Friday, December 21, 2007


Twice a year, the U.S. Treasury Department presents a report to Congress on the currency policies of countries around the world. Its report of December 2007 once again declined to designate China as a currency manipulator, but stated that the recent appreciation of its currency, the yuan, has been too modest and limited.

The report recommended that "China should significantly accelerate the [yuan’s] effective exchange rate in order to minimize the risks that are being created for China as well as the world economy, of which China is increasingly a critical part." The report stated that the U.S. will continue to use every opportunity to stress to Chinese leaders "the need for China to rebalance growth, including reform of the exchange-rate regime."

The Treasury report was issued the same day that China took a 9.9 percent stake in Morgan Stanley with a $5 billion cash injection. Morgan Stanley had to write off $9.4 billion in losses for its fiscal fourth quarter on its U.S. subprime and other mortgage investments. China came to the rescue of one of America’s premier financial houses even as it was chastised by the Treasury for mismanaging its currency.

The Treasury report amounts to the kettle calling the pot black. What was Secretary Henry Paulson and his deputies doing while the subprime mortgage crisis was building? Ditto for the Federal Reserve Board. So far, all the king’s horses and all the king’s men have been unable to put humpty-dumpty back together again. It has taken China and other cash-rich countries to help extinguish the U.S. financial fire. Rather than the Treasury criticizing China and offering advice on how to run its economy and currency, which have been remarkably well-managed for the past quarter century, perhaps the Treasury should pay attention to home-grown financial problems.

The day will come when China’s Ministry of Finance presents a report to the National People’s Congress stating that the ministry will use every opportunity to stress to American leaders "how to manage a financial system."

Monday, December 10, 2007

Is the National Retail Sales Tax a Good Idea?

Among the candidates for comprehensive reform of federal taxation is the Fair Tax, a proposal to replace the income tax with a national retail sales tax. Its proponents include Republican presidential candidate Mike Huckabee, prominent professors of economics, and Members of Congress. As co-author (with Robert E. Hall) of The Flat Tax, I’m often asked for my comments on the sales tax proposal.

In many ways, for me at least, a national retail sales tax is an attractive idea. Let me list eight reasons.

The first comes from the long-running television series Star Trek, in particular the Ferengi who excel in business. The Ferengi are governed by a code of business known as "The Ferengi Rules of Acquisition." Rule 141 states: "Only fools pay retail."

Second, I come from an extended family of uncles who advised me never to pay retail, as they can "get it for me wholesale."

Third, typical of most academics with a small sideline business of writing and lecturing, I would be eligible for an identity card that would exempt me from retail sales tax for any purchases used in my business, as sales to businesses are generally exempt to prevent cascading of taxes. All of us in similar situations would quickly learn that just about everything we buy is required for business.

Fourth, I own my own house, automobile, and other consumer durables, which I won’t need to replace anytime soon. Others, not me, will have to pay sales tax on these purchases, especially young families starting out in life.

Fifth, I’ll do all my shopping on the internet on a tax-free basis.

Sixth, I’ll be able to collect all my retirement earnings tax-free, having initially received a tax deduction when contributions were made to my plan and having enjoyed the benefits of tax-free compounding. With Medicare covering my medical requirements and my ability to eat and drink diminishing with age, I’ll build up a nice estate to pass on to my children and grandchildren, tax free.

Seventh, compared with the current federal income tax or the flat tax, a national retail sales tax will shift the tax burden away from me to others. That strikes me as eminently fair.

Eighth, a national retail sales tax rate will be very high, well above 20 percent. If the tax base excludes food, medicine, and educational expenses, it will be over 30 percent. Some estimates place it even higher. International and domestic evidence suggests that high sales tax rates encourage smuggling and evasion. A national sales tax would thus reduce the flow of money to Washington, forcing Congress to cut spending. We would all benefit from smaller government. It’s hard to argue with a proposal that has so many attractive features. If the national sales tax becomes law, I’m certain that tax planners can dream up other creative ways of avoiding or minimizing the tax.

Monday, November 26, 2007

(Mis)Understanding China

A Wall Street Journal editorial on November 26, 2007, complained of China’s refusal to allow the USS Kitty Hawk and its carrier battle group to dock in Hong Kong on Thanksgiving day. China relented a day later after the fleet was on its way to Japan. The Journal charged that China stole Thanksgiving family dinners from American sailors as 290 crew members of families had flown into Hong Kong to meet them.

On this action, the Journal proclaimed that China is not a reliable military partner. On what basis did the Journal believe that China was a reliable military partner? Is China to accede to every U.S. request or dictum, without the freedom to change its mind in response to U.S. actions such as selling military upgrades to Taiwan’s missile defense system?

The United States has its military, political, economic, and cultural interests around the world, with its military forces deployed in Korea, Japan, Germany, the Middle East, and elsewhere. China also has its interests, but to this point has deployed few military forces outside the homeland.

For the better part of four thousand years, China was the preeminent power in Asia. Compared with the West, it was much further advanced until the Industrial Revolution. From the Opium War in 1840 until the Communist armies seized control of the mainland in 1949, China suffered considerable harm and loss of dignity from several "unequal treaties" that gave Western nations control of China’s trade and extraterritorial rights in several trading ports. China has since fully recovered its sovereignty along with Hong Kong, and seeks to reunite Taiwan with the mainland. It is rapidly developing a modern economy and military. The country is beginning to flex its muscles, gradually but steadily, until it secures parity with the United States.

Secretary of the Treasury Hank Paulson, other U.S. government officials, and Members of Congress routinely advise China on what it must do and how it must behave on a host of issues, from the exchange rate of its currency to human rights. These suggestions are invariably rejected as China pursues its own course. China is no longer a land of coolies and compradors serving Western interests. How would the American government and people respond if China routinely advised the United States on what it must do and how it must behave? Hectoring China is likely to be increasingly unproductive as it gains in strength and influence.

It is natural that Americans would have a U.S.-centric view of the world, choosing to judge others on the basis of American values and interests. The same applies to China, perhaps more so, given that its civilization is over four thousand years old. American officials and journalists had better get used to an increasingly assertive China and give serious thought on how to manage the relationship between the U.S. and China. The Chinese will not take kindly to being lectured on their proper code of conduct.

Tuesday, November 20, 2007

Reconciliation in Iraq

Positive news is coming out of Iraq in the form of fewer U.S. military casualties and Iraqi civilian deaths and injuries. The explanation is that the surge in troops beginning last February has helped to curtail the destructive activities of Al-Quade, Sunni insurgents, and Shiite militias. The purpose of the surge is to stabilize Iraq and provide a more peaceful setting within which the Shiites, Sunnis, and Kurds can reconcile long-standing differences and form a unified government.

For Iraqis, the high price of oil is a godsend. Iraq exports some 2 million barrels of oil a day. At $90-100 a barrel, oil exports generate $1.4 billion a week, or $65-70 billion, a year in revenue. (It should be noted that U.S. military operations in Iraq are costing about $150 billion a year, an overhead of more than 200 percent.) This enormous flow of income, three times what it was when oil was priced at $30 a barrel, should provide an incentive for Iraqis to achieve some degree of reconciliation that would enable each community to share in this windfall. Perhaps the combination of the surge and money will achieve the U.S. mission in Iraq.

As of mid-November 2007, several U.S. generals have stated that despite the window of opportunity which the surge is providing, Iraqis have made little progress toward reconciliation. Key laws, especially the sharing of oil revenue, have not been passed. Neither greater security nor money seem to have overcome ancient enmity.

The Shiite-Sunni rift dates back fourteen centuries, grounded in the fight over who should lead the faithful after the prophet Mohammed’s death in 632 A.D. There are also important religious differences between the two sects. The Shiites were the losers in a struggle, resulting in their minority status throughout the Arab Muslim world. The Shiites have a history of subjugation at the hands of the Sunni, nowhere more so than in Iraq under the brutal regime of the late Saddam Hussein. Forgiving and forgetting is no easy task.

A dispute that is fourteen centuries old is unlikely to be resolved in a matter of years, much less the few months that the surge provides. A list of long-standing ethnic conflicts throughout the world suggests that the goal of national reconciliation in Iraq is too optimistic.

Catholics and Protestants in Northern Ireland were at each other’s throats from 1690 until a peaceful resolution, perhaps only temporary, was reached in May 2007, over three centuries later. Hutus and Tutsis in Rwanda and Burundi engaged in genocides that killed over a million people. North and South Sudan, now including Darfur, have been locked in civil war since independence. Other countries with ongoing ethnic conflicts or civil wars since they received independence include Sri Lanka, Congo, Guyana, Cyprus, Zanzibar, and Nigeria. Yugoslavia resolved its ethnic conflicts by dissolving into six different countries; one of those, Bosnia-Hercegovina, is itself separated into the Bosniak-Croat Federation and the Republic Srpska. Even peaceful Belgium is considering separating into two countries of Flemings and Walloons.

It is understandable that the United States desires the goal of a unified democratic Iraq, both as a buffer against Iran and as a model for other Arab states. A divided Iraq, either as three countries, a confederation (Swiss-style), or a federation could have difficulty retaining its autonomy. It is possible that Iraqi Shiites in the south would pursue close ties with fellow Shiites in Iran, that Turkey would resist an autonomous Kurdish region lest it inspire Kurds in Turkey to seek union with their fellow Kurds in northern Iraq, and that to resist the growth of Shia power, Sunni Arab states would intervene providing the minority Sunnis with financial and military support. But the goal of a unified democratic Iraq may be misplaced if it is impossible to achieve.

The Swiss Confederation has managed to survive two world wars and remain independent. It may be the only practical model for Iraq if the country is to retain any degree of unity. What would be needed is for the parties to agree to limit the authority of the central government and conclude a revenue sharing agreement that transfers most of the oil revenue to the separate communities. So long as U.S. policy focuses on national reconciliation, serious discussion of more viable alternatives is put on hold, perhaps when it will be too late.

Sunday, November 18, 2007

OPEC: The Cartel that Refuses to Break

In the midst of the first oil shock following the 1973 Israeli-Arab war, the late great economist Milton Friedman predicted that OPEC, the oil cartel, would ultimately collapse. His forecast was based on the historical failure of most cartels to hold together.

Here is Friedman's pronouncement in 1974 on the skyrocketing oil prices brought on by OPEC oil production cutbacks that began in October 1973: "The world crisis is now past its peak. The initial quadrupling of the price of crude oil after the Arabs cut output was a temporary response that has been working its own cure. Higher prices induced consumers to economize and other producers to step up output . . . In order to keep prices up, the Arabs would have to curtail their output to zero; they would not for long keep the world price of crude at $10 a barrel. Well before that point the cartel would collapse" (Newsweek, March 4, 1974).

Not only has the cartel held together for 33 years, it has become more influential than ever. OPEC is producing a gradually rising share of global oil output. It can count on a steady increase in demand for oil due to the need for energy imports in India and China, the latter modeling its industrializing strategy, in part, on the American experience with motor vehicles.

Oil-importing nations—Japan, the United States, most of Western Europe—want OPEC members to invest in new capacity to keep pace with rising demand, lest the price continue to rise. For its part, as a condition of investing in new capacity, OPEC wants a guarantee of secure demand for oil. What this means, in practice, is that oil- importing nations must promise not to invest too heavily in alternative energies, or take extreme measures against climate change, that would substantially reduce their imports of OPEC oil and reduce its price. This is a classic Catch-22 situation. If OPEC detects significant progress in the development of alternative energies among the oil-importing nations, it will act to keep supply tight and prices high. If, on the other hand, alternative energies are not developed, OPEC will continue to exercise a stranglehold on oil-importing economies.

OPEC meetings draw bevies of analysts and reporters, hoping to learn what its decisions will be on the price and quantity of oil. OPEC is enjoying the current high price, earning its members some $650 billion in 2006, a fivefold increase in a few short years. Saudi Arabia alone earned almost $200 billion.

This represents the beginning of a new world order, rising demand for oil and the ability of OPEC to control the supply and influence the price. In so doing, OPEC members will earn trillions of dollars in the coming years which it can use to step up its purchases of public debt and other assets of oil-importing countries. The "Golden Rule" states that "he who has the gold rules." Over time, OPEC members, many unfriendly to the United States, will gain power and influence over U.S. domestic and foreign policy.

To give but one example, OPEC is beginning to weigh a currency shift from dollars to euros, thereby reducing its exposure to a weakening dollar. Some OPEC members complain that the falling dollar is driving up inflation in their countries and reducing the purchasing power of their non-dollar imports. Such a shift would further weaken the dollar, restrict the ability of the Federal Reserve Board to lower interest rates less inflation accelerate to unacceptable levels. India recently announced that it will no longer accept dollars at its tourist attractions. Entrance fees must now be paid in rupees.

Thursday, November 15, 2007

Financing Our Enemies

Several prominent journalists, Thomas Friedman of the New York Times and Martin Wolf of the Financial Times, have chimed in on the theme of "financing our enemies." Every day the United States transfers over a billion dollars to oil-exporting nations. Among these are Russia, Venezuela, and Middle Eastern nations. Russia has rediscovered nationalism and patriotism stemming from its economic turnaround and accumulation of $400 billion in foreign currency reserves. It is becoming less cooperative with the United States and Europe on military and strategic issues. Venezuela is using its oil wealth to undercut U.S. interests throughout Latin America. Saudi Arabia, which the State Department terms a U.S. ally, has been and remains the principle source of funding for the extremist Wahabi, anti-Western rendition of Islam.

Friedman and Wolf, among others, increasingly talk of the economic and national security benefits of imposing a substantial tax on imported oil. The purposes are to reduce consumption thereby driving down the price of oil, encourage the manufacture of more fuel-efficient vehicles, guarantee producers of alternative sources of energy that there will be a floor under the price of oil, and use the revenue to reduce such other taxes as payroll taxes.

The proposal to levy a heavy tax on each barrel of imported oil has not yet gained much traction. Politicians and voters/consumers have very short-term horizons. Consumers will complain vigorously if gasoline costs $4-5 a gallon, and voters will select politicians who promise to reduce gasoline and heating oil prices. Thus far none of the major candidates has enunciated a national energy policy to reduce U.S. dependence on imported oil. Will it take another oil embargo or a dramatic disruption in supply to get the country's attention?

Wednesday, November 14, 2007

Revisiting Sovereignty

Dictionary definitions of sovereignty include "complete independence," "exclusivity of jurisdiction," "self-government," "a territory existing as an independent state," "an autonomous state," and perhaps most important, "freedom from external control." In democracies, self-government refers to the citizens of an independent state exercising their political rights to select their leaders though free and fair elections.

Freedom from external control, or undue external influence, enables a country to determine its own domestic and foreign policies. To what extent is the exercise of sovereignty under threat from the increasing pace of globalization? Does rising foreign ownership of U.S. assets limit the country’s ability to act in its national interest? Can the U.S. remain independent if foreigners own half of more of the country’s national debt, a large share of its banks and investment houses, and firms producing goods and services? Is there a tipping point when some degree of foreign ownership of a country’s productive and financial assets threatens its sovereignty? Few would raise this issue if the bulk of foreign owners were British, Scandinavian, or Canadian. It may be entirely different if they are Russian, Middle Eastern, or Latin American oil-exporting nations that are opposed to U.S. foreign policy or may be uncertain friends.

As the U.S. continues to import 12 million barrels of oil a day and transfer hundreds of billions of dollars a year abroad in excess of its foreign earnings, China, Russia, and oil exporting nations gain in power and influence.

Monday, November 5, 2007

Is Sovereignty Fully Compatible with Globalization?

Globalization is touted as an important factor in global growth, helping to uplift millions of people out of poverty in developing nations. Globalization is also touted as beneficial to the United States and other advanced economies. Moving production of goods and services offshore holds down costs, enabling American consumers to purchase a wide variety of goods and services at low prices.

But globalization is not all sweetness and honey. U.S. residents are voracious consumers. For many years, Americans have consumed more than they have produced. As a result, the U.S. economy has increasingly come to rely on foreign savings. Rising home values and other financial assets mean that Americans have more wealth than ever before, though the current slide in housing prices may correct that trend. If U.S. reliance on foreign saving and investment continues at the current pace, there is growing risk that U.S. sovereignty could be compromised as foreigners, many unfriendly to the U.S., own a larger share of the U.S. economy and accrue greater influence on U.S. foreign policy. To give but one example, four of the twenty-five largest bank holding companies in the U.S. were owned by foreign firms five years ago. That number has doubled to eight. China has become an increasing owner of U.S. government debt. New England’s residents receive subsidies in their home heating bills thanks to largess of Venezuela’s dictator, Hugo Chavez.

The dependence on foreign saving and investment is traceable to the current account deficit, foreign trade in good and services. The two principal culprits are America’s heavy dependence on imported oil and a massive trade imbalance with China. The current account deficit is in the neighborhood of $800 billion, which means that Americans transfer this sum to to oil-exporting nations and China. Sustained large trade deficits typically lead to weaker currencies. The dollar has fallen sharply in 2007 against almost all foreign currencies, those of both advanced and developing nations. Economic theory says that a weaker dollar, by raising the price of imports and lowering the price of exports, will gradually reduce the trade deficit. Exports have shown a marked rise as predicted, but high oil and commodity prices keep the trade imbalance from narrowing more than a few billion dollars. Another source of dollar weakness is interest rate cuts in the U.S. At some point, a weak dollar runs the risk of increasing inflation. The Federal Reserve Board will then have to raise interest rates, the exact opposite of current policy to prevent a meltdown in the credit markets. A return to the Catch-22 stagflation of the late 1970s and early 1980s is not inconceivable.

The steady transfer of America’s assets to foreign governments and state-owned enterprises amounts to gradual foreign socialization of the U.S. economy. This process can continue for many years to come without any noticeable decline in the American standard of living and conduct of U.S. foreign policy. But those who remember the oil embargo of 1973 in response to Israel’s victory in the Yom Kippur War, know that a great deal of damage can be done by those who curtail access to vital resources.
Promoting Democracy Abroad: Be Careful What You Wish For

President Pervez Musharaff’s declaration of martial law in Pakistan, suspension of the constitution, arrest of Supreme Court justices, and other anti-democratic measures are seen as a major setback for the Bush administration’s agenda of promoting democracy. Pakistan, a nuclear power and ally of the United States in the war on terror, is caught between the desire for democracy on the part of Pakistani moderates and the installation of a strict Muslim regime along the lines of the Taliban on the part of radical extremists.

In recent remarks at the Heritage Foundation, President Bush stated that the desire for liberty was written by the almighty into everyone’s heart. The mullahs and sheikhs that govern the Arab world believe that Allah wrote the truth into everyone’s heart. Islam is not a religion that permits its adherents to live as they wish, abandoning Islam for, say, Christianity.

Selling American values abroad to stem a tide of anti-U.S. sentiment is unlikely to achieve success in the Arab Muslim world. The main reason is that the separation of church and state in the Western world is not present in the Arab Muslim world. Lecturing Arab Muslims on the benefits of American values has exactly the opposite of its intended effect.

Speaking of democracy, President Vladimir Putin enjoys a popularity rating of 80% among the Russian people, far higher than any leader in the Western industrial democracies.
Water Water Nowhere and Nary a Drop to Drink

A town in Tennessee is out of water, period, and much of the state is threatened with water shortages. Atlanta faces severe water rationing due to an extended drought in the Southeast. How have public officials in these communities allowed these conditions to get out of hand? Why has investment in infrastructure and storage facilities failed to keep pace with rising population, bigger houses, more extensive landscaping, and other thirsty developments?
Body Count in Iraq

Recent news emanating from Iraq, namely, fewer U.S. and Iraqi casualties in October, have given Americans some measure of optimism that the surge may be having success, and that the U.S. mission of establishing a stable, democratic Iraq can succeed.

In this respect, it is instructive to examine the post-World War II process of decolonization. France and Britain generally required that rival ethnic, racial, linguistic, or tribal groups in their respective colonies form multi-ethnic governing coalitions as a precondition for independence. Many countries in Asia, Africa, and the Caribbean successfully achieved independence on the basis of a multi-ethnic coalition of moderate members of each major community, but, under the political pressure of ethnic extremists, collapsed into warring communities. Many newly independent countries—Guyana, Trinidad & Tobago, Malaysia, Sri Lanka, Northern Ireland, Cyprus, Rwanda, Zanzibar, Zimbabwe, Burundi, Lebanon, Congo, Nigeria, Sudan, and Yugoslavia, among others—suffered political instability, civil wars, dictators, coups, and loss of life and property.

How does Iraq fit into this paradigm? Kurds, Sunnis, and Shiites have been at each other’s throats for centuries. To complicate matters further, Turkey is concerned about the establishment of an autonomous Kurdish region in Iraq with oil, which might attract Kurds in Turkey to seek union with their Iraqi brethren. In the south, Iranian Shiites represent a potential alliance with fellow Iraqi Shiites. A temporary improvement in the body count is a poor predictor of the future prospect that a stable multi-ethnic central government can emerge and govern from Baghdad.

Wednesday, October 31, 2007

Money, Oil, and China

Once upon a time, the dollar was as good as gold at a fixed price per ounce at the U.S. Treasury. One dollar bills were payable in silver on demand at the U.S. Treasury. Those days are long gone. Now the dollar bill is a piece of green paper that is legal tender for all debts, public and private, in the United States. That it can be used to pay taxes gives it intrinsic value. But its real value depends on its purchasing power, what it can buy. Its exchange value depends on what people holding other currencies will pay to buy dollars. Many factors determine the exchange rate of the dollar, but one thing is clear: The dollar has been falling for reasons posted on this blog, in particular the large annual current account deficit ($800 billion), the federal budget deficit, and other factors.

Most critics point to the large trade gap with China as the bugbear of the weak dollar. The problem with this focus is that it diverts us from the real culprit of oil imports. It does so because it is easier to beat up on China than on countries in the volatile Middle East, Africa, and Latin America on whom we depend for oil. Without their oil, the price would rise to astronomical proportions, from $95 a barrel to perhaps several times that. We cannot afford to offend the oil producers, even if they are the source of anti-Americanism, anti-Semitism, and Islamic extremism. Oil producing states, which import goods and services from Europe and other countries with strong currencies, seek higher prices to compensate for the weaker dollar. The dollar is now at its weakest point in eleven years.

The challenge is to reduce our heavy dependence on imported oil. Many projects and plans are underway, but these are years away from any significant reduction in our consumption of imported oil. Worse, the trends are for oil demand to increase and prices to move higher. India’s energy demand is projected to triple in 20 years. As an increasing number of Indians enter the middle class, demand for cars will rise markedly. In China, auto sales are up 25 percent over last year, and are on track to surpass annual U.S. auto sales sometime in the next decade. Add in Vietnam, Indonesia, Thailand, and other fast-growing economies, and oil demand will continue to rise. Production will not keep pace given the stagnation in output in many of the world’s largest producers. Oil-exporting countries need hundreds of billions of dollars to maintain, renovate, and add new production facilities.

Easy Money

Instead, the markets are focused on the cost of money. Cheap money created the sub-prime loan crisis and concerns over the quality of credit. Many market participants want still cheaper money to prevent further losses and an economic slowdown. Exporters have become major beneficiaries of a weaker dollar as their foreign earnings translate into more dollars. But a weakening currency typically gives rise to inflation and economic stagnation, the condition known as stagflation that marked the U.S. economy in the late 1970s and early 1980s. Perhaps most money managers are too young to remember those difficult times.

Friday, October 26, 2007

U.S. Relations with the Muslim World

This is really a tough problem, and one which occupies the foreign policy establishment and defense department. U.S. foreign policy is often governed by mirror imaging, which amounts to Americans believing that foreigners see us from the same vantage as we see them. This is a huge problem in understanding the attitudes and actions of Islamic states. U.S. policy makers largely deal with Arabs and other Muslims in the world of Western educated elites, suits and ties, good manners, and excellent English, leaving Westerners with the impression that they are just like us. But in the Muslim Middle East, Muslims dress in flowing robes, adhere to Islamic doctrine and practices, and often loath the West for its sexual decadence. Our so-called strategic ally, Saudi Arabia, has underwritten the construction of mosques around the world and fostered an extremist, anti-Western rendition of Islam in Wahabiism. Muslim uprisings have infected Paris, London, Amsterdam, and Brussels. Our supposed ally in the war against terror, Saudi Arabia, does not permit Christians or Jews to openly practice their religion in its territory. Indeed, it is a crime to bring a Western bible into Saudi Arabia. The U.S. and Western Europe, dependent on the production of Saudi oil to keep the high price of oil from going even higher, make no attempt to secure reciprocity of religious freedom for Western residents in Saudi Arabia and other countries in the Middle East.

There is no meaningful separation of church and state in Islamic countries (save Turkey). This puts Western countries in an asymetric relationship with Islamic countries. Islam is tolerated and accepted in the West, while Christianity and Judaism are rejected in the Islamic world.

Hand-in-hand with the rise of Islam is the decline of mainline Christianity in the U.S. Here are some figures on the Catholic Church. Between 1965 and 2007, the number of diocesan and religious priests fell from 5,632 to 41,440. More alarming is the more than fifty percent fall in priestly ordinations, from 994 to 456. Graduate-level seminarians declined from 8,325 to 3,274, religious brothers from 12,271 to 5,015, religious sisters from 179,954 to 63,699, while the number of parishes without a priest increased from 549 to 3,238. Apart from Spanish-speaking parishioners, church attendance is way down.

The War in Iraq

Just when the U.S. military is reporting progress on many fronts, new crises in Iraq seem to emerge. U.S. military forces have empowered the Kurds in the north, which has emboldened the PKK, the Kurdish rebel group seeking greater autonomy for Kurds in Turkey, in killing Turkish soldiers. Turks regard PKK rebels as terrorists, and have tired of these attacks. The Turkish parliament has authorized massive military measures to halt these attacks. Tens of thousands of Turkish troops have moved to the Turkey-Iraq border and some are carrying out military operations on Iraqi soil.

The Turkish government demands that the Iraqi government and the U.S. take whatever measures are necessary to put down the rebels. This amounts to the threat of another front in Iraq. It might be recalled that the invasion plan for Iraq included moving a large number of U.S. troops from Turkey, a plan that was thrown off track when the Turkish government refused its permission.

Democracy in Pakistan?

In late October, Pakistan was riven with maneuvers among rival political groups in Pakistan, including supporters of Benazir Bhutto, President Pervez Mushariff, and radical Muslims. The U.S. government has weighed in with its support for democratic elections. Evidently no one in power can recall what happened when Hamas won the election in Gaza, when the Muslim Brotherhood picked up seats in Egypt, and Hezbollah became a major player in Lebanese politics. The U.S. government should be careful what it wishes for given a stock of several hundred nuclear bombs in Pakistan that could fall into the hands of anti-Western forces.

Getting Serious with Iran

The U.S. government announced new financial sanctions against several factions inside Iran and has been trying to mobilize leading foreign governments to support strong efforts to dissuade Iran from realizing its nuclear ambitions. President Bush has warned about a possible World War III if diplomacy does not succeed, and Vice-President Cheney has said that Iran must not be permitted to get the bomb, period. General David Petraeus has charged Iran with supplying sophisticated weapons to Iraqi militias and insurgents. The Israeli attack on a Syrian nuclear reactor site indicates the seriousness with which the Israelis regard the development of nuclear weapons by Iran. Let’s hope for diplomatic success, but prepare for a nuclear-armed Iran.

Thursday, October 18, 2007

The Staggering Dollar

The U.S. dollar hit an all-time low against the euro on October 18, 2007. The secretary of the treasury, Henry Paulson, repeated the mantra of all treasury secretaries that the U.S. supports a strong dollar policy. In contrast, Harvard professors Martin Feldstein and Kenneth Rogoff, in chorus with the International Monetary Fund, assert that the dollar has more to fall, perhaps another 20-30 percent, in order to reduce the U.S. trade deficit with the rest of the world.

In September, foreign investors were net sellers (sales minus purchases) of U.S. securities, resulting in the biggest monthly outflow since 1990. This suggests that support for the dollar is continuing to wane. Numerous reasons have been cited for the falling dollar, among them the large $800 billion annual current account deficit, the rising price of oil (surpassing $89 a barrel on October 18, 2007), the ongoing (seemingly endless) cost of U.S. military operations in Iraq, the fear of an expanded conflict in Iraq due to a possible Turkish military incursion to suppress Kurdish rebels, a slowing U.S. economy, and others. At some point, further increases in the price of oil will take a real bite out of the U.S. economy, with adverse effects on the dollar, growth, and inflation.

The G-7 (the seven leading industrial democracies) meet Friday, October 19, 2007. Topics on the agenda include the rising euro (the flip side of the falling dollar), financial turmoil stemming from the sub-prime mortgage mess, and the growing investments of sovereign wealth funds (government controlled pots of money) in private companies, which implies a partial nationalization of assets by those countries, in marked contrast with private investment. The harsh truth is that there is little the leaders of the G-7 countries can do to alter these trends, until and unless the U.S. substantially reduces its dependence on, or weans itself off, foreign sources of energy.

China is Changing Everything

Business cycles come and go. What has changed in world affairs is the rise of China, the beginnings of high growth in India, economic recovery in Russia, and the transformation of former centrally-planned economies around the world into rapidly-growing market economies. China by itself is responsible for a disproportionate increase in the global demand for energy, copper, iron ore, and other natural resources. Annual economic growth of 11 percent in China means that output doubles in 6.5 years and quadruples in 13 years. U.S. growth of 2-3 percent means that it takes between 24-36 years to double output and 48-72 years to quadruple it. Higher growth in China, India, Vietnam, and other countries implies that demand for commodities will remain strong and that prices are likely to continue to rise.

This new world differs from the twentieth century, in which China and other emerging economies were backwaters. The U.S. is so preoccupied with Iraq that it has little energy left to plan for the consequences of the new economic reality.

Chinese companies, both private and state-owned, have abundant cash to purchase overseas assets at an ever-accelerating rate. If they are blocked from doing so, this will not endear the Chinese government and people to the U.S. The official reserves of the People’s Bank of China (the central bank) have surpassed $1.4 trillion and continue to grow at a rapid rate. Should China decide to sell, or simply announce its plan to sell, a large portion of its portfolio of U.S. government securities, the dollar could fall even more rapidly.

The (Mis)Conduct of U.S. Foreign Policy

It is one thing to offer advice when asked. It is another to give unsolicited opinions, especially when it comes to telling other nations how they should change their policies to what we (the U.S.) wants because we say it is in the interest of other nations. Imagine how Americans feel when other nations tell us, without our asking, how we should behave because they know better what is in our interest.

President George H. Bush routinely advises Russia and China how to behave in their domestic and foreign affairs. He does so in a way that appears arrogant, out of place, and only strains relations with these countries. His welcome mat for the Dalai Lama, the spiritual leader of Tibet, at the White House and Congress during the weeklong meeting of the Chinese Communist Party held every five years amounts to poking a finger in the eye of the Chinese leadership. This action will be duly noted in China’s little black book of insults, to be dealt with at a later date. Instructing Russia’s president Vladimir Putin on how Russia should behave in its relations with Iran only strengthens Russia’s resolve to pursue an independent foreign policy.

The U.S. remains by far the strongest economic and military power in the world, but each year that edge slips a bit. China’s growing economy and Russia’s vast natural resources give these two potential adversaries of the U.S. more and more power and control in their relations with Asia and Europe respectively. The time when other countries will listen to unsolicited advice or implied threats from the U.S. may draw to a close sooner than U.S. leaders recognize. And the means of the U.S. to backup its advice or threats becomes less credible with each passing year.

Friday, October 12, 2007

Our Friends in Turkey

The Foreign Affairs Committee of the U.S. House of Representatives voted 27-21 on a resolution stating that Turkey’s former Ottoman Empire engaged in genocide in 1915, killing a million or more Armenians. The full House could take up the measure for consideration very soon.

Turkey’s response? It has recalled its ambassador to the United States "for consultations." If the resolution passes, Turkey could deny the U.S. the use of bases and other facilities to conduct operations in Iraq. It could invade the Kurdish region of Northern Iraq to halt what it regards as Kurdish rebel attacks on its troops and civilians, further complicating the task of U.S. forces in Iraq. The president and numerous high-ranking U.S. officials have pleaded with the House not to adopt the resolution.

It should be noted that Turkey is a Muslim state, although Turks are not [yet] subject to the same strict Islamic regulations found in Saudi Arabia and other Muslim countries. Still, if the U.S. must choose a course of pragmatism over principle on a relatively minor issue of setting the historical record straight, how can the U.S. government be expected to handle more serious threats emanating from the oil-producing Arab Muslim states, who, as in the past, could impose an oil embargo?

Our Friends in Qatar

The United States military has a major presence in Qatar. This benefits our operations in Iraq and Qatar benefits from our protection.

On October 9, 2007, Qatar’s energy minister said that the price of oil should be much higher than $80 a barrel, already a record high. He called for an increase to $100 a barrel to compensate for inflation since 1972. The U.S. currently imports over $400 billion a year in oil and petroleum products. A further $20 rise in the price of a barrel of oil would add another $80-100 billion to that. Is Qatar a helpful ally?

What is Qatar doing with its oil earnings? The ruling family recently announced an investment of $1.5 billion for a five-star hotel and other projects in Zimbabwe. Zimbabwe is one of the world’s greatest pariah states.
Too Clever by Half

For the past thirty-one years, I have been commuting from my home to my office on the campus of Stanford University. It must be noted that the undergraduate and graduate students at Stanford are among the smartest in the world, on par with Harvard, Yale, Princeton, Oxford, Cambridge, and the world’s other great universities.

Bicycles are an extremely inexpensive, popular, and convenient mode of transportation for those living on or near the campus. It is troubling to note that well over 90 percent of bicyclists do not wear helmets, use lights at night, or cease wearing headphones so they can hear the traffic around them. The Stanford Hospital treats about 200 patients every year due to bicycle accidents.

Experts in many fields of health and behavior advise individuals to eat properly, get plenty of rest, exercise, avoid tobacco and too much alcohol, and so on. If brilliant students can’t be bothered to put on a helmet to prevent serious head and brain injuries, why do you suppose the average person would listen to experts in other fields?
Investment or Consumption? Consumption or Investment? What’s a Person to do?

The minutes of the September 2007 Federal Reserve Board Meeting indicated that fed governors were concerned that "if declines in house prices were to damp consumption, that would feed back on employment and income." They voted for a 50 basis-point interest rate cut to stem that prospect.

The U.S. suffers a savings/investment imbalance. We run an annual current account deficit in excess of $700 billion. This requires that the rest of the world lend us $2 billion a day to keep our international accounts in balance. Economists decry the lack of saving on the part of Americans. Although the gap can be filled by transfers of foreign savings, it puts the U.S. in a position of dependence on foreign capital, and also puts the dollar at further risk should foreigners decide to reduce their holdings of U.S. assets.

Whenever the economy looks weak or is threatened by a reduction in consumption, pressure is put on the fed to reduce interest rates lest the economy slow down. Yet almost every member of the fed and economics communities routinely assert the need for more domestic saving. It is obvious that the latter goal cannot be met if, as a first priority, consumption must be sustained. This amounts to an "iron law of consumption." Selling the family jewels, furniture, paintings, antiques, clothing, and ultimately the mansion to sustain consumption, however desirable in the short run, has very serious long-run consequences.

Kenneth Rogoff and Maurice Obstfeld, economics professors at Harvard and U.C. Berkeley respectively, believe that continued high current account deficits could lead to another 30 percent fall in the dollar against the euro and pound. That would take the euro up to $1.80 and the pound to $2.60. Imagine the bite that travelers will feel paying a thousand dollars a night for a premier hotel room and $80 for breakfast on their European vacations or business travel.

This prospect raises an important issue: Is globalization compatible with sovereignty? (More on this later.)

Tuesday, October 2, 2007

The Thin Edge of the Flat-Tax Wedge in Britain

Speaking at the Conservative party conference in Blackpool on October 2, 2007, George Osborne, the opposition "shadow" chancellor of the exchequer, proposed several changes in British taxation. To fund reductions in property tax, increase the exemption for inheritance taxes, increase tax breaks of married couples, and abolish the 1 percent stamp tax for first-time home buyers, he proposed a change in the treatment of non-domiciled British residents.

Britain has created a tax haven for so-called non-domiciled residents. These are wealthy individuals who keep their money offshore, live and/or work in London, and only pay local council property tax and tax on earnings received in Britain, but not on offshore earnings. Osborne proposes that non-domiciled residents choose between paying normal British tax on offshore investment income or, in lieu of that, pay a flat rate of £25,000 (a bit over $50,000). Osborne estimates that there about 150,000 non-domiciled business men and women living in the United Kingdom who are not registered to pay tax, and that his proposal would collected about $7 billion in additional revenue. He further believes that multi-millionaires will not change their residents over an annual tax of $50,000.

The proposed flat tax amounts to a poll tax on a class of foreign residents. Nonetheless, it would be assessed at a flat rate, rather than a progressive rate, regardless of the amount of offshore investment income.

Aesop’s Lost Fable

The price of oil is always on the minds of politicians, investors, and economists. Although the U.S. economy uses less oil per unit of economic output and consumers spend a smaller portion of their income at the gas pump than in 1980, further increases in oil prices may begin to stoke fears of inflation and the "R" word, recession.

If oil reaches $100 a barrel, alarm bells will grow louder. During the first oil crisis in the 1970s, petro-dollars were recycled into the U.S. economy. Many people will recall double-digit inflation during President Carter’s term and the subsequent savings and loan debacle in the early 1980s.

Low-cost Chinese manufactured goods, which were not available in the earlier oil crises, have helped to cushion the shock of higher oil prices. But a stronger yuan (the Chinese currency) and rising labor costs are gradually raising the cost of Chinese goods. In the era of globalization, analysts and investors believe that if Russia, Middle Eastern, and other oil-producing countries recycle their dollars in the United States, the economy may survive $100 a barrel oil without a significant downturn. As mentioned in previous postings, there is concern that continued accumulation of U.S. assets by potentially unfriendly oil-producing nations may pose a security risk.

Friday, September 28, 2007

Blame China for High Food Prices

Over the past year the price of a bushel of wheat has almost doubled, from $4.79 to $9.50. American wheat farmers are delighted with this state of affairs, along with seed and herbicide producers and manufacturers of farm equipment. The downside is that it comes at the expense of higher bread, pasta, and tortilla prices. The average retail price of a pound loaf of whole-wheat bread and milk in U.S. cities was up 24 and 26 percent respectively over a year ago.

Americans blame China for hazardous lead-laden products, an undervalued currency, rising military expenditures, pollution, and a host of other problems. To this list we can also blame China for higher food prices. China’s 10 percent annual real growth is transforming its population into a middle-class society. Several hundred million Chinese, members of the burgeoning middle class, no long make do with a bowl of rice, salt fish, and a sprig of vegetables. Like their counterparts in the West, they want meat and milk, whose production requires more grain to feed livestock. Soaring demand for milk has tripled China’s stock of dairy cattle over the past decade. Global wheat inventories are the lowest they have been since 1960, and global corn stocks are approaching their lows of the early 1970s.

Wednesday, September 26, 2007

The Business Climate and Economic Growth

The World Bank recently issued its annual report on the global business climate, Doing Business 2008, ranking countries on the ease of doing business. Eight of the top ten are Western democracies, with Singapore and Hong Kong rounding out the list. Twenty-six of the bottom 30, ranked 149 through 178 are in Sub-Saharan Africa.

The ease of doing business should be a factor in economic growth. However, the relationship is not so straightforward. While the top ten are performing much better than the bottom thirty, none in the top ten lead the world in growth. The two fastest-growing economies are China and India, which received rankings of 83 and 130 respectively, followed closely by Vietnam at 91. While India and Vietnam’s high growth is a relatively recent phenomenon, China has averaged 9-10 percent real economic growth for the past twenty-five years. China moved up ten spots this year, from 93 to 83. Still, to be ranked so low with such spectacular growth calls into question the World Bank’s definition and measurement of the business climate, or its relevance to growth. Countries ranked ahead of China, including Jamaica, Kenya, Kazakhstan, El Salvador, Belize, Peru, Romania, Bulgaria, and Namibia, have not come close to achieving China’s sustained growth over the past twenty-five years.

Tobacco Politics

Study after study has confirmed the danger to public health from smoking. The American Heart Association reports that 440,000, the largest number, of the 2.4 million annual deaths in the United States are due to cigarette smoking. The Surgeon General has called it the leading cause of disease and preventable death in the United States. In light of these facts, it seems hard to understand that any tobacco is still grown in the United States.

Or so you would think. The Democratic Party is trying to push through Congress an expansion of the State Children’s Health Insurance Program. To help pay for the expansion, the bill includes raising the federal cigarette tax by 61¢ a pack from its current rate of 39¢ to $1, in addition to state taxes that range from a low of 17¢ in Missouri to a high of $2.57 in New Jersey. Projected revenue from the federal tax hike comes to $36 billion. Although the House of Representatives voted 265-159 to approve the bill, eight Democrats opposed the bill, either because they were from tobacco-growing districts or because they objected to the tax increase on cigarettes.

More than four years after the United States brought down the repressive Taliban government in Afghanistan, it has made no progress in reducing the cultivation of the poppy plant. The extract from the seed pods in poppies are used to produce opium, which is converted into heroin, morphine, and other deadly drugs. Afghanistan has increased its production to the point where it supplies 93 percent of the world’s output.

If members of Congress vote to protect tobacco growers in the United States, it borders on hypocrisy to complain about the inability to curtail poppy cultivation in Afghanistan.

American Manufacturing

The National Association of Manufacturers (NAM) took out a four-page ad in the September 26, 2007, edition of the Wall Street Journal, pointing to the great success of American manufacturing. However, it noted that America’s ability to compete with foreign manufacturers required several immediate steps to maintain its world leadership.

The list includes modernizing road, rail, and barge infrastructure to reduce transportation costs, developing more low-cost sources of energy (especially natural gas), improving American education in science and math and graduating more scientists and engineers to compete with China, India, and Russia, pursuing fair trade agreements, ending currency manipulation (meaning China should revalue its currency), reducing the corporate tax rate, and ending double taxation. The likelihood of achieving any these measures in the near future is slim. If the NAM is correct, American manufacturing faces a bumpy road ahead.

Tuesday, September 25, 2007

Arab Socialist Takeovers of Private Western Businesses

Abu Dhabi National Energy Company, a state-owned company in the Middle East known as TAQA, agreed on September 24, 2007, to buy Prime West Energy Trust of Calgary, Canada, which manages oil and gas properties. It agreed to pay $2.4 billion plus assumption of Prime West’s debt. Since Prime West owns oil and gas properties in the United States, the deal may be subject to a national security review by the Committee on Foreign Investment in the U.S. that investigates the transfer of U.S. assets to foreign entities.

This acquisition is TAQA’s third in Canada, bringing its investment in Canada’s energy’s sector to $7.5 billion, with the goal of reaching $20 billion by 2012. TAQA plans to acquire oil and gas pipelines and power generation and distribution facilities. TAQA’s purchase in Canada is part of a growing pattern of Middle Eastern state-owned companies acquiring Western resources and other assets. Bourse Dubai, a state-owned entity in Dubai, is seeking a 20 percent stake in Nasdaq, the second leading U.S. securities exchange.

Two points merit discussion. The first is that TAQA’s acquisition of private Western enterprises is not one private enterprise buying another. Rather, it is a government-owned entity in the volatile Middle East buy private Western businesses. This can be loosely construed as nationalizing private Western firms, placing them under the control of foreign state entities. This is not free-market capitalism.

The second point is that these are Arab state-owned entities. Not all Arab regimes are friendly to the United States. Those that are friendly today may change their allegiance tomorrow. The question can be asked if the accumulation of vital Western energy resources by Arab state-owned entities poses a potential security risk to the United States, given its heavy dependence on imported oil.

China and Russia Rising

Each year Freedom House compiles reports on the state of political freedom and civil liberties around the world. It has just released the 2007 edition of Countries at the Crossroads, analyzing the current state of governance in 60 strategic countries. The report pointed to the diminution of human rights and governance in Russia and Iran, political repression in Libya, Tunisia, and Algeria, and military coups in Thailand and Bangladesh.

Several of the countries that are retreating from democracy have been successful economically, notably Russia, Libya, Tunisia, and Algeria. The report further noted that states around the world are choosing to follow the models of growth over democracy of China and Russia. The leaders of many developing and middle income countries may be moving away from democracy in favor of stern rule that emphasizes growth over political freedom and civil liberties.

Monday, September 24, 2007

The Golden Rule

Throughout the centuries, philosophers have put forth their interpretation of "the golden rule." Perhaps the best known is "do unto others as you would have them do unto you." In the global economy of the twenty-first century, a more relevant interpretation is "he who has the gold rules." The best comment I encountered this past weekend (September 21-23) was stated by Hugh Young, a money manager in Singapore. "Asia has the cash and the west the debt." In contrast with the Asian financial crisis of a decade ago, the risk now appears to be greater in the West. The huge trade and budget deficits of the United States during the past few years has made the U.S. a large debtor nation, in which foreign claims are piling up at some $800 billion dollars a year. The cash is in the hands of Asian and Middle East central banks and sovereign wealth funds, with the debts issued by U.S. government agencies and enterprises. Something to worry about?

Speaking of Debt

In a speech on September 24, 2007, President Bush again threatened to veto Congressional appropriations bills that exceed his budget request for fiscal year 2008 (October 1, 2007, to September 30, 2008). Congressional spending bills propose $22 billion in expenditures beyond the president’s budget.

It is interesting to place the costs of continued operations in Iraq and Afghanistan against Bush’s veto threat. The Congress has appropriated $147 billion for military activities in Iraq and Afghanistan for fiscal year 2008. Defense Secretary Robert Gates proposes to request an additional $45 billion, bringing supplemental defense expenditures to $192 billion. This is an increase over fiscal year 2007s total of $165 billion. There is no immediate end in sight.

This is not to say that the $22 billion would be well spent. But one can raise similar doubts about the $192 billion achieving its objective of stability in Iraq and Afghanistan, or the total of $500 billion thus far spent with little to show for the cost in lives and treasure.

Saving the Planet

As apart of opening of the United National General Assembly, member states are holding a summit on greenhouse gas emissions in order to fight global warming. Melting glaciers and shrinking Arctic ice have pushed the issue to the forefront of global diplomacy. There is a growing scientific consensus, though not yet universal, that man-made emissions are a primary source of global warming. Some fifteen countries, the major industrial nations along with Indonesia, Brazil, China, and India, are responsible for the bulk of emissions.

Reducing emissions is a worthwhile objective. However, it is hard to see how the level of investment in research on alternate energy sources will have much impact on the near- and medium-term growth of emissions. Here are some trends that are unlikely to be slowed or halted, much less reversed. China, India, Brazil, Indonesia, and other fast-developing countries are adding several million polluting vehicles each year on their roads. Airline expansion will fill the skies with hundreds of additional polluting planes each year. China alone is adding one coal-fired power plant to its stock of generating plants each week. Each new house, filled with a wide variety of electronic appliances and entertainment features, consumes more electricity that must be generated from non-nuclear sources. If global warming is a serious problem, the U.N. summit is barely a baby’s first step in the solution. Only a precipitous decline in the use of petroleum can achieve a significant reduction in emissions. To date, the world continues to increase, not decrease, its appetite for petroleum.

Why it is so Difficult to Reduce Emissions

The American Council for an Energy Efficient Economy has compiled a list of the top 12 "green" cars. To increase fuel economy, the Department of Health and Human Services advised its 67,000 employees to purchase one of these "green" cars. The problem with this recommendation, which appeared in the department’s newsletter, is that all 12 are Japanese or Korean models. Following complaints from Detroit’s big three, HHS issued a statement saying that it regretted offending anyone. So much for this one small step to reduce oil consumption.

Negotiating with Syria

Mitchell Reiss, President Bush’s director of policy planning at the U.S. State Department during 2003-05, is advising in the September 24, 2007, issue of the Financial Times that President Bush attempt to achieve a diplomatic breakthrough with Syria. Citing the administration’s success with Libya, which agreed to abandon its nuclear program, a successful engagement with Syria would counter Iran’s growing influence in the region, reduce its interference in Lebanon, slow the movement of suicide bombers into Iraq, strengthen the Palestinian authority against Hamas, and reduce its support of Hezbollah.

Reiss cites secret talks held between Israel and Syria during the past summer in pursuit of some of these goals. If the talks went well, why did Israel bomb a Syrian target that some believe represented an early stage of nuclear weapons development with the cooperation of North Korea. Moreover, the Syrians have seemingly assassinated another anti-Syrian Lebanese politician. These are not encouraging events.

Friday, September 21, 2007

Fluorescent Lights: A Partial Solution to Global Warming?

Saving energy and reducing man-made emissions to curtail global warming have become major priorities for the United States. Inefficient incandescent bulbs, of which some four billion are installed in U.S. buildings and which convert only 5 percent of the electricity they use into light with the rest lost as heat, constitute a third of the world market. A switch to compact fluorescent bulbs would substantially cut energy use and, after paying the higher initial cost of fluorescent bulbs, save consumers $6 billion a year. If all the incandescent bulbs in the world were replaced with fluorescent bulbs, the reduction in carbon-dioxide emissions would achieve almost three-quarters of the reductions that industrial nations have pledged to curb global warning under the Kyoto Protocol. The U.S. by itself would achieve one-quarter of the reductions.

Congress is working on legislation to phase out conventional incandescent bulbs over the next seven years. Domestic U.S. manufacturers want a later phase-out date to avoid having to scrap large investments in producing more efficient incandescent bulbs.

A bigger obstacle to phasing out incandescent bulbs is an unpleasant political fact: nearly all compact fluorescent bulbs are made in China. The widening trade deficit with China has been a hot political issue in the United States for the past several years. Despite numerous official trips between Beijing and Washington, D.C., to address this issue, the U.S. trade deficit with China continues to rise. A mandated shift to fluorescent bulbs in the U.S. over a short period means that China will remain the principal supplier of fluorescent bulbs, thus undercutting U.S. efforts to narrow the trade gap. Given China’s head start in producing compact fluorescent bulbs, it is likely that China will be the world’s least-cost producer for the foreseeable future.

More on China

China is taking advantage of the U.S. preoccupation with Iraq and the Middle East by extending its political and economic influence in Africa, Latin America, and Asia. A recent deal about to be completed in the Democratic Republic of the Congo will give China access to mineral resources in exchange for $5 billion of Chinese funds to construct infrastructure projects. So long as the U.S. is tied up in the Middle East, China will continue to gain greater access to natural resources.

Russia and the European Union

European Union countries import 80 percent of their natural gas requirements and a substantial portion of their oil. A large share is imported from Russia, which gives that nation great leverage in European affairs. Shutting of the pipelines in winter for any length of time poses a major risk to Europeans. Moreover, the high price of energy means that Russia is rapidly accumulating funds that it can use to purchase European and other assets. A revived Russia under Putin is restoring a sense of pride and nationalism in Russia that may not be to the long-run benefit of Americans and Europeans. Globalization means different things to different nations. To the Western industrial democracies it means increasing trade and investment across national borders. To China, Russia, and the oil-producing countries it may also include the use of natural resources and the accumulation of foreign exchange reserves that can be deployed to achieve political ends. The West must be careful not to assume a mirror image of all its trading partners.

More on China, Russia, and Oil-Producing Nations

Congress must approve a rise in the current U.S. debt ceiling of $8.965 trillion for the U.S. government to pay its bill come October 2007. Treasury Secretary Henry Paulson has asked Congress to raise the debt ceiling by another $850 million. A considerable portion of this extra debt is likely to be purchased by foreign nations that may not have the long-term interests of the U.S. at heart. As foreigners acquire ever-greater U.S. assets, they correspondingly gain greater influence on both U.S. domestic and foreign policy. The U.S. does not allow foreign companies to buy airlines, shipping firms, television networks, and some security-related businesses. Some in the government have raised concerns about state-owned Chinese and Middle Eastern countries acquiring U.S. firms and assets.

Wednesday, September 19, 2007


Tax Reform

The leading Democratic candidates for president have begun to spell out their plans for tax reform. Charles Rangel, chairman of the tax-writing House Ways and Means Committee, is also at the forefront of tax reform. Since the Tax Reform Act of 1986, which reduced marginal rates and simplified the tax code, every tax act has further complicated the system and lengthened the code. For the past twenty years, tax reform has come to mean the exact opposite of the word. It is likely that the next administration will be no different. There will be no flat tax on a postcard or national retail sales tax to replace the current code. There will be no real simplification. At most there will be some small changes in rates, deductions, exemptions, and other features of the tax code. This amounts to rearranging the deck chairs on the Titanic.

Bread or Gasoline: Take your Pick

The recent emphasis on biofuels has driven up the price of food staples. A bushel of wheat has shot up as high as $9.00. The price of tortillas in Mexico has risen 50 percent and pasta prices in Italy have skyrocketed. Farmers are switching to corn production to profit from the demand for ethanol. Declining wheat production means higher prices for wheat foodstuffs, which most hurts the poor. Cleaner air in the West may come at the expense of a good diet in developing countries.


The fastest growing serious disability in the U.S. is autism, which has increased 600 percent in the past few decades. Studies show that a mother’s and father’s risk of delivering a child with autism steadily rises as they get older. Women ages 40 and over show a 30 percent increase compared with moms between the ages of 25 and 29. Men ages 40 and older have up to a 50 percent increased risk compared with their 25 to 29 year-old-peers. Early marriage in the 1950s and 1960s has given way to much later marriage, after women have completed their college education, professional school, and several years experience in the workplace. The feminist movement, coupled with a strong economy, has given this generation of women opportunities that their mothers lacked. But one price of later child bearing is a rise in autism.
To Consume or to Save: That is the Question

The U.S. economy depends on consumption. Whenever the economy slows, as is the case in late 2007, market analysts ask if consumers will tighten their wallets and purses, or keep spending. Reduced consumer spending can lead to slower growth. If the cutbacks are substantial, recourse to the "R" word, recession, will begin to appear in print and television.

In the same breath, economists and market analysts warn that Americans consume too much and do not save enough. The U.S. runs a current account deficit, its international trade in goods and services, of around $800 billion a year. This sum represents an increase in foreign claims on U.S. assets. The current account deficit has risen sharply over the past decade. The two leading culprits are oil imports and goods from China. The current account deficit is the flip side of a capital account surplus, which means that foreigners are lending the U.S. money or buying U.S. assets to the tune of $800 billion a year. This an imbalance between domestic saving and investment. Americans do not save enough money to finance investment in the U.S. Foreign capital buys U.S. government securities and a wide variety of other real and financial assets. Foreigners now own more than two-fifths of publicly-held U.S. Treasury bonds, up from 15 percent a few short years ago.

This deficit cannot continue indefinitely without severe repercussions. One is a fall in the value of the dollar against other currencies. Between 2002 and 2007, the Canadian dollar has risen from C$1.58 to US$1.01. The euro has risen from 88 cents to $1.39. The same holds for other currencies. Sustained large deficits could precipitate a run on the dollar. Another repercussion is the prospect of inflation from higher prices of imported goods and services. Another is the potential influence foreigners will have on U.S. foreign policy as they continue to accumulate U.S. Treasury securities and other assets.
Many argue that Americans should save more, both for their own well-being and that of the U.S. economy. The rate of return on saving influences the incentive to save. High real interest rates encourage savings. Low rates discourage saving. When Ben Bernanke and the Federal Reserve Board reduced the federal funds rate from 5.25 to 4.75 percent on September 18, 2007, they reduced the return to savers. Recall that former fed chairman Greenspan held interest rates at a low 1 percent for several years, which resulted in savers receiving a zero, or negative depending on inflation, rate on their bank deposits. The biggest losers in this low-interest world were the elderly, whose interest earnings supplement Social Security. The reduction from 6.5 to 1 percent on deposits during Greenspan’s later years at the helm of the fed cut the interest earnings of the elderly by as much as 85 percent. The September 18 reduction reduced the return on saving by nearly 10 percent, again penalizing savers. Investment bankers, home builders, financial analysts, and others are calling for further cuts in interest rates. Who will speak for savers and the elderly?

Wednesday, September 5, 2007

Does Rising Foreign Ownership of U.S. Assets Pose a Geopolitical Problem?

The August 2007 sell off in U.S. financial markets, which was triggered by the crisis in sub-prime mortgage lending and borrowing, is one illustration of a potentially larger problem. The U.S. government and the American people have been borrowing vast sums to finance spending and consumption. The federal government borrows several hundred billion dollars every year to pay its bills. The Congress periodically raises the federal debt ceiling for the government to remain in business. As of mid-August 2007, total federal debt stood at $8.97 trillion. Of this, the outstanding marketable debt of the federal government in the hands of the public, which excludes non-marketable securities held in the Social Security and Medicare Trust Funds, was $5.34 trillion, up from $346 billion at the end of 1973. Foreign ownership of marketable debt has almost tripled, from 15 percent in 1986 to about 42 percent in mid-2007, of which Asian central banks hold the lion’s share. The large share of foreign ownership of U.S. debt gives other nations, not all of whom are always friendly, the potential to influence U.S. monetary policy, interest rates, economic growth, and, perhaps more worrisome, U.S. foreign policy and national security.

Foreign ownership of federal debt is only part of the picture. A broader indicator is net foreign claims on U.S. assets. It changes with net acquisitions by foreign residents in the U.S. less net acquisitions abroad by U.S. residents. The change is largely driven by the current account deficit, the difference in U.S. purchases of goods and services over sales to foreigners, a deficit which is financed with foreign capital inflows. Largely in surplus during 1946-1981, the current account has since been in deficit since 1981. The deficit passed $100 billion in 1985, reached $214 billion in 1998, $415 billion in 2000, to about $800 billion in 2006. During the ten years 1998-2007 (which includes an estimated $800 billion in 2007), the cumulative deficit comes to about $5.4 trillion.

Economists and demographers project future trends to estimate the need for revenue to support a growing elderly population, the viability of Social Security and Medicare, and other topics. Assume that the U.S. continues to accrue a current account deficit at the present rate, or higher, for years to come. That would transfer $800 billion or more a year in U.S. assets to foreigners, disproportionately to China and oil exporting nations, especially in the volatile Middle East, home to radical Islam. Ten years would add $8 trillion, or more, to foreign claims; twenty $16 trillion, and so on. Saudi Arabia enjoys a $100 billion annual current account surplus, China, $250 billion, Russia, $80 billion, and so on.

The growth in foreign ownership of U.S. assets can be compared with the net wealth of U.S. households. Excluding real estate, the value of all U.S. household net wealth in 2006 was around $29 trillion, of which equities constituted about $16 trillion (household, pension, and insurance company holdings of corporate equities and mutual funds). Within a generation, foreign ownership of U.S. federal debt and equities will skyrocket.

A part of this ownership takes the form of an increasingly important phenomenon, sovereign wealth funds (SWF), which have captured the attention of economists and investment analysts. SWF are directly or indirectly controlled government investment vehicles funded by foreign currency assets which are managed separately from the official reserves of central banks. SWF are currently estimated at $2.2-2.5 trillion dollars, close to half of the $5.1 trillion in official foreign exchange reserves. Morgan Stanley has estimated that SWF will increase to $5 trillion by 2010 and $12 trillion by 2015. About two-thirds have derived from commodity exports (oil, gas) and one third from transfers from official foreign exchange reserves. Examples include Abu Dhabi’s Investment Authority ($875 million), Singapore’s Government Investment Corporation ($330 billion), Norway’s Petroleum Fund ($300 billion), and Russia’s stabilization Fund ($100 billion). The investments of private Saudi residents and Arab sheiks are akin to SWF. Some SWF have been and are seeking to acquire strategic foreign enterprises (banks, energy, airlines, ports, and publishing companies). Examples include the Dubai Ports Authority, CNOOC (a Chinese oil company), and Russia’s Gazprom, to name a few.

China has announced plans to create a SWF of $200 billion out of its foreign reserves of more than $1.3 trillion, which are increasing by $250 billion a year. During 1995-2006, China’s foreign reserves rose at an average annual rate of 20 percent. It is likely that China will inject additional billions into its SWF as its reserves continue to grow. In contrast with regulated private investment funds, SWF are not required to disclose governance or their portfolios.

Most economists argue that capital inflows are good for the U.S. economy, supporting investment that creates jobs and growth. Indeed, some claim that the portion of the trillions of dollars of SWF that will be invested on U.S. equity markets will help to prop up the market. The question is whether the increasing foreign ownership of U.S. assets poses economic and political risks.
Prospects for Tax Reform in the Next Administration

In November 2008, Americans will elect a new president, a new House of Representatives, and a third of the Senate. A new administration provides an opportunity to review, renew, modify, or repeal existing legislation. Taxes are always on the minds of voters, politicians, investors, businesses, and workers. What will the next administration bring? Key items on the political agenda include expiration of President Bush’s tax cuts—cuts in marginal rates, capital gains, and dividends— that were enacted in June 2001, but are due to expire at the end of 2010, addressing the alternative minimum tax (AMT), the parallel income tax that imposes a minimum level of taxes on high-income individuals but which is ensnaring millions of middle-income taxpayers in its net, and the campaign promises of the next president.

Since President Reagan signed the Tax Reform Act of 1986, subsequent legislation has proliferated new provisions and added thousands of additional pages of explanation and interpretation. Federal income tax forms for individuals number in the hundreds and the explanations for completing many of them are lengthy and often unintelligible. The tax gap, the difference between what is owed in law and collected is estimated around $300 billion. Compliance costs exceed $100 billion. Thousands earn their living assisting individuals with tax planning and reporting. Although politicians rail against the complexity of the tax code, they rarely enact real simplification.

What do the Democratic and Republican candidates for president propose? Most political analysts expect Democrats to retain control of both houses of Congress. A Democratic president is thus more likely to succeed than a Republican in enacting her/his campaign promises. The candidates’ official web sites, statements made on the campaign trail, and past votes provide sources of information.

The three leading Democratic candidates are Hillary Clinton, Barack Obama, and John Edwards (which assumes that Al Gore will not enter the race). Hillary Clinton, the prospective nominee, has not offered any details on her income tax policy in speeches, press releases, or web site. She suggests reducing, but not repealing, the AMT. She voted against repeal of and raising the estate tax exemption to $5 million. She objected to the Bush tax cuts on income, dividends, and capital gains, but has not yet said if she would allow its provisions to expire, in whole or in part. On a separate matter, Social Security, she has questioned the $100,000 income limit subject to payroll tax.

Barack Obama is more specific in his statements, though taxation is not an issue topic on his web site. Having voted against Bush’s tax cuts, Obama propose unspecified reductions to pay for health and other programs. He objects to repeal, and a higher exemption, of the estate tax. He supports unspecified tax incentives to create jobs in the U.S. instead of offshore.
Edwards, alone among the first tier, includes the issue of taxation on his web site. He advocates repealing the Bush tax cuts to pay for universal health care, supports tax preferences for the middle class (savings tax credit, expanded child care credit, increase in the earned income tax credit, reduction in the marriage penalty, and tax deductions for college tuition). The unlikely remaining candidates, Joe Biden, Chris Dodd, Mike Gravel, Dennis Kucinich, and Bill Richardson, agree on retaining the estate tax, raising rates on income, capital gains, and dividends, and favoring middle class cuts.

Among leading Republicans, none has posted their positions on taxation. Rudy Giuliani favors unspecified low rates, a lower AMT, and repealing the estate tax. Romney supports the elimination of tax on capital gains, interest, and dividends for an unspecified middle class, and has pledged no new taxes. Thompson speaks about unspecified low rates and reform to keep the U.S. economy competitive. Despite having voted against the Bush tax cuts in the first instance, John McCain, whose campaign has faltered, now supports their extension and favors repeal of the estate tax. Among second tier candidates, only Tom Tancredo and Mike Huckabee have posted details on their sites. Both support the "Fair Tax," a 34 percent retail sales tax in place of both income and payroll taxes. Sam Brownback supports an alternative flat tax.

What can we surmise from this review about the prospects for broad tax reform in the next administration? A Democratic president is likely to claw back some or all of the Bush tax cuts, especially for upper-income households, retain the estate tax will be retained, perhaps with a several million dollar exemption and slightly lower rates. If the AMT is reduced or repealed, the lost revenue will have to be replaced with higher taxes on income. A Democratic administration and Congress are likely to increases rates on capital income and earnings of high-income persons. Should a Democratic president address Social Security, she/he may propose increasing the level of income subject to payroll tax.

A Republican president will emphasize extending the Bush tax cuts. A compliant Congress could compromise on this, retaining some, but not all, of the reductions. That no top-tier candidate is proposing bold reform means that a Republican administration would tinker with, but not overhaul, the tax code. From the vantage of just over a year before the election, prospects for the next administration suggest higher rates and more complexity. Real reform and simplification will remain a will-o’-the-wisp for some years to come.

Wednesday, August 8, 2007

Why Voters are Disillusioned with Politicians

Policy makers in the United States state as a principal objective the achievement of strong economic growth to bring about greater opportunities and higher living standards for all Americans. At the same time, they express concern over the widening gap between the richest and poorest members of society. These twin concerns present a conundrum because it has proven difficult to achieve both objectives at the same time despite efforts at redistributing income through progressive taxation, public expenditure programs, thousands of regulations, and other economic policy tools. The mismatch between these and other stated goals and outcomes has led to public disaffection with politicians and the government.

Let’s examine this conundrum, and several others, to see why they are so difficult to resolve.

We are told every day that the gap between rich and poor is widening in the United States, threatening social stability, and preventing millions from achieving their dreams. One purported cause is globalization in which well-paid manufacturing jobs are being outsourced to China and other low-cost manufacturing countries. Another, and perhaps more direct, cause is the millions of illegal immigrants who enter the United States to take low-paid jobs that citizens presumably will not perform. By definition, large numbers of a steady inflow of low-paid workers widen the gap between well-paid, middle- and upper-middle class residents and low-paid immigrants. One solution is to stop illegal immigration of low-skilled persons or, going further, deport millions of illegal immigrants. The federal government has yet to make a serious attempt to address the problem lest the U.S. economy suffer a shortage of labor to harvest and process agricultural products, make beds, wait on tables, collect garbage, paint homes, install roofs, and perform other manual tasks.

Another source of the gap is the advancement of women in the labor market and professions. A majority of students in U.S. universities and colleges is women. They constitute half or more in many law, business, medical, and other professional schools. Highly-educated women who earn large incomes tend to marry well-educated men who also earn large incomes, producing couples with extremely large incomes. The education and professionalization of women, a great achievement of feminism, and their choice of partners are another cause of the gap. Dual high-income couples often hire low-wage day care, gardeners, and housekeepers, thereby exacerbating the gap. The children of these marriages begin life with much greater economic opportunities and prospects than those of single heads of household and low-income families living in poor neighborhoods with bad schools.

High housing prices in well-to-do suburbs and cities make it difficult for such modestly-paid public servants as police, fire, health, and other mid-level government employees to live in the communities in which they work. The well-to-do gnash their teeth and wring their hands over this situation, saying that there is a need to build affordable housing for these dedicated public servants. Yet proposals put forth by property developers for low- or medium-cost housing are often rejected or downsized on such grounds as additional traffic congestion, overcrowding, pressure on schools, and environmental degradation. More likely is that owners of expensive homes do not want to live near lower- and lower-middle-income classes. American communities are increasing segregated along economic and racial lines, with an increasing number of gated communities, guards, and barriers to entry.

We are told that economic and tax policy should encourage saving and investment as a means to foster growth. However, we are simultaneously told that tax cuts to stimulate saving and investment disproportionately benefit the wealthy. How can we increase saving and investment if policies directed to those ends disproportionately benefit the wealthy, thereby widening the gap between rich and poor? Indeed, many politicians on the left propose, if elected, to raise taxes on saving and investment.

We are told that there is a rising tide of negative sentiment towards the United States all around the world and that U.S. enterprises exploit workers, especially illegal immigrants. If true, why have some ten-twenty million illegal immigrants entered the United States from Central and South America, and why do millions more try to cross the border from Mexico each year? Why did tens of thousands of Irish sign up for the citizenship lottery some years ago?

Some politicians of the left dislike the U.S. military, regarding it as a source of global oppression. Yet these same politicians love military bases in their states and districts, fighting tooth and nail to prevent their closure every time a base-closing commission is established to reduce wasteful military spending and rationalize the country’s military bases.

Underlying these and other conundrums is an assault on logic and evidence as the basis of reasoned discourse, which makes intelligent discussion of public policy so difficult and the resolution of social problems almost impossible.