Archive for category China

Obama’s China Breakthrough


Today the United States and China reached a landmark agreement on battling climate change.   This is a major breakthrough and reflects in part the fact China’s scientists are alarmed about global warming and what it could do to China’s coastal cities.

China and the US are the top two polluters in the world.  Together they produce almost 50% of the world’s carbon dioxide.  With the EU having met the Kyoto targets (without harming their economy in the process – quite the contrary!), the battle against climate change depends on these two states being able to cooperate.  Until now it’s appeared almost impossible.

Unfortunately, the onus will be on the US to resist political opposition.  Global warming deniers are disappearing as the science becomes overwhelming.  In fact, outside the US it’s accepted as settled that climate change is happening, with CO2 emissions the driving force.  Only in the US, where a well funded lobby churns out disinformation and uses ideological fervor to distort the science, is there powerful opposition.  The good news is young people overwhelmingly agree something needs to be done (it’s their future after all) and climate change deniers will die out.  The bad news is that we don’t have the luxury to wait that long.

Climate change denial is irrational - doing nothing means a lot more death and economic damage

Climate change denial is irrational – doing nothing means a lot more death and economic damage

China now sees itself as a major economic power, a force behind the emerging global economic system.   As such, it recognizes that its citizens deserve clean air and water, and decent wages.   China’s leaders can no longer justify ignoring the potential devastating impact on China that climate change could have.

The deal says that the US will emit 26-28% less carbon in 2025 than it did in 2005.  China will peak at about 2030.  China has a much more difficult time altering its economy, which is growing much faster than the US.  The key point in this agreement is a signal to the world that a new Climate change treaty is do-able in 2015.

The US Senate will not ratify it at first.  But if in 2016 the Democrats take back the Senate (likely, given that the GOP will be defending 24 seats and the Democrats only 10) and a Democrat is elected President, I would bet that such a treaty including China could be ratified.  Many GOP moderates only tolerate the deniers in their party, most of them realize the science is overwhelming.

A Canadian expresses the shock many of us have that Obama gets so much criticism - when he's been doing a solid job!

A Canadian expresses the shock many of us have that Obama gets so much criticism – when he’s been doing a solid job!

This is also another reason why I’m convinced Obama will be remembered as a great President – one that oversaw a recovery from the horrific recession he inherited and who managed to end two wars.   Now it looks like his plan to weaken ISIS is working better than most expected, without using US combat troops and instead increasing local cooperation.

If this US-Chinese agreement can jump start climate change negotiations and lead to global unity to address the greatest threat facing the world — far more dangerous than ISIS or Ebola — it might be the most important act of Obama’s presidency.    It also shows that the stories of his political irrelevancy are premature.


Predictions for 2012!

1.   President Obama will win re-election, albeit narrowly if Mitt Romney is the GOP standard bearer.   He wins handily against Gingrich, Paul or Perry.   Jon Huntsman is the one Republican who could knock off Obama (I mean, the guy speaks Mandarin — we’re not talking oranges here!)

2.   Mitt Romney will win the GOP nomination.    Romney-Thune vs. Obama-Biden.

3.   The economy will improve — unemployment will still be high, but there will be a sense of relief that the great recession is finally giving way (2013 will be the year of inflation, but we’ll not dwell on that now).    This will be enough to help Obama, but isn’t a true ending of the crisis – structural imbalances still exist, very serious ones in fact.

4.  Occupy Wall Street protests will grow again in the summer, but activists will make a concerted effort to be positive and politically engaged, a very stark comparison to the summer of 1968 when protesters stormed the Democratic convention.   This will help focus the election year conversation about relative wealth and the middle class, giving Democrats a boost.

5.   The Democrats will keep the Senate and narrowly take back the House in an election that will have people saying “who’d have thunk this a year ago.”    I’ll e-mail them a link to my blog.

6.   The Democratic majorities will be narrow in each House, and President Obama will call for the “reasonable center” to govern.   It will.

7.   The New England Patriots will win the Super Bowl with Tom Brady – the best QB in the league today – MVP.

8.   Maine will pass a referendum legalizing gay marriage, tbe the first referendum to get popular support for gay marriage, not relying on the courts or a friendly state legislature.  This will mark a turning point for this issue.

9.   Iran’s nuclear controversies notwithstanding, the people will rise up in protest against the clerics that guide the Islamic Republic, leading to a severe crisis.   China, the EU and US will stay out publicly, but privately facilitate a way for change to come to Iran that doesn’t completely drive out the Supreme Leader and Guardian Council.   One result of this will be Iran publicly eschewing nuclear weapons.

10.   North Korea will also undergo a very positive change, this time driven by China.   China will influence, bribe, threaten and cajole the North Korean military to undertake a major change in policy, opening the country.   North Korea will rely on China to help it overcome high debt and poverty, and cede to China control of its nuclear weapons.  Whether North Korea will unify with the South or connect in some way with China remains an open question (not to be decided in 2012).

11.  Angela Merkel will emerge as the “person of the  year” for 2012, thanks to her steering of the EU through crisis and claims that her work with President Obama helped him secure re-election.    A feminine face on German leadership in the EU will help Europeans accept that German leadership is not only required, but no longer something to fear.

12.   Syria’s President Assad will fall, around the same time Iranian protests rachet up.   The tension in the region will escalate, as no clear successor to Assad’s government will emerge.

13.   Iraq will continue to suffer unrest and division, with Iranian and Syrian instability spreading.   Some will say the US should go back, but President Obama will note that the Iraqis have to build their own future.

14.   The unrest will have a surprising side effect — it will lead to a new Israeli-Palestinian peace plan that will surprise a lot of people.   Spooked by what Mossad says the impact of regional instability could mean for Israel, Netanyahu decides that some kind of agreement for a two state solution needs to be reached, and thanks to Wikileaks, he knows Hamas’ bark is worse than its bite.    President Obama will be part of this late summer agreement, enhancing his re-election chances.

15.  Russian President Vladimir Putin will become more openly authoritarian in his bid to win re-election as President.  But the Russian people are not as docile as they were in Soviet times and Russian protests will threaten Putin’s grip on power.   Ultimately Putin will be pushed out by bureaucratic insiders, but that will not satisfy the crowds.

16.  Mideast unrest will cause a spike in oil prices by late summer.    By the end of the year this will show itself in a slowdown of the economic recovery.

17.  After some bad early press, the Chevy Volt and other electric car alternatives will make a comeback due to technological innovations and continued government support for research and development.

18.  The EU and China will reach an agreement that expands Chinese investment in the EU and further links their economies.   In the US some will decry the EU’s “switching sides” and abandoning the US for China.   However, it simply reflects the changing balance of global politics.

The myth is that the Mayans predicted 12-21-12 as the end of the world. It may be at least the end of an era.

19.   A conference will be held near the end of the year to deal with increased threats to global economic stability and on going financial turmoil.    It will take place in Asia with the bold purpose of forging a ‘new global economic order,’ or what some call a ‘new Bretton Woods’ (though much different than the old).   The US will have to accept its diminished role due to high debt and structural economic deficiencies.    China will recognize that it can no longer simply grow as “factory to the world” and needs to shift its economy as other Asian states supply cheaper labor and products.  African states will focus on getting a fair return on resources, and the first major talks on long term energy sustainability will take place in order to avoid future ‘resource wars.’

The conference will begin around December 3rd and not close until near Christmas, the weekend of the 22nd.   Pundits will have a field day comparing this to the Mayan calendar prediction that the world will end on 12-21-12.   “The old world of US dominance and state-centric economics is indeed being pushed aside by these historic agreements; it’s both the end of an era and the beginning of a new one.”


Energy, Finance, and Geopolitics

As the EU leaders work with the IMF, various central banks around the world and China to figure out a way to prevent a Euro collapse and treat the causes rather than just the symptoms of the crisis, it’s clear that four years into this economic crisis — which would be akin to another Great Depression if not for the capacity of government to intervene more effectively in the economy — the core problems remain unresolved.

The core issues revolve around a triad of energy, finance/debt and geopolitics.   The solution summed up in one sentence:  We must restructure our energy usage so as not to be dependent on oil, restructure debt and the global financial regime so as to return to sustainability, and restructure the world system to give new prominence to rising powers such as China, India, Russia and Brazil, while the US and the EU take important but diminished roles.

Despite all the hoopla around “drill, baby, drill” and oil finds everywhere from North Dakota to off the western shore of Mexico, nothing yet denies the fact that if we are not now at the peak of production, we still will be.   This isn’t as dangerous as some would have you believe.   The traditionalist peak oil school looks at production like a regular normal curve:

This alarmist example posits a quick drop in oil production, leading to crises ever more serious and devastating

The alarmist approach could be a bit early — the peak may still be ten or fifteen years off.  But right now the data does show flat production, even when prices spiked in 2007-08, so there is evidence to support a claim we are now at peak.   The late Matthew Simmons’ book Twilight in the Desert makes a persuasive yet indefinitive case that Saudi Arabia is already peaking and hiding the fact their real reserves are not as plentiful as claimed.   Still, the normal curve shown above is based on how US reserves were depleted — the US peaked in 1973 and production declined dramatically.   The global peak will probably not play itself out in the same way.

The US peaked in an era of cheap oil; with oil expensive and the global economy as dependent as ever on it, the search for new reserves and thorough extraction from existing wells can stretch out the peak potentially quite a while.  The graph could stay around the peak for ten or twenty years and then decline at a much slower pace.  Still, switching from an oil based economy to one that runs on a diverse set of sources ranging from coal to solar, nuclear, geothermal, wind power and others will be difficult.   Waiting for the market to force change will likely assure a period of twenty years of imbalances where real crises and shortages cause political unrest and could yield dangerous movements akin to fascism of the 1930s.    Proactive efforts to actively promote alternative energies alongside efficient exploitation of remaining reserves could help make a safe transition possible; unfortunately it’s hard to find political will to do that when there is still denial that we’re in crisis.

The second issue is global debt.  Thanks in part to cheap energy and seemingly relentless growth, banks grew comfortable making large loans to governments, corporations and individuals without worrying too much about the ability to pay back the money.   The technology revolution helped rationalize this exuberance, technology means you can get more bang for the buck — more growth with fewer resources.  Governments and the private sector got addicted to a debt that could only be maintained so long as growth was rapid, requiring both cheap energy and technological advances.

All of this debt did two things; first it spurred on investment bubbles as lack of regulation (meaning the insiders could rig the game to their benefit) alongside easy credit led to investment for the sake of making “easy money” rather than investing in companies likely to grow the economy.   This created short term jobs in the bubble sectors, but those were unsustainable.  I’ve called this the ‘something for nothing‘ mentality.

What is alarming about this graph is that except for early in the Great Depression when total debt (government and private debt) hit 300%, the average has been about 150% or lower.   Through 2009 it was reaching 380% an amazing debt burden.   Since the debt to GDP ratio of the US government is about 100%, most of it is private or corporate debt.   Much of this run up was during a boom, a sign of an unsustainable economic run up.    The US is doing worse than most in this regard, but Japan, another of the largest economies, is also burdened with high debt.   One can quibble with the statistics used (at least in interpretation) and argue that the graph exaggerates the burden.   Even then the number comes out at near 300% of GDP instead of 380%, still Great Depression levels.   Clearly there is a debt problem, and it’s not limited to governments.

So here’s the deal: how do you pay down the debt without causing a deeper recession?   The only way to do that is through growth.  Spending can be cut, but realistically the best bet is to slow down spending growth.   Moreover, cutting spending during a recession can be disastrous — it does far more harm than raising taxes.  Then if high energy costs return as demand rises economic recoveries can be stopped in their tracks.

The most dangerous issue is the third, however: geopolitics.  It’s also the most promising.   The emerging markets have a lot of under used resources and human talent, and the expansion of Asian and potentially other developing world economies could lead to a global boom.   That could provide the capital to help the developed world restructure its debt.  The problem is that the first world also have to acknowledge relative decline — the balance of power would shift towards countries like Brazil, Russia, India, China and South Africa, the so-called BRICS.

The trouble is that rising powers tend to get over confident and take risks while declining powers choose to fight to try to hold on to what is slipping away.   The so called “power transition theory” may be less viable now when economics dominates and nuclear war is all but unthinkable, but the careless talk in recent Republican debates about policy towards China suggests that many in the US may not get just how vulnerable we are, and how much damage has been done to the economy over the past decades.   The good news is that the BRICS don’t want the West to collapse, economic interdependence is real.  They want to shift towards investment and a greater say in the world economy and, in exchange for helping bail out western states in various ways, influence on our domestic economies.  China is already gaining that through heavy investment in both the EU and the US.   It’s often not noticed, but it results in a real shift of power.

These aren’t the only issues of course — global climate change is still potentially a game changer, and the Mideast could explode and create an oil crisis unrelated to so-called ‘peak oil.’   High energy costs could still undermine the BRICS and thus the world economy.    Still they keys towards the future remain transitioning to new energy sources in a timely manner, turning around the build up in public and private debt in the West likely by a mix of ‘haircuts’ (simply eliminating debt) and capital support from BRICS and other emerging markets.  In exchange control of global financial institutions shift away from western dominance (though maintaining western influence).   Managed right, there is no need for on going crisis, fear of war, or concern that civilization will collapse.   But can we trust the politicians to handle this with any wisdom?


From Europe to Asia

President Obama announced the expansion of US military ties with Australia

Franklin Delano Roosevelt had a problem.   As much as he wanted to get involved with the war that started in Europe in 1939, there was intense domestic opposition.    Many Americans, especially the “isolationist” Republicans had disdain for Europe.    European states were the world’s great powers, if we focused on them we’d have to play by their rules.   Asia, on the other hand represented an opportunity for the US to expand our influence and in fact counter European power.  Hitler may be a problem, but Tokyo stood most directly in the path of US interests, especially the American desire to develop a strategic partnership with China.

Of course it took a surprise attack from Japan to get the US into World War II, and for most of the war US efforts focused on the Asian theater, leaving it to Russia and Great Britain to try to beat back the Nazis.    When the war ended, the US occupied Japan and imposed a constitution designed to assure that Japan would not be a rival for dominance in the region.   President Truman and Secretary of State Acheson had to exaggerate the danger of Communism to get the Republicans to embrace NATO and the rebuilding of Europe.  Their eyes were still on Asia.

Then in 1949 Mao Zedong’s Communist revolution put an end to US hopes for regional hegemony.   With China “lost,” the region declined in importance, and US interests shifted back towards Europe where they’ve stayed for over sixty years.    To be sure, the US fought in both Korea and Vietnam, but those conflicts were not so much about Asia, they reflected global Cold War dynamics.  Our best troops, technology, and emphasis was on the NATO alliance – Europe and the US were “twin pillars” of the western alliance according to President Kennedy, a “community of common values” said West German Chancellor Adenauer.

NATO became the most successful alliance in history

After the Cold War ended the US started to withdraw troops from Europe.   Russia was not seen as a serious security threat, especially not by the Europeans.   The US wanted to enjoy what President Bush (the Elder) called ‘the peace dividend,’ and Europeans felt they didn’t need the US to defend them.   NATO remained a successful alliance, but it’s necessity was in doubt.    Relations hit a low ebb in 2002-03 when a combination of American refusal to participate in international ventures important to the Europeans (ICC, Kyoto Protocols, etc.) and widespread European opposition to a US war in Iraq created mutual ill will.   Though they’ve patched things up again, it’s clear that relationship is not what it used to be.

With President Obama’s announcement in Australia of a growing US presence in the south Pacific, US policy has come full circle.  The future is no longer in Europe, but Asia.   Europe’s economic and financial mess rivals our own (the problems are, to be sure, different), while Asian countries represent the future, and perhaps a path towards economic stability.

As a Europeanist (that’s my specialty in political science) one might think I’d oppose such a move, but I don’t.   Moreover, I think the EU will also shift it’s priorities from the US to Asia — Asia is the new center of economic power and perhaps the engine for the 21st Century.

From the standpoint of the United States and Australia the move makes sense in realist terms.    The shift of US interests from Europe to Asia, as well as the growing importance of India and China in the region suggests that its important the US care for its alliances in the region, particularly with Australia, Japan and South Korea.   A stable balance of power will prevent China from using its power to extend hegemony and work against US interests.

In neo-liberal theory, the case isn’t clear cut.   China’s reaction was one of annoyance: China’s economic relationship with Australia poses no threat to the country, but its alliance with the US creates a threat to China.    Australia should think about whether or not its worth it to anger a friend with whom it is engaged with a cordial, mutually beneficial relationship.

Chinese-Australian economic ties have been deepening, and benefit Australia

In that sense the US has far less to offer.   The US economy can’t help pick up Australia’s as ours remains mired in recession.   As the regional economic powerhouse, its in Australia’s interest to foster good relations with China — after all, who thinks China is going to invade Australia?

The strongest case against the agreement is based on an analysis of internal Chinese politics.   For years there has been a tug of war between China’s military and civilian leaderships.   The military thinks in realist terms, seeing the US as a potential threat to Chinese power and security.   After all, despite China’s wildly successful economy, they still lag far behind the US in military prowess.   The civilians don’t see war as likely, and recognize that conflict would mess up a very well developed strategy for economic growth and influence.    Up until now they’ve placated the military by allowing them to use a chunk of China’s economic growth to develop their capacity.   Yet the rift is real.   Will this tip the balance of power within China towards the military and yield a more confrontational China?

It shouldn’t.   As much as China protests (and the civilian leadership has to protest loudly or else face a more assertive military leadership), they know that this isn’t really a threat to China.    At best it’s a hedge against China exercising undue influence in regional disputes, it provides the US and its allies a slightly stronger voice in regional politics.   China may not like that, but they can live with it, as long economic and diplomatic efforts are made that take Chinese interests into account.

Rivals more likely to become partners than enemies

Ultimately the pro-Asia lobby before WWII may end up having been prophetic.   The US has a future in Asia, not as the dominant power but in partnership with China.   China’s problems of political transformation, corruption, environmental degradation and adapting to its position in a global economy are more easily solved by working with rather than against the US.   US economic ills are real and structural; China could damage our economy severely without a shot being fired.   Yet they don’t want that because they would be hurt by the resulting economic instability.   They would rather see the US restructure its economy.   They can help  a weakened yet still relevant US adapt to new international realities.

In that sense the shift of emphasis to Asia is part of a global dance.   China and the US are still rivals and the US is dealing with a relative loss of global power while China is on the rise.   There is concern amongst US allies about growing Chinese clout.  The US worries that without the capacity for quick intervention in the region China could fill the power vacuum.    Yet this rivalry can and should turn to partnership over time.   The world is still “realist” enough that the US presence in Australia is needed to remind China of the relevance of American military power.   But globalization is rendering military power ever less important, and over time the Chinese and Americans will see that their destinies are better linked in partnership than broken in conflict.

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American Education

Teaching international relations at a public liberal arts university, I’m constantly surprised by how little most students know about the world outside the US.   There are always a few who had teachers that opened their eyes to the cultural and historical diversity of the world, but few really comprehend much about what goes on outside our borders.

Conversely, there is generally pretty good knowledge about American history and US politics.   Education majors planning to teach high school civics and social science need to take courses in US history and American government; if they take world politics or comparative politics it’s as an elective (and state requirements leave them little room for electives).   Thus the bias against teaching about the world outside the US is shaped in part by how we educate future teachers — and that’s influenced by state requirements, what’s tested for the ‘no child left behind’ program, and political pressures to focus on knowledge about the US.

If I could choose three things I would  like students to understand coming out of high school it would be:

1.   A general understanding of the intellectual history of western civilization.

2.  Comprehension of political geography — how the world is divided, and the wars, colonialism, and agreements that shaped the basic structure of the world today.   This need not be detailed, but at least a framework into which knowledge in college could be plugged.

3.  An understanding of cultural diversity to work against bigotry, knee jerk phobias, and cultural chauvinism.

Recognizing the difficulty in adding to what students already have to know, I’d even argue that this could be taught in a semester course titled something like “Global Studies.”  Each of these proposed ‘units’ could be one or even two courses.  I’m suggesting a broad overview that prepares them for detailed work in college, and awakens an interest to keep learning and growing also among those who don’t go on to higher education.

Unit One:  Who we are.  A brief look at the themes and conflicts in western thought harkening back to Plato and Aristotle.  Students should understand a bit about the history of Christianity as that religion shaped western thought, including the ethics and core values of people who are now atheists or follow other beliefs.  The influence of the reformation, the themes of the enlightenment, and the rise of secularism would follow.   These are complex topics, but in an intellectual history one need not learn all the details of the philosophies and intricate disputes.   Again, at this level students would only need a basic understanding that “who we are” is the result of 2000 years of cultural history.   What seems “natural” and “self-evident” to us comes from deep cultural biases that have shaped the West.   Understanding that “who we are” isn’t “the one people who see reality as it truly is” will make it easier to understand and appreciate other cultural perspectives.

Unit Two:  Political Geography:  This would start in Europe (and could mesh with unit one) and focus on core concepts that would be spread to the rest of the planet.   I’d suggest Napoleon and nationalism, colonialism, the causes of WWI and WWII (avoiding the simplistic ‘blame Hitler the madman’ crap) and the Cold War.  Included would be an emphasis on each continent and its own development.   After this unit students would know “where we are” globally, and have a sense of how and why the world is as it is.

Unit Three: Cultural Perspectives:  Given current events, it is fundamental for students to understand at least the basics of Islamic and Chinese culture.   These are two great cultural civilizations that are not going to go away and will not be defeated by the West.   The fear that some people have, or the ‘enemy image’ the media often promotes are counter productive.  We’re going to have to co-exist and cooperate with people of other cultures.   I’d go into some depth on China and the Islamic world, enough for students to recognize that those cultures developed much like ours, only with some different traditions and core beliefs.   They’d also grapple with cultural relativism — we need to understand other cultures on their own terms, but that doesn’t mean we have to give up value judgments.  How to do that is difficult, especially since we can’t simply assume our superiority.   I think there should be brief considerations of other cultures — Latin America, an overview of the diversity of Africa south of the Islamic world — but there isn’t a need at this level to learn everything.   As long as students understand how to look at different cultures and have a sense of global diversity, they’ll be able to build on that in college.

In terms of standardize tests I’d recommend they cover basics of Islamic and Chinese culture/history, key historical developments of the planet (outside US history) and some of the major concepts of western intellectual history.  It probably would not be difficult to develop a template of core concepts and facts that high school students should know before continuing on to college or joining the workforce.

Right now the country reacts to events and problems with uncertainty, easily swayed by demagogic rhetoric and emotion.   Fear of others, envy, anger, and blame fly easily.   People grasp for simple answers.   It can be expressed as hope for a better future, such as that which elected President Obama, or a desire to return to a simpler past as put forth by the tea party.    But clear thinking is impossible without knowledge.

Some might question whether one high school course or inclusion on a standardized test would make a difference.   I think if done well, expanding peoples’ knowledge about the world will quite often spur people to become interested in learning more on their own — to travel, read about other places, and become life long learners.   Ultimately we can’t create an educated society by simply changing how schools or universities function.  Rather, schools and universities have to awaken a desire by students to want to continue to learn and grow, consistently questioning their beliefs and ideals.    Knowledge is what makes life interesting and enjoyable; if people stop questioning and rethinking/expanding their beliefs, they stagnate and become bitter.     When people keep learning, life becomes a joy.

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President Hu and the New Reality

If Mao Zedong had said that the era of dollar dominated international currency system was a thing of the past, he would have been shrugged off.   But that’s precisely what Chinese President Hu said this week during his visit to Washington.   He’s right.  But American officials are also right that China’s currency is under-appreciated, and as China allows increased domestic consumption, this will yield inflation.   Already there are signs that China realizes that just as the current international currency system is becoming obsolete, so is their weak Yuan policy.

Presidents Obama and Hu stand at the edge of a new reality.   It is not an exaggeration to say that this summit could be one of the most important in the post-Cold War era, as the way the two countries choose to manage the tumultuous global economy will determine what kind of future we face.

We are at a pivotal point in determining the shape of the new global political economy.   The Bretton Woods system of fixed exchange rates based on the gold standard lasted from shortly after WWII to 1973.   At that point the gold standard and fixed exchange rates were dumped in favor of floating rates.    This was made necessary by the need for a system that could serve a rapidly growing, more complex world economy.    Many scholars look at the seventies as the start of the movement to what is now called “globalization” (in 1976 Keohane and Nye labeled it “complex interdependence”).

The dollar remained the world’s main reserve currency, even as the Yen, Deutschmark and Dutch Guilder stood out as stable, safe currencies.   Nothing could touch the dollar’s global importance, and this gave the US a lot of leeway in economic policy.    Policies that might cause inflation if undertaken elsewhere could be projected globally, meaning the world would absorb that inflation and the US could be relatively unaffected.   Nixon’s Treasury Secretary John Connally put it this way: “our currency, your problem.”

Up until the global crisis that began in September 2008 the dollar seemed secure.   The Yen had fallen from grace due to Japanese deflation, and the Euro was still new.   To be sure, the Euro had strengthened considerably — it nearly doubled in value relative to the dollar between 2001 and 2008, and there was talk about OPEC shifting towards Euros for oil trade.    Yet when the crisis broke out in 2008 countries and investors showed that they still had faith in the greenback, as the dollar rose in value, even before the Greek crisis hit the Eurozone.   The only competitor was gold, whose value also increased dramatically as investors also saw the writing on the wall — the dollar may be the safest currency, but that doesn’t mean it’s safe.

China has been supporting the dollar and the US current account deficit through its continual purchases of US debt.   China, with a current account surplus, had money to invest.   By investing in the US, they gained two benefits.   First, they helped enable US consumerism, meaning their economy would keep growing.   Second, they gained leverage over the US.  If they were to dump US bonds, stocks or currencies it could devastate the US economy.   However, even with recent market diversification, China is still years away from being able to do such a thing without doing considerable harm to themselves.  There is no sign that they desire US collapse — the global instability that would cause would endanger their successful economy.

Since 2008, though, the Americans and Europeans realized that they cannot sustain debt-driven economies any longer.    China realizes that it can’t rely on the US market, and that the investments in US bonds and currency aren’t as safe as they had assumed.  The Chinese also recognize that besides diversifying their export market, they need to increase domestic consumption.  They’ve brought 400 million out of poverty, but want to avoid instability caused by relative deprivation.

What Obama and Hu have to do is figure a process for countries to decide how to restructure the currency system without sacrificing free trade and stability.   If the US and China could agree on a broad framework, the rest of the world would go along and negotiations could get underway.    However it ends, one result is pretty clear: a weaker dollar, and less US clout in global economy.    Already demand for the Yuan is strong in the places where China lets it be officially traded, a sign they are moving towards making it an international currency.   Assuming the Euro weathers its crisis, it will come out stronger than before.  People are still uncertain about the long term viability of the European currency, but if they show the capacity to overcome the current crisis, the Euro will have established itself.   In such a case, the dollar and Euro will be on relatively equal footing.

The best bet for weathering this crisis is not to stumble through, but to develop a political agreement that incorporates the interests of a wide spectrum of interest — state and non-state alike.    Right now the main alternatives seem to be: 1) simply allowing multiple global currencies to co-exist, much as how things were before WWI.   The Euro, Yen, Dollar and perhaps later on the Yuan and other currencies from new economic powers will share the role the dollar has played since WWII.   2) Using the “Special Drawing Rights” of the IMF as a guide, create a single global currency that’s really a basket of existing currencies, weighted relative to the economic strength of the participants (the pre-Euro ‘ECU’ did that for the EU).   This would limit the power one country could have, and perhaps promote cooperation.  3) Return to some kind of revised gold standard.   This one isn’t likely because such a system is considered rigid working against market mechanisms, and which may have prolonged the Great Depression.

Just as the Bretton Woods agreement was not just about currency, there needs to be movement on defining the nature of how globalized trade and investment will be regulated in this new era.   Bretton Woods yielded a free trade regime,  and set up institutions like the IMF and World Bank to try to maintain stability to bring about development.  Those goals remain — sustainable development for third world states, and stability for the world economy.   No one knows how the new system might function, other than markets would be central.   Moreover, non-state actors like large multinational corporations and non-governmental organizations exist alongside sovereign states, and they need to be involved in the process as well.

Nothing could be better for our future prospects on the global economic front than for Presidents Obama and Hu to make a significant breakthrough, and agree to start the process of negotiating a new system.   It may not be announced as such, but the sooner we part with the illusion that the old system can function well in this new era of globalization with no dominant world power, the more likely we’ll find a way through this crisis without economic collapse or global conflict.

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Is North Korea About to Fall?

North Korea recently shelled Yeonpyeong island killing four people and raising speculation as to North Korea’s motives.   Few believe it was a response to South Korea firing into disputed territory (as they claim), but observers are unclear as to why North Korea would do something so provocative?

One error foreign policy analysts often make is to assume that a state’s actions on the world stage are to pursue a foreign policy objective.   When we look at foreign policy, it’s tempting to use what’s often called a ‘rational actor model,’ seeing a state as a kind of fiction-person who undertakes policies designed to achieve a particular goal.   The question then becomes:  Why did North Korea fire on Yeonpyeong island?

However, quite often actions are not the result of some choice by a leader to pursue a goal, sometimes they reflect internal political/bureaucratic dynamics within the country.  The purpose may be to bolster or undermine particular people or policy preferences within the government.    Rather than being a sign of external ambition or purpose, it may be a reflection of internal division and rivalry.

That is even more likely given the precarious situation in which North Korea finds itself.  The leader, Kim Jong Il, is reported to be sick and perhaps near death.   The recent promotion of his son, Kim Jong-un to a top military position appears to be an attempt to set the son up to succeed the father.   Kim Jong-Il, of course, succeeded his father Kim Il-Sung.  Kim Il Sung, whose attack on South Korea started the Korean War, handed his son a governmental empire with an extremely loyal bureaucracy and public when he died in 1994.

Kim Il Sung was a dedicated Communist who died just as the Cold War was ending.   Kim Jong-Il made fewer ideological pretensions, and instead focused on building a regime that would sustain itself through propaganda, patronage, force, and cronyism.   While the country was starving the leadership would use such things as illicit arms trade to maintain a very comfortable life style.  In short, North Korea under Kim Jong-Il went from being a communist dictatorship with a failing economy to becoming a mafia dictatorship with an economy set to service the elite.   Bluntly: the difference between organized crime and the Korean government is that the latter had the protection of sovereignty.

Kim Jong-Il’s son is young and untested.  If there is a chance that the “Supreme Leader” will pass, there is a real chance that there could be a coup or an internal uprising.   China’s displeasure with North Korea is now clear.   While they ardently protect the principle of sovereignty, the Chinese don’t want this corrupt regime to continue.  It is almost certain that China is trying to influence the upper echelons of North Korea’s government, and use any change in leadership is a way to push for regime change.

If a new regime came to power, supported by the Chinese, they’d move to normalize relations with the West and perhaps start unification talks with the South.   They would also untangle the web of illicit relationships the North Korean government is involved in, quietly pushing for a legitimate economic relations (centered around Chinese interests, to be sure).  They’d want to avoid a clear “victory” for the West or the US, but if the rogue arms traders of Pyongyang were shut down everyone in the West would breath a sigh of relief.  That would weaken Iran’s missile program and make it less likely that terrorists would get their hands on nuclear weapons or dirty bombs.

China would work to cement a tighter relationship with a unified Korea, perhaps setting the stage for its own unification with Taiwan.  Taiwanese investment in China is already soaring, and if meaningful autonomy is retained, the Taiwanese might find it useful to put aside the tension in the past relationship.   This would yield an Asia with less tension, and a stronger role for China.  It might also aid China in shifting its economic system from one focused soley on exports, especially to the US, to more diversity in its markets and more domestic consumption.

Perhaps those in the military, dependent on illicit arms trade, and fearing what will happen when Kim Il Jong dies or becomes too sick to rule decided tensions with the West might aid the regime’s staying power, and stymie any Chinese efforts to manipulate the situation.   In such a case, the West would be wise not to over react, and not to treat North Korea as stronger than it is.  It is a weak, fragile country with a corrupt criminal leadership waiting to be swept away.   The time may be near.   The US will then be able to leave South Korea, and reduce its presence in Japan.

Perhaps the nightmarish rule of the worst regime on the planet at this time is near an end.  One can only hope.

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Economic Malaise?

With jobs not returning as quickly as expected, and economic statistics mixed, many people are wondering if we are in for a “double dip” recession, or if the first “dip” has really ended.   What’s going on.

The answer is surprisingly clear; I reflected on it as I bought my son a new bike.  It was $100 at Target — a nice mountain bike, 20 inches, 21 speeds — and I thought to myself, “well, at least I’m helping the economy.”    And, of course, it does give some help to Target’s workers and corporate profits.   The bike, however, was made in China.   Therein lies the problem.   If the economy is stimulated through things such as tax cuts or more consumer spending, it usually goes to buying goods produced in foreign countries.   That actually worsens the underlying problems of a current account deficit and debt.   No recovery can happen without an increase in production.

To free marketeers the answer seems easy — just let the market do it with fewer regulations and lower taxes.   Alas, that is not a viable solution, the market will not on its own stimulate production.   The reason is globalization — reduce taxes and regulation and capital is as likely to seek profit abroad as at home.   Moreover, given that lack of regulative oversight caused the derivatives market to boom, thereby causing the bubble economy’s crash to be so toxic, the idea that less regulation magically leads to economic growth is dubious.   It’s not the amount of regulation, but having effective regulation.   Moreover, more heavily regulated and taxed Europe (especially Germany) is weathering the recession much better, the idea that there is a magical solution of just sitting back and letting the market work is delusional.

Yet we can’t just spend our way out of it either.   The problem is that any growth we get tends to involve increasing the trade deficit, which only enhances the problem.  We have become a country where people try to buy and sell, but not produce.   People want to figure out a way to make easy money, sometimes working very hard, but we aren’t producing enough on our own to get the economy moving.

Part of the problem is the death of the middle class.   The middle class has been constantly shrinking so you either have the very rich, usually living on investment income, the professional elite, or the poor working in the service sector.   The backbone of the US economy had been a large, productive working class, able to purchase consumer goods and have a quality lifestyle.   Fewer people than ever fit that description.

It was tolerable until now because we’ve had the Chinese providing cheap goods, meaning that with Walmart and cheap textiles, toys, and electronics a declining income did not necessarily mean you couldn’t keep consuming.   In essence, we had the equivalent of Chinese slaves producing for us, helping put American factories out of business.  Credit was cheap too, so people sacrificed their savings and got comfortable carrying debt.

To many Americans this had an upside.   I don’t want my kids to have to work in a factory, and most Americans started to see routine labor as something to avoid, instead going to college to find a profession.   Factory workers didn’t want their children punching a time clock — it’s the American way to want something better for the next generation.   The mills are closing in Maine, but how many people want their kids to work in a mill?   The problem is that if we want to close factories, we still have to produce something else of value that people here and abroad want.   We can’t all be doctors, lawyers, managers and accountants.

To rebuild the economy we have to rebuild a productive working class.   We have to produce.   But what can we produce?   We can’t undercut Chinese prices; trying to make US products as cheap as third world products would not pay a middle class wage.   Protectionism isn’t an option — China would stop financing our debt and could even hurt us by dumping dollars, stocks and bonds.   And anyway, the Smoot-Hawley bill 80 years ago during the Great Depression shows the danger of protectionism.

The problem is that the structure of the economy is not one where there are free market incentives to build a stable productive middle class.   With cheap foreign goods and high debt, the market now has incentives to further bifurcation of the US economy until inevitable class warfare breaks out.    We already see it with the so-called “tea party” movement on the right.  While they eschew talk of “class,” much of it is driven by anger at the establishment, with economic populism rampant.

If we were a third world country this would be “solved” by the market through high inflation, forcing us to buy and produce our own goods because foreign goods would become too expensive.   The US economy is too big, and the dollar still too trusted for that to be likely.  Government spending to enhance production is one feasible solution.  Some of this is already working with General Motors, and efforts to jump start alternative energy production are positive moves.    Moreover, the information revolution and “new economy,” used so far mostly to enhance the buying and selling of “traditional” products, may give us paths to produce non-industrial products that nonetheless have value.   Small companies producing local goods and generating a loyal customer base might help.    But I’m at a loss as to how we can turn this around.  We’ve been digging this hole for thirty years, there’s no easy way out.

Lastly, tax reform is necessary.   Right now taxes squeeze the middle class the most, with large chunks of our bifurcated society too poor to pay taxes.    The very wealthy can easily find tax shelters and accounts/tax lawyers adept at avoiding the taxman.   Those rich enough to be in the higher tax brackets, yet not wealthy enough to finance legal tax evasion, pay the highest percentage of their wealth.   This further bites the shrinking middle class, and breeds resentment of the nearly 50% too poor to owe taxes.

Still, the fact remains:  we need to produce.  We cannot consume our way to economic well being.   Until we produce value, we cannot expect economic recovery.

UPDATE: Talking Points Memo has a great graph illustrating precisely what I mean.

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It was 20 Years Ago Today

On every 20th anniversary of a major world event the old line from the Beatles goes through my head.   Twenty years is a long time.   People born in 1989 are now sophomores and juniors in college.   It also is long enough to start to develop an historical perspective on events.

Twenty years ago today the world awoke to news that China had cracked down on the protests at Tiananmen Square, the main square in Beijing, which for weeks had seen a growing protest movement demanding democracy and freedom .

In China economic restructuring had started a decade earlier, and had been extremely successful.  Ten years of growth and modernization was about to give way to (at least) a two decade span of near 10% a year economic growth and increasing internal prosperity.

China’s leaders did this in a very carefully planned manner.   Unlike old bureaucratic communism, they didn’t attempt to control markets or micro-manage.   They worked with markets, guiding the economy on a path towards export led growth, mimicking what Japan, South Korea and even Taiwan had done earlier.

Many Chinese believed that growing prosperity should be complimented by political openness, freedom and democracy.  Some leaders in the Chinese Communist Party agreed.  They knew they were no longer Marxists in their economic philosophy — “communism” was now used as a rationalizing principle for keeping the elites in power.  In fact, by 1989  the new entrepreneur class was earning more and living better than the average bureaucrat or party leader.

Others, however, were afraid of the change.   They knew their country was soon to be well over a billion people.  Their fear was not ideological, but historical.  China has a history defined by periods of stability, associated with stable but strict imperial rule, and periods of instability and chaos caused by regional rivalries and incompetent central government.  If they allowed the nascent democracy movement to gain support, could it destroy the country?  After all, over 700 million Chinese live in poverty.   The educated middle class were (and still are) a minority.   Could some radical movement mobilize the poor against both the Communist party and the economic reforms?    Would the regions start fighting amongst themselves?

Leaders decided that 1989 was not the time for democracy.   The crack down at Tiananmen was brutal, bloody, and efficient.   They knew they risked reprisals — they relied on external investments and external markets to keep their economic reforms moving.   But despite outrage and initial threats, the world response was mild and temporary.  US President George H.W. Bush had been ambassador to China and understood how the leaders were thinking, and thought their fears were legitimate.   China might not be ready for the kind of change being demanded.   Investment from abroad and purchases of Chinese goods, on an ever upward ride since 1979, paused a little, but continued their climb.  By 1990 the US needed China to support the American led expulsion of Iraq from Kuwait, and in exchange for that support, reprisals over Tiananmen became virtually nil.  By the mid-nineties, it was all but forgotten as Chinese economic growth went into overdrive.

China’s 1989 movement was not very broad.  Intellectuals and students made up the lions’ share of its supporters.   The growing middle class simply wanted to get rich, and the government was allowing them to do just that.  They did not want to jeopardize their new found wealth.   China could crush the protesters and most of the population, even if disappointed, weren’t willing to do anything against the government.

Yet China’s middle class has continued to grow.   As more Chinese move into prosperity, they will start questioning why the party and its bureaucracy remain in control of the country.   Meanwhile, the children of the first generation of middle class Chinese are coming of age.    They are less likely to be as satisfied with simple prosperity; they will be more likely to cast a critical eye on government policy, especially as problems caused by the world economic crisis intensify.

China in 2009 is therefore in a different place than in 1989.   There is no major protest movement, but the potential support base for reform is far broader now than it was twenty years ago.

The danger is that the Chinese Communist Party (CCP) will be unwilling to adapt to these changes.  To the extent they try to hold on to power, they risk alienating the middle class, and causing rifts between different parts of the country.   Moreover, corruption in China has become intense.   The government’s ability to control economic development has created opportunities for bureaucrats to make out big on graft and “favors.”  This not only lines their pockets but makes them feel important: the big shot who can stop a project with a stroke of a pen.   Such folk balk at reform efforts and cling to their positions — parasites don’t let go of the host without a struggle.

A western style democracy was not viable for China in 1989.  That would have been a risky experiment that might have sent China in the wrong direction.   Communist control, however, is unsustainable.

The longer they wait before beginning a power sharing process with the middle class through nascent democratic institutions, the more difficult change will become.   The protesters in 1989 overreached, but it would have been better for China if both they and the government had recognized the need for gradual reform, and had been able to compromise and work together on that path.

The US, of course, has an interest in all of this.   We should not expect an American style democracy in China — their culture and history is very different from ours, their political system will reflect who they are.   Too often we’ve made the false assumption that what works for us should work for everyone; we cannot make that same mistake with China.    We need to avoid being seen as a threat (the Chinese military tends to be far more keen to view the US as a potential enemy, often butting heads with the political leaders who focus on economics), and respect the fact China will have to control their own process of reform.

China, it has been said, looks at history different than the West.   Where we see history behind us, with our eyes and focus forward, Chinese are said to back into the future, keeping their eyes on the past.  Most people have forgotten the events of 20 years ago.  In China, however, these events are not only remembered, but are recognized as part of a dilemma China has yet to solve.

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The New China Syndrome

The term “China syndrome” refers to fear of a catastrophic nuclear meltdown, (where some of the nuclear material might ultimately bore through the earth and reach China).   So far, no nuclear power plant has suffered that extreme of a fate.  But just as fear of nuclear war gives way to fears about the economy, there is danger of a new kind of China syndrome, one involving China holding vast amounts of US dollars and US debt.  The risk, however slight, is of an economic meltdown.

China is the largest holder of foreign currency reserves, having nearly $2 trillion worth of currency assets.    China has also run consistent current accounts surpluses; the trade deficit between the US and China was $84 billion in 2000, but reached $266 billion in 2008.    China has already announced intentions to diversify its foreign currency holdings to replace dollars with other currencies, fearing that the large influx of dollars into mortgage markets, as well as high deficits thanks to the stimulus program, creates an undue risk.  The dollar, China fears, could lose considerable value, thereby depreciating the value of both China’s foreign currency reserves and bond holdings.

The US has about $3 trillion worth of foreign owned treasury bonds out there, just under $1 trillion belongs to China.  China is the largest holder of US debt, followed by Japan.  It’s likely that 70% of China’s currency reserves are currently in dollars, meaning that China’s dollar exposure is well over $2 trillion.   Moreover, that does not include other Chinese investment in the private sector in the US.

Of course, by holding so much debt China puts itself in a relatively weak position in one way — they have to worry about the US economy, the value of the dollar, and the danger of American default (which seems unthinkable, but…)  The idea that China could simply dump loads of currency and bonds, and refuse to buy more bonds, doesn’t make sense.  This would cause a run on the dollar and tremendously higher interest rates within the US, creating ‘stagflation on steroids.’   The impact on the US would be devastating, it would be a collapse of our entire system.

The fact China could do that — we are vulnerable to China in a way and at a level that would have seemed unbelievable in the past — scares a lot of people.  Yet for China this would mean that their primary market for Chinese goods would stop buying while China’s dollar and bond assets would rapidly deteriorate in value.   Moreover, given the globalized nature of the world economy, the impact of this on the system could come back with unexpected and severe consequences for China.   Given China’s very conservative approach to foreign policy and economics, it seems inconceivable that China would, out of the blue, choose to torpedo the American economy.

One can, of course, imagine some kind of international crisis that could lead to China deciding to hurt the US, but the US and China are in a kind of economic mutually assured destruction mode.   Most likely, these ties will cause both sides to avoid letting a situation get out of hand.

But what about an accidental meltdown?  What if US fiscal and monetary policy can be likened to a nuclear power plant which is powering the economy by injecting massive amounts of liquidity into the mortgage markets, and going further into debt in order to try to stimulate the economy.    This creates a fear in China that the US, by increasing the money supply and expanding debt is setting up a run on the dollar.  Their goal is to make sure that if the US dollar does lose value, China is not hurt too badly, or in fact finds a way to gain some benefits.

For instance, China joined Russia is calling for some kind of new global currency to replace the dollar.   They were only partially serious.  They know this isn’t likely to happen any time soon — you can’t just get currencies out of nowhere — but they wanted to send a message to the US that we can’t simply throw dollars around, unafraid of the consequences.   They also reportedly cut back on treasury purchases earlier this year, again signalling that we can’t assume continuing low interest rates and a highly valued dollar if we don’t have a responsible monetary policy.   In March, bond purchases went back up.

Still, as with the nuclear arms race, you can’t discount a nightmare scenario.  With nukes, in fact, the incentive to avoid error was greater — everyone knew how dire and devastating nuclear annihilation would be.  The economic stuff is more complicated, and most people really don’t understand how interdependence works.  It’s easy for people to say “stop trading with Communist China” or “protect American jobs.”   Even political leaders who should understand this often give in to populist or ideological mindsets that promote policies that are not rational economically.

One could imagine some kind of row over North Korea, human rights, or trade policy taking place just when the dollar starts showing signs of strains thanks to increased debt.    China might choose that moment to dump a small amount of US currency or stop buying bonds to remind Washington how much the two countries need each other.  The US might, however, decide that backing down in response to such an act would be a sign of weakness, and feel a need for some sort of retaliation.  Populist rage might rise in both states against the “predatory practices” of the other.   And unlike nuclear war, where it becomes clear when the button is or is not pushed, a dollar panic could reach a point of downward spiral unexpectedly fast, catching both the US and China by surprise, forcing them to react to events.  China might decide to shed dollars defensively, forcing the US economy off a cliff.    The result could be an accidental global economic meltdown.

Adding to the pressure is the fact that the current relationship is unsustainable.  The US can’t maintain high debt permanently financed by China.  China can’t simply gather up foreign reserves and US debt forever.  Indeed, China is poised to over time, perhaps decades, slowly lower the value of the dollar and create bargains in the US.   By bargains I mean cheap businesses, corporations, and other valuable assetts that will be relatively cheaper for foreign concerns as the value of the dollar drops.   Such a controlled transfer of economic clout, internationalizing the US economy, would still be traumatic for an America used to independence and skeptical of foreign influence.   This would also coincide with a lengthy decrease in the US standard of living, though if done over time might be tolerable to the American public.

But would the US acquiesce to this loss of control over our economy?  Would we decide that it’s better than economic collapse and learn to live witih it, recoginizing that the alternative might be horrific?  Or would we try to fight back, perhaps igniting the meltdown?

Finally, can we recover?   It seems a long shot, given high debt and deficits, but ultimately the US has a productive work force, a large market and the capacity to remain an economic powerhouse.   Some internationalization of control of the US economy (which has already begun) isn’t necessarily a bad thing, and if the US can get the economy moving again and combine that with decreases to debt (both public and private), it’s possible to manage this in a way that maintains vibrancy.  Yet the unsustainable bubble economy and hyperconsumerism of the last ten to fifteen years cannot return.  Reviving America’s economy will mean having to learn to live within our means.

So the best case scenario is China and the US recognizing that their economic destinies are linked, the US making fundamental readjustments in its economy to make it sustainable (reduce debt, bring the current account back into balance), and China avoiding the temptation of a power grab — to think they can dump dollars and bonds and manage to nonetheless remain on top.

The worst case scenario is a global economic meltdown, with China and the US going into the economic equivalent of total war.

Perhaps the most probable outcome is economic decline in the US due to an inability to get budgets and private debt in line, and an unwillingness to admit that that the old system could not be sustained.  In such a case we may avoid meltdown, but we’ll end up with a devalued dollar and a much lower standard of living.