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Currency Wars Are Trade Wars

Paul Krugman is all for currency wars, but not trade wars:

First of all, what people think they know about past currency wars isn’t actually true. Everyone uses some combination phrase like “protectionism and competitive devaluation” to describe the supposed vicious circle of the 1930s, but as Barry Eichengreen has pointed out many times, these really don’t go together. If country A and country B engage in a tit-for-tat of tariffs, the end result is restricted trade; if they each try to push their currency down, the end result is at worst to leave everyone back where they started.

And in reality the stuff that’s now being called “currency wars” is almost surely a net plus for the world economy. In the 1930s this was because countries threw off their golden fetters — they left the gold standard and this freed them to pursue expansionary monetary policies. Today that’s not the issue; but what Japan, the US, and the UK are doing is in fact trying to pursue expansionary monetary policy, with currency depreciation as a byproduct.

There is a serious intellectual error here, typical of much of the recent discussion of this issue. A currency war is by definition a low-level form of a trade war because currencies are internationally traded commodities. The intent (and there is much circumstantial evidence to suggest that Japan at least is acting with mercantilist intent, but that is another story for another day) is not relevant — currency depreciation is currency depreciation and still has the same effects on creditors and trade partners, whatever the claimed intent.

Krugman cites Barry Eichengreen as evidence that competitive devaluation does not necessarily mean a trade war, but Eichengreen does not address the issue of a trade war directly, much less denying the possibility of one.  Indeed, while broadly supportive of competitive devaluation Eichengreen notes that the process was “disorderly and disruptive”.

And the risks of disorder and disruption are still very real today.

As Mark Thoma noted in 2010:

While the positive effects a currency war produced in the 1930s are unlikely to reappear, there is a chance of large negative effects such as a simultaneous trade war or the breakdown of the international monetary system, so let’s hope a currency war can be avoided.

The mechanism here is very simple. Some countries — those with a lower domestic rate of inflation, like Japan — have a natural advantage in a currency war against countries with a higher domestic rate of inflation like Brazil and China. If one side runs out of leverage to debase their currency because of heightened domestic inflation, their next recourse is to resort to direction trade measures like quotas and tariffs.

And actually, the United States and China in particular have been engaging in a low-level trade and currency war for a long time.

As I noted last year:

China and Russia and Brazil have all recently expressed deep unease at America’s can-kicking and money-printing mentality. This is partly because American money printing has exported inflation to the world, as a result of the dollar’s role as the global reserve currency, and partly because these states already own a lot of American debt, and do not want to be paid off in hugely-debased money.

Since I made that statement, there has been a great lot of debasement without any great spiral of damaging trade measures. But with the world locked into ever greater monetary and trade interdependency, and with fiery trade rhetoric continuing to spew forth from the BRIC nations, who by-and-large seem to continue to believe that American money-printing is damaging their interests, and who in the past two years have put together a new global reserve currency framework, it would be deeply complacent to believe that the risks of a severe trade war have gone away.

(Unfortunately, Krugman and Eichengreen both seem to discount the reality that Okun’s law has broken down, and that monetary expansion today is supporting crony industries, and exacerbating income inequality, but those are another story for another day)

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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:

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 often 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 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 policy of a far lesser order than the sort of thing advocated in modern monetary theory can exacerbate frictions in the global currency system (although nothing bad has come to pass yet).

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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Iran’s Imminent Nuclear Weapon

Here’s some context behind the claims that Iran will imminently possess a nuclear weapon.

It started a long time ago (but not, unfortunately, in a galaxy far, far away):

1984: Soon after West German engineers visit the unfinished Bushehr nuclear reactor, Jane’s Defence Weekly quotes West German intelligence sources saying that Iran’s production of a bomb “is entering its final stages.”US Senator Alan Cranston claims Iran is seven years away from making a weapon.

Seven years away? And did they have a bomb in 1991?

1992: Israeli parliamentarian Binyamin Netanyahu tells his colleagues that Iran is 3 to 5 years from being able to produce a nuclear weapon – and that the threat had to be “uprooted by an international front headed by the US.”

1992: Israeli Foreign Minister Shimon Peres tells French TV that Iran was set to have nuclear warheads by 1999. “Iran is the greatest threat and greatest problem in the Middle East,” Peres warned, “because it seeks the nuclear option while holding a highly dangerous stance of extreme religious militancy.”

1992: Joseph Alpher, a former official of Israel’s Mossad spy agency, says “Iran has to be identified as Enemy No. 1.” Iran’s nascent nuclear program, he told The New York Times, “really gives Israel the jitters.”

So was there a bomb by the late 1990s?

1995: The New York Times conveys the fears of senior US and Israeli officials that “Iran is much closer to producing nuclear weapons than previously thought” – about five years away – and that Iran’s nuclear bomb is “at the top of the list” of dangers in the coming decade. The report speaks of an “acceleration of the Iranian nuclear program,” claims that Iran “began an intensive campaign to develop and acquire nuclear weapons” in 1987, and says Iran was “believed” to have recruited scientists from the former Soviet Union and Pakistan to advise them.

1997: The Christian Science Monitor reports that US pressure on Iran’s nuclear suppliers had “forced Iran to adjust its suspected timetable for a bomb. Experts now say Iran is unlikely to acquire nuclear weapons for eight or 10 years.“

So now we’re looking at a nuclear-armed Iran by 2007. Scary stuff, right?

2007: President Bush warns that a nuclear-armed Iran could lead to “World War III.” Vice President Dick Cheney had previously warned of “serious consequences” if Iran did not give up its nuclear program.

2007: A month later, an unclassified National Intelligence Estimate (NIE) on Iran is released, which controversially judges with “high confidence” that Iran had given up its nuclear weapons effort in fall 2003.

June 2008: Then-US Ambassador to the United Nations John Bolton predicts that Israel will attack Iran before January 2009, taking advantage of a window before the next US president came to office.

May 2009: US Senate Foreign Relations Committee reports states: “There is no sign that Iran’s leaders have ordered up a bomb.”

And Iran still doesn’t have a bomb today — all of those reports, all of that scaremongering and warmongering was wrong. Both the CIA and Mossad agree that there is no specific evidence that Iran is working on nuclear weapons today. And many experts believe that even if Iran were working on a bomb it could take up to ten to fifteen years.

Yet, it seems that nothing except a war will satisfy Binyamin Netanyahu, who felt the same way about Iraq:

There is no question whatsoever that Saddam is working towards nuclear weapons.

And how did that work out? A hugely expensive war and occupation, American imperial overstretch, thousands of dead soldiers, hundreds of thousands of dead Iraqis and no weapons of mass destruction. We should judge people on their predictive record.

On one level, I understand Netanyahu’s paranoia especially in the context of the 20th Century and the holocaust. Iranian Generals have talked about annihilating Israel.

In August 2012, Brigadier General Gholam Reza Jalali, who heads Iran’s Passive Defence Organisation, said “No other way exists apart from resolve and strength to completely eliminate the aggressive nature and to destroy Israel.”  And just six days ago in September 2012 Brigadier General Amir Ali Hajizadeh threatened to attack Israel and trigger World War III, saying that “it is possible that we will make a pre-emptive attack” which would “turn into World War III.” In the same statement, Hajizadeh threatened to attack American bases in the Middle East as well. Hajizadeh said that as a result of this attack, Israel would “sustain heavy damage and that will be a prelude to its obliteration.”

All disturbing rhetoric, yet almost certainly baseless threats given the context of Iran’s technological and military disadvantage. Iranian missiles fired at Israel would likely be shot down long before they reached Israeli airspace by Israel’s advanced missile defence systems that can intercept even short-range fire from Gaza and Lebanon. And Israel’s nuclear submarines in the Persian Gulf would almost certainly retaliate in kind. As Shimon Peres noted in 2006: “The President of Iran should remember that Iran can also be wiped off the map.” Most importantly, if Iran attacked Israel, it seems far less likely that other powers would come to Iran’s aid.

Yet an attack on Iran by Israel could well trigger a larger conflict, sucking in Iran’s trade partners who do not want to see the flow of oil and resources out of Iran disrupted. Just this week China announced new contracts to provide super-tankers to deliver oil from Iran to China. Would Russia and China sit idly by and see their Iranian investments liquidated while America and Israel invade Iran and destroy its infrastructure? Would they sit idly by and see their ally deposed? China and Pakistan have both hinted that they could defend Iran if Iran were attacked. An attack on or invasion of Iran is an incredibly risky adventure — and in my view the real danger to Israel. And for what? To discover that like Saddam Hussein, Ahmadinejad is not working on a nuclear weapon, and all the hot air about weapons of mass destruction is once again just bullshit?

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Netanyahu’s Red Line

Netanyahu wants a red line on nuclear proliferation in the Middle East:

Where exactly should we draw it?

As Justin Raimondo notes:

Here is a nation which refuses to even admit it acquired nukes long ago, and which disdains the Nonproliferation Treaty, making the case for war against a neighbor that has indeed signed the NPT and is abiding by its requirements.

That treaty gives Tehran the right to develop nuclear power. Furthermore, there is zero evidence Iran is embarked on a nuclear weapons program: our own intelligence community tells us they gave that up in 2003 and show no signs of resuming it. Their own religious and political leaders have denounced the possession of nuclear weapons as sinful: the Israelis, on the other hand, haven’t bothered reassuring us they would never use the nuke they won’t admit they have.

In a rational world, Israel would be in the dock, answering for its unwillingness to come out of the nuclear closet and admit what the whole world knows by now.

The West has sent out a message that the only way for unpopular regimes to avoid invasion is to obtain nuclear weapons. North Korea sought and obtained nuclear weapons and their vicious and economically-failed regime has stayed in power. Qaddafi gave up his nuclear ambitions, and was soon deposed by British, French and American airpower. If Iran is seeking a nuclear weapon — and the CIA and Mossad, as well as the IAEA agree they that they are not currently doing so — perhaps the fact that nuclear-armed Israel and the nuclear-armed United States keep threatening non-nuclear Iran with attack has something to do with it?

And even assuming that they are going for a nuclear weapon, how close is Iran to a nuclear weapon? According to former IAEA consultant Clinton Bastin, possibly as much as ten to fifteen years away:

Dear Prime Minister Netanyahu:

Iran may be in your red zone, but can not score.

Sure, Iran could divert a few tons of 3.5% or a ton of 20% enriched uranium hexaflouride gas for enrichment to 90+%. But what then?

No one has ever made a nuclear weapon from gas. It must be converted to metal and fabricated into components which are then assembled with high explosives.

Iran lacks experience with and facilities for these processes which are very dangerous because of potential for a criticality accident or nuclear explosion. Iran would not jeopardize its important, fully safeguarded nuclear programs by an attempt to have a deliverable, one kiloton yield nuclear weapon ten to fifteen years later.

IMPORTANT NOTE: North Korea was able to make and test a nuclear explosive soon after withdrawing from safeguards because plutonium for reactor recycle was in a form usable for a weapon.

So let’s be clear about who is threatening who:

How would Americans feel if Iran had stationed troops and aircraft on the Mexican and Canadian borders and conducted military excursions into American territory, including funding and training armed dissidents to overthrow the American government (as happened to Iran in 1953 when America overthrew a democratically-elected Iranian government and imposed a dictatorship there)? How would Americans feel if Iran, Russia and China were blowing up American scientists and using computer viruses to attack American infrastructure? How would Americans feel if Iran, Russia and China imposed sanctions on America that led to hyperinflation of the dollar?  Under those circumstances, would America not seek the means to defend itself?

Iran is not blameless, and continues to provoke Israel through its support for Hamas and Hezbollah and through eliminationist rhetoric. But given the level of provocation from the Israeli and American side, it is astonishing that Iran remains free of nuclear weapons. Yet it is a fact that Iran is not armed with nuclear weapons, and it remains a fact that Iran has not attacked nor occupied any foreign lands since World War 2. Iran is not an expansionistic country.

As neocon provocateur Patrick Clawson essentially admitted in advocating for a false flag attack to get America to war, Iran is not likely to attack either the United States or Israel. So when it comes to drawing red lines, we in the West would do well to draw a red line around our behaviour — because right now, we in the West are the ones who are stirring up trouble by threatening to strike first.

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Why I Still Fear Inflation

Paul Krugman wonders why others worry about inflation when he sees no evidence of inflationary trends:

Joe Wiesenthal makes the well-known point that aside from certain euro area countries, yields on sovereign debt have plunged since 2007; investors are rushing to buy sovereign debt, not fleeing it. I was a bit surprised by his description of this insight as being non-”mainstream”; I guess it depends on your definition of mainstream. But surely the notion that what we have is largely a process of private-sector deleveraging, with government deficits the consequence of this process, and interest rates low because we have an excess of desired saving, is pretty widespread (and backed by a lot of empirical evidence).

And there’s also a lot of discussion, which I’m ambivalent about, concerning the supposed shortage of safe assets; this is coming from bank research departments as well as academics, it’s a frequent topic on FT Alphaville, and so on. So Joe didn’t seem to me to be saying anything radical.

But those comments! It’s not just that the commenters disagree; they seem to regard Joe as some kind of space alien (or, for those who had the misfortune to see me on Squawk Box, a unicorn); they consider it just crazy and laughable to suggest that we aren’t facing an immense crisis of public deficits with Zimbabwe-style inflation just around the corner.

Krugman, of course, thinks it crazy and laughable that in the face of years of decreasing interest rates that anyone would believe that inflation could still be a menace. In fact, Krugman has made the point multiple times that more inflation would be a good thing, by decreasing the value of debt and thus allowing the private sector to deleverage a little quicker.

I remain convinced — even having watched Peter Schiff and Gonzalo Lira make incorrect inflationary projections — that there is exists the potential of significant inflationary problems in the medium and long term. Indeed, I believe elevated inflation is one of three roads out of where we are right now — the deleveraging trap.

In my worldview, this depression — although a multi-dimensional thing — has one cause above all others: too much total debt. Debt-as-a-percentage of GDP has grown significantly faster than productivity:

The deleveraging trap begins with the boom years: credit is created above and beyond the economy’s productive capacity. Incomes rise and prices rise above the rate of underlying productivity. And as the total debt level increases, more and more income that was once used for investment and consumption goes toward paying down debt and interest. This means that inflated asset prices become less and less sustainable, making the economy more and more susceptible to a downturn — wherein asset prices deflate, and the value of debt (relative to income) increases further. Under a non-interventionist regime, once the downturn occurs, this would result in credit freeze, mass default and liquidation, as occurred in 1907.

However, under an interventionist regime — like the modern Federal Reserve, or the Bank of Japan — the central bank steps in to lower rates and print money to support asset prices and bail out failed companies. This prevents the credit freeze, mass default, drastic deflation and liquidation. Unfortunately, it also sustains the debt load — following 2008, total debt remains over 350% of GDP. The easy money leads to a short cycle of expansion and growth, but the continued existence of the debt load means that consumers and businesses will still have to set aside a large part of their incomes to pay down debt. This means that any expansion will be short lived, and once the easy money begins to dry up, asset prices will again begin to deflate. The downward pressure on prices, spending and investment from the excessive debt load is huge, and requires sustained and significant central bank intervention to support asset prices and credit availability. The economy is put on life-support. Debt-as-a percentage of GDP may gradually fall (although in the Japanese example, this has not been the case) but progress is slow, and the debt load remains unsustainable.

A fundamental mistake is identifying the problem as one of aggregate demand, and not debt. Lowered aggregate demand is a symptom of the deleveraging trap caused by excessive debt and unsustainable asset prices. The Fed — and advocates of greater Fed interventionism to support aggregate demand, like Krugman — are mostly advocating the treatment of symptoms, not causes. And the treatment in this case may make the underlying causes worse — quantitative easing and low-interest rates are debt-additive policies; while supporting assets prices and GDP, they encourage the addition of debt. 

There are three routes out of the deleveraging trap; liquidation (destroying the debt via mass default), debt forgiveness (destroying the debt via systematically cancelling it), and inflating the debt away. Liquidation in a managed economy with a central bank is politically impossible. Debt forgiveness is politically difficult, although perhaps the most realistic effective bet. And inflating the debt away at a moderate rate of inflation would seem to be a slow and laborious process — the widely-advocated suggestion of a 4% inflation target would only eat slowly (if at all) into the 350%+ total debt-as-a-percentage-of-GDP load.

All three exit routes seem blocked. So the reality that we are staring at — and have been staring at for the last four years — has been remaining in the deleveraging trap.

So why in a deflationary environment like the deleveraging trap would I fear high inflation? Surely this is an absurd and unfounded fear?

Well,  Japan shows that nations can remain stuck in a deleveraging trap for a long, long time — although Japan has had to take to increasingly authoritarian measures such as mandating the purchase of treasury debt to keep rates low and so to keep the debt rolling. But eventually nations stuck in a deleveraging trap will have to take one of the routes out. While central banks refuse to consider the possibility of a debt jubilee, and refuse to consider the possibility of allowing markets to liquidate, the only route out remains inflation. 

Yet the big inflation that would be required to eject the United States from the deleveraging trap makes creditors — the sovereign states from which the US imports huge quantities of resources, energy, components, and finished goods — increasingly jittery.

According to Xinhua:

The U.S. has long been facing the same problem: living beyond its means. At present, the country has debts as high as 55 trillion U.S. dollars, including more than 14 trillion U.S. dollars of treasury bonds.

And last October:

Economists agree that as the United States’ largest foreign creditor, China should contemplate ways to pull itself out of the “dollar trap,” as the U.S. economy is faltering with its debt piling up and its currency on the brink to depreciate.

China must make fuller use of the non-financial assets in its foreign reserves, as well as speed up the diversification of investing channels to resist a possible long-term weakening of the dollar, said Xia Bing, director of the Finance Research Institutes of the Development Research Center under the State Council.

Zheng Xinli, permanent vice chairman of China Center for International Economic Exchanges, has suggested that Chinese companies boost overseas investment as a way to absorb trade surpluses and fend off the dollar risk.

And it’s not like America’s Eurasian creditors are doing nothing about this. As I wrote earlier this month:

If the exporter nations feel as if they are getting screwed, they are only more likely to escalate via the only real means they have — trade war. And having a monopoly on various resources including rare earth minerals (as well as various components and types of finished goods) gives them considerable leverage.

More and more Asian nations — led by China and Russia — have ditched the dollar for bilateral trade (out of fear of dollar instability). Tension rises between the United States and Asia over Syria and Iran. The Asian nations throw more and more abrasive rhetoric around — including war rhetoric.

And on the other hand, both Obama and Romney — as well as Hillary Clinton — seem dead-set on ramping up the tense rhetoric. Romney seems extremely keen to brand China a currency manipulator.

The Fed is caught between a rock and a hard place. If they inflate, they risk the danger of initiating a damaging and deleterious trade war with creditors who do not want to take an inflationary haircut. If they don’t inflate, they remain stuck in a deleveraging trap resulting in weak fundamentals, and large increases in government debt, also rattling creditors. 

The likeliest route from here remains that the Fed will continue to baffle the Krugmanites by pursuing relatively restrained inflationism (i.e. Operation Twist, restrained QE, no NGDP targeting, no debt jubilee, etc) to keep the economy ticking along while minimising creditor irritation. The problem with this is that the economy remains caught in the deleveraging trap. And while the economy is depressed tax revenues remain depressed, meaning that deficits will grow, further irritating creditors (who unlike bond-flipping hedge funds must eat the very low yields instead of passing off treasuries to a greater fool for a profit) who may pursue trade war and currency war strategies and gradually (or suddenly) desert US treasuries and dollars.

Geopolitical tension would spike commodity prices. And as more dollars end up back in the United States (there are currently $5+ trillion floating around Asia), there will be more inflation still. The reduced global demand for dollar-denominated assets would put pressure on the Fed to print to buy more treasuries.

Amusingly, this kind of scenario was predicted in 2003 by Krugman himself!:

The crisis won’t come immediately. For a few years, America will still be able to borrow freely, simply because lenders assume that things will somehow work out.

But at a certain point we’ll have a Wile E. Coyote moment. For those not familiar with the Road Runner cartoons, Mr. Coyote had a habit of running off cliffs and taking several steps on thin air before noticing that there was nothing underneath his feet. Only then would he plunge.

What will that plunge look like? It will certainly involve a sharp fall in the dollar and a sharp rise in interest rates. In the worst-case scenario, the government’s access to borrowing will be cut off, creating a cash crisis that throws the nation into chaos.

This is not a Zimbabwe-style scenario, but it is a potentially unpleasant one involving a sharp depreciation of the dollar, and a significant change in the shape of the American economy (and geopolitical reality). It includes the risk of costly geopolitical escalation, including proxy war or war.

However, American primary and secondary industries would look significantly more competitive, and significant inflation — while penalising savers — would cut down the debt. Such a crisis would be painful and scary, but — so long as there is no escalation — largely beneficial.

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The Absurdity of NATO

The whole world knows the name Gavrilo Princip, and that of he man he assassinated, Archduke Franz Ferdinand. Princip’s shot triggered the Austro-Hungarian invasion of Serbia that set in motion the chain of events leading to the Great War of 1914.

After Serbia appealed to Russia for help, Russia began moving towards mobilization of its army, believing that Germany was using the crisis as an excuse to launch war in the Balkans. Upon hearing news of Russia’s general mobilization, Germany declared war on Russia. The German army then launched its attack on Russia’s ally, France, through Belgium, violating Belgian neutrality and bringing Great Britain into the war as well.

Is it possible that a similar chain of events may have already begun unfurling with the Syrian downing of a Turkish F-4 fighter jet? Turkey have already invoked a full meeting of NATO,  claimed that Syria have fired on a second Turkish plane, and vowed that Syria’s actions “won’t go unpunished”.

The vast and sprawling system of national alliances that existed prior to the events 1914 were considered by policy makers of the time to be a counterbalance against excessive tension and the threat of war. The great powers created alliances ostensibly for the purpose of deterring war. The dominant view was that the potential for dragging in allies reduced the chances of an attack. In reality, it just meant that one spark could set the entire world aflame.

This is functionally the same as the interconnecting mesh of derivatives and shadow intermediation that foreshadowed the crash of 2008. As financial parties sold each other more and more “hedges“, the consensus of the time was that this made the system safer, as it allowed risk to be dissipated around the system. The theory was — and there were plenty of inaccurate mathematical models to back this up — that spreading risk around the system made the financial system safer. As it turned out, it didn’t. In the wake of MF Global and the London Whale, we know that the financial system has not learned the lessons of 2008. But it seems even more absurd that the diplomatic system has not really learned the lessons of 1914. 

The NATO system — set up to oppose the Warsaw Pact system, which no longer exists — functions the same way — rather than dissipating risk, it allows for the magnification of international tensions into full-on regional and global wars. In the late 20th century the threat of nuclear war proved a highly-effective deterrent which limited the potential for all-out-war between the great powers, offsetting much of the risk of the hyper-fragile treaty system. Yet the potential for magnifying small regional problems into bigger wars will continue to exist for as long as NATO and similar organisations prevail.

We do not know exactly what arrangements Syria has with Russia and China — there is no formal defensive pact in place (although there is one between Syria and Iran) though it is fair to assume that Russia will be keen to maintain its Syrian naval assets, a view which is supported by the fact Russia heavily subsidises the Syrian military, and has blocked all the UN-led efforts toward intervention in Syria.

After the Cold War, the Warsaw Pact was allowed to disintegrate. Until NATO is similarly allowed to disintegrate, the threat of magnification will remain large. Could a border skirmish between Syria and Turkey trigger a regional or even global war? Under the status quo, anything is possible.

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Does Syria Want a War?

We know for sure that Syria intentionally shot down a Turkish — and thus protected by NATO — warplane in its airspace. We also know that Syria is comfortable enough to admit it.

The AP reports:

Syria said Friday it shot down a Turkish military plane that entered Syrian air space, and Turkey vowed to “determinedly take necessary steps” in response.

It was the most clear and dramatic escalation in tensions between the two countries, which used to be allies before the Syrian revolt began in March 2011. Turkey has become one of the strongest critics of the Syrian regime’s brutal response to the country’s uprising.

Late Friday, Syria’s state-run news agency, SANA, said the military spotted an “unidentified aerial target” that was flying at a low altitude and at a high speed.

“The Syrian anti-air defenses counteracted with anti-aircraft artillery, hitting it directly,” SANA said. “The target turned out to be a Turkish military plane that entered Syrian airspace and was dealt with according to laws observed in such cases.”

It seems pretty clear that the Syrians know the consequences of their actions. NATO (including deluded US hawks who are happy to ignore the disastrous consequences of the drug war on the US border while talking up more intervention in the middle east) and the NATO-backed Syrian opposition has been looking for any excuse to get stuck into a new interventionist mission. We know that the NATO-backed opposition were prepared to try and get a British journalist killed in a false flag operation in order to trigger a Western intervention.

So why did Russia-armed Syria do it? And why (given the age of F-4 aircraft, it could easily have crashed of its own accord giving the Syrians a lot of plausible deniability) are they not at least denying that they shot it down?

Is it possible that the wider Eurasian anti-American coalition led by the Russians and the Chinese are confident that NATO will not intervene out of fear of triggering a wider war? After all the Russian naval base has been a great obstacle to NATO intervention. Libya didn’t have any Russian bases, and it took far less internal violence for NATO to intervene there.

Is it even possible that the Eurasians are trying to provoke NATO into another costly and damaging war? After all, the American Empire is much more indebted and militarily overstretched than it was before 9/11. Osama bin Laden’s goal of dragging the United States into the middle eastern quagmire, and thereby bankrupting America has been an unmitigated success. Could the Eurasians be trying to provoke a regional war in order to weaken NATO and draw attention away from their own weakened economic picture?

Or is this just a case of an overzealous Syrian military commander taking a potshot at an unidentified flying object and provoking a diplomatic crisis?

As someone who does not believe that war is in any way an economic stimulus and should be avoided beyond self-preservation, I hope that this crisis — and the wider Syrian situation — can be defused.

Those who want to see a big military-Keynesian stimulus may be hoping for an escalation…

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Another Day, Another Nation Dumps the Dollar

From South Africa’s City Press:

South Africa will this week take some initial steps to unseat the US dollar as the preferred worldwide currency for trade and investment in emerging economies.

Thus, the nation is expected to become party to endorsing the Chinese currency, the renminbi, as the currency of trade in emerging markets.

This means getting a renminbi-denominated bank account, in addition to a dollar account, could be an advantage for African businesses that seek to do business in the emerging markets.

The move is set to challenge the supremacy of the US dollar. This, experts say, is the latest salvo in the greatest worldwide currency war since the 1930s.

Well — like the rest of Africa alongside all of its natural resources which (in spite of Kony 2012’s best efforts) becomes more Chinese by the day — it is clear where South Africa’s allegiance lies. Most interestingly, though, this is the first nation with an Anglo-American economic elite to come out against the present global order and more or less endorse China.

Readers are reminded of this chart:


It is rather intriguing to note, by the way, that when the term “emerging economies” is used, the underlying reality is that these are the productive economies. America’s GDP is mostly spent on the consumption of foreign goods, (or goods made from foreign components), on the back of foreign oil. And the emergent reality of the 21st Century (forward-looking readers will already understand) is that consumptive nations need productive nations, but not vice verse. Right now, without “emerging nations” subsidising American consumption (and agriculture, etc), what would become of the dollar? I think the only thing standing in the way of it becoming toilet paper is U.S. military might. But what would happen to that military might as a result of a global trade slowdown resulting from — for example — the closure of the Strait of Hormuz? As I detailed last week, as a result of her addiction to fragile global trade networks, America has rendered herself extremely fragile.

From the Huffington Post:

Blocking the Strait of Hormuz would create an international and economic calamity of unprecedented severity. Here are the crude realities. America uses approximately 19 to 20 million barrels of oil per day, almost half of which is imported. If we lose just 1 million barrels per day, or suffer the type of damage sustained from Hurricane Katrina, our government will open the Strategic Petroleum Reserve (SPR), which offers a mere six- to eight-week supply of unrefined crude oil. If we lose 1.5 million barrels per day, or approximately 7.5 percent, we will ask our allies in the 28-member International Energy Agency to open their SPRs and otherwise assist. If we lose 2 million barrels per day, or 10 percent, for a protracted period, government crisis monitors say the chaos will be so catastrophic, they cannot even model it. One government oil crisis source recently told me: “We cannot put a price tag on it. If it happens, just cash in your 401(k).”

Readers may be surprised to learn that I still have a lot of faith in America and the West. Only in the West is there an intellectual climate that allows for the kind of speech published on this blog. A free intellectual climate leads to innovation, and the free and honest exchange of ideas, all of which indirectly spur economic development. And certainly, while America is not perfect, it generally has a freer intellectual climate than most other nations. Further, America has huge reserves of energy and natural resources, and a low population density and thus room to expand.

But ultimately — as we shall over the next ten or twenty years — the present day American consumerism is a glittering economic dead end. The present world order is unravelling, and Americans — like many great empires before them — are in danger of suffering a lot of fallout.

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The Beauty of America

Eric X. Li writes the most controversial piece of the year thus far, in which he concludes that democracy is a problem for the West:

Many have characterized the competition between [America and China] as a clash between democracy and authoritarianism. But this is false. America and China view their political systems in fundamentally different ways: whereas America sees democratic government as an end in itself, China sees its current form of government, or any political system for that matter, merely as a means to achieving larger national ends.

In the history of human governance, spanning thousands of years, there have been two major experiments in democracy. The first was Athens, which lasted a century and a half; the second is the modern West. If one defines democracy as one citizen one vote, American democracy is only 92 years old. In practice it is only 47 years old, if one begins counting after the Voting Rights Act of 1965 — far more ephemeral than all but a handful of China’s dynasties.

Why, then, do so many boldly claim they have discovered the ideal political system for all mankind and that its success is forever assured?

The answer lies in the source of the current democratic experiment. It began with the European Enlightenment. Two fundamental ideas were at its core: the individual is rational, and the individual is endowed with inalienable rights. These two beliefs formed the basis of a secular faith in modernity, of which the ultimate political manifestation is democracy.

In its early days, democratic ideas in political governance facilitated the industrial revolution and ushered in a period of unprecedented economic prosperity and military power in the Western world. Yet at the very beginning, some of those who led this drive were aware of the fatal flaw embedded in this experiment and sought to contain it.

The American Federalists made it clear they were establishing a republic, not a democracy, and designed myriad means to constrain the popular will. But as in any religion, faith would prove stronger than rules.

The West’s current competition with China is therefore not a face-off between democracy and authoritarianism, but rather the clash of two fundamentally different political outlooks. The modern West sees democracy and human rights as the pinnacle of human development. It is a belief premised on an absolute faith.

China is on a different path. Its leaders are prepared to allow greater popular participation in political decisions if and when it is conducive to economic development and favorable to the country’s national interests, as they have done in the past 10 years.

However, China’s leaders would not hesitate to curtail those freedoms if the conditions and the needs of the nation changed.

The fundamental difference between Washington’s view and Beijing’s is whether political rights are considered God-given and therefore absolute or whether they should be seen as privileges to be negotiated based on the needs and conditions of the nation.

Li has made a staggering error: he has conflated individual rights with democracy. These are actually two separate ideas. In fact, the two notions can sometimes be opposed: in a pure democracy, 51% of the population could successfully vote to cook and eat the other 49%. That is where the notion of individual liberty and creator-endowed rights come in: while some democracy is tenable, the actions of a democracy that would be damaging to an individual’s liberty are deemed to be unconstitutional. This was the shape of America’s constitution after the revolution.

So Li is correct — America was not at its birth a democracy. America was set up as a constitutional republic. Its constitution was designed to protect individual liberty (even if it has not always been entirely successful at doing so). The Constitution is written very simply and beautifully. Here’s the First Amendment:

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.

Simple, specific, categorical. No ifs, no buts. Other nations have paid lip-service to fundamental human freedoms, but they always wrapped themselves up in fineries. Here’s Europe’s attempt:

Everyone has the right of freedom of expression. This right shall include freedom to hold opinions and to receive and impart information and ideas without inference by public authority and regardless of frontiers. This Article shall not prevent States from requiring the licensing of broadcasting, television or cinema enterprises.

The exercise of these freedoms, since it carries with it duties and responsibilities, may be subject to such formalities, conditions, restrictions or penalties as are prescribed by law and are necessary in a democratic society, in the interests of national security, territorial integrity or public safety, for the prevention of disorder or crime, for the protection of health or morals, for the protection of the reputation or rights of others, for preventing the disclosure of information received in confidence, or for maintaining the authority and impartiality of the judiciary.

In Europe, you have a right to free expression at the discretion of the democratically-elected authorities. And that’s not really a right at all. It’s a semi-right; a right with a whole lot of strings. You have the right to life — so long as the other 51% don’t vote to cook and eat you. 

But America’s constitutional republic is a long-gone ideal. America’s Congress pumps out a wealth of legislation not specifically authorised by the Constitution. The first breaches were done with the best of intentions: the Fourteenth Amendment applied the Bill of Rights to the states, albeit shredding the Ninth and Tenth Amendments. The Civil Rights Act gave racial minorities equal accessto public and private facilities, thereby ending the right of property owners to discriminate against whomever they chose. I am broadly supportive of those measures. But later breaches have been much more dangerous.

Corporations are now routinely bailed out, destroying the market mechanism and creating an aristocracy of “systemically important” corporations with access to Uncle Sam’s chequebook. The power to coin money has been delegated from the Treasury to a private cartel known as the Federal Reserve, allowing the private bankers to create massive and dangerous credit bubbles. The PATRIOT Act, and the NDAA of 2011 shredded the Fourth Amendment and ended the ancient right to Habeas Corpus. Presidents since the Second World War have routinely gone to war without an express declaration authorised by Congress. Obamacare has created a healthcare mandate, compelling American citizens to buy a commercial product — health insurance. Even the First Amendment has been turned upside down — corporations (who are not people) can spend limitless money on political campaigns, while political protestors (who are definitely people) are now confined to caged “free speech zones”. And that’s just from the top of my head.

So it is important to remember that criticisms of America today are criticisms of the present politics of America, and not of the ideals of constitutionalism, or of individual liberty.

It is certain that America today is in dire straits: deeply indebted to the rest of the world, heightened unemployment, the world’s largest prison population, a broken and zombified financial system stripped of the market mechanism, a huge swathe of citizens without access to medical treatment, tent cities.

And it is also certain that America’s welfarism has contributed to its debt. But that is more the fault of large corporations, farmers, and the military industrial complex who suck up subsidies and then call it “profit”, than it is the poor who without subsidies probably could not eat. But certainly all the subsidies have come out of America’s newfound democratic status. Give people the ability to vote for more free stuff (and lobbyists the ability to lobby for more free stuff) and more often than not they’ll take that chance. After all, who doesn’t love a free lunch?

But it is totally foolish to blame these problems on “too much liberty”.

In fact, right now it is China that seems more libertarian — at least in purely economic terms. As I wrote last month, China’s economy consists of just 20% of federal government spending, whereas America’s consists of 37%. China is more of a market economy, while America is more statist. So while China’s leaders might have taken a more “flexible” approach to individual liberties, at least when it comes to economic liberty, they are practically way ahead of America. And maybe that’s why China is doing so well economically — the freedom to do business, to create, to produce.

When it comes to social and cultural freedom, America is way ahead of China — and unsurprisingly, America is still the world’s cultural powerhouse.

What if this little thing known as liberty — and these little things known as unalienable rights are far more important than Li recognises? What if they are the driving energy that underpins innovation, that underpins economic prosperity, that underpins a robust economic system?

America was once the richest and most productive nation on the planet (and by certain measures she still is). This was a direct product of a system of cultural and economic freedom. People were free to think differently, to act differently, to create new businesses, new products, new techniques and this ultimately led to the greatest sustained period of wealth creation in history. They didn’t have to ask the permission of a feudal lord or monarch or commissar. They didn’t have to kowtow to an aristocracy. Only now — since America has adopted statism and bureaucracy — has America begun to fall behind.

So Li’s conclusion is right, but only in a twisted and roundabout way:

The West seems incapable of becoming less democratic even when its survival may depend on such a shift. In this sense, America today is similar to the old Soviet Union, which also viewed its political system as the ultimate end.

History does not bode well for the American way. Indeed, faith-based ideological hubris may soon drive democracy over the cliff.

Yes — ideological and faith-based hubris may soon drive America off a cliff. But that ideological and faith-based hubris that we find today in American government and in the American intellectual elite is not for America’s constitution, nor for individual liberty. Instead it is for statism, for big government, for surveillance, for authoritarianism, for central planning, for endless war and imperialism. The zeal that will drive America off a cliff is exactly what Li advocates more of.

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A Time for War?

Arch-neocon Charles Krauthammer — and Secretary of Defence Leon Panetta — say that Israel is ready to strike Iran:

Our own secretary of Defense has said it’s highly likely and he gave a timeframe — April, May, June — which means the Israelis think that the moment, the zone of immunity where they can no longer attack successfully, is approaching.

On the other hand, I am becoming more sceptical of such actions by the day.

Both China and Pakistan have given assurances of some kind of support for Iran, if attacked. Why would Israel choose direct and open warfare against Iran and risk provoking a wider conflict when they can instead engage in a much less risky covert war of subterfuge, sabotage and assassination?

Furthermore, why would the US Secretary of Defence go on the record to divulge Israeli military plans? Frankly, it sounds like Panetta’s vocalisation is a decoy to keep Iran edgy, and try to incite Iranians on the ground to rise up in revolt and overthrow the regime, as a path to avoiding war.

While I have already given a pretty comprehensive breakdown of the Western motivations for such a war, the simple truth emerging is that the risks of wider trouble and blowback are too big, and outweigh all the prospective benefits. American and Israeli policymakers may have finally realised that the West just has too much to lose from antagonising China and Russia even more. And, as I have clearly drawn out, the risks to Israel and to the West from an Iranian nuclear weapon are relatively small. Furthermore, the Israeli intelligence community is not overwhelmingly committed to such an action.

The only people who seem committed to such action are the rabid neocon wing of the Republican party: people like Rick Santorum.

From Haaretz:

Republican presidential candidate Rick Santorum on Thursday accused President Barack Obama of actively seeking ways to allow Iran to gain a nuclear weapon and suggested that the administration had betrayed Israel by publicly disclosing what may be a plan to attack the Muslim nation.

The bottom line is that there is very little reason to believe that America or Israel will openly engage Iran before the Presidential election. There will be a continued war of stealth, continued drone surveillance, continued cyber attacks, continued assassinations, and a continued blockade — all aimed at provoking an Iranian revolution. I could be wrong, and the situation could change, but as more anti-American rhetoric streams out of Eurasia, as Iran enriches more uranium, as the American national debt creeps higher, the prospects of a war grow more distant.

A zealous theocratic warmonger like Santorum in the White House would change all of that..