November 27, 2011 7:38 pm

The eurozone really has only days to avoid collapse

By Wolfgang Münchau


In virtually all the debates about the eurozone I have been engaged in, someone usually makes the point that it is only when things get bad enough, the politicians finally acteurobond, debt monetisation, quantitative easing, whatever. I am not so sure. The argument ignores the problem of acute collective action.

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Last week, the crisis reached a new qualitative stage. With the spectacular flop of the German bond auction and the alarming rise in short-term rates in Spain and Italy, the government bond market across the eurozone has ceased to function.
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The banking sector, too, is broken. Important parts of the eurozone economy are cut off from credit.

The eurozone is now subject to a run by global investors, and a quiet bank run among its citizens.
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This massive erosion of trust has also destroyed the main plank of the rescue strategy. The European Financial Stability Facility derives its firepower from the guarantees of its shareholders. As the crisis has spread to France, Belgium, the Netherlands and Austria, the EFSF itself is affected by the contagious spread of the disease. Unless something very drastic happens, the eurozone could break up very soon.
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Technically, one can solve the problem even now, but the options are becoming more limited. The eurozone needs to take three decisions very shortly, with very little potential for the usual fudges.

First, the European Central Bank must agree a backstop of some kind, either an unlimited guarantee of a maximum bond spread, a backstop to the EFSF, in addition to dramatic measures to increase short-term liquidity for the banking sector. That would take care of the immediate bankruptcy threat.
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The second measure is a firm timetable for a eurozone bond. The European Commission calls it a “stability bond”, surely a candidate for euphemism of the year. There are several proposals on the table. It does not matter what you call it. What matters is that it will be a joint-and-several liability of credible size.
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The insanity of cross-border national guarantees must come to an end. They are not a solution to the crisis. Those guarantees are now the main crisis propagator.
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The third decision is a fiscal union. This would involve a partial loss of national sovereignty, and the creation of a credible institutional framework to deal with fiscal policy, and hopefully wider economic policy issues as well. The eurozone needs a treasury, properly staffed, not ad hoc co-ordination by the European Council over coffee and desert.
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I am hearing that there are exploratory talks about a compromise package comprising those three elements. If the European summit could reach a deal on December 9, its next scheduled meeting, the eurozone will survive. If not, it risks a violent collapse. Even then, there is still a risk of a long recession, possibly a depression. So even if the European Council was able to agree on such an improbably ambitious agenda, its leaders would have to continue to outdo themselves for months and years to come.
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How likely is such a grand deal? With each week that passes, the political and financial cost of crisis resolution becomes higher.

Even last week, Angela Merkel was still ruling out eurobonds. She was furious when the European Commission produced its owns proposals last week. She had planned to separate the discussion about the crisis from that of the future architecture of the eurozone. The economic advice she has received throughout the crisis has been appalling.
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Her own very public opposition to eurobonds has now become a real obstacle to a deal. I cannot quite see how the German chancellor is going to extricate herself from these self-inflicted constraints. If she had been more circumspect, she could have travelled to the summit with the proposal of the German Council of Economic Advisers, who produced a clever, albeit limited and not yet fully worked-out-plan. They are a proposing a “debt redemptionbondanother candidate for this year’s top euphemism award. The idea is to have a strictly temporary eurobond, which member states would pay off over an agreed time period. At least this proposal would be in line with the more restrictive interpretation of German constitutional law.
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Ms Merkel’s hostility to eurobonds certainly resonates with the public. Newspapers expressed outrage at the commission’s proposal. I thought both the proposal itself and its timing were rather clever. The Commission managed to change the nature of the debate. Ms Merkel can get her fiscal union, but in return she will now have to accept a eurobond. If both can be agreed, the problem is solved. It is the first intelligent official proposal I have seen in the entire crisis.
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I have yet to be convinced that the European Council is capable of reaching such a substantive agreement given its past record. Of course, it will agree on something and sell it as a comprehensive package. It always does. But the halt-life of these fake packages has been getting shorter. After the last summit, the financial markets’ enthusiasm over the ludicrous idea of a leveraged EFSF evaporated after less than 48 hours.
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Italy’s disastrous bond auction on Friday tells us time is running out. The eurozone has 10 days at most.


.Copyright The Financial Times Limited 2011


Europe’s Last Best Chance

Michael Boskin

2011-11-25


STANFORD – The resignations of Greek Prime Minister George Papandreou and Italian Prime Minister Silvio Berlusconi have highlighted how Greece, Italy, and many other countries obscured for too long their bloated public sectors’ long-standing problems with unsustainable social-welfare benefits. Indeed, for many of these countries, meaningful reform has now become unavoidable.
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The social-insurance systems in Europe, as in the United States, Japan, and elsewhere, were designed under vastly different economic and demographic circumstancesmore rapid economic growth, rising populations, and lower life expectancy – from those prevailing today. Governments (the focus is on Greece and Italy at the moment, but they are not alone) have promised too much, to too many, for too long. My 1986 book Too Many Promises pointed to the same problem with America’s social-welfare system.
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This fundamental problem has now manifested itself in these countries’ unsustainable debt dynamics. Euro membership, which temporarily enabled massive borrowing at low interest rates, merely aggravated it.
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Reforming social-welfare benefits is the only permanent solution to Europe’s crisis. One hopes that, with the help of national governments, the European Central Bank, the International Monetary Fund, and the European Financial Stability Facility, the holes in the sovereign-debt-funding dike will be temporarily plugged, and that European banks will be recapitalized. But this will work only if structural reforms make these economies far more competitive. They must both lower the tax burden and reduce bloated transfer payments. Too many people are collecting benefits relative to those working and paying taxes.
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Meanwhile, the bond market’s concern over fiscal deficits and debt dynamics is driving these countries’ borrowing costs higher. Short-term and long-term policies are therefore closely related; unless temporary stopgaps are combined with fundamental long-term structural reform, another disaster like the current one – or worse – will become inevitable.

There are three fundamental factors that determine the evolution of a country’s sovereign debt: its rate of economic growth; its borrowing costs; and its primary budget position (the budget balance net of interest payments). A country with a balanced primary budget collects enough revenue to pay its current expenses but not the interest on its outstanding debt. Higher interest rates, slower growth, and a weaker primary budget position all raise the debt-ratio trajectory.
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Italy is now paying 7% interest annually on its sovereign debt, while its economy is growing at only 1%. Thus, Italy needs sustained, large primary surpluses, much faster growth, and/or far lower interest rates to avoid a debt restructuring.
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A credible path to sufficient primary surpluses would lower interest rates. In the long run, if primary surpluses are achieved by controlling spending, the increase in national saving will promote investment and growth, whereas higher tax rates would work in the opposite direction. Successful post-World War II fiscal consolidation in OECD countries averaged $5-$6 in spending cuts per $1 of tax hikes.
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Some experts, such as former ECB President Jean-Claude Trichet, argue that fiscal consolidation would be expansionary. Specifically, it would boost confidence, which would lower interest rates and offset any direct effect on demand, as occurred in Ireland and Denmark in the 1980’s. But that is less likely now, as many countries are undertaking fiscal consolidation simultaneously, non-sovereign interest rates are already low, and monetary union prevents the most troubled countries in the eurozonePortugal, Italy, Ireland, Greece, and Spain – from devaluing their way to competitiveness.
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Substantial primary surpluses will be needed for many years in order to stabilize the debt ratio and gradually reduce it to the economic safety zone of less than 60% of GDP (Italy and Greece are over 100%). A credible long-term program of reforms must be implemented now, while temporary emergency measuresbond purchases by the EFSF, IMF, and the ECB provide breathing room. If the primary surpluses are insufficient, temporary measures will only postpone the inevitable debt debacle.
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Even more fundamental arithmetic lies at the core of the debt quandary. The tax rate required to fund social-welfare benefits depends on three factors: the dependency ratio (the ratio of recipients to taxpayers); the replacement rate (the ratio of benefits to average wages); and the economic-growth rate (roughly, productivity plus population growth).
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In other words, the more generous and widespread the government benefits, the higher the required tax rate. This core problem will increasingly affect even the Northern European countries, notwithstanding their current appearance of economic strength and fiscal soundness.
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In Europe’s highly taxed economies, better tax compliance or selective revenue measures can produce only a small amount of additional tax revenue without undermining growth. Spending cuts are the only way to improve the budget position significantly. But that course will be difficult. In many European countries, the government pays benefits to a majority of the population.
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A key question is whether incoming Greek Prime Minister Lucas Papademos and his new Italian counterpart, Mario Monti, both highly regarded economists, have the leadership skills to navigate these treacherous waters. Their examples will test whether other European democracies with heavily benefit-dependent populations can rein in the welfare state’s excesses.
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It is not an impossible challenge. Canada has staged a substantial retreat from the welfare state’s worst excesses, as center-left and center-right governments alike reduced the share of government spending as a proportion of GDP by eight percentage points in recent years. Several European countries are considering raising their remarkably low retirement ages, or have already done so. Given demographic trends, this may well be Europe’s last chance to build a firmer foundation for future prosperity.
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Winston Churchill once famously said of America that you can count on it to do the right thing once it has exhausted all other alternatives. Let us hope that his dictum proves correct for Europe as well.
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Michael Boskin, Professor of Economics at Stanford University and a senior fellow at the Hoover Institution, was Chairman of President George H. W. Bush’s Council of Economic Advisers.


Is This December Similar to 2007 & 2008 for Gold & Stocks?

November 27th, 2011 at 2:52 pm


Thus far in 2011 the overall stock market movement has been much different from what we had in 2010. This year we have seen nothing but sideways to lower prices with wild price swings on a day to day basis. There just has not been any really solid trends to take advantage of this year. Instead we had to actively trade the oversold dips and sell into the overbought rallies to just pull money out of the market on a monthly basis. Last year we saw 3 major rallies that lasted several months making it easy for anyone who bought into the trend to make money if managed properly.
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Looking forward to 2012 it looks as though we are going to see some major changes unfold globally that will change the way we do things live our lives. Unfortunately its a very negative outlook but I do have hope that something will be done to preserve are somewhat normal lifestyles. I’m not one to talk doom and gloom, there are enough of those guys out there already so lets stick with the charts and focus on what is unfolding now in the present and how to take advantage of it.
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The charts below show what I feel is likely to happen going into the new year IF we don’t get any major headline news in Europe that triggers another selloff.
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Intermarket Analysis:

There are a lot of different things unfolding within stocks, commodities, currencies and bonds right now. And it is imporatnt to know that investments are inter-connected in some way. For example, if one investment moves sharply in one direction it will have an effect on other investment classes.
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My eye is focused on the US Dollar Index which has recently had a strong run up in price. For the past couple years we have seen stocks fall when the dollar moves up. So with the dollar index now trading at a key resistance level we should see the dollar top out for a few weeks and spark a Christmas rally into year end. After that, all bets are off and we re-analyze.
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On the flop side of things, if Europe comes out with major negative headline news we could see the dollar index continue its rally and breakthrough this resistance level. If the dollar moves higher from here we could easily see a multi month run up in the dollar. You do not want to be long stocks if this happens, get short stocks and hold on tight.
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Dollar ETF Trading

Gold Daily Chart Analysis:

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Here is my positive outlook for gold and what I feel is likely to unfold near term. But keep in mind what I just said about the US dollar index above. If the dollar continues its rally and breaks out it could actually put some pressure on gold. I know gold is a safe haven so I do expect it to hold up, but a strong dollar will neutralize a lot of the buying in gold in my opinion.
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Gold Christmas Rally
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SP500 Daily Charts:

Stocks should have a solid bounce this December if the dollar finds resistance and pulls back in the coming weeks. I am expecting a bounce of 5-10% if all goes as planned.
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SP500 Christmas Rally

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Christmas Holiday Rally Trading Conclusion:
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In short, we are entering a tough time to trade the market. Volatility is low, there are a few holidays and typically we see volume thin out as December unfolds. Light volume generally favors higher prices for stocks and commodities which is one of the reasons we get the holiday lift in prices.
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The recent selloff in stocks is looking overdone to the down side and ready to bounce any day. So I am looking for signals to get long the SP500. Overall risk remains very high as sellers are still in control of the market and because we are looking to put on a trade against the intermediate trend which is down.
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On Friday morning myself and my followers exited our short position on the SP500 at the open locking in 13.5% profit. We exited the position because the intraday charts are showing signs of a potential bottom and we want to avoid the tear your face off short covering rally that I feel is just around the corner. Now we are waiting for a another low risk setup and will take action to go long or short depending how things unfold in Europe.
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I hope this report helped shed some light on the current market condition for you.
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Chris Vermeulen


BOOKSHELF

NOVEMBER 28, 2011

How the Dollar Rules by Fiat

How did the dollar become the world's principal currency and what is its future?

By JAMES GRANT


The Founders defined the dollar as a weight of gold or silver. We moderns have undefined and disembodied it. The 21st-century greenback is neither connected to nor—as they say on Wall Streetcollateralized by anything tangible. You can materialize it on a computer, like a tweet.

"Greenback Planet" is the story of this amazing monetary transformation. The narrative begins in the 18th century and races to the present, pausing to catch its breath at some of the great American monetary landmarks: Andrew Jackson's veto, in 1832, of legislation rechartering a predecessor to the Federal Reserve; Abraham Lincoln's recourse to greenbacks, or fiat currency, to finance the Civil War; resumption of the gold standard in 1879, with which it once more became possible to exchange gold for paper and vice-versa at a fixed and statutory rate; J.P. Morgan quelling the Panic of 1907; the
Federal Reserve not quelling, never mind preventing, the Great Depression; the crazy-quilt monetary improvisations of the 1930s; the halfway gold dollar of the post-World War II era; and the creation, in 1971, of the pure paper (later digital) model of today.

Mr. Brands is a paper-money man, though the subtitle of his book—"How the Dollar Conquered the World and Threatened Civilization as We Know It"—seems to betray some reservations. It betrays, as well, the author's zest for provocation. The American currency, he extravagantly claims, has "made America rich," "defeated communism" and "knitted the planet into a single economy more fully than any currency before." I would say that enterprise made America rich and that communism, rotten from the start, defeated itself, with a timely push from Ronald Reagan. And I would say that the British pound "knit" the world economy together long before the birth of Ben Bernanke, while the golden solidus of ancient Byzantium circulated as global money ages before the reign of Queen Victoria.

Without an over-scrupulous regard for history, the historical narrative zips along.
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Mr. Brands has written biographies of Benjamin Franklin, Andrew Jackson, Theodore Roosevelt, Woodrow Wilson and Franklin D. Roosevelt. He has written diplomatic history, political history and business history. Some academics—"one book men," as Samuel Flagg Bemis, the prolific Yale diplomatic historian, contemptuously called them—write hardly at all. Mr. Brands, a history professor at the University of Texas, seems to do nothing but.
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greenback
By H.W. Brands
(University of Texas Press, 139 pages, $25)
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I would advise more reading. Many have plowed the ground that Mr. Brands here so lightly treads, but to the best of these worthy forerunners the author scarcely tips his hat.
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Conspicuously unacknowledged are such critics of the modern dollar system as Jacques Rueff (1896-1978), the adviser to Charles de Gaulle who was wont to assert that the U.S., free to print as many dollars as it found expedient, was spending itself into debt and the world into crisis. Not a bad diagnosis, as things have turned out. Worse than Mr. Brands's sin of omission, however, is this sin of commission: His assertions that there is something new under the monetary sun.
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Actually, with the exception of the automatic-teller machine, we've seen it all before. Inflation is as old as the first coin clipped for a bit of valuable metal, and the first bad loan no doubt followed hard on the founding of the first bank. The author writes that Lincoln, by detaching the dollar from its golden anchor, "made possible innovations in finance unimagined by previous generations." But John Law, the 18th-century Scottish economist who served as finance minister for Louis XV in France, not only imagined this particular innovation but also implemented it for the king—with disastrously inflationary results.
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"Stubborn tradition" is Mr. Brands's explanation for the persistence of mankind's adherence to currencies backed by something other than the good intentions of the governments that print them. If so, humanity is stubborn for cause. The invariable rule on paper currencies, as the author does not quite right come out and say, is that they lose their value. Will the dollar prove an exception? The rising price of gold suggests that many doubt it.
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As if he were not a historian at all but rather a newspaper columnist up against a deadline, Mr. Brands keeps losing the historical thread. Thus he erroneously writes that "the financial panics of the early 19th century in America were local affairs, confined to a modest number of firms and affecting comparatively few people." The Panic of 1837 in fact rattled teacups in the City of London almost as violently as it did in New York and Philadelphia, as recounted in Bray Hammond's masterly 1957 history, "Banks and Politics in America."
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On the still-fraught question of the Great Depression, Mr. Brands maintains that excessive lending against stock-market collateral, "rather than Main Street mortgages," sent the banking system down the hole. The record actually shows that the banks suffered little through margin lending. Real estate was rather their salient soft spot, as it so often is.
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In the Republic of Letters, the land of authors, it falls to journalists to write the glib, forgettable books, scholars the ones that last. Law-abiding writers respect these ancient boundaries. The author of "Greenback Planet" is a trespasser.
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Mr. Grant, the editor of Grant's Interest Rate Observer, is the author, most recently, of "Mr. Speaker! The Life and Times of Thomas B. Reed, the Man Who Broke the Filibuster."


November 27, 2011, 5:00 pm

Scaling the ‘Wall in the Head’

By COSTICA BRADATAN


Walls are back in fashion. Walls and fences. Not long ago, you may recall, Republican presidential candidates expressed their devotion to them. In October Michele Bachmann signed a pledge to support the construction of a fence that would run the entire length of the United States-Mexico border. Not to be outdone, Herman Cain voiced his support for an electrified border fence, one juiced up enough to be lethal: Touch it and die. As someone who grew up behind the Iron Curtain, I happen to know how the device works; in a certain way, we invented it (we should have copyrighted it). The ability to cross the “lethal fence used to be part of the East-European survival kit.

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Of course, the issue has not gone away. Immigration was once again a third-rail topic in the most recent Republican debate. A visual message appeared this week in the media to reinforce it: The latest cover of The New Yorker magazine is a Thanksgiving-themed illustration by the artist Christoph Niemann that shows frightened Mayflower-era pilgrims breaching a barbed-wire fence in the desert.

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While walls and fences are certainly physical thingsimposing ones at that — a good deal of their power comes from elsewhere. As their role in political discourse makes clear, they are also things of the mind. And it is not a concept confined by American borders. The Germans, who seem to have a name for everything, use the phrase der Mauer im Kopf (“the wall in the head”) to refer to the phenomenon. The Berlin Wall may have been torn down long ago, but many people in Germany still feel divided; the wall is intact in their minds. (As a native of Germany, Niemann may know a thing or two about this.) Walls can be spectacular as architectural structures but they can be even more fascinating as entities that inhabit our thinking and shape cultures.

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Walls, then, are built not for security, but for a sense of security. The distinction is important, as those who commission them know very well. What a wall satisfies is not so much a material need as a mental one. Walls protect people not from barbarians, but from anxieties and fears, which can often be more terrible than the worst vandals. In this way, they are built not for those who live outside them, threatening as they may be, but for those who dwell within. In a certain sense, then, what is built is not a wall, but a state of mind.
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In a world of uncertainty and confusion, a wall is something to rely on; something standing right there, in front of youmassive, firm, reassuring. With walls come mental comfort, tranquility and even a vague promise of happiness. Their sheer presence is a guarantee that, after all, there is order and discipline in the world. A wall signifies the victory of geometrical reason over anarchic impulses.
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What can be greater than a straight line that crosses deserts, forests, swift rivers, unruly cities and ungovernable provinces? A straight line is not only the shortest distance between two points, but also the cheapest way to build a wall. Walls are geometry put into humanity’s service. True, they create divisions and distinctions, but so does reason. Walls make things look clear and distinct; they are always Cartesian. Seen from space, the Great Wall of China is the only indication that the Earth is inhabited by rational beings (if we leave aside the visible traces of industrial pollution, that is).
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Granted, walls can also block one’s view, but that should not be such big problem, especially when one wants to hide. At closer inspection, a wall occasions a dual process.

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On one hand, by building a wall I try to hide myself, to live in its shadow and, at the limit, make myself invisible. On the other, however, it is precisely by building it that I come to disclose myself in a decisive manner. Through the erection of the wall I expose myself totally; my secret fears and anxieties can now be contemplated in all their nakedness. A wall is above all the admission of a fundamental vulnerability.
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Now, if we shift perspective and look at things from the point of view of those who are “left out” (walled off), a wall is always perceived as an invitation. It is a way of putting things in a more tempting light, of making them desirable. This is all a game of teasing and seduction. There used to be nothing here, and then, one day, suddenly a wall emerges. How can you not pay attention?

The erection of a wall signifies that someone has got something precious and that the others should know about it. That she has erected the wall means, at a first reading, that she does not want to share with others whatever she’s got; however, to the extent that by building the wall she lets the others know of her new possession, it means that she may want to share after all. And that’s the point of the whole game.
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As we have learned from René Girard, this is precisely how desires are born: I desire something by way of imitation, because someone else already has it. This explains why walls are so attractive and also why they are besieged, eventually torn down and apart.
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They are just irresistible. It took the Ottomans several generations to breach the walls of Constantinople. They were incredibly stubborn, these old Turks; they persisted in their effort to the point of settling down, setting up small towns right there, next to the city walls. But they were not without help; their determination fed every single day on the sight of those Constantinopolitan walls, which made the city ever more tempting and the desire to conquer it irrepressible.
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Walls are built for various reasons and they serve different purposes, but their function is always fundamentally the same: to create divisions, to prevent people and ideas from moving freely, and to legitimize differences. In the end, it does not even matter whether a wall has been erected by people who are afraid of losing some of what they possess (the most frequent situation) or governments — like the East German state that built the Berlin Wallafraid of losing their people who, in the absence of any walls, would gladly go elsewhere. Once the wall has been erected, it acquires a life of its own and structures people’s lives according to its own rules. It gives them meaning and a new sense of direction. All those walled off now have a purpose: to find themselves, by whatever means it takes, on the other side of the wall.
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When Hadrian erected the wall in what is today Northern England in the second century, all those left north of it discovered an interesting new destination: south of the wall. When the Berlin Wall was built up in 1961, people in East Germany must have suddenly realized that there was a place absolutely worth going to: West Berlin. For almost 30 years the Wall fueled their desire to be on the other side. For many of them this desire was so irresistible that they had to give in, whatever the risks; enough died trying.
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Without walls, we would all certainly die of boredom. That’s why, if we don’t find them in the real world, we have to invent them. In Luis Buñuel’s filmEl Ángel Exterminador” a group of people find themselves mysteriously trapped in a room after a party. As the times goes by, they reveal their deeper selves.
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Also, their predicament becomes terrible: some go as far as to commit suicide, one dies, all do things through which they profoundly degrade themselves. After they reach the lowest point, somehow they manage to get out. It is then they learn that the wall that had kept them trapped existed only in their own minds. The film was made in Mexico, of all places.
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On a large historical scale, walls must be a blessing. And not only for the remarkable — if unutteredphilosophical and cross-cultural conversation that takes place continuously between those who built walls, on one hand, and those who want to tear them down, on the other. Above all, walls help keep the world alive and history in motion. A wall is always a provocation, and life is possible only as a response to provocations; a world without walls would soon become stale and dry. After all, history itself may be nothing more than an endless grand-scale game where some built walls only for others to tear them down; the better the former become at wall-building the braver the latter get at wall-tearing.
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The sharpening of these skills must be what we call progress.
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Costica Bradatan is an assistant professor in the Honors College at Texas Tech University. He is the author of “The Other Bishop Berkeley. An Exercise in Reenchantment” and other books. He is currently writing a book on martyr-philosophers.