Globalization

I've been in Washington for 16 years now, coming as many did with President Clinton back in 1993.  I have seen a lot of changes in my time here, but the rate of change we are witnessing today is breathtaking.  Just take a look at a few of the headlines today from a vastly changed political and societal landscape:

Economy Shrinks at Staggering Pace

Obama Announces Iraq Withdrawal Plan

AIG Faces Possible Breakup

Part of Denver's Past, the Rocky Says Goodbye

Broadcast TV Struggles to Stay Viable 

Obama's Greenhouse Gamble

Top Officials Expand Dialogue on Race

Playing With Fire In Pakistan

'Great Society' Plans for the Middle Class

The Bill That Could Break Up Europe

There are large and systemic changes underway here in the US and around the world. 20th century challenges, institutions, ideologies, economics, media and even racial understanding are being swept away.   A new global political era is surely emerging now, unfolding in front of us, one that our new President is both responding to and attempting to shape.  The President's ambitious budget this week was itself the most powerful examples of how much our politics is in the process of changing.  

I end my quick morning post with an excerpt from Joe Nocera's column from the New York Times today.  Nocera has been writing as intelligently as anyone about the financial and economic crisis, and this column, Propping Up A House of Cards, is an absolute required read: 

Next week, perhaps as early as Monday, the American International Group is going to report the largest quarterly loss in history. Rumors suggest it will be around $60 billion, which will affirm, yet again, A.I.G.'s sorry status as the most crippled of all the nation's wounded financial institutions. The recent quarterly losses suffered by Merrill Lynch and Citigroup - "only" $15.4 billion and $8.3 billion, respectively - pale by comparison.

At the same time A.I.G. reveals its loss, the federal government is also likely to announce - yet again! - a new plan to save A.I.G., the third since September. So far the government has thrown $150 billion at the company, in loans, investments and equity injections, to keep it afloat. It has softened the terms it set for the original $85 billion loan it made back in September. To ease the pressure even more, the Federal Reserve actually runs a facility that buys toxic assets that A.I.G. had insured. A.I.G. effectively has been nationalized, with the government owning a hair under 80 percent of the stock. Not that it's worth very much; A.I.G. shares closed Friday at 42 cents.

Donn Vickrey, who runs the independent research firm Gradient Analytics, predicts that A.I.G. is going to cost taxpayers at least $100 billion more before it finally stabilizes, by which time the company will almost surely have been broken into pieces, with the government owning large chunks of it. A quarter of a trillion dollars, if it comes to that, is an astounding amount of money to hand over to one company to prevent it from going bust. Yet the government feels it has no choice: because of A.I.G.'s dubious business practices during the housing bubble it pretty much has the world's financial system by the throat.

If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks "will face their own capital and liquidity crisis, and we could have a domino effect." A bailout of A.I.G. is really a bailout of its trading partners - which essentially constitutes the entire Western banking system. 

From the NYTimes:

The economy at the end of last year contracted at a far faster rate than initially estimated, a government report released Friday said, suggesting that the recession may be deeper and more severe than recent projections have indicated.

The country's gross domestic product fell at an annualized rate 6.2 percent in the last quarter of 2008, the steepest decline since the 1982 recession. Economists are expecting a similar drop in the first quarter of 2009.

"What a ghastly report," said John Ryding, chief economist at RDQ Economics. "This will almost certainly be the longest postwar recession, and now potentially the deepest one as well."

In her comments last night Penelope Cruz offered up a wonderful recollection.  When she was young, as a child in Spain, she would stay up late - yes very late - to watct the Oscars.  It was a night, she said, where the whole world came together, as one.  In this time of global economic struggle and fear it was a compelling way to start the night.  

To get a window into how global Hollywood and the movie business has become consider that the host of the Oscars last night was Australian, as was the Best Supporting Actor. Ms. Cruz won her statue for a bi-lingual role in an American film that took place in Spain.  Best Actress went to a Brit, and of course, the big winner of the night was Slumdog Millionaire, about, well, you know by now.   The lone American up there last night for the big ones - Sean Penn, for Best Actor.

It reminded me a litle bit like watching a European soccer match.  Each time my kids and I watch a Barcelona or Man U match we send up spending time looking at a globe, trying to locate places like Cameroon as the players now are truly from all over the world, and these teams wildly globally integrated.  We often wonder how the coaches and players talk to one another, what language is common to them all.  

No complaining about all this from this source, just something powerful to remark upon.  It reminds us that at this moment when protectionism and tribalism might very well start to make a comeback in our global life, there are powerful forces of integration and "flatness" that will be hard to overcome.  As Ms. Cruz said last night, that powerful sense of being one with the world is what sticks with her to this day. 

But it also does reflect what Fareed Zakaria has callled the "rise of the rest."  While America does still stand tall throughout the world, the rest of the world is in the process of figuring out our game.  For us to stay ahead, to stay pre-eminent, we will - all of us - have to try much much harder in the years ahead.  Global competition has increased on all fronts, and this idea - that we must do more, raise our game - must be one of the more powerful sentiments driving our "recovery" in the years ahead. 

A selection of things I found interesting this weekend. From the Economist: 

A SMALL stretch of land, a two-hour drive from end to end, reveals much about the economic transformation of a vast country. This slice of southern China runs from Guangzhou, the old treaty port reserved for foreigners before Mao expelled them, to Shenzhen, the city established after Mao's death as an experiment in private enterprise. Over the past decade it has become one of the world's fastest-whirring economic engines-a global hub in the manufacture of clothing, shoes and electronics-serviced by tens of millions of migrant workers.

Now the region is undergoing an equally remarkable contraction. In the past year thousands of factories, perhaps one-third to one-half of the total, have closed. Reliable statistics are hard to come by, not least because many factories operate in a legal netherworld, but the severity of the slump is plain. The flow of migrants has gone into reverse. Some of the newly unemployed have stuck around (and a few have started a new industry: street crime). The lucky ones have found work at factories that moved inland, although at lower pay.

On the road through Dongguan, a sprawling industrial city roughly halfway between Guangzhou and Shenzhen, building after building-residential as well as industrial-displays red banners advertising its availability. Local agents say there is no interest from buyers. A lack of demand for whatever a factory might make is part of the explanation. So is concern about the quality of properties for sale: a lot of factories were put up in a hurry and have been maintained poorly if at all. And so is the nebulousness of Chinese property laws. Purchasers cannot be sure that what they buy they will truly own.

The rapid collapse of economic activity around Dongguan indicates that China's private companies are being subjected to the same battering as their counterparts in many other countries. Yet it also raises questions about the long-term survival of many of these companies. They have been among the most dynamic components of China's fast rise towards prosperity. Their turmoil may be transient. Then again, there are also worries that it is in fact tied to profound flaws in the Chinese economy.

From a New York Times piece today about lessons from Japan's Lost Decade: 

As recession-wary Americans adapt to a new frugality, Japan offers a peek at how thrift can take lasting hold of a consumer society, to disastrous effect.

The economic malaise that plagued Japan from the 1990s until the early 2000s brought stunted wages and depressed stock prices, turning free-spending consumers into misers and making them dead weight on Japan's economy.

Today, years after the recovery, even well-off Japanese households use old bath water to do laundry, a popular way to save on utility bills. Sales of whiskey, the favorite drink among moneyed Tokyoites in the booming '80s, have fallen to a fifth of their peak. And the nation is losing interest in cars; sales have fallen by half since 1990.....

"Japan is so dependent on exports that when overseas markets slow down, Japan's economy teeters on collapse," said Hideo Kumano, an economist at the Dai-ichi Life Research Institute. "On the surface, Japan looked like it had recovered from its Lost Decade of the 1990s. But Japan in fact entered a second Lost Decade - that of lost consumption."

The Japanese have had some good reasons to scale back spending.

Perhaps most important, the average worker's paycheck has shrunk in recent years, even after companies rebounded and bolstered their profits.

That discrepancy is the result of aggressive cost-cutting on the part of Japanese exporters like Toyota and Sony. They, like American companies now, have sought to fend off cutthroat competition from companies in emerging economies like South Korea and Taiwan, where labor costs are low.

To better compete, companies slashed jobs and wages, replacing much of their work force with temporary workers who had no job security and fewer benefits. Nontraditional workers now make up more than a third of Japan's labor force.

Sounds a little too familiar for my taste.  As I wrote recently in a series of posts about Spend? Save? I still think the economic narrative being used in Washington today does not adequately take into account what happened to the incomes of everyday Americans during the Bush Recovery.  Jake Berliner also posted on this subject last week.  

And finally, Leon Wieseltier, writing in the New Republic: 

Can liberalism still explain itself? Does it remember its concepts and its words? It has been many decades since liberalism could fall back upon the power of platitudes; the platitudinous authority now belongs to the other side. Cliche may represent a failure in literature, but in politics it is the evidence of a philosophy's success. The repudiation of George W. Bush is not in itself a renovation of liberalism, and neither is the apotheosis of Barack Obama. The public has not yet broken the grip of the conservative discourse that has dominated America for a generation. Consider the insane headline on Newsweek's cover, "We Are All Socialists Now": an exclamation of its inner Hannity, as if the president is preparing to abolish private property or expropriate the means of production. All that is happening, comrades, is that our democratically constituted central government is acting to protect the whole of our economy by taking over, for a period, a part of our economy. But second natures, which are made more by culture than by thought, are not easily extinguished. Sean Wilentz was shrewd to contain the Clinton years in his recent study of "the age of Reagan," because Bill Clinton's inglorious role in the history of liberalism was to teach it to sleep with its enemy. Insofar as his renunciation of ideology was the revival of an experimental frame of mind about public policy, the good sense of "best practices," it was a welcome turn; but it was also a lousy defeatism about the war of ideas, a loss of interest, or of nerve, about first principles. On the day that Clinton pragmatically announced that "the era of big government is over," liberalism forgot itself. Pragmatism has a dark side. The allure of pragmatism was lost on the conservatives, of course. They sought power so that they could act on what they believed. And when they got their chance, they ran the republic down in almost all its aspects. We must not draw the wrong conclusion from the rubble. The problem was what they believed, not that they believed. 

Amen to that I say.  

I visited this subject in a recent post, The Utter Bankruptcy of Today's Republican Party and agree with Mr. Wieseltier that the President must make the choice the nation has in front of it much starker.  It is possible for our new President to love the sinner but hate the sin; to work with Republicans but reject their irresponsible and reckless approach to governing.  To accept their failed notions as a price for cooperation is a steep steep price for the nation to pay at this time where our great national project is dig ourselves out of the whole they dug for all of us.

On Wednesday I went on Fox News to talk about the stimulus.  Or so I thought.  Fox anchor Neil Cavuto ended up spending more time talking about cannoli and weight loss than the struggle of every day people and the American economy.  Check it out:

Each day you can feel the media and the public grow slightly more aware of the gravity of the economic problems facing America and the world.   We are all still getting our arms around this economic moment, and like Paul Krugman's column today, the emerging conventional wisdom is the recovery is going to be long and hard - longer and harder than any other recession since the Great Depression.  I feel, each day, that it is more and more apparent that we are living in no ordinary time - that the decisions made by our leaders in the days ahead here and across the world will be ones of great consequence.  Ones that will lead to a prosperous and peaceful 21st century; ones reinforcing the drift of the moment, the inability of our politics to face our challenges forthrightly; ones that could indeed make matters much much worse. 

Tuesday night the President will address the nation from the Capitol.  Once again the nation, and the world, wlll be watching.  It will be a critical opportunity for our new President to lay out the challenges we face and the solutions he envisions.  I hope he takes the opportunity to more clearly define the choice we face.  For I don't think the choice is between forward and backward any more, or between progress and failed old ideas.  I think it is a graver choice, a starker choice, a much more serious choice - one of recovery, global stability and national greatness versus continued drift, global chaos and national decline.  

As the saying goes times of crisis are also times of great opportunity.  It is increasingly clear the task of the Obama Presidency will be a great one - to prevent the world and the US from sliding into economic and political chaos, to chart a domestic and global path for recovery, and to update the successful but aging geopolitical architecture forged by FDR and Truman for a new day and a new century.  No small tasks these.  But these are the tasks that are in front of us now.  To put it simply - it is time to remake and renew the world, to offer a "new politics" on a global scale.  

If history is any guide creating this new global architecture that allows us to better manage the collective challenges in front of us won't be easy, or without pain.  Mistakes will be made, years and nations lost.  But it is now the great challenge facing our nation, whose role in the world is different from the rest.  And it will now be at the very center of our politics for perhaps decades to come.  I am anxious to see how the President talks about all this on Tuesday night, the most important night yet of his already historic Presidency.  

Earlier this week, the Federal Reserve released the minutes of the most recent meeting of its open market committee - the group that sets interest rates. Most press reports focused either on the Fed's downgrade of the near-term outlook or on its adoption of a long-run 2 percent inflation target.

But my eye was caught by the following chilling passage (yes, things are so bad that the summarized musings of central bankers can keep you up at night): "All participants anticipated that unemployment would remain substantially above its longer-run sustainable rate at the end of 2011, even absent further economic shocks; a few indicated that more than five to six years would be needed for the economy to converge to a longer-run path characterized by sustainable rates of output growth and unemployment and by an appropriate rate of inflation."

So people at the Fed are troubled by the same question I've been obsessing on lately: What's supposed to end this slump? No doubt this, too, shall pass - but how, and when?

Read on. It isn't pretty.

Last Thursday George Soros published a piece in the Huffington Post, an excerpt from his new book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means.  To get a true sense of the difficulties ahead from one of the world's most creative thinkers, I recommend reading this piece, and picking up the book. From what I've read so far it is a very helpful guide to understanding what is happening today, and contributes some important ideas to the debate about what to do now.   I particularly like his thoughts on how to remake the domestic mortgage market.

The Huffington Post article begins:

The bursting of bubbles causes credit contraction, forced liquidation of assets, deflation, and wealth destruction that may reach catastrophic proportions. In a deflationary environment, the weight of accumulated debt can sink the banking system and push the economy into depression. That is what needs to be prevented at all costs.

It can be done by creating money to offset the contraction of credit, recapitalizing the banking system, and writing off or down the accumulated debt in an orderly manner. For best results, the three processes should be combined. This requires radical and unorthodox policy measures. If these measures were successful and credit started to expand, deflationary pressures would be replaced by the specter of inflation, and the authorities would have to drain the excess money supply from the economy almost as fast as they pumped it in. Of the two operations, the second is likely to prove both technically and politically even more difficult than the first, but the alternative--global depression and world disorder--is unacceptable. There is no way to escape from a far-from-equilibrium situation--global deflation and depression--except by first inducing its opposite and then reducing it.

The size of the problem is even larger than it was in the 1930s. This can be seen from a simple calculation. Total credit outstanding was 160 percent of GDP in 1929, and it rose to 260 percent in 1932 due to the accumulation of debt and the decline of GDP. We entered into the Crash of 2008 at 365 percent, which is bound to rise to 500 percent or more by the time the full effect is felt. And this calculation does not take into account the pervasive use of derivatives, which was absent in the 1930s but immensely complicates the current situation. The situation has been further aggravated by the haphazard and arbitrary way in which it was handled by the Bush administration. The public and the business community suffered a shock in the aftermath of the Lehman Brothers default, and the economy has fallen off a cliff. The next two quarters will show rapid deterioration.

To prevent the economy from sliding into a depression, President Obama must embark on a radical and comprehensive policy package that has five major components:

1. A fiscal stimulus package
2. A thorough overhaul of the mortgage system
3. Recapitalization of the banking system
4. An innovative energy policy
5. Reform of the international financial system

Read on here for more, or visit Mr Soros' website here.

You can see them gaining currency in thank tanks, op-ed pages and tv shows.  2 questions whose answers will drive our policies and dictate the terms of our recovery - is our financial system insolvent? and Will high-levels of consumer debt force American consumers to save rather then spend, and take them out of the game over the next few years?

We've been asking the Spend? Save? question here for a few weeks now.  David Leonhardt attacked it last week in the Times, and Paul Krugman visits the question today in his column: 

Last week the Federal Reserve released the results of the latest Survey of Consumer Finances, a triennial report on the assets and liabilities of American households. The bottom line is that there has been basically no wealth creation at all since the turn of the millennium: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001.

At one level this should come as no surprise. For most of the last decade America was a nation of borrowers and spenders, not savers. The personal savings rate dropped from 9 percent in the 1980s to 5 percent in the 1990s, to just 0.6 percent from 2005 to 2007, and household debt grew much faster than personal income. Why should we have expected our net worth to go up?

Yet until very recently Americans believed they were getting richer, because they received statements saying that their houses and stock portfolios were appreciating in value faster than their debts were increasing. And if the belief of many Americans that they could count on capital gains forever sounds naïve, it's worth remembering just how many influential voices - notably in right-leaning publications like The Wall Street Journal, Forbes and National Review - promoted that belief, and ridiculed those who worried about low savings and high levels of debt.

Then reality struck, and it turned out that the worriers had been right all along. The surge in asset values had been an illusion - but the surge in debt had been all too real.

So now we're in trouble - deeper trouble, I think, than most people realize even now. And I'm not just talking about the dwindling band of forecasters who still insist that the economy will snap back any day now.

For this is a broad-based mess. Everyone talks about the problems of the banks, which are indeed in even worse shape than the rest of the system. But the banks aren't the only players with too much debt and too few assets; the same description applies to the private sector as a whole.

The other question, to the solvency of our financial system, was discussed a great deal on the Sunday talk shows yesterday.   Last week Martin Wolf of the FT wrote: 

Yet hoping for the best is what one sees in the stimulus programme and - so far as I can judge from Tuesday's sketchy announcement by Tim Geithner, Treasury secretary - also in the new plans for fixing the banking system. I commented on the former last week. I would merely add that it is extraordinary that a popular new president, confronting a once-in-80-years' economic crisis, has let Congress shape the outcome.

The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. If this "progeny of the troubled asset relief programme" fails, Mr Obama's credibility will be ruined. Now is the time for action that seems close to certain to resolve the problem; this, however, does not seem to be it.

All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency.

Under the first view, the prices of a defined set of "toxic assets" have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. This was the rationale for the original Tarp and the "super-SIV (special investment vehicle)" proposed by Henry (Hank) Paulson, the previous Treasury secretary, in 2007.

Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad - on sovereign, housing and corporate debt - will surely fall on US institutions, with dire effects.

Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a "no brainer".

The new plan seems to make sense if and only if the principal problem is illiquidity. Offering guarantees and buying some portion of the toxic assets, while limiting new capital injections to less than the $350bn left in the Tarp, cannot deal with the insolvency problem identified by informed observers. Indeed, any toxic asset purchase or guarantee programme must be an ineffective, inefficient and inequitable way to rescue inadequately capitalised financial institutions: ineffective, because the government must buy vast amounts of doubtful assets at excessive prices or provide over-generous guarantees, to render insolvent banks solvent; inefficient, because big capital injections or conversion of debt into equity are better ways to recapitalise banks; and inequitable, because big subsidies would go to failed institutions and private buyers of bad assets.

Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing. Trying to make up for this mistake by imposing pettifogging conditions on assisted institutions is more likely to compound the error than to reduce it.

And the aforementioned Professor Roubini wrote yesterday in the Washington Post:

The U.S. banking system is close to being insolvent, and unless we want to become like Japan in the 1990s -- or the United States in the 1930s -- the only way to save it is to nationalize it.

As free-market economists teaching at a business school in the heart of the world's financial capital, we feel downright blasphemous proposing an all-out government takeover of the banking system. But the U.S. financial system has reached such a dangerous tipping point that little choice remains. And while Treasury Secretary Timothy Geithner's recent plan to save it has many of the right elements, it's basically too late.

The subprime mortgage mess alone does not force our hand; the $1.2 trillion it involves is just the beginning of the problem. Another $7 trillion -- including commercial real estate loans, consumer credit-card debt and high-yield bonds and leveraged loans -- is at risk of losing much of its value. Then there are trillions more in high-grade corporate bonds and loans and jumbo prime mortgages, whose worth will also drop precipitously as the recession deepens and more firms and households default on their loans and mortgages.

Last year we predicted that losses by U.S. financial institutions would hit $1 trillion and possibly go as high as $2 trillion. We were accused of exaggerating. But since then, write-downs by U.S. banks have passed the $1 trillion mark, and now institutions such as the International Monetary Fund and Goldman Sachs predict losses of more than $2 trillion.

But if you think that $2 trillion is high, consider our latest estimates at the financial Web site RGE Monitor: They suggest that total losses on loans made by U.S. banks and the fall in the market value of the assets they are holding will reach about $3.6 trillion. The U.S. banking sector is exposed to half that figure, or $1.8 trillion. Even with the original federal bailout funds from last fall, the capital backing the banks' assets was only $1.4 trillion, leaving the U.S. banking system about $400 billion in the hole.

Two important parts of Geithner's plan are "stress testing" banks by poring over their books to separate viable institutions from bankrupt ones and establishing an investment fund with private and public money to purchase bad assets. These are necessary steps toward a healthy financial sector.

But unfortunately, the plan won't solve our financial woes, because it assumes that the system is solvent. If implemented fairly for current taxpayers (i.e., no more freebies in the form of underpriced equity, preferred shares, loan guarantees or insurance on assets), it will just confirm how bad things really are.

Nationalization is the only option that would permit us to solve the problem of toxic assets in an orderly fashion and finally allow lending to resume. Of course, the economy would still stink, but the death spiral we are in would end.

Both of these essays echo an essay Rob Shapiro wrote within days of the announcement of the original TARP, Back to Basics: Why The Treasury Plan Won't Work.  

I read these articles.  I listen to the commentators.  I and many others in positions of responsibility continue to wake each day to an even greater understanding of the enormity of the problems our nation now faces, of the hole dug by the mismanagement and ignorance of the previous administration.  Clearly, now, we have to conclude these are no ordinary times.   

So my friends watch the debate over the next few weeks and come to your own conclusion - should American consumers spend, or save? And are the banks insolvent?  How we answer these questions in the short term will dictate very much how we approach the next stage of the management of our economic crisis.