The Irrelevant Yuan?

You’re not going to change the balance of China trade by adding 25 cents to the cost of a T-shirt.

To some in Washington these days, adjusting the yuan-dollar exchange rate is the fix for all America’s ills. That single number supposedly determines which jobs stay in the United States and which go to China. It dictates which and how many goods move where. It’s attributed the mystical power to raise or destroy mighty economies by its movements or lack thereof.

Except that the real world doesn’t work that way. Recent conversations with executives responsible for supplying clothes from Asia to American shelves suggest that the yuan case may not be as clear-cut as U.S. revaluationists would have us believe.

Revaluationists argue that the price of Chinese goods expressed in dollar terms is too low because China artificially suppresses its exchange rate, making it possible to buy “too many” yuan per dollar. They want China to make its exports dearer, thus balancing bilateral trade by making Chinese goods unappealingly expensive in the U.S. and American products more affordable in China.

But how “exposed” is the total value of a finished Chinese export to the yuan-dollar exchange rate? To answer that question, you have to examine how often companies have to exchange dollars into yuan or vice versa along the supply chain—for instance, when a U.S. company converts dollars so it can pay factory workers in yuan, or when a Chinese factory receives dollars in payment for an order and exchanges into yuan to pay its electricity bill.

Revaluationists implicitly, and wrongly, assume that the bulk of the value of Chinese products is exposed to the exchange rate. If that were true for any industry, it would be true in apparel where yuan-denominated labor still accounts for a much higher proportion of costs than in more mechanized manufacturing. Yet it ain’t quite so, as an American executive at a children’s clothing retail chain recently explained. (He and the other executive in this piece asked to remain anonymous given the political sensitivity of the issue.)

This executive’s largest expense is fabric, which accounts for roughly 50% of the final cost of a piece of clothing. He also figures in a profit margin of about 15%, depending on the product. That leaves 35% of his cost for labor, utilities and the like—yuan-denominated expenses. As for the fabric cost itself, about half of that (one-quarter of the cost of the finished garment) is cotton, a globally traded commodity priced in dollars. The fabric manufacturer also might take a 15% profit, leaving 35% for yuan-denominated costs.

So take a $10 pair of boy’s summer shorts: $2.50 is cotton, the price of which won’t change with a revaluation. Another $2.50 (perhaps) is profit. That leaves roughly $5 in Chinese labor and other yuan costs that are affected by a revaluation. Subject that portion to the 5% revaluation (that’s at the upper range of current expectations for what Beijing will do) and the shorts now cost . . . $10.25.

That assumption of a surprisingly large profit margin is significant, as a chat with another American businessman makes clear. His company sells a range of brands, from high-end to low-end, and manufactures throughout Asia. When asked about the possible effects of a yuan revaluation, he first observes that his company no longer makes its cheapest products in China anyway. Rising labor costs, higher taxes on foreign businesses and the like have pushed ultra-low-price T-shirts and jeans to the likes of Vietnam or Bangladesh. What remains in China are higher-value-added, more profitable name-brand products.

One implication is that if over the short term companies can’t raise prices on U.S. consumers in the fiercely competitive apparel market they’ll at least have some room to absorb any revaluation-induced cost increases out of their profit margins. Shareholders may ultimately bear some of the revaluation cost. The more important implication is that over the longer term, when China becomes too expensive, manufacturing moves elsewhere in Asia—not back to America.

Indeed, the rising costs of Chinese manufacturing in general are a much bigger headache for some apparel manufacturers than a yuan revaluation would be. Wage increases alone force factory owners along China’s coast to boost productivity by 6% or more each year to stay competitive. Increasing productivity by another 2% or 3% to compensate for a revaluation would be tough, but perhaps not the most serious challenge.

Some apparel companies undoubtedly are more sanguine about the possible consequences of a yuan revaluation than others. They’d almost certainly feel differently if their bread and butter were low-margin cheap T-shirts. But the fact that there’s some diversity of opinion within the apparel industry on the yuan is telling.

Mr. Sternberg, who is based in Hong Kong, edits the Wall Street Journal Asia’s Business Asia column.

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Full article and photo: http://online.wsj.com/article/SB10001424052748703866704575225313944234430.html

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Time to Junk the Corporate Tax

Nobel Laureate Robert Lucas says reform would deliver great benefits at little cost, making it “the largest genuinely true free lunch I have seen.’

President Obama has put tax reform on the agenda, but surprisingly little attention is being paid to fixing the most growth-inhibiting, anticompetitive tax of all: the corporate income tax. Reducing or eliminating the corporate tax would curtail numerous wasteful tax distortions, boost growth in both the short and long run, increase America’s global competitiveness, and raise future wages.

The U.S. has the second-highest corporate income tax rate of any advanced economy (39% including state taxes, 50% higher than the OECD average). Many major competitors, Germany and Canada among them, have reduced their corporate tax rate, rendering American companies less competitive globally.

Of course, various credits and deductions—such as for depreciation and interest—reduce the effective corporate tax rate. But netting everything, our corporate tax severely retards and misaligns investment, problems that will only get worse as more and more capital becomes internationally mobile. Corporate income is taxed a second time at the personal level as dividends or those capital gains attributable to reinvestment of the retained earnings of the corporation. Between the new taxes in the health reform law and the expiration of the Bush tax cuts, these rates are soon set to explode.

This complex array of taxes on corporate income produces a series of biases and distortions. The most important is the bias against capital formation, decreasing the overall level of investment and therefore future labor productivity and wages. Also important are the biases among types of investments, depending on the speed of tax vs. true economic depreciation, against corporate (vs. noncorporate) investment, and in favor of highly leveraged assets and industries. These biases assure that overall capital formation runs steeply uphill, while some investments run more, some less uphill. It would be comical if the deleterious consequences weren’t so severe.

Of course, the corporation is a legal entity; only people pay taxes. In a static economy with no international trade, the tax is likely borne by shareholders. The U.S. economy is neither static nor closed to trade, and taxes tend to be borne by the least mobile factor of production. Capital is much more mobile globally than labor, and the part of the corporate tax that is well above that of our lowest tax competitors will eventually be borne by workers. In a growing economy, the lower investment slows productivity growth and future wages.

There is considerable evidence that high corporate taxes are economically dangerous. In a 2008 working paper entitled “Taxation and Economic Growth,” the Organization for Economic Cooperation and Development concluded that “Corporate taxes are found to be most harmful for growth, followed by personal income taxes and then consumption taxes.” Virtually every major tax reform proposal in recent decades has centered on lowering taxes on capital income and moving toward a broad-based, low-rate tax on consumption. This could be accomplished by junking the separate corporate income tax, integrating it with the personal income tax (e.g., attributing corporate income and taxes to shareholders or eliminating personal taxes on corporate distributions), and/or allowing an immediate tax deduction (expensing) for investment (which cancels the tax at the margin on new investment and hence is the priority of most economists). The Hall-Rabushka Flat Tax, the Bradford progressive consumption tax, a value-added Tax (VAT), the FairTax retail sales tax, four decades of Treasury proposals and the 2005 President’s Tax Commission proposals would all move in this direction.

Reducing or eliminating the negative effects of the corporate tax on investment would increase real GDP and future wages significantly. Junking both the corporate and personal income taxes and replacing them with a broad revenue-neutral consumption tax would produce even larger gains. Nobel Laureate Robert Lucas concluded that implementing such reforms would deliver great benefits at little cost, making it “the largest genuinely true free lunch I have seen.”

Reducing taxes on new investment could help strengthen what is a historically slow recovery from such a deep recession. It would also strengthen the economy long-term. American workers would benefit from more jobs in the short run and higher wages in the long run.

However, if a new tax device is used to grow government substantially, it will seriously erode our long-run standard of living. The VAT has served that purpose in Europe and, while better than still-higher income taxes, the larger-size governments it has enabled there are the prime reason European living standards are 30% lower than ours. Trading a good tax reform for a much larger government is beyond foolish. No tax reform can offset losses that large. Hence, a VAT should only be on the table if it is not only revenue-neutral but accompanied by serious spending control.

Further, the fraction of Americans paying no income taxes is approaching 50%. That sets up a dangerous political dynamic of voting ever-rising taxes to pay for ever-rising spending. We need more people with a stake in controlling spending. Replacing corporate and personal income taxes with a broad-based consumption tax could increase the number of those with “skin in the game.” But some reforms, for example a VAT, might be much less transparent and may not serve this purpose.

Congresses (and presidents) seem unable to avoid continually tinkering with the tax code. A tax reform that is quickly riddled with special features would lose much of its economic benefit. We need a stable tax system that changes much less frequently, so families and firms can more reliably plan their future. Current fiscal policy, loaded with immense deficits, ever-growing debt, and the prospect of higher future taxes, is the biggest threat to such stability. To balance proposed spending in Mr. Obama’s budget in 2015, his Deficit Commission’s target year, will require at least a 43% increase in everyone’s income tax. Thus, spending control is vital to tax stability.

American companies and their workers compete in the global marketplace saddled with a costly, anachronistic corporate tax system. To compete successfully in the 21st century, we will need to reform corporate taxation. There are several paths to doing so, each with its advantages. Unfortunately, tax policy is headed in exactly the wrong direction, raising taxes on corporate source income. Business investment is growing again after the collapse in the recession, which is usual in a cyclical recovery with very low interest rates. But eventually structural drags, from our antiquated tax code to massive public debt, will impede investment and economic growth.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.

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Full article and photo: http://online.wsj.com/article/SB10001424052748704627704575204203580273926.html

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EU Agrees to Prop Up Greece

110 Billion Euro Package

A man sitting outside the Bank of Greece next to graffiti reading “IMF Out.” On Sunday, European finance ministers agreed to a bail-out package for the country.

European promises of solidarity with Greece were not enough. Over the weekend, euro zone finance ministers agreed on a €110 billion package for Athens in return for even more Greek austerity measures. Whether it will be enough remains open.

The German tabloid Bild am Sonntag called it “a fateful day for the euro.” But was it? At the very least, one can say that it was an extremely hectic day for many of Europe’s leading politicians.

In Athens on Sunday morning, Greek Prime Minister Georgios Papandreou announced further deeps cuts in public spending — a package he said which involved “great sacrifices” for the Greek people. In addition to further tax increases — beyond the VAT and luxury tax hikes announced in March — the new package includes further pay cuts for public sector workers, pension cuts and in increase in the retirement age.

In return, the 16 finance ministers from countries belonging to the European common currency area, meeting on Sunday afternoon, finally released a far-reaching aid package for Greece following weeks of disagreement. The deal makes €110 billion available to Greece in the next three years — €45 billion in this year alone. Germany’s share of the aid package is €22 billion, €8.4 billion of which is due in 2010.

The agreement is to be rubber-stamped by European heads of state and government at a special summit on May 7. But Europe has sent a clear signal in response to the pessimism displayed by ratings agencies and the financial markets. The euro is to remain strong is the message from Brussels. And further, Greece has powerful allies.

‘Better for All Europeans’

“It is our mission to defend the stability of the euro zone in its entirety,” German Finance Minister Wolfgang Schäuble said. “The better we do that, the better it is for all Europeans and for Germans.”

It remains to be seen just how the financial markets will react to the weekend deal. On Monday, the euro was down slightly in early trading.

Indeed, past attempts by European politicians to shore up the euro with expressions of solidarity with Greece have proven inadequate. European summits on Feb. 11, March 25 and April 11 all had little impact on rampant speculation against the euro. The inability of Brussels to calm the markets made Sunday’s deal unavoidable.

Emergency Aid Being Rushed Through German Parliament

The governments involved now at least grasp how serious the situation is. The German government too doesn’t want to be accused of any further stonewalling after ratings agency Standard & Poor’s last week downgraded Greece’s credit rating to junk status.

Berlin is hoping to push the necessary legislation through parliament this week — with the same urgency with which it passed the banking bailout package in October 2008. President Horst Köhler is scheduled to sign the law as soon as Friday. The government hopes the speed will be seen as a further sign of strength. The opposition Social Democrats won’t stand in the way of parliamentary approval but haven’t yet declared whether they will vote in favor of the aid. The party wants commercial banks to foot part of the bill.

In terms of German domestic politics there’s a certain irony in the fact that the emergency aid is being passed on the eve of the May 9 regional election in North Rhine-Westphalia. Critics say that is precisely what Merkel had been trying to avoid in recent months in order to keep the sensitive issue out of the election campaign. A total of 56 percent of Germans are against helping out Greece, so the aid could cost the two ruling parties, Merkel’s Christian Democrats and the pro-business Free Democrats, votes in the election in North Rhine-Westphalia, Germany’s most populous state.

Merkel has reason to fear the wrath of voters. She is arguing that it was her stubbornness that forced Athens to get serious about agreeing to stringent spending cuts, and that she made sure that the International Monetary Fund’s hard-as-nails debt professionals were dispatched to keep an eye on the Greeks.

National debt of EU members as a percentage of GDP.

That may be true. But Merkel’s manoeuvring may nevertheless have made matters worse. The bailout of Greece has become more expensive than initially thought because Greece’s borrowing costs have risen dramatically in recent weeks. The market hysteria could spread. That is why even US Treasury Secretary Tim Geithner got involved and urged Berlin to take rapid action.

Success of Bailout Uncertain

It’s unclear how effective the bailout will be. Everything depends on how the economy, the government finances and political sentiment respond. Many people in Greece and around Europe are wondering how radical cutbacks with wage cuts and tax hikes are supposed to revive the Greek economy. Berlin, London and Paris have recently been rejecting spending cuts for their own countries on the grounds that such measures would throttle economic growth.

Hopes that the bailout will work have been fuelled by the surprising speed with which banks have recovered from the biggest crisis in their history. Just one year after the collapse of the financial system in 2008 they are making record profits again — and the governments that nationalized their banks in order to rescue them can now hope for profits when they sell their stakes.

Ideally, that’s also the way things should go with Greece. Germany’s government, at least, is trying to win over its skeptical public with the argument that it could actually make a profit if Greece pays back all the money it is loaned. No one can really say if that will ever happen, though. Some believe it will; others aren’t so sure.

The Banks Are Partially to Blame

One thing, though, is certain: Should Greece go bankrupt any time soon, it would be almost impossible to predict the consequences. Portugal and Spain would be the next ones to feel the heat. Indeed, it only makes sense for European governments to buy some time for themselves and Greece if they honestly expect that the situation will have calmed down in three years.

It makes equal sense to make Greece’s creditors part of the solution. In interviews, Merkel and Schäuble — both of whom belong to the center-right Christian Democratic Union (CDU) — have suggested that they want banks to be part of the aid package for Greece. Other parties have demanded that they be forced to do so. Following the initiative of Deutsche Bank CEO Josef Ackermann, a number of German companies have now openly pledged to chip in between €1 billion and €2 billion euros — in the form of loans and through the purchase of Greek government bonds.

One could call such a gesture “hypocrisy,” as some in Germany’s far left Left Party are doing, because the financial sector made a tidy profit on Greece’s slide into indebtedness. It could also, however, be seen as a pragmatic contribution. More than anything, however, it is a confession that the banks are not blameless in Greece’s misfortune.

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Full article and photos: http://www.spiegel.de/international/europe/0,1518,692619,00.html

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Post-crisis reading

Our reviews of the best books on the financial crisis and its aftermath

THE financial crisis has had many victims but for book publishers it hasn’t been so bad. For a start, the banking collapse, followed by drastic measures to stop it leading to a global depression, have made many standard economics textbooks look dated. So, students and libraries around the world will soon need to stock up on the revised editions that the textbooks’ authors are busy working on.

More important, there has also been a boom (a bubble, perhaps?) in books explaining, dissecting and apportioning the blame for the crisis. Our finance editor discusses them with our books and arts editor in this audio chat, and our Wall Street editor lists his favourites here.

Many of these books have also been reviewed in our pages. Our look at an early batch of credit-crunch books, in June last year, recommended Philip Augar’s “Chasing Alpha” and Gillian Tett’s “Fool’s Gold”, among others, the former a broad, highly readable account of how the crisis developed, the latter focused on the murky world of credit derivatives.

Prophets of doom who foresaw the crisis but mostly were not listened to

Michael Lewis’s “The Big Short” and Harry Markopolos’s “No One Would Listen” are about the prophets of doom who foresaw the crisis but who were mostly not listened to. In Mr Lewis’s book, some of those prophets profited very nicely from putting their money where their mouths were. Mr Markopolis was an analyst who smelled something fishy about the remarkable investment returns of a money manager called Bernie Madoff, who it turns out was running the world’s biggest Ponzi scheme. In “The Road to Financial Reformation”, another Cassandra of the credit crunch, Henry Kaufman—whose constant warnings about debt bubbles earned him the nickname “Dr Doom”—spends 260 pages relishing reminding us how he told us so.

Two Paulsons at the centre of the financial maelstrom

As the world’s financial system teetered in 2008, no one was closer to the centre of the action than America’s then treasury secretary, Hank Paulson, whose book “On the Brink” contains some jaw-dropping revelations and an admirably frank assessment by Mr Paulson of what he did well, and not so well, in the crisis.

Another prominent figure in the crisis and its aftermath is the former treasury secretary’s namesake, a hedge-fund manager called John Paulson, who is the subject of Gregory Zuckerman’s “The Greatest Trade Ever”. This Mr Paulson came from nowhere to make a fortune by betting that the housing bubble would pop. (Unfortunately his lucrative bets made him part of the dramatis personae of the Securities and Exchange Commission’s fraud case against Goldman Sachs.) Our review of Mr Zuckerman’s book also looked at Scott Patterson’s “The Quants”, which described the mathematical whizzes who sought their fortune by means of applying complex modelling to exploit anomalies in the markets. They conquered Wall Street, says Mr Patterson, but nearly destroyed it.

The rise and fall of Lehman

David Wessel’s “In Fed We Trust” focuses on the Federal Reserve and its boss, Ben Bernanke, giving a vivid description of how they fared as the crisis unfolded, starting with the collapse of Lehman Brothers. The rise and fall of Lehman was itself such a sizzling tale that it has merited several books all to itself. “A Colossal Failure of Common Sense”, by Lawrence McDonald and Patrick Robinson, describes the hubris of the bank’s boss, Dick Fuld, who so riled Mr Paulson that the then treasury secretary became determined to let Lehman go bust. In the same review we looked at Carmen Reinhart and Kenneth Rogoff’s comprehensive look at eight centuries of financial folly, “This Time is Different”, which is ideal for anyone looking for a more academically grounded analysis of crises past and present.

“The Devil’s Casino”, by Vicky Ward, contains some fascinating pen-portraits of Lehman’s characters—Mr Fuld and his sycophantic court; Joe Gregory, the bank’s obsessively politically correct president; and the “desperate housewives” who found that they and their husbands were married to the bank. But perhaps the best of all the fly-on-the-wall books giving the inside story of Lehman’s collapse and the broader ensuing crisis is Andrew Ross Sorkin’s “Too Big to Fail”, which is meticulously researched and littered with colourful anecdotes.

Hunting the scapegoats, grinding the axes

A meltdown on this scale was bound to offer plenty of scope for axe-grinding and blame-spreading. Joseph Stiglitz’s “Freefall” and Simon Johnson and James Kwak’s “13 Bankers” both take a potshot at financial policymakers. Mr Stiglitz traces the origins of the crisis to a deregulatory fervour fuelled by the “ideology” of free-market fundamentalism and Wall Street’s influence on politics; he argues for tough action, including the break-up of the biggest banks. Messrs Johnson and Kwak also worry about the excessive influence of an “oligarchy” of American bankers, and reach the same conclusion: banks that are “too big to fail” are too big.

The volcanic ash from American banking’s eruption spread far and wide. Three books on how Ireland’s “Celtic tiger” economy was brought low by the credit crunch dish out plenty of blame to politicians, bankers and property speculators. They all agree that greed and ineptitude on the part of the country’s wealthy and the powerful are to blame for Ireland’s economic crash-landing being more violent than its peers’.

While other authors point accusing fingers, in his book, “Don’t Blame the Shorts”, Robert Sloan leaps to the defence of short-sellers who, as he describes, have long been scapegoated for market crashes, and are being once again in the wake of the recent crisis. The Dutch East India Company was blaming its troubles on them as far back as 1609.

Re-examining the trust placed in markets

A spectacular market collapse was bound to provoke a re-examination of assumptions about the trust that modern societies place in markets. John Cassidy’s “How Markets Fail” recounts the story of America’s housing boom and bust, arguing that its roots lie in the “Utopian” idea that society is best served when individuals are left to pursue their self-interest by means of free markets.

In a similar vein, “The Myth of the Rational Market”, by Justin Fox, argues that the whole crisis was the result of an idea that failed: that markets are rational and efficient. Mr Fox provides a fascinating and entertaining history of how this powerful idea, the efficient-markets hypothesis, inspired a wave of innovative financial products, such as derivatives and securitised subprime mortgages, that believers claimed would let their users exploit the wonders of the market. Then it turned out that the market was not rational after all and trillions of dollars were wiped out.

Reinhart and Rogoff’s book was one among several notable attempts to set the recent crisis into historical context. Another is Harold James’s “The Creation and Destruction of Value”, which illustrates how financial crises provoke a reconsideration of values, not just the value of investments but in a more fundamental sense. At the moment everything from the ethics of debt and the nature of capitalism to the continued dominance of the dollar is up for debate. Past crises, Mr James argues, show that this sort of ferment can lead to changes in political power.

Central bankers and their obsessions

Liaquat Ahamed’s “Lords of Finance” describes how the central bankers of the Great Depression were obsessed with a single idea, rather like their successors today. Then, it was maintaining the gold standard; now, he says, it is controlling inflation at all costs. History doesn’t repeat itself but it does rhyme, and once again the central bankers’ big idea has been so compelling that they have ignored its unintended consequences, in this case the bubbles in the housing and stockmarkets.

After the massive stimulus packages we are all Keynesians now, so it is only natural to expect a clutch of books celebrating John Maynard Keynes and declaring “victory” for his ideas. One of them, Robert Skidelsky’s “Keynes: The Return of the Master”, uses an exposition of Keynes’s insights to argue that much modern economics is bunk.

A novel approach

Some day a great novel will be written about the credit crunch, along the lines of Anthony Trollope’s 19th-century classic, “The Way We Live Now”. In the meantime, those who want to make sense of it all will have to make do with the factual analysis of John Lanchester, a British writer of fiction. His ability to explain complex stuff in a down-to-earth and witty style makes his short book, “IOU: Why Everyone Owes Everyone and No One Can Pay”, ideal reading for financial novices.

So many post-crisis books have now hit the stands that even the most voracious bookworm will have difficulty digesting them all. Which of them is the definitive account? Perhaps none: remember that J.K. Galbraith’s masterly work, “The Great Crash, 1929”, did not come out until a quarter-century after the event. Maybe we will have to wait just as long this time.

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Full article: http://www.economist.com/business-finance/displaystory.cfm?story_id=15810590&source=hptextfeature

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The corruption eruption

Saying “no” to corruption makes commercial as well as ethical sense

IT IS 15 years since Moisés Naím coined the memorable phrase “corruption eruption”. But there is no sign of the eruption dying down. Indeed, there is so much molten lava and sulphurous ash around that some of the world’s biggest companies have been covered in it. Siemens and Daimler have recently been forced to pay gargantuan fines. BHP Billiton, a giant mining company, has admitted that it may have been involved in bribery. America’s Department of Justice is investigating some 150 companies, targeting oil and drugs firms in particular.

The ethical case against corruption is too obvious to need spelling out. But many companies still believe that, in this respect at least, there is a regrettable tension between the dictates of ethics and the logic of business. Bribery is the price that you must pay to enter some of the world’s most difficult markets (the “when in Rome” argument). Bribery can also speed up the otherwise glacial pace of bureaucracy (the “efficient grease” hypothesis). And why not? The chances of being caught are small while the rewards for bending the rules can be big and immediate.

When in Rome, behave like a Swede

But do you really have to behave like a Roman to thrive in Rome? Philip Nichols, of the Wharton School, points out that plenty of Western firms have prospered in emerging markets without getting their hands dirty, including Reebok, Google and Novo Nordisk. IKEA has gone to great lengths to fight corruption in Russia, including threatening to halt its expansion in the country, firing managers who pay bribes and buying generators to get around grasping officials holding up grid connections. What is more, Mr Nichols argues, it is misguided to dismiss entire countries as corrupt. Even the greasiest-palmed places are in fact ambivalent about corruption: they invariably have laws against it and frequently produce politicians who campaign against it. Multinationals should help bolster the rules of the game rather than pandering to the most unscrupulous players.

And is “grease” really all that efficient? In a paper published by the World Bank, Daniel Kaufmann and Shang-Jin Wei subjected the “efficient grease” hypothesis to careful scrutiny. They found that companies that pay bribes actually end up spending more time negotiating with bureaucrats. The prospect of a pay-off gives officials an incentive to haggle over regulations. The paper also found that borrowing is more expensive for corrupt companies, probably because of the regulatory flux.

The hidden costs of corruption are almost always much higher than companies imagine. Corruption inevitably begets ever more corruption: bribe-takers keep returning to the trough and bribe-givers open themselves up to blackmail. Corruption also exacts a high psychological cost on those who engage in it. Mr Nichols says that corrupt business people habitually compare their habit to having an affair: no sooner have you given in to temptation than you are trapped in a world of secrecy and guilt. On the other hand, the benefits of rectitude can be striking. Texaco, an oil giant now subsumed by Chevron, had such an incorruptible reputation that African border guards were said to wave its jeeps through without engaging in the ritual shakedown.

Moreover, the likelihood of being caught is dramatically higher than it was a few years ago. The internet has handed much more power to whistle-blowers. NGOs keep a constant watch on big firms. Every year Transparency International publishes its Corruption Perceptions Index, its Bribe Payers Index and its Global Corruption Barometer.

The likelihood of prosecution is also growing. The Obama administration has revamped a piece of post-Watergate legislation—the Foreign Corrupt Practices Act (FCPA)—and is using it to pursue corporate malefactors the world over. The Department of Justice is pursuing far more cases than it ever has before: 150 today compared with just eight in 2001. And it is subjecting miscreants to much rougher treatment. Recent legislation has made senior managers personally liable for corruption on their watch. They risk a spell in prison as well as huge fines. The vagueness of the legislation means that the authorities may prosecute for lavish entertainment as well as more blatant bribes.

America is no longer a lone ranger. Thirty-eight countries have now signed up to the OECD’s 1997 anti-corruption convention, leading to a spate of cross-border prosecutions. In February Britain’s BAE Systems, a giant arms company, was fined $400m as a result of a joint British and American investigation. Since then a more ferocious Bribery Act has come into force in Britain. On April 1st Daimler was fined $185m as a result of a joint American and German investigation which examined the firm’s behaviour in 22 countries.

Companies caught between these two mighty forces—the corruption and anti-corruption eruptions—need to start taking the problem seriously. A Transparency International study of 500 prominent firms revealed that the average company only scored 17 out of a possible 50 points on “anti-corruption practices” (Belgium was by far the worst performing European country). Companies need to develop explicit codes of conduct on corruption, train their staff to handle demands for pay-offs and back them up when they refuse them. Clubbing together and campaigning for reform can also help. Businesses played a leading role in Poland’s Clean Hands movement, for example, and a group of upright Panamanian firms have formed an anti-corruption group.

This may all sound a bit airy-fairy given that so many companies are struggling just to survive the recession. But there is nothing airy-fairy about the $1.6 billion in fines that Siemens has paid to the American and German governments. And there is nothing airy-fairy about a spell in prison. The phrase “doing well by doing good” is one of the most irritating parts of the CSR mantra. But when it comes to corruption, it might just fit the bill.

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Full article and photo: http://www.economist.com/business-finance/displaystory.cfm?story_id=16005114&source=features_box_main

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The Recovery So Far

Growth is about half as strong as it was after the last deep downturn.

President Obama yesterday hailed the first quarter growth rate of 3.2% as “an important milepost on the road to recovery,” and let’s hope he’s right. From our own current vantage point, the first quarter numbers reveal a respectable cyclical recovery, though one that is so far less robust than we’d expect after an especially deep recession.

Which is not to say the growth isn’t welcome. The quarter is the third in a row in which the national supply of goods and services expanded, after an entire year of contraction, and the report contained some good news. The American consumer, who was supposed to have gone on strike, increased spending by 3.6%, the most in three years. Americans are recovering their spending confidence. Inventories also continued to rebound, accounting for 1.57% of the 3.2% growth total, another sign of a normal upward turn in the business cycle.

On the down side, fixed investment in the likes of capital goods and buildings added little to growth. This is surprising given buoyant corporate profits, though perhaps investment will pick up as residential housing and commercial real estate recover later in the year. This all means the economy is growing but still not firing on all cylinders. Consumer spending will only remain brisk if the economy starts to create more new jobs than it has so far.

We expect better job creation this year than many economists are predicting, but it’s notable that White House economist Larry Summers warned yesterday that joblessness is likely to be an enduring problem even as the economy grows. White House aides don’t tend to broadcast such pessimistic thoughts in an election year without cause.

One way to judge the strength of a recovery is to compare it to the growth after downturns of similar severity. The best recent comparison to the recession of 2008-2009 would be that of 1981-1982. They had different causes—interest rate increases in 1981 and a financial shock in 2008—but both periods had steep declines in output and jobless rates that hit 10%.

The 1982 recession officially ended in November, and the recovery came roaring out of that year, gaining momentum throughout 1983 and carrying 8% growth into 1984 with an expansion that lasted six more years. The nearby table shows the growth rates in the first four full quarters after the recession ended.

By comparison to that boom, the current recovery has been about half as strong. The arbiters of the business cycle at the National Bureau of Economic Research still haven’t officially called the end of the 2008-2009 recession, though the economy has been growing for at least 10 months. Considering how far the economy fell in 2008 and 2009, and considering Washington’s extraordinary monetary and fiscal reflation, this recovery is much less impressive than that of 1983.

The stock market has been signaling more growth ahead, and the last two recoveries—after the mild recessions of 1991 and 2002—also started slowly but eventually gained steam. Perhaps that will happen again. One advantage this time over 1983 is that the emerging economies—China, India and Brazil—are now so much larger and are growing much more rapidly.

But it’s also worth noting another less than favorable contrast with the recovery of 1983: government policy. The full incentive-enhancing impact of the 25% Reagan reduction in marginal tax rates finally kicked in on January 1, 1983, and Paul Volcker’s Federal Reserve was starting to cut interest rates from the record highs that broke the back of inflation while causing the recession. At the same time, an era of deregulation was lowering costs across most industries. The groundwork for a durable expansion had been laid in lower taxes, lower inflation and lower business costs.

In the current recovery, the policy headwinds are very different. Taxes are set to rise significantly on January 1, 2011, and the political class is signaling the need for still more taxes to pay for the costs of stimulus and the expanding entitlement state.

As for monetary policy, the Fed has held short-term interest rates at close to zero for 16 months. The only question is how soon and how high rates will rise. Meanwhile, Washington is raising costs for business by expanding its regulatory reach via tougher antitrust enforcement, mandates on health care and energy, more political limits on telecom investment, restrictions on bank lending, and much more.

The White House bet is that the Great Reflation that began in December 2008 has ignited a recovery that is strong enough to blow through these obstacles and become another long-lived expansion. We certainly have a decent recovery. Regarding its strength and duration, the jury is still out.

Editorial, Wall Street Journal

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Full article and photo: http://online.wsj.com/article/SB10001424052748703871904575216282773704608.html

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Porn Didn’t Give Bernie Madoff His Start

Surfing the Web is not the cause of the SEC’s problems.

Ever since the dawn of the culture wars, when widespread obscenity seemed to symbolize all that was going wrong with America, no subject has furnished more demagogue gold than pornography. Of course, it backfires against the family values set on a fairly regular basis—the latest example being that Republican National Committee outing to a bondage-themed nightclub in Los Angeles—but for grandstanding purposes nothing can beat it.

Take, for example, the current outrage at the Securities and Exchange Commission, where, according to an inspector general report that was made public late last week, employees spent a great deal of time and used up prodigious amounts of computer resources gazing at Internet pornography. What’s more, their porn habits date back to 2007 and 2008, when the need for an attentive SEC was at its greatest.

The chorus of outrage is being led by California Republican Rep. Darrell Issa, who fulminated as follows to the Washington Post last Friday: “This stunning report should make everyone question the wisdom of moving forward with plans to give regulators like the SEC even more widespread authority.”

Now, if you’re looking for reasons why the SEC failed in the past they aren’t hard to come by. Start with political leaders who clearly didn’t believe in the mission; proceed to the agency’s grotesquely underfunded workplace where lawyers had to do their own filing, mail-sorting and photocopying; and arrive, finally, at the revolving door, which sometimes transformed SEC jobs into stations on the Wall Street career path and worked fairly predictable effects on enforcement.

This was an agency whose mandate, essentially, was to crawl out on an ice floe and die. Were we to look closely at its employees’ computing habits during the Bush years, I bet we’d also find that they bought stuff on eBay, wrote copious email, and read a lot of blogs.

But it’s more fun to blame everything on pornography. And so, it is suggested, porn is the reason Bernard Madoff got away with it; porn may be why Lehman Brothers failed; with enough effort we can probably figure out ways to blame porn for every federal foulup from Toyota to FEMA. Blaming porn shifts the focus away from tricky things like the 30-year-old deregulatory consensus and turns the hate on a familiar villain: depraved government functionaries, whose twisted appetites are never fully repressed by their rumpled sack suits.

Not all conservatives find the demagoguery of smut so enticing, however. If your fear and loathing of the state are pure enough, you probably believe the government has no more business policing morality than it does, say, protecting the environment. That’s why, in certain libertarian quarters, defending the rights of pornographers has become a kind of holy cause.

The Internet-spawned “pornocopia” that surrounds us today “might be called John Stuart Mill’s wet dream,” declared a 2001 editorial in Reason magazine, where the defense of porn seems to be as much of a staple as is denunciation of the Food and Drug Administration.

Indeed, the revelations about porn consumption at the SEC must be a libertarian’s own wet dream. Here you have a libertarian cause célèbre—the endless, uncontrollable oceans of Internet pornography—somehow drowning that libertarian bête noir, regulatory enforcement. Polymorphous perversity itself managed to muzzle Big Brother.

How awesome is that? Why, it’s as awesome as if Ayn Rand herself returned to earth and—shrieking, “bow to Goldman Sachs, parasites!”—led the bank industry’s lobbyists to victory over the financial reform bill.

Libertarians aren’t celebrating, though: they’ve apparently joined forces with the scolds. “Regulators inevitably download porn, either figuratively or literally,” writes Reason editor Matt Welch on the CNN Web site. “Expecting regulators to do their job well” is “fantastical.”

What we have here, in other words, is a lesson in the eternal futility of government. Federal employees will download images from skankwire-dot-com; as stunted moral creatures, it’s just what bureaucrats do. Regulation will always fail; the answer is to quit trying.

What all of this overlooks is the highly advanced concept known as “change.” The purpose of federal agencies can be redefined and their personnel changed. Once upon a time, the SEC performed well; then it performed poorly.

And now that it threatens to perform well again, we are told it can only fail, that no federal operation can ever overcome the unalterable depravity of its employees.

One thing that may come out of all this is a wiser and stronger conservative movement. Libertarians must have learned that moral finger-wagging is justified when it helps to discredit regulators. And surely the family-values crowd has come to understand the glory of porn. It is, they can now see, just another weapon in the deregulator’s arsenal, as powerful a tool in securing bureaucratic somnolence as the services of any lobby shop on K Street.

Thomas Frank, Wall Street Journal

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Full article: http://online.wsj.com/article/SB10001424052748704471204575210550829251026.html

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Is Financial Innovation the Enemy?

Hedging against risk is hardly evidence of misbehavior.

Whether Goldman is bad, very bad or very, very good depends on what business you think it should be in. But its troubles have also brought out the dime-store Jeremiahs declaiming on the perniciousness of “derivatives.”

First off, no security is more derivative than a share of stock, which is not really ownership of a company (though it’s usually claimed so) but merely a right to whatever cash management deigns to share, plus a right to whatever is left over in a bankruptcy, plus a right to participate in corporate governance in whatever limited ways a company’s bylaws permit.

A welcome for Goldman Sachs executives at yesterday’s Senate hearing.

Only an infinitesimal fraction of share sales actually finance something “real.” Most are exchanges between one punter and another. Too, any serious person knows that the best guarantee of performance is not a company’s bylaws or the SEC, but making sure the CEO owns a large chunk of stock.

By comparison, the Goldman “Abacus” CDO is simplicity itself, despite much malpractice in the press.

The CDO was not “designed to fail.” The securities that failed were the simple, wholesome straightforward mortgages that the CDO “referenced,” which were designed to extract a fair return from people who supposedly cherished their homes and would strive to pay their bills.

The CDO itself performed exactly as advertised: It paid off the winner of two opposing bets about whether large numbers of mortgage borrowers would default.

Nor was the trade the equivalent of “taking out fire insurance on your neighbor’s house,” at least in the sense that your intentions were different from what the insurer expected. Instead, it’s like you and an insurance company having the following conversation:

You: “I think house X is going to burn down.”

Insurance company: “We don’t think it will burn down and we know more about houses than you do.”

You: “It will burn down.”

Insurance company: “Will not.”

You and insurance company simultaneously: “Let’s bet!”

This is a distortion only in that it underestimates the amount of iteration. The first warning of a housing bubble in The Journal came in August 2001, just weeks after the tech crash. The debate was in full swing by late 2006, when Goldman began putting together the Abacus CDO.

Most gobsmacking, however, is the assertion that such “side bets” serve no legitimate social function.

Come again? With so many financial institutions sitting on massive portfolios of mortgages, how on earth could a mechanism to share some of the risk with willing counterparties fail to be useful? Would that more banks had done so, or that one of those counterparties (AIG) had held up its end more competently.

And how can anyone doubt the utility of John Paulson, after witnessing how vulnerable our individual savings and wealth are to large-scale blunders in the financial system? By engineering the deal, he may have walked away with a disproportionate accretion to his own net worth. For his clients, his timely shorts were probably the difference between losing a lot and losing less in the general crash. If we’re going to have a financial system so prone to catastrophic mistakes, we’re all going to need a John Paulson.

The disingenuousness is thick with the selective release of Goldman emails by Congressional investigators in advance of yesterday’s grilling of Goldman CEO Lloyd Blankfein, the subtext of which was that when Americans see the value of their homes plummet, it’s unpatriotic if not criminal not to have lost money along with them. Better than what Mr. Blankfein says now in his defense, though, is the fuller version of what he emailed to colleagues at the time: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost because of shorts. It’s not over, so who knows how it will turn out ultimately.”

To anyone not in an unseemly haste to join the Goldman whipping detail, this sounds like what every banker should have been thinking at the time: “The future is unknown and scary. Let’s hope we’re properly hedged.”

For the truth is, the “mortgage mess” would likely not have metastasized into a global financial crisis if similar emails were now to be found in the records of Fannie Mae, Freddie Mac, Bear Stearns, Citigroup, Washington Mutual, AIG, Lehman, etc.

Not beyond the wit of man (though apparently beyond the wit of the current Congress) is changing the incentives so housing and other lenders will be less driven or tempted to create “systemic risk.” In the meantime, however, all the hooey over Goldman could have genuinely dangerous consequences if it causes Washington to lose the political stomach to backstop the system with its own credit next time a panic threatens a blind run as it did in late 2008.

Holman W. Jenkings, Jr.

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Full article and photo: http://online.wsj.com/article/SB10001424052748704471204575209953018044516.html

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Land of the lost

For once, Hollywood is right to oppose innovation

“NOBODY knows anything,” said the screenwriter William Goldman of the film business. But a great many people think they do. And they may soon get the chance to back their hunches with money. On April 20th America’s Commodity Futures Trading Commission (CFTC) approved the second of two exchanges that would allow trading of contracts based on films’ box-office takings.

It is an answer to a real problem. The six main studios, which have become dependent on small numbers of big-budget films, are finding it hard to spread risk. Investors who fled during the credit crunch have not yet returned. Independent filmmakers are struggling to sell the rights to foreign box-office takings in advance—something they used to rely on to pay for their pictures. There is a need to hedge against failure. But Hollywood is not convinced that the exchanges meet it.

Although the markets run by Cantor Fitzgerald and Media Derivatives have been approved, the contracts to be traded on them have not. Hollywood is lobbying hard to stop them. It has launched a separate effort to have Congress ban box-office futures. Politicians as diverse as Barbara Boxer, a California liberal, and Orrin Hatch, a Utah conservative, have spoken out against them. It is the equivalent of a coast-to-coast marketing blitz.

Some of the objections are silly. A joint letter from Hollywood’s trade associations points out that box-office figures, though treated as reliable, are in fact estimates by the studios. True, but this is surely an argument for better figures, not for a ban on trading. There are, however, more serious problems with the exchanges.

The first is the information imbalance in the film business. Cantor’s market is based on an existing predictive market, the Hollywood Stock Exchange, which uses play money. A study of that exchange, by Thomas Gruca of the University of Iowa, found that it errs in predicting box-office returns by an average of 31%. But the studios know a lot more than other investors. They know how audiences are responding to test screenings, on how many screens a film will play, and how much they are going to spend marketing it. Although such information leaks out, it does so selectively and unevenly. As a result, almost every trade by a studio would be an insider bet.

And it is highly unlikely that a studio would ever short one of its own products. In Tinseltown, more than in almost any other industry, rumour and reality bleed together. A Hollywood executive is powerful and successful largely because he is viewed as being powerful and successful. A film that is rumoured to be a dud tends, by means of “bad buzz” leaking to newspapers and the internet, to become a dud. So a bet against a film would become self-fulfilling—to say nothing of how hard it would be to explain to the talent.

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Full article and photo: http://www.economist.com/business-finance/displaystory.cfm?story_id=15955332&source=hptextfeature

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A new idolatry

Shareholders v stakeholders

The economic crisis has revived the old debate about whether firms should focus most on their shareholders, their customers or their workers

THE era of “Jack Welch capitalism” may be drawing to a close, predicted Richard Lambert, the head of the Confederation of British Industry (CBI), in a speech last month. When “Neutron Jack” (so nicknamed for his readiness to fire employees) ran GE, he was regarded as the incarnation of the idea that a firm’s sole aim should be maximising returns to its shareholders. This idea has dominated American business for the past 25 years, and was spreading rapidly around the world until the financial crisis hit, calling its wisdom into question. Even Mr Welch has expressed doubts: “On the face of it, shareholder value is the dumbest idea in the world,” he said last year.

In an article in a recent issue of the Harvard Business Review, Roger Martin, dean of the University of Toronto’s Rotman School of Management, charts the rise of what he calls the “tragically flawed premise” that firms should focus on maximising shareholder value, and argues that “it is time we abandoned it.” The obsession with shareholder value began in 1976, he says, when Michael Jensen and William Meckling, two economists, published an article, “Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure”, which argued that the owners of companies were getting short shift from professional managers. The most cited academic article about business to this day, it inspired a seemingly irresistible movement to get managers to focus on value for shareholders. Converts to the creed had little time for other “stakeholders”: customers, employees, suppliers, society at large and so forth. American and British value-maximisers reserved particular disdain for the “stakeholder capitalism” practised in continental Europe.

Now, Mr Martin argues, shareholder value should give way to “customer-driven capitalism” in which firms “should instead aim to maximise customer satisfaction.” This idea is winning some converts. Paul Polman, who last year became boss of Unilever, a consumer-goods giant, recently said to the Financial Times, “I do not work for the shareholder, to be honest; I work for the consumer, the customer…I’m not driven and I don’t drive this business model by driving shareholder value.”

Nor is it just customers who are expected to benefit from a backlash against the cult of shareholder value. Mr Lambert reports that a recent survey of the CBI’s members found that most expected that a “more collaborative approach would emerge with various different groups of stakeholders”, including suppliers and the institutions that educate workers. And a forthcoming book by Vineet Nayar, the chief executive of HCL Technologies, a fast-growing Indian business-process outsourcing firm, takes a quite different position to Mr Martin, as is evident from its title: “Employees First, Customers Second”.

Has the shareholder-value model really failed, however? The financial meltdown has certainly undermined two of the big ideas inspired by Messrs Jensen and Meckling: that senior managers’ pay should be closely linked to their firm’s share price, and that private equity, backed by mountains of debt, would do a better job of getting managers to maximise value than the public equity markets. The bubbles during the past decade in both stockmarkets and, later, the market for corporate debt highlighted serious flaws with both of these ideas, or at least with the way they were implemented.

A firm’s share price on any given day, needless to say, can be a very poor guide to long-term shareholder value. Yet bosses typically had their pay linked to short-term movements in share prices, which encouraged them to take measures to push the share price up quickly, rather than to maximise shareholder value in the long run (by when they would probably have departed). Similarly, private-equity firms took on too much debt during the credit bubble, when it was available on absurdly generous terms, and are now having to make value-destroying cuts at many of the companies in their portfolios as a result.

In some ways the current travails of Goldman Sachs epitomise the problem. The investment bank embraced the maximisation of shareholder value when it went public in 1999. Although it insists that it does not live quarter to quarter, senior figures from its previous incarnation as a partnership, when it naturally championed the long-term interests of its employees (the partners), argue that it would have been much more wary in those days of any deals that made a quick buck at the risk of alienating customers. But, as Mr Lambert points out, “It wasn’t just the banks which had a rush of blood to the head. For a few years, a fair number of other companies seemed to put almost as much effort into managing their balance-sheets as into wooing their customers.” In his view, “If you concentrate on maximising value to shareholders over the short term, you put at risk the relationships that will determine your longer-term success.”

Yet this need not mean that the veneration of shareholder value is wrong, and should be replaced by worship at the altar of some other business deity. Most of those preaching reverence for other stakeholders concede that the two are usually not mutually exclusive, and indeed, often mutually reinforcing. Mr Martin, for example, admits that “increased shareholder value is one of the by-products of a focus on customer satisfaction.” Likewise, in India’s technology industry, where retaining talented staff is arguably managers’ hardest task, Mr Nayar’s devotion to employees, which he says has helped increase revenues and profits, may be the best way to maximise long-term shareholder value.

In other words, the problem is not the emphasis on shareholder value, but the use of short-term increases in a firm’s share price as a proxy for it. Ironically, shareholders themselves have helped spread this confusion. Along with activist hedge funds, many institutional investors have idolised short-term profits and share-price increases rather than engaging recalcitrant managers in discussions about corporate governance or executive pay.

Giving shareholders more power to influence management (especially in America) and encouraging them to use it should prompt them and the managers they employ to take a longer view. In America, Congress is considering several measures to bolster shareholders at managers’ expense. In Britain, the Financial Reporting Council has proposed a “stewardship code” to invigorate institutional investors. “This is a phoney war between shareholder capitalism and stakeholder capitalism, as we haven’t really tried shareholder capitalism,” says Anne Simpson, who oversees corporate-governance activism for CalPERS, America’s biggest public pension fund. “Rather than give up on shareholder value, let’s have a real go at setting up shareholder capitalism.”

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Full article and photo: http://www.economist.com/business-finance/displaystory.cfm?story_id=15954434&source=features_box_main

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Outfoxing the Counterfeiters

The new $100 bill is the most sophisticated attempt yet to combat forgery. Since colonial times, the U.S. has engaged in a cat-and-mouse game with criminals and foreign governments eager to pass off brilliant fakes.

The redesigned $100 bill, above, has security features like microprinting, color-shifting objects and a 3-D ribbon.

In 1690, the Massachusetts Bay Colony became the first government in the Western world to issue paper money. Some of the first counterfeiters of paper money followed soon after. Within a generation, the authorities were engaged in a running battle against forgers, whom they tried to deter by various punishments: cropping their ears, for example, or hanging them. Many colonial notes soon came with a pointed warning: “To counterfeit is DEATH.”

Last week, in a ceremony attended by Timothy Geithner and Ben Bernanke, government officials showed off a high-tech $100 bill designed to frustrate 21st-century counterfeiters. It features the pleasing pastels already seen on lesser denominations, as well as a ghostly image of a quill pen and a copper inkwell containing a bell that appears and disappears depending on the angle from which it’s viewed. Most startling of all, the front of the bill contains a vertical purple strip that contains shimmering images of the number “100″ and the Liberty Bell, all of which miraculously appear to move when the bill is tilted in one direction or another.

With well over a half trillion dollars in “Benjamins” in circulation around the world, the existing $100 bill has attracted the attention of countless counterfeiters. Most have been sophisticated criminal gangs, but there’s also a considerable (if controversial) body of evidence linking the most realistic and dangerous counterfeits—the so-called supernotes—with the North Korean government. These twin threats, more than anything else, have driven this latest eye-popping change to our money supply.

If history is any guide, it won’t be the last. Paper money in this country has followed a familiar trajectory: new designs, new dollars and, eventually, new counterfeits.

It’s perhaps appropriate that Benjamin Franklin appears on the most valuable denomination of dollar in circulation. He designed the country’s first money: the Continental dollars issued during the American Revolution to pay the costs of the war. Franklin didn’t put his own head on the currency; rather, he used a mysterious anticounterfeiting device he had devised several decades earlier.

This was the so-called nature print, which consisted of an image of a leaf or leaves. It was extraordinarily lifelike, and with good reason. Franklin had devised a way of taking a plaster cast of the surface of a leaf. That in turn could be used to cast a lead plate that would be used to print the notes. Because every leaf was unique—with a complex web of veins of varying thickness—the notes were very difficult to counterfeit.

The counterfeiters who attacked the new dollar weren’t in it for the money. They wanted to undermine the revolutionary war effort, and they spared no expense to do so. In 1776, the British occupied New York City and the counterfeiters who had already set up shop began operating under the supervision of the imperial authorities, churning out massive quantities of notes that visitors could buy for pennies and then pawn off on unsuspecting revolutionaries.

The British hadn’t invented the idea of counterfeiting as a weapon of war; counterfeiting enemy currency is a tactic that dates back to antiquity. Still, the patriots viewed these imitations as unsportsmanlike in the extreme. George Washington fumed in his private correspondence that “no Artifices are left untried by the Enemy to injure us.” Thomas Paine was even more outraged, publishing an open letter to the British commander in which he assailed the decision to counterfeit the dollar. “You, sir,” he wrote, “have the honor of adding a new vice to the military catalogue, and the reason, perhaps, why the invention was reserved for you, is, because no general before was mean enough even to think of it.”

The quality of the British counterfeits undercut the credibility of the dollar, but the real blame for the dollar’s decline lay with the revolutionaries, who issued vast quantities of Continentals to pay the costs of the war. Backed by nothing more than a shaky faith in the government, the notes depreciated, eventually becoming nearly worthless. The experience left Americans with serious misgivings about paper currency, both counterfeit and real.

The Constitution was a product of those fears. The monetary clauses of the Constitution forbade the individual states from issuing paper money or coins, though it did permit the federal government to “coin money.” It was silent on the question of whether the federal government could issue paper money, though most assumed it lacked that prerogative.

Yet paper money flourished, thanks to private banks chartered by state legislatures. These banks began issuing their own paper money in denominations and designs of their choice. Thousands of different kinds of “bank notes” floated in circulation, each with their own unique design. Ben Franklin and the other founders appeared on some, but so, too, did everyone (and everything) from portraits of obscure politicians, Greek and Roman gods, scantily clad women, slaves, Indians and scenes of everyday life. Even stranger things—Santa Claus, sea serpents and rampaging polar bears, to name a few—showed up on these private currencies.

It proved next to impossible to remember what genuine notes looked like, never mind counterfeits, and the opening decades of the 19th century marked what one historian has called the “golden age of counterfeiting.” In those decades, millions of dollars in counterfeit notes flooded the economy. The masterminds behind these counterfeits created them with the hope of making money, not sabotaging the country.

Many of these counterfeiters became folk heroes, running national criminal networks for the manufacture, distribution and sale of counterfeit notes. Absent effective police forces, these men and women operated with impunity. The federal government showed little to no interest in prosecuting counterfeiters, and it had few resources to do so anyway. As one newspaper editor bewailed in 1818: “Counterfeiters and false bank notes are so common, that forgery seems to have lost its criminality in the minds of many.”

The banks fought back, commissioning ever more elaborate notes that contain many of the same anticounterfeiting features that survive today: special inks, watermarks and proprietary paper recipes. Engravers also sought to create ever more elaborate, intricate designs that would defy imitation. Yet counterfeiters still managed to surmount every technological obstacle thrown their way.

Indeed, new technology could cut both ways. Like the digital technologies of the 21st century, the invention of photography opened up new vistas in counterfeiting. Until the 1850s, most bank notes came in one color: black. But a proliferation of photographic counterfeits prompted the creation of new colorful inks, including the invention in 1857 of a new kind of green ink that used chromium trioxide. The delicate green lines printed in this ink could not be replicated with the black-and-white photography of the day; it would appear as a black mass when photographed.

The Civil War began four years later, and the cash-strapped Union quickly got over its constitutional objections to paper money, issuing a new national currency that used this “Patent Green Tint.” The new notes became known as greenbacks. They soon circulated alongside another kind of national currency colored the same shade of green: the “national bank notes,” issued by banks that obtained federal charters and the right to issue money designed and controlled by the federal government.

The Confederacy issued its own paper money. Lacking skilled engravers and the necessary supplies, the “grayback” looked awful and followed the fate of the Continental, losing its value over the course of the war. Ordinary counterfeiters considered them unworthy of imitation, but enterprising and patriotic Unionists churned out millions of dollars’ worth of counterfeits while the federal government looked the other way. Many of these knockoffs had the distinction of being better looking than the originals.

The war marked a serious watershed in the nation’s monetary history—and in the history of counterfeiting. Out went the old system of local, private currencies, and in came a new national paper money. But the counterfeiters remained, and they immediately set to work imitating the federal notes. Government officials were not amused, and in the final years of the Civil War, some of the new notes contained blocks of text spelling out the statutory penalties for counterfeiting (up to 15 years imprisonment and hard labor, a $1,000 fine or both).

But these amounted to empty threats without a concerted campaign to crack down on counterfeits. That job fell to a newly created national police force: the Secret Service. Long before it protected the president, the Secret Service made its mark ruthlessly dismantling the domestic counterfeit economy. This campaign, which began in earnest after the Civil War and was largely complete by the 1890s, stirred journalists to hyperbole. In 1901, one newspaper marveled at what is breathlessly described as a “silent, unsleeping branch of the Government, which never appears in the public eye except in the act of pouncing on a victim and which never forgets a crime or a criminal.”

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Making Funny Money

Some famous counterfeiting ploys—by governments and criminals—through history.         

• Governments have long forged currency as a war tactic. In Renaissance Italy in the 1470s, Duke Galeazzo Sforza of Milan printed counterfeit Venetian ducats, to undermine the economy of the rival city-state.
• In the 1690s, Isaac Newton took a job as warden of the British mint, where he prosecuted and sent scores of counterfeiters to the gallows. To catch them, he kept a network of spies across London and interviewed informants himself in pubs. His biggest catch was the notorious William Chaloner, who claimed to have reproduced £30,000 (the equivalent of about $7 million today) and was hanged in 1699.
• One of the largest frauds in history is the Portuguese bank-note crisis of 1925. A con man named Alves Reis convinced a British printer that he represented the Bank of Portugal, and had them print the modern equivalent of about $125 million in bills. His scheme went unnoticed for nearly a year.
• In 1926, a group of Hungarians (including Budapest’s chief of police) pleaded guilty to printing millions of French francs, partly to fund political activities and avenge territorial losses suffered by their country. However, the quality was poor, and they were soon caught by French detectives.

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By the early 20th century, the currency was relatively safe from counterfeiters. It had also become more uniform and simple, particularly after the creation of the Federal Reserve in 1913. Ben Franklin made his debut on the $100 bill, and the nation’s currency became increasingly important, eventually displacing the British pound as the world’s dominant currency. Unfortunately, that rise attracted the attention of foreign governments. In a vivid demonstration of the old adage that imitation is the sincerest form of flattery, Joseph Stalin ordered his fledgling intelligence service to counterfeit the dollar. While he may have done so ostensibly to wage war on a capitalist country, the real reason lay with the Soviet Union’s desperate need for hard currency.

The extraordinarily well-made $100 bills that flowed from Soviet presses initially flummoxed the Secret Service. Yet the quality of the bills was not matched by the professionalism of the principals who orchestrated the scheme, and it collapsed after a series of arrests that began in Berlin. Soon after, the Soviets shut down the operation, fearful of international embarrassment.

The Nazis pulled off a far more successful counterfeiting operation during World War II, setting up a team of engravers and artisans in the Sachsenhausen concentration camp to manufacture stunning imitations of the British pound and the American dollar. While counterfeits of the pound went into limited circulation, they did little damage to Britain, and the project to counterfeit the dollar collapsed in the waning months of the war.

Few successful counterfeits of the dollar gained widespread circulation in the postwar era, and for decades the appearance of the $100 bill remained largely unchanged. In the late 1980s, the so-called supernote made its appearance: highly accurate $100s (and some $50s) that baffled investigators. The remarkable frequency with which North Korean diplomats were caught carrying the notes led many to suspect the secretive regime. During the George W. Bush administration, the U.S. formally charged North Korea with counterfeiting the dollar, a claim the Obama administration has echoed, if faintly.

Regardless of the source of the supernotes, they prompted the first major overhaul of the paper currency in decades. The first big change came with the introduction of the new $100 bill in 1996, which featured the “large head” design that has since become standard, along with watermarks and color-shifting ink. But the latest version of the $100 unveiled this week takes things to a whole different level.

The centerpiece of the redesign is a purple strip that runs from top to bottom of the bill. The strip is coated with hundreds of thousands of microscopic lenses in the shape of the number “100″ and what seems to be the Liberty Bell. Thanks to some complex optics, these thousands of lenses combine to create a single, larger image. When the bill is angled one way or another, the strip comes alive, making it seem as if the images can move.

The technology is dubbed “Motion.” Crane, the paper company that owns the rights to the technology, says that it “represents the next generation of counterfeit deterrence.” Unlike some of the first-generation deterrents—color-shifting ink, for example—Motion works its magic even in dimly lit settings like nightclubs.

The new note is a technological marvel. But looking at all the safeguards—not only the Motion strip, but the watermark, a separate security thread, microprinting, a color-shifting “100″ and the bell inside the inkwell—the effect is roughly comparable to an apartment door equipped with countless locks and latches. It screams “secure,” but the sheer abundance of security devices suggests that counterfeiters have been all too successful in breaching earlier defenses.

Crane promises that Motion will impose “tremendous barriers against a quality counterfeit.” Perhaps. But it’s a sure bet that somewhere in the world, counterfeiters are studying the new bill, looking to crack the code. And someday they will.

Stephen Mihm is associate professor of history at the University of Georgia and the author of “A Nation of Counterfeiters.”

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After the Crash, a Crashing Bore

The men behind the bailout take refuge in impenetrable jargon.

Like all Americans, I continue to seek to understand exactly what moods, facts, assumptions, dynamics, agendas and structures underlay and made possible the crash and the Great Recession.

We do this so that we will be able to bring our gained wisdom into the future and keep another crash from happening, should we ever have another bubble to precede it. We also do it so that we know who to hate.

That’s why this week’s Financial Industry Inquiry Commission hearings were so exciting, such a public service. The testimony of Charles Prince, former CEO of Citigroup, a too-big-to-fail bank that received $45 billion in bailouts and $300 billion in taxpayer guarantees, was riveting. You’ve seen it on the news, but if you were watching it live on C-Span, the stark power of his brutal candor was breathtaking. This, as you know, is what he said:

“Let’s be real. This is what happened the past 10 years. You, for political reasons, both Republicans and Democrats, finagled the mortgage system so that people who make, like, zero dollars a year were given mortgages for $600,000 houses. You got to run around and crow about how under your watch everyone became a homeowner. You shook down the taxpayer and hoped for the best.

“Democrats did it because they thought it would make everyone Democrats: ‘Look what I give you!’ Republicans did it because they thought it would make everyone Republicans: ‘I’m a homeowner, I’ve got a stake, don’t raise my property taxes, get off my lawn!’ And Wall Street? We went to town, baby. We bundled the mortgages and sold them to fools, or we held them, called them assets, and made believe everyone would pay their mortgage. As if we cared. We invented financial instruments so complicated no one, even the people who sold them, understood what they were.

“You’re finaglers and we’re finaglers. I play for dollars, you play for votes. In our own ways we’re all thieves. We would be called desperadoes if we weren’t so boring, so utterly banal in our soft-jawed, full-jowled selfishness. If there were any justice, we’d be forced to duel, with the peasants of America holding our cloaks. Only we’d both make sure we missed, wouldn’t we?”

OK, Charles Prince didn’t say that. Just wanted to get your blood going. Mr. Prince would never say something so dramatic and intemperate. I made it up. It wasn’t on the news because it didn’t happen.

It would be kind of a breath of fresh air though, wouldn’t it?

In fact, the hearings weren’t dramatic but a tepid affair, gentle and genteel. The commission members—economists, lawyers, former officeholders—actually made me miss congressmen, who can at least be relied on to emote and act out the indignation of the citizenry as they understand the citizenry. As an investigative style this isn’t pretty and usually isn’t even sincere, but it can jar witnesses into revealing, either deliberately or by accident, who they really are and what they really think.

At this week’s hearings, the questioners often spoke the impenetrable financial language of the witnesses. The leveraged capital arbitrage of the lowest CDOs were subject to the supersenior subprime exposure, as opposed to the triple-A seniors, right? The witnesses—former Fed Chairman Alan Greenspan on Wednesday, Mr. Prince and former Treasury Secretary and Citigroup Chairman Robert Rubin on Thursday—were, in their testimony, obviously anxious not to be the evening’s soundbite. Nobody wants to be the face of a bailout. This is where famous and important people being grilled hide now: in boringness, in an opacity of language so thick that following them is actually impossible. The testimony reminded me of an observation in Michael Lewis’s “The Big Short,” his study of what happened on Wall Street and why:

Language served a different purpose inside the bond market than it did in the outside world. Bond market terminology was designed less to convey meaning than to bewilder outsiders. . . . The floors of subprime mortgage bonds were not called floors—or anything else that might lead the bond buyer to form any sort of concrete image in his mind—but tranches. The bottom tranche—the risky ground floor—was not called the ground floor but the mezzanine . . . which made it sound less like a dangerous investment and more like a highly prized seat in a domed stadium.” In short, “The subprime mortgage market had a special talent for obscuring what needed to be clarified.”

Which is what the hearings were like.

By Thursday afternoon I couldn’t figure out why they’d been held. They couldn’t have been aimed at informing the citizenry. Even the tone was strange, marked by a kind of weird delicacy, a daintiness of approach, a courtesy so elaborate I thought at some points commission members were spoofing each other. “Thank you so much for appearing,” “I’m so grateful for that insight.” Guys, there’s a war on.

I want to pick out some memorable moments, but I can’t really quote them because they resist quotation.

So I’ll translate.

On Wednesday, Mr. Greenspan said it’s easy to look back and see your mistakes, but what is to be gained by endless self-examination? It’s tempting to be self-critical, but self-criticism can become self-indulgence. Systems are complex; human decision-making is shaped by the endless fact of human fallibility. I didn’t do anything wrong, and neither did Ayn Rand by the way, but next time you might try more regulation.

On Thursday Chairman Phil Angelides to Messrs. Prince and Rubin: I like you, do you like me? But we don’t like undersecuritized trilevel tranches, do we?

At one point commissioner Bill Thomas, a Republican former congressman from California, almost got an intelligent question out. It started as: How did you guys get to the top and run the show and not know what was going on below you? But Mr. Thomas got stuck in the muck of synthetic product securitized assets and then lost his thread, to the extent he had a thread. He began to ask Mr. Prince about his famous dancing quote: “As long as the music is playing, you’ve got to get up and dance,” Mr. Prince had said in 2007. But Mr. Thomas asked his question so meekly—it was an “alleged quote” and maybe it was misunderstood by the press, which is always misunderstanding things. Then Mr. Thomas suddenly wasn’t asking that, but asking if it would be nice if in the future bankers “have a structure,” a stronger federal regulatory structure, though we probably shouldn’t have one if we don’t need it, but maybe we do, to sort of stop people like you, not that people like you should be stopped in any way.

Mr. Prince seized on this to say the dancing quote was taken out of context: He’d been talking about liquidity. Ah. Well, that takes the sting out of that one.

From a commission member: The American people have experienced a 30% fall in housing values. Do you know why?

Mr. Prince: Yes, we haven’t had such a decline “since the Great Depression.” The reason is before the crash there was “a bubble.” There was too much “easy money.” Then the bubble popped.

Thank you, Sherlock.

The takeaway, as they say, of the whole event, was more or less this:

Citigroup testifiers: We didn’t do anything particularly wrong, and what happened is all so sad, isn’t it? Sad, subprimed and tranched.

Commission: Yes, all so sad and tragic. Somebody’s head should roll. I like your tie.

Can’t we do better than this?

Peggy Noonan, Wall Street Journal

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The 2010 Recovery

What happens when the reflation bill comes due?

Democrats are applauding and Republicans are criticizing Friday’s report of modest job growth in March, and for once they’re both right. The private economy is at last creating jobs, albeit not enough so far to conclude that the recovery of 2010 will become a durable expansion.

The jobs market does seem to have turned a corner, with the Labor Department’s survey of businesses reporting 162,000 new jobs in the month, plus modest upward revisions in January and February. One bright spot is manufacturing employment, up 17,000 in March and now up for three straight months, as well as a modest uptick in average hours worked to 34 in a week, from 33.9.

The companion household survey showed a heftier increase of 264,000 net jobs, rising to 1.1 million so far this year, and as we learned in the last recovery this survey tends to lead increases in what business reports in future months. The upshot is that at long last—and 13 months after the $862 billion stimulus that the White House said would keep unemployment below 8%—we should see more robust job creation in the months ahead.

The question is how robust. The March job gains included 48,000 temporary Census workers, for a total so far of 87,000 Census hires, and several hundred thousand more in the months ahead. Take out this government hiring, and job creation looks feeble. Also dismaying is that the so-called total jobless rate, which includes discouraged workers, ticked up again to 16.9%.

It’s especially distressing to see that the number of long-term jobless—those out of work for 27 weeks or more—jumped again to 6.55 million, and as a share of the total jobless hit a new record of 44.1%, up from 40.9% in February and 24.6% a year earlier. (See the nearby chart.) This means that nearly one of every two Americans who has lost his job is waiting at least a half year to get a new one. The damage in lost skills and human capital is enormous and can do life-long damage.

Congress keeps extending jobless benefits, and last week President Obama proposed a new subsidy for the jobless in the form of mortgage payment reductions if you’re out of work. Democrats think this is good politics because they can accuse Republicans of being uncaring if they vote no.

But the irony is that these extensions only increase the incentive to delay going back to work, especially if most available jobs are temporary or pay less than their old ones. Democrats are ensuring that the jobless rate stays higher for longer (it’s still a nasty 9.7%), which isn’t compassionate and can’t be good politics going into November.

***

This mixed jobs picture is symptomatic of the larger economic recovery, which has been underway for nine or so months but has felt less than dynamic. The stock market is doing well, which is one portent of future growth. Corporate profits have been increasing smartly, which is also helping stocks, as has productivity as firms squeeze more output from each worker. Thanks to China and India in particular, global manufacturing has rebounded.

And of course the banking system has gone a long way to healing itself from the panicked lows of last March. The Obama Treasury deserves some credit on this score for ignoring the advice of its friends on the left who recommended nationalizing the banks, and tempering some of the worst banker-bashing.

Mr. Obama attacked us by name Thursday in Boston—the second time in a week—for mentioning last year that his policies might have had something to do with the stock-market’s lows. We’re glad to see the President pays such close attention to our work, but one reason the market has recovered is because some of his policies have either improved (the bank “stress tests” proved to be reassuring) or appear to be stymied on Capitol Hill (cap and tax, union card check).

The U.S. economy is a fantastic engine of prosperity, and left to its own devices its tendency is to expand. Especially after falling so far in the recession, a growth rebound was inevitable—and the biggest surprise so far has been that the bounce hasn’t been more robust. Some of that must be laid at the feet of the policy uncertainty in Washington, with small businesses in particular having no clear sense of what their future costs will be. This may bear especially on the slow comeback in job creation.

The larger policy context is that the U.S. recovery has been built on an enormous reflation bet, both fiscal and monetary. The stimulus and its many sister subsidies (housing tax credits, cash for clunkers, etc.) have flooded the economy with government-directed cash and credit. We think marginal-rate tax cuts would have done much more for growth, as in 1983 and 2003.

The Federal Reserve has also kept and maintained an historically easy monetary policy. This was necessary for a time to offset the decline in monetary velocity in the wake of the credit panic, but the near-zero interest rate has also made it easier for banks to make money on interest-rate plays rather than actual lending. It is also contributing to higher commodity prices and distortions in the dollar bloc overseas. The Fed is fortunate that the mess in Greece has made the dollar seem a better reserve currency than the euro.

***

As we look beyond this year, the bill for this Great Reflation will eventually come due. Coming out of the last steep recession, in 1983, both interest rates and tax rates were coming down. Today, they are both headed up. In 1983, the regulatory state was in retreat. Today, it is expanding across most areas of the economy.

A huge tax increase hits on January 1, as the Bush rates expire. Sooner or later, the Fed will get off zero and interest rates will climb. The neo-Keynesians who have dominated U.S. economic policy since 2006 are betting—hoping—that the expansion will have built up enough steam to ride out these and other growth shocks. The rest of us have to hope they’re right.

Editorial, Wall Street Journal

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The ObamaCare Writedowns—II

Democrats blame a vast CEO conspiracy.

So the wave of corporate writedowns—led by AT&T’s $1 billion—isn’t caused by ObamaCare after all. The White House claims CEOs are reducing the value of their companies and returns for shareholders merely out of political pique.

A White House staffer told the American Spectator that “These are Republican CEOs who are trying to embarrass the President and Democrats in general. Where do you hear about this stuff? The Wall Street Journal editorial page and conservative Web sites. No one else picked up on this but you guys. It’s BS.” (We called the White House for elaboration but got no response.)

In other words, CEOs who must abide by U.S. accounting laws under pain of SEC sanction, and who warned about such writedowns for months, are merely trying to ruin President Obama’s moment of glory. Sure.

Presumably the White House is familiar with the Financial Standard Accounting Board’s 1990 statement No. 106, which requires businesses to immediately restate their earnings in light of their expected future retiree health liabilities. AT&T, Deere & Co., AK Steel, Prudential and Caterpillar, among others, are simply reporting the corporate costs of the Democratic decision to raise taxes on retiree drug benefits to finance ObamaCare.

When the Medicare prescription drug plan was debated in 2003, many feared that companies already offering such coverage would cash out and dump the costs on government. So Congress created a modest subsidy, equal to 28% of the cost of these plans for seniors who would otherwise enroll in Medicare. This subsidy is tax-free, and companies used to be allowed to deduct the full cost of the benefit from their corporate income taxes (beyond the 72% employer portion).

Democrats chose to eliminate the full exclusion and said they were closing a loophole. But whatever it’s called, eliminating it “will be highly destabilizing for retirees who rely upon employer sponsored drug coverage” and “will impose a dramatic and immediate impact on company financial statements.”

That’s how the AFL-CIO put it in a December 10 letter. The Communications Workers of America and the International Brotherhood of Electrical Workers—also known as the AT&T and Verizon workforce—were opposed too. So much for White House claims that reporting these facts is partisan.

As for whether this change is better tax policy, the new health-care bill creates a similar $5 billion fund that will subsidize health costs for early retirees between the ages of 55 and 64. These payments won’t be subject to taxation, and companies will likely be able to deduct the full cost of such coverage. (The language is vague and some experts disagree.) The Democrats now feigning tax outrage—but who are really outraged by political appearances—didn’t think twice about writing the same loophole back into the tax code. This new reinsurance program was a priority of the United Auto Workers.

The deeper concern—apart from imposing senseless business losses in a still-uncertain economy—is that companies will start terminating private retiree coverage, which in turn will boost government costs. The Employee Benefit Research Institute calculates that the 28% subsidy on average will run taxpayers $665 in 2011 and that the tax dispensation is worth $233. The same plan in Medicare costs $1,209.

Given that Congress has already committed the original sin of creating a drug entitlement that crowds out private coverage, $233 in corporate tax breaks to avoid spending $1,209 seems like a deal. If one out of four retirees is now moved into Medicare, the public fisc will take on huge new liabilities.

Meanwhile, Democrats have responded to these writedowns not by rethinking their policy blunder but by hauling the CEOs before Congress on April 21 for an intimidation session. The letter demanding their attendance from House barons Henry Waxman and Bart Stupak declared that “The new law is designed to expand coverage and bring down costs, so your assertions are a matter of concern.”

Perhaps Mr. Waxman should move his hearing to the Syracuse Carrier Dome. The Towers Watson consulting firm estimates that the total writeoffs will be as much as $14 billion, and the 3,500 businesses that offer retiree drug benefits are by law required to report and expense their losses this quarter or next. But ’twas a famous victory, ObamaCare.

Editorial, Wall Street Journal

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The Rules in China

After a Chinese court sentenced four executives of Australian mining company Rio Tinto to lengthy prison terms for bribery and stealing commercial secrets yesterday, Canberra was quick to respond. Foreign Minister Stephen Smith pointedly stated, “As China emerges into the global economy, the international business community needs to understand with certainty what the rules are in China.”

In the eight months since Australian citizen Stern Hu and his Chinese colleagues Wang Yong, Ge Minqiang and Liu Caikui were arrested, we’ve learned a great deal about the lack of certainty and rules not only in China, but also in the global commodities trade. Some of that is China’s fault, but hardly all of it. The Australian government and Rio Tinto must share the blame for lack of transparency and failing to play by the rules.

Foreign media coverage of the arrests and trial has focused on whether the Chinese authorities pursued this case for political reasons. Remember that early last year, cash-starved Rio Tinto angered China by inviting Aluminum Corp. of China, or Chinalco, to take a $19.5 billion equity stake and then backing out of the deal under a combination of shareholder, government and public pressure. Rio was also driving a tough bargain in iron-ore price negotiations with Chinese buyers. Many observers speculated that the four executives were pawns in a high stakes game of tit-for-tat orchestrated from Beijing.

Certainly the timing of the case makes such suspicions inevitable. But the reality is probably more complicated. The Chinese justice system may be manifestly unfair, and once it gains momentum a guilty verdict is a foregone conclusion. Yet Rio itself put forces in motion that led to four men losing their freedom.

It all started with the boom in the global iron-ore market in the early 2000s. That’s when China’s steel industry embarked on a massive expansion of capacity, turning the trade in ore from a buyer’s market to a seller’s market. China’s large state-owned steelmakers bought at the benchmark price negotiated by Japanese and Korean mills, while smaller firms had to pay the higher spot price. This created an incentive for arbitrage and corruption, but unfortunately both the Chinese government and the mining companies were slow to take account of this in their internal controls.

As demand soared, the benchmark and market prices for iron ore diverged and the system came under increasing stress. In 2008, the Brazilian mining giant Vale negotiated a new benchmark price, only to see its two Australian rivals, BHP Billiton and Rio Tinto, refuse to follow it. Vale reacted by tearing up its agreed benchmark price and renegotiating with producers who were over a barrel.

Then Rio Tinto also began to back out of its contracts, for instance by invoking clauses in contracts to hold back 10% of deliveries, which could then be resold at the spot price. Since Rio was facing a hostile takeover bid from BHP, the company’s managers pushed especially hard for every last dollar at the expense of their trading partners to show that they could deliver higher returns for shareholders.

Rio’s Mr. Hu himself acknowledged the problem. In 2008, after Rio negotiated a 87% price increase, Australian reporter John Garnaut interviewed him: “He said he had no qualms with driving as hard a bargain as he could on price. But he had misgivings about whether Rio Tinto should risk its integrity in China by claiming ‘force majeure’ to wriggle out of long-term contracts to chase higher prices elsewhere. ‘We acted in accordance with the letter of the contracts, but not the spirit,’ he said.”

This weakening of the bonds of contract naturally infuriated Chinese steelmakers. So when the economic crisis hit at the end of 2008 and demand for iron ore evaporated, it was payback time. Enjoying a buyer’s market again, the Chinese firms simply walked away from contracts.

The turnabout didn’t last long. Beijing’s massive fiscal stimulus program quickly revived demand for steel by the middle of 2009, and the Australians were able to start raising prices again. Negotiations over new iron-ore benchmark prices were particularly acrimonious, given the bad blood created over the past couple years. And that was the state of play when Mr. Hu and his colleagues were arrested on July 5, 2009.

One past participant in the iron-ore business, who insists on anonymity because of the sensitivities on both sides, believes that the investigation into the Rio Tinto executives was ongoing for many months before the arrests, meaning they were not directly related to the Chinalco fiasco or the ongoing price negotiations. The authorities likely started sniffing around as a result of a tip-off from someone on the Chinese side of the industry. The ill will created by the whipsawing prices and huge losses suffered by some firms supplied plenty of motivation for someone to drop the dime on Rio.

And some dirt was found. Rio Tinto has severed its relationship with the executives, saying they engaged in “deplorable behavior,” effectively accepting the verdict that they were taking kickbacks from steelmakers to arrange preferential access to iron ore. The charges of stealing commercial secrets are much more murky, as evidenced by the fact that they were heard in a totally sealed courtroom, but these too probably originated from lower down the ladder of officialdom, rather than a Beijing-led witch-hunt against Rio Tinto.

The bosses in Australia made the mistake of leaving their Chinese executives in place for too long with too little supervision. But the bigger mistake was destroying the trust of the handshake deals made with Chinese partners in the quest for a little extra margin. That is bad practice anywhere, but especially in China.

Chinalco has not held a grudge against Rio for the failed equity deal. The two companies continue to negotiate joint projects in countries like Mongolia and Guinea. The State Council’s own post-mortem report on the affair is relatively kind to Rio and admits that the Chinese side could have handled the deal better.

However, the government of Prime Minister Kevin Rudd does not come off so well. Treasurer Wayne Swan ran scared from public perceptions of being too soft on China and politicized the approval process for Chinese investments, making it clear that the Chinalco deal would not go through and future acquisitions in the natural resources industry would face strict limitations. The lack of transparency and hostility toward China came as a complete surprise to Beijing and has created lasting tension between the two countries.

It was bad luck that around the same time, Xinjiang dissident Rebiya Kadeer was invited to Australia and Canberra issued a defense white paper that singled out China as a potential threat around which to base future strategy. From Beijing’s perspective these all suggested that Australia was turning hostile and there was no certainty about the rules for Chinese companies doing business there. Had this not happened, it’s possible that greater leniency would have been shown to the four Rio Tinto executives.

Everyone doing business in China should be clear by now on the rules—there is no rule of law. Deals can be done on the basis of mutual trust, which creates some level of certainty. The four Rio Tinto executives may be guilty of corruption, but the real reason they are in prison is because that trust broke down.

Mr. Restall is a member of the editorial board of The Wall Street Journal.

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With health bill, Obama has sown the seeds of a budget crisis

When historians recount the momentous events of recent weeks, they will note a curious coincidence. On March 15, Moody’s Investors Service — the bond rating agency — published a paper warning that the exploding U.S. government debt could cause a downgrade of Treasury bonds. Just six days later, the House of Representatives passed President Obama’s health-care legislation costing $900 billion or so over a decade and worsening an already-bleak budget outlook.

Should the United States someday suffer a budget crisis, it will be hard not to conclude that Obama and his allies sowed the seeds, because they ignored conspicuous warnings. A further irony will not escape historians. For two years, Obama and members of Congress have angrily blamed the shortsightedness and selfishness of bankers and rating agencies for causing the recent financial crisis. The president and his supporters, historians will note, were equally shortsighted and self-centered — though their quest was for political glory, not financial gain.

Let’s be clear. A “budget crisis” is not some minor accounting exercise. It’s a wrenching political, social and economic upheaval. Large deficits and rising debt — the accumulation of past deficits — spook investors, leading to higher interest rates on government loans. The higher rates expand the budget deficit and further unnerve investors. To reverse this calamitous cycle, the government has to cut spending deeply or raise taxes sharply. Lower spending and higher taxes in turn depress the economy and lead to higher unemployment. Not pretty.

Greece is experiencing such a crisis. Until recently, conventional wisdom held that only developing countries — managed ineptly — were candidates for true budget crises. No more. Most wealthy societies with aging populations, including the United States, face big gaps between their spending promises and their tax bases. No one in Congress could be unaware of this.

Two weeks before the House vote, the Congressional Budget Office released its estimate of Obama’s budget, including its health-care program. From 2011 to 2020, the cumulative deficit is almost $10 trillion. Adding 2009 and 2010, the total rises to $12.7 trillion. In 2020, the projected annual deficit is $1.25 trillion, equal to 5.6 percent of the economy (gross domestic product). That assumes economic recovery, with unemployment at 5 percent. Spending is almost 30 percent higher than taxes. Total debt held by the public rises from 40 percent of GDP in 2008 to 90 percent in 2020, close to its post-World War II peak.

To criticisms, Obama supporters make two arguments. First, the CBO says the plan reduces the deficit by $143 billion over a decade. Second, the legislation contains measures (an expert panel to curb Medicare spending, emphasis on “comparative effectiveness research”) to control health spending. These rejoinders are self-serving and unconvincing.

Suppose the CBO estimate is correct. So? The $143 billion saving is about 1 percent of the projected $12.7 trillion deficit from 2009 to 2020. If the administration has $1 trillion or so of spending cuts and tax increases over a decade, all these monies should first cover existing deficits — not finance new spending. Obama’s behavior resembles a highly indebted family’s taking an expensive round-the-world trip because it claims to have found ways to pay for it. It’s self-indulgent and reckless.

But the CBO estimate is misleading, because it must embody the law’s many unrealistic assumptions and gimmicks. Benefits are phased in “so that the first 10 years of [higher] revenue would be used to pay for only six years of spending” increases, a former CBO director, Douglas Holtz-Eakin, wrote in the New York Times on March 20. Holtz-Eakin also noted the $70 billion of premiums for a new program of long-term care that reduce present deficits but will be paid out in benefits later. Then there’s the “doc fix” — higher Medicare reimbursements under separate legislation that would cost about $200 billion over a decade.

Proposals to control health spending face restrictions that virtually ensure failure. Consider the “Independent Payment Advisory Board” aimed at Medicare. “The Board is prohibited from submitting proposals that would ration care, increase revenues or change benefits, eligibility or Medicare beneficiary cost sharing,” says a summary by the Henry J. Kaiser Family Foundation. What’s left? Similarly, findings from “comparative effectiveness research” — intended to identify ineffective care — “may not be construed as mandates, guidelines or recommendations for payment, coverage or treatment.” What’s the point then?

So Obama is flirting with a future budget crisis. Moody’s emphasizes two warning signs: rising debt and loss of confidence that government will deal with it. Obama fulfills both. The parallels with the recent financial crisis are striking. Bankers and rating agencies engaged in wishful thinking to rationalize self-interest. Obama does the same. No one can tell when or whether a crisis will come. There is no magic tipping point. But Obama is raising the chances.

Robert J. Samuelson, Washington Post

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Full article: http://www.washingtonpost.com/wp-dyn/content/article/2010/03/28/AR2010032802353.html

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The War on Drugs Is Doomed

Strong demand and the high profits that are the result of prohibition make illegal trafficking unstoppable.

They say that the first step in dealing with a problem is acknowledging that you have one. It is therefore good news that Secretary of State Hillary Clinton will lead a delegation to Mexico tomorrow to talk with officials there about efforts to fight the mob violence that is being generated in Mexico by the war on drugs. U.S. recognition of this shared problem is healthy.

But that’s where the good news is likely to end.

Violence along the border has skyrocketed ever since Mexican President Felipe Calderón decided to confront the illegal drug cartels that operate there. Some 7,000 troops now patrol Juárez, a city of roughly one million. Yet even militarization has not delivered the peace. The reason is simple enough: The source of the problem is not Mexican supply. It is American demand coupled with prohibition.

It is doubtful that this will be acknowledged at tomorrow’s meeting. The drug-warrior industry, which includes both the private-sector and a massive government bureaucracy devoted to “enforcement,” has an enormous economic incentive to keep the war raging. In Washington politics both groups have substantial influence. So it is likely that we are going to get further plans to turn Juárez into a police state with the promise that more guns, tanks, helicopters and informants can stop Mexican gangsters from shoving drugs up American noses.

Last week’s gangland-style slaying of an unborn baby and three adults who had ties to the U.S. Consulate in Juárez has drawn attention to Mrs. Clinton’s trip. The incident stunned Americans. Yet tragic as they were, statistically those four deaths don’t create even a blip on the body-count chart. The running tally of drug-trafficking linked deaths in Juárez since December 2006 is more than 5,350. There has also been a high cost to the city’s economy as investors and tourists have turned away.

Even with low odds of a productive outcome, though, Mexico can’t afford to write off tomorrow’s meeting. It is an opportunity that, handled correctly, could provide for a teachable moment. I suggest that one or two of Mexico’s very fine economists trained at the University of Chicago by Milton Friedman sit down with President Obama’s team to explain a few things about how markets work. They could begin by outlining the path that a worthless weed travels to become the funding for the cartel’s firepower. In this Econ 101 lesson, students will learn how the lion’s share of the profit is in getting the stuff over the U.S. border to the American consumer. In football terms, Juárez is first and goal.

Mexico hasn’t always been an important playing field for drug cartels. For many years cocaine traffickers used the Caribbean to get their product to their customers in the largest and richest market in the hemisphere. But when the U.S. redoubled its efforts to block shipments traveling by sea, the entrepreneurs shifted to land routes through Central America and Mexico.

Mexican traffickers now handle cocaine but traditional marijuana smuggling is their cash cow, despite competition from stateside growers. In a February 2009 interview, then-Mexican Attorney General Eduardo Medina Mora told me that half of the cartel’s annual income was derived from marijuana.

This is especially troubling for Mexican law enforcement because marijuana use, through medical marijuana outlets and general social acceptance, has become de facto legal in the U.S., and demand is robust. The upshot is that consumption is cool while production, trafficking and distribution are organized-crime activities. This is what I called in a previous column, “a stimulus plan for Mexican gangsters.”

In much of the world, where institutions are weak and folks are poor, the high value that prohibition puts into drugs means that the thugs rule. Mr. Medina Mora told me in the same 2009 interview that Mexico estimated the annual cash flow from U.S. drug consumers to Mexico at around $10 billion, which of course explains why the cartels are so well armed and also able to grease the system. It also explains why Juárez is today a killing field.

Supply warriors might have a better argument if the billions of dollars spent defoliating the Colombian jungle, chasing fast boats and shooting down airplanes for the past four decades had reduced drug use. Yet despite passing victories like taking out 1980s kingpin Pablo Escobar and countless other drug lords since then, narcotics are still widely available in the U.S. and some segment of American society remains enthusiastic about using them. In some places terrorist organizations like Colombia’s FARC rebels and al Qaeda have replaced traditional cartels.

There is one ray of hope for innocent victims of the war on drugs. Last week the Journal reported that Drug Enforcement Administration agents were questioning members of an El Paso gang about their possible involvement in the recent killings in Juárez. If the escalation is now spilling over into the U.S., Americans may finally have to face their role in the mess. Mrs. Clinton’s mission will only add value if it reflects awareness of that reality.

Mary O’Grady Anastasia, Wall Street Journal

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‘Basically an Optimist’—Still

The Nobel economist says the health-care bill will cause serious damage, but that the American people can be trusted to vote for limited government in November.

“No, no. Not at all.”

So says Gary Becker when asked if the financial collapse, the worst recession in a quarter of a century, and the rise of an administration intent on expanding the federal government have prompted him to reconsider his commitment to free markets.

Mr. Becker is a founder, along with his friend and teacher the late Milton Friedman, of the Chicago school of economics. More than four decades after winning the John Bates Clark Medal and almost two after winning the Nobel Prize, the 79-year-old occupies an unusual position for a man who has spent his entire professional life in the intensely competitive field of economics: He has nothing left to prove. Which makes it all the more impressive that he works as hard as an associate professor trying to earn tenure. He publishes regularly, carries a full-time teaching load at the University of Chicago (he’s in his 32nd year), and engages in a running argument with his friend Judge Richard Posner on the “Becker-Posner Blog,” one of the best-read Web sites on economics and the law.

When his teaching schedule permits, Mr. Becker visits the Hoover Institution, the think tank at Stanford where he has been a fellow since 1988. The day he and I meet in his Hoover office, Mr. Becker has already attended a meeting with former Treasury Secretary Hank Paulson and spent several hours touring Apple headquarters down the road in Cupertino with his wife, Guity Nashat, a historian of the Middle East, and their grandson. “I guess you’d call our grandson a computer whiz,” he explains proudly. “He’s just 14, but he has already sold a couple of apps.”

I begin with the obvious question. “The health-care legislation? It’s a bad bill,” Mr. Becker replies. “Health care in the United States is pretty good, but it does have a number of weaknesses. This bill doesn’t address them. It adds taxation and regulation. It’s going to increase health costs—not contain them.”

Drafting a good bill would have been easy, he continues. Health savings accounts could have been expanded. Consumers could have been permitted to purchase insurance across state lines, which would have increased competition among insurers. The tax deductibility of health-care spending could have been extended from employers to individuals, giving the same tax treatment to all consumers. And incentives could have been put in place to prompt consumers to pay a larger portion of their health-care costs out of their own pockets.

“Here in the United States,” Mr. Becker says, “we spend about 17% of our GDP on health care, but out-of-pocket expenses make up only about 12% of total health-care spending. In Switzerland, where they spend only 11% of GDP on health care, their out-of-pocket expenses equal about 31% of total spending. The difference between 12% and 31% is huge. Once people begin spending substantial sums from their own pockets, they become willing to shop around. Ordinary market incentives begin to operate. A good bill would have encouraged that.”

Despite the damage this new legislation appears certain to cause, Mr. Becker believes we’re probably stuck with it. “Repealing this bill will be very, very difficult,” he says. “Once you’ve got a piece of legislation in place, interest groups grow up around it. Look at Medicare and Medicaid. Originally, the American Medical Association opposed Medicare and Medicaid. Then the AMA came to see them as a source of demand for physicians’ services. Today the AMA supports Medicare and Medicaid as staunchly as anyone. Something like that will happen with this new legislation.”

Bad legislation, maintained by self-seeking interest groups. Back in 1982, I remind Mr. Becker, the economist Mancur Olson published a book, “The Rise and Decline of Nations,” predicting just that trend. Over time, Olson argued, interest groups would form to press for policies that would almost invariably prove protectionist, redistributive or antitechnological. Policies, in a word, that would inhibit economic growth. Yet since the benefits of such policies would accrue directly to interest groups while the costs would be spread across the entire population, very little opposition to such self-seeking would ever develop. Interest groups—and bad policies—would proliferate, and the nation would stagnate.

Olson may have sketched his portrait during the 1980s, but doesn’t it display a remarkable likeness to the United States today? Mr. Becker thinks for a moment, swiveling toward the window. Then he swivels back. “Not necessarily,” he replies.

“The idea that interest groups can derive specific, concentrated benefits from the political system—yes, that’s a very important insight,” he says. “But you can have competing interest groups. Look at the automobile industry. The domestic manufacturers in Detroit want protectionist policies. But the auto importers want free trade. So they fight it out. Now sometimes in these fights the dark forces prevail, and sometimes the forces of light prevail. But if you have competing interest groups you don’t end up with a systematic bias toward bad policy.”

Mr. Becker places his hands behind his head. Once again, he reflects, then smiles wryly. “Of course that doesn’t mean there isn’t any systematic bias toward bad policy,” he says. “There’s one bias that we’re up against all the time: Markets are hard to appreciate.”

Capitalism has produced the highest standard of living in history, and yet markets are hard to appreciate? Mr. Becker explains: “People tend to impute good motives to government. And if you assume that government officials are well meaning, then you also tend to assume that government officials always act on behalf of the greater good. People understand that entrepreneurs and investors by contrast just try to make money, not act on behalf of the greater good. And they have trouble seeing how this pursuit of profits can lift the general standard of living. The idea is too counterintuitive. So we’re always up against a kind of in-built suspicion of markets. There’s always a temptation to believe that markets succeed by looting the unfortunate.”

As he speaks, Mr. Becker appears utterly at ease. He wears loose-fitting clothes and slouches comfortably in his chair. His hair, wispy and white, sets off his most striking feature—penetrating eyes so dark they seem nearly black. Yet those dark eyes display not foreboding, but contentment. He does not have the air of a man contemplating national decline.

I read aloud from an article by historian Victor Davis Hanson that had appeared in the morning newspaper. “[W]e are in revolutionary times,” Mr. Hanson argues, “in which the government will grow to assume everything from energy to student loans.” Next I read from a column by economist Thomas Sowell. “With the passage of the legislation allowing the federal government to take control of the medical system,” Mr. Sowell asserts, “a major turning point has been reached in the dismantling of the values and institutions of America.”

“They’re very eloquent,” Mr. Becker replies, his equanimity undisturbed. “And maybe they’re right. But I’m not that pessimistic.” The temptation to view markets with suspicion, he explains, is just that: a temptation. Although voters might succumb to the temptation temporarily, over time they know better.

“One of the points Secretary Paulson made earlier today was how outraged—how unexpectedly outraged—the American people became when the government bailed out the banks. This belief in individual responsibility—the belief that people ought to be free to make their own decisions, but should then bear the consequences of those decisions—this remains very powerful. The American people don’t want an expansion of government. They want more of what Reagan provided. They want limited government and economic growth. I expect them to say so in the elections this November.”

Even if ordinary Americans still want limited government, I ask, what about those who dominate the press and universities? What about the molders of received opinion who claim that the financial crisis marked the demise of capitalism, rendering the Chicago school irrelevant?

“During the financial crisis,” he replies, “the government and markets—or rather, some aspects of markets—both failed.”

The Federal Reserve, Mr. Becker explains, kept interest rates too low for too long. Freddie Mac and Fannie Mae made the mistake of participating in the market for subprime instruments. And as the crisis developed, regulators failed to respond. “The Fed and the Treasury didn’t see the crisis coming until very late. The SEC didn’t see it at all,” he says.

“The markets made mistakes, too. And some of us who study the markets made mistakes. Some of my colleagues at Chicago probably overestimated the ability of the Fed to smooth disruptions. I didn’t write much about the Fed, but if I had I would probably have overestimated the Fed myself. As the banks developed new instruments, economists paid too little attention to the systemic risks—the risks the instruments posed for the whole financial system—as opposed to the risks they posed for individual institutions.

“I learned from Milton Friedman that from time to time there are going to be financial problems, so I wasn’t surprised that we had a financial crisis. But I was surprised that the financial crisis spilled over into the real economy. I hadn’t expected the crisis to become that bad. That was my mistake.”

Once again, Mr. Becker reflects. “So, yes, we economists made mistakes. But has the experience of the past few years invalidated the finding that markets remain the most efficient means for producing economic growth? Not in any way.

“Look at growth in developed countries since the Second World War,” he continues. “Even after you take into account the various recessions, including this one, you still end up with a good record. So even if a recession as bad as this one were the price of free markets—and I don’t believe that’s the correct way of looking at it, because government actions contributed so greatly to the current problem—but even if a bad recession were the price, you’d still decide it was worth paying.

“Or look at developing countries,” he says. “China, India, Brazil. A billion people have been lifted out of poverty since 1990 because their countries moved toward more market-based economies—a billion people. Nobody’s arguing for taking that back.”

My last question involves a little story. Not long before Milton Friedman’s death in 2006, I tell Mr. Becker, I had a conversation with Friedman. He had just reviewed the growth of spending that was then taking place under the Bush administration, and he was not happy. After a pause during the Reagan years, Friedman had explained, government spending had once again begun to rise. “The challenge for my generation,” Friedman had told me, “was to provide an intellectual defense of liberty.” Then Friedman had looked at me. “The challenge for your generation is to keep it.”

What was the prospect, I asked Mr. Becker, that this generation would indeed keep its liberty? “It could go either way,” he replies. “Milton was right about that.”

Mr. Becker recites some figures. For years, federal spending remained level at about 20% of GDP. Now federal spending has risen to 25% of GDP. On current projections, federal spending would soon rise to 28%. “That concerns me,” Mr. Becker says. “It concerns me a great deal.

“But when Milton was starting out,” he continues, “people really believed a state-run economy was the most efficient way of promoting growth. Today nobody believes that, except maybe in North Korea. You go to China, India, Brazil, Argentina, Mexico, even Western Europe. Most of the economists under 50 have a free-market orientation. Now, there are differences of emphasis and opinion among them. But they’re oriented toward the markets. That’s a very, very important intellectual victory. Will this victory have an effect on policy? Yes. It already has. And in years to come, I believe it will have an even greater impact.”

The sky outside his window has begun to darken. Mr. Becker stands, places some papers into his briefcase, then puts on a tweed jacket and cap. “When I think of my children and grandchildren,” he says, “yes, they’ll have to fight. Liberty can’t be had on the cheap. But it’s not a hopeless fight. It’s not a hopeless fight by any means. I remain basically an optimist.”

Mr. Robinson, a former speechwriter for President Ronald Reagan, is a fellow at Stanford University’s Hoover Institution.

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Fair play

The origins of selflessness

It is not so much that cheats don’t prosper, but that prosperity does not cheat

FOR the evolutionarily minded, the existence of fairness is a puzzle. What biological advantage accrues to those who behave in a trusting and co-operative way with unrelated individuals? And when those encounters are one-off events with strangers it is even harder to explain why humans do not choose to behave selfishly. The standard answer is that people are born with an innate social psychology that is calibrated to the lives of their ancestors in the small-scale societies of the Palaeolithic. Fairness, in other words, is an evolutionary hangover from a time when most human relationships were with relatives with whom one shared a genetic interest and who it was generally, therefore, pointless to cheat.

The problem with this idea is that the concept of fairness varies a lot, depending on which society it happens to come from—something that does not sit well with the idea that it is an evolved psychological tool. Another suggestion, then, is that fairness is a social construct that emerged recently in response to cultural changes such as the development of trade. It may also, some suggest, be bound up with the rise of organised religion.

Joseph Henrich at the University of British Columbia and his colleagues wanted to test these conflicting hypotheses. They reasoned that if notions of fairness are, indeed, calibrated to the Palaeolithic, then any variation from place to place should be random. If such notions are cultural artefacts, though, they will vary systematically with some aspect of society. In a study just published in Science, Dr Henrich and his team looked at the relationship between notions of fairness and two social phenomena: the degree to which a society is economically integrated and how religious the individuals within it are.

Play up, play up and play the game

To do the study Dr Henrich recruited 2,148 volunteers from 15 contemporary, small-scale societies. The societies in question included the Dolgan (hunters in Siberia), the Hadza (foraging nomads in Tanzania) and the Sanquianga (fishermen in Colombia).

First, the volunteers were asked to play a series of games that would measure their notions of fairness. One of these is called the dictator game. In it, two players (who do not actually meet) are given a sum of money. One of them then divides the money and gives whatever fraction he chooses to the other. Not much of a game, perhaps, but it provides a good measure of the first player’s sense of fairness, since he has the power to be as unfair as he likes.

Another game the researchers asked participants to play was more subtle. In it, the second player has the opportunity to reject the sum offered by the first, in which case neither player receives anything. In this version, however, the second player must decide what offer he would accept (within a 10% margin of error), and do so before he hears what the offer actually is. That provides a measure of willingness to punish, even at a cost to the punisher. Yet another game looked at interactions with third parties.

Having established prevailing notions of fairness in each of the societies they were examining, the researchers then calculated a measure of that society’s market integration. They arrived at this by working out the percentage of a household’s total calories that were purchased from the market, as opposed to being grown, hunted or fished. The volunteers were also asked whether they participated in a world religion (rather than a tribal one).

The results back a cultural explanation of fairness—or, at least, of the variable levels of fairness found in different societies. In fact, those societies that most resemble the anthropological consensus of what Palaeolithic life would have been like (hunting and gathering, with only a modicum of trade) were the ones where fairness seemed to count least. People living in communities that lack market integration display relatively little concern with fairness or with punishing unfairness in transactions. Notions of fairness increase steadily as societies achieve greater market integration (see chart). People from better-integrated societies are also more likely to punish those who do not play fair, even when this is costly to themselves.

For progressives, this finding brings great comfort. It suggests that people are, if not perfectible, at least morally malleable in positive ways. If economic integration is the driving force for fairness then it may make sense to view it as something like a type of technology. As societies have become more complex, those that have developed systems of sanitation, transport, energy and so on have been more successful than those which have not. It may be that the notion of fair play is an intangible equivalent of these systems.

Dr Henrich also, however, found that the sense of fairness in a society was linked to the degree of its participation in a world religion. Participation in such religion led to offers in the dictator game that were up to 10 percentage points higher than those of non-participants.

World religions such as Christianity, with their moral codes, their omniscient, judgmental gods and their beliefs in heaven and hell, might indeed be expected to enforce notions of fairness on their participants, so this observation makes sense. From an economic point of view, therefore, such judgmental religions are actually a progressive force. That might explain why many societies that have embraced them have been so successful, and thus why such beliefs become world religions in the first place.

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Full article and photo: http://www.economist.com/science-technology/displaystory.cfm?story_id=15717188&source=hptextfeature

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Yuan to stay cool

The best thing American politicians can do to encourage a stronger Chinese currency is keep calm

ONE of the few good things about the Great Recession of 2008-09 was a merciful absence of complaints from America’s Congress about China’s currency. The yuan’s gradual appreciation stopped in July 2008, and China has since kept its currency tightly pegged to the dollar. But even as America suffered its worst downturn in the post-war period, its legislators steered clear of ranting against China.

That restraint was driven partly by fear. At the depths of the crisis even the most myopic Congressmen worried about a descent into 1930s-style protectionism. And it was driven partly by the facts. As investors’ flight to safety strengthened the dollar in late 2008, the yuan rose along with it. With America’s imports slumping it was hard to blame Chinese workers for American joblessness. And thanks to its huge domestic stimulus China added to global demand last year, as its current-account surplus shrank sharply.

Now things have, unfortunately, gone into reverse. As policymakers in both countries shift from cushioning recession to managing recovery, the rigidity of the yuan is, once again, becoming a source of tension—one that a still-fragile global recovery can ill afford.

America sounds increasingly determined to push its exports, and its attitude to China has hardened. Mr Obama has set a goal of doubling exports in five years and has promised to “get much tougher” over what it regards as unfair competition from China. Speculation is rising in Washington, DC, that the Treasury will brand China a currency “manipulator” in its next exchange-rate report. With America’s unemployment at 9.7% and the mid-term elections approaching, the appeal of China-bashing is rising in Congress, too. Several senators recently revived a mothballed demand that the Commerce Department should investigate China’s currency regime as an unfair trade subsidy.

Beijing, in turn, shows little sign of budging on the yuan, even though the latest figures show surprisingly strong export growth and higher-than-expected inflation. Zhou Xiaochuan, the head of China’s central bank, caused a brief flurry in currency markets when he argued on March 6th that keeping the yuan stable against the dollar was “part of our package of policies for dealing with the global financial crisis” from which China would exit “sooner or later”. But he made it quite clear that China would be cautious and gave no hint that sudden exit was imminent. In recent days various other Chinese officials have put even more emphasis on the stability of the currency, bristled at outside pressure to hurry up and denounced American “politicisation” of the exchange-rate issue.

A speedy end to the dollar peg makes economic sense for China as well as for the world. A stronger, more flexible currency would make it easier for China to control inflation and asset bubbles. A dearer yuan would also help rebalance China’s economy towards domestic spending by boosting Chinese consumers’ purchasing power, discouraging excessive investment in manufacturing and squeezing corporate profits. That would put the global recovery on a steadier footing, especially if a stronger yuan were mirrored by appreciation of the currencies of other Asian emerging economies. And China would gain politically by helping to diffuse protectionist pressure from abroad.

But it would not be a magic bullet, either within China or outside. Rebalancing China’s economy will require big structural reforms, from tax to corporate governance, as well as a stronger currency. A stronger yuan would not suddenly bring back millions of jobs to America. Since America no longer makes most of the products it imports from China, a stronger yuan would initially act more like a tax on consumers.

Soft-soaping, not sabre-rattling

Will the administration’s new tough talk move things in the right direction? Those who argue in favour of sabre-rattling do so on two grounds: first, that it is likely to shift China’s position, and second, that a stronger stance against China’s currency from the White House will diffuse protectionist sentiment in Congress. Both are dubious. China’s reactions so far suggest that American complaints make an imminent currency shift less, not more, likely. And a row could spur rather than diffuse anti-China action in Congress.

Rather than raising a bilateral ruckus, America would be far better off convincing other big economies in the G20 to press together for a yuan appreciation as part of the world’s exit strategy from the crisis. Cool and calm multilateral leadership will achieve more, with fewer risks, than a Sino-American currency spat.

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Full article and photo: http://www.economist.com/opinion/displayStory.cfm?story_id=15663352&source=features_box2

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Big Think In the Boardroom

How business moved from affable amateurism to specialized, intellectualized ‘models’ and expertise.

As a business journalist and former editorial director of the Harvard Business Review, Walter Kiechel has had the unenviable task of spending much of his life hanging around with management theorists. These are the folks who bring out book after book of business advice that readers find unreadable and managers find unmanageable. Yet by some miracle Mr. Kiechel has remained immune to the maladies of the genre. His “The Lords of Strategy” is a clear, deft and cogent portrait of what the author calls the most powerful business idea of the past half-century: the realization that corporate leaders needed to abandon their go-it-alone focus on their company’s fortunes and instead pursue policies based on a detailed study of the competitive environment and of broader business trends.

The “strategy revolution” began in the 1960s when the Boston Consulting Group upended the industry. Rather than take the usual tack of just cozying up to individual chief executives for a bit of corporate kibitzing and calling it consulting, BCG produced a series of elegant intellectual models that could be broadly applied across the business world. BCG’s model for the “experience curve,” for instance, taught companies that they could reduce their costs as they expanded their market share, thanks to the accumulation of know-how. The “growth share matrix” encouraged companies to view themselves not as an undifferentiated whole but as a portfolio of businesses that make different contributions to the bottom line (“cash cows” vs. “dogs,” for example). Nowadays that sort of thinking might be unexceptional, but it was a radical development in the stagnant, inward-looking world of 1960s corporate America.

The 1970s and the decades that followed saw the institutionalization of the revolution. One of BCG’s main competitors, McKinsey & Co., shook itself out of a complacent torpor and began enthusiastically running out its own management-strategy models. Bill Bain and several other BCG executives left the company in the 1970s and started a rival enterprise, Bain & Co. Meanwhile, Michael Porter brought strategy to the heart of the business establishment, the Harvard Business School. He added a powerful tool to the discipline’s arsenal, the notion of the “value chain,” which helped managers break down a business into its component parts, from raw materials to finished products, and then subject those parts to the rigors of cost-benefit analysis.

Yet success brought intense scrutiny and self-examination. In 1982, Tom Peters and Robert Waterman—McKinsey stars at the time—argued in the best-selling “In Search of Excellence” that the obsession with strategy was leading managers to ignore the human side of things. The year before, Richard Pascale, another McKinseyian, said in “The Art of Japanese Management” that the Japanese, who were then sweeping all before them, regarded the West’s newfound passion for strategy as strange, much “as we might regard their enthusiasm for kabuki or sumo wrestling.” And an army of young thinkers began shifting attention to more nuts-and-bolts matters, such as business processes (which could be re-engineered) and “core competencies” (which needed to be cultivated).

Today the status of strategic thinking in the business world is somewhat confused: An idea that owed its appeal to the seemingly hard truths presented by models is becoming ever more nebulous. The lords of strategy are now given to happy talk about “people”—on the grounds that people are the key to innovation and innovation is the key to long-term success. Such concerns can easily degenerate into bromides about the need to treat employees well. Perhaps it is no coincidence that, at least before the current financial crisis wreaked its havoc, young business hotshots were turning their attention to financial engineering. About a third of former McKinsey and BCG consultants currently work in the private-equity business.

“The Lords of Strategy” is at its best describing and explaining the evolution of an influential idea in American business. The book is less successful as the “secret history” it claims to be. Mr. Kiechel has the habit of pulling aside the veil on the darker side of the management business only to pull it back again. He says that management gurus are known to hire ghost-writing outfits such as Wordworks to produce their books—but he refrains from telling us the gritty ( perhaps disgraceful) details of the marketing and packaging process. He notes that a worrying number of consulting engagements end in tears—McKinsey had a long-term relationship with Enron, for example—but he skimps on evidence.

Mr. Kiechel makes up for this coyness, though, with his enthusiasm for telling the bigger story at the heart of his book: the intellectualization of business. Back in the days of the “organization man” in the 1950s, business people tended to be affable types—pleasant, easy to get along with, but hardly rocket scientists. Since then an ever greater amount of brain power has been applied to business as more and more graduate students pursue MBAs (150,000 annually in the U.S., up from 3,000 a year in 1948), and the brightest MBAs often go on to become business consultants.

The story that Mr. Kiechel tells does not have a particularly happy ending: The “quants” who would supposedly take business to a new level of intellectual sophistication designed financial tools such as the credit default swap that instead took the world economy to the brink of catastrophe. But Mr. Kiechel is surely right that we cannot begin to understand the world that we live in unless we grasp how corporate intellectuals came to have such a dramatic influence on the business world—and how old-fashioned virtues, such as judgment and common sense, were side-lined in the process.

Mr. Wooldridge is The Economist’s management editor and the author of its Schumpeter column.

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Skyway Robbery: Stories From the Future of Aviation

Trans Orient Pacific to Charge for Standby

March 10, 2010 — Following the lead of American Airlines, which announced in February that it would begin charging a $50 fee to passengers who wished to fly standby, Trans Orient Pacific Airlines will adopt the same pricing structure. “Our passengers value flexibility,” said Topac spokesman Steve McCroskey, “and where there’s value, there’s revenue. You just have to monetize it.” The charge comes on the heels of other new fees adopted by many carriers. Last month, American began requiring passengers in coach to pay $8 for a blanket and pillow.

Topac Out Front With New Fees

June 7, 2010 — “We’ve embarked on a new era of competitiveness,” said Trans Orient Pacific Director of Media Relations Steve McCroskey, citing the carrier’s innovative pricing structures. For example, water, soda and coffee will now be $5, refills $4.98. And to cover the costs of in-flight video (currently showing, episodes of “Full House,” “Car 54, Where Are You?” and “Jersey Shore”) all tickets will be assessed a $6.95 entertainment fee. Mr. McCroskey did point out, however, that passengers can choose to sit in a section of the plane without the video presentation for an extra $22.75 each.

The Rising Cost of Carrying On

August 24, 2010 — As airlines have raised the cost of checked baggage passengers have taken to carrying all their luggage on-board. Trans Orient Pacific’s VP for Communications, Steve McCroskey, says that too many carry-on bags slow boarding and deplaning. In the interest of passenger convenience, Topac will now allow one carry-on bag, at a cost of $20. Extra carry-ons will be $50 each. Mr. McCroskey said the use of overhead bins will remain free, “at least for the moment.”

Fuel Prices Down; Fuel Surcharges Up

September 18, 2010 — Trans Orient Pacific has begun adding a $27.98 fuel surcharge to all domestic tickets. Airline executives were asked to explain the fee in light of falling fuel prices. “We bet heavily that oil would soar this year, and so I have to admit we did some pretty aggressive hedging on jet-fuel futures,” explained Senior Vice President for Strategy Stephen McCroskey. “I think we can all agree that Topac should not have to bear the brunt of this kind of market volatility.” The new surcharge will be applied retroactively to all tickets purchased within the past three years.

Not Just Luggage Getting Weighed

October 3, 2010 — In an effort to lighten the load, Trans Orient Pacific Airlines will begin putting its passengers on the scales. “Charging grossly overweight passengers for a second seat just seemed to us a sort of arbitrary discrimination against the morbidly obese,” says Stephen McCroskey, Executive Vice President for Operations at Topac. “We thought it would be fairer to weigh everyone and assess a dollar-a-pound surcharge across the board.”

Got to Go, Got to Pay

November 22, 2010 — Just in time for the busy Thanksgiving travel weekend, Trans Orient Pacific Airlines announced it will begin charging for the use of lavatories. “People are tired of standing in line for the bathroom,” says Trans Orient COO Stephen J. McCroskey. “We’re instituting a congestion-pricing strategy that prioritizes the bathrooms for those who need to use them most.” Use of the lavatories can be paid with a major credit card, and rates begin at $5 per minute, rising to $10 a minute in the final hour of the flight. Tokens will also be available (for a nominal service fee). Even so, “Passenger comfort is one of our top priorities,” Mr. McCroskey insisted. “If a plane is delayed on the Tarmac for more than two hours, we will offer a 10% discount on lavatory use.”

Topac to Drop Some Charges

November 23, 2010 — In a surprise move today, Trans Orient Pacific Airlines pledged to roll back some of the new fees that have infuriated flyers. “I’m pleased to say that Topac in its relentless pursuit of excellence, will no longer be charging passengers for water, soda, or coffee,” said newly named CEO Stephen J. McCroskey. Water will be distributed in liter bottles, coffee will be served in 24 ounce cups, and each passenger will be given a two-liter bottle of Coca-Cola, Diet Coke or Sprite. (Lavatory fees will remain in force.)

New Safety Procedures on Domestic Flights

January 3, 2011 — Trans Orient Pacific Airlines announced it had reached an agreement with the FAA regarding changes to routine safety announcements. The agency approved new instructions flight crews will give to passengers before takeoff, including this change to the traditional script: “In the unlikely event of cabin depressurization, oxygen masks will drop from above you. To get the oxygen flowing, insert a major credit or debit card. If you are traveling with a child, pay for your mask first then pay for your child’s.” Chairman of the Topac board, Stephen McCroskey explained that the airline was forced to look for new sources of revenue now that so few people are flying.

Eric Felten, Wall Street Journal

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Recovery in progress

World trade is on the mend, but the strength of the rebound remains uncertain

IS THE glass half empty or half full for world trade? Figures released on March 1st by the Netherlands Bureau for Economic Policy Analysis (CPB), which maintains a close watch on global trade volumes, point to renewed vigour at the end of 2009. Trade volumes rose by 6%, quarter-on-quarter, in the final three months of the year.

But these figures also underline just how severely trade was affected by the global recession. The CPB reckons that volumes shrank by a staggering 13.2% during 2009. They have fallen in only two other years since 1961, when comprehensive data begin. But those declines—by 1.9% in 1975 and 0.9% in 1982—pale in comparison with last year’s huge drop.

Still, a revival is clearly under way. The volume of trade went up by 5% in December alone. Weak growth of 1.2% in October and 1.1% in November might have suggested that the recovery which began earlier in the year was faltering.

Unfortunately, it may be too early to be sanguine about a sustained recovery in trade and thus in the world economy. Figures from the World Bank, which track the value rather than the volume of trade, point to a deceleration in the final quarter, not the acceleration that the CPB’s data suggest. According to the bank, the value of exports from a sample of 56 countries making up the lion’s share of world trade continued to rise in the final quarter, but at a slower rate than in the third quarter.

Data on trade values partly reflect exchange-rate fluctuations, so it is not unusual for them to lead to somewhat different conclusions from volume figures. But there are other reasons to be cautious. December is typically a good month for global commerce because of holiday spending in many parts of the world. Strength in December is therefore by no means sure to have continued into the new year.

Looking ahead, it is not hard to see threats to trade’s recovery. Global demand is still being propped up by government intervention on an enormous scale. Its withdrawal, if mistimed, would pose fresh dangers for the global economy, and with it for trade. As Caroline Freund of the World Bank points out, “There is a risk of stagnation in 2010, as restocking is completed and effect of the stimulus on demand growth wanes. While the stimulus will continue to boost trade volumes in 2010, any growth effect will be much smaller.”

The strength of the recovery varies from one part of the world to the next. Export data reflect both the now-robust growth of emerging economies and the still-anaemic performance of the rich world. Investment demand from emerging-market countries does help manufacturers of more sophisticated goods, such as machinery, in rich ones. But demand from ordinary consumers in poorer countries mainly bolsters exports in other developing economies. In keeping with this, the volume of exports from emerging economies grew by 8.7% in the three months to December. Rich countries’ exports increased by only 4.1%.

The relative performance of China, the leading exporter among emerging economies, and Germany, the rich world’s champion, is a case in point. Last year China overtook Germany to become the world’s largest exporter of goods. Germany’s sales abroad in 2009 were $1,121 billion, compared with China’s $1,202 billion.

That emerging economies are, besides increasing their exports, becoming an important source of demand for traded goods can be seen in their imports, which grew by 7.4% in the final three months of last year. Imports into rich countries grew by only 3.9%.

By the end of the year trade values had risen by almost 30% from their nadir last February. However, the World Bank’s economists point out that they were still 20% lower than before the crisis. They think they are 40% below where they would have been had the crisis never happened. World trade may be on the mend, but its recovery is far from complete.

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Full article and photo: http://www.economist.com/business-finance/displaystory.cfm?story_id=15599453&source=features_box3

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Bring Back the Robber Barons

There’s a big difference between entrepreneurs who make a fortune in the market, and those who do so by gaming the government.

Faced with high, painful unemployment as far as the eye can see, the government naturally is here to help.

The Senate passed a $15 billion “jobs bill.” Its proudest piece is a tax credit for employers who hire a person out of work at least 60 days. The employer won’t have to pay the 6.2% Social Security payroll tax for what remains of this year. If the worker stays on the job at least a year, the government will give the employer $1,000.

As to the earlier $787 billion stimulus bill, Vice President Joe Biden praised it in Orlando this week as an engine of job creation, while he stood before a pile of broken concrete and asphalt. The subject was highways.

Finally, Barack Obama’s government now may force companies to raise wages and benefits by squeezing their federal contracts if they don’t.

Maybe there’s a better way.

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Let’s bring back the robber barons.

“Robber baron” became a term of derision to generations of American students after many earnest teachers made them read Matthew Josephson’s long tome of the same name about the men whose enterprise drove the American industrial age from 1861 to 1901.

Josephson’s cast of pillaging villains was comprehensive: Rockefeller, Carnegie, Vanderbilt, Morgan, Astor, Jay Gould, James J. Hill. His table of contents alone shaped impressions of those times: “Carnegie as ‘business pirate’.” “Henry Frick, baron of coke.” “Terrorism in Oil.” “The sack of California.”

I say, bring ‘em back, and the sooner the better. What we need, a lot more than a $1,000 tax credit, are industries no one has thought of before. We need vision, vitality and commercial moxie. This government is draining it away.

The antidote to Josephson’s book is a small classic by Hillsdale College historian Burton W. Folsom called “The Myth of the Robber Barons: A New Look at the Rise of Big Business in America” (Young America’s Foundation). Prof. Folsom’s core insight is to divide the men of that age into market entrepreneurs and political entrepreneurs.

Market entrepreneurs like Rockefeller, Vanderbilt and Hill built businesses on product and price. Hill was the railroad magnate who finished his transcontinental line without a public land grant. Rockefeller took on and beat the world’s dominant oil power at the time, Russia. Rockefeller innovated his way to energy primacy for the U.S.

Political entrepreneurs, by contrast, made money back then by gaming the political system. Steamship builder Robert Fulton acquired a 30-year monopoly on Hudson River steamship traffic from, no surprise, the New York legislature. Cornelius Vanderbilt, with the slogan “New Jersey must be free,” broke Fulton’s government-granted monopoly.

If the Obama model takes hold, we will enter the Golden Age of the Political Entrepreneur. The green jobs industry that sits at the center of the Obama master plan for the American future depends on public subsidies for wind and solar technologies plus taxes on carbon to suppress it as a competitor. Politically connected entrepreneurs will spend their energies running a mad labyrinth of bureaucracies, congressional committees and Beltway door openers. Our best market entrepreneurs, instead of exhausting themselves on their new ideas, will run to ground gaming Barack Obama’s ideas.

If the goal is job growth, we need to admit one fact: Political entrepreneurs create fewer jobs than do market entrepreneurs. We need new mass markets, really big markets of the sort Ford, Rockefeller and Carnegie created. Great employment markets are discoverable only by people who create opportunities or see them in the cracks of what already exists—a Federal Express or Wal-Mart. Either you believe that the philosopher kings of the Obama administration can figure out this sort of thing, or you don’t. I don’t.

FDIC chief Sheila Bair whacked bank bonuses Tuesday. People on the East Coast spend too much time around the finance and insurance industries. If the price of rediscovering the American job machine is some people across the land getting really rich, it’s a small price.

One of the richest now is Larry Ellison, the 1977 founder of Oracle Corp. (49,000 employees), whose tastes run to huge boats, bigger houses and paying Elton John to play for his friends at the Cow Palace. Someone in our politics has to find the courage to say, So what? If the next Ellison and Oracle ripples into American life as many new jobs and family incomes, I’m happy to be grossed out by parties and boats. The alternative is a nation of Pecksniffs, choking on virtue.

We live in a world of rising competitors—foreign robber barons—who don’t much care about our endless quest for health-care justice. The U.S. on its current path to a stage-managed economy floating in a lake of taxes will keep down the greatest population of intellectual and managerial firepower the world has seen. The rest of the world admits that, with the recent exception of the Chinese, who think we’re ready to be taken. We have young people impatient for the chance to do what Carnegie, Rockefeller and Hill did. Let them.

Daniel Henninger, Wall Street Journal

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Full article and photo: http://online.wsj.com/article/SB10001424052748703862704575099572105775414.html

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Seven Ideas to Beat the Crisis

Funny Business

Times are tough. But not so tough, as it turns out, that you can’t make a buck. From bovine meditation to organic bird buffets, SPIEGEL ONLINE brings you seven strange business ideas that should never have worked — but did. 

The German economy isn’t what it used to be. Just this week, it was announced that the economy didn’t grow at all during the fourth quarter of 2009, leading many to fear that the country might have to wait a while longer to recover from the economic downturn. 

Even worse, the European common currency, the euro, is in turmoil as speculators continue to try and profit from Greek budgetary woes. The currency has fallen substantially against the dollar in recent weeks and there are fears that it could continue to plummet. Indeed, things have gotten so bad that a Greek consumer group has called for a boycott of German products, as a result of criticism from Germany — most particularly in the form of a tasteless cover from the newsmagazine Focus — of Greece’s financial practices. 

But while many would prefer to stick their heads in the sand and wait out the crisis, there are those who prefer to confront uncertainty with ingenuity. If you’ve got the right idea, now might just be the time to start up your own business. Why not begin baking specialty products for pets? Or start a travel agency for stuffed animals? Meditation with farm animals is certainly also a good opportunity for instant profits. After all, a bit of time in the stall is sure to calm the nerves of today’s stressed out managers. 

For those who think they might have a good business idea, but are too shy to try, SPIEGEL ONLINE brings you some inspiration — in the form of seven business concepts that never should have found success, but did. 

Travelling Teddies 

Apparently there are around 1.2 billion cuddly toy animals in the world — and you can bet that most of them have never seen the city of Prague. Or indeed, many other prime European tourist destinations (unless it happens to be their home town, of course). Now a Czech company, The Czech Toy Traveling agency, aims to change all that. Send them your inanimate, furry friend and they will send you pictures back of your stuffed beast in front of various landmarks around Prague. 

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The concept for the toy travel agency was inspired by the French film “Amelie,” in which a character receives mysterious pictures of his stolen garden gnome posed in front of famous monuments around the world.

The idea received support after it appeared on the Czech version of reality television, investment show, Dragon’s Den.

A basic package tour for your teddy bear costs €90 and includes 30 photos on a disc, a certificate of proof that your bear was there, a profile created on your bear’s behalf on social networking sites and daily e-mail contact from your bear, or any other stuffed toy you care to send their way.

The most expensive package, which costs €150, includes a special travel box, with a pillow and blanket, so that the cuddly toy travels first class all the way back home.

Agency co-owner Tomio Okamura said that although the business only launched last week, “we already have dozens of orders, mostly from the US, Japan and Germany.”

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The concept, which was inspired by the French film “Amelie,” in which a character receives mysterious pictures of his stolen garden gnome posed in front of famous monuments around the world, received support after it appeared on the Czech version of the reality television investment show “Dragon’s Den.” In the Czech Republic, the show is called “Den D” (or D-Day). 

A basic package tour for your teddy bear costs €90 and includes 30 photos on a disc, a certificate of proof that your bear was there, a profile created on your bear’s behalf on social networking sites and daily e-mail contact from your bear, or any other stuffed toy you care to send their way. The most expensive package, which costs €150, includes a special travel box, with a pillow and blanket, so that the cuddly toy travels first class all the way back home. Owners can also specify whether their insensate sweeties are vegetarian or should be allowed a drink after dinner. “We are focusing on North American, Southeast Asia and the European markets,” agency co-owner Tomio Okamura told SPIEGEL ONLINE. “We launched our business last week and we already have dozens of orders, mostly from the US, Japan and Germany.” 

Okamura, who is one of the businessmen supporting the venture financially and also the vice president of the Association of Tour Operators and Travel Agents of the Czech Republic, explains that once a travel reservation has been made for a toy, and payment received, the fluffy friend can be posted to the company. Sightseeing in Prague will take between one and three days and the Toy Traveling Agency will also take stuffed animals to special events upon request. “We already have a request from Japan to take the toy to see a top-flight European football match,” Okamura says. 

Eventually the company’s founders also want to be able to offer toys travel opportunities to other European cities, including Berlin, Munich and Bratislava. 

First on the Dance Floor  

The party is great, the music is playing, your feet are tapping. But the dance floor is empty. Even though you are aching to get out there and shake your proverbial thing, you don’t dare to hit the dance floor all alone. And then all of a sudden, there they are: Two enthusiastic hoofers who don’t seem to care who sees them getting down. Relieved, you — and all the other bashful bootie shakers — migrate to the dance floor while the host stands by, satisfied and smiling broadly that this fest is such a success. 

Such success, as it turns out, can be bought. A Berlin company, called Be My Dancer, hires out people to break the dance floor ice. Most of the firm’s business involves the time honored profession of the “taxi dancer,” the name first given to the courteous men who hired themselves out as dancing partners after World War I where there weren’t enough masculine dancing partners around. The trade has survived primarily on cruise ships, providing elderly, single ladies with a waltz partner. But in Berlin, the modernized Be My Dancer provides male and female dance partners to suit any occasion, from one’s first cha cha session to themed swing nights and tango parties. 

The Be My Dancer crew can be rented solo or as a team and each dancer costs around €40 an hour. It is also possibly to hire the trained professionals as private dance teachers. Most often the company’s employees can be seen strutting their stuff at the Bohème Sauvage, themed 20s costume parties in historic locations. 

Meditating with Cows 

Forget staring at stones or focusing for hours on single blades of grass. A Dutch farmer, Corné de Regt, has come up with a whole new method for meditation. And it all takes place in his cow stalls on his property on the outskirts of Denekamp, near the German border. One of the services de Regt’s business, “Rode Wangen” (Red Cheeks) offers is a wellness retreat for stressed out businessmen. And when it comes time for a spot of meditation, de Regt and his clients head out onto the farm. Into the cow stalls, to be more exact — where they will sit on hay bales together and meditate. 

“Unfortunately the silence is often broken,” de Regt told German freelance journalist Helmut Hetzel. “When a cow drops something, or when the animals are unsettled. But all of that belongs to the meditation sessions. Some of my guests complain about the smell. But that too, is all part of it. Ultimately all of one’s senses are stimulated through meditating alongside the animals. It is a unique experience. And most of the managers that come here like it.” 

Besides finding metaphysical peace with our bovine friends, the stressed will also be able to relieve their anxieties through other farm-based activities. Excess energy is expended through a hearty round of testosterone-fuelled wood chopping, which can then be followed up with a skinny dip in a nearby stream. There’s also plenty of fresh farm food, historical walks and the enterprising de Regt also offers a selection of goods for sale, including wooden toys, baked goods, woolen hats and slippers and apple juice. 

“My concept for therapy counts upon the fact that the business men who come to me have red cheeks before they leave. They are ‘refueled’ — and not only with fresh country air but also with the unique experiences they have on the farm and in the cow stalls,” de Regt says. 

Breaking Up with the Help of the ‘Terminator’ 

So you want out but you just bear to tell your erstwhile loved one it’s all over? Call the professionals. As the Web site for Berlin-based firm, The Separation Agency, says: “We can end it — perfectly and forever. We will turn one unhappy couple into two satisfied singles. Either that, or your partner gets one last warning, as delivered by us.” 

The agency offers a variety of packages. If you just can’t face it, then for €29.95, the agency will conduct the split over the telephone and make sure you two stay on friendly terms. For a little more — €64.95 — they will conduct that conversation with your soon-to-be-ex in person. If you are literarily challenged, then they will help you write the most appropriate “dear John” letter. And if you have just, plain and simple, had enough and want them to go away and leave you alone, then the agency will let the lover-turned-stalker know that too. 

Along with all of the above, the agency guarantees “delivery of the unwelcome news, de-escalation of pent up emotions, guidance on the difficult talks” and, best of all, your stuff back. 

Since it was founded in 2006, the agency which is run by former insurance salesman Bernd Dressler, has been a success. The “Terminator”, as Dressler has come to be known, doesn’t do any jobs without money up front and most of his customers are women in their 20s. He has even written a book about his experiences. Dressler says he delivers the message in a style that it is in accordance with his customer’s wishes. As he told the British media: “I say to them: ‘Good day, my name is Bernd Dressler from the Separation Agency and I have been asked by your partner to inform you that he or she wishes to end your relationship.’” 

Table Football Fashion  

When it comes to sports in Germany, there is really only one game in town. Newspaper sport sections, to be sure, report copiously on handball, ping pong and luge — or on any other sport that a German athlete may excel at. But football is the undisputed national pastime. 

And for those without the hand-foot coordination to succeed on the pitch, there is table football — known to Americans as foosball. It is a serious pastime in Germany, accompanied with shouts of joy, groans of dismay and no small amount of perspiration. To the consternation (and distraction) of non-players, tables can be found in offices across the country. The best players can even get the static plastic figures to pass the ball to each other. 

Perhaps it comes as no surprise then, that a German company offers little jerseys for the little players. For just €15.90, you can outfit your entire team with the football shirt of your choice — the company, known as Kicker Trikot — has a number of national teams on offer along with a selection of German league teams. Recently, the company has even begun making custom jerseys to order — for €49.90 a set. 

The company, based in Hamburg, started in 2006 and has seen a steady rise in turnover since then. With the World Cup just around the corner, the company is no doubt hoping for another uptick in sales. North Korea anyone? 

Baking for the Birds 

Germans love organic food. Despite the economic downturn and ongoing uneasiness about the robustness of the recovery, people in Germany have continued to pay extra for the knowledge that their foodstuffs are free of pesticides and insecticides. 

“Fears that consumers would save on their purchases of organic products during the financial and economic crises have proven false,” said the market research group GfK in a statement earlier this month. 

With such an addiction to food purity, it is perhaps no surprise that a company near Bielefeld offers organic snacks for parrots. Called the Parrot Bakery, the company’s product line includes palm oil muffins, Eucalyptus snacks and nut balls for your favorite feathered friend. “Only the best for your parrots,” is the company’s motto. 

Products are available both in Marita Grabowski’s small shop as well as on the Internet. Grabowski started her company when, in 2007, her Gray Parrot “Charlie” fell ill and she had to make him crackers without seeds. Her company has since found substantial success, supplying pet food stores across Europe. She has even written a book: “The Cookbook for Parrots and Parakeets.” 

The Karaoke Cab 

“Turn it up, driver, I love this song.” It’s a common enough refrain, heard in taxis all over the world as they ferry a weekend’s worth of merry makers to their destinations. And although some cab drivers find this annoying, there is one clever chap in the German city of Münster, in the state of North Rhine-Westphalia, who is making a business out of those kinds of requests. 

Taxi driver Nizamettin Kilincli has installed a screen in the back of his eight-person taxi van, over which he can play karaoke tracks, or even movies. The reasons passengers like his service are as varied as the passengers themselves, Kilincli told the online city magazine Echo Münster. 

During the day Taxi Niza, as his business is known, drives around the city like any normal van-for-hire. The screen in the vehicle might be used for a family who wants to keep the kids quiet on the way out to the airport. But by night, it becomes a rolling fun palace, with party goers on the way to a club or a disco entertaining themselves by belting out a few numbers. 

Best of all, the service costs no more than any other cab ride. All of this has seen the clearly very tolerant Kilincli gain a regular clientele who prefer a ride in his taxi above all others. 

As for the kind of drunken, often tuneless, yodeling coming from the back seats, Kilincli does not mind it at all. He’s never been one for singing along, he told the Münster magazine, and anyway, he has to concentrate on the road. 

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Full article and photos: http://www.spiegel.de/international/zeitgeist/0,1518,680604,00.html

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Is the Dismal Science Really a Science?

Some macroeconomists say if we just study the numbers long enough we’ll be able to design better policy. That’s like the sign in the bar: Free Beer Tomorrow.

For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what happened to the economy and what’s going to happen next.

Is the mess we’re in a market failure or a government failure? Is the stimulus plan working? Would tax cuts for small business spur employment? When will the job market improve? Is inflation coming? Do deficits matter?

So many questions and so little in the way of answers. And so it is the worst of times for economists. There is no consensus on the cause of the crisis or the best way forward.

There were Nobel Laureates who thought the original stimulus package should have been twice as big. And there are those who blame it for keeping unemployment high. Some economists warn of hyperinflation while others tell us not to worry.

It makes you wonder why people call it the Nobel Prize in Economic Science. After all, most sciences make progress. Nobody in medicine wants to bring back lead goblets. Sir Isaac Newton understood a lot about gravity. But Albert Einstein taught us more.

But in economics, theories that were once discredited surge back into favor. John Maynard Keynes and the view that government spending can create prosperity seem immortal. I thought stagflation had put a stake in the heart of this idea back in the 1970s. Suddenly, he’s a genius once again. F.A. Hayek, Keynes’s more laissez-faire sparring partner, is drawing interest. There are various monetarists to choose from, too. Which paradigm is the “right” way to think about the boom and the bust? Or are they all wrong?

I once thought econometrics—the application of statistics to economic questions—would settle these disputes and the truth would out. Econometrics is often used to measure the independent impact of one variable holding the rest of the relevant factors constant. But I’ve come to believe there are too many factors we don’t have data on, too many connections between the variables we don’t understand and can’t model or identify.

I’ve started asking economists if they can name a study that applied sophisticated econometrics to a controversial policy issue where the study was so well done that one side’s proponents had to admit they were wrong. I don’t know of any. One economist told me that in general my point was well taken, but that his own work (of course!) had been decisive in settling a particular dispute.

Perhaps what we’re really doing is confirming our biases. Ed Leamer, a professor of economics at UCLA, calls it “faith-based” econometrics. When the debate is over $2 trillion in additional government spending vs. zero, we’ve stopped being scientists and become philosophers. Do we want to be more like France with a bigger role for government, or less like France?

Facts and evidence still matter. And economists have learned some things that have stood the test of time and that we almost all agree on—the general connection between the money supply and inflation, for example. But the arsenal of the modern econometrician is vastly overrated as a diviner of truth. Nearly all economists accept the fundamental principles of microeconomics—that incentives matter, that trade creates prosperity—even if we disagree on the implications for public policy. But the business cycle and the ability to steer the economy out of recession may be beyond us.

The defenders of modern macroeconomics argue that if we just study the economy long enough, we’ll soon be able to model it accurately and design better policy. Soon. That reminds me of the permanent sign in the bar: Free Beer Tomorrow.

We should face the evidence that we are no better today at predicting tomorrow than we were yesterday. Eighty years after the Great Depression we still argue about what caused it and why it ended.

If economics is a science, it is more like biology than physics. Biologists try to understand the relationships in a complex system. That’s hard enough. But they can’t tell you what will happen with any precision to the population of a particular species of frog if rainfall goes up this year in a particular rain forest. They might not even be able to count the number of frogs right now with any exactness.

We have the same problems in economics. The economy is a complex system, our data are imperfect and our models inevitably fail to account for all the interactions.

The bottom line is that we should expect less of economists. Economics is a powerful tool, a lens for organizing one’s thinking about the complexity of the world around us. That should be enough. We should be honest about what we know, what we don’t know and what we may never know. Admitting that publicly is the first step toward respectability.

Mr. Roberts is a research fellow at Stanford University’s Hoover Institution, professor of economics at George Mason University and a distinguished scholar in the Mercatus Center.

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Full article: http://online.wsj.com/article/SB10001424052748704804204575069123218286094.html

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Obama’s Business Buyout

President Obama is proposing that the U.S. government both guide the economy and do so with a new, aggressively redistributive tax policy.

It made perfect sense for President Obama to speak yesterday to the Business Roundtable. Businesses big and small could use a pep talk just now. Bank lending last year fell the most since 1942. San Francisco Fed President Janet Yellen describes a jobless recovery, with the economy not returning to U.S.-style Mach speed until 2013.

But instead of giving a speech about reviving business confidence in the economy, Mr. Obama gave a speech about reviving business confidence in him.

“I take the time to make these points because we have arrived at a juncture in our politics where reasonable efforts to update our regulations, or make basic investments in our future, are too often greeted with cries of ‘government takeover’ or even ‘socialism.’”

The evening before this speech, Mr. Obama held a small White House dinner for some CEOs from household-name corporations, such as AT&T, Xerox, State Farm, Verizon, PepsiCo and GE. The reason for a linen-tablecloth dinner followed by a big speech to really big business is the White House has concluded it is wrongly seen as antibusiness.

I agree. This White House is pro-business. In fact, it’s so pro-business it’s proposing a virtual merger with the private sector. Ladies and gentlemen of the business community, meet your new partner—Uncle Sam.

Under the terms of the proposed deal, the White House will drive the locomotive of the American economy and U.S. business will ride in the passenger cars. You’re being told to get over it.

Now, the president doesn’t talk that way when he speaks, as yesterday, to the Business Roundtable. And some of the “antibusiness” rap is the result of the Obama folks doing what they felt they had to do the past year to get the financial and credit systems back on track.

Along with this came some traditional pistol-whipping of bankers and brokers. Blame transferral is what politicians do. Everyone big enough to be a Fortune 500 CEO understands how this game is played.

But then along came a $90 billion tax on banks? That’s a high price for taking a fall.

And how did it come to pass that the just-released Obama budget includes a $122 billion tax on businesses’ overseas profits? Business thought it had beaten back this tax last October. What happened?

The answer lies, as it always has, in Mr. Obama’s first budget statement—”A New Era of Responsibility: Renewing America’s Promise”—released last Feb. 26. This is the most important presidential budget document since Ronald Reagan’s April 1981 “Additional Details on Budget Savings.” There Reagan offered an explicit philosophical rationale for his reordering of the federal government’s role. The Obama statement does the same for events the past year.

“A New Era of Responsibility” describes the years before Mr. Obama as “an era of profound irresponsibility that engulfed both private and public institutions.” From this emerged the two core themes of the Obama presidency.

The first is that “government,” which Mr. Obama identifies as “we,” must “transform our economy for the 21st Century.” Thus, the now-familiar initiatives on carbon auctions, a green-jobs economy, and health care. “At this particular moment,” Mr. Obama said a year ago, “government must lead the way.” This isn’t just an antirecession patch, but something new and permanent.

Mr. Obama said yesterday it is not a “government takeover.” Nothing so crude at all. It’s an M&A agreement between Uncle Sam and the private economy.

This in turn requires what Mr. Obama many times has called “investments”: Thus this year’s long list of tax increases—the fees, fines and taxes in the health-care bill, the overseas profits tax and the 2011 expiration of the Bush tax cuts.

This is about more than just siphoning tax revenue. It’s about big theme No. 2: “For the better part of three decades (my emphasis), a disproportionate share of the nation’s wealth has been accumulated by the wealthy. Technological advances and growing global competition, while transforming whole industries—and birthing new ones—has accentuated the trend toward rising inequality.”

I take this to mean that while the tax and economic policies of the past four presidencies worked for the economy—birthing whole industries—it was bad for society, as Mr. Obama understands it.

He is proposing that the U.S. government both guide the economy (“the right balance between the private and public sectors,” he said yesterday) and do so with a new, aggressively redistributive tax policy, which was made explicit in his just-released budget. Guide and redistribute. Agree or not, it’s a bold argument. But will it work?

This is radical, a big change indeed from the past three decades. It’s also a roll of the dice with the American economy. But as politics, it isn’t working. It has produced anxiety—the state-election surprises, the tea partiers, weak consumer confidence, nervous credit markets and surly executives.

If it were working, Mr. Obama wouldn’t have to give speeches to revive public confidence in his new vision for a new era. Could be, most people were fine with the one we had, until now.

Daniel Henninger, Wall Street Journal

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Full article: http://online.wsj.com/article/SB10001424052748704240004575085691881400382.html

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Can Washington Meet the Demand to Cut Spending?

Americans have reached a consensus. What’s lacking is trust.

President Obama’s decision to appoint Erskine Bowles and Alan Simpson to his bipartisan commission on government spending is politically shrewd and, in terms of policy, potentially helpful.

It is shrewd in that he is doing what he has been urged to do, which is bring in wise men. Here are two respected Beltway veterans, one from each party. It shows the president willing to do what he said he’d do when he ran, which is listen to other voices. The announcement subtly underscores the trope “The system is broken and progress through normal channels is impossible,” which is the one Democrats prefer to “Boy did we mess up the past year and make things worse.” And the commission gets some pressure off the president. Every time he’s knocked for spending, he can say “I agree, it’s terrible. Help me tell the commission!”

It’s potentially helpful in that good ideas may come of it, some rough and realistic Washington consensus encouraged.

Is it too late? Maybe. Even six months ago, when the president’s growing problems with the public were becoming apparent, the commission and its top appointees might have been received as fresh and hopeful—the adults have arrived, the system can be made to work. Republicans would have felt forced to be part of it, or seen the gain in partnership. Now it looks more as if the president is trying to save his own political life. Timing is everything.

But this is an interesting time. It’s easy to say that concern about federal spending is old, because it is. It’s at least as old as Robert Taft, Barry Goldwater and Ronald Reagan. But the national anxiety about spending that we’re experiencing now, and that is showing up in the polls, is new. The past eight years have concentrated the American mind. George W. Bush’s spending, the crash and Barack Obama’s spending have frightened people. It’s not just “cranky right-wingers” who are concerned. If it were, the president would not have appointed his commission. Its creation acknowledges that independents are anxious, the center is alarmed—the whole country is. The people are ahead of their representatives in Washington, who are stuck in the ick of old ways.

Conservatives all my adulthood have said the American people were, on the issue of spending, the frog in the pot of water: The rising heat lulled him, and when the water came full boil, he wouldn’t be able to jump out.

The House Budget Committee ranking Republican Rep. Paul Ryan, R-Wis.

But that is the great achievement, if you will, of the past few years. The frog is coming awake at just the last moment. He is jumping out of the water.

People are freshly aware and concerned about the real-world implications of a $1.6 trillion dollar deficit, of a $14 trillion debt. It will rob America of its economic power, and eventually even of its ability to defend itself. Militaries cost money. And if other countries own our debt, don’t they in some new way own us? If China holds enough of your paper, does it also own some of your foreign policy? Do we want to find out? And there are the moral implications of the debt, which have so roused the tea-party movement: The old vote themselves benefits that their children will have to pay for. What kind of a people do that?

It has been two or three years since I have heard a Republican or conservative say deficits don’t matter. Huge ones do, period. As for Democrats and new spending, the air is, for now, out of the balloon.

A question among Republicans is whether to back, as a party, Rep. Paul Ryan’s road map, his far-reaching and creative attempt to cut the deficit and the debt. The Congressional Budget Office says its numbers add up: It would, actually, remove the deficit in the long term. But the Ryan plan is, inevitably, as complicated as the entitlements it seeks to reform, involving vouchers and tax credits, cost controls and privatization. It is always possible that this is right for the moment, for the new antispending era. But the party itself has some other jobs right now, and one of them is to encourage the circumstances that will make real change possible. Here the abstract collides with the particular.

In the long run the Republicans have to do two things, and one they probably cannot do alone, or rather probably cannot do without holding the presidency, and a gifted president he would have to be. They have to prepare the ground for an American decision—a decision by a solid majority of America’s adults—that they can faithfully back specific cuts in federal spending: that they can trust the cuts will be made fairly, that we will all be treated equally, that no finagling pols will sneak in “protection” for this pet interest group or that power lobby, that we are in this together as a nation and can make progress together as a nation.

This is a huge job, and may ultimately require one strong and believable voice.

Second the Republicans should tread delicately while moving forward seriously. Voters are feeling as never before in recent political history the vulnerability of their individual positions. There is no reason to believe they are interested in highly complicated and technical reforms, the kind that go under the heading “homework.” As in: “I know my future security depends on understanding this thing and having a responsible view, but I cannot make it out. My whole life is homework. I cannot do more.”

We are not a nation of accountants, however much our government tries to turn us into one.

Margaret Thatcher once told me what she learned from the poll-tax protests that prompted her downfall. She said she learned in a deeper way how anxious people are, how understandably questioning and even suspicious they are of governmental reforms and changes: “They’re frightened, you see.” None of us feel we have a wide enough margin for error.

Americans lack trust that government will act in good faith, which is part of why they’re anxious. They look at every bill, proposal and idea with an eye to hidden horrors.

The good news is the new consensus that America must move forward in a new way to get spending under control. The bad news is we don’t trust Washington to do it. And in the end, only Washington can.

Paul Ryan is doing exactly what a representative who’s actually serious should do—putting forward innovative and honest ideas for long-term solutions. He should continue going to the people with it, making his case and seeing how they respond, from the Tennessee Tea Party to the Bergen County, N.J., Republican Club. Maybe a movement will start, maybe not. But it’s a good conversation to be having.

The GOP itself should be going forward with its philosophy, with the things it’s long stood for and, in some cases, newly rediscovered, and painting the broader picture of the implications of endless, compulsive high spending. Those lawmakers who have a good reputation in this area—Sen. Tom Coburn is one—should be moved forward more prominently. Congressmen who focus on earmarks, on controllable spending, are doing something wise. They are trying to demonstrate that those who can be trusted with small things—cutting back what can be removed now—can be trusted with larger things.

Peggy Noonan, Wall Street Journal

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Voters to Democrats: Jobs, Jobs, Jobs

Evan Bayh’s withdrawal from politics could be a harbinger of doom for the party—but it doesn’t have to be.

Sen. Evan Bayh’s stunning decision to retire should serve as more than a wake-up call to Democrats. It should spur a fundamental re-examination and reorientation of the party’s policies, practices and approaches leading into the fall election.

Let’s be clear. The Democratic brand is in trouble—big trouble. There are at least eight Senate seats up for grabs, and another two or three potentially in play, putting control of the Senate in play.

A betting man would have to give pretty good odds that the Republicans at least come away with the eight seats where they are currently either even or ahead in the polls (Arkansas, Colorado, Illinois, Nevada, Pennsylvania, Indiana, Delaware and North Dakota). The momentum is moving in the Republicans’ direction, and this election will be closer than anything in recent memory and likely produce last-minute swings to the Republicans.

Even without a dramatic swing to the Republicans, the Democratic brand is going to struggle. And when the Senate goes, the House is not likely to be far behind. Analysts can already count 25-30 endangered Democrats in the House, and the number is likely to swell as time goes on.

What then, do the Democrats need to do?

First, they need pro-growth, fiscally conservative policies. The tea party movement is not a Republican movement, and anyone who sees it as such is making a mistake. Rather, the tea party movement is a reaffirmation of a trend that has long been happening in American politics since 1964, with the move away from liberal, big-spending and big-taxing policies. It played out with California’s Proposition 13 in 1978, which limited property taxes there and inspired nationwide tax revolts just two years before Ronald Reagan was elected. It was evident when the Republicans won control of the House and Senate in 1994. And it certainly contributed to George W. Bush’s election and re-election in 2000 and 2004.

It is a profound mistake to believe that the Democratic resurgence and President Barack Obama’s election were a validation or an endorsement of a return to big government and Democratic liberalism. Rather, the party’s victories were a reaction against the Bush spending policies and paralysis in Washington, and frustration with an increasingly out-of-touch Congress. Indeed, the rhetoric and approach that candidate Obama employed in 2008 was decidedly anti-Washington and made a point to avoid an embrace of big government and big spending.

President Obama made it clear that he would produce a fundamental degree of change in the way government operates and practices. Well, it didn’t happen. Not by a long shot.

The Democrats need to do a number of things. First and foremost, they need to recognize there is only one fundamental issue in America: jobs. Unless there are pro-growth policies of the kind that have been articulated by the Kauffman Foundation and are supported by 70% to 80% of the American people according to Kauffman-sponsored research, Democrats are not going to win enough support quickly enough to reclaim their credibility.

These policies include a broad-based payroll tax holiday, building from the one Sens. Charles Schumer (D., N.Y.) and Orrin Hatch (R., Utah) have embraced, an extension of the Bush tax cuts, educational initiatives to educate the next generation of entrepreneurs, and tax policies that provide clear incentives to small businesses to get started and to hire new employees. Of late, President Obama has paid lip-service to the concept of creating private-sector jobs, but there is much more he can and should do to become the “jobs president” rather than the “health-care president.”

Speaking of health care, Mr. Obama must go back to square one. The American people have rejected the bulk of the Democratic initiative time and time again. As we say in politics, “This dog don’t hunt.”

What that means very simply is that the Democrats need to start over and embrace ideas that have broad-based support, like insurance reform, cost control, affordability, eliminating denials of insurance coverage based on pre-existing conditions, and electronic record-keeping.

The president is wrong to say that doing this will be seen as capitulation to the Republicans. It is quite the opposite. When Bill Clinton adopted the bulk of the Republican ideas on taxes, spending and welfare reform in 1996, he was able to seize some political ground and demonize House Speaker Newt Gingrich and Republican presidential candidate Bob Dole.

Mr. Obama can do the same thing if he is prepared to be shrewd tactically, rather than try to stand on his high horse and say that the Republicans are not being fair. Of course they are not being fair. They are playing politics. But he has the White House, and he can use it constructively to win.

The administration is setting itself, and its party, up to fail unless it commits to serious deficit reduction and spending cuts. It needs to understand that the American people, particularly those who support the tea party movement, will only come back to Democrats if it demonstrates that it understands voters’ desire to return to the kind of limited government the movement endorses.

The tea party movement is strong enough to elect a Republican House and Senate and shake up politics in ways we haven’t seen or considered. A commitment to deficit reduction and spending cuts, as well as a willingness to consider a continuation of the Bush tax cuts for another year until growth is stimulated, is critically important to reviving the Democratic brand.

Evan Bayh’s withdrawal from politics could be an extraordinary harbinger of the end for the Democrats, but it doesn’t have to be. Mr. Obama can lead his party, and the country, into great success by heeding the calls from the American people to create jobs, limit spending, and work towards bipartisanship. Anything less will spell doom for Democrats across the board.

Mr. Schoen, formerly a pollster for President Bill Clinton, is the author of “The Political Fix: Changing the Game of American Democracy, from the Grass Roots to the White House ” (Henry Holt, 2010).

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Mix message

Barack Obama’s advisers lay out some steps to a rebalanced economy. Others are out of his hands

FEW things have frustrated Washington’s punditocracy more than the search for “Obamanomics”, a consistent set of principles that underpins Barack Obama’s thinking on the American economy. “We can’t afford another so-called economic ‘expansion’ like the one from the last decade…where prosperity was built on a housing bubble and financial speculation,” Mr Obama declared in his state-of-the-union address last month. Well, OK. But what, then, should the next expansion be like? It usually falls to a president’s Council of Economic Advisers to drape his pronouncements in respectable economics. Mr Obama’s council attempts to do just that in its annual “Economic Report of the President”, released on February 11th.

In a nutshell, the report argues that it is not enough for the economy to start growing again. Rather, “the composition of spending needs to be reoriented.” That means smaller roles for consumption and housing, and bigger roles for saving, investment and exports. The report elegantly reframes much of Mr Obama’s domestic agenda as microeconomic nudges in the direction of this overall macroeconomic rebalancing.

In the years leading up to the crisis soaring asset prices, financial innovations and low unemployment all encouraged Americans to spend more and save less. Their saving as a share of disposable income fell steadily from around 10% in the early 1980s to around 1%, while home-ownership rates and residential-construction activity both outran levels justified by demography alone. Wealth, credit availability and unemployment have all now reversed. The report predicts consumption and home-building will be smaller shares of GDP while the personal-saving rate will stabilise at a higher equilibrium of between 4% and 7%. Mr Obama is pushing this process along by making retirement-saving plans more readily available and encouraging employers to increase employee contributions. The report does not say so, but the logical result of his financial reforms will be closer scrutiny of lending practices that will deprive marginal borrowers of credit.

In place of consumption and housing, the report says, business investment will expand. Investment since the 2001 recession has been “abnormally low”. Two forces will reverse that. First, higher personal-saving rates and (more optimistically) a lower federal deficit will hold down long-term interest rates and the cost of capital. Second, the prospective return on investments will be buoyed by “promising technological developments”.

The administration thinks it can intensify the second force by funding more basic research. Private research and development (R&D) is hamstrung by uncertainty over the fate of an R&D tax credit, which at present must be renewed by Congress each year. Mr Obama proposes making it permanent. The backlogged Patent and Trademark Office can take up to four years to approve a patent application. Mr Obama has endorsed congressional plans to let it charge more to speed things up. The administration is telling federal agencies to track the results of the research they fund so that money is spent to maximum effect.

The report argues that as personal savings rise and the federal deficit declines, America’s appetite for foreign savings will shrink. The current-account deficit, which topped 6% of GDP in 2006, will narrow in the long run to between 1% and 2% of GDP, where it stood in the mid-1990s. Aiding this shift is a boost to exports that the report predicts will be a natural consequence as other countries, especially in Asia, rebalance their own economies towards greater consumption and investment.

In his state-of-the-union address Mr Obama called for a doubling of exports in five years. Achieving that is a stretch but the report nonetheless argues that the Export-Import Bank, which Mr Obama wants to increase its financing for smaller exporters, can help. More boldly, the report and Mr Obama’s speech suggest that the president has set aside his ambivalence about free trade and may soon take up stalled free-trade agreements with South Korea, Colombia and Panama. The report also argues that a more progressive tax system, expanded health care and worker retraining are better ways to respond to the inevitable disruptions trade brings than protectionism. (Some of this is contrived: increased health-care coverage may well soften the sting of jobs lost to freer trade, but that is not why Mr Obama is pursuing it.)

The mercy of others

Laudable as most of these microeconomic moves are, rebalancing depends crucially on two macroeconomic levers Mr Obama either cannot or will not touch: interest rates and the dollar. The council’s report frankly acknowledges that by draining national saving, the federal deficit, which will hit a record 10.6% of GDP this year, will hinder rebalancing. Yet it argues that tackling the deficit should wait until the “Federal Reserve…has the tools to counteract” the fallout. That will not be for a while yet. The report says that even with interest rates at zero, monetary policy remains “unusually tight” because negative rates would be more appropriate. Put less diplomatically, this means unless the Fed drags its feet on raising rates, fiscal contraction risks choking the economy. But that is a decision for the Fed, not Mr Obama.

A weaker dollar is also critical to rebalancing growth. Indeed, its decline to date correlates almost perfectly with the drop in the non-oil trade deficit since 2006, according to Martin Baily and Robert Lawrence, two economists at the Brookings Institution and Harvard University respectively. This is not, however, something America, as the world’s biggest debtor and the custodian of its reserve currency, can be seen to encourage. Nor is it solely America’s choice to make. The dollar is also captive to other countries’ exchange-rate policies and saving habits. As a result the “Economic Report of the President” is largely silent on the currency. Mr Obama seems to understand that the economy needs to rebalance. Whether it does may be out of his hands.

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Full article and photo: http://www.economist.com/businessfinance/economicsfocus/displayStory.cfm?story_id=15497977&source=hptextfeature

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