Waiting For Something To Turn Up: Europe’s Looming Pensions-based Sovereign Debt Crisis

As Irwin Stelzer argued in a recent opinion article in the Wall Street Journal, Spain’s Prime Minister José Luis Rodríguez Zapatero seems to be an admirer of Charles Dickens’s character Mr. Micawber. When asked what he plans to do about Spain’s 11.4% fiscal deficit, first he promises to extend the retirement age, only to later tell us the measure may not be necessary. Then he promises a public-sector wage freeze, only to have his Economy Minister, Elena Salgado, say he really doesn’t mean exactly what he seems to say. And in any event, we shouldn’t worry too much, since given that Spain is a serious country, somehow or other the fiscal deficit will be cut to 3% by 2013, even though most serious analysts consider the economic growth numbers on which the budget plans are based to have their origins more in the dreams of an Alice long lost in Wonderland than in any kind of sobre analysis of real possibilities. “We do have a plan,” deputy prime minister, Maria Teresa Fernandez de la Vega assures us, but to many that plan now seems to be little better than hoping, like the proverbial Mr. Micawber, that “something will turn up.” Continue reading

Defying Gravity In Japan

Popular myth and, allegedly, the laws of aerodynamics have it that the bumblebee should not be able to take flight. Yet still, our good bumblebee refuses to be pulled down by such nit-picking details, and year after year it takes flight as if none of this mattered. This little allegory applies, adding a little imagination, to Japans economy too. Year after year it gives us the impression of simply being able to ramp up domestic debt to cover the evident shortfall in both domestic consumption and  investment demand, since having a savvy export sector, and a strong net foreign asset position, mean that Japan does not have to rely on foreign investors to finance government debt outlays. Add to this a central bank definitively bogged down  in what appears suspiciously like perpetual Quantitative Easing  mode given the persistent deflation from which the country suffers and there we have the core of Japan’s “bumblebee moment”. Continue reading

Serious Problems Emerge For The F-UK-De Group Of Countries

Well, I for one can’t help thinking that it’s now well time we all stopped getting carried away with the use of so many acronyms. Not only may one man’s meat easily prove to be another’s poison, it may even be that for some the entire meal will be so distasteful as to prove totally indigestable. And so it is with the latest set of proposals to appear on that diagnostic lab bench which has been hastily erected in the search for that magic “cure all” for the eurozone’s many ills.

Daniel Gros, in a well meaning, but I feel fatally flawed, move to get us all away from talking about some of the members of our own community as if they were PIGS, has decided to tell us that they are not pigs at all, they are merely GIPSYs. Of course, depending on which way you look at it, such forms of reference could be taken as a compliment (“you sure do eat like a pig”), or not, but stopping to think for a moment about the kind of controversy which has been provoked by the arrival of large numbers of Roma in Italy, perhaps telling the countries which lie on Europe’s periphery that the best way to conceptualise them is as a bunch of “gitanos” is not the best way to get reasoned debate going. Nor is it necessarily the best way to do this to tell the members of core Europe that they as things stand they are essentially F-UK-De. But there it is. That’s just how things are these days. Continue reading

Premature evaluation: Lords of Finance

Liaquat Ahmed’s Lords of Finance is somewhere between a history of the world economy between the First World War and the Great Depression and a group biography of the key central bankers of that era – Montagu Norman of the Bank of England, Emile Moreau of the Banque de France, Hjalmar Schacht of the Reichsbank, and Benjamin Strong of the New York Federal Reserve.

This group of wildly disparate men – Strong was a stereotypical American believer in common sense and the private sector, Moreau a career official deeply suspicious of English-speakers, Schacht a neurotic Wilhelmine imperialist, Norman an Edwardian half-mystic eccentric – succeeded in maintaining their own private special relationship, all believing that they enjoyed a distinctive personal partnership with the others in the common cause of restoring the world economy as it had been before the first world war.

However, a major theme of the book is the illusion of personal politics – in the event, the central bankers maintained their cordial partnership while their policies became progressively more inconsistent and set them more and more at variance with the governments and economies that stood behind them. The special relationships became an end in themselves; and as more and more effort went into maintaining them, they increasingly came to provide an illusion of unity and consensus.

Something else that provided an illusory consensus was the gold standard. Another main theme in Lords of Finance is the European tragedy; all four men were horrified by the collapse of the old world of open borders and concert diplomacy into the first world war, and perhaps as much by the abandonment of gold and the binge on inflationary finance that went with it as by the war itself. The struggle to return was the mental leitmotiv – the gold standard was the way to get there, not least because it was what was available.

Everywhere, in July 1914, the crisis had been greeted by an epic crash. Only the exact nature of the panic varied depending on national financial culture. In the United States, of course, it manifested itself as a massive Wall Street crash. In London, the interbank credit markets froze up. In France, there was a run on the franc and on the banks, with gold coins vanishing from circulation overnight and Les Halles struggling to find enough change. In Germany, the government took over as the mobilisation plan went into effect. All four men were involved one way or another in coping with this financial prelude to the war – Norman in preventing a banking collapse, Strong in finding ways for US travellers in Europe to cash their travellers’ cheques on the House of Morgan’s credit, Schacht in managing the Nationalbank’s response, Moreau in implementing France’s detailed mobilisation war book for bankers.

War book for bankers? Yes; in a financial counterpart to the Anglo-German arms race, the French and German central banks had been hoarding gold for years, which had given the Banque de France the biggest gold reserve in the world. It also had no fewer than 250 branches, whose managers all had in their safes an extract from the national mobilisation plan. As the plan went into action, their instructions were to immediately clamp down on any circulation of gold whatsoever, and to do everything possible to defend the Republic’s treasure, even if their branch came under enemy occupation. As it turned out, the Banque actually clung on to the gold throughout the war, on the grounds that it would be even more useful afterwards.

But the primary element in any central banker’s preparations for war was to know where the printing press was. Many, many people expected that financial constraints would stop the war; even John Maynard Keynes, who plays the role of a sort of shadow Lord of Finance in the book, popping up regularly in order to be right, thought that the combatants would run out of money by the end of 1914. Instead, they borrowed, taxed, and inflated.

Some of them kept going after the war; there is a fantastic and fantastical description of the Reichsbank in 1923, whose president had apparently sublimated his concerns about the great inflation into the sheer logistics of printing and distributing that much money. As he explained to a parliamentary committee that summer, he was now capable of doubling the money supply in a week, and the limiting factor was not monetary, but rather the capacity of the German printing industry and the problems of cash distribution. One can see how the idea of managed money might have struggled to gain acceptance.

Ahmed is good on how, although the international gold standard was actually relatively new, this tended only to reinforce its status as a secular religion. Bank of England officials looked to The Resumption – when the Bank went back on gold after the Napoleonic and Revolutionary wars – as their founding achievement, one that was not that far from current memory. It almost sounds like a church festival, the third Sunday after Resumption-tide. Rather than being an ancient tradition, it was felt to be a live achievement.

As a result, the Bank was always going to be desperate to Resume as soon as possible after the war, and it had the vigorous support of its fellow-central banks in doing so, specifically the New York Fed. If any two central bankers had a special relationship, Norman and Strong did, but as always in the Anglo-American special relationship, what was in the interests of the relationship was not necessarily in the interests of either Britain or America. Strong felt that the British should be forced to go back on gold; Norman felt much the same about the British government, and the British felt that they needed to go easy on the other big economic issue of the time in order to get the Americans’ support in doing what the Americans wanted them to do.

The other issue was the vast pile of multilateral debts left over from the war. This is well-known – France and the smaller Allies owed the UK, which in turn owed the US, and the French hoped to pay the UK with reparations extracted from Germany. In the interests of the special financial relationship, on Norman’s advice, the UK Treasury accepted the first US offer and agreed to pay the bulk of the bill. The French, on the advice of Emile Moreau, held out on them, and eventually got a significantly better deal. The Italians held out longer still and did even better.

But this didn’t solve any of the underlying problems, nor did the special relationship between the central bankers. A gold standard with most of the gold concentrated in the US and France – which went back on gold at a deeply devalued rate, and therefore hoarded the stuff even faster than it had done in the prewar gold race – was fundamentally dysfunctional. The special relationship between the US and Germany, Schacht, Strong, and Stresemann’s political fix, only solved things as long as hot money continued to flow into Germany, and remained deeply vulnerable to a “sudden stop”. The UK’s position on gold was always tenuous.

And the central banks themselves were idiosyncratic institutions; the Bank of England was probably the least odd, but lacked gold, the Federal Reserve was a curious lashup in which the individual Feds and the board of governors in Washington competed for power, marked by a lot of sub-standard political appointees, and the Banque de France was a private-sector entity owned by the first couple of hundred aristocratic shareholders to squeeze into the annual meeting but manned by career civil servants. Germany had had two central banks during part of the great inflation – having given the director of the Reichsbank tenure for life, on the suggestion of the British, the German government had to create a new agency, the currency commission, to manage Schacht’s monetary stabilisation while the official central bank continued to spew paper two miles across central Berlin.

Essentially, the departure from the gold standard, and the effort to restore it, created the first republic of the central bankers. The restored standard was so unstable, after all, that it demanded continuous policy inputs to keep going – quite the opposite of the aims of a gold standard. But the basis of personal understandings between the major central banks was simply insufficient to cope with the reality that the standard itself was flawed, that the various political/financial fixes adopted to work around its flaws were leading to the build-up of huge global imbalances, and that the national political objectives of the major economies were incompatible with each other and with those of the central bankers.

About that Greek public sector

Charlemagne, over at the Economist blog, can be… uneven. But this recent post about Greece’s public sector is IMO top notch. It puts the creation of Greece’s huge, poorly paid, inefficient public sector in historical context:

Take the painful question of the huge public sector, and all those civil servants with jobs for life, and unusually generous retirement packages. The existence of those jobs for life is not a cultural quirk, in which Greek officials simply like coffee and backgammon too much to do any work. It is the end result of a brutal, multi-decade power struggle between the left and the right: a struggle that got people killed within living memory…

The Greek civil war, and the bloody score-settling that followed, is a living memory for many Greeks. Any consideration of Greek nepotism or clientelism needs to be seen in that light. So for example, it is not enough to say that Greek civil servants enjoy jobs for life, and that is a big problem. (Though it is a big problem, not least because many Greek civil servants are paid pitiful wages—partly because there are so many of them. That means they will resist austerity measures all the harder, because they feel like victims in this crisis, not fat cats.) But the bloated public sector is also a function of history… Continue reading

German Exports and that Looming Double Dip

I hadn’t seen an advance release of the January German export data, when I wrote the following on Tuesday, honest injun I hadn’t:

Well, this is only a hypothesis. But if the hypothesis has any validity we should be able to make some predictions on the basis of it. I would make two. Firstly, since East Europe’s economies are often dependent for their growth on exports to the West, and in particular to Germany, then we should be able to see some “shadow” of this German process cast out into the East.

In the second place, we should see the process continue to some extent in Q1 2010. That is, based on what we have seen so far, in Q1 imports should rise, as industrial output in the early parts of the supply chain surges, and net trade should as a consequence be less positive than in Q4 2009. On the other hand, all the imported components awaiting processing should make inventories rise. So that’s a prediction. Now we need to wait and see how good it is.

Continue reading

The German Economy Is Essentially “Intact”

According to Bundesbank President Axel Weber, Germany’s economic recovery is “essentially intact”, and is now set to benefit from stronger demand in countries outside the euro region.

“I firmly believe that the recovery process that began in summer 2009 is essentially intact, and that it will continue despite the slower growth dynamic in the winter semester. An additional factor in this context is that the German labor market continues to be in extremely robust shape.”

What exactly it means to say that an economy is intact we will explore below, but it is clear that some confirmation for the view that the German economy is benefiting from increased demand originating outside the Eurozone can be found in the latest press release on manufacturing industry turnover from the Federal Statistics Office, where they note that while January’s manufacturing sector turnover surpassed that of January 2009 – by a working day adjusted 2.6% – domestic sales actually fell (by 1.1%), and export turnover rose by 7.3%. Most interestingly, as between destinations, sales to euro area countries only increased by 2.4%, while those to other foreign countries were up 12.0%. This illustrates two points: that the German economy is now more dependent than ever on exports, and that sales to emerging markets are what is really driving export growth at this point. This latter development is hardly surprising given the strong fiscal corrections being applied in many of Germany’s former customer countries. Continue reading

Sunday UK Strategic Defence Review: Chapter 2

OK, so it’s time for another chapter of the Strategic Defence Review as a Blog.

Chapter 2 begins as follows:

The use of force as an option is becoming more complicated. It is likely to become more difficult to use force in the way in which we have used it in the last two decades.

This is of course code for Iraq. The Iraq experience is a considerable theme through the chapter.

Many of our assumptions about joint working and expeditionary capabilities have been validated. But experience has shown that our operations have developed in more complex ways than we envisaged. We have sometimes underestimated the intricacy of working in multi-national operations and with non-military actors

To put it another way: We were right to expect we wouldn’t spend all our time in Germany. Further, we had to talk to the RAF. But one particular operation turned out to be much more complicated and much more serious than we allowed ourselves to imagine.

Looking ahead, The Future Character of Conflict will grow more complex. We are likely to face a range of simultaneous threats and adversaries in challenging operating areas – such as fighting in urban areas against enemies concealed amongst civilians. We are also likely to be subject to greater scrutiny from the media and public, both in the UK and overseas. Communications is now a key component of any campaign.

That seems to be communications as in “strategic communications” – PR, in other words. Nothing to do with being Better Off With Map And Nokia. Snark aside, again, this is the experience of Iraq glaring through.

Technological development, especially in the fields of cyberspace and space, may further change our understanding of conflict. It is likely to be more difficult to maintain our technological edge over some adversaries, or to bring that edge to bear on others, with a profound effect on the way we operate.

Anything electronic is now cheap, and the big power monopoly of satellite reconnaissance is breaking down.

There follows a list of operations and arguments that tend to support the 1998 SDR and the later New Chapter. They do not include Iraq, and only mention Afghanistan in passing on the grounds that we got there logistically, until we get to this paragraph:

Special Forces have demonstrated their value across a broad spectrum of activity, from operating alongside our conventional forces in Iraq and Afghanistan to capacity-building with partners or hostage rescue.

However, when we get on to the “lessons learned”, we get this:

Our assumption that we could “go first, go fast and go home” has proved false. We believed that we could deploy our forces for the most difficult early intervention stage of a conflict, and leave the subsequent stabilisation and development tasks to partners. But we have not been able – or wished – to disengage as we had planned. We have therefore further improved our ability to sustain deployed forces, including, for example, through additional procurement of strategic lift.

I think this is important. Going first, going fast, and going home was very close to the early Rumsfeld view – airpower, strategic mobility, force protection, and an almost neurotic self-assertion towards allies. It’s rather what the European Council on Foreign Relations says here; Europe was meant to do the boring stuff. It reminds me of the old line about “America cooks and Europe washes up”. Well, if you never wash up, eventually you get typhoid. The reference to additional lift was the decision to lease, at vast cost, and eventually buy the RAF some C-17 transports – a sort of shadow of the concurrent procurement train crash around the Future Strategic Transport Aircraft.

The international and national policy and legal framework is having an increasing impact on our operations. Defence continues to make an important contribution to tackling terrorism overseas, following the lines set out in the SDR New Chapter in 2002. The role of Defence in working with other departments to tackle the drivers of terrorism, and to build security capacity, is crucial – although the scope for conducting overseas counterterrorism operations is narrower than envisaged in 2002.

Indeed – 2002, and the spirit of 2002, are a long time ago, and:

In many cases, our operations have developed in much more complex and dynamic ways than we envisaged and planned for, and we have not been able to adapt as rapidly as we would have liked.

Indeed.

In particular, in our focus on our geographical area of responsibility, for example in Basra, we may have placed insufficient emphasis on the multi-national operational level. In the later stages of operations in Iraq, the full integration of UK staff into US and coalition headquarters significantly improved the coordination of our contribution. We are taking that lesson forward in Afghanistan.

To put it another way: We thought we could ignore what was going on in Baghdad, Anbar, and Multinational Division South-Centre, and just crack on in Basra without rocking the boat. But it’s impossible to divide the problems of war, whether between land, sea, and air or between geographies within the same theatre. When they wanted war elsewhere, we opted out of the big decisions and lost the ability to say no effectively.

Our deployment of formed headquarters and formations for limited periods has not reflected the need for “campaign continuity”. We have now extended the tour lengths for key headquarters personnel and are looking at options that would ensure greater continuity throughout the headquarters. We are clear that we need to go further to produce better campaign continuity.

This was a problem for the Americans in Vietnam and also for the British Army in various counterinsurgencies. It’s probably common to all armies involved in a long war that isn’t utterly central to their worldview, because it’s driven by career structures. To be a general, you must have a general’s command, and why would you be a general if not to command? Further, what they usually command is a formation, and formations usually rotate. Ad-hoc geographical or functional commands are against the bureaucratic structures involved – perhaps it’s because of this that they are always necessary.

We have found it challenging to identify and rapidly implement lessons in doctrine. This is inherently difficult, but in some areas we have already moved a long way. The Army recently issued a new Counter-Insurgency Doctrine, and we now have a dedicated training facility for counter-insurgency in the UK.

Well, they’re right, really.

Often, innovation within the operation has minimised the adverse impact of these weaknesses. In our current operations, we have incorporated those insights into our strategic policy. Our Afghanistan/ Pakistan Strategy, and General McChrystal’s strategy, are based on a clear understanding of the challenges we face, a long-term vision founded on integrated political, development and military action and an overarching regional approach. Our Urgent Operational Requirements (UORs) procedures are delivering the equipment our forces need as the requirements evolve. The Government has approved over £5.5 billion of UORs in Afghanistan since the operation began.

To put it another way – we muddled through, sort of. The reference to UORs corroborates this – part of the reason why the armed forces don’t buy all they need through UORs is that they go around much of the procurement process, in order to be urgent. This means, of course, that they may end up paying more, or getting less. On the other hand, the very fact that they needed to raise £5.5 billion worth of them for Afghanistan – that’s as much as the carriers – suggests that the normal procurement process is dysfunctional.

What about the future? It’s likely to be:

* Contested – access and freedom of manoeuvre – even as we attempt to deploy into the regional theatre – will have to be fought for;
* Congested – we are likely to be unavoidably drawn into urban areas, the littoral and lower airspace;
* Cluttered – we will find it difficult to discriminate between a mass of ambiguous targets – friendly forces, other international actors such as non-governmental organisations or development agencies, media representatives, local civilians and our adversaries;
* Connected – key lines of communication, including critical military infrastructure, maritime chokepoints and computer networks, will be vulnerable to attack and disruption; and
* Constrained – legal and social changes will place additional limits on our actions.

This is true, but hardly original. This is a good book.

Our preferred way of warfare – concentrating force, bringing technology to bear and seeking rapid defeat of our adversaries – may not be as effective as it has been in the past.

Is that our preferred way of warfare? I think this might need a debate. It sounds a lot like a classic statement of the American way of war, which may be the problem. Of course, nobody wants to disperse force, fail to use technology to best advantage, and seek endless, inconclusive struggle – but if Rupert Smith is right and struggle tends to be endless and inconclusive, and technology less decisive than expected, perhaps this should have some bearing on our preferences.

And here comes the dread word: “cyber”.

Cyber Space, in particular, poses serious and complex challenges for UK security and for the Armed Forces’ operations. Our increasing dependence on cyber capabilities creates opportunities but also serious vulnerabilities. Cyber attacks are already an important element of the security environment and are growing in seriousness and frequency. The most sophisticated threat is from established and capable states but cyber eliminates the importance of distance, is low cost and is anonymous in nature, making it an important domain, not just for hostile states, but terrorists, and criminals alike. Cyber space is critical to much of our military effort here and overseas and to our national infrastructure.

Note that the most sophisticated threat comes from states – not the main or the most serious threat. Of course, if the feared attack involves an electron microscope or a quantum computer, a state is the most likely attacker. But it’s in the very nature of information security that the great overwhelming majority of threats come from a huge diversity of tiny actors, and they are just as capable of doing serious damage as anyone else.

Further, defence against these threats tends to be the same – basically, sensible network management. The good news here is that there is no talk of giant firewalls or of “cyberdeterrence” – just of sensible security precautions. Further, the realities of the threat environment are taken seriously. No Dr. Evil plots here, nor cold war fantasies, just a space rather like the sea. The upshot of this is that the UK has far greater interests in keeping the infrastructure up, working, and open to all than it could possibly have in disrupting it. Very like the sea. The White House appears also to be heading this way, as Kings of War points out.

The National Security Strategy also set out the increasing challenges we face in Space. The Armed Forces’ dependence on space has grown rapidly over recent years. Access to space-derived information is now critical to our ability to conduct operations. This makes us vulnerable. The development of offensive counter-space capabilities is a particular concern. But, given our reliance on assets we do not control, there is also a risk of loss of access in periods of high demand – such as during large-scale operations or in the event of a sudden reduction in existing capacity. A continued close relationship with the US underpins our access to space capabilities. But we intend to look closely at how we contribute to allied programmes or develop national capabilities.

This is probably the most significant paragraph in the chapter. After 1971, the UK hasn’t tried to maintain its own reconnaissance satellite capability, nor has it participated in multilateral projects. It is thought, although as with everything between the UK and the USA, it is not written down in anything subject to ratification, that there is an understanding that the USA would share its overhead imagery with the UK. We know that this was turned down at least once during the Falklands War.

Tellingly, during the Iraq war, European countries fell in three groups. Those who had their own imagery – France and Germany. They didn’t participate at all. Those who got such a capability after the spring of 2003 – Spain and Italy. They left early. Those who had nothing at all – everyone else, basically. The outlier is Turkey, which didn’t have such a capability (although they did have representatives at the EU Satellite Centre) but didn’t get involved. Then, the Turks probably had good human sources in Iraq. They’ve since ordered a high-resolution photographic satellite from Telespazio of Italy.

Exactly what the US chose to share with us out of the wealth of imagery its national technical means, as they say, produced remains one of the great questions about the UK’s involvement in Iraq.

Research and development investment in defence technology in emerging nations has been increasing significantly over the past decade. Some key equipment produced by these countries is already as capable as equivalent equipment produced by the UK and our key allies and partners.

Civil investment in research and development, both nationally and globally, is now much larger than equivalent defence spending. Much of this research is developing technology – for example in communications, materials or biomedical science – which could be used in a military or wider security context. But the Ministry of Defence and our international partners in defence can expect to have less visibility of and expertise in such cutting edge technology than we have had in the past.

Loss of our technological edge in significant areas of military capability would have a profound effect on the way we operate.

This is the Arduino question; the proliferation of what used to be technology confined to the superpowers, or as Phil Hunt put it, what happens when a Congolese workshop with a RepRap can make a surface to air missile? Arguably, the key point here is that there is nothing we can do about it except for getting more like that ourselves – which comes back to the procurement economy.

As Kings of War’s David Betz says, this is an argument for general-purpose forces more than anything else. He also quotes the Navy as follows:

* Firstly, what do you want to defend and what are the Standing Commitments for Defence?
* Secondly, we need to have a clear idea about what we as a country would aspire to do on our own.
* Third, where the UK is operating as a coalition member, how do we want to influence our partners?

Latvia: No victory yet, no defeat either

Some comments or, perhaps better, some additions to Ed Hugh’s piece of February 26, To Soon To Cry “Victory” on Latvia?, by Morten Hansen, Stockholm School of Economics in Riga.

Thanks a lot to Ed for welcoming some comments/further arguments on the debate on whether Latvia can indeed cry “Victory” (as seemingly suggested by Edward Lucas in The Economist) in the internal devaluation battle that it is fighting. Continue reading

Russia on the rebound

Two interesting facts:

1) After sharply negative growth last year, Russia’s growth is predicted to exceed 6% this year. Okay, that’s just clawing back what they lost. But it’s still better than almost anywhere else in Eastern Europe.

2) For the first time in many, many years Russia’s population grew slightly: by a little over 20,000 people in 2009.

This growth is a combination of a slight downturn in the death rate, a noticeable uptick in the birth rate, and a sharp rise in immigration — it hit a ten year high, with about 240,000 people moving into Russia.

So: short-term blip, or sustainable? Continue reading