial real estate recover later in the year. This all means the economy is growing but still not firing on all cylinders. Consumer spending will only remain brisk if the economy starts to create more new jobs than it has so far.


We expect better job creation this year than many economists are predicting, but it’s notable that White House economist Larry Summers warned yesterday that joblessness is likely to be an enduring problem even as the economy grows. White House aides don’t tend to broadcast such pessimistic thoughts in an election year without cause.

One way to judge the strength of a recovery is to compare it to the growth after downturns of similar severity. The best recent comparison to the recession of 2008-2009 would be that of 1981-1982. They had different causes—interest rate increases in 1981 and a financial shock in 2008—but both periods had steep declines in output and jobless rates that hit 10%.

The 1982 recession officially ended in November, and the recovery came roaring out of that year, gaining momentum throughout 1983 and carrying 8% growth into 1984 with an expansion that lasted six more years. The nearby table shows the growth rates in the first four full quarters after the recession ended.

By comparison to that boom, the current recovery has been about half as strong. The arbiters of the business cycle at the National Bureau of Economic Research still haven’t officially called the end of the 2008-2009 recession, though the economy has been growing for at least 10 months. Considering how far the economy fell in 2008 and 2009, and considering Washington’s extraordinary monetary and fiscal reflation, this recovery is much less impressive than that of 1983.

The stock market has been signaling more growth ahead, and the last two recoveries—after the mild recessions of 1991 and 2002—also started slowly but eventually gained steam. Perhaps that will happen again. One advantage this time over 1983 is that the emerging economies—China, India and Brazil—are now so much larger and are growing much more rapidly.

But it’s also worth noting another less than favorable contrast with the recovery of 1983: government policy. The full incentive-enhancing impact of the 25% Reagan reduction in marginal tax rates finally kicked in on January 1, 1983, and Paul Volcker’s Federal Reserve was starting to cut interest rates from the record highs that broke the back of inflation while causing the recession. At the same time, an era of deregulation was lowering costs across most industries. The groundwork for a durable expansion had been laid in lower taxes, lower inflation and lower business costs.

In the current recovery, the policy headwinds are very different. Taxes are set to rise significantly on January 1, 2011, and the political class is signaling the need for still more taxes to pay for the costs of stimulus and the expanding entitlement state.

As for monetary policy, the Fed has held short-term interest rates at close to zero for 16 months. The only question is how soon and how high rates will rise. Meanwhile, Washington is raising costs for business by expanding its regulatory reach via tougher antitrust enforcement, mandates on health care and energy, more political limits on telecom investment, restrictions on bank lending, and much more.

The White House bet is that the Great Reflation that began in December 2008 has ignited a recovery that is strong enough to blow through these obstacles and become another long-lived expansion. We certainly have a decent recovery. Regarding its strength and duration, the jury is still out.

Editorial, Wall Street Journal


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Porn Didn’t Give Bernie Madoff His Start

Surfing the Web is not the cause of the SEC’s problems.

Ever since the dawn of the culture wars, when widespread obscenity seemed to symbolize all that was going wrong with America, no subject has furnished more demagogue gold than pornography. Of course, it backfires against the family values set on a fairly regular basis—the latest example being that Republican National Committee outing to a bondage-themed nightclub in Los Angeles—but for grandstanding purposes nothing can beat it.

Take, for example, the current outrage at the Securities and Exchange Commission, where, according to an inspector general report that was made public late last week, employees spent a great deal of time and used up prodigious amounts of computer resources gazing at Internet pornography. What’s more, their porn habits date back to 2007 and 2008, when the need for an attentive SEC was at its greatest.

The chorus of outrage is being led by California Republican Rep. Darrell Issa, who fulminated as follows to the Washington Post last Friday: “This stunning report should make everyone question the wisdom of moving forward with plans to give regulators like the SEC even more widespread authority.”

Now, if you’re looking for reasons why the SEC failed in the past they aren’t hard to come by. Start with political leaders who clearly didn’t believe in the mission; proceed to the agency’s grotesquely underfunded workplace where lawyers had to do their own filing, mail-sorting and photocopying; and arrive, finally, at the revolving door, which sometimes transformed SEC jobs into stations on the Wall Street career path and worked fairly predictable effects on enforcement.

This was an agency whose mandate, essentially, was to crawl out on an ice floe and die. Were we to look closely at its employees’ computing habits during the Bush years, I bet we’d also find that they bought stuff on eBay, wrote copious email, and read a lot of blogs.

But it’s more fun to blame everything on pornography. And so, it is suggested, porn is the reason Bernard Madoff got away with it; porn may be why Lehman Brothers failed; with enough effort we can probably figure out ways to blame porn for every federal foulup from Toyota to FEMA. Blaming porn shifts the focus away from tricky things like the 30-year-old deregulatory consensus and turns the hate on a familiar villain: depraved government functionaries, whose twisted appetites are never fully repressed by their rumpled sack suits.

Not all conservatives find the demagoguery of smut so enticing, however. If your fear and loathing of the state are pure enough, you probably believe the government has no more business policing morality than it does, say, protecting the environment. That’s why, in certain libertarian quarters, defending the rights of pornographers has become a kind of holy cause.

The Internet-spawned “pornocopia” that surrounds us today “might be called John Stuart Mill’s wet dream,” declared a 2001 editorial in Reason magazine, where the defense of porn seems to be as much of a staple as is denunciation of the Food and Drug Administration.

Indeed, the revelations about porn consumption at the SEC must be a libertarian’s own wet dream. Here you have a libertarian cause célèbre—the endless, uncontrollable oceans of Internet pornography—somehow drowning that libertarian bête noir, regulatory enforcement. Polymorphous perversity itself managed to muzzle Big Brother.

How awesome is that? Why, it’s as awesome as if Ayn Rand herself returned to earth and—shrieking, “bow to Goldman Sachs, parasites!”—led the bank industry’s lobbyists to victory over the financial reform bill.

Libertarians aren’t celebrating, though: they’ve apparently joined forces with the scolds. “Regulators inevitably download porn, either figuratively or literally,” writes Reason editor Matt Welch on the CNN Web site. “Expecting regulators to do their job well” is “fantastical.”

What we have here, in other words, is a lesson in the eternal futility of government. Federal employees will download images from skankwire-dot-com; as stunted moral creatures, it’s just what bureaucrats do. Regulation will always fail; the answer is to quit trying.

What all of this overlooks is the highly advanced concept known as “change.” The purpose of federal agencies can be redefined and their personnel changed. Once upon a time, the SEC performed well; then it performed poorly.

And now that it threatens to perform well again, we are told it can only fail, that no federal operation can ever overcome the unalterable depravity of its employees.

One thing that may come out of all this is a wiser and stronger conservative movement. Libertarians must have learned that moral finger-wagging is justified when it helps to discredit regulators. And surely the family-values crowd has come to understand the glory of porn. It is, they can now see, just another weapon in the deregulator’s arsenal, as powerful a tool in securing bureaucratic somnolence as the services of any lobby shop on K Street.

Thomas Frank, Wall Street Journal


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Is Financial Innovation the Enemy?

Hedging against risk is hardly evidence of misbehavior.

Whether Goldman is bad, very bad or very, very good depends on what business you think it should be in. But its troubles have also brought out the dime-store Jeremiahs declaiming on the perniciousness of “derivatives.”

First off, no security is more derivative than a share of stock, which is not really ownership of a company (though it’s usually claimed so) but merely a right to whatever cash management deigns to share, plus a right to whatever is left over in a bankruptcy, plus a right to participate in corporate governance in whatever limited ways a company’s bylaws permit.

A welcome for Goldman Sachs executives at yesterday’s Senate hearing.

Only an infinitesimal fraction of share sales actually finance something “real.” Most are exchanges between one punter and another. Too, any serious person knows that the best guarantee of performance is not a company’s bylaws or the SEC, but making sure the CEO owns a large chunk of stock.

By comparison, the Goldman “Abacus” CDO is simplicity itself, despite much malpractice in the press.

The CDO was not “designed to fail.” The securities that failed were the simple, wholesome straightforward mortgages that the CDO “referenced,” which were designed to extract a fair return from people who supposedly cherished their homes and would strive to pay their bills.

The CDO itself performed exactly as advertised: It paid off the winner of two opposing bets about whether large numbers of mortgage borrowers would default.

Nor was the trade the equivalent of “taking out fire insurance on your neighbor’s house,” at least in the sense that your intentions were different from what the insurer expected. Instead, it’s like you and an insurance company having the following conversation:

You: “I think house X is going to burn down.”

Insurance company: “We don’t think it will burn down and we know more about houses than you do.”

You: “It will burn down.”

Insurance company: “Will not.”

You and insurance company simultaneously: “Let’s bet!”

This is a distortion only in that it underestimates the amount of iteration. The first warning of a housing bubble in The Journal came in August 2001, just weeks after the tech crash. The debate was in full swing by late 2006, when Goldman began putting together the Abacus CDO.

Most gobsmacking, however, is the assertion that such “side bets” serve no legitimate social function.

Come again? With so many financial institutions sitting on massive portfolios of mortgages, how on earth could a mechanism to share some of the risk with willing counterparties fail to be useful? Would that more banks had done so, or that one of those counterparties (AIG) had held up its end more competently.

And how can anyone doubt the utility of John Paulson, after witnessing how vulnerable our individual savings and wealth are to large-scale blunders in the financial system? By engineering the deal, he may have walked away with a disproportionate accretion to his own net worth. For his clients, his timely shorts were probably the difference between losing a lot and losing less in the general crash. If we’re going to have a financial system so prone to catastrophic mistakes, we’re all going to need a John Paulson.

The disingenuousness is thick with the selective release of Goldman emails by Congressional investigators in advance of yesterday’s grilling of Goldman CEO Lloyd Blankfein, the subtext of which was that when Americans see the value of their homes plummet, it’s unpatriotic if not criminal not to have lost money along with them. Better than what Mr. Blankfein says now in his defense, though, is the fuller version of what he emailed to colleagues at the time: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost because of shorts. It’s not over, so who knows how it will turn out ultimately.”

To anyone not in an unseemly haste to join the Goldman whipping detail, this sounds like what every banker should have been thinking at the time: “The future is unknown and scary. Let’s hope we’re properly hedged.”

For the truth is, the “mortgage mess” would likely not have metastasized into a global financial crisis if similar emails were now to be found in the records of Fannie Mae, Freddie Mac, Bear Stearns, Citigroup, Washington Mutual, AIG, Lehman, etc.

Not beyond the wit of man (though apparently beyond the wit of the current Congress) is changing the incentives so housing and other lenders will be less driven or tempted to create “systemic risk.” In the meantime, however, all the hooey over Goldman could have genuinely dangerous consequences if it causes Washington to lose the political stomach to backstop the system with its own credit next time a panic threatens a blind run as it did in late 2008.

Holman W. Jenkings, Jr.


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Land of the lost

For once, Hollywood is right to oppose innovation

“NOBODY knows anything,” said the screenwriter William Goldman of the film business. But a great many people think they do. And they may soon get the chance to back their hunches with money. On April 20th America’s Commodity Futures Trading Commission (CFTC) approved the second of two exchanges that would allow trading of contracts based on films’ box-office takings.

It is an answer to a real problem. The six main studios, which have become dependent on small numbers of big-budget films, are finding it hard to spread risk. Investors who fled during the credit crunch have not yet returned. Independent filmmakers are struggling to sell the rights to foreign box-office takings in advance—something they used to rely on to pay for their pictures. There is a need to hedge against failure. But Hollywood is not convinced that the exchanges meet it.

Although the markets run by Cantor Fitzgerald and Media Derivatives have been approved, the contracts to be traded on them have not. Hollywood is lobbying hard to stop them. It has launched a separate effort to have Congress ban box-office futures. Politicians as diverse as Barbara Boxer, a California liberal, and Orrin Hatch, a Utah conservative, have spoken out against them. It is the equivalent of a coast-to-coast marketing blitz.

Some of the objections are silly. A joint letter from Hollywood’s trade associations points out that box-office figures, though treated as reliable, are in fact estimates by the studios. True, but this is surely an argument for better figures, not for a ban on trading. There are, however, more serious problems with the exchanges.

The first is the information imbalance in the film business. Cantor’s market is based on an existing predictive market, the Hollywood Stock Exchange, which uses play money. A study of that exchange, by Thomas Gruca of the University of Iowa, found that it errs in predicting box-office returns by an average of 31%. But the studios know a lot more than other investors. They know how audiences are responding to test screenings, on how many screens a film will play, and how much they are going to spend marketing it. Although such information leaks out, it does so selectively and unevenly. As a result, almost every trade by a studio would be an insider bet.

And it is highly unlikely that a studio would ever short one of its own products. In Tinseltown, more than in almost any other industry, rumour and reality bleed together. A Hollywood executive is powerful and successful largely because he is viewed as being powerful and successful. A film that is rumoured to be a dud tends, by means of “bad buzz” leaking to newspapers and the internet, to become a dud. So a bet against a film would become self-fulfilling—to say nothing of how hard it would be to explain to the talent.


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A new idolatry

Shareholders v stakeholders

The economic crisis has revived the old debate about whether firms should focus most on their shareholders, their customers or their workers

THE era of “Jack Welch capitalism” may be drawing to a close, predicted Richard Lambert, the head of the Confederation of British Industry (CBI), in a speech last month. When “Neutron Jack” (so nicknamed for his readiness to fire employees) ran GE, he was regarded as the incarnation of the idea that a firm’s sole aim should be maximising returns to its shareholders. This idea has dominated American business for the past 25 years, and was spreading rapidly around the world until the financial crisis hit, calling its wisdom into question. Even Mr Welch has expressed doubts: “On the face of it, shareholder value is the dumbest idea in the world,” he said last year.

In an article in a recent issue of the Harvard Business Review, Roger Martin, dean of the University of Toronto’s Rotman School of Management, charts the rise of what he calls the “tragically flawed premise” that firms should focus on maximising shareholder value, and argues that “it is time we abandoned it.” The obsession with shareholder value began in 1976, he says, when Michael Jensen and William Meckling, two economists, published an article, “Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure”, which argued that the owners of companies were getting short shift from professional managers. The most cited academic article about business to this day, it inspired a seemingly irresistible movement to get managers to focus on value for shareholders. Converts to the creed had little time for other “stakeholders”: customers, employees, suppliers, society at large and so forth. American and British value-maximisers reserved particular disdain for the “stakeholder capitalism” practised in continental Europe.

Now, Mr Martin argues, shareholder value should give way to “customer-driven capitalism” in which firms “should instead aim to maximise customer satisfaction.” This idea is winning some converts. Paul Polman, who last year became boss of Unilever, a consumer-goods giant, recently said to the Financial Times, “I do not work for the shareholder, to be honest; I work for the consumer, the customer…I’m not driven and I don’t drive this business model by driving shareholder value.”

Nor is it just customers who are expected to benefit from a backlash against the cult of shareholder value. Mr Lambert reports that a recent survey of the CBI’s members found that most expected that a “more collaborative approach would emerge with various different groups of stakeholders”, including suppliers and the institutions that educate workers. And a forthcoming book by Vineet Nayar, the chief executive of HCL Technologies, a fast-growing Indian business-process outsourcing firm, takes a quite different position to Mr Martin, as is evident from its title: “Employees First, Customers Second”.

Has the shareholder-value model really failed, however? The financial meltdown has certainly undermined two of the big ideas inspired by Messrs Jensen and Meckling: that senior managers’ pay should be closely linked to their firm’s share price, and that private equity, backed by mountains of debt, would do a better job of getting managers to maximise value than the public equity markets. The bubbles during the past decade in both stockmarkets and, later, the market for corporate debt highlighted serious flaws with both of these ideas, or at least with the way they were implemented.

A firm’s share price on any given day, needless to say, can be a very poor guide to long-term shareholder value. Yet bosses typically had their pay linked to short-term movements in share prices, which encouraged them to take measures to push the share price up quickly, rather than to maximise shareholder value in the long run (by when they would probably have departed). Similarly, private-equity firms took on too much debt during the credit bubble, when it was available on absurdly generous terms, and are now having to make value-destroying cuts at many of the companies in their portfolios as a result.

In some ways the current travails of Goldman Sachs epitomise the problem. The investment bank embraced the maximisation of shareholder value when it went public in 1999. Although it insists that it does not live quarter to quarter, senior figures from its previous incarnation as a partnership, when it naturally championed the long-term interests of its employees (the partners), argue that it would have been much more wary in those days of any deals that made a quick buck at the risk of alienating customers. But, as Mr Lambert points out, “It wasn’t just the banks which had a rush of blood to the head. For a few years, a fair number of other companies seemed to put almost as much effort into managing their balance-sheets as into wooing their customers.” In his view, “If you concentrate on maximising value to shareholders over the short term, you put at risk the relationships that will determine your longer-term success.”

Yet this need not mean that the veneration of shareholder value is wrong, and should be replaced by worship at the altar of some other business deity. Most of those preaching reverence for other stakeholders concede that the two are usually not mutually exclusive, and indeed, often mutually reinforcing. Mr Martin, for example, admits that “increased shareholder value is one of the by-products of a focus on customer satisfaction.” Likewise, in India’s technology industry, where retaining talented staff is arguably managers’ hardest task, Mr Nayar’s devotion to employees, which he says has helped increase revenues and profits, may be the best way to maximise long-term shareholder value.

In other words, the problem is not the emphasis on shareholder value, but the use of short-term increases in a firm’s share price as a proxy for it. Ironically, shareholders themselves have helped spread this confusion. Along with activist hedge funds, many institutional investors have idolised short-term profits and share-price increases rather than engaging recalcitrant managers in discussions about corporate governance or executive pay.

Giving shareholders more power to influence management (especially in America) and encouraging them to use it should prompt them and the managers they employ to take a longer view. In America, Congress is considering several measures to bolster shareholders at managers’ expense. In Britain, the Financial Reporting Council has proposed a “stewardship code” to invigorate institutional investors. “This is a phoney war between shareholder capitalism and stakeholder capitalism, as we haven’t really tried shareholder capitalism,” says Anne Simpson, who oversees corporate-governance activism for CalPERS, America’s biggest public pension fund. “Rather than give up on shareholder value, let’s have a real go at setting up shareholder capitalism.”


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Outfoxing the Counterfeiters

The new $100 bill is the most sophisticated attempt yet to combat forgery. Since colonial times, the U.S. has engaged in a cat-and-mouse game with criminals and foreign governments eager to pass off brilliant fakes.

The redesigned $100 bill, above, has security features like microprinting, color-shifting objects and a 3-D ribbon.

In 1690, the Massachusetts Bay Colony became the first government in the Western world to issue paper money. Some of the first counterfeiters of paper money followed soon after. Within a generation, the authorities were engaged in a running battle against forgers, whom they tried to deter by various punishments: cropping their ears, for example, or hanging them. Many colonial notes soon came with a pointed warning: “To counterfeit is DEATH.”

Last week, in a ceremony attended by Timothy Geithner and Ben Bernanke, government officials showed off a high-tech $100 bill designed to frustrate 21st-century counterfeiters. It features the pleasing pastels already seen on lesser denominations, as well as a ghostly image of a quill pen and a copper inkwell containing a bell that appears and disappears depending on the angle from which it’s viewed. Most startling of all, the front of the bill contains a vertical purple strip that contains shimmering images of the number “100” and the Liberty Bell, all of which miraculously appear to move when the bill is tilted in one direction or another.

With well over a half trillion dollars in “Benjamins” in circulation around the world, the existing $100 bill has attracted the attention of countless counterfeiters. Most have been sophisticated criminal gangs, but there’s also a considerable (if controversial) body of evidence linking the most realistic and dangerous counterfeits—the so-called supernotes—with the North Korean government. These twin threats, more than anything else, have driven this latest eye-popping change to our money supply.

If history is any guide, it won’t be the last. Paper money in this country has followed a familiar trajectory: new designs, new dollars and, eventually, new counterfeits.

It’s perhaps appropriate that Benjamin Franklin appears on the most valuable denomination of dollar in circulation. He designed the country’s first money: the Continental dollars issued during the American Revolution to pay the costs of the war. Franklin didn’t put his own head on the currency; rather, he used a mysterious anticounterfeiting device he had devised several decades earlier.

This was the so-called nature print, which consisted of an image of a leaf or leaves. It was extraordinarily lifelike, and with good reason. Franklin had devised a way of taking a plaster cast of the surface of a leaf. That in turn could be used to cast a lead plate that would be used to print the notes. Because every leaf was unique—with a complex web of veins of varying thickness—the notes were very difficult to counterfeit.

The counterfeiters who attacked the new dollar weren’t in it for the money. They wanted to undermine the revolutionary war effort, and they spared no expense to do so. In 1776, the British occupied New York City and the counterfeiters who had already set up shop began operating under the supervision of the imperial authorities, churning out massive quantities of notes that visitors could buy for pennies and then pawn off on unsuspecting revolutionaries.

The British hadn’t invented the idea of counterfeiting as a weapon of war; counterfeiting enemy currency is a tactic that dates back to antiquity. Still, the patriots viewed these imitations as unsportsmanlike in the extreme. George Washington fumed in his private correspondence that “no Artifices are left untried by the Enemy to injure us.” Thomas Paine was even more outraged, publishing an open letter to the British commander in which he assailed the decision to counterfeit the dollar. “You, sir,” he wrote, “have the honor of adding a new vice to the military catalogue, and the reason, perhaps, why the invention was reserved for you, is, because no general before was mean enough even to think of it.”

The quality of the British counterfeits undercut the credibility of the dollar, but the real blame for the dollar’s decline lay with the revolutionaries, who issued vast quantities of Continentals to pay the costs of the war. Backed by nothing more than a shaky faith in the government, the notes depreciated, eventually becoming nearly worthless. The experience left Americans with serious misgivings about paper currency, both counterfeit and real.

The Constitution was a product of those fears. The monetary clauses of the Constitution forbade the individual states from issuing paper money or coins, though it did permit the federal government to “coin money.” It was silent on the question of whether the federal government could issue paper money, though most assumed it lacked that prerogative.

Yet paper money flourished, thanks to private banks chartered by state legislatures. These banks began issuing their own paper money in denominations and designs of their choice. Thousands of different kinds of “bank notes” floated in circulation, each with their own unique design. Ben Franklin and the other founders appeared on some, but so, too, did everyone (and everything) from portraits of obscure politicians, Greek and Roman gods, scantily clad women, slaves, Indians and scenes of everyday life. Even stranger things—Santa Claus, sea serpents and rampaging polar bears, to name a few—showed up on these private currencies.

It proved next to impossible to remember what genuine notes looked like, never mind counterfeits, and the opening decades of the 19th century marked what one historian has called the “golden age of counterfeiting.” In those decades, millions of dollars in counterfeit notes flooded the economy. The masterminds behind these counterfeits created them with the hope of making money, not sabotaging the country.

Many of these counterfeiters became folk heroes, running national criminal networks for the manufacture, distribution and sale of counterfeit notes. Absent effective police forces, these men and women operated with impunity. The federal government showed little to no interest in prosecuting counterfeiters, and it had few resources to do so anyway. As one newspaper editor bewailed in 1818: “Counterfeiters and false bank notes are so common, that forgery seems to have lost its criminality in the minds of many.”

[CovJump2]The banks fought back, commissioning ever more elaborate notes that contain many of the same anticounterfeiting features that survive today: special inks, watermarks and proprietary paper recipes. Engravers also sought to create ever more elaborate, intricate designs that would defy imitation. Yet counterfeiters still managed to surmount every technological obstacle thrown their way.

Indeed, new technology could cut both ways. Like the digital technologies of the 21st century, the invention of photography opened up new vistas in counterfeiting. Until the 1850s, most bank notes came in one color: black. But a proliferation of photographic counterfeits prompted the creation of new colorful inks, including the invention in 1857 of a new kind of green ink that used chromium trioxide. The delicate green lines printed in this ink could not be replicated with the black-and-white photography of the day; it would appear as a black mass when photographed.

The Civil War began four years later, and the cash-strapped Union quickly got over its constitutional objections to paper money, issuing a new national currency that used this “Patent Green Tint.” The new notes became known as greenbacks. They soon circulated alongside another kind of national currency colored the same shade of green: the “national bank notes,” issued by banks that obtained federal charters and the right to issue money designed and controlled by the federal government.

The Confederacy issued its own paper money. Lacking skilled engravers and the necessary supplies, the “grayback” looked awful and followed the fate of the Continental, losing its value over the course of the war. Ordinary counterfeiters considered them unworthy of imitation, but enterprising and patriotic Unionists churned out millions of dollars’ worth of counterfeits while the federal government looked the other way. Many of these knockoffs had the distinction of being better looking than the originals.

The war marked a serious watershed in the nation’s monetary history—and in the history of counterfeiting. Out went the old system of local, private currencies, and in came a new national paper money. But the counterfeiters remained, and they immediately set to work imitating the federal notes. Government officials were not amused, and in the final years of the Civil War, some of the new notes contained blocks of text spelling out the statutory penalties for counterfeiting (up to 15 years imprisonment and hard labor, a $1,000 fine or both).

But these amounted to empty threats without a concerted campaign to crack down on counterfeits. That job fell to a newly created national police force: the Secret Service. Long before it protected the president, the Secret Service made its mark ruthlessly dismantling the domestic counterfeit economy. This campaign, which began in earnest after the Civil War and was largely complete by the 1890s, stirred journalists to hyperbole. In 1901, one newspaper marveled at what is breathlessly described as a “silent, unsleeping branch of the Government, which never appears in the public eye except in the act of pouncing on a victim and which never forgets a crime or a criminal.”


Making Funny Money

Some famous counterfeiting ploys—by governments and criminals—through history.         

  • Governments have long forged currency as a war tactic. In Renaissance Italy in the 1470s, Duke Galeazzo Sforza of Milan printed counterfeit Venetian ducats, to undermine the economy of the rival city-state.
  • In the 1690s, Isaac Newton took a job as warden of the British mint, where he prosecuted and sent scores of counterfeiters to the gallows. To catch them, he kept a network of spies across London and interviewed informants himself in pubs. His biggest catch was the notorious William Chaloner, who claimed to have reproduced £30,000 (the equivalent of about $7 million today) and was hanged in 1699.
  • One of the largest frauds in history is the Portuguese bank-note crisis of 1925. A con man named Alves Reis convinced a British printer that he represented the Bank of Portugal, and had them print the modern equivalent of about $125 million in bills. His scheme went unnoticed for nearly a year.
  • In 1926, a group of Hungarians (including Budapest’s chief of police) pleaded guilty to printing millions of French francs, partly to fund political activities and avenge territorial losses suffered by their country. However, the quality was poor, and they were soon caught by French detectives.


By the early 20th century, the currency was relatively safe from counterfeiters. It had also become more uniform and simple, particularly after the creation of the Federal Reserve in 1913. Ben Franklin made his debut on the $100 bill, and the nation’s currency became increasingly important, eventually displacing the British pound as the world’s dominant currency. Unfortunately, that rise attracted the attention of foreign governments. In a vivid demonstration of the old adage that imitation is the sincerest form of flattery, Joseph Stalin ordered his fledgling intelligence service to counterfeit the dollar. While he may have done so ostensibly to wage war on a capitalist country, the real reason lay with the Soviet Union’s desperate need for hard currency.

The extraordinarily well-made $100 bills that flowed from Soviet presses initially flummoxed the Secret Service. Yet the quality of the bills was not matched by the professionalism of the principals who orchestrated the scheme, and it collapsed after a series of arrests that began in Berlin. Soon after, the Soviets shut down the operation, fearful of international embarrassment.

The Nazis pulled off a far more successful counterfeiting operation during World War II, setting up a team of engravers and artisans in the Sachsenhausen concentration camp to manufacture stunning imitations of the British pound and the American dollar. While counterfeits of the pound went into limited circulation, they did little damage to Britain, and the project to counterfeit the dollar collapsed in the waning months of the war.

Few successful counterfeits of the dollar gained widespread circulation in the postwar era, and for decades the appearance of the $100 bill remained largely unchanged. In the late 1980s, the so-called supernote made its appearance: highly accurate $100s (and some $50s) that baffled investigators. The remarkable frequency with which North Korean diplomats were caught carrying the notes led many to suspect the secretive regime. During the George W. Bush administration, the U.S. formally charged North Korea with counterfeiting the dollar, a claim the Obama administration has echoed, if faintly.

Regardless of the source of the supernotes, they prompted the first major overhaul of the paper currency in decades. The first big change came with the introduction of the new $100 bill in 1996, which featured the “large head” design that has since become standard, along with watermarks and color-shifting ink. But the latest version of the $100 unveiled this week takes things to a whole different level.

The centerpiece of the redesign is a purple strip that runs from top to bottom of the bill. The strip is coated with hundreds of thousands of microscopic lenses in the shape of the number “100” and what seems to be the Liberty Bell. Thanks to some complex optics, these thousands of lenses combine to create a single, larger image. When the bill is angled one way or another, the strip comes alive, making it seem as if the images can move.

The technology is dubbed “Motion.” Crane, the paper company that owns the rights to the technology, says that it “represents the next generation of counterfeit deterrence.” Unlike some of the first-generation deterrents—color-shifting ink, for example—Motion works its magic even in dimly lit settings like nightclubs.

The new note is a technological marvel. But looking at all the safeguards—not only the Motion strip, but the watermark, a separate security thread, microprinting, a color-shifting “100” and the bell inside the inkwell—the effect is roughly comparable to an apartment door equipped with countless locks and latches. It screams “secure,” but the sheer abundance of security devices suggests that counterfeiters have been all too successful in breaching earlier defenses.

Crane promises that Motion will impose “tremendous barriers against a quality counterfeit.” Perhaps. But it’s a sure bet that somewhere in the world, counterfeiters are studying the new bill, looking to crack the code. And someday they will.

Stephen Mihm is associate professor of history at the University of Georgia and the author of “A Nation of Counterfeiters.”


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After the Crash, a Crashing Bore

The men behind the bailout take refuge in impenetrable jargon.

Like all Americans, I continue to seek to understand exactly what moods, facts, assumptions, dynamics, agendas and structures underlay and made possible the crash and the Great Recession.

We do this so that we will be able to bring our gained wisdom into the future and keep another crash from happening, should we ever have another bubble to precede it. We also do it so that we know who to hate.

That’s why this week’s Financial Industry Inquiry Commission hearings were so exciting, such a public service. The testimony of Charles Prince, former CEO of Citigroup, a too-big-to-fail bank that received $45 billion in bailouts and $300 billion in taxpayer guarantees, was riveting. You’ve seen it on the news, but if you were watching it live on C-Span, the stark power of his brutal candor was breathtaking. This, as you know, is what he said:

“Let’s be real. This is what happened the past 10 years. You, for political reasons, both Republicans and Democrats, finagled the mortgage system so that people who make, like, zero dollars a year were given mortgages for $600,000 houses. You got to run around and crow about how under your watch everyone became a homeowner. You shook down the taxpayer and hoped for the best.

“Democrats did it because they thought it would make everyone Democrats: ‘Look what I give you!’ Republicans did it because they thought it would make everyone Republicans: ‘I’m a homeowner, I’ve got a stake, don’t raise my property taxes, get off my lawn!’ And Wall Street? We went to town, baby. We bundled the mortgages and sold them to fools, or we held them, called them assets, and made believe everyone would pay their mortgage. As if we cared. We invented financial instruments so complicated no one, even the people who sold them, understood what they were.

“You’re finaglers and we’re finaglers. I play for dollars, you play for votes. In our own ways we’re all thieves. We would be called desperadoes if we weren’t so boring, so utterly banal in our soft-jawed, full-jowled selfishness. If there were any justice, we’d be forced to duel, with the peasants of America holding our cloaks. Only we’d both make sure we missed, wouldn’t we?”

OK, Charles Prince didn’t say that. Just wanted to get your blood going. Mr. Prince would never say something so dramatic and intemperate. I made it up. It wasn’t on the news because it didn’t happen.

It would be kind of a breath of fresh air though, wouldn’t it?

In fact, the hearings weren’t dramatic but a tepid affair, gentle and genteel. The commission members—economists, lawyers, former officeholders—actually made me miss congressmen, who can at least be relied on to emote and act out the indignation of the citizenry as they understand the citizenry. As an investigative style this isn’t pretty and usually isn’t even sincere, but it can jar witnesses into revealing, either deliberately or by accident, who they really are and what they really think.

At this week’s hearings, the questioners often spoke the impenetrable financial language of the witnesses. The leveraged capital arbitrage of the lowest CDOs were subject to the supersenior subprime exposure, as opposed to the triple-A seniors, right? The witnesses—former Fed Chairman Alan Greenspan on Wednesday, Mr. Prince and former Treasury Secretary and Citigroup Chairman Robert Rubin on Thursday—were, in their testimony, obviously anxious not to be the evening’s soundbite. Nobody wants to be the face of a bailout. This is where famous and important people being grilled hide now: in boringness, in an opacity of language so thick that following them is actually impossible. The testimony reminded me of an observation in Michael Lewis’s “The Big Short,” his study of what happened on Wall Street and why:

Language served a different purpose inside the bond market than it did in the outside world. Bond market terminology was designed less to convey meaning than to bewilder outsiders. . . . The floors of subprime mortgage bonds were not called floors—or anything else that might lead the bond buyer to form any sort of concrete image in his mind—but tranches. The bottom tranche—the risky ground floor—was not called the ground floor but the mezzanine . . . which made it sound less like a dangerous investment and more like a highly prized seat in a domed stadium.” In short, “The subprime mortgage market had a special talent for obscuring what needed to be clarified.”

Which is what the hearings were like.

By Thursday afternoon I couldn’t figure out why they’d been held. They couldn’t have been aimed at informing the citizenry. Even the tone was strange, marked by a kind of weird delicacy, a daintiness of approach, a courtesy so elaborate I thought at some points commission members were spoofing each other. “Thank you so much for appearing,” “I’m so grateful for that insight.” Guys, there’s a war on.

I want to pick out some memorable moments, but I can’t really quote them because they resist quotation.

So I’ll translate.

On Wednesday, Mr. Greenspan said it’s easy to look back and see your mistakes, but what is to be gained by endless self-examination? It’s tempting to be self-critical, but self-criticism can become self-indulgence. Systems are complex; human decision-making is shaped by the endless fact of human fallibility. I didn’t do anything wrong, and neither did Ayn Rand by the way, but next time you might try more regulation.

On Thursday Chairman Phil Angelides to Messrs. Prince and Rubin: I like you, do you like me? But we don’t like undersecuritized trilevel tranches, do we?

At one point commissioner Bill Thomas, a Republican former congressman from California, almost got an intelligent question out. It started as: How did you guys get to the top and run the show and not know what was going on below you? But Mr. Thomas got stuck in the muck of synthetic product securitized assets and then lost his thread, to the extent he had a thread. He began to ask Mr. Prince about his famous dancing quote: “As long as the music is playing, you’ve got to get up and dance,” Mr. Prince had said in 2007. But Mr. Thomas asked his question so meekly—it was an “alleged quote” and maybe it was misunderstood by the press, which is always misunderstanding things. Then Mr. Thomas suddenly wasn’t asking that, but asking if it would be nice if in the future bankers “have a structure,” a stronger federal regulatory structure, though we probably shouldn’t have one if we don’t need it, but maybe we do, to sort of stop people like you, not that people like you should be stopped in any way.

Mr. Prince seized on this to say the dancing quote was taken out of context: He’d been talking about liquidity. Ah. Well, that takes the sting out of that one.

From a commission member: The American people have experienced a 30% fall in housing values. Do you know why?

Mr. Prince: Yes, we haven’t had such a decline “since the Great Depression.” The reason is before the crash there was “a bubble.” There was too much “easy money.” Then the bubble popped.

Thank you, Sherlock.

The takeaway, as they say, of the whole event, was more or less this:

Citigroup testifiers: We didn’t do anything particularly wrong, and what happened is all so sad, isn’t it? Sad, subprimed and tranched.

Commission: Yes, all so sad and tragic. Somebody’s head should roll. I like your tie.

Can’t we do better than this?

Peggy Noonan, Wall Street Journal


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The 2010 Recovery

What happens when the reflation bill comes due?

Democrats are applauding and Republicans are criticizing Friday’s report of modest job growth in March, and for once they’re both right. The private economy is at last creating jobs, albeit not enough so far to conclude that the recovery of 2010 will become a durable expansion.

The jobs market does seem to have turned a corner, with the Labor Department’s survey of businesses reporting 162,000 new jobs in the month, plus modest upward revisions in January and February. One bright spot is manufacturing employment, up 17,000 in March and now up for three straight months, as well as a modest uptick in average hours worked to 34 in a week, from 33.9.

The companion household survey showed a heftier increase of 264,000 net jobs, rising to 1.1 million so far this year, and as we learned in the last recovery this survey tends to lead increases in what business reports in future months. The upshot is that at long last—and 13 months after the $862 billion stimulus that the White House said would keep unemployment below 8%—we should see more robust job creation in the months ahead.

The question is how robust. The March job gains included 48,000 temporary Census workers, for a total so far of 87,000 Census hires, and several hundred thousand more in the months ahead. Take out this government hiring, and job creation looks feeble. Also dismaying is that the so-called total jobless rate, which includes discouraged workers, ticked up again to 16.9%.

It’s especially distressing to see that the number of long-term jobless—those out of work for 27 weeks or more—jumped again to 6.55 million, and as a share of the total jobless hit a new record of 44.1%, up from 40.9% in February and 24.6% a year earlier. (See the nearby chart.) This means that nearly one of every two Americans who has lost his job is waiting at least a half year to get a new one. The damage in lost skills and human capital is enormous and can do life-long damage.

Congress keeps extending jobless benefits, and last week President Obama proposed a new subsidy for the jobless in the form of mortgage payment reductions if you’re out of work. Democrats think this is good politics because they can accuse Republicans of being uncaring if they vote no.

But the irony is that these extensions only increase the incentive to delay going back to work, especially if most available jobs are temporary or pay less than their old ones. Democrats are ensuring that the jobless rate stays higher for longer (it’s still a nasty 9.7%), which isn’t compassionate and can’t be good politics going into November.


This mixed jobs picture is symptomatic of the larger economic recovery, which has been underway for nine or so months but has felt less than dynamic. The stock market is doing well, which is one portent of future growth. Corporate profits have been increasing smartly, which is also helping stocks, as has productivity as firms squeeze more output from each worker. Thanks to China and India in particular, global manufacturing has rebounded.

And of course the banking system has gone a long way to healing itself from the panicked lows of last March. The Obama Treasury deserves some credit on this score for ignoring the advice of its friends on the left who recommended nationalizing the banks, and tempering some of the worst banker-bashing.

Mr. Obama attacked us by name Thursday in Boston—the second time in a week—for mentioning last year that his policies might have had something to do with the stock-market’s lows. We’re glad to see the President pays such close attention to our work, but one reason the market has recovered is because some of his policies have either improved (the bank “stress tests” proved to be reassuring) or appear to be stymied on Capitol Hill (cap and tax, union card check).

The U.S. economy is a fantastic engine of prosperity, and left to its own devices its tendency is to expand. Especially after falling so far in the recession, a growth rebound was inevitable—and the biggest surprise so far has been that the bounce hasn’t been more robust. Some of that must be laid at the feet of the policy uncertainty in Washington, with small businesses in particular having no clear sense of what their future costs will be. This may bear especially on the slow comeback in job creation.

The larger policy context is that the U.S. recovery has been built on an enormous reflation bet, both fiscal and monetary. The stimulus and its many sister subsidies (housing tax credits, cash for clunkers, etc.) have flooded the economy with government-directed cash and credit. We think marginal-rate tax cuts would have done much more for growth, as in 1983 and 2003.

The Federal Reserve has also kept and maintained an historically easy monetary policy. This was necessary for a time to offset the decline in monetary velocity in the wake of the credit panic, but the near-zero interest rate has also made it easier for banks to make money on interest-rate plays rather than actual lending. It is also contributing to higher commodity prices and distortions in the dollar bloc overseas. The Fed is fortunate that the mess in Greece has made the dollar seem a better reserve currency than the euro.


As we look beyond this year, the bill for this Great Reflation will eventually come due. Coming out of the last steep recession, in 1983, both interest rates and tax rates were coming down. Today, they are both headed up. In 1983, the regulatory state was in retreat. Today, it is expanding across most areas of the economy.

A huge tax increase hits on January 1, as the Bush rates expire. Sooner or later, the Fed will get off zero and interest rates will climb. The neo-Keynesians who have dominated U.S. economic policy since 2006 are betting—hoping—that the expansion will have built up enough steam to ride out these and other growth shocks. The rest of us have to hope they’re right.

Editorial, Wall Street Journal


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The ObamaCare Writedowns—II

Democrats blame a vast CEO conspiracy.

So the wave of corporate writedowns—led by AT&T’s $1 billion—isn’t caused by ObamaCare after all. The White House claims CEOs are reducing the value of their companies and returns for shareholders merely out of political pique.

A White House staffer told the American Spectator that “These are Republican CEOs who are trying to embarrass the President and Democrats in general. Where do you hear about this stuff? The Wall Street Journal editorial page and conservative Web sites. No one else picked up on this but you guys. It’s BS.” (We called the White House for elaboration but got no response.)

In other words, CEOs who must abide by U.S. accounting laws under pain of SEC sanction, and who warned about such writedowns for months, are merely trying to ruin President Obama’s moment of glory. Sure.

Presumably the White House is familiar with the Financial Standard Accounting Board’s 1990 statement No. 106, which requires businesses to immediately restate their earnings in light of their expected future retiree health liabilities. AT&T, Deere & Co., AK Steel, Prudential and Caterpillar, among others, are simply reporting the corporate costs of the Democratic decision to raise taxes on retiree drug benefits to finance ObamaCare.

When the Medicare prescription drug plan was debated in 2003, many feared that companies already offering such coverage would cash out and dump the costs on government. So Congress created a modest subsidy, equal to 28% of the cost of these plans for seniors who would otherwise enroll in Medicare. This subsidy is tax-free, and companies used to be allowed to deduct the full cost of the benefit from their corporate income taxes (beyond the 72% employer portion).

Democrats chose to eliminate the full exclusion and said they were closing a loophole. But whatever it’s called, eliminating it “will be highly destabilizing for retirees who rely upon employer sponsored drug coverage” and “will impose a dramatic and immediate impact on company financial statements.”

That’s how the AFL-CIO put it in a December 10 letter. The Communications Workers of America and the International Brotherhood of Electrical Workers—also known as the AT&T and Verizon workforce—were opposed too. So much for White House claims that reporting these facts is partisan.

As for whether this change is better tax policy, the new health-care bill creates a similar $5 billion fund that will subsidize health costs for early retirees between the ages of 55 and 64. These payments won’t be subject to taxation, and companies will likely be able to deduct the full cost of such coverage. (The language is vague and some experts disagree.) The Democrats now feigning tax outrage—but who are really outraged by political appearances—didn’t think twice about writing the same loophole back into the tax code. This new reinsurance program was a priority of the United Auto Workers.

The deeper concern—apart from imposing senseless business losses in a still-uncertain economy—is that companies will start terminating private retiree coverage, which in turn will boost government costs. The Employee Benefit Research Institute calculates that the 28% subsidy on average will run taxpayers $665 in 2011 and that the tax dispensation is worth $233. The same plan in Medicare costs $1,209.

Given that Congress has already committed the original sin of creating a drug entitlement that crowds out private coverage, $233 in corporate tax breaks to avoid spending $1,209 seems like a deal. If one out of four retirees is now moved into Medicare, the public fisc will take on huge new liabilities.

Meanwhile, Democrats have responded to these writedowns not by rethinking their policy blunder but by hauling the CEOs before Congress on April 21 for an intimidation session. The letter demanding their attendance from House barons Henry Waxman and Bart Stupak declared that “The new law is designed to expand coverage and bring down costs, so your assertions are a matter of concern.”

Perhaps Mr. Waxman should move his hearing to the Syracuse Carrier Dome. The Towers Watson consulting firm estimates that the total writeoffs will be as much as $14 billion, and the 3,500 businesses that offer retiree drug benefits are by law required to report and expense their losses this quarter or next. But ’twas a famous victory, ObamaCare.

Editorial, Wall Street Journal


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The Rules in China

After a Chinese court sentenced four executives of Australian mining company Rio Tinto to lengthy prison terms for bribery and stealing commercial secrets yesterday, Canberra was quick to respond. Foreign Minister Stephen Smith pointedly stated, “As China emerges into the global economy, the international business community needs to understand with certainty what the rules are in China.”

In the eight months since Australian citizen Stern Hu and his Chinese colleagues Wang Yong, Ge Minqiang and Liu Caikui were arrested, we’ve learned a great deal about the lack of certainty and rules not only in China, but also in the global commodities trade. Some of that is China’s fault, but hardly all of it. The Australian government and Rio Tinto must share the blame for lack of transparency and failing to play by the rules.

Foreign media coverage of the arrests and trial has focused on whether the Chinese authorities pursued this case for political reasons. Remember that early last year, cash-starved Rio Tinto angered China by inviting Aluminum Corp. of China, or Chinalco, to take a $19.5 billion equity stake and then backing out of the deal under a combination of shareholder, government and public pressure. Rio was also driving a tough bargain in iron-ore price negotiations with Chinese buyers. Many observers speculated that the four executives were pawns in a high stakes game of tit-for-tat orchestrated from Beijing.

Certainly the timing of the case makes such suspicions inevitable. But the reality is probably more complicated. The Chinese justice system may be manifestly unfair, and once it gains momentum a guilty verdict is a foregone conclusion. Yet Rio itself put forces in motion that led to four men losing their freedom.

It all started with the boom in the global iron-ore market in the early 2000s. That’s when China’s steel industry embarked on a massive expansion of capacity, turning the trade in ore from a buyer’s market to a seller’s market. China’s large state-owned steelmakers bought at the benchmark price negotiated by Japanese and Korean mills, while smaller firms had to pay the higher spot price. This created an incentive for arbitrage and corruption, but unfortunately both the Chinese government and the mining companies were slow to take account of this in their internal controls.

As demand soared, the benchmark and market prices for iron ore diverged and the system came under increasing stress. In 2008, the Brazilian mining giant Vale negotiated a new benchmark price, only to see its two Australian rivals, BHP Billiton and Rio Tinto, refuse to follow it. Vale reacted by tearing up its agreed benchmark price and renegotiating with producers who were over a barrel.

Then Rio Tinto also began to back out of its contracts, for instance by invoking clauses in contracts to hold back 10% of deliveries, which could then be resold at the spot price. Since Rio was facing a hostile takeover bid from BHP, the company’s managers pushed especially hard for every last dollar at the expense of their trading partners to show that they could deliver higher returns for shareholders.

Rio’s Mr. Hu himself acknowledged the problem. In 2008, after Rio negotiated a 87% price increase, Australian reporter John Garnaut interviewed him: “He said he had no qualms with driving as hard a bargain as he could on price. But he had misgivings about whether Rio Tinto should risk its integrity in China by claiming ‘force majeure’ to wriggle out of long-term contracts to chase higher prices elsewhere. ‘We acted in accordance with the letter of the contracts, but not the spirit,’ he said.”

This weakening of the bonds of contract naturally infuriated Chinese steelmakers. So when the economic crisis hit at the end of 2008 and demand for iron ore evaporated, it was payback time. Enjoying a buyer’s market again, the Chinese firms simply walked away from contracts.

The turnabout didn’t last long. Beijing’s massive fiscal stimulus program quickly revived demand for steel by the middle of 2009, and the Australians were able to start raising prices again. Negotiations over new iron-ore benchmark prices were particularly acrimonious, given the bad blood created over the past couple years. And that was the state of play when Mr. Hu and his colleagues were arrested on July 5, 2009.

One past participant in the iron-ore business, who insists on anonymity because of the sensitivities on both sides, believes that the investigation into the Rio Tinto executives was ongoing for many months before the arrests, meaning they were not directly related to the Chinalco fiasco or the ongoing price negotiations. The authorities likely started sniffing around as a result of a tip-off from someone on the Chinese side of the industry. The ill will created by the whipsawing prices and huge losses suffered by some firms supplied plenty of motivation for someone to drop the dime on Rio.

And some dirt was found. Rio Tinto has severed its relationship with the executives, saying they engaged in “deplorable behavior,” effectively accepting the verdict that they were taking kickbacks from steelmakers to arrange preferential access to iron ore. The charges of stealing commercial secrets are much more murky, as evidenced by the fact that they were heard in a totally sealed courtroom, but these too probably originated from lower down the ladder of officialdom, rather than a Beijing-led witch-hunt against Rio Tinto.

The bosses in Australia made the mistake of leaving their Chinese executives in place for too long with too little supervision. But the bigger mistake was destroying the trust of the handshake deals made with Chinese partners in the quest for a little extra margin. That is bad practice anywhere, but especially in China.

Chinalco has not held a grudge against Rio for the failed equity deal. The two companies continue to negotiate joint projects in countries like Mongolia and Guinea. The State Council’s own post-mortem report on the affair is relatively kind to Rio and admits that the Chinese side could have handled the deal better.

However, the government of Prime Minister Kevin Rudd does not come off so well. Treasurer Wayne Swan ran scared from public perceptions of being too soft on China and politicized the approval process for Chinese investments, making it clear that the Chinalco deal would not go through and future acquisitions in the natural resources industry would face strict limitations. The lack of transparency and hostility toward China came as a complete surprise to Beijing and has created lasting tension between the two countries.

It was bad luck that around the same time, Xinjiang dissident Rebiya Kadeer was invited to Australia and Canberra issued a defense white paper that singled out China as a potential threat around which to base future strategy. From Beijing’s perspective these all suggested that Australia was turning hostile and there was no certainty about the rules for Chinese companies doing business there. Had this not happened, it’s possible that greater leniency would have been shown to the four Rio Tinto executives.

Everyone doing business in China should be clear by now on the rules—there is no rule of law. Deals can be done on the basis of mutual trust, which creates some level of certainty. The four Rio Tinto executives may be guilty of corruption, but the real reason they are in prison is because that trust broke down.

Mr. Restall is a member of the editorial board of The Wall Street Journal.


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With health bill, Obama has sown the seeds of a budget crisis

When historians recount the momentous events of recent weeks, they will note a curious coincidence. On March 15, Moody’s Investors Service — the bond rating agency — published a paper warning that the exploding U.S. government debt could cause a downgrade of Treasury bonds. Just six days later, the House of Representatives passed President Obama’s health-care legislation costing $900 billion or so over a decade and worsening an already-bleak budget outlook.

Should the United States someday suffer a budget crisis, it will be hard not to conclude that Obama and his allies sowed the seeds, because they ignored conspicuous warnings. A further irony will not escape historians. For two years, Obama and members of Congress have angrily blamed the shortsightedness and selfishness of bankers and rating agencies for causing the recent financial crisis. The president and his supporters, historians will note, were equally shortsighted and self-centered — though their quest was for political glory, not financial gain.

Let’s be clear. A “budget crisis” is not some minor accounting exercise. It’s a wrenching political, social and economic upheaval. Large deficits and rising debt — the accumulation of past deficits — spook investors, leading to higher interest rates on government loans. The higher rates expand the budget deficit and further unnerve investors. To reverse this calamitous cycle, the government has to cut spending deeply or raise taxes sharply. Lower spending and higher taxes in turn depress the economy and lead to higher unemployment. Not pretty.

Greece is experiencing such a crisis. Until recently, conventional wisdom held that only developing countries — managed ineptly — were candidates for true budget crises. No more. Most wealthy societies with aging populations, including the United States, face big gaps between their spending promises and their tax bases. No one in Congress could be unaware of this.

Two weeks before the House vote, the Congressional Budget Office released its estimate of Obama’s budget, including its health-care program. From 2011 to 2020, the cumulative deficit is almost $10 trillion. Adding 2009 and 2010, the total rises to $12.7 trillion. In 2020, the projected annual deficit is $1.25 trillion, equal to 5.6 percent of the economy (gross domestic product). That assumes economic recovery, with unemployment at 5 percent. Spending is almost 30 percent higher than taxes. Total debt held by the public rises from 40 percent of GDP in 2008 to 90 percent in 2020, close to its post-World War II peak.

To criticisms, Obama supporters make two arguments. First, the CBO says the plan reduces the deficit by $143 billion over a decade. Second, the legislation contains measures (an expert panel to curb Medicare spending, emphasis on “comparative effectiveness research”) to control health spending. These rejoinders are self-serving and unconvincing.

Suppose the CBO estimate is correct. So? The $143 billion saving is about 1 percent of the projected $12.7 trillion deficit from 2009 to 2020. If the administration has $1 trillion or so of spending cuts and tax increases over a decade, all these monies should first cover existing deficits — not finance new spending. Obama’s behavior resembles a highly indebted family’s taking an expensive round-the-world trip because it claims to have found ways to pay for it. It’s self-indulgent and reckless.

But the CBO estimate is misleading, because it must embody the law’s many unrealistic assumptions and gimmicks. Benefits are phased in “so that the first 10 years of [higher] revenue would be used to pay for only six years of spending” increases, a former CBO director, Douglas Holtz-Eakin, wrote in the New York Times on March 20. Holtz-Eakin also noted the $70 billion of premiums for a new program of long-term care that reduce present deficits but will be paid out in benefits later. Then there’s the “doc fix” — higher Medicare reimbursements under separate legislation that would cost about $200 billion over a decade.

Proposals to control health spending face restrictions that virtually ensure failure. Consider the “Independent Payment Advisory Board” aimed at Medicare. “The Board is prohibited from submitting proposals that would ration care, increase revenues or change benefits, eligibility or Medicare beneficiary cost sharing,” says a summary by the Henry J. Kaiser Family Foundation. What’s left? Similarly, findings from “comparative effectiveness research” — intended to identify ineffective care — “may not be construed as mandates, guidelines or recommendations for payment, coverage or treatment.” What’s the point then?

So Obama is flirting with a future budget crisis. Moody’s emphasizes two warning signs: rising debt and loss of confidence that government will deal with it. Obama fulfills both. The parallels with the recent financial crisis are striking. Bankers and rating agencies engaged in wishful thinking to rationalize self-interest. Obama does the same. No one can tell when or whether a crisis will come. There is no magic tipping point. But Obama is raising the chances.

Robert J. Samuelson, Washington Post


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The War on Drugs Is Doomed

Strong demand and the high profits that are the result of prohibition make illegal trafficking unstoppable.

They say that the first step in dealing with a problem is acknowledging that you have one. It is therefore good news that Secretary of State Hillary Clinton will lead a delegation to Mexico tomorrow to talk with officials there about efforts to fight the mob violence that is being generated in Mexico by the war on drugs. U.S. recognition of this shared problem is healthy.

But that’s where the good news is likely to end.

Violence along the border has skyrocketed ever since Mexican President Felipe Calderón decided to confront the illegal drug cartels that operate there. Some 7,000 troops now patrol Juárez, a city of roughly one million. Yet even militarization has not delivered the peace. The reason is simple enough: The source of the problem is not Mexican supply. It is American demand coupled with prohibition.

It is doubtful that this will be acknowledged at tomorrow’s meeting. The drug-warrior industry, which includes both the private-sector and a massive government bureaucracy devoted to “enforcement,” has an enormous economic incentive to keep the war raging. In Washington politics both groups have substantial influence. So it is likely that we are going to get further plans to turn Juárez into a police state with the promise that more guns, tanks, helicopters and informants can stop Mexican gangsters from shoving drugs up American noses.

Last week’s gangland-style slaying of an unborn baby and three adults who had ties to the U.S. Consulate in Juárez has drawn attention to Mrs. Clinton’s trip. The incident stunned Americans. Yet tragic as they were, statistically those four deaths don’t create even a blip on the body-count chart. The running tally of drug-trafficking linked deaths in Juárez since December 2006 is more than 5,350. There has also been a high cost to the city’s economy as investors and tourists have turned away.

Even with low odds of a productive outcome, though, Mexico can’t afford to write off tomorrow’s meeting. It is an opportunity that, handled correctly, could provide for a teachable moment. I suggest that one or two of Mexico’s very fine economists trained at the University of Chicago by Milton Friedman sit down with President Obama’s team to explain a few things about how markets work. They could begin by outlining the path that a worthless weed travels to become the funding for the cartel’s firepower. In this Econ 101 lesson, students will learn how the lion’s share of the profit is in getting the stuff over the U.S. border to the American consumer. In football terms, Juárez is first and goal.

Mexico hasn’t always been an important playing field for drug cartels. For many years cocaine traffickers used the Caribbean to get their product to their customers in the largest and richest market in the hemisphere. But when the U.S. redoubled its efforts to block shipments traveling by sea, the entrepreneurs shifted to land routes through Central America and Mexico.

Mexican traffickers now handle cocaine but traditional marijuana smuggling is their cash cow, despite competition from stateside growers. In a February 2009 interview, then-Mexican Attorney General Eduardo Medina Mora told me that half of the cartel’s annual income was derived from marijuana.

This is especially troubling for Mexican law enforcement because marijuana use, through medical marijuana outlets and general social acceptance, has become de facto legal in the U.S., and demand is robust. The upshot is that consumption is cool while production, trafficking and distribution are organized-crime activities. This is what I called in a previous column, “a stimulus plan for Mexican gangsters.”

In much of the world, where institutions are weak and folks are poor, the high value that prohibition puts into drugs means that the thugs rule. Mr. Medina Mora told me in the same 2009 interview that Mexico estimated the annual cash flow from U.S. drug consumers to Mexico at around $10 billion, which of course explains why the cartels are so well armed and also able to grease the system. It also explains why Juárez is today a killing field.

Supply warriors might have a better argument if the billions of dollars spent defoliating the Colombian jungle, chasing fast boats and shooting down airplanes for the past four decades had reduced drug use. Yet despite passing victories like taking out 1980s kingpin Pablo Escobar and countless other drug lords since then, narcotics are still widely available in the U.S. and some segment of American society remains enthusiastic about using them. In some places terrorist organizations like Colombia’s FARC rebels and al Qaeda have replaced traditional cartels.

There is one ray of hope for innocent victims of the war on drugs. Last week the Journal reported that Drug Enforcement Administration agents were questioning members of an El Paso gang about their possible involvement in the recent killings in Juárez. If the escalation is now spilling over into the U.S., Americans may finally have to face their role in the mess. Mrs. Clinton’s mission will only add value if it reflects awareness of that reality.

Mary O’Grady Anastasia, Wall Street Journal


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‘Basically an Optimist’—Still

The Nobel economist says the health-care bill will cause serious damage, but that the American people can be trusted to vote for limited government in November.

“No, no. Not at all.”

So says Gary Becker when asked if the financial collapse, the worst recession in a quarter of a century, and the rise of an administration intent on expanding the federal government have prompted him to reconsider his commitment to free markets.

Mr. Becker is a founder, along with his friend and teacher the late Milton Friedman, of the Chicago school of economics. More than four decades after winning the John Bates Clark Medal and almost two after winning the Nobel Prize, the 79-year-old occupies an unusual position for a man who has spent his entire professional life in the intensely competitive field of economics: He has nothing left to prove. Which makes it all the more impressive that he works as hard as an associate professor trying to earn tenure. He publishes regularly, carries a full-time teaching load at the University of Chicago (he’s in his 32nd year), and engages in a running argument with his friend Judge Richard Posner on the “Becker-Posner Blog,” one of the best-read Web sites on economics and the law.

When his teaching schedule permits, Mr. Becker visits the Hoover Institution, the think tank at Stanford where he has been a fellow since 1988. The day he and I meet in his Hoover office, Mr. Becker has already attended a meeting with former Treasury Secretary Hank Paulson and spent several hours touring Apple headquarters down the road in Cupertino with his wife, Guity Nashat, a historian of the Middle East, and their grandson. “I guess you’d call our grandson a computer whiz,” he explains proudly. “He’s just 14, but he has already sold a couple of apps.”

I begin with the obvious question. “The health-care legislation? It’s a bad bill,” Mr. Becker replies. “Health care in the United States is pretty good, but it does have a number of weaknesses. This bill doesn’t address them. It adds taxation and regulation. It’s going to increase health costs—not contain them.”

Drafting a good bill would have been easy, he continues. Health savings accounts could have been expanded. Consumers could have been permitted to purchase insurance across state lines, which would have increased competition among insurers. The tax deductibility of health-care spending could have been extended from employers to individuals, giving the same tax treatment to all consumers. And incentives could have been put in place to prompt consumers to pay a larger portion of their health-care costs out of their own pockets.

“Here in the United States,” Mr. Becker says, “we spend about 17% of our GDP on health care, but out-of-pocket expenses make up only about 12% of total health-care spending. In Switzerland, where they spend only 11% of GDP on health care, their out-of-pocket expenses equal about 31% of total spending. The difference between 12% and 31% is huge. Once people begin spending substantial sums from their own pockets, they become willing to shop around. Ordinary market incentives begin to operate. A good bill would have encouraged that.”

Despite the damage this new legislation appears certain to cause, Mr. Becker believes we’re probably stuck with it. “Repealing this bill will be very, very difficult,” he says. “Once you’ve got a piece of legislation in place, interest groups grow up around it. Look at Medicare and Medicaid. Originally, the American Medical Association opposed Medicare and Medicaid. Then the AMA came to see them as a source of demand for physicians’ services. Today the AMA supports Medicare and Medicaid as staunchly as anyone. Something like that will happen with this new legislation.”

Bad legislation, maintained by self-seeking interest groups. Back in 1982, I remind Mr. Becker, the economist Mancur Olson published a book, “The Rise and Decline of Nations,” predicting just that trend. Over time, Olson argued, interest groups would form to press for policies that would almost invariably prove protectionist, redistributive or antitechnological. Policies, in a word, that would inhibit economic growth. Yet since the benefits of such policies would accrue directly to interest groups while the costs would be spread across the entire population, very little opposition to such self-seeking would ever develop. Interest groups—and bad policies—would proliferate, and the nation would stagnate.

Olson may have sketched his portrait during the 1980s, but doesn’t it display a remarkable likeness to the United States today? Mr. Becker thinks for a moment, swiveling toward the window. Then he swivels back. “Not necessarily,” he replies.

“The idea that interest groups can derive specific, concentrated benefits from the political system—yes, that’s a very important insight,” he says. “But you can have competing interest groups. Look at the automobile industry. The domestic manufacturers in Detroit want protectionist policies. But the auto importers want free trade. So they fight it out. Now sometimes in these fights the dark forces prevail, and sometimes the forces of light prevail. But if you have competing interest groups you don’t end up with a systematic bias toward bad policy.”

Mr. Becker places his hands behind his head. Once again, he reflects, then smiles wryly. “Of course that doesn’t mean there isn’t any systematic bias toward bad policy,” he says. “There’s one bias that we’re up against all the time: Markets are hard to appreciate.”

Capitalism has produced the highest standard of living in history, and yet markets are hard to appreciate? Mr. Becker explains: “People tend to impute good motives to government. And if you assume that government officials are well meaning, then you also tend to assume that government officials always act on behalf of the greater good. People understand that entrepreneurs and investors by contrast just try to make money, not act on behalf of the greater good. And they have trouble seeing how this pursuit of profits can lift the general standard of living. The idea is too counterintuitive. So we’re always up against a kind of in-built suspicion of markets. There’s always a temptation to believe that markets succeed by looting the unfortunate.”

As he speaks, Mr. Becker appears utterly at ease. He wears loose-fitting clothes and slouches comfortably in his chair. His hair, wispy and white, sets off his most striking feature—penetrating eyes so dark they seem nearly black. Yet those dark eyes display not foreboding, but contentment. He does not have the air of a man contemplating national decline.

I read aloud from an article by historian Victor Davis Hanson that had appeared in the morning newspaper. “[W]e are in revolutionary times,” Mr. Hanson argues, “in which the government will grow to assume everything from energy to student loans.” Next I read from a column by economist Thomas Sowell. “With the passage of the legislation allowing the federal government to take control of the medical system,” Mr. Sowell asserts, “a major turning point has been reached in the dismantling of the values and institutions of America.”

“They’re very eloquent,” Mr. Becker replies, his equanimity undisturbed. “And maybe they’re right. But I’m not that pessimistic.” The temptation to view markets with suspicion, he explains, is just that: a temptation. Although voters might succumb to the temptation temporarily, over time they know better.

“One of the points Secretary Paulson made earlier today was how outraged—how unexpectedly outraged—the American people became when the government bailed out the banks. This belief in individual responsibility—the belief that people ought to be free to make their own decisions, but should then bear the consequences of those decisions—this remains very powerful. The American people don’t want an expansion of government. They want more of what Reagan provided. They want limited government and economic growth. I expect them to say so in the elections this November.”

Even if ordinary Americans still want limited government, I ask, what about those who dominate the press and universities? What about the molders of received opinion who claim that the financial crisis marked the demise of capitalism, rendering the Chicago school irrelevant?

“During the financial crisis,” he replies, “the government and markets—or rather, some aspects of markets—both failed.”

The Federal Reserve, Mr. Becker explains, kept interest rates too low for too long. Freddie Mac and Fannie Mae made the mistake of participating in the market for subprime instruments. And as the crisis developed, regulators failed to respond. “The Fed and the Treasury didn’t see the crisis coming until very late. The SEC didn’t see it at all,” he says.

“The markets made mistakes, too. And some of us who study the markets made mistakes. Some of my colleagues at Chicago probably overestimated the ability of the Fed to smooth disruptions. I didn’t write much about the Fed, but if I had I would probably have overestimated the Fed myself. As the banks developed new instruments, economists paid too little attention to the systemic risks—the risks the instruments posed for the whole financial system—as opposed to the risks they posed for individual institutions.

“I learned from Milton Friedman that from time to time there are going to be financial problems, so I wasn’t surprised that we had a financial crisis. But I was surprised that the financial crisis spilled over into the real economy. I hadn’t expected the crisis to become that bad. That was my mistake.”

Once again, Mr. Becker reflects. “So, yes, we economists made mistakes. But has the experience of the past few years invalidated the finding that markets remain the most efficient means for producing economic growth? Not in any way.

“Look at growth in developed countries since the Second World War,” he continues. “Even after you take into account the various recessions, including this one, you still end up with a good record. So even if a recession as bad as this one were the price of free markets—and I don’t believe that’s the correct way of looking at it, because government actions contributed so greatly to the current problem—but even if a bad recession were the price, you’d still decide it was worth paying.

“Or look at developing countries,” he says. “China, India, Brazil. A billion people have been lifted out of poverty since 1990 because their countries moved toward more market-based economies—a billion people. Nobody’s arguing for taking that back.”

My last question involves a little story. Not long before Milton Friedman’s death in 2006, I tell Mr. Becker, I had a conversation with Friedman. He had just reviewed the growth of spending that was then taking place under the Bush administration, and he was not happy. After a pause during the Reagan years, Friedman had explained, government spending had once again begun to rise. “The challenge for my generation,” Friedman had told me, “was to provide an intellectual defense of liberty.” Then Friedman had looked at me. “The challenge for your generation is to keep it.”

What was the prospect, I asked Mr. Becker, that this generation would indeed keep its liberty? “It could go either way,” he replies. “Milton was right about that.”

Mr. Becker recites some figures. For years, federal spending remained level at about 20% of GDP. Now federal spending has risen to 25% of GDP. On current projections, federal spending would soon rise to 28%. “That concerns me,” Mr. Becker says. “It concerns me a great deal.

“But when Milton was starting out,” he continues, “people really believed a state-run economy was the most efficient way of promoting growth. Today nobody believes that, except maybe in North Korea. You go to China, India, Brazil, Argentina, Mexico, even Western Europe. Most of the economists under 50 have a free-market orientation. Now, there are differences of emphasis and opinion among them. But they’re oriented toward the markets. That’s a very, very important intellectual victory. Will this victory have an effect on policy? Yes. It already has. And in years to come, I believe it will have an even greater impact.”

The sky outside his window has begun to darken. Mr. Becker stands, places some papers into his briefcase, then puts on a tweed jacket and cap. “When I think of my children and grandchildren,” he says, “yes, they’ll have to fight. Liberty can’t be had on the cheap. But it’s not a hopeless fight. It’s not a hopeless fight by any means. I remain basically an optimist.”

Mr. Robinson, a former speechwriter for President Ronald Reagan, is a fellow at Stanford University’s Hoover Institution.


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Fair play

The origins of selflessness

It is not so much that cheats don’t prosper, but that prosperity does not cheat

FOR the evolutionarily minded, the existence of fairness is a puzzle. What biological advantage accrues to those who behave in a trusting and co-operative way with unrelated individuals? And when those encounters are one-off events with strangers it is even harder to explain why humans do not choose to behave selfishly. The standard answer is that people are born with an innate social psychology that is calibrated to the lives of their ancestors in the small-scale societies of the Palaeolithic. Fairness, in other words, is an evolutionary hangover from a time when most human relationships were with relatives with whom one shared a genetic interest and who it was generally, therefore, pointless to cheat.

The problem with this idea is that the concept of fairness varies a lot, depending on which society it happens to come from—something that does not sit well with the idea that it is an evolved psychological tool. Another suggestion, then, is that fairness is a social construct that emerged recently in response to cultural changes such as the development of trade. It may also, some suggest, be bound up with the rise of organised religion.

Joseph Henrich at the University of British Columbia and his colleagues wanted to test these conflicting hypotheses. They reasoned that if notions of fairness are, indeed, calibrated to the Palaeolithic, then any variation from place to place should be random. If such notions are cultural artefacts, though, they will vary systematically with some aspect of society. In a study just published in Science, Dr Henrich and his team looked at the relationship between notions of fairness and two social phenomena: the degree to which a society is economically integrated and how religious the individuals within it are.

Play up, play up and play the game

To do the study Dr Henrich recruited 2,148 volunteers from 15 contemporary, small-scale societies. The societies in question included the Dolgan (hunters in Siberia), the Hadza (foraging nomads in Tanzania) and the Sanquianga (fishermen in Colombia).

First, the volunteers were asked to play a series of games that would measure their notions of fairness. One of these is called the dictator game. In it, two players (who do not actually meet) are given a sum of money. One of them then divides the money and gives whatever fraction he chooses to the other. Not much of a game, perhaps, but it provides a good measure of the first player’s sense of fairness, since he has the power to be as unfair as he likes.

Another game the researchers asked participants to play was more subtle. In it, the second player has the opportunity to reject the sum offered by the first, in which case neither player receives anything. In this version, however, the second player must decide what offer he would accept (within a 10% margin of error), and do so before he hears what the offer actually is. That provides a measure of willingness to punish, even at a cost to the punisher. Yet another game looked at interactions with third parties.

Having established prevailing notions of fairness in each of the societies they were examining, the researchers then calculated a measure of that society’s market integration. They arrived at this by working out the percentage of a household’s total calories that were purchased from the market, as opposed to being grown, hunted or fished. The volunteers were also asked whether they participated in a world religion (rather than a tribal one).

The results back a cultural explanation of fairness—or, at least, of the variable levels of fairness found in different societies. In fact, those societies that most resemble the anthropological consensus of what Palaeolithic life would have been like (hunting and gathering, with only a modicum of trade) were the ones where fairness seemed to count least. People living in communities that lack market integration display relatively little concern with fairness or with punishing unfairness in transactions. Notions of fairness increase steadily as societies achieve greater market integration (see chart). People from better-integrated societies are also more likely to punish those who do not play fair, even when this is costly to themselves.

For progressives, this finding brings great comfort. It suggests that people are, if not perfectible, at least morally malleable in positive ways. If economic integration is the driving force for fairness then it may make sense to view it as something like a type of technology. As societies have become more complex, those that have developed systems of sanitation, transport, energy and so on have been more successful than those which have not. It may be that the notion of fair play is an intangible equivalent of these systems.

Dr Henrich also, however, found that the sense of fairness in a society was linked to the degree of its participation in a world religion. Participation in such religion led to offers in the dictator game that were up to 10 percentage points higher than those of non-participants.

World religions such as Christianity, with their moral codes, their omniscient, judgmental gods and their beliefs in heaven and hell, might indeed be expected to enforce notions of fairness on their participants, so this observation makes sense. From an economic point of view, therefore, such judgmental religions are actually a progressive force. That might explain why many societies that have embraced them have been so successful, and thus why such beliefs become world religions in the first place.


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Yuan to stay cool

The best thing American politicians can do to encourage a stronger Chinese currency is keep calm

ONE of the few good things about the Great Recession of 2008-09 was a merciful absence of complaints from America’s Congress about China’s currency. The yuan’s gradual appreciation stopped in July 2008, and China has since kept its currency tightly pegged to the dollar. But even as America suffered its worst downturn in the post-war period, its legislators steered clear of ranting against China.

That restraint was driven partly by fear. At the depths of the crisis even the most myopic Congressmen worried about a descent into 1930s-style protectionism. And it was driven partly by the facts. As investors’ flight to safety strengthened the dollar in late 2008, the yuan rose along with it. With America’s imports slumping it was hard to blame Chinese workers for American joblessness. And thanks to its huge domestic stimulus China added to global demand last year, as its current-account surplus shrank sharply.

Now things have, unfortunately, gone into reverse. As policymakers in both countries shift from cushioning recession to managing recovery, the rigidity of the yuan is, once again, becoming a source of tension—one that a still-fragile global recovery can ill afford.

America sounds increasingly determined to push its exports, and its attitude to China has hardened. Mr Obama has set a goal of doubling exports in five years and has promised to “get much tougher” over what it regards as unfair competition from China. Speculation is rising in Washington, DC, that the Treasury will brand China a currency “manipulator” in its next exchange-rate report. With America’s unemployment at 9.7% and the mid-term elections approaching, the appeal of China-bashing is rising in Congress, too. Several senators recently revived a mothballed demand that the Commerce Department should investigate China’s currency regime as an unfair trade subsidy.

Beijing, in turn, shows little sign of budging on the yuan, even though the latest figures show surprisingly strong export growth and higher-than-expected inflation. Zhou Xiaochuan, the head of China’s central bank, caused a brief flurry in currency markets when he argued on March 6th that keeping the yuan stable against the dollar was “part of our package of policies for dealing with the global financial crisis” from which China would exit “sooner or later”. But he made it quite clear that China would be cautious and gave no hint that sudden exit was imminent. In recent days various other Chinese officials have put even more emphasis on the stability of the currency, bristled at outside pressure to hurry up and denounced American “politicisation” of the exchange-rate issue.

A speedy end to the dollar peg makes economic sense for China as well as for the world. A stronger, more flexible currency would make it easier for China to control inflation and asset bubbles. A dearer yuan would also help rebalance China’s economy towards domestic spending by boosting Chinese consumers’ purchasing power, discouraging excessive investment in manufacturing and squeezing corporate profits. That would put the global recovery on a steadier footing, especially if a stronger yuan were mirrored by appreciation of the currencies of other Asian emerging economies. And China would gain politically by helping to diffuse protectionist pressure from abroad.

But it would not be a magic bullet, either within China or outside. Rebalancing China’s economy will require big structural reforms, from tax to corporate governance, as well as a stronger currency. A stronger yuan would not suddenly bring back millions of jobs to America. Since America no longer makes most of the products it imports from China, a stronger yuan would initially act more like a tax on consumers.

Soft-soaping, not sabre-rattling

Will the administration’s new tough talk move things in the right direction? Those who argue in favour of sabre-rattling do so on two grounds: first, that it is likely to shift China’s position, and second, that a stronger stance against China’s currency from the White House will diffuse protectionist sentiment in Congress. Both are dubious. China’s reactions so far suggest that American complaints make an imminent currency shift less, not more, likely. And a row could spur rather than diffuse anti-China action in Congress.

Rather than raising a bilateral ruckus, America would be far better off convincing other big economies in the G20 to press together for a yuan appreciation as part of the world’s exit strategy from the crisis. Cool and calm multilateral leadership will achieve more, with fewer risks, than a Sino-American currency spat.


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Big Think In the Boardroom

How business moved from affable amateurism to specialized, intellectualized ‘models’ and expertise.

As a business journalist and former editorial director of the Harvard Business Review, Walter Kiechel has had the unenviable task of spending much of his life hanging around with management theorists. These are the folks who bring out book after book of business advice that readers find unreadable and managers find unmanageable. Yet by some miracle Mr. Kiechel has remained immune to the maladies of the genre. His “The Lords of Strategy” is a clear, deft and cogent portrait of what the author calls the most powerful business idea of the past half-century: the realization that corporate leaders needed to abandon their go-it-alone focus on their company’s fortunes and instead pursue policies based on a detailed study of the competitive environment and of broader business trends.

The “strategy revolution” began in the 1960s when the Boston Consulting Group upended the industry. Rather than take the usual tack of just cozying up to individual chief executives for a bit of corporate kibitzing and calling it consulting, BCG produced a series of elegant intellectual models that could be broadly applied across the business world. BCG’s model for the “experience curve,” for instance, taught companies that they could reduce their costs as they expanded their market share, thanks to the accumulation of know-how. The “growth share matrix” encouraged companies to view themselves not as an undifferentiated whole but as a portfolio of businesses that make different contributions to the bottom line (“cash cows” vs. “dogs,” for example). Nowadays that sort of thinking might be unexceptional, but it was a radical development in the stagnant, inward-looking world of 1960s corporate America.

The 1970s and the decades that followed saw the institutionalization of the revolution. One of BCG’s main competitors, McKinsey & Co., shook itself out of a complacent torpor and began enthusiastically running out its own management-strategy models. Bill Bain and several other BCG executives left the company in the 1970s and started a rival enterprise, Bain & Co. Meanwhile, Michael Porter brought strategy to the heart of the business establishment, the Harvard Business School. He added a powerful tool to the discipline’s arsenal, the notion of the “value chain,” which helped managers break down a business into its component parts, from raw materials to finished products, and then subject those parts to the rigors of cost-benefit analysis.

Yet success brought intense scrutiny and self-examination. In 1982, Tom Peters and Robert Waterman—McKinsey stars at the time—argued in the best-selling “In Search of Excellence” that the obsession with strategy was leading managers to ignore the human side of things. The year before, Richard Pascale, another McKinseyian, said in “The Art of Japanese Management” that the Japanese, who were then sweeping all before them, regarded the West’s newfound passion for strategy as strange, much “as we might regard their enthusiasm for kabuki or sumo wrestling.” And an army of young thinkers began shifting attention to more nuts-and-bolts matters, such as business processes (which could be re-engineered) and “core competencies” (which needed to be cultivated).

Today the status of strategic thinking in the business world is somewhat confused: An idea that owed its appeal to the seemingly hard truths presented by models is becoming ever more nebulous. The lords of strategy are now given to happy talk about “people”—on the grounds that people are the key to innovation and innovation is the key to long-term success. Such concerns can easily degenerate into bromides about the need to treat employees well. Perhaps it is no coincidence that, at least before the current financial crisis wreaked its havoc, young business hotshots were turning their attention to financial engineering. About a third of former McKinsey and BCG consultants currently work in the private-equity business.

“The Lords of Strategy” is at its best describing and explaining the evolution of an influential idea in American business. The book is less successful as the “secret history” it claims to be. Mr. Kiechel has the habit of pulling aside the veil on the darker side of the management business only to pull it back again. He says that management gurus are known to hire ghost-writing outfits such as Wordworks to produce their books—but he refrains from telling us the gritty ( perhaps disgraceful) details of the marketing and packaging process. He notes that a worrying number of consulting engagements end in tears—McKinsey had a long-term relationship with Enron, for example—but he skimps on evidence.

Mr. Kiechel makes up for this coyness, though, with his enthusiasm for telling the bigger story at the heart of his book: the intellectualization of business. Back in the days of the “organization man” in the 1950s, business people tended to be affable types—pleasant, easy to get along with, but hardly rocket scientists. Since then an ever greater amount of brain power has been applied to business as more and more graduate students pursue MBAs (150,000 annually in the U.S., up from 3,000 a year in 1948), and the brightest MBAs often go on to become business consultants.

The story that Mr. Kiechel tells does not have a particularly happy ending: The “quants” who would supposedly take business to a new level of intellectual sophistication designed financial tools such as the credit default swap that instead took the world economy to the brink of catastrophe. But Mr. Kiechel is surely right that we cannot begin to understand the world that we live in unless we grasp how corporate intellectuals came to have such a dramatic influence on the business world—and how old-fashioned virtues, such as judgment and common sense, were side-lined in the process.

Mr. Wooldridge is The Economist’s management editor and the author of its Schumpeter column.


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Skyway Robbery: Stories From the Future of Aviation

Trans Orient Pacific to Charge for Standby

March 10, 2010 — Following the lead of American Airlines, which announced in February that it would begin charging a $50 fee to passengers who wished to fly standby, Trans Orient Pacific Airlines will adopt the same pricing structure. “Our passengers value flexibility,” said Topac spokesman Steve McCroskey, “and where there’s value, there’s revenue. You just have to monetize it.” The charge comes on the heels of other new fees adopted by many carriers. Last month, American began requiring passengers in coach to pay $8 for a blanket and pillow.

Topac Out Front With New Fees

June 7, 2010 — “We’ve embarked on a new era of competitiveness,” said Trans Orient Pacific Director of Media Relations Steve McCroskey, citing the carrier’s innovative pricing structures. For example, water, soda and coffee will now be $5, refills $4.98. And to cover the costs of in-flight video (currently showing, episodes of “Full House,” “Car 54, Where Are You?” and “Jersey Shore”) all tickets will be assessed a $6.95 entertainment fee. Mr. McCroskey did point out, however, that passengers can choose to sit in a section of the plane without the video presentation for an extra $22.75 each.


The Rising Cost of Carrying On

August 24, 2010 — As airlines have raised the cost of checked baggage passengers have taken to carrying all their luggage on-board. Trans Orient Pacific’s VP for Communications, Steve McCroskey, says that too many carry-on bags slow boarding and deplaning. In the interest of passenger convenience, Topac will now allow one carry-on bag, at a cost of $20. Extra carry-ons will be $50 each. Mr. McCroskey said the use of overhead bins will remain free, “at least for the moment.”

Fuel Prices Down; Fuel Surcharges Up

September 18, 2010 — Trans Orient Pacific has begun adding a $27.98 fuel surcharge to all domestic tickets. Airline executives were asked to explain the fee in light of falling fuel prices. “We bet heavily that oil would soar this year, and so I have to admit we did some pretty aggressive hedging on jet-fuel futures,” explained Senior Vice President for Strategy Stephen McCroskey. “I think we can all agree that Topac should not have to bear the brunt of this kind of market volatility.” The new surcharge will be applied retroactively to all tickets purchased within the past three years.

Not Just Luggage Getting Weighed

October 3, 2010 — In an effort to lighten the load, Trans Orient Pacific Airlines will begin putting its passengers on the scales. “Charging grossly overweight passengers for a second seat just seemed to us a sort of arbitrary discrimination against the morbidly obese,” says Stephen McCroskey, Executive Vice President for Operations at Topac. “We thought it would be fairer to weigh everyone and assess a dollar-a-pound surcharge across the board.”

Got to Go, Got to Pay

November 22, 2010 — Just in time for the busy Thanksgiving travel weekend, Trans Orient Pacific Airlines announced it will begin charging for the use of lavatories. “People are tired of standing in line for the bathroom,” says Trans Orient COO Stephen J. McCroskey. “We’re instituting a congestion-pricing strategy that prioritizes the bathrooms for those who need to use them most.” Use of the lavatories can be paid with a major credit card, and rates begin at $5 per minute, rising to $10 a minute in the final hour of the flight. Tokens will also be available (for a nominal service fee). Even so, “Passenger comfort is one of our top priorities,” Mr. McCroskey insisted. “If a plane is delayed on the Tarmac for more than two hours, we will offer a 10% discount on lavatory use.”

Topac to Drop Some Charges

November 23, 2010 — In a surprise move today, Trans Orient Pacific Airlines pledged to roll back some of the new fees that have infuriated flyers. “I’m pleased to say that Topac in its relentless pursuit of excellence, will no longer be charging passengers for water, soda, or coffee,” said newly named CEO Stephen J. McCroskey. Water will be distributed in liter bottles, coffee will be served in 24 ounce cups, and each passenger will be given a two-liter bottle of Coca-Cola, Diet Coke or Sprite. (Lavatory fees will remain in force.)

New Safety Procedures on Domestic Flights

January 3, 2011 — Trans Orient Pacific Airlines announced it had reached an agreement with the FAA regarding changes to routine safety announcements. The agency approved new instructions flight crews will give to passengers before takeoff, including this change to the traditional script: “In the unlikely event of cabin depressurization, oxygen masks will drop from above you. To get the oxygen flowing, insert a major credit or debit card. If you are traveling with a child, pay for your mask first then pay for your child’s.” Chairman of the Topac board, Stephen McCroskey explained that the airline was forced to look for new sources of revenue now that so few people are flying.

Eric Felten, Wall Street Journal


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Recovery in progress

World trade is on the mend, but the strength of the rebound remains uncertain

IS THE glass half empty or half full for world trade? Figures released on March 1st by the Netherlands Bureau for Economic Policy Analysis (CPB), which maintains a close watch on global trade volumes, point to renewed vigour at the end of 2009. Trade volumes rose by 6%, quarter-on-quarter, in the final three months of the year.

But these figures also underline just how severely trade was affected by the global recession. The CPB reckons that volumes shrank by a staggering 13.2% during 2009. They have fallen in only two other years since 1961, when comprehensive data begin. But those declines—by 1.9% in 1975 and 0.9% in 1982—pale in comparison with last year’s huge drop.

Still, a revival is clearly under way. The volume of trade went up by 5% in December alone. Weak growth of 1.2% in October and 1.1% in November might have suggested that the recovery which began earlier in the year was faltering.

Unfortunately, it may be too early to be sanguine about a sustained recovery in trade and thus in the world economy. Figures from the World Bank, which track the value rather than the volume of trade, point to a deceleration in the final quarter, not the acceleration that the CPB’s data suggest. According to the bank, the value of exports from a sample of 56 countries making up the lion’s share of world trade continued to rise in the final quarter, but at a slower rate than in the third quarter.

Data on trade values partly reflect exchange-rate fluctuations, so it is not unusual for them to lead to somewhat different conclusions from volume figures. But there are other reasons to be cautious. December is typically a good month for global commerce because of holiday spending in many parts of the world. Strength in December is therefore by no means sure to have continued into the new year.

Looking ahead, it is not hard to see threats to trade’s recovery. Global demand is still being propped up by government intervention on an enormous scale. Its withdrawal, if mistimed, would pose fresh dangers for the global economy, and with it for trade. As Caroline Freund of the World Bank points out, “There is a risk of stagnation in 2010, as restocking is completed and effect of the stimulus on demand growth wanes. While the stimulus will continue to boost trade volumes in 2010, any growth effect will be much smaller.”

The strength of the recovery varies from one part of the world to the next. Export data reflect both the now-robust growth of emerging economies and the still-anaemic performance of the rich world. Investment demand from emerging-market countries does help manufacturers of more sophisticated goods, such as machinery, in rich ones. But demand from ordinary consumers in poorer countries mainly bolsters exports in other developing economies. In keeping with this, the volume of exports from emerging economies grew by 8.7% in the three months to December. Rich countries’ exports increased by only 4.1%.

The relative performance of China, the leading exporter among emerging economies, and Germany, the rich world’s champion, is a case in point. Last year China overtook Germany to become the world’s largest exporter of goods. Germany’s sales abroad in 2009 were $1,121 billion, compared with China’s $1,202 billion.

That emerging economies are, besides increasing their exports, becoming an important source of demand for traded goods can be seen in their imports, which grew by 7.4% in the final three months of last year. Imports into rich countries grew by only 3.9%.

By the end of the year trade values had risen by almost 30% from their nadir last February. However, the World Bank’s economists point out that they were still 20% lower than before the crisis. They think they are 40% below where they would have been had the crisis never happened. World trade may be on the mend, but its recovery is far from complete.


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Bring Back the Robber Barons

There’s a big difference between entrepreneurs who make a fortune in the market, and those who do so by gaming the government.

Faced with high, painful unemployment as far as the eye can see, the government naturally is here to help.

The Senate passed a $15 billion “jobs bill.” Its proudest piece is a tax credit for employers who hire a person out of work at least 60 days. The employer won’t have to pay the 6.2% Social Security payroll tax for what remains of this year. If the worker stays on the job at least a year, the government will give the employer $1,000.

As to the earlier $787 billion stimulus bill, Vice President Joe Biden praised it in Orlando this week as an engine of job creation, while he stood before a pile of broken concrete and asphalt. The subject was highways.

Finally, Barack Obama’s government now may force companies to raise wages and benefits by squeezing their federal contracts if they don’t.

Maybe there’s a better way.


Let’s bring back the robber barons.

“Robber baron” became a term of derision to generations of American students after many earnest teachers made them read Matthew Josephson’s long tome of the same name about the men whose enterprise drove the American industrial age from 1861 to 1901.

Josephson’s cast of pillaging villains was comprehensive: Rockefeller, Carnegie, Vanderbilt, Morgan, Astor, Jay Gould, James J. Hill. His table of contents alone shaped impressions of those times: “Carnegie as ‘business pirate’.” “Henry Frick, baron of coke.” “Terrorism in Oil.” “The sack of California.”

I say, bring ’em back, and the sooner the better. What we need, a lot more than a $1,000 tax credit, are industries no one has thought of before. We need vision, vitality and commercial moxie. This government is draining it away.

The antidote to Josephson’s book is a small classic by Hillsdale College historian Burton W. Folsom called “The Myth of the Robber Barons: A New Look at the Rise of Big Business in America” (Young America’s Foundation). Prof. Folsom’s core insight is to divide the men of that age into market entrepreneurs and political entrepreneurs.

Market entrepreneurs like Rockefeller, Vanderbilt and Hill built businesses on product and price. Hill was the railroad magnate who finished his transcontinental line without a public land grant. Rockefeller took on and beat the world’s dominant oil power at the time, Russia. Rockefeller innovated his way to energy primacy for the U.S.

Political entrepreneurs, by contrast, made money back then by gaming the political system. Steamship builder Robert Fulton acquired a 30-year monopoly on Hudson River steamship traffic from, no surprise, the New York legislature. Cornelius Vanderbilt, with the slogan “New Jersey must be free,” broke Fulton’s government-granted monopoly.

If the Obama model takes hold, we will enter the Golden Age of the Political Entrepreneur. The green jobs industry that sits at the center of the Obama master plan for the American future depends on public subsidies for wind and solar technologies plus taxes on carbon to suppress it as a competitor. Politically connected entrepreneurs will spend their energies running a mad labyrinth of bureaucracies, congressional committees and Beltway door openers. Our best market entrepreneurs, instead of exhausting themselves on their new ideas, will run to ground gaming Barack Obama’s ideas.

If the goal is job growth, we need to admit one fact: Political entrepreneurs create fewer jobs than do market entrepreneurs. We need new mass markets, really big markets of the sort Ford, Rockefeller and Carnegie created. Great employment markets are discoverable only by people who create opportunities or see them in the cracks of what already exists—a Federal Express or Wal-Mart. Either you believe that the philosopher kings of the Obama administration can figure out this sort of thing, or you don’t. I don’t.

FDIC chief Sheila Bair whacked bank bonuses Tuesday. People on the East Coast spend too much time around the finance and insurance industries. If the price of rediscovering the American job machine is some people across the land getting really rich, it’s a small price.

One of the richest now is Larry Ellison, the 1977 founder of Oracle Corp. (49,000 employees), whose tastes run to huge boats, bigger houses and paying Elton John to play for his friends at the Cow Palace. Someone in our politics has to find the courage to say, So what? If the next Ellison and Oracle ripples into American life as many new jobs and family incomes, I’m happy to be grossed out by parties and boats. The alternative is a nation of Pecksniffs, choking on virtue.

We live in a world of rising competitors—foreign robber barons—who don’t much care about our endless quest for health-care justice. The U.S. on its current path to a stage-managed economy floating in a lake of taxes will keep down the greatest population of intellectual and managerial firepower the world has seen. The rest of the world admits that, with the recent exception of the Chinese, who think we’re ready to be taken. We have young people impatient for the chance to do what Carnegie, Rockefeller and Hill did. Let them.

Daniel Henninger, Wall Street Journal


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Seven Ideas to Beat the Crisis

Funny Business

Times are tough. But not so tough, as it turns out, that you can’t make a buck. From bovine meditation to organic bird buffets, SPIEGEL ONLINE brings you seven strange business ideas that should never have worked — but did. 

The German economy isn’t what it used to be. Just this week, it was announced that the economy didn’t grow at all during the fourth quarter of 2009, leading many to fear that the country might have to wait a while longer to recover from the economic downturn. 

Even worse, the European common currency, the euro, is in turmoil as speculators continue to try and profit from Greek budgetary woes. The currency has fallen substantially against the dollar in recent weeks and there are fears that it could continue to plummet. Indeed, things have gotten so bad that a Greek consumer group has called for a boycott of German products, as a result of criticism from Germany — most particularly in the form of a tasteless cover from the newsmagazine Focus — of Greece’s financial practices. 

But while many would prefer to stick their heads in the sand and wait out the crisis, there are those who prefer to confront uncertainty with ingenuity. If you’ve got the right idea, now might just be the time to start up your own business. Why not begin baking specialty products for pets? Or start a travel agency for stuffed animals? Meditation with farm animals is certainly also a good opportunity for instant profits. After all, a bit of time in the stall is sure to calm the nerves of today’s stressed out managers. 

For those who think they might have a good business idea, but are too shy to try, SPIEGEL ONLINE brings you some inspiration — in the form of seven business concepts that never should have found success, but did. 

Travelling Teddies 

Apparently there are around 1.2 billion cuddly toy animals in the world — and you can bet that most of them have never seen the city of Prague. Or indeed, many other prime European tourist destinations (unless it happens to be their home town, of course). Now a Czech company, The Czech Toy Traveling agency, aims to change all that. Send them your inanimate, furry friend and they will send you pictures back of your stuffed beast in front of various landmarks around Prague. 


The concept for the toy travel agency was inspired by the French film “Amelie,” in which a character receives mysterious pictures of his stolen garden gnome posed in front of famous monuments around the world.

The idea received support after it appeared on the Czech version of reality television, investment show, Dragon’s Den.

A basic package tour for your teddy bear costs €90 and includes 30 photos on a disc, a certificate of proof that your bear was there, a profile created on your bear’s behalf on social networking sites and daily e-mail contact from your bear, or any other stuffed toy you care to send their way.

The most expensive package, which costs €150, includes a special travel box, with a pillow and blanket, so that the cuddly toy travels first class all the way back home.

Agency co-owner Tomio Okamura said that although the business only launched last week, “we already have dozens of orders, mostly from the US, Japan and Germany.”


The concept, which was inspired by the French film “Amelie,” in which a character receives mysterious pictures of his stolen garden gnome posed in front of famous monuments around the world, received support after it appeared on the Czech version of the reality television investment show “Dragon’s Den.” In the Czech Republic, the show is called “Den D” (or D-Day). 

A basic package tour for your teddy bear costs €90 and includes 30 photos on a disc, a certificate of proof that your bear was there, a profile created on your bear’s behalf on social networking sites and daily e-mail contact from your bear, or any other stuffed toy you care to send their way. The most expensive package, which costs €150, includes a special travel box, with a pillow and blanket, so that the cuddly toy travels first class all the way back home. Owners can also specify whether their insensate sweeties are vegetarian or should be allowed a drink after dinner. “We are focusing on North American, Southeast Asia and the European markets,” agency co-owner Tomio Okamura told SPIEGEL ONLINE. “We launched our business last week and we already have dozens of orders, mostly from the US, Japan and Germany.” 

Okamura, who is one of the businessmen supporting the venture financially and also the vice president of the Association of Tour Operators and Travel Agents of the Czech Republic, explains that once a travel reservation has been made for a toy, and payment received, the fluffy friend can be posted to the company. Sightseeing in Prague will take between one and three days and the Toy Traveling Agency will also take stuffed animals to special events upon request. “We already have a request from Japan to take the toy to see a top-flight European football match,” Okamura says. 

Eventually the company’s founders also want to be able to offer toys travel opportunities to other European cities, including Berlin, Munich and Bratislava. 

First on the Dance Floor  

The party is great, the music is playing, your feet are tapping. But the dance floor is empty. Even though you are aching to get out there and shake your proverbial thing, you don’t dare to hit the dance floor all alone. And then all of a sudden, there they are: Two enthusiastic hoofers who don’t seem to care who sees them getting down. Relieved, you — and all the other bashful bootie shakers — migrate to the dance floor while the host stands by, satisfied and smiling broadly that this fest is such a success. 

Such success, as it turns out, can be bought. A Berlin company, called Be My Dancer, hires out people to break the dance floor ice. Most of the firm’s business involves the time honored profession of the “taxi dancer,” the name first given to the courteous men who hired themselves out as dancing partners after World War I where there weren’t enough masculine dancing partners around. The trade has survived primarily on cruise ships, providing elderly, single ladies with a waltz partner. But in Berlin, the modernized Be My Dancer provides male and female dance partners to suit any occasion, from one’s first cha cha session to themed swing nights and tango parties. 

The Be My Dancer crew can be rented solo or as a team and each dancer costs around €40 an hour. It is also possibly to hire the trained professionals as private dance teachers. Most often the company’s employees can be seen strutting their stuff at the Bohème Sauvage, themed 20s costume parties in historic locations. 

Meditating with Cows 

Forget staring at stones or focusing for hours on single blades of grass. A Dutch farmer, Corné de Regt, has come up with a whole new method for meditation. And it all takes place in his cow stalls on his property on the outskirts of Denekamp, near the German border. One of the services de Regt’s business, “Rode Wangen” (Red Cheeks) offers is a wellness retreat for stressed out businessmen. And when it comes time for a spot of meditation, de Regt and his clients head out onto the farm. Into the cow stalls, to be more exact — where they will sit on hay bales together and meditate. 

“Unfortunately the silence is often broken,” de Regt told German freelance journalist Helmut Hetzel. “When a cow drops something, or when the animals are unsettled. But all of that belongs to the meditation sessions. Some of my guests complain about the smell. But that too, is all part of it. Ultimately all of one’s senses are stimulated through meditating alongside the animals. It is a unique experience. And most of the managers that come here like it.” 

Besides finding metaphysical peace with our bovine friends, the stressed will also be able to relieve their anxieties through other farm-based activities. Excess energy is expended through a hearty round of testosterone-fuelled wood chopping, which can then be followed up with a skinny dip in a nearby stream. There’s also plenty of fresh farm food, historical walks and the enterprising de Regt also offers a selection of goods for sale, including wooden toys, baked goods, woolen hats and slippers and apple juice. 

“My concept for therapy counts upon the fact that the business men who come to me have red cheeks before they leave. They are ‘refueled’ — and not only with fresh country air but also with the unique experiences they have on the farm and in the cow stalls,” de Regt says. 

Breaking Up with the Help of the ‘Terminator’ 

So you want out but you just bear to tell your erstwhile loved one it’s all over? Call the professionals. As the Web site for Berlin-based firm, The Separation Agency, says: “We can end it — perfectly and forever. We will turn one unhappy couple into two satisfied singles. Either that, or your partner gets one last warning, as delivered by us.” 

The agency offers a variety of packages. If you just can’t face it, then for €29.95, the agency will conduct the split over the telephone and make sure you two stay on friendly terms. For a little more — €64.95 — they will conduct that conversation with your soon-to-be-ex in person. If you are literarily challenged, then they will help you write the most appropriate “dear John” letter. And if you have just, plain and simple, had enough and want them to go away and leave you alone, then the agency will let the lover-turned-stalker know that too. 

Along with all of the above, the agency guarantees “delivery of the unwelcome news, de-escalation of pent up emotions, guidance on the difficult talks” and, best of all, your stuff back. 

Since it was founded in 2006, the agency which is run by former insurance salesman Bernd Dressler, has been a success. The “Terminator”, as Dressler has come to be known, doesn’t do any jobs without money up front and most of his customers are women in their 20s. He has even written a book about his experiences. Dressler says he delivers the message in a style that it is in accordance with his customer’s wishes. As he told the British media: “I say to them: ‘Good day, my name is Bernd Dressler from the Separation Agency and I have been asked by your partner to inform you that he or she wishes to end your relationship.'” 

Table Football Fashion  

When it comes to sports in Germany, there is really only one game in town. Newspaper sport sections, to be sure, report copiously on handball, ping pong and luge — or on any other sport that a German athlete may excel at. But football is the undisputed national pastime. 

And for those without the hand-foot coordination to succeed on the pitch, there is table football — known to Americans as foosball. It is a serious pastime in Germany, accompanied with shouts of joy, groans of dismay and no small amount of perspiration. To the consternation (and distraction) of non-players, tables can be found in offices across the country. The best players can even get the static plastic figures to pass the ball to each other. 

Perhaps it comes as no surprise then, that a German company offers little jerseys for the little players. For just €15.90, you can outfit your entire team with the football shirt of your choice — the company, known as Kicker Trikot — has a number of national teams on offer along with a selection of German league teams. Recently, the company has even begun making custom jerseys to order — for €49.90 a set. 

The company, based in Hamburg, started in 2006 and has seen a steady rise in turnover since then. With the World Cup just around the corner, the company is no doubt hoping for another uptick in sales. North Korea anyone? 

Baking for the Birds 

Germans love organic food. Despite the economic downturn and ongoing uneasiness about the robustness of the recovery, people in Germany have continued to pay extra for the knowledge that their foodstuffs are free of pesticides and insecticides. 

“Fears that consumers would save on their purchases of organic products during the financial and economic crises have proven false,” said the market research group GfK in a statement earlier this month. 

With such an addiction to food purity, it is perhaps no surprise that a company near Bielefeld offers organic snacks for parrots. Called the Parrot Bakery, the company’s product line includes palm oil muffins, Eucalyptus snacks and nut balls for your favorite feathered friend. “Only the best for your parrots,” is the company’s motto. 

Products are available both in Marita Grabowski’s small shop as well as on the Internet. Grabowski started her company when, in 2007, her Gray Parrot “Charlie” fell ill and she had to make him crackers without seeds. Her company has since found substantial success, supplying pet food stores across Europe. She has even written a book: “The Cookbook for Parrots and Parakeets.” 

The Karaoke Cab 

“Turn it up, driver, I love this song.” It’s a common enough refrain, heard in taxis all over the world as they ferry a weekend’s worth of merry makers to their destinations. And although some cab drivers find this annoying, there is one clever chap in the German city of Münster, in the state of North Rhine-Westphalia, who is making a business out of those kinds of requests. 

Taxi driver Nizamettin Kilincli has installed a screen in the back of his eight-person taxi van, over which he can play karaoke tracks, or even movies. The reasons passengers like his service are as varied as the passengers themselves, Kilincli told the online city magazine Echo Münster

During the day Taxi Niza, as his business is known, drives around the city like any normal van-for-hire. The screen in the vehicle might be used for a family who wants to keep the kids quiet on the way out to the airport. But by night, it becomes a rolling fun palace, with party goers on the way to a club or a disco entertaining themselves by belting out a few numbers. 

Best of all, the service costs no more than any other cab ride. All of this has seen the clearly very tolerant Kilincli gain a regular clientele who prefer a ride in his taxi above all others. 

As for the kind of drunken, often tuneless, yodeling coming from the back seats, Kilincli does not mind it at all. He’s never been one for singing along, he told the Münster magazine, and anyway, he has to concentrate on the road. 


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Is the Dismal Science Really a Science?

Some macroeconomists say if we just study the numbers long enough we’ll be able to design better policy. That’s like the sign in the bar: Free Beer Tomorrow.

For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what happened to the economy and what’s going to happen next.

Is the mess we’re in a market failure or a government failure? Is the stimulus plan working? Would tax cuts for small business spur employment? When will the job market improve? Is inflation coming? Do deficits matter?

So many questions and so little in the way of answers. And so it is the worst of times for economists. There is no consensus on the cause of the crisis or the best way forward.

There were Nobel Laureates who thought the original stimulus package should have been twice as big. And there are those who blame it for keeping unemployment high. Some economists warn of hyperinflation while others tell us not to worry.

It makes you wonder why people call it the Nobel Prize in Economic Science. After all, most sciences make progress. Nobody in medicine wants to bring back lead goblets. Sir Isaac Newton understood a lot about gravity. But Albert Einstein taught us more.

But in economics, theories that were once discredited surge back into favor. John Maynard Keynes and the view that government spending can create prosperity seem immortal. I thought stagflation had put a stake in the heart of this idea back in the 1970s. Suddenly, he’s a genius once again. F.A. Hayek, Keynes’s more laissez-faire sparring partner, is drawing interest. There are various monetarists to choose from, too. Which paradigm is the “right” way to think about the boom and the bust? Or are they all wrong?

I once thought econometrics—the application of statistics to economic questions—would settle these disputes and the truth would out. Econometrics is often used to measure the independent impact of one variable holding the rest of the relevant factors constant. But I’ve come to believe there are too many factors we don’t have data on, too many connections between the variables we don’t understand and can’t model or identify.

I’ve started asking economists if they can name a study that applied sophisticated econometrics to a controversial policy issue where the study was so well done that one side’s proponents had to admit they were wrong. I don’t know of any. One economist told me that in general my point was well taken, but that his own work (of course!) had been decisive in settling a particular dispute.

Perhaps what we’re really doing is confirming our biases. Ed Leamer, a professor of economics at UCLA, calls it “faith-based” econometrics. When the debate is over $2 trillion in additional government spending vs. zero, we’ve stopped being scientists and become philosophers. Do we want to be more like France with a bigger role for government, or less like France?

Facts and evidence still matter. And economists have learned some things that have stood the test of time and that we almost all agree on—the general connection between the money supply and inflation, for example. But the arsenal of the modern econometrician is vastly overrated as a diviner of truth. Nearly all economists accept the fundamental principles of microeconomics—that incentives matter, that trade creates prosperity—even if we disagree on the implications for public policy. But the business cycle and the ability to steer the economy out of recession may be beyond us.

The defenders of modern macroeconomics argue that if we just study the economy long enough, we’ll soon be able to model it accurately and design better policy. Soon. That reminds me of the permanent sign in the bar: Free Beer Tomorrow.

We should face the evidence that we are no better today at predicting tomorrow than we were yesterday. Eighty years after the Great Depression we still argue about what caused it and why it ended.

If economics is a science, it is more like biology than physics. Biologists try to understand the relationships in a complex system. That’s hard enough. But they can’t tell you what will happen with any precision to the population of a particular species of frog if rainfall goes up this year in a particular rain forest. They might not even be able to count the number of frogs right now with any exactness.

We have the same problems in economics. The economy is a complex system, our data are imperfect and our models inevitably fail to account for all the interactions.

The bottom line is that we should expect less of economists. Economics is a powerful tool, a lens for organizing one’s thinking about the complexity of the world around us. That should be enough. We should be honest about what we know, what we don’t know and what we may never know. Admitting that publicly is the first step toward respectability.

Mr. Roberts is a research fellow at Stanford University’s Hoover Institution, professor of economics at George Mason University and a distinguished scholar in the Mercatus Center.


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Obama’s Business Buyout

President Obama is proposing that the U.S. government both guide the economy and do so with a new, aggressively redistributive tax policy.

It made perfect sense for President Obama to speak yesterday to the Business Roundtable. Businesses big and small could use a pep talk just now. Bank lending last year fell the most since 1942. San Francisco Fed President Janet Yellen describes a jobless recovery, with the economy not returning to U.S.-style Mach speed until 2013.

But instead of giving a speech about reviving business confidence in the economy, Mr. Obama gave a speech about reviving business confidence in him.

“I take the time to make these points because we have arrived at a juncture in our politics where reasonable efforts to update our regulations, or make basic investments in our future, are too often greeted with cries of ‘government takeover’ or even ‘socialism.'”

The evening before this speech, Mr. Obama held a small White House dinner for some CEOs from household-name corporations, such as AT&T, Xerox, State Farm, Verizon, PepsiCo and GE. The reason for a linen-tablecloth dinner followed by a big speech to really big business is the White House has concluded it is wrongly seen as antibusiness.

I agree. This White House is pro-business. In fact, it’s so pro-business it’s proposing a virtual merger with the private sector. Ladies and gentlemen of the business community, meet your new partner—Uncle Sam.

Under the terms of the proposed deal, the White House will drive the locomotive of the American economy and U.S. business will ride in the passenger cars. You’re being told to get over it.

Now, the president doesn’t talk that way when he speaks, as yesterday, to the Business Roundtable. And some of the “antibusiness” rap is the result of the Obama folks doing what they felt they had to do the past year to get the financial and credit systems back on track.

Along with this came some traditional pistol-whipping of bankers and brokers. Blame transferral is what politicians do. Everyone big enough to be a Fortune 500 CEO understands how this game is played.

But then along came a $90 billion tax on banks? That’s a high price for taking a fall.

And how did it come to pass that the just-released Obama budget includes a $122 billion tax on businesses’ overseas profits? Business thought it had beaten back this tax last October. What happened?

The answer lies, as it always has, in Mr. Obama’s first budget statement—”A New Era of Responsibility: Renewing America’s Promise”—released last Feb. 26. This is the most important presidential budget document since Ronald Reagan’s April 1981 “Additional Details on Budget Savings.” There Reagan offered an explicit philosophical rationale for his reordering of the federal government’s role. The Obama statement does the same for events the past year.

“A New Era of Responsibility” describes the years before Mr. Obama as “an era of profound irresponsibility that engulfed both private and public institutions.” From this emerged the two core themes of the Obama presidency.

The first is that “government,” which Mr. Obama identifies as “we,” must “transform our economy for the 21st Century.” Thus, the now-familiar initiatives on carbon auctions, a green-jobs economy, and health care. “At this particular moment,” Mr. Obama said a year ago, “government must lead the way.” This isn’t just an antirecession patch, but something new and permanent.

Mr. Obama said yesterday it is not a “government takeover.” Nothing so crude at all. It’s an M&A agreement between Uncle Sam and the private economy.

This in turn requires what Mr. Obama many times has called “investments”: Thus this year’s long list of tax increases—the fees, fines and taxes in the health-care bill, the overseas profits tax and the 2011 expiration of the Bush tax cuts.

This is about more than just siphoning tax revenue. It’s about big theme No. 2: “For the better part of three decades (my emphasis), a disproportionate share of the nation’s wealth has been accumulated by the wealthy. Technological advances and growing global competition, while transforming whole industries—and birthing new ones—has accentuated the trend toward rising inequality.”

I take this to mean that while the tax and economic policies of the past four presidencies worked for the economy—birthing whole industries—it was bad for society, as Mr. Obama understands it.

He is proposing that the U.S. government both guide the economy (“the right balance between the private and public sectors,” he said yesterday) and do so with a new, aggressively redistributive tax policy, which was made explicit in his just-released budget. Guide and redistribute. Agree or not, it’s a bold argument. But will it work?

This is radical, a big change indeed from the past three decades. It’s also a roll of the dice with the American economy. But as politics, it isn’t working. It has produced anxiety—the state-election surprises, the tea partiers, weak consumer confidence, nervous credit markets and surly executives.

If it were working, Mr. Obama wouldn’t have to give speeches to revive public confidence in his new vision for a new era. Could be, most people were fine with the one we had, until now.

Daniel Henninger, Wall Street Journal


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Can Washington Meet the Demand to Cut Spending?

Americans have reached a consensus. What’s lacking is trust.

President Obama’s decision to appoint Erskine Bowles and Alan Simpson to his bipartisan commission on government spending is politically shrewd and, in terms of policy, potentially helpful.

It is shrewd in that he is doing what he has been urged to do, which is bring in wise men. Here are two respected Beltway veterans, one from each party. It shows the president willing to do what he said he’d do when he ran, which is listen to other voices. The announcement subtly underscores the trope “The system is broken and progress through normal channels is impossible,” which is the one Democrats prefer to “Boy did we mess up the past year and make things worse.” And the commission gets some pressure off the president. Every time he’s knocked for spending, he can say “I agree, it’s terrible. Help me tell the commission!”

It’s potentially helpful in that good ideas may come of it, some rough and realistic Washington consensus encouraged.

Is it too late? Maybe. Even six months ago, when the president’s growing problems with the public were becoming apparent, the commission and its top appointees might have been received as fresh and hopeful—the adults have arrived, the system can be made to work. Republicans would have felt forced to be part of it, or seen the gain in partnership. Now it looks more as if the president is trying to save his own political life. Timing is everything.

But this is an interesting time. It’s easy to say that concern about federal spending is old, because it is. It’s at least as old as Robert Taft, Barry Goldwater and Ronald Reagan. But the national anxiety about spending that we’re experiencing now, and that is showing up in the polls, is new. The past eight years have concentrated the American mind. George W. Bush’s spending, the crash and Barack Obama’s spending have frightened people. It’s not just “cranky right-wingers” who are concerned. If it were, the president would not have appointed his commission. Its creation acknowledges that independents are anxious, the center is alarmed—the whole country is. The people are ahead of their representatives in Washington, who are stuck in the ick of old ways.

Conservatives all my adulthood have said the American people were, on the issue of spending, the frog in the pot of water: The rising heat lulled him, and when the water came full boil, he wouldn’t be able to jump out.

The House Budget Committee ranking Republican Rep. Paul Ryan, R-Wis.

But that is the great achievement, if you will, of the past few years. The frog is coming awake at just the last moment. He is jumping out of the water.

People are freshly aware and concerned about the real-world implications of a $1.6 trillion dollar deficit, of a $14 trillion debt. It will rob America of its economic power, and eventually even of its ability to defend itself. Militaries cost money. And if other countries own our debt, don’t they in some new way own us? If China holds enough of your paper, does it also own some of your foreign policy? Do we want to find out? And there are the moral implications of the debt, which have so roused the tea-party movement: The old vote themselves benefits that their children will have to pay for. What kind of a people do that?

It has been two or three years since I have heard a Republican or conservative say deficits don’t matter. Huge ones do, period. As for Democrats and new spending, the air is, for now, out of the balloon.

A question among Republicans is whether to back, as a party, Rep. Paul Ryan’s road map, his far-reaching and creative attempt to cut the deficit and the debt. The Congressional Budget Office says its numbers add up: It would, actually, remove the deficit in the long term. But the Ryan plan is, inevitably, as complicated as the entitlements it seeks to reform, involving vouchers and tax credits, cost controls and privatization. It is always possible that this is right for the moment, for the new antispending era. But the party itself has some other jobs right now, and one of them is to encourage the circumstances that will make real change possible. Here the abstract collides with the particular.

In the long run the Republicans have to do two things, and one they probably cannot do alone, or rather probably cannot do without holding the presidency, and a gifted president he would have to be. They have to prepare the ground for an American decision—a decision by a solid majority of America’s adults—that they can faithfully back specific cuts in federal spending: that they can trust the cuts will be made fairly, that we will all be treated equally, that no finagling pols will sneak in “protection” for this pet interest group or that power lobby, that we are in this together as a nation and can make progress together as a nation.

This is a huge job, and may ultimately require one strong and believable voice.

Second the Republicans should tread delicately while moving forward seriously. Voters are feeling as never before in recent political history the vulnerability of their individual positions. There is no reason to believe they are interested in highly complicated and technical reforms, the kind that go under the heading “homework.” As in: “I know my future security depends on understanding this thing and having a responsible view, but I cannot make it out. My whole life is homework. I cannot do more.”

We are not a nation of accountants, however much our government tries to turn us into one.

Margaret Thatcher once told me what she learned from the poll-tax protests that prompted her downfall. She said she learned in a deeper way how anxious people are, how understandably questioning and even suspicious they are of governmental reforms and changes: “They’re frightened, you see.” None of us feel we have a wide enough margin for error.

Americans lack trust that government will act in good faith, which is part of why they’re anxious. They look at every bill, proposal and idea with an eye to hidden horrors.

The good news is the new consensus that America must move forward in a new way to get spending under control. The bad news is we don’t trust Washington to do it. And in the end, only Washington can.

Paul Ryan is doing exactly what a representative who’s actually serious should do—putting forward innovative and honest ideas for long-term solutions. He should continue going to the people with it, making his case and seeing how they respond, from the Tennessee Tea Party to the Bergen County, N.J., Republican Club. Maybe a movement will start, maybe not. But it’s a good conversation to be having.

The GOP itself should be going forward with its philosophy, with the things it’s long stood for and, in some cases, newly rediscovered, and painting the broader picture of the implications of endless, compulsive high spending. Those lawmakers who have a good reputation in this area—Sen. Tom Coburn is one—should be moved forward more prominently. Congressmen who focus on earmarks, on controllable spending, are doing something wise. They are trying to demonstrate that those who can be trusted with small things—cutting back what can be removed now—can be trusted with larger things.

Peggy Noonan, Wall Street Journal


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Voters to Democrats: Jobs, Jobs, Jobs

Evan Bayh’s withdrawal from politics could be a harbinger of doom for the party—but it doesn’t have to be.

Sen. Evan Bayh’s stunning decision to retire should serve as more than a wake-up call to Democrats. It should spur a fundamental re-examination and reorientation of the party’s policies, practices and approaches leading into the fall election.

Let’s be clear. The Democratic brand is in trouble—big trouble. There are at least eight Senate seats up for grabs, and another two or three potentially in play, putting control of the Senate in play.

A betting man would have to give pretty good odds that the Republicans at least come away with the eight seats where they are currently either even or ahead in the polls (Arkansas, Colorado, Illinois, Nevada, Pennsylvania, Indiana, Delaware and North Dakota). The momentum is moving in the Republicans’ direction, and this election will be closer than anything in recent memory and likely produce last-minute swings to the Republicans.

Even without a dramatic swing to the Republicans, the Democratic brand is going to struggle. And when the Senate goes, the House is not likely to be far behind. Analysts can already count 25-30 endangered Democrats in the House, and the number is likely to swell as time goes on.

What then, do the Democrats need to do?

First, they need pro-growth, fiscally conservative policies. The tea party movement is not a Republican movement, and anyone who sees it as such is making a mistake. Rather, the tea party movement is a reaffirmation of a trend that has long been happening in American politics since 1964, with the move away from liberal, big-spending and big-taxing policies. It played out with California’s Proposition 13 in 1978, which limited property taxes there and inspired nationwide tax revolts just two years before Ronald Reagan was elected. It was evident when the Republicans won control of the House and Senate in 1994. And it certainly contributed to George W. Bush’s election and re-election in 2000 and 2004.

It is a profound mistake to believe that the Democratic resurgence and President Barack Obama’s election were a validation or an endorsement of a return to big government and Democratic liberalism. Rather, the party’s victories were a reaction against the Bush spending policies and paralysis in Washington, and frustration with an increasingly out-of-touch Congress. Indeed, the rhetoric and approach that candidate Obama employed in 2008 was decidedly anti-Washington and made a point to avoid an embrace of big government and big spending.

President Obama made it clear that he would produce a fundamental degree of change in the way government operates and practices. Well, it didn’t happen. Not by a long shot.

The Democrats need to do a number of things. First and foremost, they need to recognize there is only one fundamental issue in America: jobs. Unless there are pro-growth policies of the kind that have been articulated by the Kauffman Foundation and are supported by 70% to 80% of the American people according to Kauffman-sponsored research, Democrats are not going to win enough support quickly enough to reclaim their credibility.

These policies include a broad-based payroll tax holiday, building from the one Sens. Charles Schumer (D., N.Y.) and Orrin Hatch (R., Utah) have embraced, an extension of the Bush tax cuts, educational initiatives to educate the next generation of entrepreneurs, and tax policies that provide clear incentives to small businesses to get started and to hire new employees. Of late, President Obama has paid lip-service to the concept of creating private-sector jobs, but there is much more he can and should do to become the “jobs president” rather than the “health-care president.”

Speaking of health care, Mr. Obama must go back to square one. The American people have rejected the bulk of the Democratic initiative time and time again. As we say in politics, “This dog don’t hunt.”

What that means very simply is that the Democrats need to start over and embrace ideas that have broad-based support, like insurance reform, cost control, affordability, eliminating denials of insurance coverage based on pre-existing conditions, and electronic record-keeping.

The president is wrong to say that doing this will be seen as capitulation to the Republicans. It is quite the opposite. When Bill Clinton adopted the bulk of the Republican ideas on taxes, spending and welfare reform in 1996, he was able to seize some political ground and demonize House Speaker Newt Gingrich and Republican presidential candidate Bob Dole.

Mr. Obama can do the same thing if he is prepared to be shrewd tactically, rather than try to stand on his high horse and say that the Republicans are not being fair. Of course they are not being fair. They are playing politics. But he has the White House, and he can use it constructively to win.

The administration is setting itself, and its party, up to fail unless it commits to serious deficit reduction and spending cuts. It needs to understand that the American people, particularly those who support the tea party movement, will only come back to Democrats if it demonstrates that it understands voters’ desire to return to the kind of limited government the movement endorses.

The tea party movement is strong enough to elect a Republican House and Senate and shake up politics in ways we haven’t seen or considered. A commitment to deficit reduction and spending cuts, as well as a willingness to consider a continuation of the Bush tax cuts for another year until growth is stimulated, is critically important to reviving the Democratic brand.

Evan Bayh’s withdrawal from politics could be an extraordinary harbinger of the end for the Democrats, but it doesn’t have to be. Mr. Obama can lead his party, and the country, into great success by heeding the calls from the American people to create jobs, limit spending, and work towards bipartisanship. Anything less will spell doom for Democrats across the board.

Mr. Schoen, formerly a pollster for President Bill Clinton, is the author of “The Political Fix: Changing the Game of American Democracy, from the Grass Roots to the White House ” (Henry Holt, 2010).


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Mix message

Barack Obama’s advisers lay out some steps to a rebalanced economy. Others are out of his hands

FEW things have frustrated Washington’s punditocracy more than the search for “Obamanomics”, a consistent set of principles that underpins Barack Obama’s thinking on the American economy. “We can’t afford another so-called economic ‘expansion’ like the one from the last decade…where prosperity was built on a housing bubble and financial speculation,” Mr Obama declared in his state-of-the-union address last month. Well, OK. But what, then, should the next expansion be like? It usually falls to a president’s Council of Economic Advisers to drape his pronouncements in respectable economics. Mr Obama’s council attempts to do just that in its annual “Economic Report of the President”, released on February 11th.

In a nutshell, the report argues that it is not enough for the economy to start growing again. Rather, “the composition of spending needs to be reoriented.” That means smaller roles for consumption and housing, and bigger roles for saving, investment and exports. The report elegantly reframes much of Mr Obama’s domestic agenda as microeconomic nudges in the direction of this overall macroeconomic rebalancing.

In the years leading up to the crisis soaring asset prices, financial innovations and low unemployment all encouraged Americans to spend more and save less. Their saving as a share of disposable income fell steadily from around 10% in the early 1980s to around 1%, while home-ownership rates and residential-construction activity both outran levels justified by demography alone. Wealth, credit availability and unemployment have all now reversed. The report predicts consumption and home-building will be smaller shares of GDP while the personal-saving rate will stabilise at a higher equilibrium of between 4% and 7%. Mr Obama is pushing this process along by making retirement-saving plans more readily available and encouraging employers to increase employee contributions. The report does not say so, but the logical result of his financial reforms will be closer scrutiny of lending practices that will deprive marginal borrowers of credit.

In place of consumption and housing, the report says, business investment will expand. Investment since the 2001 recession has been “abnormally low”. Two forces will reverse that. First, higher personal-saving rates and (more optimistically) a lower federal deficit will hold down long-term interest rates and the cost of capital. Second, the prospective return on investments will be buoyed by “promising technological developments”.

The administration thinks it can intensify the second force by funding more basic research. Private research and development (R&D) is hamstrung by uncertainty over the fate of an R&D tax credit, which at present must be renewed by Congress each year. Mr Obama proposes making it permanent. The backlogged Patent and Trademark Office can take up to four years to approve a patent application. Mr Obama has endorsed congressional plans to let it charge more to speed things up. The administration is telling federal agencies to track the results of the research they fund so that money is spent to maximum effect.

The report argues that as personal savings rise and the federal deficit declines, America’s appetite for foreign savings will shrink. The current-account deficit, which topped 6% of GDP in 2006, will narrow in the long run to between 1% and 2% of GDP, where it stood in the mid-1990s. Aiding this shift is a boost to exports that the report predicts will be a natural consequence as other countries, especially in Asia, rebalance their own economies towards greater consumption and investment.

In his state-of-the-union address Mr Obama called for a doubling of exports in five years. Achieving that is a stretch but the report nonetheless argues that the Export-Import Bank, which Mr Obama wants to increase its financing for smaller exporters, can help. More boldly, the report and Mr Obama’s speech suggest that the president has set aside his ambivalence about free trade and may soon take up stalled free-trade agreements with South Korea, Colombia and Panama. The report also argues that a more progressive tax system, expanded health care and worker retraining are better ways to respond to the inevitable disruptions trade brings than protectionism. (Some of this is contrived: increased health-care coverage may well soften the sting of jobs lost to freer trade, but that is not why Mr Obama is pursuing it.)

The mercy of others

Laudable as most of these microeconomic moves are, rebalancing depends crucially on two macroeconomic levers Mr Obama either cannot or will not touch: interest rates and the dollar. The council’s report frankly acknowledges that by draining national saving, the federal deficit, which will hit a record 10.6% of GDP this year, will hinder rebalancing. Yet it argues that tackling the deficit should wait until the “Federal Reserve…has the tools to counteract” the fallout. That will not be for a while yet. The report says that even with interest rates at zero, monetary policy remains “unusually tight” because negative rates would be more appropriate. Put less diplomatically, this means unless the Fed drags its feet on raising rates, fiscal contraction risks choking the economy. But that is a decision for the Fed, not Mr Obama.

A weaker dollar is also critical to rebalancing growth. Indeed, its decline to date correlates almost perfectly with the drop in the non-oil trade deficit since 2006, according to Martin Baily and Robert Lawrence, two economists at the Brookings Institution and Harvard University respectively. This is not, however, something America, as the world’s biggest debtor and the custodian of its reserve currency, can be seen to encourage. Nor is it solely America’s choice to make. The dollar is also captive to other countries’ exchange-rate policies and saving habits. As a result the “Economic Report of the President” is largely silent on the currency. Mr Obama seems to understand that the economy needs to rebalance. Whether it does may be out of his hands.


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An Order of Prosperity, to Go

PRESIDENT OBAMA called on America to “export more of our goods” in his State of the Union address last month, setting a goal of doubling what we sell abroad in five years. Good idea, but it would have been so much better if he had said “goods and services.”

Editing the president’s speeches isn’t my job, but the missing words suggest that the White House, like much of the rest of the country, hasn’t realized that exports of services are one of America’s 21st-century success stories. We still picture exports being loaded on ships or planes, but — as the accompanying chart based on Commerce Department data shows — overseas sales are today increasingly delivered in person or sent across the Internet.

Exports of American services have jumped by 84 percent since 2000, while the growth rate among goods was 66 percent. America trails both China and Germany in sales of goods abroad, but ranks No. 1 in global services by a wide margin. And while trade deficits in goods have been enormous — $840 billion in 2008 — the country runs a large and growing surplus in services: we exported $144 billion more in services than we imported, dwarfing the surpluses of $75 billion in 2000 and $58 billion in 1992.

Equally important, Commerce Department data show that the United States is a top-notch competitor in many of the high-value-added services that support well-paying jobs.

One of the brightest spots is operational leasing — a segment of the industry that handles short-term deals on airplanes, vehicles and other equipment — in which exports exceeded imports by eight to one. Our edge was six to one in distributing movies and television shows, and nearly four to one in architectural, construction and engineering services. Royalties and license fees, one of the largest categories in dollar terms, came out better than three to one, as did exports in advertising, education, finance, legal services and medicine.

All told, the United States is competitive in 21 of 22 services trade categories. It recorded striking surpluses in 12 of them. Only in insurance did America run a significant deficit, a persistent outcome that reflects foreign prowess in reinsurance (that is, policies insurers take out from other insurance companies to protect against catastrophic losses).

This pattern holds over time. The pecking order may change from year to year — for example, industrial engineering had the biggest surplus in 2006 and film and television held the top spot in 2007 — but the data consistently show the United States is highly competitive in a wide range of services categories.

So, given how well we are selling services abroad already, can we reach President Obama’s five-year goal of doubling exports? Actually, it shouldn’t be that daunting. Our overseas sales of goods and services combined rose nearly 80 percent from 2003 to 2008. In fact, the current weak dollar and continuing economic growth in Asia might be enough to carry us the rest of the way to the goal even if the president’s proposed National Export Initiative fails to get off the ground. That said, there are some concrete measures that should be taken now that will pay off in the longer term, most having to do with free trade.

The president said he would “reform export controls” and “continue to shape” an agreement that opens global markets during the so-called Doha round of World Trade Organization negotiations. But those talks are in their ninth year, and a final accord is a long way off. For now, we have to look at trade as a two-way street: increasing our opportunities to export entails giving other countries greater access to the American market. We can complain as much as we want about China and other nations stifling domestic sales of our products, but our companies will get nowhere if the United States comes to the bargaining table with a something-for-nothing mindset.

President Obama’s call for investing in the skills and education of our people will help exports, as our services tend to entail a great deal of specialized knowledge. Improving this labor force takes time, however, so any education improvements aren’t going to spur exports in the next few years. The quickest way to upgrade the labor force to meet Mr. Obama’s goal lies in immigration reform that admits more well-educated foreigners. A good place to start is by passing laws to allow more American-educated foreigners to stay in the country after they get their degrees.

A word of caution on jobs: the bilateral nature of trade suggests the president’s goal on exports, even if reached, might not produce the net gain of two million jobs he prophesied. While rising exports will create jobs, higher imports would cut into employment. Still, even if a doubling of exports leads to a wash in the job count, the nation would be better off because the American jobs created will be higher-paying than those we lose.

Last, the details of Mr. Obama’s export initiative haven’t been fleshed out yet, but its very words should give us pause. They have the government meddling in a part of the economy where the private sector has been succeeding.

For example, will Washington offer tax breaks or other export incentives? While businesses may clamor for them, these would be a setback for freer trade — after all, for years it has been America that has been hectoring other countries to end their subsidies to exporters. Will Washington try to pick winners in the global marketplace, like green energy? More often than not, this kind of industrial policy wastes money, fosters inefficiency and creates few permanent jobs.

So, let’s assume the government does its part to break down barriers and open more foreign markets — what can our businesses themselves do to improve their performance? First, no company should assume that its services can’t be exported. Today’s technologies allow us to do things that were unthinkable just a decade ago. For example, surgeons are using high-speed data connections and robotics to operate on patients thousands of miles away.

Second, companies should also think about how they can adapt services to the local market. For example, the food retailer Yum Brands augmented its all-American KFC menu in China with noodles, steamed vegetables and pot stickers.

American executives also cannot show timidity in the face of supposed anti-Americanism. By and large, foreign consumers are fascinated by our products and consumerism. American companies took eight of the top 10 spots in Interbrand’s 2009 survey of best global brands.

President Obama was right to place a new emphasis on exports, but the best thing the administration can do is reduce impediments to trade and then get out of the way so America’s resourceful companies and talented workers can increase their dominance in the global marketplace.

W. Michael Cox, the former chief economist for the Federal Reserve Bank of Dallas, is the director of the Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business.


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China Has a Plan, America Doesn’t

Chimerica’s Monetary Management

Lender and borrower: Chinese President Hu Jintao (L) and US President Barack Obama

America has been squandering money it borrowed from the Chinese. Instead of criticizing China’s monetary policy, US President Barack Obama should acknowledge the financial skill being displayed by the new world power and learn a few useful lessons.

Everyone knows that it is important to have friends. But in politics it is just as important to have enemies. Being united against a common foe can be more than helpful.

So it may come as no surprise that the embattled US president, Barack Obama, is continuing where his predecessor George W. Bush left off: complaining about the Chinese. Obama recently said China’s monetary policy was hurting the US job market. That strikes a chord with Americans. It’s even true. But it doesn’t make any difference.

The US is the world’s biggest debtor and therefore not in the best position to get its way with the People’s Republic of China. Of each dollar that Obama wants to spend in 2010, over 30 cents are borrowed. And a large part of the loan comes from ChinaIt might be smarter for the US to stop with the reproaches and to learn from the Chinese instead. When compared to the Americans, their financial situation is more than rosy. And their monetary policy is highly sophisticated.

The Days of Cheap Money are Over

The Chinese don’t borrow, they save. And they do this with the kind of dedication with which the Americans spend. An ordinary Chinese person puts 40 percent of his or her salary into their bank account, while an ordinary American saves at most 3 percent. The People’s Bank of China has hoarded over $2 trillion in currency reserves. America meanwhile has a small dollar reserve and an XXL-sized budget deficit which currently stands at just under $14 trillion.

China is gently putting a stop to the expansionary monetary policy that helped to stabilize the fragile monetary system during the financial crisis. The government has increased interest rates and forced private commercial banks to hold larger reserves. It is withdrawing the liquidity it pumped into the market. The days of cheap money are ending.

America can’t yet bring itself to end its debt-financed anti-crisis policy. The Federal Reserve is still lending money at close to zero interest. It is devoting billions of dollars to shoring up the real estate market. It’s an attempt to buy the recovery now and pay for it later.

On the international stage, China’s monetary policy officials are givers, not takers. They are starting to issue government debt abroad, even though the country doesn’t need to borrow any money. But many states, for example Brazil, India and Russia, are happy to have an alternative to the US bond market. They buy Chinese bonds, and the Chinese in turn use this money to buy Russian, Indian and Brazilian bonds. This has created a second monetary circuit alongside the dollar.

This won’t replace the dollar as a global currency in the foreseeable future, but it will help to prepare the ground for its replacement. Xiao Gang, the chairman of the board of directors of the Bank of China, said last summer: “The time has come to internationalize the yuan.”

China Becoming a Mini World Bank

America by contrast is self-absorbed with its monetary policy. It has ignored warnings of rising inflation and a new asset price bubble — and in doing so is isolating itself, also from the Europeans. In the meantime, China is forging new alliances.

The People’s Republic has quietly been taking stakes in virtually all the world’s regional development banks. Like a mini-World Bank, China has been helping to shore up financially troubled countries in Latin America, Africa and Asia. It has also increased its stake in the International Monetary Fund, by $50 billion. Chinese monetary experts, not Chinese soldiers, have been driving the nation’s expansion — silently and efficiently.

The oil business is the foundation of the dollar’s hegemony. The oil-producing states do some $2.2 trillion dollars’ worth of business each year in the US currency. Larry Summers, Obama’s top economic adviser, once compared the dollar to the English language in terms of its importance to international trade.

But China, a huge consumer of oil, is already discussing alternative means of payment with its suppliers. It would like to pay in yuan. The oil states wouldn’t be able to use that currency worldwide, but they could make purchases in China. That, by contrast, would be like learning Mandarin.

China is talking down the dollar to serve its own interests. When the dollar depreciates against the euro and the yen, the yuan declines as well, because the Chinese currency is pegged to the dollar. And the declining yuan helps boost Chinese exports to Europe and elsewhere in Asia.

China now sells significantly more goods in Europe than it does in America. Rarely has a government used the instruments of state monetary policy in such a calculated way. Obama is complaining, China keeps on growing and we’re all confused.

The economics textbooks never imagined a planned economy that was also run so cleverly. The world of planned economies is “a completely paralyzed, artificially distorted, pseudo-order incapable of reaction,” Ludwig Erhard, the former German chancellor and economy minister widely credited with engineering Germany’s post-war economic miracle, once said. It would “collapse like a pack of cards.”

If he were alive today, Erhard would definitely change his mind, given Asia’s successes. That’s because China has a plan, and America apparently doesn’t.

Gabor Steingart, Der Spiegel


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Fair dues

Employees sniff out unfairness when money is involved

IF YOU can count your money you don’t have a billion dollars, opined Jean Paul Getty, an oil magnate. You may feel peeved for other reasons, too. A study published this month in the journal Psychological Science reveals that employees’ perceptions of how fairly they are being rewarded depend on whether they are getting bonuses in the form of goods or money.

Sanford DeVoe of the University of Toronto and Sheena Iyengar of Columbia University asked 268 participants to read a scenario about a manager handing out equal rewards to ten employees with vastly different performance records. In some scenarios the participants were told that the manager divided up 20 boxes of chocolates or 20 extra days of holiday equally among employees. In others, they were told that the managers divided up $20,000 or $20,000-worth of credit-card reward points equally. Participants were asked to rate the fairness of the manager’s behaviour on a nine-point scale, where one was extremely unfair and nine was extremely fair.

The researchers found these egalitarian tactics won average fairness values of 6.66 and 6.63 respectively for chocolates and extra holiday, but much lower average values of 5.46 and 5.93 for money and points, a statistically significant difference. This suggested to the authors that something about these rewards made people feel more strongly that they should reflect individual effort.

To test this further, they ran a similar study on another 427 participants. This time they presented them with one of five scenarios involving credit-card reward points. Managers gave their differently performing employees equal amounts of points that could be used only on electronics, only on books, only on films, only on music, or on all four of these types of products.

When points could be spent on only a single type of product, participants rated managers’ behaviour as 6.18 on the fairness scale. But this number dropped to 5.56 when credit-card points could be spent on all four of the product types. The authors suggest that the exchangeability of currency invokes a market mindset. “This is one reason why cutting all workers’ hours equally, such as moving from a five-day to a four-day work week, can come off as a much fairer approach than making equal pay cuts across the board,” says Mr DeVoe.


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New dangers for the world economy

When the crisis started, governments helped save the world economy. Now they are the problem

LAST year it was banks; this year it is countries. The economic crisis, which seemed to have eased off in the latter part of 2009, is once again in full swing as the threat of sovereign default looms.

Europe’s leaders are struggling to avert the biggest financial disaster in the euro’s 11-year history. This week all eyes have been on Greece. If it defaults, it will be the first EU member to do so. As The Economist went to press EU leaders were meeting to discuss what to do, and there was talk of a German-led rescue scheme. If it happens, other European candidates may be queueing up. Bond markets are worried about the capacity of Spain, Ireland and Portugal to repay their debts, forcing these countries to increase taxes and cut spending, even as they remain mired in recession.

Europe’s troubles have given investors good reason to worry; but they are not the only cause for concern. Policy changes around the world have also spooked investors. China’s government began to rein in its lending binge last month, worried about accelerating inflation and asset bubbles. India’s central bank has raised reserve requirements and Brazil’s fiscal stimulus is being phased out. The rich world’s big central banks are gradually unwinding the emergency liquidity facilities they introduced at the height of the crisis. “Quantitative easing”, the process of printing money to buy longer-dated securities, is coming to an end—or at least being put on hold.

All this has knocked asset prices. Stockmarkets are down sharply, commodity prices have tumbled and volatility is up. The MSCI World Index of global share prices has fallen by almost 10% from its peak on January 14th. Optimism about a “V”-shaped recovery is being replaced with pessimism about a double-dip recession, as fears grow that policymakers will be forced, or will mistakenly choose, to remove monetary and fiscal props too soon.

Acropolis now?

Three factors will determine whether such fears are justified. The first is the strength of the recovery—whether it is self-sustaining, or still propped up by government stimulus. The second is the scale of the sovereign-debt problems—whether Greece is a basket-case all of its own, or investors lose confidence in other heavily indebted governments. The third is the deftness with which the world’s central bankers and finance ministers design and co-ordinate the withdrawal of policy stimulus.

The picture on global growth is increasingly split. Big emerging economies are in the best shape, with strong growth in domestic demand and scant spare capacity. Countries such as India and Brazil have largely put the downturn behind them. Given the scale of its government-directed lending binge, China’s economy is vulnerable to a sudden clampdown by bureaucrats. But, for all the markets’ worries, there are few signs that it will tighten too much too fast. A slowing is possible, indeed desirable, but a serious stumble seems unlikely.

Not so in the rich world, where there are still few signs of strong private-demand growth. America’s latest, buoyant, GDP figures are misleading. Output grew at an annualised rate of 5.7% in the fourth quarter of 2009 mainly because firms were rebuilding their stocks. With the economy still shedding jobs (albeit at a lower rate), share prices falling, the housing market still wobbly and household debt shrinking, consumer spending is likely to remain subdued. Nor, with plenty of capacity sitting idle, are firms likely to go on an investment binge. In Europe and Japan the situation is far grimmer. Though exports are recovering, Japan has slipped back into deflation. In the euro zone, recovery was faltering long before the Greek crisis hit. Domestic demand has stalled even in countries, such as Germany, where households have no excess debt to pay off.

Searching for the exit

This disparity between the rich and emerging worlds should be reflected in their macroeconomic policies. Emerging economies can, and should, unwind their stimulus and raise interest rates before inflation takes off. But in big, weak, rich economies it is still too soon to tighten. The dangers of repeating the mistakes made in America in 1937 and Japan in 1997—when premature tax increases and tighter monetary policy pushed fragile economies back into recession—are greater than the risks of inaction. With output so far below potential and credit growth stagnant, there is little chance of sustained inflation. Nor, in most countries, should fear of bondholders lead to sudden fiscal austerity. The right lesson to draw from the travails of Greece, Spain and Portugal is not that all deficits today are dangerous, but that governments need to do more to control their deficits and boost economic growth in the medium term in order to make room for looseness today.

Most big, rich economies have absorbed half that message. At their gathering on February 6th, the G7’s finance ministers concluded, rightly, that it was too early to begin withdrawing stimulus. But no rich country has laid out a credible, medium-term fiscal plan. Top of the list should be reforms, like raising the retirement age or means-testing future benefits, which improve countries’ fiscal outlook without crimping demand today. France is leaning in the right direction, with its mooted overhaul of the pension system. America’s new budget, which simply punted on the medium term, was a shocking failure in that regard.

Equally important is a more explicit agenda to boost growth in the medium term. To minimise the risk that they fall into a Japanese-style morass of high public debt and slow growth, the rich world’s economies must spur productivity, encourage investment and foster competition. That points to a renewed focus on freeing trade, cutting spending rather than raising taxes and agreeing on new financial regulations.

Some of today’s nervousness comes from “policy risk”. Nobody—neither firms, banks nor individuals—is quite sure where government policy is going. The more that governments can do to reduce such uncertainty, the stronger the recovery is likely to be.


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Pass impasse

The giant neighbours are more rivals than partners

China and India: Prospects for Peace. By Jonathan Holslag. Columbia University Press; 234 pages; $37.50 and £26.

FOR a book about two countries whose most recent war was five decades ago, “Prospects for Peace” seems a quirky subtitle. Jonathan Holslag, a Brussels-based think-tanker, argues that, since China’s swift and bloody humiliation of India in 1962, the neighbours have “tottered at least five times on the verge of war”. But the last time troops massed on the border was in 1986. Since then the territorial dispute that sparked the war has been “put to one side”. Bilateral trade has boomed, and hundreds of thousands of Indians and Chinese now visit the other country each year, including a succession of senior politicians toasting a beautiful friendship.

As Mr Holslag explains, however, the relationship is still marked as much by unremitting strategic mistrust as by burgeoning co-operation. His contribution to a recent flurry of India-China books attempts to reconcile these contradictory trends. His conclusions are rather unsettling.

Most of the other books on the area concentrate inevitably on the implications of the two countries’ economic rise. The simultaneous emergence into the global economy of two countries containing nearly two-fifths of the world’s people is after all an unprecedented phenomenon. Moreover, China’s dominance of global manufacturing seems matched by India’s arrival as an important provider of information-technology and other services. Mr Holslag quotes Zhu Rongji, a former Chinese prime minister: “You are number one in software. We are number one in hardware…Together we are the world’s number one.” That is India’s misfortune. Hundreds of thousands of Indians work in IT services whereas manufacturing for export provides China with tens of millions of jobs. Mr Holslag predicts that India will challenge China’s role as the world’s manufacturer, but that seems far-fetched.

This complementarity has been accompanied by a number of alliances of convenience, most notably in resisting pressure from the rich world to agree to fixed targets for limiting carbon emissions. There was even an agreement in 2006 to work together to avoid bidding up the prices of energy resources in third countries.

The limited effect of that pact, however, is one reason to believe Mr Holslag’s prognosis of a “fiercer economic rivalry and more aggressive regional diplomacy”. Another is what Lalit Mansingh, a former Indian diplomat, calls “the ghost at the banquet”: China’s increasing diplomatic and military influence in Asia—and India’s fear of it.

As Mr Holslag notes, the defeat in 1962 has left a deep suspicion of China in India’s political, academic and diplomatic circles, which is reflected in public opinion. India claims an area of Chinese-held territory in Kashmir the size of Switzerland, while China claims an area three times larger in what is now Indian Arunachal Pradesh. The border dispute remains unresolved. What had lazily been assumed to be the obvious solution—the status quo, in which each country keeps large swathes of territory claimed by the other—seems, if anything, further away than ever. The political difficulties of selling such a deal in India have long been obvious. But China’s renewed harping on its claim in recent years suggests that it in fact does want more than it already has.

In putting the strategic rivalry at the centre of his analysis, Mr Holslag provides a useful corrective to some of the more starry-eyed visions of a semi-cohesive “Chindia”. He cannot, however, overcome the two biggest difficulties of tackling the subject. One is that both countries are so big and so complex that at times broad-brush simplification of their histories and policies veers into distortion.

The second is that India is full of voluble politicians, academics, diplomats and ordinary people with fiercely held views on China. Across the border, however, fewer Chinese regard India as an issue of immediate importance, and debate on the relationship is far more circumscribed. Cyberspace may be the exception, but it is largely ignored in this account. A consequence of this—and it is something many Indians are painfully aware of—is that Indian policy often appears fragile, contradictory and self-defeating, whereas China’s seems coherent, single-minded and effective. Yet it is hard to imagine that China can have a higher foreign-policy goal in South Asia than keeping relations with India on a fairly even keel. Maybe, for once, it is Chinese policy that is in disarray.


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Clueless in Washington

Neither the president nor Congress shows any sign of knowing how to tackle the deficit

IT WAS never reasonable to expect that Barack Obama’s budget proposal, delivered to Congress on February 1st, would do much to bring down America’s vast deficit in the near term. True, the economy has returned to growth. But a big part of that consists of restocking after a savage downturn that has left inventories depleted. Consumers are still struggling with the collapse in the values of their homes and other assets. And unemployment stands at a stubborn 10%: the administration forecasts see only a fractional fall in joblessness this year.

Unlike other rich countries, America lacks the “automatic stabilisers” that kick in during times of recession to help boost demand. Unemployment benefit is extremely limited. Most states are legally barred from running deficits, so when their revenues fall in times of recession they make painful cuts, firing workers and ending programmes—thus exacerbating the downturn rather than offsetting it. Only the federal government can fill the demand gap, and if it is too parsimonious and the recession returns, the deficit would get much worse.

So the eye-popping $1.56 trillion deficit for the current fiscal year previewed in this week’s budget, to be followed by a further $1.27 trillion in fiscal 2011 (which begins on October 1st), ought mostly to be seen as a consequence of the downturn that Mr Obama inherited. And some of the measures proposed for this year and next make sense, particularly the tax breaks for employers taking on new hires—though in our view Mr Obama is probably adding more stimulus than is needed, especially when it comes to 2011.

What is truly worrying, though, is the medium-term outlook. Mr Obama’s budget reveals a road-map to fiscal catastrophe. At no point over the coming decade will the deficit be below 3.6% of GDP; and after 2018, it starts rising again. The cuts the president has proposed are comically insufficient: a budget freeze on non-security discretionary spending, which amounts to only about 17% of the entire $3.8 trillion budget; and a toothless deficit commission (a better version has already been killed by obstructive Republicans in Congress) whose recommendations will doubtless be ignored.

Entitled to live in debt for ever?

In the medium term there are only two ways to bring the deficit back to a sustainable level—which means no more than 3% of GDP. Either taxes will have to rise, or a serious attempt must be made to rein in the entitlements—legally mandated programmes such as Medicare, Medicaid and Social Security—that constitute the great bulk of spending. Mr Obama is proposing only a bit of the first, and none of the second. Taxes on the rich (those earning $250,000 a year or more) will go up from next January, as the Bush tax cuts expire; but Mr Obama had promised middle America that it will pay “not one single dime” more in tax, and so he is extending George Bush’s budget-busting tax cuts for the remaining 98% of Americans.

Any serious attempt to tackle entitlements now looks doomed. Health care offered a chance to do so (broader coverage could come with tougher cost controls). But a weak administration and a greedy Congress conspired to produce a baggy monster of a bill which, from a fiscal point of view, might have made things worse. No one dares touch defence, in a troubled world. The Social Security pension scheme is deemed sacrosanct by nervy politicians. It is a deeply depressing picture—and Mr Obama did nothing this week to lighten it.


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Facing up to China

Making room for a new superpower should not be confused with giving way to it

FOR six decades now, Taiwan has been where the simmering distrust between China and America most risks boiling over. In 1986 Deng Xiaoping called it the “one obstacle in Sino-US relations”. So there was something almost ritualistic about the Chinese government’s protestations this week that it was shocked, shocked and angered by America’s decision to sell Taiwan $6 billion-worth of weaponry. Under the Taiwan Relations Act, passed in 1979, all American administrations must help arm Taiwan so that it can defend itself. And China, which has never renounced what it says is its right to “reunify” Taiwan by force, feels just as bound to protest when arms deals go through. After a squall briefly roils the waters, relations revert to their usual choppy but unthreatening passage.

With luck, this will happen again. But the squalls are increasing in number, and the world’s most important bilateral relationship is getting stormy. If it goes wrong, historians will no doubt heap much of the blame on China’s aggression; but they will also measure Barack Obama on this issue, perhaps more than any other.

The China ascendancy

As if to highlight the underlying dangers, China has this time gone further than the usual blood-and-thunder warnings and suspension of military contacts. It has threatened sanctions against American firms and the withdrawal of co-operation on international issues. Those threats, if carried out, would damage China’s interests seriously, so its use of them suggests that it hopes it can persuade Mr Obama to buckle—if not on this sale then perhaps on Taiwan’s mooted future purchases of advanced jet-fighters. But the unusual ferocity of the Chinese regime’s response also points to three dangerous undercurrents.

The first is the failure of China’s Taiwan policy. Under the presidency of Ma Ying-jeou, Taiwan’s relations with the mainland have been better than ever before. Travel, trade and tourist links have strengthened. A free-trade agreement is under negotiation. Yet there is little sign of progress towards China’s main goal of “peaceful reunification”. Most Taiwanese want both economic co-operation and de facto independence. A similar failure haunts policy in Tibet, where our correspondent, on a rarely permitted trip to the region, found the attempt to buy Tibetans’ loyalty through the fruits of development apparently futile. As talks between China and the emissaries of the Dalai Lama ended in the usual stalemate this week, China warned Mr Obama against his planned meeting with Tibet’s exiled spiritual leader.

Again, nothing new in that. There is, however, a new self-confidence these days in China’s familiar harangues about anything it deems sovereign. That is the second trend: China, after its successful passage through the financial crisis of late 2008, is more assertive and less tolerant of being thwarted—and not just over its “internal affairs”. From its perceived position of growing economic strength, China has been throwing its weight around. It played a central and largely unhelpful role at the climate-change talks in Copenhagen; it looks as if it will wreck a big-power consensus over Iran’s nuclear programme; it has picked fights in territorial disputes with India, Japan and Vietnam. At gatherings of all sorts, Chinese officials now want to have their say, and expect to be heeded.

This suggests a dangerous third trend. As China has opened its economy since 1978, it has been frantically engaged in catching up with the rich West. That has led to the idea, even among many Chinese, that it would gradually become more “Western”. The slump in the West, however, has undermined that assumption. Many Chinese now feel they have little to learn from the rich world. On the contrary, a “Beijing consensus” has been gaining ground, extolling the virtues of decisive authoritarianism over shilly-shallying democratic debate. In the margins of international conferences such as the recent Davos forum, even American officials mutter despairingly about their own “dysfunctional” political system.

A swing not a seesaw

Two dangers arise from this loss of Western self-confidence. One is of trying to placate China. The delay in Mr Obama’s meeting with the Dalai Lama in order to smooth his visit to China in November gave too much ground, as well as turning an issue of principle into a bargaining chip. America needs to stand firmer. Beefing up the deterrent capacity of Taiwan, which China continues to threaten with hundreds of missiles, is in the interests of peace. Mr Obama should therefore proceed with the arms sales and European governments should back him. If American companies, such as Boeing, lose Chinese custom for political reasons, European firms should not be allowed to supplant them.

On the other hand the West should not be panicked into unnecessary confrontation. Rather than ganging up on China in an effort to “contain” it, the West would do better to get China to take up its share of the burden of global governance. Too often China wants the power due a global giant while shrugging off the responsibilities, saying that it is still a poor country. It must be encouraged to play its part—for instance, on climate change, on Iran and by allowing its currency to appreciate. As the world’s largest exporter, China’s own self-interest lies in a harmonious world order and robust trading system.

It is in the economic field that perhaps the biggest danger lies. Already the Obama administration has shown itself too ready to resort to trade sanctions against China. If China now does the same using a political pretext, while the cheapness of its currency keeps its trade surplus large, it is easy to imagine a clamour in Congress for retaliation met by a further Chinese nationalist backlash. That is why the administration and China’s government need to work together to pre-empt trouble.

Some see confrontation as inevitable when a rising power elbows its way to the top table. But America and China are not just rivals for global influence, they are also mutually dependent economies with everything to gain from co-operation. Nobody will prosper if disagreements become conflicts.


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Hugger-Mugger in the Executive Suite

Countries spy on one another. Companies do, too

An earnest corporate executive outlines his company’s anticipated earnings for the next quarter in a conference call to financial analysts, who pepper him with questions. Unbeknownst to him, part of his audience includes ex-CIA interrogators trained in “tactical behavioral assessment.”

It is a technique that has been honed by the CIA for years as a quick means of detecting lies. The corporate chief is modestly optimistic, but the nuanced and nervous way he answers questioners tells the interrogators that he is probably lying. They write up a report for their firm, which sells it to an interested client, a hedge fund. The hedge fund sells the company’s stock short, betting that its price will drop. When the company’s dismal earnings are finally revealed, the fund makes a bundle.

This is one of the more thought-provoking scenes from Eamon Javers’s “Broker, Trader, Lawyer, Spy,” a book that describes the ways in which companies try to figure out what their rivals are up to—or try to counter such efforts. Mr. Javers takes us on a meandering tour of corporate espionage, reaching back into history and trying to bring us up-to-date. In particular, he tells us how corporations, these days, can use private spy agencies—equipped with talent and techniques borrowed from the CIA, the FBI, the KGB and other intelligence agencies—to protect themselves from illegal wiretaps, hidden closed-circuit televisions or the infiltration of their ranks by rival “agents.”

In the wake of Google’s stunning announcement last month that it had been the victim of a computer attack by hackers based in China—other high-tech companies had been hacked by China, too—it is good to be reminded that corporations are vulnerable to the snooping of outsiders.

Unfortunately, Mr. Javers has nothing to say about computer hacking and is almost mute about China, whose covert activities on behalf of China Inc. have flooded the FBI with cases. Before going after Google, for instance, Chinese agents stole night-vision equipment from a U.S. military contractor. Though weak on current examples, Mr. Javers does acknowledge, late in his book, that “the business of corporate espionage has gone global. And not everyone in this business has America’s best interests at heart.”

Mr. Javers does a better job of reminding us that spying has long been a part of doing business. Allan Pinkerton and his agents, in the 1850s, stalked counterfeiters and others who intended harm to banks and express companies. In the 1930s, wire-tappers even hooked into the phones of the Supreme Court, to get early word on decisions that might affect business. And in the 1970s, Howard Hughes used Intertel, a group formed from ex-Justice Department strike forces, to show how the author Clifford Irving had published a phony biography of Hughes.

By the early 1990s, one Washington-based private spy firm, called Diligence LLC, had found a way to monitor power plants, figuring out that when their coal piles were low, plants often shut down for maintenance. This was money-making news for electricity traders, who used it to judge when prices would trend upward because of low supply. Unfortunately Diligence’s major client—Enron—soon teetered into a self-made mire of bankruptcy and fraud.

In a chapter called “The Chocolate War,” Mr. Javers describes the hugger-mugger between Swiss-based Nestlé and the U.S. giant Mars Inc. In the 1990s, Nestlé was trying to sell a chocolate-covered toy in the U.S. market. Mars responded by covertly using consultants to prod federal agencies to outlaw the product on safety grounds. Nestlé pieced together the Mars plot by hiring former Secret Service agents to bribe garbage men, who brought them bags of Mars’s trash. Amid coffee grounds and empty soda cans, the sleuths found incriminating documents. The tidy folks at Mars had shredded them first but had stuffed all the shreds in the same bag, allowing Nestlé to piece them together.

Then there are the adventures of Jack Kroll, a former staffer for Robert F. Kennedy who founded J. Kroll Associates in 1972. The author describes him as the “Johnny Appleseed of corporate intelligence firms” because so many other companies spun off from Kroll. The company’s main work has been to track stolen money, at one point helping the Russian Republic follow billions of dollars that were stolen and moved out of the country amid the collapse of the Soviet Union.

As Mr. Javers’s chronicle shows, a lot of private sleuths tend to lack judgment, offering their services to shady types. Kroll’s firm spent time doing due diligence work for Allen Stanford, now accused of running an $8 billion Ponzi scheme. Hal Lipset, a former San Francisco detective and wire-tapper plied his craft for Jim Jones, the cult leader who urged his followers into mass suicide in Guyana in 1978.

What we could have used more of, in “Broker, Trader, Lawyer, Spy,” were fresh stories of foreign attacks on U.S. companies and stories of corporate heroes who admit their losses and help the government focus on the corporate-espionage problem. Boards of directors and CEOs need to grasp that it is a problem that will only get worse.

Mr. Fialka, a former Wall Street Journal reporter, is the author of “War by Other Means: Economic Espionage in America (1997)


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They Don’t Just Trust—They Verify

Good Housekeeping puts its own money behind its recommendations. No government agency does.

Like terrorism scares, product recalls have become a regular feature of modern life. Some, like last week’s Toyota recall, earn headlines, but others simply make for bleak reading on the Consumer Product Safety Commission Web site. On Jan. 21, for instance, the CPSC announced that Johnson Health Tech North America would voluntarily recall about 18,000 of its Horizon Fitness and Livestrong Fitness elliptical trainers. Though no injuries have been reported, the company is aware of 58 allegations that foot pedals “can become disengaged” and possibly send folks flying. The commission also announced that day that Conair would voluntarily recall about 162,000 Lysol Steam Cleaning Mops. “Conair has received 14 reports of hot water forcefully spilling out of the water reservoir compartment including two minor burn injuries to consumers who sought medical attention,” the company said in its own press release.

While our litigious society too often turns small problems into big lawsuits or recalls, no one wants to waste good money on a product that is flimsy, ineffective or—at worst—dangerous. Merits of the products recalled on Jan. 21 aside, how can we best choose gym equipment and mops that won’t go berserk?

There’s a simple answer to that question: We can follow the recommendations of Consumer Reports or Good Housekeeping. Consumer Reports just named six safe, user-friendly elliptical models. And February’s Good Housekeeping gave the Swiffer Sweeper (a Lysol mop competitor) its Hall of Fame award—naming it to its collection of innovative products deemed effective and safe by the Good Housekeeping Research Institute.

In both cases, the recommendations of these private, independent watchdogs were based on rigorous testing. But while Good Housekeeping and Consumer Reports are both influential, I suspect the average person who bought an elliptical trainer, broom or mop didn’t bother to consult them. Too many Americans place too much faith in government oversight and not enough on market-based solutions.

If your American-history class in high school was like mine, you probably learned a simple narrative about the rise of consumer-safety regulations. Back in the late 1800s and early 1900s, as modern advertising first spread, snake-oil salesmen hawked all manner of tainted foods and dangerous products. Then Upton Sinclair wrote “The Jungle” and eventually we got the Food and Drug Administration. Later, we got the CPSC to protect us from other nefarious goods. This story has been told so many times that most of us imagine that, in the absence of an alphabet soup of federal agencies, unsafe and useless products would be constantly foisted on hapless consumers.

But there are two problems with this story. First, most government agencies investigate problems only after the fact—just because a product is on the market doesn’t mean it’s safe or does what it claims. And second, there’s no reason to assume that the private sector couldn’t have come up with other—better—protections.

In fact, our forebears were just as worried about defective products as we are. That’s why Good Housekeeping launched its seal of approval in 1909, long before the CPSC’s existence, offering a two-year limited warranty on products advertised in its magazine. “We are assuming a tremendous liability,” says Miriam Arond, the current director of the GHRI. “People do take us up on it,” and so to minimize potential losses, the institute’s researchers weigh dirt, embed it in carpet, and vacuum like maniacs before any vacuum cleaner is promoted on the magazine’s pages. They undertake similar tests for washing machines, blenders, swimsuits and even rain boots. After all, “people are short on time,” Ms. Arond says. No consumer now, or in 1909, would have the time to evaluate every claim for herself.

Perhaps, rather than assuming that government agencies make sure all toys are safe, and getting upset when they aren’t, we’d be better off purchasing only those toys that GHRI researchers (or similar researchers at Consumer Reports and other places) have spent hours dropping and then studying to see if young children could choke on the small parts that result. My guess is that, in an alternative universe where Congress had never created the CPSC, more of us would do just that—and more private-sector labs and independent research institutes would come into being to help us make informed choices.

No system is perfect, of course. Consumer Reports’ Don Mays notes that “we can never have 100% confidence,” because while his organization’s tests uncover performance and safety defects, some recalls result from quality-control lapses in single batches of otherwise well-designed products (or exceedingly rare or nebulous problems, like Toyota’s pedals). But Good Housekeeping’s Ms. Arond reports that claims against the magazine’s warranty have been relatively rare in the more than 100 years it has awarded its seal. When the magazine says a product is good, it usually is.

To see how a more market-based consumer protection system might work, we can look at one segment of the economy with parallels to early 1900s consumer culture: today’s nascent green industry.

Environmentally friendly goods are increasingly popular, but there are no federal guidelines on what can be “green.” Hucksters can claim what they want. So last year, Good Housekeeping launched a Green Good Housekeeping Seal to evaluate “the increasing number of marketing claims—frankly, green-washing claims—made by products everywhere,” says Rosemary Ellis, the magazine’s editor. She reports that they’re doing a brisk business among companies clamoring to stand out in a crowded marketplace.

You can be reasonably sure that if there’s a future recall of a purportedly green product, it won’t be of one with the seal. After all, Good Housekeeping puts its own money behind all its endorsements. No government agency can say that.

Ms. Vanderkam is author of “168 Hours,” to be published by Portfolio in late May.


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How to Make a Weak Economy Worse

FDR’s war against business showed that a president must choose between retribution and recovery.

You get the feeling President Obama is girding for battle with the financial sector. In last week’s State of the Union address, he promised to regulate the industry. On Jan. 21, he was blunter, warning that he would not let companies that enjoyed “soaring profits and obscene bonuses” block his financial reforms. “If these folks want a fight,” he said, “it’s a fight I’m ready to have.”

This declaration of war echoes that of Franklin Delano Roosevelt. In 1936, late in his campaign for a second presidential term, FDR spoke of the challenges of “business and financial monopoly, speculation, reckless banking.” Wall Streeters and businessmen hated him, he said, adding that “I welcome their hatred.”

Then Roosevelt escalated: “I should like to have it said of my first administration that in it the forces of selfishness and the lust for power met their match. I should like to have it said of my second administration that in it these forces met their master.”

Mr. Obama might want to stick to a moderate approach. FDR’s war against business played to the crowd, but it hurt the economy. While monetary policies impeded recovery in the late 1930s, it was the administration’s assault on companies and capital that ensured the Depression’s duration.

Roosevelt had initially opted for safety and picked relatively moderate advisers. His first Treasury Secretary, William Woodin, was a railroad executive. Roosevelt also kept over a Hoover-era official, Jesse Jones, at the TARP of the day, the Reconstruction Finance Corp. James Warburg, the son of Wall Street banker Paul Warburg, also joined the team.

In the crucial days before March 5, 1933, when FDR declared a “bank holiday” to halt the bank run, New Dealers worked with Republicans to resolve the financial crisis. When it came to reforming Wall Street, they were likewise measured. Yes, they created the Securities and Exchange Commission. But their regulation seemed designed to serve markets, not stamp them out. At least mostly.

Though there was nothing establishment about the centerpiece of the early New Deal, the National Recovery Administration, it was friendly to big business. Indeed, too much so. Under the NRA, the largest players in each industrial sector were judged too big to fail not because their failure would create systemic financial risk—the argument for banks today—but rather in the faith that firms of such scale could serve as engines of recovery.

And Roosevelt, like Presidents Obama and Bush, dumped billions in cash onto the country. There was, not surprisingly, a Roosevelt market rally, just as there has been an Obama rally.

But complete recovery proved elusive. The public spending programs had less effect than hoped. Smaller firms complained, accurately, that the NRA’s minimum wages and limits on hours disadvantaged them. Unemployment was still high. FDR knew he could not keep asking Congress to authorize enormous outlays forever.

Frustrated, the president shifted to retribution. By 1935, FDR decided that firms, especially big firms, were impeding recovery. They must now redeem themselves and save the economy by sacrificing—or else.

The attacks started with taxes. In 1935, well before the “hatred” speech, FDR led Congress in passaging a law that replaced a flat rate on corporate income with a graduated rate—itself a penalty on larger firms. Personal income taxes went up, as did other rates. In 1936 FDR signed into law the undistributed profits tax, which aimed to force reluctant firms to disgorge cash as dividends or by paying higher wages. This levy too was graduated, with a top rate of 27%.

The 1935 Wagner Act was a tiger that makes today’s union law look like a pussycat. It favored unions over companies in nearly every way, including institutionalizing the closed shop. And after Roosevelt’s landslide victory in 1936, the closed shop and the sit-down strike stole thousands of productive workdays from companies, punishing earnings and limiting ability to hire.

Of particular relevance today was Roosevelt’s switch on antitrust policy. The large companies once rewarded by the NRA now became targets.

The final front of the war was utilities, the country’s most hopeful industry. FDR’s 1935 law, the Public Utilities Holding Company Act, made it so difficult for private-sector firms in this industry to raise capital that it was called a death sentence.

The result of it all was the Depression within the Depression of 1937 and 1938, when industrial production plummeted and unemployment climbed back into the higher teens. Even John Maynard Keynes chided FDR for his attitude about businessmen: “It is a mistake to think they are more immoral than politicians.”

Among themselves, the New Dealers acknowledged failure. FDR’s second Treasury Secretary, Henry Morgenthau, eventually determined that the problem was lack of what he labeled “business confidence.” Late in the decade, Morgenthau dared to call for tax cuts. He even placed a sign on his desk asking, “Does it contribute to recovery?” Roosevelt told him the sign was “very stupid.”

Ultimately the war abroad required FDR to give up his war at home. Now the same industries that had been under prosecution were at the War Production Board, signing contracts. Scholars have argued that wartime spending ended the Depression. But the truce with business played an important role.

The 1930s story suggests not that any individual reform is wrong per se. It reminds us rather that frustrated presidents are inconsistent, that antibusiness policies are cumulative, and that hostility yields more damage than benefit. Presidents can choose between retribution and recovery. They cannot have both.

Miss Shlaes, a senior fellow in economic history at the Council on Foreign Relations, is author of “The Forgotten Man: A New History of the Great Depression” (HarperCollins, 2007).


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The President’s Priorities

One of the greatest spend-while-you-can documents in American history.

One rule of budget reporting is to watch what the politicians are spending this year, not the frugality they promise down the road. By that measure, the budget that President Obama released yesterday for fiscal 2011 is one of the greatest spend-while-you-can documents in American history.

We now know why the White House leaked word of a three-year spending freeze on a few domestic accounts before this extravaganza was released. No one would have noticed such a slushy promise amid this glacier of spending. The budget reveals that overall federal outlays will reach $3.72 trillion in fiscal 2010, and keep rising to $3.834 trillion in 2011.

As a share of the economy, outlays will reach a post-World War II record of 25.4% this year. This is a new modern spending landmark, up from 21% of GDP as recently as fiscal 2008, and far above the 40-year average of 20.7%.


In the “out years” in mid-decade, the White House promises that spending will fall all the way back to 23% of GDP. Even if you choose to believe such a political prediction, that still means Mr. Obama is proposing a new and more or less permanently higher plateau of federal spending.

And here you thought the “stimulus” was supposed to be temporary. This is also before the baby boomers retire and send Medicare and Social Security accounts soaring.

If this budget is Mr. Obama’s first clear demonstration of his long-term governing priorities, then it’s hard not conclude that this spending boom is deliberate. It is an effort to put in place programs and spending commitments that will require vast new tax increases and give the political class a claim on far more private American wealth.

Despite talk of “tough choices” in yesterday’s document, the Administration wants $25 billion in new spending for states for Medicaid, $100 billion for yet another jobs “stimulus,” big boosts in spending for low-income family programs, for health research, heating assistance and education. If Mr. Obama’s priorities become law, federal outlays will have grown an astonishing 29% since 2008.

As further proof, the White House proposes to convert long-standing “discretionary” spending that requires annual appropriations into permanent entitlement programs. A case in point is the Pell Grant program for college, which the budget would shift into the “mandatory” spending column at a cost of $307 billion over 10 years. The political goal here is to make a college education as much of a universal entitlement as Social Security.

All of this spending must be financed, and so deficits and taxes are both scheduled to rise to record levels. The deficit will hit 10.6% of GDP this year, far more than Ronald Reagan ever dreamed of. The deficits are then predicted to fall but still to only a tad below 4% of GDP on average for the rest of the decade. We wouldn’t mind those numbers if they were financing tax cuts to revive growth.

But the reality is that even these still-high deficits are based on assumptions for growth and revenue gains from record tax increases starting January 1, 2011. And what a list of tax increases it is—no less than $2 trillion worth over the decade. The nearby table lists some of the largest, all of which the Administration and its economists claim to believe will have little or no impact on growth. If they’re wrong, the deficits will be even larger.

Our favorite euphemism is the Administration’s estimate that it can get $122.2 billion in new revenue via a “reform” of the “U.S. international tax system.” Reform usually means closing some loopholes in return for lower tax rates. But this is a giant tax increase on American companies that operate overseas, and it includes no offsetting cut in the U.S. 35% corporate tax rate, which is among the highest in the world. The Administration agreed last year to drop this idea when it was seeking the help of the Business Roundtable to pass health care. But so much for that, now that the White House needs the money.

Even these tax increases won’t be enough to pay for the spending that this Administration is unleashing in its first two remarkable years. On the evidence of this budget, the Massachusetts Senate election never happened.

Editorial, Wall Street Journal


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Budget day

Barack Obama is caught between a rising deficit, stubborn unemployment and political paralysis

A MEETING between Barack Obama and Republican members of the House of Representatives last week proved to be an unusually frank, if polite, affair. The president sought to put the members of the minority party on the spot before the television cameras, allowing them to voice their concerns but also asking them to offer proposals. Both sides were pleased with having a chance to make their rivals squirm. The deficit was an area of particular focus.

The Republicans, as well as the amorphous but vigorous “tea party” movement, have managed to put deficit spending on the national agenda like at no time since the early 1990s when Bill Clinton came to office on a wave of anxiety about the economy. During Mr Clinton’s terms the economy boomed and deficits became surpluses. During those of his successor, George Bush, the public let slip its attention on overspending. Two wars, two popular tax cuts, economic ups and downs, and an expensive drug benefit for Medicare (the health system for the elderly) that was supported by both parties, pushed public finances deep into the red.

As hard as Mr Obama and his advisers have tried to remind voters of the fiscal situation that he inherited, the president is now seen to “own” the economy and the tide of red ink that America faces. So as he proposes his first full-year budget on Monday February 1st, he is stressing not the goodies the budget will dole out but the programmes he is cutting and consolidating. According to the White House, the new budget cuts 120 programmes, with savings expected to total $20 billion. These include combining 38 education programmes into 11, and cutting money for parks, brownfield development and other areas.

Whereas the deficit has become more prominent the White House has its eyes on another concern: jobs. In the early 1980s under Ronald Reagan, and then in the late 1990s under Mr Clinton, the unemployment rate and presidential popularity corresponded eerily closely. Late last week GDP figures for the fourth quarter of 2009 showed the strongest quarterly economic growth since 2003. But the president and his supporters have reacted cautiously, as economic analysts warn that the recovery remains fragile and as job figures and (closely related) consumption numbers remain weak.

Can the president get Americans back to work? On Friday he proposed a package of tax incentives for job creation: small businesses would get a $5,000 tax credit for every worker hired. In addition, those who raise pay above inflation for existing workers will get a credit on their Social Security taxes, a payroll tax that adds a good deal to the cost of every worker. Republicans dismiss this as small beer and remind the president that not just Reagan but John Kennedy pushed through economy-wide, broad-based tax cuts to stimulate the economy in a recession.

Neither party talks comfortably about the real tax-and-spend issue, entitlements. Last week the Congressional Budget Office said that the national debt is on course to triple in ten years. The three-year discretionary-spending freeze Mr Obama backed at his state-of-the-union address last week would reap only small savings next to the rising costs of Medicare, Social Security and Medicaid, the health-insurance programme for the poor. Mr Obama wants a commission to propose a deficit-reduction plan that would have to pass Congress without amendment. This could be one way to tackle entitlements.

But Mr Obama could not get the creation of such a commission through the Senate (and thus has talked of creating one by executive order). Many Republicans want such a commission to focus only on spending cuts and not tax increases, and some Democrats fear entitlement cuts. The Republican refusal to countenance tax increases could make them look irresponsible. But they may gamble that with control of Congress and the presidency, any political pain for deficits, joblessness and the rest will only be felt by the Democrats. The most shameless partisans on both sides glory in trying to make the other look like it will throw the elderly out in the cold if Medicare and Social Security are reformed. Making hard choices is all but impossible when political gamesmanship is at the fore.

The Economist


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Good and Boring

In times of crisis, good news is no news. Iceland’s meltdown made headlines; the remarkable stability of Canada’s banks, not so much.

Yet as the world’s attention shifts from financial rescue to financial reform, the quiet success stories deserve at least as much attention as the spectacular failures. We need to learn from those countries that evidently did it right. And leading that list is our neighbor to the north. Right now, Canada is a very important role model.

Yes, I know, Canada is supposed to be dull. The New Republic famously pronounced “Worthwhile Canadian Initiative” (from a Times Op-Ed column in the ’80s) the world’s most boring headline. But I’ve always considered Canada fascinating, precisely because it’s similar to the United States in many but not all ways. The point is that when Canadian and U.S. experience diverge, it’s a very good bet that policy differences, rather than differences in culture or economic structure, are responsible for that divergence.

And anyway, when it comes to banking, boring is good.

First, some background. Over the past decade the United States and Canada faced the same global environment. Both were confronted with the same flood of cheap goods and cheap money from Asia. Economists in both countries cheerfully declared that the era of severe recessions was over.

But when things fell apart, the consequences were very different here and there. In the United States, mortgage defaults soared, some major financial institutions collapsed, and others survived only thanks to huge government bailouts. In Canada, none of that happened. What did the Canadians do differently?

It wasn’t interest rate policy. Many commentators have blamed the Federal Reserve for the financial crisis, claiming that the Fed created a disastrous bubble by keeping interest rates too low for too long. But Canadian interest rates have tracked U.S. rates quite closely, so it seems that low rates aren’t enough by themselves to produce a financial crisis.

Canada’s experience also seems to refute the view, forcefully pushed by Paul Volcker, the formidable former Fed chairman, that the roots of our crisis lay in the scale and scope of our financial institutions — in the existence of banks that were “too big to fail.” For in Canada essentially all the banks are too big to fail: just five banking groups dominate the financial scene.

On the other hand, Canada’s experience does seem to support the views of people like Elizabeth Warren, the head of the Congressional panel overseeing the bank bailout, who place much of the blame for the crisis on failure to protect consumers from deceptive lending. Canada has an independent Financial Consumer Agency, and it has sharply restricted subprime-type lending.

Above all, Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk. The United States used to have a boring banking system, but Reagan-era deregulation made things dangerously interesting. Canada, by contrast, has maintained a happy tedium.

More specifically, Canada has been much stricter about limiting banks’ leverage, the extent to which they can rely on borrowed funds. It has also limited the process of securitization, in which banks package and resell claims on their loans outstanding — a process that was supposed to help banks reduce their risk by spreading it, but has turned out in practice to be a way for banks to make ever-bigger wagers with other people’s money.

There’s no question that in recent years these restrictions meant fewer opportunities for bankers to come up with clever ideas than would have been available if Canada had emulated America’s deregulatory zeal. But that, it turns out, was all to the good.

So what are the chances that the United States will learn from Canada’s success?

Actually, the financial reform bill that the House of Representatives passed in December would significantly Canadianize the U.S. system. It would create an independent Consumer Financial Protection Agency, it would establish limits on leverage, and it would limit securitization by requiring that lenders hold on to some of their loans.

But prospects for a comparable bill getting the 60 votes now needed to push anything through the Senate are doubtful. Republicans are clearly dead set against any significant financial reform — not a single Republican voted for the House bill — and some Democrats are ambivalent, too.

So there’s a good chance that we’ll do nothing, or nothing much, to prevent future banking crises. But it won’t be because we don’t know what to do: we’ve got a clear example of how to keep banking safe sitting right next door.

Paul Krugman, New York Times


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The book of Jobs

It has revolutionised one industry after another. Now Apple hopes to transform three at once

APPLE is regularly voted the most innovative company in the world, but its inventiveness takes a particular form. Rather than developing entirely new product categories, it excels at taking existing, half-baked ideas and showing the rest of the world how to do them properly. Under its mercurial and visionary boss, Steve Jobs, it has already done this three times. In 1984 Apple launched the Macintosh. It was not the first graphical, mouse-driven computer, but it employed these concepts in a useful product. Then, in 2001, came the iPod. It was not the first digital-music player, but it was simple and elegant, and carried digital music into the mainstream. In 2007 Apple went on to launch the iPhone. It was not the first smart-phone, but Apple succeeded where other handset-makers had failed, making mobile internet access and software downloads a mass-market phenomenon.

As rivals rushed to copy Apple’s approach, the computer, music and telecoms industries were transformed. Now Mr Jobs hopes to pull off the same trick for a fourth time. On January 27th he unveiled his company’s latest product, the iPad—a thin, tablet-shaped device with a ten-inch touch-screen which will go on sale in late March for $499-829. Years in the making, it has been the subject of hysterical online speculation in recent months, verging at times on religious hysteria: sceptics in the blogosphere jokingly call it the Jesus Tablet.

The enthusiasm of the Apple faithful may be overdone, but Mr Jobs’s record suggests that when he blesses a market, it takes off. And tablet computing promises to transform not just one industry, but three—computing, telecoms and media.

Companies in the first two businesses view the iPad’s arrival with trepidation, for Apple’s history makes it a fearsome competitor. The media industry, by contrast, welcomes it wholeheartedly. Piracy, free content and the dispersal of advertising around the web have made the internet a difficult environment for media companies. They are not much keener on the Kindle, an e-reader made by Amazon, which has driven down book prices and cannot carry advertising. They hope this new device will give them a new lease of life, by encouraging people to read digital versions of books, newspapers and magazines while on the move. True, there are worries that Apple could end up wielding a lot of power in these new markets, as it already does in digital music. But a new market opened up and dominated by Apple is better than a shrinking market, or no market at all.

Keep taking the tablets

Tablet computers aimed at business people have not worked. Microsoft has been pushing them for years, with little success. Apple itself launched a pen-based tablet computer, the Newton, in 1993, but it was a flop. The Kindle has done reasonably well, and has spawned a host of similar devices with equally silly names, including the Nook, the Skiff and the Que. Meanwhile, Apple’s pocket-sized touch-screen devices, the iPhone and iPod Touch, have taken off as music and video players and hand-held games consoles.

The iPad is, in essence, a giant iPhone on steroids. Its large screen will make it an attractive e-reader and video player, but it will also inherit a vast array of games and other software from the iPhone. Apple hopes that many people will also use it instead of a laptop. If the company is right, it could open up a new market for devices that are larger than phones, smaller than laptops, and also double as e-readers, music and video players and games consoles. Different industries are already converging on this market: mobile-phone makers are launching small laptops, known as netbooks, and computer-makers are moving into smart-phones. Newcomers such as Google, which is moving into mobile phones and laptops, and Amazon, with the Kindle, are also entering the fray: Amazon has just announced plans for an iPhone-style “app store” for the Kindle, which will enable it to be more than just an e-reader.

If the past is any guide, Apple’s entry into the field will not just unleash fierce competition among device-makers, but also prompt consumers and publishers who had previously been wary of e-books to take the plunge, accelerating the adoption of this nascent technology. Sales of e-readers are expected to reach 12m this year, up from 5m in 2009 and 1m in 2008, according to iSuppli, a market-research firm.

Hold the front pixels

Will the spread of tablets save struggling media companies? Sadly not. Some outfits—metropolitan newspapers, for instance—are probably doomed by their reliance on classified advertising, which is migrating to dedicated websites. Others are too far gone already. Tablets are expensive, and it will be some years before they are widespread enough to fulfil their promise. In theory a newspaper could ask its readers to sign up for a two-year electronic subscription, say, and subsidise the cost of a tablet. But such a subsidy would be hugely pricey, and expensive printing presses will have to be kept running for readers who want to stick with paper.

Still, even though tablets will not save weak media companies, they are likely to give strong ones a boost. Charging for content, which has proved difficult on the web, may get easier. Already, people are prepared to pay to receive newspapers and magazines (including The Economist) on the Kindle. The iPad, with its colour screen and integration with Apple’s online stores, could make downloading books, newspapers and magazines as easy and popular as downloading music. Most important, it will allow for advertising, on which American magazines, in particular, depend. Tablets could eventually lead to a wholesale switch to digital delivery, which would allow newspapers and book publishers to cut costs by closing down printing presses.

If Mr Jobs manages to pull off another amazing trick with another brilliant device, then the benefits of the digital revolution to media companies with genuinely popular products may soon start to outweigh the costs. But some media companies are dying, and a new gadget will not resurrect them. Even the Jesus Tablet cannot perform miracles.


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After the Massachusetts Massacre

It was not a referendum on Barack Obama, who in every poll remains one of the most popular politicians in America. It was not a rejection of universal health care, which Massachusetts mandated (with Scott Brown’s State Senate vote) in 2006. It was not a harbinger of a resurgent G.O.P., whose numbers remain in the toilet. Brown had the good sense not to identify himself as a Republican in either his campaign advertising or his victory speech.

And yet Tuesday’s special election was a dire omen for this White House. If the administration sticks to this trajectory, all bets are off for the political future of a president who rode into office blessed with more high hopes, good will and serious promise than any in modern memory. It’s time for him to stop deluding himself. Yes, last week’s political obituaries were ludicrously premature. Obama’s 50-ish percent first-anniversary approval rating matches not just Carter’s but Reagan’s. (Bushes 41 and 43 both skyrocketed in Year One.) Still, minor adjustments can’t right what’s wrong.

Obama’s plight has been unchanged for months. Neither in action nor in message is he in front of the anger roiling a country where high unemployment remains unchecked and spiraling foreclosures are demolishing the bedrock American dream of home ownership. The president is no longer seen as a savior but as a captive of the interests who ginned up the mess and still profit, hugely, from it.

That’s no place for any politician of any party or ideology to be. There’s a reason why the otherwise antithetical Leno and Conan camps are united in their derision of NBC’s titans. A TV network has become a handy proxy for every mismanaged, greedy, disloyal and unaccountable corporation in our dysfunctional economy. It’s a business culture where the rich and well-connected get richer while the employees, shareholders and customers get the shaft. And the conviction that the game is fixed is nonpartisan. If the tea party right and populist left agree on anything, it’s that big bailed-out banks have and will get away with murder while we pay the bill on credit cards — with ever-rising fees.

Politically, no other issue counts. In last weekend’s Washington Post/ABC News poll, 42 percent of Americans chose the economy as the country’s most pressing concern. Only 5 percent picked terrorism, and 2 percent Afghanistan. Obama’s highest approval ratings are now on foreign policy and national security issues — despite the relentless hammering from the Cheney right — but voters don’t care.

Does health care matter? Not as much as you’d think after this yearlong crusade. In the Post/ABC poll, the issue was second-tier — at 24 percent. Obama has blundered, not by positioning himself too far to the left but by landing nowhere — frittering away his political capital by being too vague, too slow and too deferential to Congress. The smartest thing said as the Massachusetts returns came in Tuesday night was by Howard Fineman on MSNBC: “Obama took all his winnings and turned them over to Max Baucus.”

Worse, the master communicator in the White House has still not delivered a coherent message on his signature policy. He not only refused to signal his health care imperatives early on but even now he, like Congressional Democrats, has failed to explain clearly why and how reform relates to economic recovery — or, for that matter, what he wants the final bill to contain. Sure, a president needs political wiggle room as legislative sausage is made, but Scott Brown could and did drive his truck through the wide, wobbly parameters set by Obama.

Ask yourself this: All these months later, do you yet know what the health care plan means for your family’s bottom line, your taxes, your insurance? It’s this nebulousness, magnified by endless Senate versus House squabbling, that has allowed reform to be caricatured by its foes as an impenetrable Rube Goldberg monstrosity, a parody of deficit-ridden big government. Since most voters are understandably confused about what the bills contain, the opponents have been able to attribute any evil they want to Obamacare, from death panels to the death of Medicare, without fear of contradiction.

It’s too late to rewrite that history, but it may not be too late for White House decisiveness. Whatever happens now — good, bad or ugly — must happen fast. Each day Washington spends dickering over health care is another day lost while the election-year economy, stupid, remains intractable for Americans who are suffering.

On the economic front, Obama needs both stylistic and substantive makeovers. He has stepped up the populist rhetoric lately — and markedly after political disaster struck last week — but few find this serene Harvard-trained lawyer credible when slinging populist rhetoric at “fat-cat” bankers. His two principal economic policy makers are useless, if not counterproductive, surrogates. Timothy Geithner, the Treasury secretary, was probably fatally compromised from the moment his tax lapses surfaced; now he is stalked by the pileup of unanswered questions about the still-not-transparent machinations at the New York Fed when he was knee-deep in the A.I.G. bailout. Lawrence Summers, the top administration economic guru, is a symbol of the Clinton-era deregulatory orgy that helped fuel the bubble.

The White House clearly knows this duo is a political albatross. After the news broke that 85,000 more jobs had been lost in December despite some economists’ more optimistic predictions, Christina Romer, a more user-friendly (though still academic) economic hand, was dispatched to the Sunday shows. This is at best a makeshift solution.

Obama needs more independent economists like Paul Volcker, who was hastily retrieved from exile last week after the Massachusetts massacre prompted the White House to tardily embrace his strictures on big banks. Obama also needs economic spokesmen who are not economists and who can authentically speak to life on the ground. Obama must also reconnect. The former community organizer whose credit card was denied at the Hertz counter during the 2000 Democratic convention now spends too much time at the White House presiding over boardroom-table meetings and stiff initiative rollouts instead of engaging with Americans not dressed in business suits.

When it comes to economic substance, small symbolic gestures (the proposed new bank “fee”) won’t cut it. Nor will ineffectual presidential sound bites railing against Wall Street bonuses beyond the federal government’s purview. There’s no chance of a second stimulus. The White House will have to jawbone banks on foreclosures, credit card racketeering and the loosening of credit to small businesses. This means taking on bankers who were among the Obama campaign’s biggest backers and whose lobbyists have castrated regulatory reform by buying off congressmen of both parties. It means pressing for all constitutional remedies that might counter last week’s 5-to-4 Supreme Court decision allowing corporate campaign contributions to buy off even more.

It’s become so easy to pin financial elitism on Democrats that the morning after Brown’s victory the Republican Senatorial Campaign Committee had the gall to accuse them of being the “one party who bailed out the automakers and insurance companies.” Never mind that the Bush White House gave us the bank (and A.I.G.) bailouts, or that the G.O.P. is even more in hock than Democrats to corporate patrons. The Obama administration is so overstocked with Goldman Sachs-Robert Rubin alumni and so tainted by its back-room health care deals with pharmaceutical and insurance companies that conservative politicians, Brown included, can masquerade shamelessly as the populist alternative.

Last year the president pointedly studied J.F.K.’s decision-making process on Vietnam while seeking the way forward in Afghanistan. In the end, he didn’t emulate his predecessor and escalated the war. We’ll see how that turns out. Meanwhile, Obama might look at another pivotal moment in the Kennedy presidency — and this time heed the example.

The incident unfolded in April 1962 — some 15 months into the new president’s term — when J.F.K. was infuriated by the U.S. Steel chairman’s decision to break a White House-brokered labor-management contract agreement and raise the price of steel (but not wages). Kennedy was no radical. He hailed from the American elite — like Obama, a product of Harvard, but, unlike Obama, the patrician scion of a wealthy family. And yet he, like that other Harvard patrician, F.D.R., had no hang-ups about battling his own class.

Kennedy didn’t settle for the generic populist rhetoric of Obama’s latest threats to “fight” unspecified bankers some indeterminate day. He instead took the strong action of dressing down U.S. Steel by name. As Richard Reeves writes in his book “President Kennedy,” reporters were left “literally gasping.” The young president called out big steel for threatening “economic recovery and stability” while Americans risked their lives in Southeast Asia. J.F.K. threatened to sic his brother’s Justice Department on corporate records and then held firm as his opponents likened his flex of muscle to the power grabs of Hitler and Mussolini. (Sound familiar?) U.S. Steel capitulated in two days. The Times soon reported on its front page that Kennedy was at “a high point in popular support.”

Can anyone picture Obama exerting such take-no-prisoners leadership to challenge those who threaten our own economic recovery and stability at a time of deep recession and war? That we can’t is a powerful indicator of why what happened in Massachusetts will not stay in Massachusetts if this White House fails to reboot.

Frank Rich, New York Times


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Obama v. Wall Street

The President gets serious about moral hazard.

President Obama and Democrats have settled on demonizing Wall Street as a campaign theme for November’s elections. If history is any guide, Mr. Obama and New York Senator Chuck Schumer will now persuade Wall Street to underwrite this campaign. Ah, the politics of hope and change. How refreshing.

Phony populism aside, yesterday Mr. Obama introduced his first serious idea into the debate on reforming the financial system. In calling for an end to proprietary trading at firms with a federal safety net, the President showed that he now understands an important principle: Risk-taking in the capital markets is incompatible with a taxpayer guarantee.

Under the President’s still-sketchy plan, firms that hold government-insured deposits or are eligible to receive cheap loans in an emergency from the Federal Reserve would not be able to trade for their own accounts. The firms could facilitate customer orders as brokers have always done and continue to underwrite new issues of stocks and bonds, but they could not make bets with their own capital or own or invest in hedge funds.

Yesterday’s announcement is a critical departure from the reform plan Mr. Obama introduced last year—largely incorporated in the House and Senate bills written by Barney Frank and Chris Dodd. Those plans all sought to expand the universe of too-big-to-fail companies eligible for taxpayer rescue. Mr. Obama has at last joined the most important policy discussion: How to eliminate the moral hazard now embedded in the U.S. financial system. Political assaults on banker compensation have done nothing to address this core problem that enables gargantuan bonuses.

The days ahead will demonstrate whether Mr. Obama is serious, or if this is merely a political tactic to encourage Republicans to defend big banks. If he’s serious, he will add to his plan a taxpayer exit strategy from the most expensive bailouts—at Fannie Mae and Freddie Mac.

He’ll also soon realize that while his plan raises the right questions, its details will be crucial. Since there’s a counterparty on the other end of every trade made by Goldman Sachs, it won’t always be easy to discern trades made for customers versus those made for Goldman.

More fundamentally, even if the logistics can be mastered, the President’s plan would not have prevented the credit chaos of 2008. Bear Stearns was not a bank, could not borrow from the Fed’s discount window and wasn’t even all that big, yet the government still wouldn’t let it fail. Under Mr. Obama’s new rules, Goldman might simply decide to sell its bank—yet investors and its own traders would still assume it is too big to fail. That problem still needs to be addressed.

Mr. Obama also keeps peddling the illusion that the entire crisis was caused by the bankers. But the root cause was a credit mania, courtesy of the Federal Reserve. The mania was concentrated in the housing market, courtesy of Congress and several Presidential Administrations.

If we are going to have a Fed and a political class as reckless as we have, then we need a more comprehensive answer to financial risk. Bankruptcy for risk-takers who bet wrong is the best option. Barring that, strict limits on margin and leverage, especially for holders of insured deposits, can be helpful. Mr. Obama’s suggestion yesterday of limits on the size of financial firms—with the limits still to be determined—deserves a hearing but would seem more problematic.

Still, we’re encouraged by yesterday’s announcement. The Democrats appear to finally realize that too-big-to-fail is a problem to be solved, not the foundation of a modern banking system.

Editorial, Wall Street Journal


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Books on Finance During Trouble

These books on finance in a time of trouble pay big dividends, says Duff McDonald

1. The House of Morgan

By Ron Chernow

Atlantic Monthly, 1990

Can a bank actually be heroic? Ron Chernow suggests as much in his exhaustive history of J.P. Morgan and its instrumental role in the development of the industrial Western economy from the late 19th century to the end of the 20th. But the clear-eyed Chernow does not ignore the less-than-heroic in this National Book Award-winning title, which is as much a social and political history as it is the story of the Morgan dynasty. Of the fallout from the Crash of 1873, Chernow writes: “Not for the last time, America turned against Wall Street with puritanical outrage and a sense of offended innocence.” When World War I erupted: “Wall Street, which prided itself on its prescience, was once again caught napping by a historic event.” Both tendencies remain in place today. What we do not have is a Wall Street king like John Pierpont Morgan, the man who built the banking dynasty and who had the power to intervene personally in the Panic of 1893 and save the U.S. Treasury by launching a syndicate to replenish the nation’s gold supply.

2. The Go-Go Years

By John Brooks

Weybright & Talley, 1973

Just as the stock market moves in cycles, even though each new generation seems to think each new high and low is happening for the first time, so, too, do market players often imagine that they’re breaking new ground when most are not. Today’s high-flyers are pretty much the same as those depicted by John Brooks in “The Go-Go Years,” his account of how the stock market changed during the 1960s. At the very moment when stocks were truly going mainstream in America, Brooks produced one of the most enjoyable and insightful books ever written about the tribes and tactics of the stock market. Chronicling the escapades of almost-forgotten swashbucklers such as Gerald Tsai and Saul Steinberg, he produced incomparable observations about Wall Street’s merry-go-round of triumph and tragedy. He describes 1968 as the year “Wall Street had become a mindless glutton methodically eating itself to paralysis and death,” something that happened again in the period 2004-07. And what of our capacity to learn from our mistakes? “Reform is a frail flower that languishes in the hot glare of prosperity,” he observes. Given that prosperity still looks a while off at this point in 2010, maybe reform will actually bloom.

3. The Bubble Economy

By Christopher Wood

Atlantic Monthly, 1992

“What everybody knows is seldom worth knowing,” begins “The Bubble Economy,” an incisive, readable assessment of the Japanese real-estate boom and bust of the 1980s. Christopher Wood, the former Tokyo bureau chief for the Economist, writes with such flair that it’s a shame he gave up journalism, becoming a financial analyst and the publisher of the newsletter Greed & Fear. His book has aged well; swap out names and institutions and it might have been written last year. “Isaac Newton actually arrived in Japan in 1990,” Wood writes. “His presence did not prove a pretty sight in a country where too many people had concluded that the laws of gravity, when applied to their own financial markets, had somehow been suspended.” Like a faded rock star, the 367-year-old Newton is back for another world tour.

4. When Genius Failed

By Roger Lowenstein

Random House, 2000

A raft of books have been written—and are still being written—trying to explain the complex financial products, such as collateralized debt obligations and credit default swaps, behind the near collapse of Wall Street about 16 months ago. The last time something this complicated took the system to the brink, it was the crash in 1998 of the gigantic hedge fund Long-Term Capital Management, when its “relative value” trades went bad. Luckily Roger Lowenstein was on the case—there is no better writer for explaining the intricacies of finance in eminently understandable terms. His description of how Wall Street reached its precarious state in 1998, necessitating a rush to bail out LTCM, capturesthe birth of the “too big to fail” doctrine: “Almost imperceptibly, the Street had bought into a massive faith game, in which each bank had become knitted to its neighbor through a web of contractual obligations requiring little or no down payment.” A decade later, we’d done it again. If more people had read “When Genius Failed,” today’s miseries might have been avoided.

5. Point of No Return

By John P. Marquand

Little, Brown, 1949

While Wall Street hardly has trouble generating stories that seem straight out of a novel, there are a handful of sublime works of fiction that capture the spirit of its strivers in ways that nonfiction cannot. These novels, like Tom Wolfe’s excellent “Bonfire of the Vanities,” show us what the traders were thinking as well as what they were doing. Nearly four decades before “Bonfire,” John P. Marquand wrote “Point of No Return,” a lost masterpiece that shines a bright light on the mind-set of that species of Banker Americanus that helped to build the modern financial-services edifice and that colonized suburbia. Marquand’s protagonist, Charles Gray, managed not just to survive but to thrive in the 1929 stock market crash, the Depression and its aftermath, and he has collected an enviable set of trophies: the new house in Westchester County, the wife, the two kids and the country-club membership. But “Point of No Return” is hardly a cheerful success story. Instead, it’s a gripping portrayal of a man obsessed with roads not taken and of the insecurities that lie just beneath a veneer of seeming achievement. “The more you get, the more afraid you get,” says Gray. “Maybe fear is what makes the world go round.”

Mr. McDonald is the author of “Last Man Standing: The Ascent of Jamie Dimon and JP Morgan Chase” (Simon & Schuster, 2009). He is a contributing editor at New York magazine.


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Flowers for a funeral

Google and China

Censorship and hacker attacks provide the epitaph for Google in China

“WE’RE in this for the long haul,” wrote a Google executive four years ago when the company launched a self-censored version of its search engine for the China market. Now Google says it might have to pull out of the country because of alleged attacks by hackers in China on its e-mail service and a tightening of China’s restrictions on free speech on the internet. Its change of heart, as the company rightly points out, could have “far-reaching consequences”.

Google’s “new approach to China”, as the company’s chief legal officer, David Drummond, called it on January 12th on the company’s official blog, will certainly infuriate China’s government. The authorities are sensitive to foreign complaints about internet controls in China. In November, during a visit by President Barack Obama, his obliquely worded criticism of Chinese online censorship was itself censored from official reports. If it does close down in China, Google would be the first big-brand foreign company to do so citing freedom of speech in many years.

Mr Drummond’s blog-posting also contained unusually direct finger-pointing by a foreign multinational at China as a source of hacker attacks. It said that in mid-December Google detected a “highly sophisticated and targeted attack” on its corporate computer systems “originating from China”. It found that at least 20 other large companies from various industries had also been attacked. A primary goal, of the hacking of Google, it said, appeared to be to gain access to the e-mail of Chinese human-rights activists who use Google’s “Gmail” service. The hackers succeeded in partially penetrating two such accounts.

“Third parties” had also, wrote Mr Drummond, “routinely” gained access to the Gmail accounts of dozens of other human-rights advocates in America, Europe and China itself. Unlike the mid-December attack, these breaches appeared to involve “phishing” scams or “malware” on users’ computers rather than direct attacks on Google’s systems. All this, he said, along with attempts over the past year to impose further limits on free speech on the web, had led Google to “review the feasibility” of its Chinese business.

The company has decided to stop censoring the results of its China-based search engine, Mr Drummond said this might result in having to shut down and Google’s offices in China. In the face of much criticism from Western human-rights advocates, Google justified its decision to set up in 2006 by pointing out that China often blocked its uncensored engine, Better to offer a censored service (with warnings to users that results were filtered), the company argued, than nothing at all. China would certainly not allow an uncensored search engine to be based on its territory.

Google’s decision at the time was presumably driven in part by the lure of China’s rapidly expanding internet market. In part because of intermittent blocking of, and the slowness of access to the company’s foreign-based servers, Baidu, a Beijing-based company listed on America’s NASDAQ exchange, dwarfed Google’s share of the search-engine business in China. The launch of did little to dent Baidu’s domination.

Nor has Google’s acquiescence in self-censorship of its searches made China any less wary of its other, uncensored, services. Google’s video-sharing site, YouTube, has been blocked since March, because of footage of Chinese police beating Tibetan monks. Its photo-album site, Picasa Web Albums, suffered the same fate soon after. Access to Google’s blog service, Blogger, has long been intermittent. It is currently unavailable in Beijing.

Google’s frustrations are widely shared. In the build-up to the Beijing Olympics in August 2008, China lifted longstanding blocks on several websites, as it tried to present a more open image to foreign visitors. Since then, controls have been stepped up to unprecedented levels. Internet access in the western region of Xinjiang has been all but cut off since ethnic riots erupted there in July.

The unrest also prompted a shutdown of foreign social-networking sites such as Twitter and Facebook. The role of such sites in protests in Iran, after its stolen elections in June, had already alarmed the government. Its fear of dissent around the 60th anniversary in October of the founding of communist China prompted even greater vigilance against sensitive debate online. But there has been no sign of relaxation since then. In recent weeks the authorities have tightened restrictions on the registration of websites under the .cn domain name (only businesses may apply). A crackdown on internet pornography has led to closer scrutiny by internet service providers of non-porn websites.

In December Yeeyan, a site with translations of articles from foreign newspapers including the Guardian and the New York Times, was closed for several days. It was allowed to reopen after putting tighter controls in place on the publication of politically sensitive pieces. Ecocn, a site offering translations of articles from this newspaper, was also briefly shut down as officials trawled for pornography, but resurfaced unscathed. The volunteers who run this informal operation make translations of sensitive articles available only to users they trust.

The anti-porn drive turned up the heat on Google too. Last year was among several search engines in China accused by the authorities of providing links to pornographic sites. The state-controlled press gave particular prominence to Google’s alleged transgressions, which the company promised to investigate. The Chinese media have also published frequent criticisms in recent months of Google’s alleged violations of Chinese copyrights in its Google Books venture.

In Silicon Valley, its home, Google’s change of tack in China was widely applauded. But some were asking whether it was “more about business than thwarting evil” to quote TechCrunch, a widely read website. Besides pointing to Google’s failure to eat into Baidu’s market share, cynics noted that, whereas, according to Mr Drummond, Google’s revenues in China are “truly immaterial”, its costs are not. It employs about 700 people in China, some of them royally paid engineers, who may now may have to look for other jobs. Hacker attacks and censorship, critics say, are convenient excuses for something Google wanted to do anyway, without appearing to be retreating commercially. Google strongly rejects this interpretation.

In China, however, the government is clearly fearful that the company’s public stand against censorship will be celebrated by many Chinese internet-users. Chinese news accounts of the company’s decision failed to mention the reason for Google’s actions. Chinese web portals buried the story. Many internet-users in China have become adept at finding ways of circumventing China’s blocks on overseas websites, including the installation of “virtual private network” software. Numerous tributes to Google that rapidly appeared on Chinese internet discussion forums, and flowers laid outside Google’s office in Beijing, showed that the attempts at censorship had failed. Few, however, believe the company’s announcement will dissuade China from keeping on trying.


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Not just another fake

China’s economy

The similarities between China today and Japan in the 1980s may look ominous. But China’s boom is unlikely to give way to prolonged slump

CHINA rebounded more swiftly from the global downturn than any other big economy, thanks largely to its enormous monetary and fiscal stimulus. In the year to the fourth quarter of 2009, its real GDP is estimated to have grown by more than 10%. But many sceptics claim that its recovery is built on wobbly foundations. Indeed, they say, China now looks ominously like Japan in the late 1980s before its bubble burst and two lost decades of sluggish growth began. Worse, were China to falter now, while the recovery in rich countries is still fragile, it would be a severe blow not just at home but to the whole of the world economy.

On the face of it, the similarities between China today and bubble-era Japan are worrying. Extraordinarily high saving and an undervalued exchange rate have fuelled rapid export-led growth and the world’s biggest current-account surplus. Chronic overinvestment has, it is argued, resulted in vast excess capacity and falling returns on capital. A flood of bank lending threatens a future surge in bad loans, while markets for shares and property look dangerously frothy.

Just as in the late 1980s, when Japan’s economy was tipped to overtake America’s, China’s strong rebound has led many to proclaim that it will become number one sooner than expected. In contrast, a recent flurry of bearish reports warn that China’s economy could soon implode. James Chanos, a hedge-fund investor (and one of the first analysts to spot that Enron’s profits were pure fiction), says that China is “Dubai times 1,000, or worse”. Another hedge fund, Pivot Capital Management, argues that the chances of a hard landing, with a slump in capital spending and a banking crisis, are increasing.

Scary stuff. However, a close inspection of pessimists’ three main concerns—overvalued asset prices, overinvestment and excessive bank lending—suggests that China’s economy is more robust than they think. Start with asset markets. Chinese share prices are nowhere near as giddy as Japan’s were in the late 1980s. In 1989 Tokyo’s stockmarket had a price-earnings ratio of almost 70; today’s figure for Shanghai A shares is 28, well below its long-run average of 37. Granted, prices jumped by 80% last year, but markets in other large emerging economies went up even more: Brazil, India and Russia rose by an average of 120% in dollar terms. And Chinese profits have rebounded faster than those elsewhere. In the three months to November, industrial profits were 70% higher than a year before.

China’s property market is certainly hot. Prices of new apartments in Beijing and Shanghai leapt by 50-60% during 2009. Some lavish projects have much in common with those in Dubai—notably “The World”, a luxury development in Tianjin, 120km (75 miles) from Beijing, in which homes will be arranged as a map of the world, along with the world’s biggest indoor ski slope and a seven-star hotel.

Average home prices nationally, however, cannot yet be called a bubble. On January 14th the National Development and Reform Commission reported that average prices in 70 cities had climbed by 8% in the year to December, the fastest pace for 18 months; other measures suggest a bigger rise. But this followed a fall in prices in 2008. By most measures average prices have fallen relative to incomes in the past decade (see chart 1).

The most cited evidence of a bubble—and hence of impending collapse—is the ratio of average home prices to average annual household incomes. This is almost ten in China; in most developed economies it is only four or five. However, Tao Wang, an economist at UBS, argues that this rich-world yardstick is misleading. Chinese homebuyers do not have average incomes but come largely from the richest 20-30% of the urban population. Using this group’s average income, the ratio falls to rich-world levels. In Japan the price-income ratio hit 18 in 1990, obliging some buyers to take out 100-year mortgages.

Furthermore, Chinese homes carry much less debt than Japanese properties did 20 years ago. One-quarter of Chinese buyers pay cash. The average mortgage covers only about half of a property’s value. Owner-occupiers must make a minimum deposit of 20%, investors one of 40%. Chinese households’ total debt stands at only 35% of their disposable income, compared with 130% in Japan in 1990.

China’s property boom is being financed mainly by saving, not bank lending. According to Yan Wang, an economist at BCA Research, a Canadian firm, only about one-fifth of the cost of new construction (commercial and residential) is financed by bank lending. Loans to homebuyers and property developers account for only 17% of Chinese banks’ total, against 56% for American banks. A bubble pumped up by saving is much less dangerous than one fuelled by credit. When the market begins to crack, highly leveraged speculators are forced to sell, pushing prices lower, which causes more borrowers to default.

Even if China does not (yet) have a credit-fuelled housing bubble, the fact that property prices in Beijing and Shanghai are beyond the reach of most ordinary people is a serious social problem. The government has not kept its promise to build more low-cost housing, and it is clearly worried about rising prices. In an attempt to thwart speculators, it has reimposed a sales tax on homes sold within five years, has tightened the stricter rules on mortgages for investment properties and is trying to crack down on illegal flows of foreign capital into the property market. The government does not want to come down too hard, as it did in 2007 by cutting off credit, because it needs a lively property sector to support economic recovery. But if it does not tighten policy soon, a full-blown bubble is likely to inflate.

The world’s capital

China’s second apparent point of similarity to Japan is overinvestment. Total fixed investment jumped to an estimated 47% of GDP last year—ten points more than in Japan at its peak. Chinese investment is certainly high: in most developed countries it accounts for around 20% of GDP. But you cannot infer waste from a high investment ratio alone. It is hard to argue that China has added too much to its capital stock when, per person, it has only about 5% of what America or Japan has. China does have excess capacity in some industries, such as steel and cement. But across the economy as a whole, concerns about overinvestment tend to be exaggerated.

Pivot Capital Management points to China’s incremental capital-output ratio (ICOR), which is calculated as annual investment divided by the annual increase in GDP, as evidence of the collapsing efficiency of investment. Pivot argues that in 2009 China’s ICOR was more than double its average in the 1980s and 1990s, implying that it required much more investment to generate an additional unit of output. However, it is misleading to look at the ICOR for a single year. With slower GDP growth, because of a collapse in global demand, the ICOR rose sharply everywhere. The return to investment in terms of growth over a longer period is more informative. Measuring this way, BCA Research finds no significant increase in China’s ICOR over the past three decades.

Mr Chanos has drawn parallels between China and the huge misallocation of resources in the Soviet Union, arguing that China is heading the same way. The best measure of efficiency is total factor productivity (TFP), the increase in output not directly accounted for by extra inputs of capital and labour. If China were as wasteful as Mr Chanos contends, its TFP growth would be negative, as the Soviet Union’s was. Yet over the past two decades China has enjoyed the fastest growth in TFP of any country in the world.

Even in industries which clearly do have excess capacity, China’s critics overstate their case. A recent report by the European Union Chamber of Commerce in China estimates that in early 2009 the steel industry was operating at only 72% of capacity. That was at the depth of the global downturn. Demand has picked up strongly since then. The report claims that the industry’s overcapacity is illustrated by “a startling figure”: in 2008, China’s output of steel per person was higher than America’s. So what? At China’s stage of industrialisation it should use a lot of steel. A more relevant yardstick is the America of the early 20th century. According to Ms Wang of UBS, China’s steel capacity of almost 0.5kg (about 1lb) per person is slightly lower than America’s output in 1920 (0.6kg) and far below Japan’s peak of 1.1kg in 1973.

Many commentators complain that China’s capital-spending spree last year has merely exacerbated its industrial overcapacity. However, the boom was driven mainly by infrastructure investment, whereas investment in manufacturing slowed quite sharply (see chart 2). Given the scale of the spending, some money is sure to have been wasted, but by and large, investment in roads, railways and the electricity grid will help China sustain its growth in the years ahead.

Some analysts disagree. Pivot, for instance, argues that China’s infrastructure has already reached an advanced level. It has six of the world’s ten longest bridges and it boasts the world’s fastest train; there is little room for further productive investment. That is nonsense. A country in which two-fifths of villages lack a paved road to the nearest market town still has plenty of scope for building roads. The same goes for railways. Again, a comparison of China today with the America of a century ago is pertinent. China has roughly the same land area as America, but 13 times more people than the United States did then. Yet on current plans it will have only 110,000km of railway by 2012, compared with more than 400,000km in America in 1916. Unlike Japan, which built “bridges to nowhere” to prop up its economy, China needs better infrastructure.

It is true that in the short term, the revenue from some infrastructure projects may not be enough to service debts, so the government will have to cover losses. But in the long term such projects should lift productivity across the economy. During Britain’s railway mania in the mid-19th century, few railways made a decent financial return, but they brought huge long-term economic benefits.

The biggest cause for worry about China is the third point of similarity to Japan: the recent tidal wave of bank lending. Total credit jumped by more than 30% last year. Even assuming that this slows to less than 20% this year, as the government has hinted, total credit outstanding could hit 135% of GDP by December. The authorities are perturbed. This week they increased banks’ reserve requirement ratio by half a percentage point. They have also raised the yield on central-bank bills.

However, too many commentators talk as if Chinese banks have been on a lending binge for years. Instead, the spurt in 2009, which was engineered by the government to revive the economy, followed several years in which credit grew more slowly than GDP (see chart 3). Michael Buchanan, of Goldman Sachs, estimates that since 2004 China’s excess credit (the gap between the growth rates of credit and nominal GDP) has risen by less than in most developed economies.

Even so, recent lending has been excessive; combined with overcapacity in some industries, it is likely to cause an increase in banks’ non-performing loans. Ms Wang calculates that if 20% of all new lending last year and another 10% of this year’s lending turned bad, this would create new bad loans equivalent to 5.5% of GDP by 2012, on top of 2% now. That is far from trivial, but well below the 40% of GDP that bad loans amounted to in the late 1990s.

Much of the past year’s bank lending should really be viewed as a form of fiscal stimulus. Infrastructure projects that have little hope of repaying loans will end up back on the government’s books. It would have been much better if such projects had been financed more transparently through the government’s budget, but the important question is whether the state can afford to cover the losses.

Official gross government debt is less than 20% of GDP, but China bears argue that this is an understatement, because it excludes local-government debt and the bonds issued by the asset-management companies that took over banks’ previous non-performing loans. Total government debt could be 50% of GDP. But that is well below the average ratio in rich countries, of around 90%. Moreover, the Chinese government owns lots of assets, for example shares of listed companies which are worth 35% of GDP.

Ying and yang

Even if, as argued above, concerns about a financial crash in China are premature, the risks of a dangerous bubble and excessive investment will clearly increase if credit continues to expand at its recent pace. The stitching on the Chinese economy could fray and burst. Would that imply the end of China’s era of rapid growth?

Predictions that China is heading for a prolonged Japanese-style slump ignore big differences between China today and Japan in the late 1980s. Japan was already a mature, developed economy, with a GDP per person close to that of America. China is still a poor, developing country, whose GDP per person is less than one-tenth of America’s or Japan’s. It has ample room to play catch-up with rich economies by adding to its capital stock, importing foreign technology and boosting productivity by shifting labour from farms to factories. This would make it easier for China to recover from the bursting of a bubble.

Chart 4 examines the relationship between growth rates and income per head for six Asian economies. Each plot shows a country’s growth rate and GDP per person relative to America’s for successive ten-year periods, starting when their rapid growth took off. It illustrates how growth rates slow as economies catch up with America, the technological leader. The fact that China’s GDP per head is much lower than Japan’s in the 1980s suggests that its growth potential over the next decade is much higher. Even though China’s labour force will start shrinking after 2016, rapid productivity gains mean that its trend GDP growth rate is still around 8%, down from 10% in the past decade.

Japan’s stockmarket and land-price bubbles in the early 1960s offer a better (and more cheerful) analogy to China than the 1980s bubble era does. Japan’s economy was poorer then, although relative to America its GDP per person was more than double China’s today, and its trend rate of growth was around 9%. According to HSBC, after the bubble burst in 1962-65, Japan’s annual growth rate dipped to just under 6%, but then quickly rebounded to 10% for much of the next decade.

South Korea and Taiwan, which experienced big stockmarket bubbles in the 1980s, are also worth examining. In the five years to 1990, Taipei’s stockmarket surged by 1,600% (in dollar terms) and Seoul’s by 700%, easily beating Tokyo’s 450% gain in the same period. After share prices slumped, annual growth in both South Korea and Taiwan slowed to around 6%, but soon regained its previous pace of 7-8%.

The higher a country’s potential growth rate, the easier it is for the economy to recover after a bubble bursts, so long as its fiscal and external finances are in reasonable shape. Rapid growth in nominal GDP means that asset prices do not need to fall so far to regain fair value, bad loans are easier to work off and excess capacity can be more quickly absorbed by rising demand. The experience of Japan in the 1960s suggests that if China’s bubble bursts, it will hurt growth temporarily but not lead to prolonged stagnation.

However, it is Japan’s experience after the 1980s that most influences the thinking of policymakers in Beijing. Many blame Japan’s deflation and its lost decades of growth on the fact that its government caved in to American demands for an appreciation of the yen. In 1985 central banks in the big rich economies agreed, in the Plaza Accord, to intervene to push down the dollar. By 1988 the yen had risen by more than 100% against the greenback. One reason why policymakers in Beijing have resisted a big rise in the yuan is that they fear it could send their economy, like Japan’s, into a deflationary slump.

The wrong lesson

Yet Japan’s real mistake was not that it allowed the yen to rise, but that it had previously resisted an appreciation for too long, so that when it did happen the yen soared. A second error was that Japan tried to offset the adverse economic effects of a strong yen with over-lax monetary policy. If policy had been tighter, the financial bubble would have been smaller and its aftermath less painful.

This offers two important lessons to China. First, it is better to let the exchange rate rise sooner and more gradually than to risk a much sharper appreciation later. Second, monetary policy should not be too slack. Raising reserve requirements is a small step in the right direction. Despite the bears’ growling, China’s economic collapse is neither imminent nor inevitable. But if it continues to draw the wrong lesson from the tale of Japan, then one day its economy may look just as tatty.


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Bin Laden’s legacy

Terrorists hurt America most by making it close its borders

HAVING removed his shoes, coat, gloves, hat, jacket, wallet and keys, Lexington walked through the metal detector. It beeped. Your columnist had forgotten to remove his belt. The two security guards in attendance began to shout and make disparaging remarks about his ability to perform simple tasks. This scene occurred outside the American embassy in London last month, when Lexington was renewing his visa. The rest of the process passed smoothly, but those boorish security guards were a poor advertisement for the greatest country on earth.

Americans are, by and large, a courteous bunch. Interactions with strangers are typically sweetened with a generous frosting of “Sir”, “Ma’am” and “Excuse me”. Yet in a survey commissioned by the travel industry, more than half of visitors found American border officials rude and unpleasant. By a two-to-one margin, the country’s entry process was rated the world’s worst. This is not a problem only for whingeing journalists and other foreign riff-raff. It is also a problem for America.

The system is geared towards keeping out a tiny number of terrorists. Fair enough—such people should indeed be kept out. But there should be a trade-off. An immigration official lives in fear of admitting the next Mohammed Atta, but there is no penalty for excluding the next Einstein, or for humiliating tourists who subsequently summer in France. Osama bin Laden has arguably inflicted more harm on America indirectly than directly. To stop his acolytes from striking again, the government has made entering America far more difficult and degrading than it need be.

This has slowed the influx of foreign brains. In 2001, 28% of students who studied abroad did so at American universities. By 2008 that figure had shrunk to 21%, though since the absolute number of globally mobile students grew by 50% over that period, the absolute number in America has flattened, not fallen. Does this matter? Well, foreigners and immigrants make up more than half of the scientific researchers in the United States, notes Edward Alden, the author of a fine book called “The Closing of the American Border”. Among postdoctoral students doing top-level research, 60% are foreign-born. Boffins flock to America because its universities are the best, but the ordeal of getting a visa prompts many to take their ideas elsewhere.

A similar problem afflicts even short-term visitors. Organisers of international scientific conferences are increasingly reluctant to hold them in America because not everyone they invite will be able to attend. Last year, for example, Alik Ismail-Zadeh, a prominent Russian geophysicist, applied for a visa to attend a meeting of the American Geophysical Union. He allowed three months, but did not get his passport back until after his plane had departed. Kathie Bailey-Mathae of the National Academy of Sciences says that the hassles have eased in the past year, but only somewhat. When foreign scientists run into problems repeatedly, they become loth to collaborate with their American peers, she says.

Barack Obama came to office promising to reform the immigration system. So far, he has made only small changes, such as ending commando-style raids on factories suspected of hiring illegal workers; other matters have demanded his attention. But behind the scenes there are rumblings about immigration. Chuck Schumer, a Democratic senator from New York, and Lindsey Graham, a Republican from South Carolina, are working on a comprehensive reform bill, which they may unveil soon. Angela Kelley of the Centre for American Progress (CAP), a think-tank closely aligned with the Obama administration, says she is optimistic that something will happen this year.

Last week her think-tank published a study touting the benefits of reform. Its author, Raúl Hinojosa-Ojeda of the University of California, Los Angeles, models what might happen if immigration laws are made more welcoming. First, he assumes that Congress creates a pathway for the estimated 12m illegal immigrants already in the country to earn legal status and eventually citizenship—by paying taxes, staying out of trouble, and so on. Second, he assumes that the current rigid cap on the number of visas issued to economic migrants is replaced with one that takes into account what the American labour market needs. These two changes would raise America’s GDP by $1.5 trillion over ten years, calculates Mr Hinojosa-Ojeda. A less generous programme (allowing only temporary work visas) would swell the economy by only half as much, he reckons. Mass deportation would cost more than the Iraqi and Afghan wars combined.

Fear not, said he

American blue-collar workers fear that Mexican immigrants will undercut their wages. Mr Hinojosa-Ojeda says they won’t if they are legal. The fear of deportation makes illegal workers accept worse conditions, he finds. Once legal, they demand higher wages, and no longer drag down those of the native-born. And once immigrants are confident that they can stay, they are more likely to invest in the future, for example by starting a business.

Such arguments may help nudge immigration reform through Congress. But it will be a heck of a fight. (When George Bush tried, nativists in his own party kneecapped him.) With a more Democratic Congress, reform may be easier. But it is unclear whether reformers will try to make the system more talent-friendly. In 2008, more than four times as many people earned green cards (ie, permanent residency) because of family ties to America than because of their skills. While other countries, such as Canada and Australia, seek to attract the best brains from around the world, America’s immigration system is a recipe for stagnation. In the long term, it poses a serious threat to America’s status as top nation, argues a report from the Council on Foreign Relations, a think-tank. But in the short term, it could be fixed.

Lexington, The Economist


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Turning the tables

America’s banks

America’s banks will find out what it feels like to cover someone else’s losses

“I DID not run for office to be helping out a bunch of fat-cat bankers,” Barack Obama recently declared. On Thursday January 14th he drove the point home, unveiling a special levy on large financial institutions to cover losses by taxpayers on the Troubled Asset Relief Programme (TARP). The “Financial Crisis Responsibility Fee” will snare around 50 banks and insurers with assets of more than $50 billion—35 American institutions and 15 or so domestic subsidiaries of foreign firms. Each will pay 0.15% of its eligible liabilities, measured as total assets minus capital and deposits (or, for insurers, policy reserves). Investment banks with few deposits, such as Goldman Sachs and Morgan Stanley, will be hit much harder than commercial banks.

The fee will last a minimum of ten years, and longer if that is necessary to recoup the full cost of TARP. In a statement Mr Obama promised to “recover every single dime the American people are owed”. In fact The Treasury expects the fee to raise $90 billion over that period, and that this will be sufficient to cover the final bill—though its most conservative estimate is a loss of $120 billion. Officials argue that, far from springing a surprise on banks, they are following the letter of the law that created the TARP, which called for the bail-out’s costs to be recouped from the financial sector by 2013.

The politics of the levy are clear. As banks’ pockets bulge again, they grow less popular. According to a Bloomberg National Poll conducted in December, 64% of Americans think bailing them out was a mistake. Legislators are under pressure to respond to this anger, especially those facing mid-term elections in November.

Politics is not the only motive. Hitting the giants addresses a genuine worry about banks whose size poses systemic dangers. Some, however, worry that the banks will simply pass the extra costs to customers. Another concern is that the levy will strip banks of funds that could otherwise be used to bolster their capital.

The timing of the fee is not coincidental. Bonus season is looming on Wall Street. America’s big banks are girding themselves for a storm of abuse when they unveil their annual results and compensation, starting on Friday with JPMorgan Chase. They were vilified for vast losses in 2007-08 but the problem now for the pace-setters is voluminous profits. The rebound in capital markets has pushed revenues back towards pre-crisis levels, and compensation pools with them. Goldman Sachs is expected to fork out $18 billion for 2009, not much less than its record payout in 2007. This is awkward, given the helping hand-outs banks got from the taxpayer.

Banks are not taking the issue lightly. They are addressing skewed incentives by, for instance, paying a bigger share of bonuses as deferred shares, with a greater opportunity to claw this back if trades go wrong. More importantly for their public image, banks are lowering their “compensation ratios”. Investment banks used to give half their net revenues to employees. This year it will be closer to 40%.

Even so, the absolute numbers will still look indefensible, especially to the one in ten Americans workers without a job. That leaves the banks destined to please no one: the public will see the pay numbers as disgracefully large and employees as disappointingly low. The mood on Wall Street is part frustration (that the cut in compensation ratios has failed to soften hearts); part fear (over possible defections to hedge funds); and part anger (over what financiers see as the Obama administration’s fanning of anti-bank sentiment).

All three emotions were heightened this week when Andrew Cuomo, New York’s attorney-general, demanded detailed information on pay policies from big banks. The Federal Deposit Insurance Corporation, meanwhile, said it would use pay structures in calculating contributions to its deposit-insurance fund. And compensation featured heavily when bosses of four big banks testified to the first hearing of the Financial Crisis Inquiry Commission.

But it is the new tax that really has bankers foaming at the mouth (in private, of course; they have learned not to slam such things in public). They complain that its design is fundamentally unfair, since it hits institutions that have settled their debt to the taxpayer: most big banks have already repaid their TARP funds, with interest. The bulk of the losses will come at American International Group (which is covered by the fee) and carmakers (which are not), along with spending for mortgage-modification programmes.

Such bleating rings hollow. With banks paying fat bonuses so soon after a gut-wrenching rescue of the financial system, they themselves are largely to blame for the yawning disconnect with the beleaguered taxpayer. Like him, they are set to get a taste of what it is like to cover someone else’s losses.

The Economist


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What Comes Next for the Crisis-Stricken Country?

Rebooting Iceland

Iceland has been like the canary in the coalmine of the global economic crisis. The government was driven out of office, the banks were nationalized and Iceland’s people will be bailing the country out for years to come. Reykjavik’s next great experiment will be reinvention. 

Downtown Reykjavik

Hannes Holmsteinn Gissurarson, the man who gave Iceland the dream of one day becoming the world’s finest country, is standing in the middle of his small office at Reykjavik University and, for a second, he is acting modestly. He now simply wants to be remembered as a man unjustly condemned by history even though he did everything right. 

Fifty-six-year-old Gissurarson adores such attention. He wears black Nike trousers, trainers and a black T-shirt. He takes a deep breath, and perceptibly grows in stature. 

Iceland, he says, reminds him of Icarus: The man who wanted to fly all the way to the sun but fell down to Earth. Gissurarson pauses briefly. Then he says, “It’s a Greek tragedy, a tragedy of mythical proportions.” 

Gissurarson’s book “How Can Iceland Become the Richest Country in the World?” was published in 2001. That was the expectation back then, albeit couched in a question. The people of Iceland were well-educated and wealthy. Now they wanted to become the richest country in the world. Gissurarson’s book supplied the screenplay for this Icelandic dream. 

Gissurarson says Iceland did everything right. The economy was liberalized, companies were privatized, taxes were lowered. He imagined Iceland as a laboratory for the entire world. 

A photo on the wall in Gissurarson’s office shows him standing next to Margaret Thatcher. Both are holding a glass of champagne. Gissurarson is quite good at imitating her way of speaking. He still considers her a major role model. He marvels at her clarity, her single-mindedness. 

Professor Gissurarson’s theories were soon put into practice. Important surveys saw Iceland climbing to the top of the pack, and Gissurarson recalls how Icelanders viewed themselves as the richest and perhaps the luckiest people on the planet. 

The Year Iceland Came off the Rails 

The euphoria was justified until 2004, when the dream started going bad, although no-one noticed at the time. Power had always remained in the hands of a small clique in Iceland; men who had often sat next to one another in school. 

Gissurarson describes 2004 as the year in which Iceland came off the rails. A strong prime minister was forced to step aside for a weaker one, and without his control the old boys’ network turned into a plutocracy. Many of the “old boys” had become millionaires and now harbored dreams of becoming billionaires. They controlled the regulatory bodies and the media. “We underestimated the danger of handing over power to the plutocrats,” Gissurarson says. “The country lost its soul.” 

Gissurarson feels betrayed. By his former friends and by Europe as a whole. First everyone took Iceland as a shining example, and now every country only looks after its own interests. Last year Iceland reached an agreement with the governments of Britain and the Netherlands over money that Dutch and British investors had put into the Icelandic bank Icesave, money which was subsequently lost during the financial crisis. The British and Dutch governments compensated the investors, and the plan was for Iceland to reimburse them eventually — with 5.55 percent interest for good measure. 

The agreement would have cost Iceland €3.8 billion ($5.51 billion), a sum of such magnitude that it would have plunged the island into debt until 2024. In late December, the Icelandic parliament approved the agreement with a narrow majority. But resistance to the deal has grown day-by-day ever since. Several hundred protesters camped outside the president’s official residence, and within a few days opponents of the plan gathered some 62,000 signatures — about a quarter of the country’s electorate — for a petition demanding the agreement be torn up. The pressure became so great that the president felt obliged to step in at the beginning of last week and offer to hold a referendum on the matter. 

An Unfair Agreement? 

Gissurarson, who has continued to grow in stature, says the Icesave agreement is comparable to the Treaty of Versailles with which the victorious Allies pinned blame for World War I solely on Germany and saddled it with crippling reparations. He sees it as bullying. “We haven’t attacked anybody!” he shouts across his small office. 

In reality, he says, the losses during the financial crisis were merely paper losses; virtual profits that had somehow failed to be converted into cold, hard cash. He says the crisis was not an industrial one, but a wake-up call that had simply toppled a few theoretical models. “Where in Iceland have any machines been destroyed?” he cries. “Where are the destroyed ships, the destroyed factories?” 

He says the profits of the boom years were just profits on paper. And as such, the losses are only paper losses. Iceland’s virtual wealth was followed by a virtual crisis in which it lost something that hadn’t existed anyway. 

Reality isn’t half as painful when it’s explained to you by Professor Gissurarson in his small office in Reykjavik, far away from the rest of the world. It’s more brutal when you leave the Icelandic capital and visit some of the places that once thought it was a good idea to network with Iceland and with the ideas of Hannes Holmsteinn Gissurarson. 

A Piece of Iceland in Germany 

A building in Frankfurt used to house the headquarters of Kaupthing Edge, the German branch of the Kaupthing Bank. In 2008 many Germans invested their money in Kaupthing because of the high interest rates it offered. 

Michael Kramer was the managing director of Kaupthing Edge. In the end, he was the man responsible for ensuring that every single German Kaupthing investor got his money back. 

Kramer opens the door himself. Shortly before, he was sitting at his desk trying to reach a computer technician to fix the damn server. Now he leans out of the upper storey window and calls down to his visitors at street level to tell them which bell to press. 

Kramer waits upstairs by the door. He’s wearing jeans, suede shoes and an open shirt. After all, why dress smartly when you’re the only employee? 

He leads the way back to his desk. The doors of the other offices are ajar. From his chair he looks out over desks at which nobody works anymore, computer screens that are gathering dust, and coffee cups that were put down and forgotten some time in the distant past. The German headquarters of Kaupthing looks like it was abandoned in a hurry. 

Kaupthing Edge was the retail deposit arm of Kaupthing Bank; a piece of Iceland in Germany, if you will. Until October 2008, Kaupthing was the largest of Iceland’s three major banks. But when the financial crisis hit, the Icelandic state had to step in to rescue the bank, prompting German financial regulators to issue the German branch of Kaupthing Bank with a moratorium and freeze all its accounts. Kramer was a banker who lost control of his bank. He had to sack his marketing manager, his computer technician and his financial expert. Eventually he even had to let his secretary go. 

In the end, only Kramer remained. Someone had to clear up the mess that was left behind. Every morning for a year, he drove to his empty office to wind up the Iceland of the past. 

The Best Opportunities and the Best Returns 

Kramer had originally been brought in to Kaupthing because the bank needed fresh money. He was hired to attract private customers, and to convince them to invest their money in a bank no-one knew. It was his job to sell the Icelandic economic miracle to Germans with cash to spare. 

The idea was that Iceland would become a model. The island on the northern edge of Europe had had some turbulent years behind it. Stocks, house prices, corporate shares — everything had increased in value. Iceland offered the best opportunities and the best returns, and so the small country became a kind of laboratory for testing the free market economy. And everything seemed possible. 

Kramer combined German caution with Icelandic optimism. He had a small team — just five people — low overheads and open doors. “Extremely lean,” Kramer says. Just like Iceland. 

An old villa in the Westend area of Frankfurt was the perfect place to set up a bank. It had parquet floors, stucco, and chandeliers hanging down from tall ceilings. Illustrated books with titles like “Iceland: Island of Fire and Ice” and “The Finest Images of Iceland” lined the shelves. “Go straight” was their motto, a philosophy that perfectly encapsulated the mood. And everything moved so quickly that they didn’t even find the time to hang up some pictures. 

On March 17, 2008 Kramer announced, “We’ve gone live!” The business model was simple: Kaupthing Edge offered a top rate of 5.65 percent on overnight money, more than nearly anyone else. In the first six months they attracted 80,000 customers. Kramer brought in €800 million. “Everything was sweetness and light until Lehman happened,” he says. 

Europe’s Crash Test Lab 

Lehman Brothers “happened” on Sept. 15, 2008, and less than four weeks after the American investment bank collapsed, Iceland’s three largest banks had all been nationalized. Iceland itself teetered on the verge of bankruptcy. All of a sudden, Iceland was Europe’s crash-test lab, for it seemed that what it was experiencing would sooner or later befall the rest of the world: a huge national debt, economic crisis, unemployment and inflation. 

Some 550,000 e-mails flooded into Kramer’s small online bank. Investors wanted their money back. They had bet on Iceland, and had lost their bet. 

Kramer walks over to the conference room. On the table there are boxes containing all that is left of the Icelandic model. “Transfer cancellations” someone had written on the boxes in permanent marker. “Interest demands,” “100 percent account liquidations,” “lawyers.” Each letter a loss of faith. 

All that remains are complaints and threatened lawsuits, the entire legal caboodle. 

Iceland’s Economic Bubble 

The question is what will replace it. What will become of a country that narrowly escaped death? Can it be brought back to life? And if so, what sort of a life will it be? 

The headquarters of Kaupthing Bank still exists, although the institution itself is now called Arion Bank. Its new boss is Finnur Sveinbjörnsson, a small, polite man in his early fifties. From the desk in his corner office Sveinbjörnsson has a marvelous view over the bay of Reykjavik and the snow-capped mountains beyond. The green waves are crowned with froth. 

Sveinbjörnsson was named as Kaupthing’s new chairman just over a year ago. The appointment brought him his very first corner office. Sveinbjörnsson first worked at a savings bank then spent many years at the Icelandic central bank before heading the small stock exchange in Reykjavik. His career has been solid and pretty unglamorous for a banker. 

By 2007 he was no longer in any doubt that Iceland’s boom was a huge bubble, Sveinbjörnsson says. At the start of the new millennium, more and more banks in Iceland were being privatized. The bubble continued to grow for years. Because short-term interest rates were lower than long-term ones, people took short-term loans to invest money long-term. The banks were funding projects that were risky, but they were earning money from the interest. 

The value of Iceland’s banks rose. In 2007 Kaupthing became the first Icelandic firm in the top 800 on the Forbes list of the world’s biggest companies. At one point, the balance sheet total of the three major banks was ten times the size of Iceland’s gross domestic product. 

With that sort of a ratio, it’s unlikely anyone could have bailed the banks out when crisis struck. At first, Sveinbjörnsson recalls, he was hoping for a soft landing. But in the end all that mattered was to minimize the force of the impact. 

Pruning Back to Allow New Growth 

Since then, all Kaupthing’s riskier assets have been transferred into a kind of “bad bank” that is being put through insolvency. Sveinbjörnsson’s job is to turn Kaupthing Bank from a risk-loving behemoth into a small, low-risk savings bank. Iceland’s strategy is the strategy of landscape gardeners: prune back to allow new growth. 

Unfortunately nearly all the Kaupthing workforce has had to be laid off, Sveinbjörnsson says, looking out over the bay. Some of his former bankers have gone back to university, others have turned to writing poetry. 

Sveinbjörnsson himself has a one-year contract. At the end of this time his post will be re-advertised. He says the aim is to dispel all suspicions of cronyism by sending out a clear signal that the old boys’ network no longer holds the reins of power in Iceland. 

About 10 to 15 percent of Kaupthing’s customers are classified as “problem cases,” that is, customers who temporarily can’t meet their long-term obligations. Sveinbjörnsson says he has to “develop solutions” for them. In other words, reschedule payments, extend deadlines and write off bad debt. Bankers have become rescuers — saviors of the nation’s souls. Icelandic banking is now about security rather than returns. 

An Icelandic writer found a pithy image for the country’s current situation, one that comes from the world of mining: In the past, mineworkers often took a canary down into the mineshaft with them. Canaries are extremely sensitive to changes in oxygen levels, and miners knew that it was safe to work as long as their canary carried on singing. The writer suggested that Iceland is the canary of international financial capitalism. When it fell off its perch, the other countries recognized that danger was close at hand. Today the bird is coughing, it looks rather disheveled, but it has survived its fall, and that’s all that matters. 

‘The Boulevard of Broken Dreams’ 

Sveinbjörnsson says one major question still hasn’t been answered yet: Were the bankers merely unlucky in the autumn of 2008 or were they simply too stupid to see the dangers that lay ahead? 

The final report on an investigation into the matter is due to be published in early February. The answer this report gives to the question will decide if the people of Iceland ever regain confidence in their banks, their government and indeed the entire system. 

Kaupthing’s headquarters, a light cube of glass and granite, stands directly opposite a tower block built by Björgolfur Thor Björgolfsson, Iceland’s richest man. The skyscraper is now a white elephant, and no-one knows what will become of it. 

Just a few yards further on there is the historic guesthouse in which Ronald Reagan and Mikhail Gorbachev met in 1986 to discuss ending the Cold War. Icelanders say that whereas communism’s fate was sealed in the guesthouse, Björgolfsson’s building, diagonally opposite, sealed capitalism’s fate. They call the street between the two houses the “Boulevard of Broken Dreams.” 

Also nearby are the offices of a man who must now pick up the pieces and sweep up all the debris left behind by Professor Gissurarson’s friends. Gylfi Magnusson is the new government’s economics minister. Because he used to criticize the old system, he believes he now has a duty to help develop another. 

It’s hard to see the crisis from his office window high up on the fourth floor. There are still a surprisingly large number of SUVs on Reykjavik’s roads — Range Rovers, Audis and BMWs. These powerful vehicles were much sought-after before the crisis. But nobody wants them anymore, not even used. 

Magnusson wears a black suit and a red tie. He speaks quietly, a little like a mortician who is afraid to disturb the mourners. Magnusson says it’s fair to describe Iceland’s case as an invisible disaster. 

When he moved into his new office, he put a few books on his shelf: “Why Iceland?”, written by Kaupthing Bank’s chief economist, “Fixing Global Finance,” and “Surviving Large Losses.” Guidebooks. Books that provide few answers but ask many questions. 

Just how close did Iceland come to bankruptcy in the autumn of 2008? 

Magnusson gives a thin smile. 

“If the government hadn’t saved the banking system, Iceland would have been all but insolvent. It was touch and go.” 

‘The Costs Are Huge but Nowhere Near Crippling’ 

Why can’t you see the effects of the disaster? Why does life go on as if nothing had ever happened? 

Many companies are as good as bankrupt, Magnusson says. They took out loans that they couldn’t service, and they invested their money in bonds and shares that lost nearly all their value in the financial crisis. 

What’s more, imports have fallen dramatically since the crisis hit. There are hardly any buyers for furniture and luxury goods in Iceland. Car imports, for instance, have plummeted by almost 90 percent. 

Complete collapse was only prevented because the International Monetary Fund promised Iceland $2.1 billion. The welfare system remained largely intact, the new banking system is practically the same as the old one, though without the imagination, the overconfidence and the virtual madness. 

Magnusson says that by 2014 Iceland will be back where it was before the crisis. Unless there are some nasty surprises. “We’ll lose five, maybe six years. Iceland has lost its innocence. The costs are huge, but they are nowhere near crippling.” 

Magnusson is an economics professor by trade. The job of minister gives him a unique opportunity to put his models to the test in a real-life situation. 

He says his belief in the capacity of market self-regulation has dramatically eroded. Market prices aren’t fair and “mistakes that are made will be made.” 

A Hiccup of History 

On the other hand, there were positive aspects about the crisis. Magnusson, himself a father of five, recently read a survey which found that Icelanders are rediscovering traditions and values that were forgotten during the boom years. They have started wearing traditional Icelandic clothes again, vacationing in Iceland and cooking local dishes. Parents have more time for their children, time for family walks and to read to them. 

The new Iceland is like pre-boom Iceland because the one that existed in-between wasn’t real. It was a mistake, an error, perhaps; a hiccup of history. 

The new era is allowing new people rise to prominence and making room for new ideas. One of the players in this new era is Gudjon Mar Gudjonsson. 

Gudjonsson’s headquarters are located in a former furniture store on the Reykjavik harbor. The furniture business folded right at the beginning of the crisis. Now his former store is home to the House of Ideas. 

Gudjonsson always carries a book around with him. Although the cover is marked “The Idea Book,” most of the pages are blank. Now and again he flips it open and hastily scribbles down an idea. Gudjonsson wears a gray shirt and jeans. His eyes are set deep in their sockets. He is a nerd who had the good fortune to make a lot of money early on with a software company. That gives him the freedom to have visions, and credibility among those he wants to sell his blueprint for a new Iceland. 

‘We Are About the Future’ 

In mid-November Gudjonsson invited about 1,500 Icelanders to a kind of national assembly in Reykjavik. He wanted them to debate the country’s future, to discuss values and what makes Iceland special. The idea, Gudjonsson says, was to capitalize on the “wisdom of the crowd,” as he calls it. 

“The recovery (of the government) is about the past,” he says. “We are about the future.” 

Gudjonsson thinks countries ought be run more like companies. He says Wikipedia — not the Encyclopedia Britannica, Linux and not Windows — is the business model for the 21st century. He wants a society that communicates via Facebook and Twitter, has ideas and can put good ideas into practice. He models himself not on Margaret Thatcher, but on Barack Obama. 

It’s now dark outside. Gudjonsson’s wife has come to the House of Ideas with their two children, and they are waiting in the cold outside the door. Although she knocked, Gudjonsson didn’t hear her. He’s busy enthusing about “wikinomics” and the “renaissance plan” that is to be put into practice in April next year to “reboot” Iceland. 

Eventually his wife rings him on his mobile phone, but he leaves her out in the cold a little longer because he simply must finish what he’s saying. 

How The Crisis Has Hit Everyday People 

Society would have been forced to change anyway, he says. The crisis just made the change more urgent. Gudjonsson imagines the “wisdom of the crowds” as being like a colony of ants. Individual ants can’t see danger coming, but each helps to move the nest to a safer place because they all sense danger is in the air. 

The crisis is just about money, not war, Gudjonsson says, although he adds that it’s not quite true that the crisis is equally invisible to all or that the losses are purely virtual. The losses are pretty real for 38-year-old Gunnar Hansson and thousands of others like him. 

Hansson is an actor, and he’s currently shooting the second season of a comedy series that’s extremely successful in Iceland. He suggested we meet at the National Museum in Reykjavik. He arrives on a bright-yellow Vespa through the drizzle that has draped itself over Iceland like a gray flannel. 

Hansson loves Vespas. During a 2007 vacation in Italy, he even visited the headquarters of the company that makes them in Pontedera. When he inquired about a scooter, the dealer thought Hansson wanted to import Vespas to Iceland. As a man who believes opportunities should never be passed up, Hansson left the store as an authorized Vespa retailer. 

It was a business idea based on a fortunate misunderstanding. Nevertheless, the Icelandic banks he asked for advice were thrilled by it. But then, as early as December 2007, they suddenly became more hesitant. They promised him a loan, but demanded Hansson’s apartment as collateral. 

At first everything went smoothly. Hansson put his scooter between the sofas in the furniture store that is now the House of Ideas, and by September 2008 he had already sold 80 of them. Hansson conducted real business on the back of the virtual wealth of others. In fact he made good money from it. 

But as the Icelandic krona gradually lost value, Hansson was forced to increase his prices with every delivery he received. When the furniture store ran into financial trouble in early October 2008, he moved to a car showroom. 

‘Everything Froze Up’ 

At the end of 2008, the car dealership also went bankrupt. Suddenly, Hansson recalls, “everything froze up.” Last May he received his last shipment of Vespas. A little later he sold the business without making any profit, though more importantly not at any great loss. 

Unfortunately he had less luck with the apartment he had bought in February 2007 and had offered he bank as the security on his loan. The loan on the apartment was initially in Icelandic krona. However because the loan was coupled to the rate of inflation, Hansson’s debts grew even though he was keeping up with his repayments. 

The bank therefore recommended he convert the loan into a foreign-currency loan. “All you read in the newspapers and saw on the television back then was ‘foreign-currency loans!'” Hansson says. “Banks called their customers: Foreign-currency loans!” 

Hansson decided on the Japanese yen and Swiss francs; the world’s safest currencies — at least according to his advisor at the bank. When the Icelandic krona went into freefall, Hansson’s debts doubled. Today he owes some 46 million Icelandic krona. 

How much is that in euros? 

Hansson grabs his mobile phone and pulls up the calculator function. “No idea,” he mumbles. “I haven’t had the courage to work it out yet.” He hits a few keys, stares at the display and then, clearly impressed, says, “Two hundred and fifty thousand euros!” 

Discipline, Modesty and Optimism 

In this respect, Hansson of all people is one of the Icelanders for whom the virtual crisis became very real in the end. He wasn’t involved in the virtual boom, partly for lack of money, partly a lack of opportunity, but he — and maybe also his children — will have to carry the burden. 

After a moment’s reflection, Hansson says he still hopes the krona will eventually rise in value again, that the debts which ballooned during the financial crisis will shrink again one day. 

Perhaps this is the new model Iceland; “Iceland rebooted,” so to speak. A country characterized by discipline, modesty and optimism, a country with an eye for what is possible, an example of how to draw genuine consequences from a virtual crisis. 

Hansson’s loan has a 35-year lifespan. At the very latest, he’ll be rid of his debts by the time he’s 73. “In this way, we are reminded every day how bad the crash was,” he says. “It touches so many things and has changed so many others, maybe forever.” 

Then he goes outside. “I used to be proud to be Icelandic when I was abroad. Today I’m embarrassed by it.” 

He climbs on his bright yellow Vespa, the only one he has left, tightens the strap of his helmet below his chin, and drives off. Soon he is gone, swallowed by the drizzle. 


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Don’t Like the Numbers? Change ‘Em

If a CEO issued the kind of distorted figures put out by politicians and scientists, he’d wind up in prison.

Politicians and scientists who don’t like what their data show lately have simply taken to changing the numbers. They believe that their end—socialism, global climate regulation, health-care legislation, repudiating debt commitments, la gloire française—justifies throwing out even minimum standards of accuracy. It appears that no numbers are immune: not GDP, not inflation, not budget, not job or cost estimates, and certainly not temperature. A CEO or CFO issuing such massaged numbers would land in jail.

The late economist Paul Samuelson called the national income accounts that measure real GDP and inflation “one of the greatest achievements of the twentieth century.” Yet politicians from Europe to South America are now clamoring for alternatives that make them look better.

A commission appointed by French President Nicolas Sarkozy suggests heavily weighting “stability” indicators such as “security” and “equality” when calculating GDP. And voilà!—France outperforms the U.S., despite the fact that its per capita income is 30% lower. Nobel laureate Ed Prescott called this disparity the difference between “prosperity and depression” in a 2002 paper—and attributed it entirely to France’s higher taxes.

With Venezuela in recession by conventional GDP measures, President Hugo Chávez declared the GDP to be a capitalist plot. He wants a new, socialist-friendly way to measure the economy. Maybe East Germans were better off than their cousins in the West when the Berlin Wall fell; starving North Koreans are really better off than their relatives in South Korea; the 300 million Chinese lifted out of abject poverty in the last three decades were better off under Mao; and all those Cubans risking their lives fleeing to Florida on dinky boats are loco.

There is historical precedent for a “socialist GDP.” When President George H.W. Bush sent me to help Mikhail Gorbachev with economic reform, I found out that the Soviet statistics office kept two sets of books: those they published, and those they actually believed (plus another for Stalin when he was alive).

In Argentina, President Néstor Kirchner didn’t like the political and budget hits from high inflation. After a politicized personnel purge in 2002, he changed the inflation measures. Conveniently, the new numbers showed lower inflation and therefore lower interest payments on the government’s inflation-linked bonds. Investor and public confidence in the objectivity of the inflation statistics evaporated. His wife and successor Cristina Kirchner is now trying to grab the central bank’s reserves to pay for the country’s debt.

America has not been immune from this dangerous numbers game. Every president is guilty of spinning unpleasant statistics. President Richard Nixon even thought there was a conspiracy against him at the Bureau of Labor Statistics. But President Barack Obama has taken it to a new level. His laudable attempt at transparency in counting the number of jobs “created or saved” by the stimulus bill has degenerated into farce and was just junked this week.

The administration has introduced the new notion of “jobs saved” to take credit where none was ever taken before. It seems continually to confuse gross and net numbers. For example, it misses the jobs lost or diverted by the fiscal stimulus. And along with the congressional leadership it hypes the number of “green jobs” likely to be created from the explosion of spending, subsidies, loans and mandates, while ignoring the job losses caused by its taxes, debt, regulations and diktats.

The president and his advisers—their credibility already reeling from exaggeration (the stimulus bill will limit unemployment to 8%) and reneged campaign promises (we’ll go through the budget “line-by-line”)—consistently imply that their new proposed regulation is a free lunch. When the radical attempt to regulate energy and the environment with the deeply flawed cap-and-trade bill is confronted with economic reality, instead of honestly debating the trade-offs they confidently pronounce that it boosts the economy. They refuse to admit that it simply boosts favored sectors and firms at the expense of everyone else.

Rabid environmentalists have descended into a separate reality where only green counts. It’s gotten so bad that the head of the California Air Resources Board, Mary Nichols, announced this past fall that costly new carbon regulations would boost the economy shortly after she was told by eight of the state’s most respected economists that they were certain these new rules would damage the economy. The next day, her own economic consultant, Harvard’s Robert Stavis, denounced her statement as a blatant distortion.

Scientists are expected to make sure their findings are replicable, to make the data available, and to encourage the search for new theories and data that may overturn the current consensus. This is what Galileo, Darwin and Einstein—among the most celebrated scientists of all time—did. But some climate researchers, most notably at the University of East Anglia, attempted to hide or delete temperature data when that data didn’t show recent rapid warming. They quietly suppressed and replaced the numbers, and then attempted to squelch publication of studies coming to different conclusions.

The Obama administration claims a dubious “Keynesian” multiplier of 1.5 to feed the Democrats’ thirst for big spending. The administration’s idea is that virtually all their spending creates jobs for unemployed people and that additional rounds of spending create still more—raising income by $1.50 for each dollar of government spending. Economists differ on such multipliers, with many leading figures pegging them at well under 1.0 as the government spending in part replaces private spending and jobs. But all agree that every dollar of spending requires a present value of a dollar of future taxes, which distorts decisions to work, save, and invest and raises the cost of the dollar of spending to well over a dollar. Thus, only spending with large societal benefits is justified, a criterion unlikely to be met by much current spending (perusing the projects on doesn’t inspire confidence).

Even more blatant is the numbers game being used to justify health-insurance reform legislation, which claims to greatly expand coverage, decrease health-insurance costs, and reduce the deficit. That magic flows easily from counting 10 years of dubious Medicare “savings” and tax hikes, but only six years of spending; assuming large cuts in doctor reimbursements that later will be cancelled; and making the states (other than Sen. Ben Nelson’s Nebraska) pay a big share of the cost by expanding Medicaid eligibility. The Medicare “savings” and payroll tax hikes are counted twice—first to help pay for expanded coverage, and then to claim to extend the life of Medicare.

One piece of good news: The public isn’t believing much of this out-of-control spin. Large majorities believe the health-care legislation will raise their insurance costs and increase the budget deficit. Most Americans are highly skeptical of the claims of climate extremists. And they have a more realistic reaction to the extraordinary deterioration in our public finances than do the president and Congress.

As a society and as individuals, we need to make difficult, even wrenching choices, often with grave consequences. To base those decisions on highly misleading, biased, and even manufactured numbers is not just wrong, but dangerous.

Squandering their credibility with these numbers games will only make it more difficult for our elected leaders to enlist support for difficult decisions from a public increasingly inclined to disbelieve them.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.


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Who’s Sleeping Now?

C. H. Tung, the first Chinese-appointed chief executive of Hong Kong after the handover in 1997, offered me a three-sentence summary the other day of China’s modern economic history: “China was asleep during the Industrial Revolution. She was just waking during the Information Technology Revolution. She intends to participate fully in the Green Revolution.”

I’ll say. Being in China right now I am more convinced than ever that when historians look back at the end of the first decade of the 21st century, they will say that the most important thing to happen was not the Great Recession, but China’s Green Leap Forward. The Beijing leadership clearly understands that the E.T. — Energy Technology — revolution is both a necessity and an opportunity, and they do not intend to miss it.

We, by contrast, intend to fix Afghanistan. Have a nice day.

O.K., that was a cheap shot. But here’s one that isn’t: Andy Grove, co-founder of Intel, liked to say that companies come to “strategic inflection points,” where the fundamentals of a business change and they either make the hard decision to invest in a down cycle and take a more promising trajectory or do nothing and wither. The same is true for countries.

The U.S. is at just such a strategic inflection point. We are either going to put in place a price on carbon and the right regulatory incentives to ensure that America is China’s main competitor/partner in the E.T. revolution, or we are going to gradually cede this industry to Beijing and the good jobs and energy security that would go with it.

Is President Obama going to finish health care and then put aside the pending energy legislation — and carbon pricing — that Congress has already passed in order to get through the midterms without Republicans screaming “new taxes?” Or is he going to seize this moment before the midterms — possibly his last window to put together a majority in the Senate, including some Republicans, for a price on carbon — and put in place a real U.S. engine for clean energy innovation and energy security?

I’ve been stunned to learn about the sheer volume of wind, solar, mass transit, nuclear and more efficient coal-burning projects that have sprouted in China in just the last year.

Here’s e-mail from Bill Gross, who runs eSolar, a promising California solar-thermal start-up: On Saturday, in Beijing, said Gross, he announced “the biggest solar-thermal deal ever. It’s a 2 gigawatt, $5 billion deal to build plants in China using our California-based technology. China is being even more aggressive than the U.S. We applied for a [U.S. Department of Energy] loan for a 92 megawatt project in New Mexico, and in less time than it took them to do stage 1 of the application review, China signs, approves, and is ready to begin construction this year on a 20 times bigger project!”

Yes, climate change is a concern for Beijing, but more immediately China’s leaders know that their country is in the midst of the biggest migration of people from the countryside to urban centers in the history of mankind. This is creating a surge in energy demand, which China is determined to meet with cleaner, homegrown sources so that its future economy will be less vulnerable to supply shocks and so it doesn’t pollute itself to death.

In the last year alone, so many new solar panel makers emerged in China that the price of solar power has fallen from roughly 59 cents a kilowatt hour to 16 cents, according to The Times’s bureau chief here, Keith Bradsher. Meanwhile, China last week tested the fastest bullet train in the world — 217 miles per hour — from Wuhan to Guangzhou. As Bradsher noted, China “has nearly finished the construction of a high-speed rail route from Beijing to Shanghai at a cost of $23.5 billion. Trains will cover the 700-mile route in just five hours, compared with 12 hours today. By comparison, Amtrak trains require at least 18 hours to travel a similar distance from New York to Chicago.”

China is also engaged in the world’s most rapid expansion of nuclear power. It is expected to build some 50 new nuclear reactors by 2020; the rest of the world combined might build 15.

“By the end of this decade, China will be dominating global production of the whole range of power equipment,” said Andrew Brandler, the C.E.O. of the CLP Group, Hong Kong’s largest power utility.

In the process, China is going to make clean power technologies cheaper for itself and everyone else. But even Chinese experts will tell you that it will all happen faster and more effectively if China and America work together — with the U.S. specializing in energy research and innovation, at which China is still weak, as well as in venture investing and servicing of new clean technologies, and with China specializing in mass production.

This is a strategic inflection point. It is clear that if we, America, care about our energy security, economic strength and environmental quality we need to put in place a long-term carbon price that stimulates and rewards clean power innovation. We can’t afford to be asleep with an invigorated China wide awake.

Thomas L. Friedman, New York Times


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The Other Plot to Wreck America

THERE may not be a person in America without a strong opinion about what coulda, shoulda been done to prevent the underwear bomber from boarding that Christmas flight to Detroit. In the years since 9/11, we’ve all become counterterrorists. But in the 16 months since that other calamity in downtown New York — the crash precipitated by the 9/15 failure of Lehman Brothers — most of us are still ignorant about what Warren Buffett called the “financial weapons of mass destruction” that wrecked our economy. Fluent as we are in Al Qaeda and body scanners, when it comes to synthetic C.D.O.’s and credit-default swaps, not so much.

What we don’t know will hurt us, and quite possibly on a more devastating scale than any Qaeda attack. Americans must be told the full story of how Wall Street gamed and inflated the housing bubble, made out like bandits, and then left millions of households in ruin. Without that reckoning, there will be no public clamor for serious reform of a financial system that was as cunningly breached as airline security at the Amsterdam airport. And without reform, another massive attack on our economic security is guaranteed. Now that it can count on government bailouts, Wall Street has more incentive than ever to pump up its risks — secure that it can keep the bonanzas while we get stuck with the losses.

The window for change is rapidly closing. Health care, Afghanistan and the terrorism panic may have exhausted Washington’s already limited capacity for heavy lifting, especially in an election year. The White House’s chief economic hand, Lawrence Summers, has repeatedly announced that “everybody agrees that the recession is over” — which is technically true from an economist’s perspective and certainly true on Wall Street, where bailed-out banks are reporting record profits and bonuses. The contrary voices of Americans who have lost pay, jobs, homes and savings are either patronized or drowned out entirely by a political system where the banking lobby rules in both parties and the revolving door between finance and government never stops spinning.

It’s against this backdrop that this week’s long-awaited initial public hearings of the Financial Crisis Inquiry Commission are so critical. This is the bipartisan panel that Congress mandated last spring to investigate the still murky story of what happened in the meltdown. Phil Angelides, the former California treasurer who is the inquiry’s chairman, told me in interviews late last year that he has been busy deploying a tough investigative staff and will not allow the proceedings to devolve into a typical blue-ribbon Beltway exercise in toothless bloviation.

He wants to examine the financial sector’s “greed, stupidity, hubris and outright corruption” — from traders on the ground to the board room. “It’s important that we deliver new information,” he said. “We can’t just rehash what we’ve known to date.” He understands that if he fails to make news or to tell the story in a way that is comprehensible and compelling enough to arouse Americans to demand action, Wall Street and Washington will both keep moving on, unchallenged and unchastened.

Angelides gets it. But he has a tough act to follow: Ferdinand Pecora, the legendary prosecutor who served as chief counsel to the Senate committee that investigated the 1929 crash as F.D.R. took office. Pecora was a master of detail and drama. He riveted America even without the aid of television. His investigation led to indictments, jail sentences and, ultimately, key New Deal reforms — the creation of the Securities and Exchange Commission and the Glass-Steagall Act, designed to prevent the formation of banks too big to fail.

As it happened, a major Pecora target was the chief executive of National City Bank, the institution that would grow up to be Citigroup. Among other transgressions, National City had repackaged bad Latin American debt as new securities that it then sold to easily suckered investors during the frenzied 1920s boom. Once disaster struck, the bank’s executives helped themselves to millions of dollars in interest-free loans. Yet their own employees had to keep ponying up salary deductions for decimated National City stock purchased at a heady precrash price.

Trade bad Latin American debt for bad mortgage debt, and you have a partial portrait of Citigroup at the height of the housing bubble. The reckless Citi executives of our day may not have given themselves interest-free loans, but they often walked away with the short-term, illusionary profits while their employees were left with shredded jobs and 401(k)’s. Among those Citi executives was Robert Rubin, who, as the Clinton Treasury secretary, helped repeal the last vestiges of Glass-Steagall after years of Wall Street assault. Somewhere Pecora is turning in his grave

Rubin has never apologized, let alone been held accountable. But he’s hardly alone. Even after all the country has gone through, the titans who fueled the bubble are heedless. In last Sunday’s Times, Sandy Weill, the former chief executive who built Citigroup (and recruited Rubin to its ranks), gave a remarkable interview to Katrina Brooker blaming his own hand-picked successor, Charles Prince, for his bank’s implosion. Weill said he preferred to be remembered for his philanthropy. Good luck with that.

Among his causes is Carnegie Hall, where he is chairman of the board. To see how far American capitalism has fallen, contrast Weill with the giant who built Carnegie Hall. Not only is Andrew Carnegie remembered for far more epic and generous philanthropy than Weill’s — some 1,600 public libraries, just for starters — but also for creating a steel empire that actually helped build America’s industrial infrastructure in the late 19th century. At Citi, Weill built little more than a bloated gambling casino. As Paul Volcker, the regrettably powerless chairman of Obama’s Economic Recovery Advisory Board, said recently, there is not “one shred of neutral evidence” that any financial innovation of the past 20 years has led to economic growth. Citi, that “innovative” banking supermarket, destroyed far more wealth than Weill can or will ever give away.

Even now — despite its near-death experience, despite the departures of Weill, Prince and Rubin — Citi remains as imperious as it was before 9/15. Its current chairman, Richard Parsons, was one of three executives (along with Lloyd Blankfein of Goldman Sachs and John Mack of Morgan Stanley) who failed to show up at the mid-December White House meeting where President Obama implored bankers to increase lending. (The trio blamed fog for forcing them to participate by speakerphone, but the weather hadn’t grounded their peers or Amtrak.) Last week, ABC World News was also stiffed by Citi, which refused to answer questions about its latest round of outrageous credit card rate increases and instead e-mailed a statement blaming its customers for “not paying back their loans.” This from a bank that still owes taxpayers $25 billion of its $45 billion handout!

If Citi, among the most egregious of Wall Street reprobates, feels it can get away with business as usual, it’s because it fears no retribution. And it got more good news last week. Now that Chris Dodd is vacating the Senate, his chairmanship of the Banking Committee may fall next year to Tim Johnson of South Dakota, home to Citi’s credit card operation. Johnson was the only Senate Democrat to vote against Congress’s recent bill policing credit card abuses.

Though bad history shows every sign of repeating itself on Wall Street, it will take a near-miracle for Angelides to repeat Pecora’s triumph. Our zoo of financial skullduggery is far more complex, with many more moving pieces, than that of the 1920s. The new inquiry does have subpoena power, but its entire budget, a mere $8 million, doesn’t even match the lobbying expenditures for just three banks (Citi, Morgan Stanley, Bank of America) in the first nine months of 2009. The firms under scrutiny can pay for as many lawyers as they need to stall between now and Dec. 15, deadline day for the commission’s report.

More daunting still is the inquiry’s duty to reach into high places in the public sector as well as the private. The mystery of exactly what happened as TARP fell into place in the fateful fall of 2008 thickens by the day — especially the behind-closed-door machinations surrounding the government rescue of A.I.G. and its counterparties. Last week, a Republican congressman, Darrell Issa of California, released e-mail showing that officials at the New York Fed, then led by Timothy Geithner, pressured A.I.G. to delay disclosing to the S.E.C. and the public the details on the billions of bailout dollars it was funneling to its trading partners. In this backdoor rescue, taxpayers unknowingly awarded banks like Goldman 100 cents on the dollar for their bets on mortgage-backed securities.

Why was our money used to make these high-flying gamblers whole while ordinary Americans received no such beneficence? Nothing less than complete transparency will connect the dots. Among the big-name witnesses that the Angelides commission has called for next week is Goldman’s Blankfein. Geithner, Henry Paulson and Ben Bernanke should be next.

If they all skate away yet again by deflecting blame or mouthing pro forma mea culpas, it will be a sign that this inquiry, like so many other promises of reform since 9/15, is likely to leave Wall Street’s status quo largely intact. That’s the ticking-bomb scenario that truly imperils us all.

Frank Rich, New York Times


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Fear of the dragon

China’s export prospects

China’s share of world markets increased during the recession. It will keep rising

MANY people start the new year by resolving to change their old ways. Not China. On December 27th Zhong Shan, the country’s vice-minister of trade, declared that China will continue to increase its share of world exports. Figures due out on January 11th are expected to show that China’s exports in December were higher than a year ago, after 13 months of year-on-year declines. China’s exports fell by around 17% in 2009 as a whole, but other countries’ slumped by even more. As a result China overtook Germany to become the world’s largest exporter and its share of world exports jumped to almost 10%, up from 3% in 1999 (see chart).

China takes an even bigger slice of America’s market. In the first ten months of 2009 America imported 15% less from China than in the same period of 2008, but its imports from the rest of the world fell by 33%, lifting China’s market share to a record 19%. So although America’s trade deficit with China narrowed, China now accounts for almost half of America’s total deficit, up from less than one-third in 2008.

Trade frictions with the rest of the world are hotting up. On December 30th America’s International Trade Commission approved new tariffs on imports of Chinese steel pipes, which it ruled were being unfairly subsidised. This is the largest case of its kind so far involving China. On December 22nd European Union governments voted to extend anti-dumping duties on shoes imported from China for another 15 months.

Foreigners insist that the main reason for China’s growing market share is that the government in Beijing has kept its currency weak. But there are several other reasons why China’s exports held up better than those of its competitors during the global recession. Lower incomes encouraged consumers to trade down to cheaper goods, and the elimination of textile quotas in January 2009 allowed China to increase its slice of that market.

How high could China’s market share go? Over the ten years to 2008 China’s exports grew by an annual average of 23% in dollar terms, more than twice as fast as world trade. If it continued to expand at this pace, China might grab around one-quarter of world exports within ten years. That would beat America’s 18% share of world exports in the early 1950s, a figure that has since dropped to 8%. China’s exports are likely to grow more slowly over the next decade, as demand in rich economies remains subdued, but its market share will probably continue to creep up. Projections in the IMF’s World Economic Outlook imply that China’s exports will account for 12% of world trade by 2014.

Its 10% slice this year will equal that achieved by Japan at its peak in 1986, but Japan’s share has since fallen back to less than 5%. Its exporters were badly hurt by the sharp rise in the yen—by more than 100% against the dollar between 1985 and 1988—and many moved their factories abroad, some of them to China. The combined export-market share of the four Asian tigers (Hong Kong, Singapore, South Korea and Taiwan) also peaked at 10% before slipping back. Will China’s exports hit the same barrier as a result of weakening competitiveness, or rising protectionism?

An IMF working paper published in 2009 calculated that if China remained as dependent on exports as in recent years, then to sustain annual GDP growth of 8% its share of world exports would rise to about 17% by 2020. To consider whether that was feasible, the authors analysed the global absorption capacity of three export industries—steel, shipbuilding and machinery. They concluded that to achieve the required export growth, China would have to reduce prices, which would be increasingly hard to manage, whether through productivity gains or a squeeze in profits. In many export industries, particularly steel, margins are already wafer-thin.

However, China’s future export growth is likely to come not from existing industries but from higher-value products, such as computer chips and cars. Japan’s exports also moved swiftly up the value chain, but whereas this was not enough to support durable gains in its market share, China has the advantage of capital controls that will prevent its exchange rate rising as abruptly as Japan’s did in the 1980s. When China does eventually allow the yuan to rise, it will do so gradually.

Another big difference is the vastness of China’s economy. China consists, in effect, of several economies with different wage levels. As Japan moved into higher-value exports, rising productivity pushed up wages, making old industries, such as textiles, uncompetitive. In China, as factories in the richer coastal areas switch to more sophisticated goods, the production of textiles and shoes can move inland where costs remain cheaper. As a result China may be able to remain competitive in a wider range of industries for longer.

Foreign hostility to China’s export dominance is growing. Paul Krugman, the winner of the 2008 Nobel economics prize, wrote recently in the New York Times that by holding down its currency to support exports, China “drains much-needed demand away from a depressed world economy”. He argued that countries that are victims of Chinese mercantilism may be right to take protectionist action.

From Beijing, things look rather different. China’s merchandise exports have collapsed from 36% of GDP in 2007 to around 24% last year. China’s current-account surplus has fallen from 11% to an estimated 6% of GDP. In 2007 net exports accounted for almost three percentage points of China’s GDP growth; last year they were a drag on its growth to the tune of three percentage points. In other words, rather than being a drain on global demand, China helped pull the world economy along during the course of last year.

Foreigners look at only one side of the coin. China’s imports have been stronger than its exports, rebounding by 27% in the year to November, when its exports were still falling. America’s exports to China (its third-largest export market) rose by 13% in the year to October, at the same time as its exports to Canada and Mexico (the two countries above China) fell by 14%.

Some forecasters, such as the IMF, expect China’s trade surplus to start widening again this year unless the government makes bold policy changes, such as revaluing the yuan. However, Chris Wood, an analyst at CLSA, a brokerage, argues that China is doing more for global rebalancing than America. Rebalancing requires that China spends more and America saves more. Mr Wood argues that China is doing more to boost domestic consumption (for example, through incentives to stimulate purchases of cars and consumer durables, and increased health-care spending) than America is doing to boost its saving. America’s total saving rate fell in the third quarter of last year to only 10% of GDP, barely half its level a decade ago. Households saved more, but this was more than offset by increased government “dissaving”.

Strong growth in China’s spending and imports is unlikely to dampen protectionist pressures, however. China’s rising share of world exports will command much more attention. Foreign demands to revalue the yuan will intensify. A new year looks sure to entrench old resentments.


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Questions for the Big Bankers

Today, the Financial Crisis Inquiry Commission, which Congress established last year to investigate the causes of the financial crisis, is scheduled to question the heads of four big banks — Lloyd Blankfein of Goldman Sachs, Jamie Dimon of JPMorgan Chase, John Mack of Morgan Stanley and Brian Moynihan of Bank of America. The Op-Ed editors asked eight financial experts to pose questions they would like to hear the bankers answer. 

1. Bankers are dealers in money. The Federal Reserve is a creator of money — since the crisis began in August 2007, it has conjured up $1.1 trillion. Given the ease with which these dollars are materialized on a computer screen, how can they be worth anything? 

2. The Federal Reserve’s setting of its benchmark federal funds rate at nearly 1 percent in 2003 to 2004 was a primary cause of the housing and mortgage debacle. Yet, in an attempt to nurse the economy back to health, the Fed has set that rate at nearly zero percent. So what’s the next bubble, and how do you intend to profit by it? 

3. For Mr. Blankfein: In capitalism, profits are no sin, yet Goldman Sachs keeps making excuses for its success in 2009. If you earned the money honestly, what are you apologizing for? And if you didn’t earn it honestly, how did you do it? 

— JAMES GRANT, the editor of Grant’s Interest Rate Observer and the author, most recently, of “Mr. Market Miscalculates” 

1. It still isn’t clear precisely how mortgage-related losses in the financial sector grew to be many times greater than the actual losses on the mortgages themselves. What role did synthetic collateralized debt obligations — a Wall Street invention that uses credit default swaps to mimic the payments from mortgages — play in multiplying the losses? Is there any way in which a synthetic debt obligation adds value to the real economy? 

2. Goldman Sachs and other Wall Street firms argue that the clients to whom they sold mortgage-related securities were sophisticated investors who fully understood the risks. Goldman has said this was also the case when its clients bought the very same mortgage securities that Goldman, on its own behalf, was betting would default. Did these clients indeed understand all the gory details? 

3. At the height of the panic in the fall of 2008, Wall Street firms blamed short-sellers for trying to destroy them. What short positions did Wall Street firms have in one another’s shares, and were they also betting against each other using credit default swaps? 

— BETHANY McLEAN, a contributing editor for Vanity Fair, who is co-writing a book about the financial crisis with Joe Nocera of The Times 

1. Without the Troubled Asset Relief Program, Wall Street banks would not have survived the shock to the financial system that occurred in September 2008. Nor would they have subsequently accrued large profits and bonus pools in 2009. Shouldn’t a substantial share of those bonus pools be sequestered on bank balance sheets for several years to increase the banks’ capital levels and shield taxpayers against another bailout? 

2. All deposits insured by the Federal Deposit Insurance Corporation that were held by Wall Street financial conglomerates should have been insulated in separate bank subsidiaries that were prohibited from trading, holding derivative securities and investing in risky assets like equities or bonds with less than a AAA rating. Wouldn’t such safeguards have reduced excess banker risk-taking, thereby reducing the need for taxpayer bailouts? 

3. Wall Street turbocharged the subprime mortgage boom from 2002 to 2006 by providing billions in cheap warehouse loans to non-bank lenders that otherwise had virtually no capital or financing. Had the Federal Reserve kept short-term interest rates at a more normal 4 percent to 5 percent, rather than pushing them down to 1 percent, would this not have greatly curtailed the reckless growth of subprime loans? 

— DAVID STOCKMAN, a director of the Office of Management and Budget under President Ronald Reagan 

1. One result of the Pecora commission, the Depression equivalent of this investigation, was the Glass-Steagall Act, which kept investment banking separate from commercial banking until the act was repealed in 1999. Many experts now believe that divide should be reinstated. Yet commercial banks like Washington Mutual lost a lot of money during the crisis without having any investment banking activities, and pure investment banks like Bear Stearns and Lehman Brothers collapsed without being deposit-taking institutions. This suggests that the problem does not lie with mingling commercial and investment banking. Are you in favor of the return of Glass-Steagall, and why? 

2. Many people argue that the financial industry now accounts for far too much of the gross domestic product and that it is unproductive, indeed counterproductive, to devote so much of the nation’s resources to simply moving money around rather than making things. Why has this shift occurred and what, if anything, can the government do about it? 

3. Over the last 20 years, the world of finance has been irrevocably transformed: individuals have moved their money from savings accounts into money market funds, and institutional investors now keep their cash in the repo market, where Treasury securities are borrowed and lent, rather than as deposits in commercial banks. As a result, before the crisis, half of the credit provided in the United States was being channeled outside the commercial banking system. What regulatory changes do we need to ensure that our current financial system is as stable as the traditional banking system that served us so well from 1936 to 1996? 

— LIAQUAT AHAMED, the author of “Lords of Finance: The Bankers Who Broke the World” 

1. Describe in detail the three worst investments your bank made in 2007 and 2008 — that is, those transactions on which you lost the most money. How much did the bank lose in each case? 

2. What was the total compensation of each manager or executive supervising those three transactions — including yourself — in 2007 and 2008? 

3. Are those executives still with your bank? What investments do they supervise today? How much will they be paid for 2009, including their bonuses? 

— SIMON JOHNSON, a professor at the M.I.T. Sloan School of Management and a senior fellow at the Peterson Institute for International Economics 

Some of your firms received payouts on credit-default swap contracts with American International Group. Most of those guarantees resulted from hedging supposedly safe investments (they had AAA ratings, after all) with A.I.G. or other insurers. This hedging allowed traders to book “profits” that had not yet been earned — profits that would be counted in calculating their bonuses. 

However, this insurance was likely to fail, as your risk managers surely knew. It involved so-called wrong-way risk: the guarantor (A.I.G.) was certain to be damaged by the same event (the housing market collapse) that would lead you to seek payment on the insurance. The insurance was effective only because the government stepped in, theoretically on the taxpayers’ behalf, and made payments for A.I.G., an otherwise bankrupt firm. Since employees’ bonuses, and ultimately yours, were based on these fraudulent profits, my questions are these: 

1. How much profit did your firm record for bonus purposes on these trades that ultimately delivered huge losses? How much of those bogus profits were paid out in bonuses? 

2. Have you made any effort to recover the bonuses? If not, why not? 

— YVES SMITH, the head of Aurora Advisors, a management consulting firm, and the author of the blog Naked Capitalism and the forthcoming book “Econned: How Unenlightened Self-Interest Undermined Democracy and Corrupted Capitalism” 

1. Why did Wall Street continue to package and sell as securities so many mortgages of questionable value and underwriting standards even as the housing market started to collapse? 

2. Why were Wall Street traders and other moneymen permitted to make bets — through the use of so-called credit-default swaps — on the long-term value of securities they didn’t even own? (This is akin to everyone in your neighborhood being allowed to buy fire insurance on your house. Since the only way that bet can pay off is if your house burns down, it shouldn’t be any surprise when that is exactly what happens.) 

3. Why aren’t bankers and traders required to have more skin in the game — that is, more of their own salary at risk — and not just a marginal part of one year’s bonus? (In the old days, when investment banks were private partnerships, a partner’s entire net worth was on the line, every day.) 

— WILLIAM D. COHAN, a former Wall Street banker and the author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street,” who writes a regular column on business at 

1. How did you use the bailout money, and to what extent did it result in more lending or higher bonuses for your employees than you otherwise would have provided? 

2. What, if any, changes do you contemplate making to your pay programs for executives and other high-level employees in light of recent events and related public concerns? 

3. What have you done to modify your risk management and oversight structures to reduce the possibility that the problems of 2008 and 2009 will occur again? 

— DAVID M. WALKER, the president and chief executive of the Peter G. Peterson Foundation and the comptroller general of the United States from 1998 to 2008 


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Is China the Next Enron?

Reading The Herald Tribune over breakfast in Hong Kong harbor last week, my eye went to the front-page story about how James Chanos — reportedly one of America’s most successful short-sellers, the man who bet that Enron was a fraud and made a fortune when that proved true and its stock collapsed — is now warning that China is “Dubai times 1,000 — or worse” and looking for ways to short that country’s economy before its bubbles burst.

China’s markets may be full of bubbles ripe for a short-seller, and if Mr. Chanos can find a way to make money shorting them, God bless him. But after visiting Hong Kong and Taiwan this past week and talking to many people who work and invest their own money in China, I’d offer Mr. Chanos two notes of caution.

First, a simple rule of investing that has always served me well: Never short a country with $2 trillion in foreign currency reserves.

Second, it is easy to look at China today and see its enormous problems and things that it is not getting right. For instance, low interest rates, easy credit, an undervalued currency and hot money flowing in from abroad have led to what the Chinese government Sunday called “excessively rising house prices” in major cities, or what some might call a speculative bubble ripe for the shorting. In the last few days, though, China’s central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves — precisely to head off inflation and take some air out of any asset bubbles.

And that’s the point. I am reluctant to sell China short, not because I think it has no problems or corruption or bubbles, but because I think it has all those problems in spades — and some will blow up along the way (the most dangerous being pollution). But it also has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so (unlike us).

And here is the other thing to keep in mind. Think about all the hype, all the words, that have been written about China’s economic development since 1979. It’s a lot, right? What if I told you this: “It may be that we haven’t seen anything yet.”

Why do I say that? All the long-term investments that China has made over the last two decades are just blossoming and could really propel the Chinese economy into the 21st-century knowledge age, starting with its massive investment in infrastructure. Ten years ago, China had a lot bridges and roads to nowhere. Well, many of them are now connected. It is also on a crash program of building subways in major cities and high-speed trains to interconnect them. China also now has 400 million Internet users, and 200 million of them have broadband. Check into a motel in any major city and you’ll have broadband access. America has about 80 million broadband users.

Now take all this infrastructure and mix it together with 27 million students in technical colleges and universities — the most in the world. With just the normal distribution of brains, that’s going to bring a lot of brainpower to the market, or, as Bill Gates once said to me: “In China, when you’re one-in-a-million, there are 1,300 other people just like you.”

Equally important, more and more Chinese students educated abroad are returning home to work and start new businesses. I had lunch with a group of professors at the Hong Kong University of Science and Technology, or HKUST, who told me that this year they will be offering some 50 full scholarships for graduate students in science and technology. Major U.S. universities are sharply cutting back.

Tony Chan, a Hong Kong-born mathematician, recently returned from America after 20 years to become the new president of HKUST. What was his last job in America? Assistant director of the U.S. National Science Foundation in charge of the mathematical and physical sciences. He’s one of many coming home.

One of the biggest problems for China’s manufacturing and financial sectors has been finding capable middle managers. The reverse-brain drain is eliminating that problem as well.

Finally, as Liu Chao-shiuan, Taiwan’s former prime minister, pointed out to me: when Taiwan moved up the value chain from low-end, labor-intensive manufacturing to higher, value-added work, its factories moved to China or Vietnam. It lost them. In China, low-end manufacturing moves from coastal China to the less developed Western part of the country and becomes an engine for development there. In Taiwan, factories go up and out. In China, they go East to West.

“China knows it has problems,” said Liu. “But this is the first time it has a chance to actually solve them.” Taiwanese entrepreneurs now have more than 70,000 factories in China. They know the place. So I asked several Taiwanese businessmen whether they would “short” China. They vigorously shook their heads no as if I’d asked if they’d go one on one with LeBron James.

But, hey, some people said the same about Enron. Still, I’d rather bet against the euro. Shorting China today? Well, good luck with that, Mr. Chanos. Let us know how it works out for you.

Thomas L. Friedman, New York Times


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When Greed Is Not Good

Wall Street has quickly rediscovered the virtues of mammoth paychecks. Why hasn’t there been more financial reform?

I hear Gordon Gekko is making a comeback. So is greed.

They say markets are alternately ruled by greed and fear. Well, our panic-stricken financial markets have been ruled by fear for so long that a little greed might serve as an elixir. But everybody knows you can overdose on an elixir.

When economists first heard Gekko’s now-famous dictum, “Greed is good,” they thought it a crude expression of Adam Smith’s “Invisible Hand”—which is one of history’s great ideas. But in Smith’s vision, greed is socially beneficial only when properly harnessed and channeled. The necessary conditions include, among other things: appropriate incentives (for risk taking, etc.), effective competition, safeguards against exploitation of what economists call “asymmetric information” (as when a deceitful seller unloads junk on an unsuspecting buyer), regulators to enforce the rules and keep participants honest, and—when relevant—protection of taxpayers against pilferage or malfeasance by others. When these conditions fail to hold, greed is not good.

Plainly, they all failed in the financial crisis. Compensation and other types of incentives for risk taking were badly skewed. Corporate boards were asleep at the switch. Opacity reduced effective competition. Financial regulation was shamefully lax. Predators roamed the financial landscape, looting both legally and illegally. And when the Treasury and Federal Reserve rushed in to contain the damage, taxpayers were forced to pay dearly for the mistakes and avarice of others. If you want to know why the public is enraged, that, in a nutshell, is why.

American democracy is alleged to respond to public opinion, and incumbents are quaking in their boots. Yet we stand here in January 2010 with virtually the same legal and regulatory system we had when the crisis struck in the summer of 2007, with only minor changes in Wall Street business practices, and with greed returning big time. That’s both amazing and scary. Without major financial reform, “it” can happen again.

It is true that regulators are much more watchful now, that Bernie Madoff is in jail (where he should have more company), and that much of “fancy finance” died a violent death in the marketplace. All good. But history shows that financial markets have a remarkable ability to forget the past and revert to their bad old ways. And we’ve made essentially no progress on lasting financial reform.

Perhaps reformers just need more patience. The Treasury made a fine set of proposals that the president’s far-flung agenda left him little time to pursue—so far. The House of Representatives passed a pretty good financial reform bill late last year. And while there’s been no action in the Senate as yet, at least they are talking about it. As Yogi Berra famously said, “it ain’t over ’til it’s over.”

But I’m worried. The financial services industry, once so frightened that it scurried under the government’s protective skirts, is now rediscovering the virtues of laissez faire and the joys of mammoth pay checks. Wall Street has mounted ferocious lobbying campaigns against virtually every meaningful aspect of reform, and their efforts seem to be paying off. Yes, the House passed a good bill. Yet it would have been even better but for several changes Financial Services Committee Chairman Barney Frank (D., Mass.) had to make to get it through the House. Though the populist political pot was boiling, lobbyists earned their keep.

I expect they’ll earn more. Even before Senate Banking Committee Chairman Christopher Dodd (D., Conn.) announced his retirement, it appeared likely that any bill that could survive the Senate would be weaker than the House bill. Then came Mr. Dodd’s announcement, which reshuffled the deck.

There are two diametrically opposed hypotheses about how his retirement will affect the legislation. Conventional wisdom holds that it is good news for reformers: Freed from crass political concerns, Mr. Dodd can now steer his committee more firmly toward a better bill. Let’s hope so. But an opposing view reminds us that lame ducks lose power rapidly in power-mad Washington. To lead, someone must be willing to follow.

My fear is that a once-in-a-lifetime opportunity to build a sturdier and safer financial system is slipping away. Let’s remember what happened to health-care reform (a success story!) as it meandered toward 60 votes in the Senate. The world’s greatest deliberative body turned into a bizarre bazaar in which senators took turns holding the bill hostage to their pet cause (or favorite state). With zero Republican support, every one of the 60 members of the Democratic caucus held an effective veto—and several used it.

If financial reform receives the same treatment, we are in deep trouble, both politically and substantively.

To begin with the politics, recent patterns make it all too easy to imagine a Senate bill being bent toward the will of Republicans—who want weaker regulation—but then garnering no Republican votes in the end. We’ve seen that movie before. If the sequel plays in Washington, passing a bill will again require the votes of every single Democrat plus the two independents. With veto power thus handed to each of 60 senators, the bidding war will not be pretty.

On substance, while both health-care and financial reform are complex, health care at least benefited from broad agreement within the Democratic caucus on the core elements: expanded but not universal coverage, subsidies for low-income families, enough new revenue to pay the bills, insurance exchanges, insurance reform (e.g., no denial of coverage for pre-existing conditions), and experiments in cost containment to “bend the curve.” The fiercest political fights were over peripheral issues like the public option, abortion rights (how did that ever get in there?), and whether Nebraskans should pay like other Americans (don’t try to explain that one to foreigners).

But financial regulatory reform is not like that. Every major element is contentious: a new resolution authority for ailing institutions, a systemic risk regulator, a separate consumer protection agency, whether to clip the Fed’s wings or broaden them, restrictions on executive compensation, regulation of derivatives, limits on proprietary trading, etc.

The elements are interrelated; you can’t just pick one from column A and two from column B. What’s worse, several components would benefit from international cooperation—for example, consistent regulation of derivatives across countries. This last point raises the degree of difficulty substantially. No one worried about international agreement while Congress was writing a health-care bill.

All and all, enacting sensible, comprehensive financial reform would be a tall order even if our politics were more civil and bipartisan than they are. To do so, at least a few senators—Republicans or Democrats—will have to temper their partisanship, moderate their parochial instincts, slam the door on the lobbyists, and do what is right for America. Figure the odds. Gordon Gekko already has.

Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.


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Stimulus? There’s No Stimulus Here.

The president wants to spend more, but don’t ask him what the money is for.

Assuming that Barack Obama holds another White House press conference—his last was back in July—here’s a question worth asking: If the stimulus is truly the success you and your team claim, why are you so reluctant to use the word?

It’s a timely question, with Congress returning to Washington this week after a year of record spending. Right now the spotlight is on the effort by the Democratic leadership to ram through a health-care bill—any health-care bill—in time for the president to declare victory in his State of the Union. But a second stimulus may not be far behind, with the House having already passed a version before members left for Christmas.

The House approved its $154 billion second stimulus package in its last vote of 2009, little more than a week after a policy address Mr. Obama delivered at the Brookings Institution. In that Dec. 8 speech, he reviewed the progress of the earlier stimulus—the $787 billion American Recovery and Reinvestment Act of 2009—and used the occasion to call for additional congressional spending. The headlines rightly described what he was proposing as a “second stimulus.”

Yet perhaps the most intriguing part of that speech is what the president did not say.

Not once did he use the word “stimulus.” If you search under “speeches and remarks” on the White House Web site, it will tell you that the last time the president used the word “stimulus” in public remarks was in an offhand reference in a speech about clean energy in October. A month before that he used the term once in a speech that was about the stimulus.

The president’s increasing shyness about the S-word does not appear to be a coincidence. Here’s a snippet from a December exchange between White House Press Secretary Robert Gibbs and one reporter:

Reporter: “[W]hy are we talking about a second stimulus now?”

Mr. Gibbs: “Well, again, you haven’t heard the President talk about a second stimulus. You heard the President discuss targeted ideas that he believes and the economic team believe will have a positive impact on private sector hiring, and creating an environment that will allow the private sector to make those hiring decisions positively.”

Reporter: “So it’s not a stimulus?”

Mr. Gibbs: “The President hasn’t called it that and I don’t believe it is.”

Mr. Gibbs goes on to characterize the new package of billions in government spending as “targeted ideas.” Hmm. Old Washington hands might rightly wonder whether there is not some memo circulating in the West Wing informing senior staffers that “stimulus” may have acquired a pejorative meaning to the American public—and that White House personnel ought to avoid the word when talking about new spending.

After all, Messrs. Gibbs and Obama are not alone. Others appear to have got the memo, too. While making the rounds of the Sunday shows this weekend, Christina Romer, chair of the White House Council of Economic Advisers, remarkably avoided saying “stimulus” herself. When CNN’s John King specifically asked her about “more stimulus money being spent in the new year,” she took a page out of Mr. Gibbs’ book by speaking of “targeted actions.”

Why the reticence? In itself, “stimulus” ought to be a political positive. After all, describing a bill as a stimulus assumes it will stimulate. Certainly that’s the sense that Paul Krugman—a Nobel-winning economist and New York Times columnist—uses it when he complains that the first stimulus was too small.

Perhaps the reluctance to call the new package a second stimulus has something to do with the extravagant promises Mr. Obama made to sell the first. Less than a month into Mr. Obama’s presidency, the first stimulus was pushed through partly on the promise that doing so would keep unemployment south of 8%. With Friday’s jobs numbers, the same people who sold us that one now have to explain why keeping unemployment at 10% is progress.

A report from the Associated Press that came out yesterday cannot have helped. It analyzed what was thought to be one of the healthiest parts of stimulus—spending on roads and bridges—and concluded that the billions in taxpayer dollars have had “no effect on local employment.” The article goes on to express surprise that “despite the disconnect, Congress is moving quickly to give Obama the road money” he wants for his second stimulus.

That’s not disconnect. It’s classic Beltway. In Washington when your policies don’t work, you don’t change them. You change the name and hope nobody notices.

William McGurn, Wall Street Journal


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Hard to Count the Cost

Prices are often irrational. So are consumers.

Almost two-thirds of retail prices end in a nine on some estimates. These “charm prices”—set just below a round number—are meant to lead consumers to round down rather than up. While some doubt their effectiveness, plainly Steve Jobs is a believer, insisting initially that all tracks on iTunes be priced at 99 cents, as is Jeff Bezos, whose Kindle was first priced at $359, later $299 and then $259.

In “Priceless,” William Poundstone explains charm prices and other common pricing anomalies. More broadly, he explores some of the basic notions of behavioral economics and argues that psychology matters as much as logic in many simple economic decisions. Most prices, Mr. Poundstone notes, are not the result of exact science but are “slippery and contingent,” relying on “coherent arbitrariness”: Consumers don’t know the “right” price for anything and mainly respond to price increases and the price of one thing compared with another.

Not surprisingly, retailers and marketers exploit consumer psychology to make consumers think that they are getting more for less and to divert attention from any attempt to charge more. Sometimes, for instance, manufacturers stealthily reduce the size of their product. Mr. Poundstone cites Skippy peanut butter, which recently added an indentation to its jars that reduced its size by 9%. Consumers tent to react less to this subtle price inflation than to a higher price tag—particularly for regularly purchased products whose price consumers will remember. Eventually, a company will run out of corners to cut and can then start over with an entirely new package and price that is hard to compare to the old one.

Another popular pricing technique is to use expensive “anchors” that consumers use as comparison points. Mr. Poundstone says, for instance, that Prada carries a few “obscenely high priced” items to make everything else seem affordable by comparison. Restaurants sometimes use similar tactics. The “$1,000 caviar and lobster omelet” on the menu at New York restaurant Norma’s is principally for show, not sale. Even if no one orders it, its astronomical price tag may tend to “bewitch” customers into spending more than they would have otherwise.

Whatever the pain of an irrationally expensive breakfast, it pales in comparison with buying an over-priced house. To avoid that mistake, however, a buyer may need to cover up the price tag and appraise the house without being influenced by the seller’s number. In one experiment, a group of licensed real estate agents were shown a house and told that it had been listed for $119,900. When asked to estimate a reasonable purchase price, their average was $111,454. When a different group of agents was told that the listing price for exactly the same house was $149,900, their average estimate was $127,318. The agents had subconsciously used the listing price as a reference point for their appraisals—even though they knew it was irrelevant.

Consumers, of course, are aware of all these tricks. And yet the evidence is overwhelming that they are influenced by them. Forewarned but not forearmed: Individuals are far less rational than they often believe.

This notion has been best explained by Dan Ariely in “Predictably Irrational” (2008), which Mr. Poundstone cites frequently. Mr Ariely explored some of the basic notions of behavioral economics—and showed how real-life decision-making differs from utilitarian economic models. At the core of much behavioral economics is “prospect theory,” a set of ideas that were developed by Daniel Kahneman (winner of the 2002 Nobel Prize in economics) and Amos Tversky.

The theory emphasizes how risk—or risk aversion—affects decision-making, and it helps to explain why actual prices often differ from what one might rationally expect, even for something that is easy to value—like money itself. Consumers tend to over-value certainty: When offered the choice between a certain $3,000 and an 80% chance of $4,000, most people choose the lower amount even though the alternative’s expected value—its average probability-weighted return—is $3,200. Similarly, individuals have an irrationally high aversion to loss: Most people turn down an offer to flip a coin and win $110 for heads and lose $100 for tails. A study of contestants on the TV game show “Deal or No Deal” found that more decisions were consistent with prospect theory than with maximizing the expected return.

The additional value that individuals place on locking in certainty and avoiding loss explains why consumers are willing to buy financial products that otherwise seem to make no sense—such as extended product warranties where the price of the warranty is greater than the expected value of the loss being protected. Similarly it explains why consumers over-pay for flat-rate plans—say, unlimited calling plans, when a limited plan would likely be cheaper: They want to avoid the risk of a huge bill.

While Mr. Poundstone explains the increasingly sophisticated techniques that businesses use to exploit human irrationality, he says little about the effect that the rise of e-commerce may have on all this pricing strategy. While there may still be some scope for psychological manipulation, consumers should be harder to confuse with access to instant price comparisons and product research online. Relatedly, the Web may offer opportunities for better customer segmentation and hence finer price differentiation—where prices take into account each consumer’s willingness to pay. Why give everyone a discount when some people will pay full price? Perhaps the customer that searched for “highest rated” will pay more than someone who searched for “lowest price.” Tailored offers and customized bundles can muddy the water for comparisons. As Robert Crandall, a former CEO of American Airlines, has said: “If I have 2,000 customers on a given route and 400 different prices, I’m obviously short 1,600.”

Mr. Philips is executive vice president of News Corp., which owns Dow Jones & Co., the publisher of The Wall Street Journal.

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Should Old Articles Be Forgot

OVER the past year, Americans have spent an average of 11.8 hours a day consuming information, sucking up, in aggregate, 3.6 zettabytes of data and 10,845 trillion words. That, said the University of California, San Diego, researcher who computed these figures, is triple the amount of “content” that we consumed in 1980.

Thanks to this gargantuan download from all forms of media, we now know vastly more than we did a year ago about bankers’ bonuses, Sarah Palin, “death panels,” Glenn Beck, where Barack Obama was born, Jon and Kate, and cocktail waitresses who have spent quality time with Tiger Woods.

Hidden among that avalanche of diverting gigabytes were some developments of more enduring significance. Here are just a few:

ROBOTIC WARFARE The use of drones became a central part of the American antiterrorism strategy this year, with President Obama sanctioning about 50 Predator strikes — more than George W. Bush approved in his entire second term. As Jane Mayer of The New Yorker reported earlier this year, most of the targets of these assassinations were in the tribal regions of Pakistan, with as many as 500 people killed. Those killed in the missile attacks include many high-ranking Qaeda and Taliban figures and dozens of women and children who lived with them or happened to be nearby.

The military is so enthusiastic about these remotely piloted planes that it is building new ones as fast as it can (including a more heavily armed version called the Reaper). It also announced that it will deploy drones to scour the Gulf of Mexico, the Pacific Ocean and the Caribbean for drug smugglers. What’s more, the government is now working on “nano” drones the size of a hummingbird, which would be able to pursue targets into homes and buildings.

CAR CRAZY IN CHINA This year, China surpassed the United States as the largest consumer of that iconic American machine — the automobile. China’s emerging middle class has fallen in love with cars, with sales up more than 40 percent over 2008; there are now long waiting lists for the coolest and hottest models, ranging from the Buick LaCrosse to BMWs. Automakers are expected to sell 12.8 million cars and light trucks in China this year — 2.5 million more than in America.

China’s auto boom, of course, has major implications for global efforts to reduce greenhouse-gas emissions. The nation of 1.3 billion is on pace to double its consumption of gasoline and diesel over the next decade.

REAL WORKING WIVES In more than a third of American households, women are now the chief breadwinners. This reversal of traditional roles was accelerated by a brutal two-year recession, in which 75 percent of all jobs lost were held by men.

Even in homes where both spouses work, one in four wives now earns more than her husband. That’s partly because of rising education levels among women, falling salaries in manufacturing and blue-collar jobs and the growing need for both spouses to bring home a paycheck. Wives’ earnings, said Kristin Smith, a professor of sociology at the University of New Hampshire, have become “critical to keeping families afloat.”

A NEW SOURCE OF STEM CELLS Scientists re-engineered regular skin cells from mice into stem cells that are just as versatile as embryonic stem cells. To demonstrate that these re-engineered adult cells could be used to create any kind of cell in the body, the Chinese research team inserted just a few of them into placental tissue and developed them into healthy mice. “We have gone from science fiction to reality,” said Robert Lanza, a cell biologist.

If further research on the new technique proves successful, it may create a viable means for scientists to use a patient’s own tissue to produce a replacement liver, kidney or other organ — without the ethical concerns attached to the harvesting of stem cells from human embryos. But reprogramming adult cells opens the door to a new ethical problem: a rogue scientist could use the method to create human beings from a few cells scraped from a person’s arm. “All the pieces are there for serious abuse,” Mr. Lanza said.

TEEMING WITH PLANETS Astronomers are closing in on identifying distant worlds that may have the right conditions to support life. Techniques for detecting “exoplanets” are becoming more sophisticated, and over 400 have been discovered so far — 30 in October alone. This year brought two particularly intriguing finds. One is Gliese 581d, orbiting a star at a distance that could indicate surface temperatures not so different from Earth’s. Astronomers also discovered a “waterworld” composed mostly of H2O, which would be a prime candidate for extraterrestrial life if it were just a little farther from its sun.

The discovery of Earth-like planets, with water and moderate temperatures, is now so likely that the Vatican held a conference of astrobiologists this year to discuss the theological repercussions of extraterrestrial life. “If biology is not unique to the Earth, or life elsewhere differs biochemically from our version, or we ever make contact with an intelligent species in the vastness of space, the implications for our self-image will be profound,” said Chris Impey, a professor of astronomy at the University of Arizona.

Discovering that we have company in the universe, in fact, might open our eyes to what’s important on Earth.

William Falk is the editor in chief of The Week magazine.


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The Sidney Awards II

On Friday, I gave out the first batch of Sidney Awards for the best magazine essays of the year. Frankly, it was disappointing to see how quickly some winners were corrupted by fame. Several have already abandoned their families, accepted spots on reality shows and begun hanging out with Lil Wayne. I’m hoping today’s winners will do a better job of keepin’ it real.

Steven Brill’s essay, “The Rubber Room,” in The New Yorker generated a lot of discussion. It’s about the room where New York City schoolteachers who have been dismissed for incompetence sit for years on end and continue to collect their six-figure salaries for doing nothing. The word Dickensian doesn’t fully describe the madness of a system that cannot get rid of bad teachers.

Brill takes readers inside the room, and describes the arbitration hearings for teachers who want to be reinstated. One hearing, with clear-cut evidence against the teacher, stretches on 50 per cent longer than the O.J. trial.

Few essays are as ruthlessly honest as Bethany Vaccaro’s piece, “Shock Waves,” in The American Scholar. Vaccaro’s brother Robert suffered a brain injury, caused by an I.E.D. explosion in Iraq in January 2007.

Vaccaro describes her first glimpse of him weeks after the explosion at Bethesda Naval Hospital. “Robert was swollen and bloated; his skin was puffy and enamel white. He looked worse than dead and somehow a bit reptilian.” But the real subject of the essay is the injury’s effect on her family. “Now it defines our daily existence. The ongoing process of rehabilitation since his injury has tenaciously enmeshed each one of us, altering our plans, our family structure and interactions, our ideas about life and sacrifice, and most resolutely our belief that if he would only make it back home, everything would be O.K.”

Robert’s injury, she writes, has “allowed him to come so close to being normal, and yet miss it altogether … He will frequently prattle away with wide-eyed seriousness and then collapse into silly laughter that is sweet and uninhibited but also sad coming from a 25-year-old man.”

After the Israeli incursion into Gaza, the U.N. produced the Goldstone Report, a tendentious and simple-minded account of Israeli tactics. But the report at least produced a sophisticated response, “The Goldstone Illusion,” by Moshe Halbertal in The New Republic.

Here’s a typical problem: Hamas fires rockets from apartment buildings. Israel calls the residents of the buildings to warn them a counterattack is coming. Hamas then escorts the residents to the roof, knowing Israeli drones will not fire on crowded roofs. Israel then deploys a “roof-knocking missile,” a weapon designed to scare people off roofs in preparation for an attack. Halbertal wrestles with the moral boundaries that should guide this kind of warfare.

On the big think front, Josef Joffe has a bracing essay, “The Default Power,” in Foreign Affairs, puncturing the claims that America is in decline. William M. Chace wrote “The Decline of the English Department” in The American Scholar on why fewer and fewer college students major in the humanities.

Jim Manzi’s essay, “Keeping America’s Edge,” in National Affairs, explores two giant problems. First, widening inequality; second, economic stagnation, the fear that without rapid innovation, the U.S. will fall behind China and other rising powers.

Manzi investigates a dilemma. Most efforts to expand the welfare state to tackle inequality will slow innovation. Efforts to free up enterprise, meanwhile, will only exacerbate inequality because the already educated will benefit most from information economy growth.

In her Policy Review essay, “Is Food the New Sex?,” Mary Eberstadt notes that people in modern societies are freer to consume more food and sex than their ancestors. But this has produced a paradox. For most of human history, food was a matter of taste while sex was governed by universal moral laws. Now the situation is nearly reversed. Food has become enmeshed in moralism while the privacy of the bedroom is sacred. Eberstadt asks why, and provides a philosophical answer.

It’s become fashionable to bash Malcolm Gladwell for being too interesting and not theoretical enough. This is absurd. Gladwell’s pieces in The New Yorker are always worth reading, so I’ll just pick out one, “Offensive Play,” on the lingering effects of football violence, for a Sidney award — in part to celebrate his work and in part as protest against the envious herd.

There are, of course, many other essays that, in a less arbitrary world, would get Sidneys. Fortunately there are a few Web sites that provide daily links to the best that is thought and said. Arts and Letters Daily is the center of high-toned linkage on the Web. The Browser is a trans-Atlantic site with a superb eye for the interesting and the profound. Book Forum has a more academic feel, but it is also worth a daily read.

David Brooks, New York Times


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The Deficit Commission Trap

Democrats now want Republican cover for their tax increases.

After signing a $787 billion economic stimulus and embracing two annual blowout budgets that will double the national debt over 10 years even before ObamaCare, President Obama is poised to pivot next (election) year and denounce the horrors of deficit spending. So the White House it is now floating a bipartisan commission to reduce federal borrowing, and much of the political class is all for it.

We only hope Republicans aren’t foolish enough to fall down this trap door, though some are already tempted. A budget deficit commission is nothing more than a time-tested ploy to get Republicans to raise taxes. In the 2009 version, Republicans are being teed up to hold hands with Democrats and agree to become the tax collectors for Obamanomics.

The deficit reduction commission is a longstanding idea that is now being pushed with renewed fervor by Republican Frank Wolf of Virginia and Democrat Jim Cooper of Tennessee in the House and Democrat Kent Conrad of North Dakota and Republican Judd Gregg of New Hampshire in the Senate. All you need to know about the sincerity of the two Democrats is that they’re both supporting the multitrillion-dollar health-care entitlement even as they moan about the fiscal dangers of current entitlements.

Mr. Wolf says the commission would be “a 16-member panel that would look at everything—from what the government is required to spend on mandatory entitlements to spending on all other programs to tax policy.” Congress would agree to vote up or down on the package through expedited procedures without amendments. Messrs. Gregg and Wolf believe this is the only way to force a Washington consensus to slow the growth of federal spending.

They’re correct that current federal commitments are unsustainable, starting with $37 trillion in unfunded Medicare liabilities. They’re also right that a Washington consensus is likely to emerge from such a commission, but history shows it is unlikely to favor more than token future spending reductions. The real goal is to get GOP political cover for tax increases so Democrats aren’t run out of town in 2010 and 2012 for blowing up the national balance sheet.

Let Mr. Conrad explain: “If one looks at the history of how these major [deficit reduction] agreements have been reached, it’s almost always been through some sort of special process.” He mentions in particular the 1983 Social Security commission and the 1990 budget deal.

Remember those gems? In 1983 Ronald Reagan and Congressional Republicans agreed to decades of job-destroying increases in payroll taxes to “fix” Social Security, which you may have noticed still isn’t fixed. As for 1990, that was the infamous Andrews Air Force Base summit when President George H.W. Bush renounced his no-new-taxes pledge and made himself a one-termer. No wonder Mr. Conrad wants a repeat. The budget deficit nearly doubled in the year after that deal, and it wasn’t eliminated until Republicans took Congress in 1994 and reduced the rate of spending increases.

Democrats are candid, at least in private, about the kind of the deal they have mind this time around. Democrats would agree to means-test entitlements, which means that middle and upper-middle class (i.e., GOP) voters would get less than they were promised in return for a lifetime of payroll taxes. Democrats would also agree to cut appropriations by two or three percentage points and live under pay-as-you-go budget rules—the same rules Democrats promised to live by in 2006 but have since violated routinely.

In return, Republicans would agree to an increase in the top income tax rate to as high as 49% and in addition to a new energy tax, a stock transaction tax, or value-added tax. The Indians got a better deal for selling Manhattan.

New taxes will only reduce the pressure to cut future spending. From 2001 to 2008, under President Bush, federal spending on discretionary spending grew by 54%. Mr. Obama’s policies have expanded these agency budgets by another 57% over just two years. So an offer to cut these programs by 2% to 3% gives up very little.

The other big spending drivers are Medicare and Medicaid, which grew in fiscal 2009 by 10.1% and 24.6% respectively. But the House and Senate health bills would vastly expand the latter and likely retain the status quo for the former, at least at first. And rather than use repaid financial bailout money to reduce the deficit, Democrats are now moving to take $130 billion in TARP cash and spend it on a new “jobs” stimulus even as the economy has begun to grow again. Why should Republicans sign up as the tax collectors for this agenda?

The Democrats will use a tax-and-spend commission to confront Republicans with the false choice between huge tax increases or fiscal disaster. Republicans should respond with their own choice: They’ll agree to a deficit commission only if it takes tax increases off the table and forces all of Washington to confront the hard spending trade-offs between guns and butter, old and young, the poor and middle class, and social welfare and corporate welfare. Otherwise, Democrats should be forced to defend and finance their own destructive fiscal choices.

Editorial, Wall Street Journal


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The Big Zero

Maybe we knew, at some unconscious, instinctive level, that it would be an era best forgotten. Whatever the reason, we got through the first decade of the new millennium without ever agreeing on what to call it. The aughts? The naughties? Whatever. (Yes, I know that strictly speaking the millennium didn’t begin until 2001. Do we really care?)

But from an economic point of view, I’d suggest that we call the decade past the Big Zero. It was a decade in which nothing good happened, and none of the optimistic things we were supposed to believe turned out to be true.

It was a decade with basically zero job creation. O.K., the headline employment number for December 2009 will be slightly higher than that for December 1999, but only slightly. And private-sector employment has actually declined — the first decade on record in which that happened.

It was a decade with zero economic gains for the typical family. Actually, even at the height of the alleged “Bush boom,” in 2007, median household income adjusted for inflation was lower than it had been in 1999. And you know what happened next.

It was a decade of zero gains for homeowners, even if they bought early: right now housing prices, adjusted for inflation, are roughly back to where they were at the beginning of the decade. And for those who bought in the decade’s middle years — when all the serious people ridiculed warnings that housing prices made no sense, that we were in the middle of a gigantic bubble — well, I feel your pain. Almost a quarter of all mortgages in America, and 45 percent of mortgages in Florida, are underwater, with owners owing more than their houses are worth.

Last and least for most Americans — but a big deal for retirement accounts, not to mention the talking heads on financial TV — it was a decade of zero gains for stocks, even without taking inflation into account. Remember the excitement when the Dow first topped 10,000, and best-selling books like “Dow 36,000” predicted that the good times would just keep rolling? Well, that was back in 1999. Last week the market closed at 10,520.

So there was a whole lot of nothing going on in measures of economic progress or success. Funny how that happened.

For as the decade began, there was an overwhelming sense of economic triumphalism in America’s business and political establishments, a belief that we — more than anyone else in the world — knew what we were doing.

Let me quote from a speech that Lawrence Summers, then deputy Treasury secretary (and now the Obama administration’s top economist), gave in 1999. “If you ask why the American financial system succeeds,” he said, “at least my reading of the history would be that there is no innovation more important than that of generally accepted accounting principles: it means that every investor gets to see information presented on a comparable basis; that there is discipline on company managements in the way they report and monitor their activities.” And he went on to declare that there is “an ongoing process that really is what makes our capital market work and work as stably as it does.”

So here’s what Mr. Summers — and, to be fair, just about everyone in a policy-making position at the time — believed in 1999: America has honest corporate accounting; this lets investors make good decisions, and also forces management to behave responsibly; and the result is a stable, well-functioning financial system.

What percentage of all this turned out to be true? Zero.

What was truly impressive about the decade past, however, was our unwillingness, as a nation, to learn from our mistakes.

Even as the dot-com bubble deflated, credulous bankers and investors began inflating a new bubble in housing. Even after famous, admired companies like Enron and WorldCom were revealed to have been Potemkin corporations with facades built out of creative accounting, analysts and investors believed banks’ claims about their own financial strength and bought into the hype about investments they didn’t understand. Even after triggering a global economic collapse, and having to be rescued at taxpayers’ expense, bankers wasted no time going right back to the culture of giant bonuses and excessive leverage.

Then there are the politicians. Even now, it’s hard to get Democrats, President Obama included, to deliver a full-throated critique of the practices that got us into the mess we’re in. And as for the Republicans: now that their policies of tax cuts and deregulation have led us into an economic quagmire, their prescription for recovery is — tax cuts and deregulation.

So let’s bid a not at all fond farewell to the Big Zero — the decade in which we achieved nothing and learned nothing. Will the next decade be better? Stay tuned. Oh, and happy New Year.

Paul Krugman, New York Times


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The Sidney Awards I

Every year, I give out Sidney Awards to the best magazine essays of the year. In an age of zipless, electronic media, the idea is to celebrate (and provide online links to) long-form articles that have narrative drive and social impact.

The first rule of the Sidneys is that they cannot go to any article that appeared in The Times. So David Rohde does not get a Sidney for his unforgettable series on being held captive by the Taliban. But those pieces possess exactly the virtues that the Sidneys are meant to honor, and they make one proud to be a journalist.

This year, magazines had a powerful effect on the health care debate. Atul Gawande’s piece, “The Cost Conundrum,” in The New Yorker, was the most influential essay of 2009, and David Goldhill’s “How American Health Care Killed My Father,” in The Atlantic, explained why the U.S. needs fundamental health reform. But special recognition should also go to Jonathan Rauch’s delightful essay, “Fasten Your Seat Belts — It’s Going to Be a Bumpy Flight,” in The National Journal.

Rauch described what the airline industry would look like if it worked the way the health care industry works. The piece takes the form of a customer trying to book a flight with a customer service representative. The customer wants to fly from Washington, D.C., to Oregon on Oct. 3, but the airline lady can squeeze him in only in January or February. He can call each of two dozen other airlines if he wants to check other availability.

When he finally gets on a flight, he finds that his airline will only take him to Chicago, since it’s an eastern-region specialist. He’ll have to find a western-region specialist to get to Eugene. In addition, he’ll have to fax in a 30-page travel history questionnaire, make arrangements with a separate luggage transport provider and see if he can find a fuelist who might be free to make fuel arrangements on that date. That is, if the airline is in his insurance company’s provider network, which it isn’t.

The most powerful essay I read this year was David Grann’s “Trial by Fire” in The New Yorker. Grann investigated the case of Cameron Todd Willingham, who was executed in 2004 for murdering his three children by setting their house on fire.

In the first part of the essay, Grann lays out the evidence that led to Willingham’s conviction: the marks on the floor and walls that suggested that a fire accelerant had been splashed around; the distinct smoke patterns suggesting arson; the fact that Willingham was able to flee the house barefoot without burning his feet.

Then, in the rest of the essay, Grann raises grave doubts about that evidence. He tells the story of a few people who looked into the matter, found a miscarriage of justice and then had their arguments ignored as Willingham was put to death. Grann painstakingly describes how bogus science may have swayed the system to kill an innocent man, but at the core of the piece there are the complex relationships that grew up around a man convicted of burning his children. If you can still support the death penalty after reading this piece, you have stronger convictions than I do.

I try not to give Sidneys to the same people year after year, but the fact is, talent is not randomly distributed. Some people, like Matt Labash of The Weekly Standard, just know how to write. His piece, “A Rake’s Progress” was a sympathetic and gripping profile of Marion Barry, the former Washington, D.C., mayor, crack-smoker and recent girlfriend-stalker.

At the start of his first interview, Labash, making small talk, asked Barry if he still has a scar from an old bullet wound: “ ‘Let’s see,’ he says, lifting his shirt, so that within ten minutes of arriving, I’m eyeball to areola with Barry’s left nipple. It’s a move that’s very Barry. Most times, he reveals nothing at all. Then he reveals too much.”

Labash delights in Barry’s rascally nature, but also captures why the voters of Barry’s ward don’t merely vote for him, they possess him and cherish him.

The region around Afghanistan is now regarded as a global backwater, but S. Frederick Starr’s “Rediscovering Central Asia,” in The Wilson Quarterly, is an eye-opening look at what once was. A thousand years ago, those mountains were the intellectual center of the world. Central Asians invented trigonometry, used crystallization as a means of purification, estimated the Earth’s diameter with astonishing precision and anticipated Darwin’s theory of evolution. Starr describes glittering cities and a flowering of genius. He also describes the long decline — the Sunni-Shia split played a role — and modern glimmers of revival.

On Tuesday, we will publish another batch of Sidney winners, so turn off “It’s a Wonderful Life.” Read these today.

David Brooks, New York Times


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A Low, Dishonest Decade

The press and politicians were asleep at the switch.

Stock-market indices are not much good as yardsticks of social progress, but as another low, dishonest decade expires let us note that, on 2000s first day of trading, the Dow Jones Industrial Average closed at 11357 while the Nasdaq Composite Index stood at 4131, both substantially higher than where they are today. The Nasdaq went on to hit 5000 before collapsing with the dot-com bubble, the first great Wall Street disaster of this unhappy decade. The Dow got north of 14000 before the real-estate bubble imploded.

And it was supposed to have been such an awesome time, too! Back in the late ’90s, in the crescendo of the Internet boom, pundit and publicist alike assured us that the future was to be a democratized, prosperous place. Hierarchies would collapse, they told us; the individual was to be empowered; freed-up markets were to be the common man’s best buddy.

Such clever hopes they were. As a reasonable anticipation of what was to come they meant nothing. But they served to unify the decade’s disasters, many of which came to us festooned with the flags of this bogus idealism.

Before “Enron” became synonymous with shattered 401(k)s and man-made electrical shortages, the public knew it as a champion of electricity deregulation—a freedom fighter! It was supposed to be that most exalted of corporate creatures, a “market maker”; its “capacity for revolution” was hymned by management theorists; and its TV commercials depicted its operations as an extension of humanity’s quest for emancipation.

Jack Abramoff

Similarly, both Bank of America and Citibank, before being recognized as “too big to fail,” had populist histories of which their admirers made much. Citibank’s long struggle against the Glass-Steagall Act was even supposed to be evidence of its hostility to banking’s aristocratic culture, an amusing image to recollect when reading about the $100 million pay reportedly pocketed by one Citi trader in 2008.

The Jack Abramoff lobbying scandal showed us the same dynamics at work in Washington. Here was an apparent believer in markets, working to keep garment factories in Saipan humming without federal interference and saluted for it in an op-ed in the Saipan Tribune as “Our freedom fighter in D.C.”

But the preposterous populism is only one part of the equation; just as important was our failure to see through the ruse, to understand how our country was being disfigured.

Ensuring that the public failed to get it was the common theme of at least three of the decade’s signature foul-ups: the hyping of various Internet stock issues by Wall Street analysts, the accounting scandals of 2002, and the triple-A ratings given to mortgage-backed securities.

The grand, overarching theme of the Bush administration—the big idea that informed so many of its sordid episodes—was the same anti-supervisory impulse applied to the public sector: regulators sabotaged and their agencies turned over to the regulated.

The public was left to read the headlines and ponder the unthinkable: Could our leaders really have pushed us into an unnecessary war? Is the republic really dividing itself into an immensely wealthy class of Wall Street bonus-winners and everybody else? And surely nobody outside of the movies really has the political clout to write themselves a $700 billion bailout.

What made the oughts so awful, above all, was the failure of our critical faculties. The problem was not so much that newspapers were dying, to mention one of the lesser catastrophes of these awful times, but that newspapers failed to do their job in the first place, to scrutinize the myths of the day in a way that might have prevented catastrophes like the financial crisis or the Iraq war.

The folly went beyond the media, though. Recently I came across a 2005 pamphlet written by historian Rick Perlstein berating the big thinkers of the Democratic Party for their poll-driven failure to stick to their party’s historic theme of economic populism. I was struck by the evidence Mr. Perlstein adduced in the course of his argument. As he tells the story, leading Democratic pollsters found plenty of evidence that the American public distrusts corporate power; and yet they regularly advised Democrats to steer in the opposite direction, to distance themselves from what one pollster called “outdated appeals to class grievances and attacks upon corporate perfidy.”

This was not a party that was well-prepared for the job of iconoclasm that has befallen it. And as the new bunch muddle onward—bailing out the large banks but (still) not subjecting them to new regulatory oversight, passing a health-care reform that seems (among other, better things) to guarantee private insurers eternal profits—one fears they are merely presenting their own ample backsides to an embittered electorate for kicking.

Thomas Frank, Wall Street Journal


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A God of the Copybook Headings

The uncommon wisdom of George Melloan.

In the Carboniferous Epoch were promised abundance for all;

By robbing selected Peter to pay for collective Paul;

But, though we had plenty of money, there was nothing our money could buy;

And the Gods of the Copybook Headings said: “If you don’t work, you die.”

—Rudyard Kipling

In a couple of days, the Senate will give its 60 ayes to the largest expansion of government since the Great Society. The Obama administration is proposing a third round of fiscal stimulus, because the first two worked so well. And Ben Bernanke is, without irony, Time’s Person of the Year.

All of which is a reminder that, unlike vampires, there’s no driving a stake through the heart of a bad idea. Karl Marx will always be with us, at least at the New Yorker. So will Jean-Jacques Rousseau, the patron saint of environmentalists even if they don’t know it. And so will John Maynard Keynes, godfather of Obamanomics. History is only repeated as farce to those who either have forgotten it or enjoy the sick humor of a disaster foretold.

Then again, as George Melloan reminds us in “The Great Money Binge: Spending Our Way to Socialism,” just as bad ideas never quite go out of fashion, neither do good ones. Readers looking for an antidote to this season’s political gloom will find more than the full dose in this splendid book.

Mr. Melloan was, of course, the writer of this column for many years, one of the labors in a career at the Journal that spanned 54 years as a reporter, editor and commentator. Among the benefits of a long career is a long memory and an imperviousness to intellectual fads. In Kipling’s terms, he is one of the Gods of the Copybook Headings—the unfashionable keepers of hard truths about which we must occasionally be reminded.

In today’s economy, the hard truth is that we can’t spend, consume, manipulate and inflate our way to general prosperity—as opposed merely to the enrichment of Democratic Party interest groups. This was the dominant economic model of the 1970s, with results that were once well known. “The Great Money Binge” makes short work of the theory:

“Demand-side economics holds that the economy derives its momentum from consumption, and it is of little moment if that consumption is financed by credit,” he writes. “But if that were true, everyone could merrily use his credit card to supply his wants and never have to work. Maybe there’s a logical flaw there somewhere.”

The great strength of Mr. Melloan’s book is to show, in exacting detail, not only how we came to our current crisis—thank you, Barney Frank, Chris Dodd, Alan Greenspan and Tom DeLay—but where that logical flaw is destined to take us again.

The alternative is supply-side economics, which, for all the invective heaped upon it, boils down to the inescapable fact that “consumption must be paid for with production”—that if you don’t work (i.e., produce) you die (i.e., can’t consume). The obviousness of this is so manifest that the real wonder is how it has escaped the grasp of otherwise intellectually competent people.

Perhaps more interesting is how it didn’t escape the grasp of Mr. Melloan, one of whose principal achievements was his role—along with the Bob Bartley—in turning the Journal’s editorial pages into the great disseminator of supply-side thinking. Mr. Melloan chalks it up to his background as the son of an Indiana yeoman farmer for whom there was nothing abstract about the words property, production and market. “We Journal editors were a rather proletarian lot to be promoting capitalism,” he writes. “We were not the voice of big business, as our critics glibly called us at the time, but exponents of free-market capitalism, an economic system that allows any individual to build a business and compete with the big boys. The two things are definitely not the same.”

But what Mr. Melloan doesn’t say is that he is also an heir to the antisophistic tradition of the Western philosophy—stretching from Socrates to Paul to William of Ockham to Jean-Baptiste Say to Karl Popper—that insisted that truth was more likely to be found in simplicity than complexity. No surprise, sophists of every age have attacked this tradition (sophistically) as “simplistic,” and people like Mr. Melloan have had to endure it.

Yesterday, President Obama made the remarkable observation that “we can’t continue to spend as if deficits don’t have consequences, as if waste doesn’t matter, as if the hard earned tax dollars of the American people can be treated like Monopoly money.” Maybe he’s finally learned, as Kipling taught,

That after this is accomplished, and the brave new world begins

When all men are paid for existing, and no man must pay for his sins,

As surely as Water will wet us, as surely as Fire will burn,

The Gods of the Copybook Headings with terror and slaughter return!

Then again, maybe the president finally got around to reading George Melloan.

Bret Stephens, Wall Street Journal


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The ‘Global Imbalances’ Myth

Different countries have always played different roles in the world economy.

As the economic crisis has eased in recent months, a questionable international consensus has emerged: The global economy needs to be rebalanced. “We cannot follow the same policies that led to such imbalanced growth,” President Barack Obama said during his Asia trip last month. European Central Bank head Jean-Claude Trichet declared in September that “imbalances have been at the roots of the present difficulties. If we don’t correct them, we’ll have the recipe for the next major crisis.”

These global “imbalances” supposedly include excessive American consumption, too much trade flowing from Asia to the West and not enough from the U.S. to Asia, and too much saving combined with insufficient spending by Chinese consumers. But what if the whole notion of global imbalances is a myth, and that policies to reverse them only make things worse?

The blunt fact is that at no point in the past century has there been anything resembling a global economic equilibrium.

Consider the heyday of the “American century” after World War II, when Western European nations were ravaged by war, and the Soviet Union and its new satellites slowly rebuilding. In 1945, the U.S. accounted for more than 40% of global GDP and the preponderance of global manufacturing. The country was so dominant it was able to spend the equivalent of hundreds of billions of dollars to regenerate the economies of Western Europe via the Marshall Plan, and also of Japan during a seven year military occupation. By the late 1950s, 43 of the world’s 50 largest companies were American.

The 1970s were hardly balanced—not with the end of the gold standard, the oil shocks and the 1973 Arab oil embargo, inflation and stagflation, which spread from the U.S. through Latin America and into Europe.

The 1990s were equally unbalanced. The U.S. consumed and absorbed much of the available global capital in its red-hot equity market. And with the collapse of the Soviet Union and the economic doldrums of Germany and Japan, the American consumer assumed an ever-more central position in the world. The innovations of the New Economy also gave rise to a stock-market mania and overshadowed the debt crises of South America and the currency implosion of South Asia—all of which were aggravated by the concentration of capital in the U.S. and the paucity of it in the developing world. When the tech bubble burst in 2000, it had little to do with these global dynamics and everything to do with a glut of telecommunication equipment in the U.S., and stock-market exuberance gone wild.

When officials and economists today speak of correcting global imbalances, it is unclear what benchmark they have in mind.

So-called excessive American consumption, East-West trade flows, Chinese savings and the like were not responsible for the recent crisis. That was instead triggered by massive misplaced bets on the U.S. housing market and trillions of dollars of derivatives built upon that flimsy foundation.

Yes, many have woven a compelling narrative of how the relationship between China and the U.S.—distorted by China’s fixed and nonconvertible currency on the one hand and America’s debt-fueled appetites on the other—led to massive flows of capital out of the U.S. But that money flowed right back into the U.S. in the form of Chinese purchases of Treasury bonds, mortgage-backed securities and other dollar-denominated assets, which then flowed into our banking system, which then made its way back to U.S. business and to the Treasury, some of which then circulated back into China.

What some see as imbalances can also be described as a system of capital and goods in constant motion. Chinese reserves and U.S. government debt didn’t trigger the meltdown, nor did U.S. consumers cause the meltdown. It wasn’t even U.S. consumer debt—after all, more than 90% of Americans have remained current on their credit cards and their mortgages. The real (and much messier) cause of the meltdown was a potent brew of financial innovation, electronic and instantaneous flow of capital, greed on the part of banks and investors world-wide, against a backdrop of an economic fusion between China and the U.S. that kept interest rates low and inflation lower.

Today’s consensus sounds very much like the orthodoxy of yesteryear—let each nation be its own system in equilibrium, interacting with other systems to create one mega-balanced system. Yet such balance has only existed in theory and only ever will.

Indeed, if the crisis of the past year teaches us anything it should be that forcing reality to conform to abstract theory is a sure recipe for disaster. Forced to act with expediency in the moment, the central banks and governments of the world did a surprisingly good job of triage during the economic emergency that swept the globe. The eclectic demands of a crisis outweighed models and theories, and that was a good thing.

Now that the crisis has eased, the greatest danger is that our collective belief in how the world should work drowns out the creative nimbleness of policy that adapts to the world as it is actually working. Policies that might stem from the global imbalances consensus include American government incentives to increase domestic savings. This sounds good, but not if it leads to underinvestment in innovation, education and infrastructure.

It could also lead Chinese officials to attempt to shift away from exports and state spending. Over the long term this might be beneficial, but it could wreak havoc on domestic Chinese growth and global supply chains if it is done under the erroneous belief that urgent action is required. For its part, the European Union rightly claims that it has not been a primary cause of the perceived imbalances. But its leaders have been central to pushing that thesis and urging China and the U.S. to redress them.

Thankfully, there is less risk of the Chinese government upsetting their apple cart than there is of the American government acting precipitously.

Mr. Karabell is president of River Twice Research and the author, most recently, of “Superfusion: How China and America Became One Economy” (Simon & Schuster, 2009).


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A look at how Americans lose their jobs

George Clooney as a modern terminator in the film “Up in the Air.”

“Last year,” Ryan Bingham says, “I spent 322 days on the road, which means that I had to spend 43 miserable days at home.” Home is an Omaha rental unit less furnished than a hotel room. He likes it that way.

Today he is where he feels at home, in an airport — glass walls and glistening steel, synthetic sincerity and antiseptic hospitality. Today he is showing Natalie, a ferocious young colleague, how an expert road warrior deals with lines at security screening:

Avoid, he says, getting behind travelers with infants (“I’ve never seen a stroller collapse in less than 20 minutes”). Or behind elderly people (“Their bodies are littered with hidden metal, and they never seem to appreciate how little time they have left on Earth”). Do get behind Asians: “They’re light packers, treasure efficiency and have a thing for slip-on shoes.”

Natalie: “That’s racist.”

Bingham: “I stereotype. It’s faster.”

Played with seemingly effortless perfection by the preternaturally smooth George Clooney, Bingham is the cool porcelain heart of the movie “Up in the Air.” It is a romantic comedy, although Bingham begins immune to romance and, after a brief and ill-advised lapse into feeling, ends the movie that way. And the comedy is about pain — about administering it somewhat humanely to people who are losing their jobs.

Bingham is a “termination engineer.” He fires people for companies that want to outsource the awkward, and occasionally dangerous, unpleasantness of downsizing. His pitter-patter for the fired — “Anybody who ever built an empire, or changed the world, sat where you are now” — rarely consoles. But with his surgeon’s detachment, he is more humane than Natalie, who says this:

“This is the first step of a process that will end with you in a new job that fulfills you. . . . I’d appreciate it if you didn’t spread the news just yet. Panic doesn’t help anybody.”

Her brainstorm as a confident young cost-cutter from Cornell is to fire people by video-conferencing. She tells one desolated man:

“Perhaps you’re underestimating the positive effect your career transition may have on your children. . . . Tests have shown that children under moderate trauma have a tendency to apply themselves academically as a method of coping.”

Bingham considers his low emotional metabolism an achievement, and in motivational speeches he urges his audiences to cultivate it: “Your relationships are the heaviest components of your life. . . . The slower we move, the faster we die. We are not swans. We’re sharks.”

The movie begins and ends with everyday people talking to the camera, making remarkably sensitive statements about the trauma of being declared dispensable. Some, however, recall that the consequences included being reminded that things they retained, such as their human connections, are truly indispensable.

The opening soundtrack is a weird version of Woody Guthrie’s “This Land Is Your Land.” This hymn to Depression-era radicalism is catnip for people eager to tickle a political manifesto from any movie that has a contemporary social setting.

But although “Up in the Air” may look like a meditation on the Great Recession — “The Grapes of Wrath” for a service economy — it is based on a novel published in 2001, during the mildest recession since the Depression, and written before that.

You must remember this: In 2006, the last full year before this downturn, when the economy grew 2.7 percent and the unemployment rate was just 4.6 percent, 3.3 million people lost their jobs to the normal churning of a dynamic economy. This “creative destruction” has human costs but no longer is optional.

America has an aging population and has chosen to have a welfare state that siphons increasing amounts of wealth from the economy to give to the elderly. Having willed this end, America must will the means to it — sometimes severe economic efficiency to generate revenue to finance the entitlement culture. So “Up in the Air” is sobering entertainment for a nation contemplating a giant addition to the entitlement menu.

In addition to being perhaps the best American movie of 2009, “Up in the Air” is two mature themes subtly braided and nuanced for grown-ups. One is the sometimes shattering sense of failure, desperation and worthlessness that overwhelms middle-aged people who lose their livelihoods. The other is that such shocks can be reminders that there is more to life than livelihoods.

But not for Bingham. He is, in his fashion, content. In E.M. Forster’s novel, “Howards End,” Margaret famously exhorted, “Only connect!” Bingham would rather not.

George F. Will, Washington Post


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Tiger Woods, Person of the Year

AS we say farewell to a dreadful year and decade, this much we can agree upon: The person of the year is not Ben Bernanke, no matter how insistently Time magazine tries to hype him into its pantheon. The Fed chairman was just as big a schnook as every other magical thinker in Washington and on Wall Street who believed that housing prices would go up in perpetuity to support an economy leveraged past the hilt. Unlike most of the others, it was Bernanke’s job to be ahead of the curve. Yet as recently as June of last year he could be found minimizing the possibility of a substantial economic downturn. And now we’re supposed to applaud him for putting his finger in the dike after disaster struck? This is defining American leadership down.

If there’s been a consistent narrative to this year and every other in this decade, it’s that most of us, Bernanke included, have been so easily bamboozled. The men who played us for suckers, whether at Citigroup or Fannie Mae, at the White House or Ted Haggard’s megachurch, are the real movers and shakers of this century’s history so far. That’s why the obvious person of the year is Tiger Woods. His sham beatific image, questioned by almost no one until it collapsed, is nothing if not the farcical reductio ad absurdum of the decade’s flimflams, from the cancerous (the subprime mortgage) to the inane (balloon boy).

As of Friday, the Tiger saga had appeared on 20 consecutive New York Post covers. For The Post, his calamity has become as big a story as 9/11. And the paper may well have it right. We’ve rarely questioned our assumption that 9/11, “the day that changed everything,” was the decade’s defining event. But in retrospect it may not have been. A con like Tiger’s may be more typical of our time than a one-off domestic terrorist attack, however devastating.

Indeed, if we go back to late 2001, the most revealing news story may have been unfolding not in New York but Houston — the site of the Enron scandal. That energy company convinced financial titans, the press and countless investors that it was a business deity. It did so even though very few of its worshipers knew what its business was. Enron is the template for the decade of successful ruses that followed, Tiger’s included.

What makes the golfing superstar’s tale compelling, after all, is not that he’s another celebrity in trouble or another fallen athletic “role model” in a decade lousy with them. His scandal has nothing to tell us about race, and nothing new to say about hypocrisy. The conflict between Tiger’s picture-perfect family life and his marathon womanizing is the oldest of morality tales.

What’s striking instead is the exceptional, Enron-sized gap between this golfer’s public image as a paragon of businesslike discipline and focus and the maniacally reckless life we now know he led. What’s equally striking, if not shocking, is that the American establishment and news media — all of it, not just golf writers or celebrity tabloids — fell for the Woods myth as hard as any fan and actively helped sustain and enhance it.

People wanted to believe what they wanted to believe. Tiger’s off-the-links elusiveness was no more questioned than Enron’s impenetrable balance sheets, with their “special-purpose entities” named after “Star Wars” characters. Fortune magazine named Enron as America’s “most innovative company” six years in a row. In the January issue of Golf Digest, still on the stands, some of the best and most hardheaded writers in America offer “tips Obama can take from Tiger,” who is typically characterized as so without human frailties that he “never does anything that would make him look ridiculous.”

Perhaps the most conspicuous player in the Tiger hagiography business has been a company called Accenture, one of his lustrous stable of corporate sponsors. In a hilarious Times article, Brian Stelter described the extreme efforts this outfit is now making to erase its six-year association with its prized spokesman. Alas, the many billboards with slogans like “Go On. Be a Tiger” are not so easily dismantled, and collectors’ items like “Accenture Match Play Tiger Woods Caddy Bib” are a growth commodity on eBay.

From what I can tell, Accenture is a solid company. But the Daily News columnist Mike Lupica raised a good point when I spoke with him last week: “If Tiger Woods was so important to Accenture, how come I didn’t know what Accenture did when they fired him?” According to its Web site, Accenture is “a global management consulting, technology services and outsourcing company,” but who cared about any fine print? It was Tiger, and Tiger was it, and no one was to worry about the details behind the mutually advantageous image-mongering. One would like to assume that Accenture’s failure to see or heed any warning signs about a man appearing in 83 percent of its advertising is an anomalous lapse. One would like to believe that business and government clients didn’t hire Accenture just because it had Tiger’s imprimatur. But in a culture where so many smart people have been taken so often, we can’t assume anything.

As cons go, Woods’s fraudulent image as an immaculate exemplar of superhuman steeliness is benign. His fall will damage his family, closest friends, Accenture and the golf industry much more than the rest of us. But the syndrome it epitomizes is not harmless. We keep being fooled by leaders in all sectors of American life, over and over. A decade that began with the “reality” television craze exemplified by “American Idol” and “Survivor” — both blissfully devoid of any reality whatsoever — spiraled into a wholesale flight from truth.

The most lethal example, of course, were the two illusions marketed to us on the way to Iraq — that Saddam Hussein had weapons of mass destruction and some link to Al Qaeda. That history has since been rewritten by Bush alumni, Democratic politicians who supported the Iraq invasion and some of the news media that purveyed the White House fictions (especially the television press, which rarely owned up to its failure as print journalists have). It was exclusively “bad intelligence,” we’re now told, that pushed us into the fiasco. But contradictions to that “bad intelligence” were in plain sight during the run-up to the war — even sometimes in the press. Yet we wanted to suspend disbelief. Much of the country, regardless of party, didn’t want to question its leaders, no matter how obviously they were hyping any misleading shred of intelligence that could fit their predetermined march to war. It’s the same impulse that kept many from questioning how Mark McGwire’s and Barry Bonds’s outlandishly cartoonish physiques could possibly be steroid-free.

In the political realm, our bipartisan credulousness has also been on steroids in this decade, even by our national standards. Many Democrats didn’t want to see the snake-oil salesman in John Edwards, blatant as his “Two America” self-contradictions were if you cared merely to look at him on YouTube. Republicans incessantly fell for family values preacher politicians like David Vitter, John Ensign and Larry Craig. Fred Thompson was seen by many, in the press as well as his party, as the second coming of Ronald Reagan. Karl Rove was widely hailed as a mastermind who would assemble a permanent Republican majority. Bernie Kerik was considered a plausible secretary of homeland security. Eliot Spitzer was viewed as a crusader of uncompromising principle.

But these scam artists are pikers next to the financial hucksters. I’m not just talking about Bernie Madoff and Enron’s Ken Lay, but about those titans who legally created and sold the securities that gamed and then wrecked the system. You’d think after Enron’s collapse that financial leaders and government overseers would question the contents of “exotic” investments that could not be explained in plain English. But only a few years after Enron’s very public and extensively dissected crimes, the same bankers, federal regulatory agencies and securities-rating companies were giving toxic “assets” a pass. We were only too eager to go along for the lucrative ride until it crashed like Tiger’s Escalade.

After his “indefinite break” from golf, Woods will surely be back on the links once the next celebrity scandal drowns his out. But after a decade in which two true national catastrophes, a wasteful war and a near-ruinous financial collapse, were both in part byproducts of the ease with which our leaders bamboozled us, we can’t so easily move on.

This can be seen in the increasingly urgent political plight of Barack Obama. Though the American left and right don’t agree on much, they are both now coalescing around the suspicion that Obama’s brilliant presidential campaign was as hollow as Tiger’s public image — a marketing scam designed to camouflage either his covert anti-American radicalism (as the right sees it) or spineless timidity (as the left sees it). The truth may well be neither, but after a decade of being spun silly, Americans can’t be blamed for being cynical about any leader trying to sell anything. As we say goodbye to the year of Tiger Woods, it is the country, sad to say, that is left mired in a sand trap with no obvious way out.

Frank Rich, New York Times


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That Hobby Looks Like a Lot of Work

HOOKED ON DESIGN Yokoo Gibran, in her Oatmeal Soopascarf, started a business on Etsy.

QUIT your day job?

To some craft enthusiasts that is just the name of a popular blog on Etsy, the fast-growing Web site that serves as a marketplace for crafts and vintage goods.

But to Yokoo Gibran, it was an epiphany.

Ms. Gibran, who is in her 30s, had been selling her hand-knit scarves and accessories on the site for less than a year when she decided last November to quit her day job at a copy center in Atlanta. Thirteen months later, she would seem to be living the Etsy dream: running a one-woman knitwear operation, Yokoo, from her home and earning more than $140,000 a year, more than many law associates.

Jealous? How could you not be? Her hobby is her job. But consider this before you quit your day job: at the pace she’s working, she might as well be a law associate.

“I have to wake up around 8, get coffee or tea, and knit for hours and hours and hours and hours,” said Ms. Gibran, who leveraged the exposure she got on the site to forge a deal with Urban Outfitters. “I’m like an old lady in a chair, catching up on podcasts, watching old Hitchcock shows. I will do it for 13 hours a day.” And even after all those hours knitting, she is constantly sketching new designs or trading e-mail messages with 50 or more customers a day.

“Etsy saved my life,” Ms. Gibran said. But, she added, “this is the hardest job I’ve ever had.”

These days, the fantasy of building a career on Etsy, an eBay of sorts of the do-it-yourself movement, is not just the stuff of dreams. Even before the recession, the site, which was founded in Brooklyn in 2005, was riding the “crafting” boom to prominence. When the job market collapsed, many hobbyists who already were selling jewelry or glassware as a sideline suddenly needed a real income.

PRODUCTION MEETING Angie Davis and her dog Gertrude in their studio, formerly a schoolbus depot.

While most people would find it impossible to meet a mortgage payment selling $8 crocheted mug cozies, some top-sellers on Etsy have moved beyond the stage of earning pocket money and are building careers — in some cases, earning six-figure incomes.

But even the successes add a note of “seller beware.” To build a profitable business on the site, they say — well, it’s a business. You need to build a brand identity, which often means courting design blogs or the news media. You need to manage distribution, which might mean standing in post office lines with a baby on your hip and a garbage bag filled with 30 self-packed boxes to ship. And as with any start-up, you need to maintain the morale of the labor force, which can be particularly challenging when you are the labor force, and the workday runs from “Good Morning America” to “Late Night With Jimmy Fallon.”

“Working from home, people think it’s so easy and great,” said Caroline Colom Vasquez, of Austin, Tex., who last year made $120,000 in sales from her Etsy shop, Paloma’s Nest, which specializes in ceramic and wood collectibles for weddings and other special occasions. But “there’s nobody there to tell you to take a break, or take a vacation.”

This year, she expects her business to have $250,000 in sales, but she will have to divide that with the three employees she just hired because Ms. Vasquez, who has a young daughter, could no longer handle the strain.

“I physically could just not do it in 24 hours,” she said. “My husband and I used to get up at 4 or 5 in the morning before the baby, then stay up till 1 or 2, stamping boxes, making shipping labels.”

As sales heated up for the holidays, Angie Davis, a former project architect in Minneapolis who lost her job last year, said her Etsy shop, Byrd and Belle, which sells handmade handbags and cases for iPods, laptops and cellphones, has “easily matched a month of architecture salary in five days, but I’m also working 16 hours a day.” To deal with the holiday rush, Ms. Davis said, she had to produce 112 cases in 48 hours, which involved turning her loft into a mini assembly line, where she cut leather and stitched and sewed cotton and wool fabric until 10 p.m. “It’s surprising how physical it can be on my core muscles,” she said. To get the work processed in time, she had to call in her mother from Iowa to help make tags and press fabric.

The number of people turning to Etsy as a full-time career is unknown. The site does not track how many of its members try to make a living, and it does not disclose the sales figures for individual sellers, said Maria Thomas, chief executive of Etsy. But over the last year, the number of registered members has more than doubled to 3.75 million, and the Quit Your Day Job blog on Etsy now attracts 2 million page views a month.

Several shop owners interviewed for this article, including Morgan Peterson, who runs a fashion label — Eliza + Axel — on Etsy, view their layoffs from traditional jobs as an opportunity to build a more fulfilling career online. In Ms. Peterson’s case, she lost her job as an assistant designer for Dillard’s and decided to create and sell her own line, made from reclaimed fabrics.

“In fashion school, they tell you you can do anything, they push you to be creative, but as soon as you get a job in a corporate environment, you’re only able to do certain things and it has to make money,” said Ms. Peterson, who said that she supplements her income on Etsy by selling wholesale to several boutiques. “With Etsy, I have my styles that make a lot of money, but I can also put work out there that I do just for creative reasons.”

As with eBay, start-up costs are a lot lower for people opening a “shop” on Etsy than a shop on Main Street; the site charges sellers 20 cents for each item listed and 3.5 percent of each sale. Etsy, which has a user base consisting largely of women, also provides a support network, including several blogs and forums where sellers swap tips and words of encouragement.

A healthy income, however, is far from guaranteed. After Tara Scheuerman was laid off from her job as an office assistant at a college in Milwaukee, she started a company, Cracked Designs, that sells greeting cards and wedding invitations on Etsy. After a slow start, she said she is thrilled to be selling more than 50 cards a week and is optimistic about her long-term earnings, but said she now spends more than 40 hours a week on her line, not only designing and making her products, but tirelessly promoting them on design blogs like Poppytalk and Design*Sponge as well as in magazines (her cards were recently featured in House Beautiful). So far, she said, she is earning about $15,000 to $20,000 a year, which on the low end works out to about $7.25 an hour — the same as Wisconsin’s minimum wage.

“You have to be really realistic with your goals and know you’re probably not even going to make a profit the first couple of years,” said Ms. Scheuerman, 26, who relies primarily on her husband’s income.

Such experiences were the focus of an essay, much-circulated among so-called Etsians, that ran last June in DoubleX, an online lifestyle magazine. In it, the journalist Sara Mosle (also a contributor to The New York Times) argued that Etsy was profiting off unrealistic expectations held by many women. “What Etsy is really peddling isn’t only handicrafts,” Ms. Mosle wrote, “but also the feminist promise that you can have a family and create hip arts and crafts from home during flexible, reasonable hours while still having a respectable, fulfilling, and remunerative career.”

But the experiences of at least some of the site’s successes, like Ms. Vasquez, don’t support that view. Still, Ms. Vasquez said, there is an unforeseen psychic tax even when — or especially if — one’s profit outstrips initial expectations. As her business, once a sideline run from the kitchen table, grew into a six-figure powerhouse, her work not only swallowed more rooms of her house, but also her family life. At dinners, she and her husband talked only about business.

“I felt like I was being a bad mother, a bad wife, being all-consumed by business. That was the breaking point,” she said. Ms. Vasquez has found time to exhale, at least occasionally, since hiring a staff. The family even took a trip, the first since she started the business, to the nearby Texas Hill Country.

Still, the challenge is to find balance. “What’s the point of doing something you love,” she asked, “if you are too exhausted to do what you love?”

Alex Williams, New York Times


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Merry Marketing

Stores give us something to believe in—shopping.

I like Christmas as much as the next Christian. And by that I mean the Feast of the Nativity—the one with Jesus being born in a manger. The one Linus talks about every year on “A Charlie Brown Christmas.” That Christmas I like.

The Christmas I don’t like is the one most people don’t: the commercial one. And this year what’s been irking me are the slogans that companies are deploying in their December ad campaigns that hope to have it both ways: They’re using religious themes without actually being religious. Call it faith-based advertising.

Some aren’t bad. This year J.C. Penney’s ads featured the slogan “The Joy of Giving.” (Giving is, needless to say, laudable.) But many advertisers couldn’t seem to decide how religious their ads could be. Most are eager to glom onto the highly profitable Christmas angle without being Christian, which would be a challenge even for Don Draper and his “Mad Men” copywriters. The cover of the Land’s End catalog, which is bursting with preppy families who apparently divide their time between laughing dementedly, drinking steaming mugs of hot chocolate and petting horses, says: “Make it Merry!” Make what merry? Celebrating the birth of Christ or petting a horse?

Likewise, the Container Store, a packaging company, wanted to remind shoppers to mail in time for Christmas but couldn’t quite bring itself to say the word. “Only 15 Days Left!” said one of its ads on Dec. 10. Fifteen days till what? Arbor Day?

“Magic” is another popular word on Madison Avenue: Pier One’s catalog says, “Make Christmas Magic!” Sadly, all I can think of is Mary and Joseph standing around Harry Potter in a manger.

And this year the Gap’s ads are just plain weird. Their TV commercials feature perky models rapping out the following ditty: “Go Christmas! Go Hannukah! Go Kwanzaa! Go Solstice! You 86 the rules, you do what just feels right. Happy Whatever-you-wannukah, and to all a cheery night!” But the models are clearly wearing sweaters and scarves in bright red, the traditional Christmas color. In other words, the Gap is selective about what gets 86ed. Actual religious beliefs? Those go. Holiday trappings that can move a few sweaters? Those stay.

The winner of this year’s worst catch phrase is a tie: between Macy’s and Eddie Bauer. Macy’s shopping bags say, “A million reasons to believe!” In what? What does Macy’s want us to believe in? That Jesus is the Son of God? (Imagine that on a bag.)

Nearly as maddening was the cover of this year’s Eddie Bauer catalog, which proclaims “We believe.” As with Macy’s, I was eager to find out just what Eddie Bauer believed in. The Council of Chalcedon’s fifth-century declaration that Jesus was fully human and fully divine? Not exactly. Page three professed the retailer’s creed: “We believe in the world’s best down.”

Of course I know that this is the way marketing works. Retailers use anything to hawk a product. And I’m sorry to be a stickler, but it’s strange seeing the Christian faith being used and denied at the same time.

Nonetheless, I try not to get too upset about it, because I don’t want to let commercialism distract me from the reason to celebrate Christmas Day. Because I really do have a million reasons to believe.

Father Martin is a Jesuit priest and author of “My Life With the Saints.”


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The Backdating Molehill Revisited

Why are the prosecutions going so badly? Maybe because there was no crime.

It pains us, naturally, to see our forecasts and premonitions borne out in such exacting detail in the government’s backdating prosecutions—why didn’t we take our moment of searing foresight to the dog track instead?

Yesterday a judge threw out, with resort to unceremonious language, criminal charges against Broadcom co-founder Henry Nicholas III.

Mr. Nicholas, a physically large man, with an erratic personality, and accused of patronizing drug dealers and prostitutes, must have seemed a prosecutors’ dream, since he gave them so much to talk about besides the details of backdating, which when examined closely invariably lead careful reasoners to wonder: Where’s the crime here?

Mr. Nicholas did not benefit from any backdated stock options. He was Broadcom’s largest shareholder, thus had no natural or unnatural interest in overpaying employees with backdated stock options. The company’s outside auditor also appears to have blessed the essential no-no here, which amounts to reading into accounting rules a logic and coherence that didn’t exist at the time.

Broadcom co-founder Henry Nicholas III

The goal of backdating, it becomes clearer than ever, was to motivate employees at the lowest possible cost to shareholders. This was done by granting stock options that, at the date of issue, were “in the money”—because, it appears, Broadcom and hundreds of other Silicon Valley companies discovered in practice what a Nobel Prize in economics had discovered in theory: That people overvalue a seeming bird in the hand.

As far as we know, no court has gotten to the essential nullity of the backdating “wrong,” but U.S. District Judge Cormac J. Carney seems to have gotten close. Less than a week earlier, he had thrown out the conviction of Broadcom co-founder Henry Samueli—who had pleaded guilty—saying he did not believe Mr. Samueli had committed a crime.

Yesterday he dismissed the remaining criminal charges against Mr. Nicholas and the company’s former chief financial officer William J. Ruehle, saying the government’s behavior had been “shameful,” that it had made a “mockery” of a defendant’s constitutional rights, and that prosecutors had “intimidated and improperly influenced” three crucial witnesses, including threatening one with prosecution if he repeated testimony already given to the SEC in a civil proceeding.

Now, call us cynical, but aren’t threats often used against employees to turn them into friendly witnesses for the government? The judge complained that prosecutors had improperly leaked details of the investigation to the press—also unattractive behavior by government servants, but not exactly unusual.

Indeed, it’s hard to escape the sense that such behavior was judged especially beyond the pale in this case because it was in the service of a prosecution that fundamentally never deserved to be brought.

To be sure, because of the incoherence of the applicable accounting rules, Broadcom had to take the biggest charge of any company to rectify its accounting for employee stock options: $2.2 billion. Investors would have understood, though, that this was not real cash, that indeed under then-regnant accounting rules Broadcom could have tried to give away the entire market cap of the company to employees without taking an accounting charge, had it simply issued “at the money” options instead of “in the money” options.

As we say, most backdating cases amount to companies trying to behave rationally amid irrational accounting rules, rather than the media’s standard trope of businessmen a-lyin’ and a-stealin’. Deep, rich and disappointing, then, is the irony of a recent decision by federal prosecutors to have a second go at another former Silicon Valley CEO, Gregory Reyes, of Brocade Communications

All that distinguished the Brocade case from hundreds of other instances of backdating was a prosecutor’s allegation that, in order to effect backdating, Mr. Reyes had misled the company’s own finance department.

This was laughable, since the SEC was simultaneously charging two former heads of Brocade’s finance department with participating in and profiting from backdating. The prosecution’s sole witness on the vital point recanted almost as soon as she got off the stand, and a federal appeals court eventually overturned Mr. Reyes’s conviction on grounds of prosecutorial misconduct.

Why a U.S. attorney in San Francisco would want to try Mr. Reyes again is a mystery to us, but maybe it’s time for an investigation of backdating investigations.

We can’t close without mentioning the exemplary diligence and enterprise with which, way back when, certain reporters and editors uncovered the backdating phenomenon, and then the intellectual sluggishness with which they analyzed it.

They found an interesting story (one that fit well under the current interest in behavioral economics) and then got it fundamentally wrong by insisting on shoving it into a procrustean off-the-shelf narrative of executive “greed.”

Indeed, for want of a single paragraph explaining why backdating could be (in the words of a recent academic paper) a case of optimum contracting between companies and employees, we might have avoided the waste and injustice of these misguided backdating prosecutions.

Holman W. Jenkins Jr., Wall Street Journal


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The Audacity of Debt

Comparing today’s deficits to those in the 1980s.

At least someone in America isn’t feeling a credit squeeze: Uncle Sam. This week Congress will vote to raise the national debt ceiling by nearly $2 trillion, to a total of $14 trillion. In this economy, everyone de-leverages except government.

It’s a sign of how deep the fiscal pathologies run in this Congress that $2 trillion will buy the federal government only one year before it has to seek another debt hike—conveniently timed to come after the midterm elections. Since Democrats began running Congress again in 2007, the federal debt limit has climbed by 39%. The new hike will lift the borrowing cap by another 15%.

There is surely bipartisan blame for this government debt boom. George W. Bush approved gigantic spending increases for Medicare and bailouts. He also sponsored the first ineffective “stimulus” in February 2008—consisting of $168 billion in tax rebates and spending that depleted federal revenues in return for no economic lift.

Democrats ridiculed Mr. Bush as “the most fiscally irresponsible President in history,” but then they saw him and raised. They took an $800 billion deficit and made it $1.4 trillion in 2009 and perhaps that high again in 2010. In 10 months they have approved more than $1 trillion in spending that has saved union public jobs but has done little to assist private job creation. Still to come is the multitrillion-dollar health bill and another $100 billion to $200 billion “jobs” bill.

We’ve never obsessed over the budget deficit, because the true cost of government is the amount it spends, not the amount it borrows. Milton Friedman used to say that the nation would be far better off with a budget half the current size but with larger deficits. Mr. Obama and his allies in Congress have done the opposite: They have increased the budget by 50% and financed the spending with IOUs.

Our concern is that the Administration and Congress view this debt as a way to force a permanently higher tax base for decades to come. The liberal grand strategy is to use their accidentally large majorities this year to pass new entitlements that start small but will explode in future years. U.S. creditors will then demand higher taxes—taking income taxes back to their pre-Reagan rates and adding a value-added tax too. This would expand federal spending as a share of GDP to as much as 30% from the pre-crisis 20%.

Remember the 1980s and 1990s when liberals said they worried about the debt? We now know they were faking it. When the Gipper chopped income and business tax rates by roughly 25% and then authorized a military build-up, Democrats and their favorite economists predicted doom for a decade. The late Paul Samuelson, the revered dean of the neo-Keynesians, expressed the prevailing view in those days when he called the Reagan deficits “an all-consuming evil.”

But wait: Those “evil” Reagan deficits averaged less than $200 billion a year, or about one-quarter as large in real terms as today’s deficit. The national debt held by the public reached its peak in the Reagan years at 40.9%, and hit 49.2% in 1995. This year debt will hit 61% of GDP, heading to 68% soon even by the White House’s optimistic estimates.

Our view is that there is good and bad public borrowing. In the 1980s federal deficits financed a military buildup that ended the Cold War (leading to an annual peace dividend in the 1990s of 3% of GDP), as well as tax cuts that ended the stagflation of the 1970s and began 25 years of prosperity. Those were high return investments.

Today’s debt has financed . . . what exactly? The TARP money did undergird the financial system for a time and is now being repaid. But most of the rest has been spent on a political wish list of public programs ranging from unemployment insurance to wind turbines to tax credits for golf carts. Borrowing for such low return purposes makes America poorer in the long run.

By the way, today’s spending and debt totals don’t account for the higher debt-servicing costs that are sure to come. The President’s own budget office forecasts that annual interest payments by 2019 will be $774 billion, which will be more than the federal government will spend that year on national defense, education, transportation—in fact, all nondefense discretionary programs.

Democrats want to pass the debt limit increase as a stowaway on the defense funding bill, hoping that few will notice while pledging to reduce spending at some future date. Republicans ought to force a long and careful debate that educates the public. Ultimately, the U.S. government has to pay its bills and the debt limit bill will have to pass. But debt limit votes are one of the few times historically when taxpayer advocates have leverage on Capitol Hill. Republicans and Democrats who care should use it to discuss genuine ways to put Washington on a renewed and tighter spending regime.

“Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren,” Senator Barack Obama said during the 2006 debt-ceiling debate. “America has a debt problem and a failure of leadership. Americans deserve better.” That was $2 trillion ago, when someone else was President.


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Why Everyone Read Samuelson

The late Nobel laureate’s mathematical approach to economics has been a mixed blessing.

Three years after World War II drew to a close, a young professor at MIT published “Foundations of Economic Analysis.” Its mathematical approach to economics would revolutionize the profession. And its author, Paul Samuelson, would go on to earn many awards and honors, culminating in 1970, when he won the Nobel Prize in economics—the second year it was awarded. Samuelson died on Sunday at the age of 94.

His influence has been profound, but the mathematization of economics has been a mixed blessing. The downside is that the math hurdle in leading U.S. economics programs is now so high that people who grasp the power of economic concepts to explain human behavior are losing out in the competition to mathematicians.

The upside is that Samuelson sometimes used math to resolve issues that had not been resolved at a theoretical level for decades. As fellow Nobel laureate Robert Lucas of the University of Chicago said in a 1982 interview, “He’ll take these incomprehensible verbal debates that go on and on and just end them; formulate the issue in such a way that the question is answerable, and then get the answer.”

For instance, Swedish economist Bertil Ohlin had argued that international trade would tend to equalize the prices of factors of production. Trade between, say, India and the United States would narrow wage-rate differentials between the two countries. Samuelson, using mathematical tools, showed the conditions under which the differentials would be driven to zero: It’s called the Factor Price Equalization Theorem.

He contributed fundamental insights in consumer theory and welfare economics, international trade, finance theory, capital theory, general equilibrium and macroeconomics. In finance theory, which he took up at age 50, Samuelson did some of the initial work that showed that properly anticipated futures prices should fluctuate randomly.

Economists had long believed that there were goods that would be hard for the private sector to provide because of the difficulty of charging those who benefit from them. National defense is one of the best examples of such a good. In the 1954 Review of Economics and Statistics, Samuelson gave a rigorous definition of a public good that is still standard in the literature.

“Let those who will write the nation’s laws if I can write its textbooks,” Samuelson said during a speech at Trinity University in San Antonio, Texas. He revised his own widely read textbook, “Economics,” about every three years since 1948. One of the best and punchiest statements in the 1970 edition was his comment about a proposal to raise the minimum wage from its existing level of $1.45 an hour to $2.00 an hour: “What good does it do a black youth to know that an employer must pay him $2.00 an hour if the fact that he must be paid that amount is what keeps him from getting a job?”

This is the kind of comment that causes many on the left to grit their teeth; and yet Samuelson was a liberal Keynesian and the best-known rival of the late libertarian monetarist, Milton Friedman. The two men respected each other highly, but the intellectual influence was mainly one way. Over time, Samuelson came more to Friedman’s views, especially on monetary policy.

In the 1948 edition of his textbook, Samuelson wrote dismissively, “few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle.” But in the 1967 edition, he wrote that monetary policy had “an important influence” on total spending. In the 1985 edition, Samuelson and co-author William Nordaus (of Yale) would write, “Money is the most powerful and useful tool that macroeconomic policymakers have,” and the Fed “is the most important factor” in making policy.

Paul Samuelson began teaching at the Massachusetts Institute of Technology in 1940 at the age of 26 and remained there, publishing on average almost one technical paper a month for over 50 years. In addition to the Nobel Prize, he also earned the John Bates Clark Award in 1947, awarded for the most outstanding work by an economist under age 40. He was president of the American Economic Association in 1961.

Samuelson, like Milton Friedman, had a regular column in Newsweek (from 1966 to 1981). Unlike Friedman, he did not have a passionate belief in free markets—or, for that matter, in government intervention in markets. His pleasure seemed to come from providing new proofs, demonstrating technical finesse, turning a clever phrase, and understanding the world better.

But not always. Samuelson had an amazingly tin ear about communism. As early as the 1960s, economist G. Warren Nutter at the University of Virginia had done empirical work showing that the much-vaunted economic growth in the Soviet Union was a myth. Samuelson did not pay attention. In the 1989 edition of his textbook, Samuelson and William Nordhaus wrote, “the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive.”

Although I was never a fan of Samuelson’s textbook, an appendix on futures markets in a late 1960s edition laid out beautifully how the profit motive in futures markets causes reallocation from times of relative plenty to future times of relative scarcity. In 1990 I asked him to do an article on futures markets for “The Fortune (now “Concise”) Encyclopedia of Economics.” He replied quickly that he did not have time and ended graciously, “My loss.”

Mr. Henderson is a research fellow with Stanford University’s Hoover Institution and an economics professor at the Naval Postgraduate School in Monterey, Calif. He is editor of “The Concise Encyclopedia of Economics” (Liberty Fund, 2008.)


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Banker Baiting 101

Obama’s latest populist turn won’t help the recovery.

The Obama Administration desperately wants a strong economic recovery, or so it says, but does it have any idea how to encourage one?

It says it wants job growth, but its policies keep raising the cost of creating new jobs. It says it wants small business to take risks, but it keeps reducing the rewards if those risks succeed. And it says it wants banks to lend more money, even as it keeps threatening to punish bankers if they make too many bad loans or make too much money.


The last contradiction is again on display as President Obama rolls out his latest populist blame-the-bankers campaign. This is becoming a White House financial staple. Recall how the President joined the Congressional posse amid this year’s earlier AIG bonus uproar, until it threatened to run out of control. Later Mr. Obama targeted Chrysler’s bond holders who weren’t eager to accept the government’s meager dictated terms. The bond holders rolled over, but everyone in financial markets got a message about what this Administration thinks about the sanctity of contracts.