National Governments, the IMF, and Blame

I was just reading a little bit about the Greek Economy and wanted to highlight the following observation about the IMF that ends up giving it a bad name for government's mistakes:

One key feature in all this woe has to be a political process that is extremely ineffective, and driven by the fact that no one likes to hear bad news, and that the last thing a politician is able to say is tighten-up your belts now lads and lasses, we are in for a rough ride. But isn’t this just how the IMF gets such a bad name for itself, since the IMF doctors get called in just where the domestic political process breaks down, and where local politicians haven’t the ability to stand up in front of their citizens and say, it’s going to have to be like this, I’m afraid. Isn’t this what just happened in Ukraine, Hungary and Latvia? And then people say, those “nasty folk” at the IMF, they cut pensions everywhere they go, and wages are down 8% in Hungary, and 15% in Latvia once the IMF get to run the show. That is the IMF make for a convenient scapegoat, but people seldom ask themselves why wages needed reducing, or why there is no money to pay the pensions.

Granted, there are other ways to reduce a deficit and the IMF might be biased on how it wants to cut deficits but the general point stands.

Should we have let them fail?

In a recent WSJ article Oliver Hart and Luigi Zingales suggest that since the main reason behind bailing out the likes of Bear Stearns and AIG because of worries about counter-party risk the government should have instead guaranteed those obligations:

[I]t suggests that the best way to proceed is to help third parties rather than the distressed company itself. In other words, instead of bailing out AIG and its creditors, it would have been better for the government to guarantee AIG's obligations to J.P. Morgan and those who bought insurance from AIG. Such an action would have nipped the contagion in the bud, probably at much smaller cost to taxpayers than the cost of bailing out the whole of AIG. It would also have saved the government from having to take a position on AIG's viability as a business, which could have been left to a bankruptcy court. Finally, it would have minimized concerns about moral hazard.

I'd be very curious to hear more about what others think about this proposal and how workable it would have been. How exactly would the government have guaranteed some of the complex obligations and what kind of risks would it have taken on by doing so? Would this have assuaged investors' concerns?

Lots of Reading, Little Blogging

During the beginning of the Financial Crisis I spent virtually all of my reading time focusing on current events and reading articles and research papers online. I now feel I have a much more solid background on what is going on and am focusing on reading books again and while I still keep up with everything that comes in through my RSS feeds things have definitely slowed down since the beginning of the crisis. I do have several unfinished blog posts that I will post in the days ahead and will update more regularly again once I get caught up on some reading that I had to delay in favor of reading online and blogging.

I recently finished George Soros' The New Paradigm for Financial Markets which was interesting as an insight into Soros' thinking (more about that in a later post) but did not really give me any new insight into the economic troubles. After that I decided it was time to make my way through all the China books that have been sitting on my shelf, starting with the Chinese Economy, both The Chinese Economy: Transitions and Growth and Rural China Takes Off were excellent reads that I recommend highly, Grassroots Political Reform in Contemporary China, a collection of research studies on reform was less interesting.

Next up were less academic accounts of China, China Inc. and China Road, the former of which was annoying and not very deep while the latter was beautiful and insightful. I was reading them both at the same time (one on audio, the other on paper) and it really made me realize how many 'popular books' try much too hard to seem important and be liked by the reader and thereby simply become exaggerated and boring. Rob Gifford, author of China Road, never tries to force you to appreciate his work but instead gives a wonderfully natural and fun to read account of his journey along Route 312. Now I'm reading The Cambridge Illustrated History of China and next up is Chinese Civilization to be followed by 3 books on Chinese Foreign Policy.

On the fiction side I recently read A Passage to India by E.M. Forster which I loved and which made me want to go back to India again. I was horrified and saddened by the recent attacks in Mumbai having spent three days there in January, relaxing from a hectic Journey through Northern India, but I would not hesitate to go back as early as a few weeks from now. One of my favorite blog posts about the events was this heartfelt post about how terror will never succeed and how our way of life will continue (found via A Fistful of Euros).

After enjoying A Passage to India this much I am now reading A Room with a View, after reading about it in a wonderful travel article on Florence in the NYTimes that references it heavily.

Finally, I want to say how much I've come to love Audiobooks - yes, they are slower than just reading the book myself but they allow me to 'read' while I'm driving to work or working out at the gym and therefore save a lot of time. I don't think I would have as much time to read fiction without them.

Africa and the Financial Crisis

I've been writing a lot about the Financial Crisis and relatively little about African development but I found a great short little paper by Shanta Devarajan, Chief Economist of the Africa Region at the World Bank, about the impact of the crisis on Africa that combines the too. If you're curious about how the crisis has impacted other countries here's a post about it's impact in Eastern Europe and Iceland. It's late and I want to keep this short but here's the core idea followed by the five ways of how the crisis could have an impact, read the paper for more:

It is argued that the transmission mechanisms between the financial systems in Africa and the rest of the world are weak and will minimize the impact on the crisis. African financial institutions are not exposed to risks emanating from complex instruments in international financial markets because most banks in Sub-Saharan Africa rely on deposits to fund their loan portfolios (which they keep on their books to maturity); the interbank market is small; the market for securitized or derivative instruments is either small or nonexistent, and few rely on foreign borrowing to fund their lending operations. Exceptions to this position are then made for countries like Nigeria and South Africa which are seen as having meaningful transmission mechanisms with the larger financial systems in crisis.

This conventional position is now being challenged. As the immediate crisis faced in the last couple of months subsides, and policymakers begin to consider the longer term impact of the crisis in Africa, an emerging view is that the impact on the financial sector in Africa may actually be more significant and longer lasting than first assumed, and the impact on the non-financial sector in Africa will be more notable.

Impacts:

1. Weakened local investor confidence in equities and bonds on African Stock Exchanges
   
2. Return to ultraconservative lending practices 
   
3. Losses arising from central bank reserve management practices 
   
4. Renewed debate on the role of governments in the financial system 
   
5. Weakened balance sheets resulting from a downturn in the real economy
   

Finally, one obvious way the crisis will affect the real economy is through a drop in commodity prices:

Declining demand for commodities will impact African countries significantly. In Zambia for example, the economy is likely to take a hit from a share decline in copper prices (-24%ytd). As the financial crisis surges into all parts of the real economy in developed economies, African countries will experience a substantial decline in exports as the rapid pace of trade expansion in this decade decelerates sharply.

Decentralization And Corruption

Another paper by Ray Fisman, this one together with Roberta Gatti on how government decentralization affects corruption. They use cross country data and find that "fiscal decentralization in government expenditure is strongly and significantly associ-
ated with lower corruption." I'm not going to go into the actual methodology of the paper here - it's definitely an area that needs some further study but I wanted to summarize the different theories as to why decentralization might increase or decrease corruption (from the paper):
Decrease:

• Political competition reduces the ability of bureaucrats to extract rents in exchange for services - The Power to Tax, Brennan and Buchanan (1980)
  
• Competition among localities will more generally discourage governments from establishing interventionist and distortionary policies that might drive away valuable factors of production - Regional Decentralization and Fiscal Incentives, Jin et. al (1999)
  
• Related to last point: Implement corruption free zones to force other localities to improve their own bureaucracies - Special Governance Zone: A Practical Entry-Point for a Winnable Anti-Corruption Program, Shang-Jin Wei (2000)
• Agents in centralized bureaucracy are responsible for many tasks in many jurisdictions, in decentralized bureaucracy they are responsible for a single task. This makes them more directly accountable while in centralized bureaucracy only the aggregate performance is measured - Constitutional determinants of government spending, Persson and Tabellini (2000)

Increase:

• Decentralized regimes are less likely to attract high quality bureaucrats, since the rewards to local politicians will be small relative to bureaucrats at the central level - Fiscal federalism and efficiency, Tanzi (1996).
  
• The post may be more prestigious, visible, and monitored better - Constitutional determinants of government spending, Persson and Tabellini (2000)  
• Lack of coordination among bureaucrats in extracting bribes may lead to ‘excess’ rent extraction, in much the same manner that successive monopolies result in a total price markup above the monopoly level - Corruption, Shleifer and Vishny (1993) - [Great paper, I read this for IPS 207]

Important: Tie local revenue generation to local expenditures, since vertical fiscal transfers may allow local officials to ignore the financial consequences of mismanagement.

The Value of Connections to Dick Cheney

David Fisman, Ray Fisman, Julia Galef, and Rakesh Khurana have a fascinating (I know I overuse this word but it's really deserved here) working paper that tries to estimate the value to a company of a connection to Vice President Dick Cheney. They look at the market reaction (i.e. stock price) of companies connected to Cheney to Cheney's heart attacks, his selection as Vice President, the likelihood war in Iraq at certain points in time, and the probability of a Bush victory in 2000 to see if these events cause the companies to significantly over- or underperform their respective sectors. They find that the value of such ties is zero.They think that this is to some degree generally applicable to individual politicians in the US:

While prior evidence suggests that business-government relations are an important part of U.S. commerce, our results suggest that these connections are more institutional than personal. That is, there are well-organized institutions (such as political action committees and other lobbying entities) for facilitating these relations that differ from the deeply personalized favor exchange that characterize business-politics relations in so much of the world.

I think that this result needs much further study but the implication that the value to a company of a personal connection to a politician is relatively unimportant compared to more formal and broad lobbying and PACs is going to be hugely important in figuring how to best fight corruption and the influence of special interests.

Update: Here's another similar paper Estimating the Value of Political Connections by Ray Fisman on how news about former Indonesian President Suharto's impacted companies with connections to him. I remember reading this about two years ago but don't remember for which class...

Iceland's Crisis

As most people have heard at this point, Iceland has been one of the hardest hit in the current financial crisis. Björk summarizes the situation best in this very thoughtful article in the London Times:

Gigantic loans, it has been revealed, were taken out abroad by a few individuals and without the full knowledge of the Icelandic people. Now the nation seems to be responsible for having to pay them back.

This weekend I wanted to learn a bit more about what the situation in Iceland is like and found an Icelandic blog Iceland Weather Report linked from A Fistful of Euros that has been giving regular updates on the situation on the ground:

[T]here were massive layoffs here at the end of last month. Most of those were in the construction industry - manual workers, designers, architects … anyone in the business of constructing new buildings. Many were foreign citizens who had been living and working here temporarily in construction. The second-largest hard-hit industry was, obviously, the financial services sector - bank workers being laid off. The third-largest was retail. In addition, many people have been laid off and then re-hired on different terms, which usually has meant that they’ve had to take a pay cut.

Basically, things here have slowed down drastically. Public and private spending has been cut back wherever possible. Pretty much anything that can be postponed, has been postponed. That goes for companies and institutions [public and private], as well as individuals. People aren’t going out to buy new cars or even new clothes these days, nobody is remodelling their house or doing anything of the sort that isn’t absolutely crucial. A state of affairs that I suspect isn’t unique to Iceland - this is what happens across the board in a recession.

What IS unique to Iceland - and very troubling - is the state of our currency.

The New York Times had an article on the impact as well, much of it focusing on the implications of Kronur's rapid fall in value on the economy. The starkness of it all didn't really hit me until I read that a third of Icelanders are considering leaving though:

Her fixed costs are no longer fixed. Five years ago, the company built a new factory, borrowing the 120 million kronur — about $1.5 million — in foreign currencies. But the currency’s fall has increased her debt to 200 million kronur. This summer, her monthly payments were 2.5 million kronur; now they may be double that — the equivalent of $38,500 in Iceland’s debased currency.
“My financial manager is talking to the banks every day, and we don’t know how much we’re supposed to pay,” Ms. Hedinsdottir said.
In a recent survey, one-third of Icelanders said they would consider emigrating. Foreigners are already abandoning Iceland.

So how did this happen? Tom Friedman explains the basics:

The Icelandic banks, while not invested in U.S. subprime mortgages, had gone on their own borrowing and lending binges, wooing savers from across Europe with 5.45 percent interest savings accounts [Note: Interest rates were around 15% because of high inflation].

In a flat world, money can easily seek out the highest returns, and when word got around about Iceland, deposits poured in from Britain — some $1.8 billion. Unfortunately, though, when global credit markets closed up, and the krona fell, “the Icelandic banks were unable to finance their debts, many of which were denominated in foreign currencies.”

The current situation is dire and its enormity is somewhat difficult to comprehend, Iceland is a small country and according to Iceland Weather Report the claims that Britan is making on Landsbanki , "are 3-4 times higher than the war compensation claims Germany was made to pay after World War II." Recovering from a shock like this is going to be a difficult, long, and painful process. And yet I want to end this post on a somewhat positive note. While the effects of this crisis are truly terrible and none of what happened can be excused it is also an opportunity to reevaluate and to change direction. Icelanders are a proud, dynamic, and well-educated people and have recovered from worse, or (once more) in the words of Iceland Weather Report:

Cultivating what really matters. A return to basic values. That’s the prevailing emphasis around here these days and yes, it is a Very Good Thing. A few short weeks ago the media was still glorifying our “Tycoons” and doing features on people who decorated their massive concrete homes with cold fixtures and soulless minimalist furniture. What we get now is stories of people sticking together, helping each other [...]

Education authorities are making sure children have a secure place in the preschools even if their parents default on payments. A crisis committee is being set up to help people who have lost their jobs. Mortgages are all being taken over by the state’s Housing Financing Fund and those who can’t make mortgage payments can apply to have them halted for the time being. [..]

We have good, solid resources: fish in the sea, heat in the ground, copious amounts of energy, a beautiful country with myriad opportunities in tourism, and an excellent workforce: a nation of well-educated and hard working people, many of whom are now out of work and who can use their expertise to help rebuild our economy and much of the infrastructure. After all, this is not the worst that we have endured: on two or three occasions in the past the Icelandic nation has been close to being wiped out by calamities much worse than this, such as volcanic eruptions and the bubonic plague.

Factors in the Surge's Success

After my initial (somewhat hastily written) piece on the Surge and the followup I wanted to present some thoughts from someone who was actually on the ground in Iraq before and after the Surge. Lieutenant Colonel Dale Kuehl has a paper in Small Wars Journal that you should read in full but I will present his key points here and then delve into the case of a certain Abu Abed (summary is quoted from the article):

• The factors that led to the drop in violence are extremely complex. It is an oversimplification to say that the surge itself led to the drop in violence. However, on the other hand it is a gross oversimplification that it was a result of paying off Sunni militia.
• The surge in troops was invaluable to help us defeat al-Qaeda and stop the advance of JAM in northwest Baghdad.
• The surge was only as good as the operational design that went along with it. The change in focus from transitioning security to the Iraqi Security Forces to protecting the populace was also a major part of the success last year.
• While units before us were conducting COIN operations we did make fundamental changes in how we conducted COIN based upon the change in operational design. These included changes in tactics at the patrol level, but probably more important a concerted effort at battalion and brigade levels to increase our engagements with the populace and leadership within the communities. Some of these changes we implemented early, some we made as we adapted to the changing situation.

One particularly interesting point is the initial goal of the battalion in training the Iraqi army instead of directly focusing on the security situation:

When we arrived in Iraq in October 2006, the focus of the operational concept was transition to the Iraqi Security Forces. Gen Casey briefed us at the COIN Academy in Taji that we would be transitioning the lead for security in Baghdad to the ISF by summer 2007 while our forces would provide tactical overwatch over these security forces. [...]

We soon shifted our focus from transition to protecting the populace. While I am sure units were doing what they could to protect the populace, the focus upon our arrival was on transition. [...] By [doing this] we made a distinct change in our understanding of the center of gravity of this fight. With this understanding we came to one quick conclusion: we were doing a poor job in protecting the populace. The shift in focus led to a subsequent shift in our tactics, techniques and procedures that placed greater emphasis on getting into the community and engaging the populace to a greater degree at all levels.

Additionally, a big part of the success of the Surge was gaining the support of Sunni groups that had previously been fighting together with al-Qaeda and I think that understanding how exactly this was accomplished is important. Kuehl spends some time discussing this and its implications:

As for why Abu Abed and his men came forward when they did…I don’t know for sure, but do have some thoughts based upon my conversations with him and community leaders. First, these guys did not just spontaneously erupt. I believe there was a group of people who were willing to work with us against al-Qaeda, a minority against the cause of the AQI led insurgency. This minority was getting organized and looking for an opportunity. Among this minority were the imams that Col Gentile introduced me to. Not all were on board at first. I think this group was looking for the right time

A story in the Guardian from last year gives a more in-depth account of Abu Abed in his group, agreeing with their reasons for joining the US efforts but cautioning of the dangers of giving so much power to these warlords that might come back to haunt the US and Iraq military later down the line.

Finally, while there are many important lessons in the paper I wanted to point out one that everyone can relate to but that is also difficult to write about. As someone unaffected by this violence it is very easy for me to say this but I have incredible respect for those who can do the right thing when faced with this circumstance. Violence breeds violence: when we are attacked by someone it is easy to lash out and blame everyone in their group/country/religion/etc. but in a situation like Iraq a carefully measured and targeted response will not only help to make sure that the right people will be found and brought to justice but also that future killing will be prevented:

During this time we also put in a COP in northwest Ameriyah. While putting in this outpost a deep buried IED exploded killing an entire Bradley crew of six Soldiers and one interpreter. I believe that our response to this catastrophic event was also one of the reasons the Sons of Iraq came forward when they did. One of the imams told me later that the whole neighborhood expected us to tear the place apart after this event. We had been going through a tough month with six other Soldiers killed in the previous two weeks. The restraint and discipline of our Soldiers was noted and cited by the locals themselves as one of the reasons they chose to work with us.

Non-State Actors and the Future of Military Power

I found a very interesting paper on the future of US military (ground) power by Thomas Donnelly in the Small Wars Journal through Tom Barnett's blog. Like all SWJ papers it is relatively short (3-5 pages) and it's well worth reading (one interesting bit: The US Military as a fighting force for use abroad didn't really exist until WW1, before that it was more tasked with protecting people in the frontiers, etc.). What I found particularly interesting though was the following analysis of the role of the military in fighting 'extremism' and/or 'terrorism' (of some forms). The idea that groups like Hezbollah are turning into small "privatized" armies and how to countervail them is very interesting:

Even less persuasive is the idea that, because military power is not the only requirement for success, that we won’t need sufficient military power. Or that, because the enemy won’t mass forces the way the Soviets used to, that there won’t be significant “battles.” We’re not fighting a condition called “extremism,” we’re fighting a series of quite distinct enemies motivated by an extremist ideology and a vicious version of a faith that does not much distinguish between the personal and political, a backwards-looking travesty of Islam that not only elevates God’s law above man’s law but in fact finds the vary notion of man-made law to be illegitimate and blasphemous. Thus, Clausewitz still rules: these wars are politics by other means.

Consider the case of Hezbollah in southern Lebanon (read either the brief section on the 2006 war with Israel in Ground Truth or, for a more thorough and recent analysis, The 2006 Lebanon Campaign and the Future of Warfare by Steve Biddle and Jeffrey Friedman). The organizations are wrongly described as “non-state actors;” they are proto-states, or mini-states, but they are clearly entities that evince state-like behavior. And as they become moreso, their military behavior will become more conventional. We had better start counting and understanding Hezbollah-style “brigades.” The true answer to the irregular-verus-conventional argument is “both.”

Extreme Signs of Global Economic Readjustment

The volatility in Oil, Food, Metal, and Transportation Prices is astounding these days, this paragraph in a Washington Post article really hit that point home:

China has also trimmed the importation of other materials that have fueled its spectacular run of growth. [Charles Bradford, metals analyst at Soleil Securities] noted that ocean freight rates for iron ore from Brazil to China are down to $12 per ton today from about $108 last May.

The Financial Crisis and Human Capital Allocation

Here's an excellent article by Fareed Zakaria on why the financial crisis also presents a huge opportunity to clean up some of the problems of the political, financial, and economic system of the last decade(s) and how the new administration has (available) the brain power to effect this change:

Volcker has also argued that the highly complex financial system was not nearly as stable as people believed and that far-reaching efforts were needed to regulate and stabilize it. Now these issues will get attention at the highest level. The fear on Wall Street is that a Democratic administration would overregulate. But look at who is advising Barack Obama—Buffett, Volcker, former Treasury secretaries Robert Rubin and Larry Summers. It is more likely that what will come from their efforts will be a better-regulated financial system that, while producing less-extravagant profits, will be more stable and secure.

What I personally find really interesting is his succinct summary of something I have heard over and over in the last few weeks - How the inflated financial industry caused a misallocation of talent into the financial sector:

The financial industry itself is likely to shrink, and that's not a bad thing, either. It has ballooned dramatically in size. Curry points out that "30 percent of S&P 500 profits last year were earned by financial firms, and U.S. consumers were spending $800 billion more than they earned every year. As a result, most of our top math Ph.D.s were being pulled into nonproductive financial engineering instead of biotech research and fuel technology. Capital expenditures went into retail construction instead of critical infrastructure." The crisis will stop the misallocation of human and financial resources and redirect them in more-productive ways. If some of the smart people now on Wall Street end up building better models of energy usage and efficiency, that would be a net gain for the economy.

Esther Duflo recently wrote about this for VoxEU and two years ago I read an excellent paper on the incentives for productive and unproductive economic behavior by William Baumol that I cannot recommend strongly enough:

[The] allocation between productive activities such as innovation and largely unproductive activities such as rent seeking and organized crime. This allocation is heavily influenced by the relative payoffs society offers to such activities. This implies that policy can influence the allocation of entrepreneurship more effectively than it can influence its supply.

More on the Rising Dollar

I recently posted on how increasingly broad deposit insurance might be one reason for the rising dollar and wanted to post some more on this after seeing the following referenced by Tom Barnett from an Economist article I read a while ago (Btw, the Barnett article is really interesting if you're following the whole 'Post American Century' debate):

[Kristin Forbes] found that a lack of financial development at home makes foreigners keener to invest in America. What attracts them is the size, liquidity, efficiency and transparency of its financial markets compared with what is on offer in their domestic markets. This finding adds weight to theories which explain global imbalances as a consequence of slow financial progress. In this view, poor countries save hard and buy foreign securities because of a dearth of good options at home.

Capital Controls?

Capital Controls (i.e. government regulation on financial flows in and out of the country) are a complex topic that I've been meaning to learn more about for a while (and will suspend judgment on for now). I haven't had the chance to do that yet (and probably won't for a while) but I did see the following in Paul Krugman's column on Malaysia's response to the Asian financial crisis:

The scope of global "contagion"--the rapid spread of the crisis to countries with no real economic links to the original victim--convinced me that IMF critics such as Jeffrey Sachs were right in insisting that this was less a matter of economic fundamentals than it was a case of self-fulfilling prophecy, of market panic that, by causing a collapse of the real economy, ends up validating itself. But I also concluded that the threat of further capital flight would prevent Asian economies from simply reflating, that is, increasing public spending and cutting interest rates to get their economies growing again. And so I found myself advocating temporary restrictions on the ability of investors to pull money out of crisis economies--a curfew, if you like, on capital flight--as part of a recovery strategy.

Krugman (in 1999 at least) seems like a cautious supporter of Capital Controls:

Until the Malaysian experiment, the prevailing view among pundits was that even if financial crises were driven by self-justifying panic, there was nothing governments could do to curb that panic except to reschedule bank debts--part, but only part, of the pool of potential flight capital--and otherwise try to restore confidence by making a conspicuous display of virtue. Austerity and reform were the watchwords. The alternative--preventing capital flight directly, and thereby gaining a breathing space--was supposed to be completely impossible, with any attempt a sure recipe for disaster. Now we know better. Capital controls are not necessarily the answer for every country that experiences a financial crisis; sometimes confidence can be restored without the need for coercive measures, and even when calming words fail, "burden sharing" by banks and other lenders will often be enough. But it would now be foolish to rule out controls as a measure of last resort.

Dani Rodrik seems to be a more vocal supporter, as witnessed by this piece in the FT and his post on Nonsensical Arguments Against Capital Controls. Finally, for those who want to learn more is an empirical study on the Malaysian situation by Rodrik and Kaplan showing that Capital Controls were indeed effective there.

The Impossible Trinity

While reading O Canada, an article by Paul Krugman on Robert Mundell's Nobel Prize I saw the following bit of brilliance:

Later Mundell would broaden this initial insight by proposing the concept of the "impossible trinity"; free capital movement, a fixed exchange rate, and an effective monetary policy. The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain--or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today, or for that matter most of Europe).

When looking at the Wikipedia article for said 'Impossible Trinity' I found it to reference exactly that quote from this same article. Well, it really is an excellent summary of a very interesting idea.

Why the Dollar will remain the World's Reserve Currency

After my recent post on the (questionable) value of a countries' currency being a reserve currency, I wanted to follow up with an excerpt from a brilliant article by Bill Emmott, former Editor of The Economist. The article itself is about the issues facing the US and the rest of world in the years ahead, both politically and economically. It really is a great article and worth reading, but what I wanted to point out here is a very good argument for why it is unlikely that the Dollar will cease to be Reserve Currency of choice any time soon:

The first point to be made is that the dollar's role in global foreign-exchange reserves was much smaller in 1990 (50 percent of global reserves) than it is today (about 63 percent), so even a fresh decline in its use would not be path-breaking. The second is to ask what the alternative is: the euro, the currency of a region that has gone into recession more quickly than the United States, and whose banks are just as troubled? And not, certainly, China's yuan, unless that country's leaders are poised to surprise us all by making it convertible and reducing controls on capital flows, both of which are necessary before a currency can take on reserve status. By default, the dollar is likely to keep its leading role. Whether the United States will again be a beacon of economic policy and performance depends on how bad its recession proves to be and on how well it adjusts to a new period of higher household savings and lower consumption and debt.

Strategic Petroleum Reserve

Sophia was just reading an article about the Strategic Petroleum Reserve of the United States (and a proposal to double it) and while I knew how much oil was being stored I had no idea about how it was stored, very very cool (from Wikipedia):

The Strategic Petroleum Reserve (SPR) is an emergency fuel store of oil maintained by the United States Department of Energy.
The US SPR is the largest emergency supply in the world with the current capacity to hold up to 727 million barrels (1.156E+8 m3). The second largest emergency supply of oil is Japan's with a 2003 reported capacity of 579 million barrels (9.21E+7 m3).

The reserve is stored at four sites on the Gulf of Mexico, each located near a major center of petrochemical refining and processing. Each site contains a number of artificial caverns created in salt domes below the surface.
Individual caverns within a site can be up to 1000 m below the surface, average dimensions are 60 m wide and 600 m deep, and capacity ranges from 6 to 37 million barrels (1 to 4.3 million m³). Almost $4 billion was spent on the facilities. The decision to store in caverns was taken to reduce costs; the Dept. of Energy claims it is roughly 10 times cheaper to store oil below surface with the added advantages of no leaks and a constant natural churn of the oil due to a temperature gradient in the caverns. The caverns were created by drilling down and then dissolving the salt with water.

Unlimited Deposit Insurance: One Reason the Dollar is Rising?

Here's a great article on the problems with unlimited deposit insurance from Alan Blinder and Glenn Hubbard (via Greg Mankiw's 'More Commentary on the Financial Mess'). One of the interesting parts was about increasingly broad deposit insurance might be one of the reasons that the dollar is rising as savers in other countries with less favorable schemes move their money to the US to keep it secure. This would normally be expected anyway as spooked investors move their money to the more stable US but in this case financial insecurity is spreading from the US to the rest of the world but legislation like this might be one of the factors that money is still pouring into the US:

Third, an unlimited deposit guarantee in the U.S. would pull funds out of other countries, just as Ireland's guarantee led to an inflow of money into Irish bank offices in the United Kingdom. The Irish-British deposit flow happened on a small scale; but the U.S. is the 800-pound gorilla of the world market. Even amidst all this chaos, money has been flocking to our shores.

Thus we might wind up worsening an odd sort of beggar-thy-neighbor game, causing a "giant sucking sound" as deposits fled other countries for the sanctuary of the U.S. and its FDIC. The implications for our international friends could be enormous. In a misguided attempt to create financial security at home, we might inadvertently make the world a significantly more dangerous place to live.

Environmentalists Get Their Story Right

I've been writing a lot about the financial crisis because its a current issue and it's really exposing some of the underwork of the world financial system but with everyone talking about that and the upcoming US election there is less focus on long term issues. One of these is global warming/environmental destruction, and I just read a BBC article about the newly released Living Planet Report by the WWF (which uses Apture on its site) and about how they are comparing it to the current financial crisis by calling it an ecological credit crunch:

The Living Planet Report is the work of WWF, the Zoological Society of London and the Global Footprint Network.
It says that more than three quarters of the world's population lives in countries where consumption levels are outstripping environmental renewal. This makes them "ecological debtors", meaning that they are drawing - and often overdrawing - on the agricultural land, forests, seas and resources of other countries to sustain them.

He said the more than $2 trillion (£1.2 trillion) lost on stocks and shares was dwarfed by the up to $4.5 trillion worth of resources destroyed forever each year. The report's Living Planet Index, which is an attempt to measure the health of worldwide biodiversity, showed an average decline of about 30% from 1970 to 2005 in 3,309 populations of 1,235 species.

Really great and timely marketing. And also an important thing to keep in mind and to put things into perspective.

Krugman on Stockmarket Bubbles

Paul Krugman makes a great argument that the Fed shouldn't worry too much about stockmarket bubbles because their bursting doesn't cause the same excessive supply as bubbles in the real economy.

The thing to understand is that a stock market boom is not like a boom in physical investment--say, a boom in condominium construction. That kind of boom depresses future spending because it leaves behind a landscape littered with unsellable condos. But that isn't quite what happens when stocks surge: When the market value of Croesus.com doubles, that doesn't mean there will be an overhang of vacant dotcoms weighing down rental rates two years from now. It's paper gains today, paper losses tomorrow; who cares?

One thing that might potentially be an issue is indirect effects of stock markets on other parts of the economy but that's for future investigation. One other bit about the article that I found particularly interesting (and amusing) was the following mention of the dangers of excessive indebtedness:

Ah, they say, but what about debt? Shouldn't Greenspan act to counter the defaults that could accompany a market crash? If consumers go deeply into debt to buy stock or to buy consumer goods because their market gains make them feel rich, this could depress spending later on. But really bad debt overhangs come when businesses (especially real estate developers) overborrow, which is not, as far as I can tell, a big problem in America right now.

Incredible as this sounds now, it wasn't actually a lack of foresight because the article was written in early 1999 when levels of indebtedness had not yet reached the highs they did over the last 5 years.

Krugman on the Value of Reserve Currencies

A very short and interesting article by Paul Krugman on why having your currency be a Reserve Currency might not be too big of a deal:

What about our ability to borrow in dollars, to sell dollar- denominated bonds to foreigners? Hey, other countries do that too. But our debts are in our own currency! So? We still pay interest on them. True, we could inflate away our foreign debt. But we won't--and if investors thought we would, they would demand higher interest rates.

P.s. If you feel like you've been seeing a lot about Paul Krugman recently you are absolutely right: I like to learn by reading a lot by the same person at a time so I'm slowly making my way through his writings and academic work. The key thing is to know when you start seeing diminishing returns and read other things and to make sure to pick smart people.

Economic Modeling

When I first started learning about Development Economics (in Public Policy 184, Poverty and Policies in Developing Economies, which I actually eventually dropped in favor of other things) I was struck by a lecture on the Harrod-Domar model because it was very obvious to me that the model was completely insufficient and overly simplistic. I had already read The Elusive Quest for Growth by William Easterly who basically made fun of people for ever believing this model could accurately describe anything (Easterly sums it up as "GDP growth will be proportional to the share of investment spending in GDP."). 

After class I decided to ask the Professor about what the benefit of studying a model like this was since there were clearly hundreds of other factors which played a role. She explained that while this was absolutely true, it was important to try to strip away as many factors as possible and build something that one can easily reason about and see if it still makes useful predictions because it can help one get a better understanding of what is actually going on.

One should be careful to realize that there may be lots of other processes at work but that trying to understand all processes at once was not going to lead to any useful analysis. While the Harrod-Domar model is in fact far too simplistic - it's assumption of constant returns to capital make lots of sense in the short term when there is high unemployment but makes little sense once there is a balance between labor and capital - it did lead to a better understanding of some of the processes at work.

While reading a piece by Paul Krugman on High Development Theory (more on that in a future post) I was struck by this following explanation of how useful simple models can be:

Dave Fultz was a meteorological theorist at the University of Chicago, who asked the following question: what factors are essential to generating the complexity of actual weather? Is it a process that depends on the full complexity of the world -- the interaction of ocean currents and the atmosphere, the locations of mountain ranges, the alternation of the seasons, and so on -- or does the basic pattern of weather, for all its complexity, have simple roots?

He was able to show the essential simplicity of the weather's causes with a "model" that consisted of a dish-pan filled with water, placed on a slowly rotating turntable, with an electric heating element bent around the outside of the pan. Aluminum flakes were suspended in the water, so that a camera perched overhead and rotating with the pan could take pictures of the pattern of flow.

The setup was designed to reproduce two features of the global weather pattern: the temperature differential between the poles and the equator, and the Coriolis force that results from the Earth's spin. Everything else -- all the rich detail of the actual planet -- was suppressed. And yet the dish-pan exhibited an unmistakable resemblance to actual weather patterns: a steady flow near the rim evidently corresponding to the trade winds, constantly shifting eddies reminiscent of temperate-zone storm systems, even a rapidly moving ribbon of water that looked like the recently discovered jet stream.

What did one learn from the dish-pan? It was not telling an entirely true story: the Earth is not flat, air is not water, the real world has oceans and mountain ranges and for that matter two hemispheres. The unrealism of Fultz's model world was dictated by what he was able to or could be bothered to build -- in effect, by the limitations of his modeling technique. Nonetheless, the model did convey a powerful insight into why the weather system behaves the way it does.

Much has been said of late about how Krugman specializes in building highly stylized and extremely simple (and initially much criticized) models that turn out to capture everything that is necessary to prove his point:

You make a set of clearly untrue simplifications to get the system down to something you can handle; those simplifications are dictated partly by guesses about what is important, partly by the modeling techniques available. And the end result, if the model is a good one, is an improved insight into why the vastly more complex real system behaves the way it does.

In many of my later Economics classes I found that most Professors just taught the models without explaining their inherent limitations and it made everything feel fake - instead of using the models to elucidate the underlying processes they were using smoke and mirrors to make simplistic points. Lectures became intricate exercises in trying to figure out where the models broke down and started diverging from reality when the lecture itself never mentioned the fact - a useful exercise for the conscious student but very dangerous for everyone else. In conclusion, models are extremely useful in studying economic proccesses (and many other things) as long as one is aware of the limitations, or in Krugman's words:

The problem is that there is no alternative to models. We all think in simplified models, all the time. The sophisticated thing to do is not to pretend to stop, but to be self-conscious -- to be aware that your models are maps rather than reality.

The Financial Crisis Abroad

When not writing about Sarah Palin or the Presidential Election, most American news sources are focusing on the Financial Crisis the world is going through right now. Most of my readings on the topic have come from Greg Mankiw's blog via his excellent 'Commentary on the Financial Mess' posts which link to recent articles by important Economists from all over the web and has provided an incredibly rich collection of opinions and theories on what is going on in the economy.

Unfortunately, while some of these do touch upon the situation in other countries, most of them are very US centric. The Economist does a very good job of covering the situation in other countries, this week it had an interesting briefing on how the global financial crisis is impacting Eastern Europe. But the Economist has only so much space to devote to the issue each week and I have found that most of my information actually comes from the excellent Europe focused A Fistful of Euros blog. They seem to be having some issues with broken links right now (especially in their archive) but if you want detailed information about the impact of the crisis on Europe this is an excellent source. Many of their recent blog posts have been extremely detailed and informative so head over there and check it out. Here are their articles on Hungary, Kazakhstan, Spain, and the Baltic States

Simone White - The Beep Beep Song

These days I spend most of my time listening to The Economist Audio Edition or Podcasts and don't have nearly enough time to listen to music (though I still make it to concerts - I saw Stereolab at the Fillmore yesterday). Furthermore, this blog is largely focused around academic subjects, but music is still a big part of my life and as such I wanted to post the video for incredible an incredible song by Simone White here:

I heard about it through a very clever and beautiful commercial for the relatively new Audi R8 supercar (which I first saw last summer in Monterey and have seen all over the place since then). Enjoy.

Cyclically Adjusted P/E: A Reason for Optimism with a Note of Caution

I first read about Cyclically adjusted Price to Earnings Ratio in Greg Mankiw's post last week (referencing a WSJ article) and thought it was interesting but this week's Economist article on the matter made me want to post it. Here's the explanation from the Economist:

In his book, “Irrational Exuberance”, Robert Shiller calculated the cyclically adjusted price/earnings ratio over history. This measure, which takes an average of profits over the previous ten years and adjusts for inflation, is superior to the traditional p/e ratio because profits are highly volatile. In January 2000 the cyclically adjusted p/e on the S&P 500 was 44.3; the previous peak, just before the crash of 1929, was 32.6. That suggested markets had a long way to fall. And share prices did indeed suffer a long period of decline.

And here the gist of why this is a reason for long term optimism from Mankiw:

[T]he Standard & Poor's 500-stock index is priced at 15 times earnings by the Graham-Shiller measure. That is a 25% decline since Sept. 30 alone. The Graham P/E has not been this low since January 1989; the long-term average in Prof. Shiller's database, which goes back to 1881, is 16.3 times earnings. But when the stock market moves away from historical norms, it tends to overshoot. 

And a reason as to why investors should be careful about acting on this advice without careful consideration (from the Economist again):

Why does this matter? The existence of a bear market does not preclude the possibility of fantastic returns over shorter periods. Indeed, one striking point about the Dow’s 936-point gain on October 13th was that it climbed more in that one day than it did in the first 85 years of its existence (it was founded in 1896). Two of the very best years in American stockmarket history were 1933 and 1935, right in the middle of the Depression. But bear markets behave rather like Lucy in the Peanuts cartoon strip. Just when Charlie Brown is persuaded to attempt to kick the football, she snatches it away. Just when investors are persuaded the bottom of a bear market has been reached, share prices slump once more.

The Cost of Doing Nothing

After overhearing two friends talking about how the money budgeted for the bailout could be used for better things I wanted to post two excerpts from an Economist article on the British banking bailout. Leaving aside the exact details of the US plan the important point to underscore is that there are two sides to the issue of budgeting - government spending and government revenue. While the bailout is clearly a drain on the budget, so is a slowing economy, and a dramatically slowing economy would be an economic nightmare. So spending money to help avoid economic disaster is a good idea, and an approaching recession is the wrong time to bring on budgetary austerity. Next up - getting the details of the bailout as right as possible.

Government Spending:

Such a ballooning in the government’s liabilities may seem ominous, but this is to look at only one side of the public balance-sheet now that the Treasury has turned banker: on the other side stand the assets. [...] In 40 banking rescues studied by Luc Laeven, an economist at the IMF, the taxpayer typically recouped some but not all of their cost.

Set against this, the stakes are intended to be temporary, and the public purse could profit when the shares are eventually sold. Taxpayers could also make running gains from the overall package, says Ben Broadbent, an economist at Goldman Sachs, a bank. Although the Treasury will have to pay interest on the new gilts it issues to fund the recapitalisation, it will recoup over half of this from the 12% interest its preference shares in the banks will earn. It will also charge fees for the guarantees it is providing on £250 billion of new debt issued by British banks—another part of the rescue package. Putting it all together, Mr Broadbent estimates that the net gain to the exchequer—assuming it does not have to pay out on the guarantees—could be nearly £3 billion a year.

Government Revenue:

Recessions wreak havoc on the public finances by both cutting tax revenues and raising unemployment-related spending. For every percentage point that GDP is lower than expected, public borrowing will be roughly £7.5 billion higher than forecast in the first year, rising to £10 billion higher in the second year, according to the Treasury’s ready reckoner. If the economy were simply to stall in 2008-09 and 2009-10, this could double planned borrowing of £38 billion next year; if output were to contract over the period the outcome would be costlier yet.

Why I love the Economist

Well, there are many reasons, but one is wit:

In April 2007 Gazprom, an energy firm controlled by the Kremlin, made a Dr-Evil-style prediction that its market value would reach $1 trillion (ten times today’s level).

- Emerging markets and the global financial turmoil, The Economist, Oct 11th 2008

Paul Krugman on Economic Hangovers

First of all, congratulations to Paul Krugman for winning this year's Nobel Prize in Economics, I don't think anyone expected him to win this year (with most people thinking that he would win after the end of a Bush presidency so that the prize would be entirely focused on his research work, not his political opinions) but I could not be happier.

Of course everyone is writing about him and why he is important now, but what better way to write about someone's career than to dive straight into his work. Here is an excellent article from Slate on why 'The Hangover Theory' that recessions are a necessary part of the economic cycle that follow booms and must be accepted as they are makes little sense when examined more closely. Here's an excerpt, but do read the whole thing.

The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.

Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less.

Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.

More on Understanding the Surge

I recently wrote a post about the Surge of Troops in Iraq and here is a follow up post with an excellent explanation of why the Surge was so effective that should also leave no doubt that it cannot be simply transferred to Afghanistan as is (though I have no doubt military commanders are fully aware of this). The core point is again that the additional troops helped implement a series of policies but that they were in not the central reason why the surge was successful. Here's how the Washington Post article put it (article via Tom Barnett):

How did Gen. David H. Petraeus do it? My answer? Bottom line, for the first time since the war began, a U.S. leader decided to address the political motivations of the Iraqi combatants. Petraeus convened a study group that shrewdly analyzed the raging sectarian conflict, then came up with what he called "the Anaconda strategy" to address the underlying dynamic.

I think this is crucial to understand - more than playing politics, General Petraeus took time to understand the different forces at play and why they were fighting and then developed a strategy to counteract this.

On how the insurgency was created (in addition to not having enough troops to secure the situation on the ground and control weapons stashes and the border):

[...] disbanding Saddam Hussein's Baath Party and the old regime's security services -- had helped create the Sunni insurgency. They produced a critical mass of angry men worried that the Sunnis who had run the old Iraq would wind up on the bottom in the new one.

Larry Diamond talks a lot about the problem of the overly deep debaathification where most of Iraq's soldiers, civil servants, teachers, etc. were fired in his podcast on Stanford on iTunes U. While removing top level members of the Baath party from the public sphere was clearly necessary, many others were solely party members to be able to keep their jobs under Saddam's regime.

The importance of winning over the alienated Sunnis:

On June 2, 2007, Petraeus gathered his commanders and told them to engage with influential Sunnis and insurgents and persuade them to stop fighting. "Tribal engagement and local reconciliation work!" he said. "Encourage it!"
[...]
As the Sunni insurgents switched sides, they passed vital intelligence to their U.S. partners and paymasters, which enabled Petraeus's forces to target Sunni holdouts, including diehards affiliated with al-Qaeda in Iraq. U.S. soldiers also employed new techniques to control the Iraqi population and provide for its safety and to identify fighters hidden among the civilians.

How this was achieved:

Why were so many Sunnis -- insurgents and civilians alike -- ready to respond to the U.S. overture? Because they were getting desperate and saw Petraeus's outstretched hand as their best chance of surviving a campaign of sectarian violence and ethnic cleansing led by the Shiites and fueled by neighboring Iran. The secular Sunnis' alliance with the jihadist insurgents had always been an uneasy marriage of convenience, and it broke up when Petraeus made a better offer.

On how Moqtada al-Sadr and his Mahdi Army were brought under control:

That move has been widely misinterpreted as a spontaneous, unilateral gesture; in fact, it came after months of military and political pressure. Iraqi special operations forces, backed by elite U.S. combat advisers, conducted near-nightly raids against the most extreme elements of the Mahdi Army.
[...]
That said, the intra-Shiite competition for power will persist for years; the trick is to channel it into politics, not violence -- and to continue to make use of the competition between Maliki and Sadr.

An excellent read.

Dealing with Inflation

I found this excellent article on how to deal with the rise in inflation by Frederic Mishkin several weeks ago through Greg Mankiw's blog and while the worsening financial crisis has shifted attention away from inflation worries I still think that it makes a very interesting point on how central banks should deal with the current spike in inflation:

It is certainly true that central banks should be worried about high headline inflation caused by high commodity prices. After all, households daily pay for energy and food items, and they are a big chunk of people's budgets. But central banks cannot control relative prices for food and energy. When a cold snap freezes the Florida orange crop or a tropical storm hits the gasoline refineries along the Gulf Coast, monetary policy cannot reverse the resulting spikes in prices for fresh orange juice or for gasoline at the pump that lead to high inflation in the short run. Particularly volatile items like food and energy, which are included in headline measures of inflation, are inherently noisy and often do not reflect changes in the underlying rate of inflation, the rate at which headline inflation is likely to settle and which monetary policy can affect.
...
If the monetary authorities react to headline inflation numbers, they run the risk of making serious policy mistakes.
...
Monetary policy should not overreact to headline inflation. It can do little about the first-round effects of a rise in energy prices, which include both its direct impact on the energy component of overall consumer prices, and the pass-through of higher energy costs into prices of non-energy goods and services. But the Fed does have to worry about possible second-round effects associated with changes in the underlying trend rate of inflation. Such second-round effects are likely to be quite limited only as long as the rise in the relative price of energy does not lead to a rise in long-run inflation expectations. Here there is good news as well. Inflation expectations have remained quite well grounded during this recent spike in energy and commodity prices.

Excerpts from a Speech by Robert Gates

One of my strongest convictions is that proper security (and probably foreign) policy should be driven by pragmatism, not ideology. This is one of many reasons I am very happy with Robert Gates, the current US Secretary of Defense. Here are some excerpts from a speech he gave at Oxford (via Tom Barnett).

In short, I believe the statesman would be well advised to listen, in contrast to the Roman emperors whose man in the chariot whispered “sic transit Gloria mundi” – all glory is fleeting – to listen to those who simply whisper, “Sir, we’re not sure what the hell is going on here.”

Today, we face a set of global security challenges that may be unprecedented in complexity and scope – presenting dilemmas that do not lend themselves to a simple choice between popular conceptions of Churchill and Chamberlain.

The period following the collapse of the Soviet Union and the end of the Cold War unleashed old ethnic, religious, and nationalist hatreds and rivalries that had been largely buried since the Great War: The ethnic and religious slaughter in the Balkans; Russia’s seeming return to Czarist habits and aspirations; the fault lines between Sunni and Shia in Iraq and across the Middle East. The cast of characters sounds disturbingly familiar even at a century’s remove.

And after talking about more threats and problems:

Still, even given the jaded disposition of an old spy, there are ample grounds for optimism. First and foremost is the extraordinary growth of political and economic freedom around the world since I last served in government 15 years ago.

But to secure these remarkable gains, and protect our most vital interests and aspirations in this global environment, the next American administration, working with our allies and partners, will need to employ a pragmatic blend of resolve and restraint to deal with the threats that confront us.

The Surge

With the ongoing election there has been a lot of talk about the Surge in Iraq, mostly in the "They didn't think the surge would work, bastards!" kind of way. I think that few people would look at Iraq today compared to Iraq 3 years ago and say that things have not improved. I think that very few people out there understand why and I think that understanding the reasons why the surge was successful is going to be extremely important in planning future military action. This has been something I have been interested in for a while and I'll try to start writing more about this on this blog without veering into politics (which I like to avoid here).

I remember listening to experts around the time the idea of the surge first started circulating who mostly thought that it wouldn't work due to a lack in sufficient number of new troops. If you compare the pre-surge numbers to the post-surge numbers (which I have to admit I don't know exactly) you will see that the percentage difference is really not that great, mostly because more troops were simply not available. I think that everyone at the time already agreed that the proper way to go into Iraq (ignoring the question of whether that was a good idea) would have been with a number of troops comparable to what we had then to make sure that non of the instability started in the first place. AT the time of the surge it seemed difficult to fathom how a small increase in troops would be able to stop the insurgency that was then in full force.

I think this relatively small increase is crucial to understanding the actual process: most people think the surge simply meant 'more troops' and everything else happened magically. From my current understanding it was quite the opposite: a serious of new approaches that required more people to work but also meant changing the behavior of the troops that were already on the ground. David Petraeus' counter insurgency manual gave the first indication of how one should deal with the problem and Tom Barnett points out two key reasons for its success:

The surge works for two key reasons, both of which couldn’t have been exploited to the point of solidification without additional bodies: 1) all Iraqis were tired of conflict and were looking for a way out: 2) the “awakening” due to al Qaeda’s over-reach. Fair enough.

Barnett then goes on to point out the lack of a 'diplomatic surge' on the political side to further help slow the insurgency and help American lives that I think points to a larger issue with US security policy:

I agreed with the logic of more troops (my SysAdmin-bias allowed me no other opinion). My problem with the surge was the lack of the diplomatic counterpart, now bequeathed to the next president, because I felt the lack of one meant—again—too many American lives needlessly lost and whatever gains we achieved logically held hostage to their neighbors and their willingness to wait us out and start trouble once we inevitably had to draw down, possibly making this whole success a complete illusion and thus wasting more American lives to no good end (not to mention those we waste in the future). 

The United States is fortunate to have an extremely capable military (with many brilliant leaders) that when faced with a new challenge/threat in the field is able to adapt to it and overcome it. David Petraeus deserves all the praise possible for fixing the military's approach to Iraq, like many in the military he has done an exceptional job of taking a difficult situation and improving it. I think that US military commanders are generally very pragmatic once they are on their ground and troops lives are at stakes: they want to protect their soldiers and make their mission a success instead of worrying about particular ideological approaches. The real problem is what assignments and situations the military is given by its civilian leaders.

Barnett on Big Wars

I've been reading Tom Barnett's blog since seeing his talk at PopTech last year. He is a military geostrategist and his blog links to a large variety of excellent articles from the New York Times, Washington Post, Financial Times, Wall Street Journal, etc. with brief commentary and is currently one of my main ways of discovering interesting articles. Barnett is a big believer in the US military's need to transform itself to be better adapted towards small wars and 'sysadmin work' instead of the current (changing) focus on large wars with other global powers (e.g. Russia and China). I find the following comment to a McClatchy article on the need for big war capabilities the best explanation for why the US doesn't need to worry too much about the big war capabilities of ground forces:

Here is the missing piece to this argument: America can impose its big-war willpower nicely with air power and air power alone. If we're not going to own the aftermath, then we can just bomb, bomb, bomb and not care about what comes next. I can do that with air assets from Navy and Air Force. If I'm not going to put my ground forces at risk in small wars, why the hell would I put them at maximal risk in big ones?
[...]
If we are going to fight high-end, then it'll be missiles and drones and high-altitude bombers and guided this and that. It will not be the Marines storming some beach en masse, nor Normandy with the Army. In short, we can have our SysAdmin green force and use it too, while maintaining an appropriate lead in the blue Leviathan force.

What happened to WaMu?

Two excerpts from a NYTimes article on what happened to the troubled mortgage lender:

What this means:

“This institution was a big question mark about the health of the deposit fund,” Sheila C. Bair, the chairwoman of the F.D.I.C., said on a conference call Thursday. “It was unique in its size and exposure to higher risk mortgages and the distressed housing market. This is the big one that everybody was worried about.” She said that the bank’s rapidly deteriorating condition prompted regulators to seize it Thursday, and not on a Friday as is typical for bank closures.

Why it happened:

[Chief Executive Kerry K. Killinger's] goal was to transform what was once a sleepy Seattle thrift into the “Wal-Mart of Banking,” which would cater to lower- and middle-class consumers that other banks deemed too risky. It offered complex mortgages and credit cards whose terms made it easy for the least creditworthy borrowers to get financing, a strategy the bank extended in big cities, including Chicago, New York and Los Angeles. With this grand plan, Mr. Killinger built Washington Mutual into the sixth-largest bank in the United States.

Manipulation at Intrade?

Doug just sent me a fascinating article on online betting on the Presidential Elections and how it looks like Intrade's numbers are being manipulated. The authors best guess is that this is just some random individual (or group) manipulating the market (and I don't much believe in conspiracies) but the methology in tracking this down is fascinating.

Right now, Obama is trading at 52.3 points. That is, Intrade implies that he has a 52.3 percent chance to become the next President. [...] Over at BetFair, another large UK-based gambling and futures site, you can also buy an Obama contract. But the price there is 1.62, which implies a 61.7 percent chance that Obama will become the next President.

That is a huge spread, 51.5 points versus 61.7 points. This is the equivalent of the Giants being 3-point favorites at the Bellagio Sportsbook, and 7-point favorites at the Mirage down the block. Those things just don't happen in efficient, sufficiently liquid markets, because they create arbitrage opportunities [...]

Well worth reading.

The Wallstreet Bailouts

I haven't had any time to post over the last week or two due to way too many things happening it once but I think the following short post is very interesting and timely. There'll be more regular posting soon.

The following is from Greg Mankiw's short summary of articles by Paul Krugman (here) and Doug Elmendorf (here):

[The] government should be putting capital into banks and other financial institutions, in exchange for a share of bank equity, rather than using taxpayer dollars to buy bank assets that no one else wants at prices no one else will pay.

Directly from Elmendorf's article:

A second problem with buying troubled debt is that it provides the most help to the financial institutions that made what are, in retrospect, the worst investment decisions. Banks that stayed clear of this debt or sold such debt at cut-rate prices earlier this year in an effort to move beyond the crisis would receive no direct gain from such a program, while banks that made the biggest commitments to low-quality mortgages and have delayed dealing with their balance-sheet problems would be the biggest beneficiaries.

Third, this approach saddles taxpayers with significant downside risk but limited potential upside gain. One crucial feature of the Treasury and Federal Reserve rescues of Fannie Mae, Freddie Mac, and AIG is that taxpayers received substantial equity shares in these companies and could receive solid returns if financial markets rebound.

And from Krugman:

[T]he financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

That’s what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It’s also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)

Very worth reading

P.s: My advice when reading short posts like this on any blog is that if you find the post interesting, go and read the source material. This is one of my favorite ways of discovering interesting reading and getting a deeper understanding of world issues.

BarCamp Africa

Sophia forwarded me an email about BarCamp Africa this morning and I have to say that I haven't been this excited about a conference or event in a long time. For those of you who don't know about BarCamp it an unconference initially started as a response to O'Reilly's invite only FooCamp (which Tristan and Beau from Apture attended this July) where people interested in a particular topic (generally related to technology) get together to give talks and host discussions about the format in question. What makes BarCamp Africa so exciting? It is the first local event that I have heard of that brings together people from Silicon Valley with academics, social entrepreneurs, and activists interested in Africa. As someone who is extremely interested in both of these I am very happy that there will be a forum for people from both communities to be able to learn from each other. If you are interested in technology and development you should definitely attend (sign up here). 

Saturday, October 11, 2008
Google Campus, Mountain View, CA
8:15 am Sign-in begins
9:00 am BarCamp sessions begin
5:00 pm BarCamp sessions end

More information can be found on the conference Wiki, the BarCamp blog FAQ, and on the blog itself.

The world isn't flat anymore

While The web isn't flat anymore is one of the slogans of Apture, the startup I co-founded, this post is actually not about that, but about a comment that David Abernethy made during one of his lectures on India on the Stanford Travel podcast. For those of you who don't know about it, Stanford has a large number of classes and lectures available for free download on iTunes, and I've been making my way through them for the last few weeks. I will write more about these other lectures later.

I have never read Tom Friedman's The World is Flat because it's a very long book with a relatively simple point and there are so many other fascinating things to read, but I found this particular comment really interesting. Abernathy thinks that "The World is Flat" is actually a misnomer because what the book is really about is certain points of the world being much closer connected to other points, e.g. Bangalore being linked more closely to Palo Alto.

He then goes on to argue that the world was in fact flat before the industrial revolution when economic production dependent almost entirely on human labor and the economic output of a country was roughly proportional to its population. While there were obviously some inequities due to differences in geography, etc. and some minor technological advances gdp-per-capita was relatively uniform throughout the world - the world was flat. Only with the start of the industrial revolution were some countries/regions able to vastly increase their productivity and thereby race ahead of the others and if you look at charts of per region GDP over the last few centuries you really do see them starting at relatively equal levels and then see a big gap opening up. The world isn't flat anymore. Not rocket science but an interesting thing to keep in mind. I very much recommend the whole lecture, (European "Envasions:" Competition for Wealth and Power, 1498 -1757).

Rules for Advisors in Iraq

After reading Squandered Victory, Larry Diamond's excellent book about his experience as an advisor to the CPA during the early days after the invasion I've found the topic of how American's can work together effectively with the Iraqi administration very interesting. The book both strongly condemns many of the planning and strategic mistakes that were made both before (much discussed) and after the invasion (less well known) but also shows the efforts of people on the ground who are trying to bootstrap democracy in an unfamiliar and increasingly hostile environment. I recently found a great (and very short) article in the Small Wars Journal with advice to new Advisors in Iraq and wanted to link it here (click on the Apture link to read the Document).

Many of the lessons are relevant to working with any foreign government, especially the first one:

Since my first time in Iraq, in 2005, one essential fact on the ground has completely changed. While Coalition troops are still the most powerful fighting force in the country, the Coalition is no longer in control. The Iraqi Government is now exercising its sovereignty, and does not wish to be dictated to. This attitude filters down to the lowest levels and will color your interaction with Iraqis. You will only be able to perform your role as an advisor if you accept this fact and work with it. You are there to offer help, not to dictate, and your advice should be offered subtly and without appearing to be a demand.

Protesting at the Olympics

Nicholas Kristof of the The International Herold Tribune tried to register a protest for the Beijing Olympics and made a video about the procedure. He talks about the difficulty of his endeavor and comes to the conclusion that there was no actual process for allowing protests (as mirrored in the Economist excerpt below) but then goes on to talk about Freedom in China today and about how China has made real progress in given its people more freedom - allowing them to move more freely, marry more easily, switch jobs, and generally live their lives more like they want to. This is not to ignore many of the very real issues it still very much faces but an important thing to be aware of and keep in mind. Nothing new here but an interesting video nonetheless.

The Economist on the lack of protests:

For all the good cheer generated by the gold medals, the party is clearly nervous of the slightest challenge to its authority. Having named three Beijing parks where protests would be allowed during the Olympics, the police turned down all of at least 77 applications for permission to hold demonstrations. Among those who applied were two women in their 70s who wanted to complain about inadequate compensation for being relocated from their homes. The authorities responded to their request by sentencing both to a year in labour camp, though the sentences are suspended as long as they behave well.

Powersharing Agreements: Probably as bad as they initially seem

Here's another interesting article I found through Chris Blattman's blog, this time on Zimbabwe (I swear I'm going to switch to articles from elsewhere soon, I'm just catching up on the week's reading and posting things as I find them). I've always been very skeptical about these kinds of power sharing agreements that are forced upon opposition parties that have a legitimate claim to an actual election victory, but I haven't read any formal studies. Are these compromises better than continued post election violence or will they only lead to even less effective government and therefore make things worse in the future? Can actors resolve their disagreements and work together effectively?

Power sharing certainly works in many European governments (though it is often very unstable as recent events in my native Austria show) but I think it is virtually impossible in a situation like Zimbabwe where the ruling party is willing to try virtually anything to undermine its new 'partner'. The article cites many reasons as to why power sharing wont work but I think the most important is the point below:

Even if a power-sharing arrangement was a viable option and could prevent more violence in the shorter or longer term, it is not necessarily a strategy worth pursuing. Allowing a small number of elites to determine outcomes is inherently undemocratic, and manifestly ignores voters' choices. It would make more sense to hold new elections as soon as possible, preferably under a caretaker government. Otherwise, a terrible precedent is set, encouraging politicians who are not committed to democracy to attempt to steal elections and then, through power-sharing agreements, secure a much stronger position than they otherwise would have held. The Zimbabwean opposition and international actors would be well advised to consider this before supporting further negotiations.

To Sanction or Not To Sanction?

I have been feeling ambivalent about the effectiveness of sanctions for longer than I can remember but have spend very little time reading about this topic. This is partially why two articles about the effect of sanctions on Sudan linked by Chris Blattman particularly struck my interest this week. While I've read Prunier's book on Darfur I don't spend too much time following the conflict but these are worth a read to anyone who is interested in whether sanctions can affect positive change in a country (e.g. Cuba, Myanmar, Iraq, ...) though - sorry to disappoint - you won't find any definite answer here.

High Time to Lift Sanctions by Ibrahim Adam (which I read first) makes some interesting points but left me unconvinced. The most immediately questionable claim is that removing sanctions would allow President Bashir the resources (financial and political) to affect change in Sudan:

So, what’s in it for either John McCain or Barack Obama to lift the sanctions from Sudan? Big dividends. It would give President Bashir political space to hasten changing Sudan to an equitable, democratic country, as specified by the landmark 2005 north-south Sudan peace agreement – the policy anchor of US government.

I don't think that affecting change is in Bashir's interest and it certainly does not seem to be a priority and it doesn't seem to be a good assumption to base an argument upon. The following section was, however, far more interesting:

Removing sanctions would help Sudan’s political institutions mature, too. The deafening criticism of Khartoum by Washington accompanying US sanctions often crowds out civil society and government discourse on other important, but ‘normal’, policy issues. Agriculture reforms, for example. US private investment into southern Sudan, thus far stifled by reputation risk fears, would also surely grow strongly following the abolition of the sanctions.

While Daniel Millenson's rebuttal (more on it below) questions the causality of the war, I do think that the argument below played a role in escalating some of the underlying issues:

US-led isolation meant the Sudanese government got, for example, just $56 million in foreign budgetary support during 1994-1998 according to IMF data. At roughly forty cents per person per year, that’s hardly enough for the government to build some roads and a couple of schools in Darfur, never mind cater for all Sudan. Protracted, severe constraints on public finances in one of the world’s largest (10th), but poorest countries (141 out of 176 in the 2006 UN Human Development Index) could only ever lead to one outcome. Crystallizing or, in the case of Darfur, reviving older badges of identification (kinship, religious, locality and ethnic ties), due to the collapse of public investment and welfare spending over most of the last two decades.

Millenson's explanation for the immediate causes of the war seems more accurate, but I was more interested in the exceptions to the sanction regime that he points out - I think that details like this are extremely important to understanding the impact of sanctions.

Darfur reached its staggering death toll primarily because al Bashir escalated the conflict, arming janjaweed militias to attack civilian populations. In a relationship exactly inverse to that described by Mr. Adam’s thesis, the war in Darfur was bankrolled by the very oil-driven foreign direct investment (FDI) inflows he praises.
...
While US sanctions have caused myriad headaches and missed business opportunities for the NIF/NCP regime, contrary to Mr. Adam’s claims, they have done little to further the plight of ordinary Sudanese. Then and now, US sanctions provide generous exemptions for food (which apparently even includes Coca-Cola’s syrup) and medical products to enter the country. It is hard to take seriously Ibrahim Adam’s claim that “‘excess’ deaths from US sanctions… probably runs into the hundreds of thousands.” Surely the government of Sudan, which provided the small arms and air force behind the initial and most violent 2003-2004 stage of the war (not to mention the North-South civil war), bears more direct responsibility for “excess” deaths.

The central question is still if and when sanctions are an effective instrument for affecting change in countries with bad leaders and if not, what would more effective alternatives be? I hope to have better answers at some point in the future.

Chris Blattman on Travelling and Development

An excellent short interview with Chris Blattman on travelling on economic development as well as a more general point on development. I really liked the following bit on what it will take to lift more African countries out of poverty:

The difference between a poor country (say, $2000 per head) and a middle income one (say, $12000 per head) is simple: one has a manufacturing sector and one does not. Something like forty percent of Kenya's GDP comes from the 5 percent of the workforce: those in light and medium industry. That sector is crucial. Most African nations won't have a self-sustaining education and health system until they build some sort of industrial tax base. What's needed to get there? Reliable roads and electricity are a start. Reducing the red tape faced by business can help too. But realistically, I believe real wages in Asia will probably have to rise before it becomes profitable to produce in Africa. The faster China and India get rich, the sooner we'll see a transformation in Africa. In the meantime, preferential trade and tax treatment by the US and Europe for African goods could help foster industry and technology transfer.

Taking up Blogging Again

I've been thinking about taking up blogging for a while now and I think I'm going to give it a try. For me this is really a more efficient way of keeping track of my readings and sharing them with others. It also makes it easier for me to keep track of development in blogging tools and use Apture in a more real environment.