Category Archives: International Relations

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Chinese Treasury Contradictions…

One mistake I may have made in the two years I have been writing publicly is taking the rhetoric of the Chinese and Russian governments a little too seriously, particularly over their relationship with the United States and the dollar.

Back in 2011, both China and Russia made a lot of noise about dumping US debt, or at least investing a lot less in it. Vladimir Putin said:

They are living beyond their means and shifting a part of the weight of their problems to the world economy. They are living like parasites off the global economy and their monopoly of the dollar. If [in America] there is a systemic malfunction, this will affect everyone. Countries like Russia and China hold a significant part of their reserves in American securities. There should be other reserve currencies.

And China were vocally critical too:

China, the largest foreign investor in US government securities, joined Russia in criticising American policymakers for failing to ensure borrowing is reined in after a stopgap deal to raise the nation’s debt limit.

People’s Bank of China governor Zhou Xiaochuan said China‘s central bank would monitor US efforts to tackle its debt, and state-run Xinhua News Agency blasted what it called the “madcap” brinkmanship of American lawmakers.

But just this month — almost two years after China blasted America for failing to cut debt levels — China’s Treasury holdings hit a record level of  $1.223 trillion.  And Russian treasury holdings are $20 billion higher than they were in 2012. So all of those protestations, it seems, were a lot of hot air. While it is true that various growing industrial powers are setting up alternative reserve currency systems, China and Russia aren’t ready to dump the dollar system anytime soon.

Now, the Federal Reserve has to some degree further enticed China into buying treasuries by giving them direct access to the Treasury auctions, allowing them to cut out the Wall Street middlemen. Maybe if that hadn’t happened, Chinese Treasury ownership would be lower.

But ultimately, the present system is very favourable for the BRICs, who have been able to build up massive manufacturing and infrastructural bases as a means to satisfy American and Western demand. In that sense, the post-Bretton Woods globalisation has been as much a free lunch for the developing world as it has been for anyone else. And why would China and Russia want to rock the boat by engaging in things like mass Treasury dumpings, trade war or proxy wars? They are slowly and gradually gaining on the West, without having to engage in war or trade war. As I noted in 2011:

I believe that the current world order suits China very much — their manufacturing exporters (and resource importers) get the stability of the mega-importing Americans spending mega-dollars on a military budget that maintains global stability. Global instability would mean everyone would pay more for imports, due to heightened insurance costs and other overheads.

Of course, a panic in the Chinese mainland — maybe a financial crash, or the bursting of the Chinese property bubble — might result in China’s government doing something rash.

But until then it is unlikely we will see the Eurasian holders of Treasuries engaging in much liquidation anytime soon — however much their leaders complain about American fiscal and monetary policy. Actions speak louder than words.

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Why Europe Is Still In Peril, In Two Charts

A lot of analysts, including myself, have given the European situation a rest since last year. There were certainly some signs that the ECB and IMF had slowed (if not stopped) the deterioration by providing liquidity backstops to the addled banking system. But perhaps that was just the calm before the storm.

In truth, things were still was probably just as perilous as ever up until yesterday when the ECB and IMF decided to start a banking panic by enforcing a haircut of up to 10% on bank depositors. That was literally the stupidest thing that anyone has done since the Euro crisis began, and while it may not lead to utter disaster, there is a significant chance that it will. Not only is it excruciatingly unjust (it’s theft!), it is also incredibly suicidal. Many, many Spaniards, Italians, Greeks and Portuguese will have looked at the Cyprus haircut in horror, and wondered “Am I next?” Some of those will withdraw their money from the bank and stuff it in a mattress or into tangible assets, furthering stressing the already-fragile and highly-leveraged European banking system. Even a 1% drop in European deposits would lead to over €100 billion of withdrawals.

The background to this is soaring European unemployment:

EuroUnemployment

The people running the European financial system and engineering the bailouts and austerity (ECB, EU, IMF, Germany) have ploughed on through with more and deeper austerity even as European countries (other, of course, than Germany) have run up to higher and higher unemployment levels. Spain and Greece are above 25%. Italy is above 10%, and Portugal above 15%. Hiking taxes and cutting spending is leading to more and more people in unemployment oblivion. That isn’t healthy. Let’s not forget what happened to Germany the last time when over 25% of its people found themselves unemployed:

Chart-German-Unemployment-and-Nazi-Links

If bank runs materialise across Europe next week, the unemployment situation is most likely to worsen even further. If that happens, expect more and more unemployed, underemployed and angry Europeans to start voting for increasingly radical political parties. This is suicidal. Europe needs to not only reverse the awful, stupid Cypriot haircut, but also to put fiscal consolidation on hold (it has, lest we forget, so far been counterproductive) and start worrying about unemployment levels.

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Explaining The WTI-Brent Spread Divergence

Something totally bizarre has happened in the last three years. Oil in America has become much, much cheaper than oil in Europe. Oil in America is now almost $30 cheaper than oil in Europe.

This graph is the elephant in the room:

3 year brent spread

And this graph shows how truly historic a move this has been:

brent-WTI-spread

Why?

The ostensible reason for this is oversupply in America. That’s right — American oil companies have supposedly been producing much, much more than they can sell:

This is hilarious if prices weren`t so damn high, but despite a robust export market for finished products, crude oil is backing up all the way to Cushing, Oklahoma, and is only going to get worse in 2013.

Now that Enterprise Products Partners LLP has let the cat out of the bag that less than a month after expanding the Seaway pipeline capacity to 400,000 barrels per day, The Jones Creek terminal has storage capacity of 2.6 million barrels, and it is basically maxed out in available storage.

But there’s something fishy about this explanation. I don’t know for sure about the underlying causality — and it is not impossible that the oil companies are acting incompetently — but are we really supposed to believe that today’s oil conglomerates in America are so bad at managing their supply chain that they will oversupply the market to such an extent that oil sells at a 25% discount on the price in Europe? Even at an expanded capacity, is it really so hard for oil producers to shut down the pipeline, and clear inventories until the price rises so that they are at least not haemorrhaging such a huge chunk of potential profit on every barrel of oil they are selling? I mean, that’s what corporations do (or at least, what they’re supposed to do) — they manage the supply chain to maximise profit.

To me, this huge disparity seems like funny business. What could possibly be making US oil producers behave so ridiculously, massively non-competitively?

The answer could be government intervention. Let’s not forget that the National Resource Defence Preparedness Order gives the President and the Department of Homeland Security the authority to:

(c)  be prepared, in the event of a potential threat to the security of the United States, to take actions necessary to ensure the availability of adequate resources and production capability, including services and critical technology, for national defense requirements;

(d)  improve the efficiency and responsiveness of the domestic industrial base to support national defense requirements; and

(e)  foster cooperation between the defense and commercial sectors for research and development and for acquisition of materials, services, components, and equipment to enhance industrial base efficiency and responsiveness.

And the ability to:

(e)  The Secretary of each resource department, when necessary, shall make the finding required under section 101(b) of the Act, 50 U.S.C. App. 2071(b).  This finding shall be submitted for the President’s approval through the Assistant to the President and National Security Advisor and the Assistant to the President for Homeland Security and Counterterrorism.  Upon such approval, the Secretary of the resource department that made the finding may use the authority of section 101(a) of the Act, 50 U.S.C. App. 2071(a), to control the general distribution of any material (including applicable services) in the civilian market.

My intuition is that it is possible that oil companies may have been advised (or ordered) under the NDRP (or under the 1950 Defense Production Act) to keep some slack in the supply chain in case of a war, or other national or global emergency. This would provide a capacity buffer in addition to the Strategic Petroleum Reserve.

If that’s the case, the question we need to ask is what does the US government know that other governments don’t? Is this just a prudent measure to reduce the danger of a resource or energy shock, or does the US government have some specific information of a specific threat?

The other possible explanation, of course, is ridiculous incompetence on the part of US oil producers. Which, I suppose, is almost believable in the wake of Deepwater Horizon…

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America Loves Drone Strikes

This graph shows everything we need to know about the geopolitical reality of Predator Drones (coming soon to the skies of America to hunt down fugitives?).

The American public loves drone strikes:

BC2a006CAAEBSj2

The American public does not approve of the extrajudicial killing of American citizens. But for everyone else, it’s open season.

But everyone else — most particularly and significantly, the countries in the Muslim world — largely hates and resents drone strikes.

And it is the Muslim world that produces the radicalised extremists who commit acts like 9/11, 7/7, the Madrid bombings, and the Bali bombings.  With this outpouring of contempt for America’s drone strikes, many analysts are coming to believe that Obama’s drone policy is now effectively a recruitment tool for al-Qaeda, the Taliban and similar groups:

2_Hands

Indeed, evidence is beginning to coalesce to suggest exactly this. PressTV recently noted:

The expanding drone war in Yemen, which often kills civilians, does in fact cause blowback and help al-Qaeda recruitment – as attested to by numerous Yemen experts, investigative reporting on the ground, polling, testimony from Yemen activists, and the actual fact that recent bungled terrorist attacks aimed at the U.S. have cited such drone attacks as motivating factors.

After another September drone strike that killed 13 civilians, a local Yemeni activist told CNN, “I would not be surprised if a hundred tribesmen joined the lines of al-Qaeda as a result of the latest drone mistake. This part of Yemen takes revenge very seriously.”

“Our entire village is angry at the government and the Americans,” a Yemeni villager named Mohammed told the Post. “If the Americans are responsible, I would have no choice but to sympathize with al-Qaeda because al-Qaeda is fighting America.”

Many in the U.S. intelligence community also believe the drone war is contributing to the al-Qaeda presence in Yemen. Robert Grenier, who headed the CIA’s counter-terrorism center and was previously a CIA station chief in Pakistan, told The Guardian in June that he is “very concerned about the creation of a larger terrorist safe haven in Yemen.”

“We have gone a long way down the road of creating a situation where we are creating more enemies than we are removing from the battlefield,” he said regarding drones in Yemen.

Iona Craig reports that civilian casualties from drone strikes “have emboldened al-Qaeda” and cites the reaction to the 2009 U.S. cruise missile attack on the village of al-Majala in Yemen that killed more than 40 civilians (including 21 children):

That one bombing radicalized the entire area,” Abdul Gh ani al-Iryani, a Yemeni political analyst, said. “All the men and boys from those families and tribes will have joined [al-Qaeda] to fight.

And al-Qaeda’s presence and support in Yemen has grown, not shrunk since the start of the targeted killing program:

Meanwhile Yemen Central Security Force commander Brig. Gen. Yahya Saleh, nephew of ousted president Ali Abdullah Saleh, told Abdul-Ahad that al-Qaeda has more followers, money, guns and territory then they did a year and a half ago.

All at a time when Yemen is facing a “catastrophic” food crisis, with at least 267,000 children facing life-threatening levels of malnutrition. Hunger has doubled since 2009, and the number of displaced civilians is about 500,000 and rising.

As U.S. drones drop bombs on south Yemen villages and AQAP provides displaced civilians with “free electricity, food and water,” tribes in the area are becoming increasingly sympathetic to AQAP.

Let’s be intellectually honest. If a country engages in a military program that carries out strikes that kill hundreds of civilians — many of whom having no connection whatever with terrorism or radicalism — that country is going to become increasingly hated. People in the countries targeted — those who may have lost friends, or family members — are going to plot revenge, and take revenge. That’s just how war works. It infuriates. It radicalises. It instils hatred.

The reality of Obama’s drone program is to create new generations of America-hating radicalised individuals, who may well go on to be the next Osama bin Laden, the next Ayman al-Zawahiri, the next Abu Musab al-Zarqawi. The reality for Obama’s drone program is that it is sowing the seeds for the next 9/11 — just as American intervention in the middle east sowed the seeds for the last, as Osama bin Laden readily admitted.

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The Importance of Free Immigration

Judge Andrew Napolitano has incensed critics of immigration with his defence of the idea of immigration as a natural right:

Since the freedom of speech, the development of personality, the right to worship or not to worship, the right to use technologically contemporary means for self-defense, the right to be left alone, and the right to own and use property all stem from our humanity, the government simply is without authority to regulate human behavior in these areas, no matter what powers it purports to give to itself and no matter what crises may occur. Among the rights in this category is the freedom of movement, which today is called the right to travel.

The right to travel is an individual personal human right, long recognized under the natural law as immune from governmental interference. Of course, governments have been interfering with this right for millennia. The Romans restricted the travel of Jews; Parliament restricted the travel of serfs; Congress restricted the travel of slaves; and starting in the late 19th century, the federal government has restricted the travel of non-Americans who want to come here and even the travel of those already here. All of these abominable restrictions of the right to travel are based not on any culpability of individuals, but rather on membership in the groups to which persons have belonged from birth.

Americans are not possessed of more natural rights than non-Americans; rather, we enjoy more opportunities to exercise those rights because the government is theoretically restrained by the Constitution, which explicitly recognizes the natural law. That recognition is articulated in the Ninth Amendment, which declares that the enumeration of certain rights in the Constitution shall not be used by the government as an excuse to deny or disparage other unnamed and unnamable rights retained by the people.

So, if I want to invite my cousins from Florence, Italy, to come here and live in my house and work on my farm in New Jersey, or if a multinational corporation wants the best engineers from India to work in its labs in Texas, or if my neighbor wants a friend of a friend from Mexico City to come here to work in his shop, we have the natural right to ask, they have the natural right to come here, and the government has no moral right to interfere with any of these freely made decisions.

I agree with Napolitano. Giving the state the power to restrict freedom of movement is a dangerous precedent, and a dangerous concentration of power. Powerful and well-connected groups and industries can use the largesse of the state to protect their own uncompetitive ventures by restricting immigration.

And why should the state have the power to determine who can and who cannot live where? Surely market forces are a better determinant of the need for workers and migration than a central planner setting migration targets based on their own dislocated criteria?

These are by no means the most significant arguments for the freedom of movement. Ludwig von Mises theorised:

vonMisesimmigration

This is a critical dynamic. If a government enacts laws that are undesirable, workers (if they can) will move to another jurisdiction with more desirable laws. Freedom of movement is the status quo today for capital — under the current global regulatory framework, the free flow of capital means that governments have to compete to attract capital from around the globe. Governments do not have to do the same thing for labour, as the flow of immigration is very restricted compared to the flow of capital. This disparity may well have contributed to the extant reality that around the world — but particularly in the United States — capital’s share of output is increasing, while labour’s share is shrinking. Freer immigration could change all that.

There are various misconceptions of immigration. Perhaps most prominent is the idea that immigrants cost natives jobs. But the evidence suggests that this is not true. Eduardo Porter notes:

For years, economists have been poring through job market statistics looking for evidence that immigrants undercut less-educated Americans in the labor market. The most recent empirical studies conclude that the impact is slight: they confirm earlier findings that immigration on the whole has not led to fewer jobs for American workers. More significantly, they suggest that immigrants have had, at most, a small negative impact on the wages of Americans who compete with them most directly, those with a high school degree or less.

Meanwhile, the research has found that immigrants – including the poor, uneducated ones coming from south of the border — have a big positive impact on the economy over the long run, bolstering the profitability of American firms, reducing the prices of some products and services by providing employers with a new labor source and creating more opportunities for investment and jobs. Giovanni Peri, an economist at the University of California at Davis, estimated that the wave of immigrants that entered the United States from 1990 to 2007 increased national income per worker by about $5,400 a year on average, in 2007 dollars. He also concluded that the wave had a small positive impact on the average wage of American workers, by lifting the overall economy. If immigrants hurt anyone, it was the previous cohort of immigrants, with whom they most directly compete in the labor market.

Recent estimates have concluded that a liberalisation of global immigration policies could lift global GDP significantly. More importantly, empirical studies have confirmed the reality that immigration eases the fiscal balance — helpful for developed countries with ageing populations and a shrinking tax base. A 2011 report by Madeleine Zavodny of the American Enterprise Institute found that immigrants on average pay much more tax than they consume in government services:

fiscalimpact

This means that one frequent objection to immigration — that immigrants overstretch government programs and infrastructure — is irrelevant. Working immigrants pay more than enough in taxes to fund their own costs — often many times over.

The study also found that rather than taking up jobs, each immigrant worker generated jobs for the native population. The supply of work is not fixed. Each additional 100 H1-B workers were found to have generated 183 new jobs for the native population, and each 100 additional H2-B workers generated 464 new jobs for the native population.

But what about the countries that immigrants leave behind? Surely the countries left behind by thousands or millions of workers will fall into recession? Well, perhaps to some extent — although not so much in countries with higher birth rates or slack employment — but that’s the point. Countries that suffer a labour drain may have to reform their legal and political structure to attract workers. This alone would significantly boost competitiveness in the long run. And emigrants frequently send money back to their country of origin, and acquire new skills while working abroad that they can bring back home, in turn enriching their home country.

On the other hand, it might be unwise for countries to immediately switch from a restrictive policy to an open-door immigration policy. While freedom of movement is an essential economic freedom, a radical change in policy could prove destabilising, and cause significant cultural and social dislocation, friction or ghettoisation. Such a large change in policy should be undertaken slowly and cautiously — it would be unwise for governments to rush forward with policies that are unwanted and unpopular with the wider population.

But in the long run, though, the benefits of freedom of movement are clear, and will likely become clearer in the coming decades as more countries and blocs experiment with freer migration policies.

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The Return of Mercantilism

Mercantilist trade policies have returned in a big, big way.

Dani Rodrik:

The liberal model views the state as necessarily predatory and the private sector as inherently rent-seeking. So it advocates a strict separation between the state and private business. Mercantilism, by contrast, offers a corporatist vision in which the state and private business are allies and cooperate in pursuit of common objectives, such as domestic economic growth or national power.

The mercantilist model can be derided as state capitalism or cronyism. But when it works, as it has so often in Asia, the model’s “government-business collaboration” or “pro-business state” quickly garners heavy praise. Lagging economies have not failed to notice that mercantilism can be their friend. Even in Britain, classical liberalism arrived only in the mid-nineteenth century – that is, after the country had become the world’s dominant industrial power.

A second difference between the two models lies in whether consumer or producer interests are privileged. For liberals, consumers are king. The ultimate objective of economic policy is to increase households’ consumption potential, which requires giving them unhindered access to the cheapest-possible goods and services.

Mercantilists, by contrast, emphasize the productive side of the economy. For them, a sound economy requires a sound production structure. And consumption needs to be underpinned by high employment at adequate wages.

These different models have predictable implications for international economic policies. The logic of the liberal approach is that the economic benefits of trade arise from imports: the cheaper the imports, the better, even if the result is a trade deficit. Mercantilists, however, view trade as a means of supporting domestic production and employment, and prefer to spur exports rather than imports.

Today’s China is the leading bearer of the mercantilist torch, though Chinese leaders would never admit it  – too much opprobrium still attaches to the term.

I have three things to add.

First, states around the world including in the West, and especially America, have massively adopted corporatist domestic policies, even while spouting the rhetoric of free trade and economic liberalism publicly. One only has to look at the growth trend in American Federal spending to see that America has drifted further and further and further away from its free market rhetoric, and toward a centrally planned economy.

Second, the key difference between a free market economy, and a corporatist command economy is the misallocation of capital by the central planning process. While mercantile economies can be hugely productive, the historic tendency in the long run has been toward the command economies — which allocate capital based on the preferences of the central planner — being out-innovated and out-grown by the dynamic free market economies, which allocate capital based on the spending preferences of consumers in the wider economy.

Third, these two facts taken together mean that the inherent long-term advantage of the free market system — and by implication, of the United States over the BRICs — has to some degree been eradicated. This means that the competition is now over who can run the most successful corporatist-mercantilist system. The BRIC nations, particularly China, are committed to domestic production and employment, to domestic supply chains and domestic resource strength. America continues to largely ignore such factors, and allow its productive base to emigrate to other nations. And the production factor in which America still has some significant advantage — design, innovation, and inventions — has been eroded by the fact that the BRIC nations can easily appropriate American designs and innovations, because these designs are now being manufactured predominantly outside of America, and because of (American) communication technologies like the internet. This is the worst of both worlds for America. All of the disadvantages of mercantilism — the rent-seeking corporate-industrial complex, the misallocation of capital through central planning, the fragility of a centralised system — without the advantage of a strong domestic productive base.

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Why Modern Monetary Theory is Wrong About Government Debt

I’ve taken some criticism — particularly from advocates of modern monetary theory and sectoral balances and all that — for using total debt rather than just private debt in my work.

The modern monetary theory line (in one sentence, and also in video form) is that government debt levels are nothing to worry about, because governments are the issuer of the currency, and can always print more.

This evokes the words of Alan Greenspan:

The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.

Of course, the point I am trying to make in worrying about total debt levels is not the danger of mass default (although certainly default cascades a la Lehman are a concern in any interconnective financial system), but that large debt loads can lead to painful spells of deleveraging and economic depression as has occurred in Japan for most of the last twenty years (where twenty years of crunching debt deflation has preceded Japan electing a leader who seems hell-bent on trying to start a war with China, but that is another story for another day):

Japan-Debt-Hoisington-27

Of course, before the crisis in America (as was the case in Japan at the beginning of their crisis) government debt was not really a great contributor to the total debt level , meaning that the total debt graph looks far more similar to the private debt line than the public debt line, which means that when I talk about the dangers of growing total debt I am talking much more about private debt than public debt:

010212_2140_TheDebtwatc1

But what Japan empirically illustrates is the fact that all debt matters. Japan’s private debt levels have reset to below the pre-crisis norm, yet the economy remains depressed while public debt continues to climb (both in absolute terms, and as a percentage of GDP). If excessive private debt was the sole factor in Japan’s depression, Japan would have recovered long ago. What we have seen in Japan has been the transfer of the debt load from the private sector to the public, with only a relative small level of net deleveraging.

And high and growing public sector deficits lead to contractionary tax hikes and spending cuts. This happened time and again during Japan’s lost decades. Peter Tasker of the Financial Times writes:

When Japan’s bubble economy imploded in the early 1990s, public finances were in surplus and government debt was a mere 20 per cent of gross domestic product. Twenty years on, the government is running a yawning deficit and gross public debt has swollen to a sumo-sized 200 per cent of GDP.

How did it get from there to here? Not by lavish public spending, as is sometimes assumed. Japan’s experiment with Keynesian-style public works programmes ended in 1997. True, they had failed to trigger durable economic recovery. But the alternative hypothesis – that fiscal and monetary virtue would be enough – proved woefully mistaken. Economic growth had been positive in the first half of the “lost decade”, but after the government raised consumption tax in 1998 any momentum vanished. Today Japan’s nominal GDP is lower than in 1992.

The real cause of fiscal deterioration was the damage done to tax revenues by this protracted slump. Central government outlays as a percentage of GDP are no higher now than in the early 1980s, but the tax take has fallen by 5 per cent of GDP since 1989, the year that consumption taxes were introduced.

A rise in debt relative to income has historically tended to lead to contractionary deleveraging irrespective of whether the debt is public or private.

The notion at the heart of modern monetary theory that governments that control their own currency do not have to engage in contractionary deleveraging remains largely ignored. Just because nations can (in a worst case scenario) always print money to pay their debt, doesn’t mean that they will always print money to pay their debt. They will often choose to adopt an austerity program (as is often mandated by the IMF), or default outright instead (as happened in Russia in the 1990s).

And what governments cannot guarantee is that the money they print will have value. This is determined by market participants. In the real economy people in general and creditors (and Germans) in particular are very afraid of inflation and increases in the money supply. History is littered with currency collapses, where citizens have lost confidence in the currency (although in truth most hyperinflations have occurred after some great shock to the real economy like a war or famine, and not solely as a result of excessive money printing).

And there has always been a significant danger of deleterious currency, trade and political retaliations by creditors and creditor nations, as a result of the perception of “money printing”. Many, many wars have been fought over national debts, and over currencies and their devaluation. One only has to look at China’s frustrated rhetoric regarding America’s various monetary expansions, the fact that many Eurasian creditor nations are moving away from the dollar as a reserve currency, as well as the growth of American-Chinese trade measures and retaliations, to see how loose policy (of a far lesser order than the sort of thing advocated in modern monetary theory) can exacerbate frictions in the global currency system.

Governments controlling their own currencies are likely to continue to defy the prescriptions of the modern monetary theorists for years to come. And that means that expansionary increases in government debt relative to the underlying economy will continue to be a prelude to contractionary deleveraging, just as is the case with the private sector. All debt matters.

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The Growing Probability of a One State Solution

The unstoppable force of Israel’s settlement movement is about to hit the immovable object of Israel’s desire to be a Jewish-majority democracy.

Israeli politicians may have paid a whole lot of lip-service to the notion of a two-state solution over the years, but they continue to carve up and settle the very land that that Palestinian state would be founded upon.

Mahmoud Abbas is calling their bet. He is now threatening to disband the Palestinian authority and hand over control of the West Bank to Israel in retaliation for Israel’s ongoing settlement building activities:

Palestinian president, Mahmoud Abbas, said he will hand over responsibilty for the West Bank to Israel if peace talks are not renewed after Israel’s elections, Haaretz newspaper reported on Thursday.

In an interview with the Israeli newspaper, Abbas said he would relinquish control and disband the Palestinian authority if there was no progress after January 22.

This — if carried through — is quite literally the single smartest thing any Palestinian leader has ever done. As Jeffrey Goldberg noted back in November:

There is a strategy the Palestinians could implement immediately that would help move them toward independence: They could give up their dream of independence.

It’s a very simple idea. When Abbas goes before the UN, he shouldn’t ask for recognition of an independent state. Instead, he should say the following: “Israel occupied the West Bank and Gaza 45 years ago, and shows no interest in letting go of the West Bank, in particular.We, the Palestinian people, recognize two things: The first is that we are not strong enough to push the Israelis out. Armed resistance is a path to nowhere. The second is that the occupation is permanent. The Israelis are here to stay. So we are giving up our demand for independence. Instead, we are simply asking for the vote. Israel rules our lives. We should be allowed to help pick Israel’s rulers.”

Reaction would be seismic and instantaneous. The demand for voting rights would resonate with people around the world, in particular with American Jews, who pride themselves on support for both Israel and for civil rights at home. Such a demand would also force Israel into an untenable position; if it accedes to such a demand, it would very quickly cease to be the world’s only Jewish-majority state, and instead become the world’s 23rd Arab-majority state. If it were to refuse this demand, Israel would very quickly be painted by former friends as an apartheid state.

Israel’s response, then, can be reasonably predicted: Israeli leaders eager to prevent their country from becoming a pariah would move to negotiate the independence, with security caveats, of a Palestinian state on the West Bank, and later in Gaza, as well. Israel would simply have no choice.

This is the very best chance that the Palestinians have of getting a state, and if not a state at least equal democratic rights and some kind of peace. By accepting Israeli rule, Israel would be forced to choose between offering citizenship to the millions of Arabs living in the land it controls (endangering Israel’s status as a Jewish-majority state), or losing its status as a democracy (by denying West Bank Arabs votes) which has brought it significant international support and millions of dollars of aid. Goldberg’s theory is that Israel would choose to remain Jewish-majority, bring the settlement movement under control and relinquish land to the West Bank Arabs to found a Palestinian state.

But I don’t think that Israelis will overwhelmingly choose to abandon the settlements and retreat to the ’67 borders. The growth of Naftali Bennett’s Jewish Home party which advocates for a one state solution where West Bank Arabs are left without voting rights illustrates this very well. So too does Likud’s recent transformation into a party largely opposed to the two-state solution, under the control of hardliners like Moshe Feiglin and Danny Danon.

Indeed, the religious right in Israel appears wholly committed to the idea of not giving up an inch of the biblical land of Israel:

510px-Early-Historical-Israel-Dan-Beersheba-Judea-Corrected

The interesting thing is that Gaza is not part of that historic territory. It is often said that including the entirety of the Palestinian territories, Jews and Arabs are very close in population — according to 2007 data, there are 5,300,000 Arabs, and 6,000,000 Jews. However discluding Gaza, Jews retain a large majority — 6,000,000 against just 3,700,000 Arabs. What this means is that by withdrawing from Gaza as Sharon did, Israel could in theory annex the West Bank, grant full-citizenship to the Arab residents (and so remain a democracy), and remain heavily Jewish-majority for the foreseeable future.

This simple fact means that the likeliest compromise between Israel’s settlement movement and its desire to portray itself as a Jewish-majority democracy is the annexation of only the West Bank, leaving Gaza to either merge with Egypt — increasingly likely given the well-known ties between Hamas and the Muslim Brotherhood — or to exist as the Palestinian state.

While some like Naftali Bennett may push to keep West Bank Arabs from getting Knesset votes, Israel’s Jewish-majority status would not be threatened by every single West Bank Arab receiving a Knesset vote. This may very well be the best that West Bank Arabs can hope for — they are already under Israeli rule backed by overwhelming Israeli military superiority, and a diehard settlement movement, and have been for almost fifty years. And although there is significant discrimination against Arabs under Israeli rule — indeed, a majority of Israeli Jews openly advocate it —  a larger Arab voting bloc would minimise this.

Mahmoud Abbas’ threat is a wise acceptance of this reality. Israeli settlements are not going anywhere. The two state solution is effectively dead. Palestinians in the West Bank can either continue fighting futilely against an overwhelming enemy, or work toward equal rights in the state in which they now live.

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Comparative Advantage and Global Trade Fragility

One of the cornerstones of the global economic status quo is globalisation and integration of markets. Here’s the growth in world trade as a percentage of global GDP since the 1970s:

worldtrade

There have been two key forces behind this outgrowth in global trade. First of all, the American military acting as hegemonic global policeman with bases in more than 150 countries and backed has created a situation generally known as the Pax Americana where goods and intermediaries can be shipped around the globe with minimal fear of piracy, seizure, theft, etc. Second, the international community has incentivised trade liberalisation through the policies of organisations including the International Monetary Fund (IMF), and World Trade Organization (WTO) requiring nations requesting loans or aid to open their markets to foreign trade competitors.

Most global policymakers and trade economists remain committed to and ultra-bullish about the agenda of global integration of markets. The OECD claims:

If G20 economies reduced trade barriers by 50%, they could gain:

More jobs: 0.3% to 3.3% rise in jobs for lower-skilled workers and 0.9 to 3.9% for higher-skilled workers, depending on the country.

Higher real wages 1.8% to 8% increase in real wages for lower-skilled workers and 0.8% to 8.1% for higher-skilled workers, depending on the country.

Increased exports: All G20 countries would see a boost in exports if trade barriers were halved. In the long run, many G20 countries could see their exports rise by 20% and in the Eurozone by more than 10%.

The overarching intellectual motivation for these policies is found in the work of the English classical economist David Ricardo and his neoclassical successors. The concept of comparative advantage introduced by Ricardo and expanded and formalised via equilibrium models by neoclassical economists including Samuelson, Mankiw, Hecksher and Ohlin (etc) has underpinned most of these policies.

Comparative advantage is the idea that nations benefit from specialising in what they are best at. Ricardo introduced the notion during debates about Britain opening her markets to European trade. Ricardo pointed out that total output and welfare would be greater for all countries in total if they specialised in what they were best at, and traded with each other to get what they wanted.

This principle works in Ricardo’s simple verbal model (and in the more sophisticated equilibrium models developed since). However empirical studies and meta-studies of modern day trade liberalisation suggest that there are some problems with this theory in practice.

Dani Rodrik noted in 2001:

Do lower trade barriers spur greater economic progress? The available studies reveal no systematic relationship between a country’s average level of tariff and nontariff barriers and its subsequent economic growth rate. If anything, the evidence for the 1990s indicates a positive relationship between import tariffs and economic growth.

The evidence on the benefits of liberalizing capital flows is even weaker. In theory, the appeal of capital mobility seems obvious: If capital is free to enter (and leave) markets based on the potential return on investment, the result will be an efficient allocation of global resources. But in reality, financial markets are inherently unstable, subject to bubbles (rational or otherwise), panics, shortsightedness, and self-fulfilling prophecies. There is plenty of evidence that financial liberalization is often followed by financial crash — just ask Mexico, Thailand, or Turkey — while there is little convincing evidence to suggest that higher rates of economic growth follow capital-account liberalization.

So what’s the difference between theory and reality?

There are a number of potential reasons why the theoretical promise of comparative advantage has not played out in reality.

First is graft and corruption. If countries are taking on loans from international institutions, and those loans are being deposited in the Swiss bank accounts of corrupt officials or businessmen instead of being spent on improving industry, skills or infrastructure, then what chance do developing countries have of developing?

Second is the danger of bubbles during the liberalisation process. Global capital flows into newly-liberalised countries can stoke bubbles in almost every sector (but especially equities, real estate, etc). When the bubble bursts, capital flows out, leaving the domestic economy deeply depressed.

Third is the social upheaval costs to labour, skills and institutions. As we have seen in the United States, manufacturing jobs and skills migrated abroad. Workers often cannot be retrained cheaply and easily, and often do not want or cannot afford to migrate to wherever their skills would be best-compensated. This stickiness can result in endemic unemployment and resultant economic weakness.

Fourth is the cost to capital stock.

As Steve Keen noted:

Some capital is necessarily destroyed by the opening up of trade.

Since capital is destroyed when trade is liberalised, the watertight argument that trade necessarily improves material welfare springs a leak.

Converting capital stock again and again to keep up with changing economic winds can be an expensive, difficult and mistake-ridden process.

Fifth is the problem of trade fragility.  Events like natural disasters and foreign wars can disrupt production and trade flows. Specialisation could cripple a country that depends on imports from foreign disrupted countries. Dependency on imported good and intermediates renders countries vulnerable to shocks outside their borders. Wars and disasters that affect exporters have at times seriously disrupted and damaged the economies of importers, and vice verse.

The fact that trade liberalisation can have large social costs, create economic fragility and produce asset bubbles is a cause for pause. Is IMF-imposed globalisation opposed by the wider public really producing freer markets, or is it a misguided central planning experiment? Has the dogmatic pursuit of globalisation left global industry fragile to supply chain shocks caused by natural disasters and wars? Can the status quo really even be considered free trade, given that it is supported and smoothed by huge military-industrial subsidies? Does freedom of trade not also include freedom of nations to choose to protect domestic industries, institutions and supply chains from foreign competition? Why should the industries of developing countries be expected to compete against corporate multinational juggernauts?

While global trade may have provide a major disincentive against trade-disrupting wars, it seems probable that it has created a deep underlying systemic fragility. Trade interdependence means that regional or domestic shocks to production like a war or natural disaster may have consequences throughout the entire world, transmitted through dependencies. Similarly to the interconnective global financial system and the 2008 financial crisis, geopolitical shocks in coming years may well be magnified by globalisation.

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How Palestinians Can Finally Achieve Independence

Jeffrey Goldberg’s suggestion:

There is a strategy the Palestinians could implement immediately that would help move them toward independence: They could give up their dream of independence.

It’s a very simple idea. When Abbas goes before the UN, he shouldn’t ask for recognition of an independent state. Instead, he should say the following: “Israel occupied the West Bank and Gaza 45 years ago, and shows no interest in letting go of the West Bank, in particular. We, the Palestinian people, recognize two things: The first is that we are not strong enough to push the Israelis out. Armed resistance is a path to nowhere. The second is that the occupation is permanent. The Israelis are here to stay. So we are giving up our demand for independence. Instead, we are simply asking for the vote. Israel rules our lives. We should be allowed to help pick Israel’s rulers.”

Reaction would be seismic and instantaneous. The demand for voting rights would resonate with people around the world, in particular with American Jews, who pride themselves on support for both Israel and for civil rights at home. Such a demand would also force Israel into an untenable position; if it accedes to such a demand, it would very quickly cease to be the world’s only Jewish-majority state, and instead become the world’s 23rd Arab-majority state. If it were to refuse this demand, Israel would very quickly be painted by former friends as an apartheid state.

Israel’s response, then, can be reasonably predicted: Israeli leaders eager to prevent their country from becoming a pariah would move to negotiate the independence, with security caveats, of a Palestinian state on the West Bank, and later in Gaza, as well. Israel would simply have no choice.

This follows my own train of thought very precisely. Trying to fight the world’s second or third most powerful military with small artillery is a dead end that just kills Palestinians and gives Israel an excuse to continue the blockade of Gaza. Palestinian resistance has just hardened Israelis in their determination to hold onto the land. Violence has failed the Palestinians, and will continue to fail the Palestinians. In order to move forward, Palestinians need to completely reject violence, recognise the reality of the state of Israel and demand voting rights in the state under whose authority they now reside.

Goldberg concludes that none of this will happen because the Palestinians are shortsighted. Maybe, but maybe not. Shortsightedness can easily be corrected.