April 3, 2012 7:34 pm

Two cheers for China’s rebalancing

Ingram Pinn Comment Page illustration pfeatures



China’s economy is changing. Indeed, it has to change, as I argued two weeks ago (“How to blow away China’s gathering storm clouds”, 20 March 2012). The good news is the scale of the external rebalancing. The bad news is that this is at the cost of larger internal imbalances.



China’s balance of payments has been a roller coaster (see charts). Thus, between 2003 and 2007, the current account surplus rose from 2.8 per cent to 10.1 per cent of gross domestic product. The surplus then fell sharply, to 2.9 per cent, by 2011. Over the same period, the share of exports and imports in GDP exploded upwards and then fell once again.

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In orthodox theory the level of current account surpluses and deficits reflect voluntary decisions to save and invest: countries with surplus savings, such as China, export capital while countries with a deficit import it. Surplus countries enjoy a higher return on savings; deficit countries enjoy a lower cost of investment. Everything is for the best in the best of all possible worlds. It seems peculiar that a poor country exports capital to rich ones, as China has done, but there is no reason, in this view, to question the wisdom of the underlying choices.



Unfortunately, this Panglossian view is hardly plausible after the repeated shocks in international finance over the past three decades, which culminated with the crisis in high-income countries that broke out in 2007. The US, in particular, proved incapable of using its capital inflows wisely: they financed fiscal deficits and the construction of unneeded houses. Of course, the US is largely to blame for this sad outcome, as are other capital-importers. But large external deficits also have a contractionary impact on demand. This did not seem to matter when the latter was strong. It matters a great deal now when it is weak.



Beyond these general points, specific issues arose over the past explosion in China’s surpluses. These were partly the consequence of interventions in foreign currency markets and consequent accumulation of foreign currency reserves. The latter rose from $170bn in January 2001 to $3.2tn at the end of last year.

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One tool in the policy box was to sterilise the monetary consequences of these interventions. All these are mercantilist policies.



Moreover, if a country is to have a huge investment boom and a strong external position, consumption normally has to be repressed and savings encouraged. This is what happened: private consumption fell from 46 per cent of GDP in 2000 to just 36 per cent in 2007. Public and private consumption together fell from 62 to 49 per cent of GDP, while gross saving jumped from 38 to 51 per cent of GDP. A substantial part of these savings were invested abroad, in low-yielding assets, at great cost: China’s external reserves are $2,300 for every man, woman and child, or as much as 40 per cent of GDP.


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Thus, a reduction in the external surpluses has been in the interests of both the rest of the world and China. So how happy should the results make us? The answer is: not ecstatic.



First, even a decline in the current account surplus, as a share of GDP, might mean a rising surplus, relative to the rest of the world’s output. In 2008, China’s surplus was $412bn, or 9.1 per cent of GDP. By 2011, it was just under half of the 2008 level, at $201bn. But the share of China’s GDP fell to 2.9 per cent.

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Suppose the share remained at 2.9 per cent: the surplus would be over $400bn by 2016 if China’s dollar GDP grew at 15 per cent a year. That is a plausible rate, since China’s real exchange rate is likely to appreciate. If one wants to assess the adjustment imposed on others, one has to look at surpluses in relation to their GDP, not China’s.


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Second, the domestic counterpart of the external adjustment consisted of ever higher investment as a share of GDP: between 2007 and 2010, the share of investment in GDP rose by close to 7 percentage points. In every year since 2007, real fixed investment has grown faster than GDP. The Organisation for Economic Co-operation and Development made the point in China in Focus: “thus far, the adjustment towards domestic demand has almost entirely reflected strong public infrastructure investment that has been financed off-budget”. Wen Jiabao, the premier, has himself frequently described China’s development as “unbalanced, unsustainable, and uncoordinated.” Unfortunately, the process of eliminating one important imbalance – the external surplus – has exacerbated the most striking of the internal imbalances – the extraordinarily high investment.




Suppose that China were to grow over the next decade at the still high rate of 7 per cent a year. Suppose, too, that investment (including investment in inventories) fell from 50 per cent of GDP to a still very high 40 per cent, because a smaller rate of investment is needed to support lower growth.



Suppose, too, that the external surplus remained 3 per cent of GDP. To achieve the expected 7 per cent GDP rate of growth, consumption (public and private) needs to grow at a real rate of 9 per cent while investment grows at 4.6 per cent. This would be an astonishing reversal. It would be impossible, without a big shift in the distribution of income towards households. That, in turn, would require comprehensive reforms in the financial system, in corporate governance and even in the power structure of the country.

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Moreover, there is a risk that such reform lowers investment far more than it adds to consumption. The result could be a very hard landing.



China has done a far better job of eliminating its huge current account and trade surpluses than I expected. The principal domestic cause of this shift has, however, been a surge in investment to still dizzier heights, assisted by appreciations in the real exchange rate. But that makes the domestic adjustment now required even bigger than before the crisis. If the external surplus is to remain a constant share of GDP, while the rate of economic growth slows, an extraordinary turnaround in relative rates of growth of consumption and investment is essential. To put it bluntly, the growth dynamic of the past 15 years must be reversed. Is that feasible? Perhaps. But it requires a huge expansion in consumption relative to investment. Will that happen, while the economy continues to grow? Nobody knows.


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Copyright The Financial Times Limited 2012.

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April 4, 2012
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Spain Jolts Euro Zone Back on Alert
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By RAPHAEL MINDER and JACK EWING





MADRID — A surge in borrowing costs for Spain on Wednesday unsettled financial markets and showed that even if the European debt crisis was in remission, it was not cured.




A decision by the European Central Bank on Wednesday to leave its main interest rate unchanged also reflected concerns about the broader euro zone, where the economy was sputtering and credit was still tight.


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The Spanish debt auction came just days after the government of Prime Minister Mariano Rajoy announced deep budget cuts meant to reassure investors that Madrid could meet its deficit-reduction targets. Spain sold €2.6 billion, or $3.4 billion of debt, near the bottom of its targeted range. Yields were higher than in recent auctions as the government sought to counter falling demand amid concerns about the effects of the budget cuts on an economy that was sinking into its second recession in three years.


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Following the disappointing bond auction, Spain’s long-term borrowing costs soared to their highest levels since December, with the yield on the benchmark 10-year government bonds rising 25 basis points, or 0.25 percentage points, to 5.7 percent. It had fallen as low as 4.6 percent in January, when banks in Spain and elsewhere in the euro zone started to buy more government bonds, using the proceeds of low-interest loans provided by the European Central Bank.

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“There has long been a dearth of foreign buyers, so if domestic buyers are now starting to retreat, the Spanish treasury has a serious problem on its hands,” said Nicholas Spiro, founder of Spiro Sovereign Strategy, a London-based consulting firm specializing in sovereign credit risk. “I think this is the beginning of a new bout of nervousness centered around Spain, but also possibly Italy.”


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In Europe, all major indexes fell 2 percent or more on Wednesday, with the Euro Stoxx 50, a barometer of European blue-chip stocks, slipping 2.5 percent and the FTSE 100 in London losing 2.3 percent. In Frankfurt, the DAX tumbled 2.8 percent.


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The decision by the E.C.B. governing council to leave its benchmark rate at 1 percent, a record low, was expected. A rate increase would have signaled the central bank’s intention to tamp down inflation in the 17-nation euro zone. At an annual rate of 2.6 percent in March, inflation is well above the E.C.B.’s target of about 2 percent. But any concerns policy makers may have had about prices were apparently outweighed by recent economic data showing that the euro zone economy was stuck in recession.

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Unemployment in the euro zone reached its highest level in 15 years during February, according to data published Monday. In addition, recent surveys have shown that business managers have grown more pessimistic and that credit is difficult to come by, especially in countries like Spain that have been hardest hit by the debt crisis.


.Spain’s problems, including the disappointing results of Wednesday’s debt auction, raised the possibility that the European sovereign debt crisis could accelerate again, and contributed to a sharp decline in main European stock indexes as well as the euro.


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Asked at a news conference in Frankfurt about the Spanish bond auction, Mario Draghi, the president of the E.C.B., warned countries that they could be penalized if investors conclude they were wavering in efforts to cut spending and improve economic performance.


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Financial markets “are asking these governments to deliver,” he said.


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In early March, Mr. Rajoy defied his European counterparts by softening the country’s deficit target. Since then, Spain’s long-term borrowing costs have remained above those of Italy, the other large and troubled economy in the euro zone. As he presented the government’s plan to reduce its annual budget deficit, Mr. Rajoy also disclosed that the total national debt would rise to 80 percent of gross domestic product this year, from 68.5 percent in 2011.


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To help alleviate investors’ concerns, Mr. Rajoy is now counting on a €27.3 billion squeeze in the central government’s budget for this year. His 2012 budget, introduced last Friday, calls for government ministries to cut spending 17 percent, on average. Mr. Rajoy, who took office only three months ago, is also relying on an amnesty program intended to increase tax revenue by bringing to the surface part of the income generated by Spain’s underground economy. That decision, however, has generated opposition from some regional governments, including that of the Basque Country, which want Madrid to take more forceful measures to track down tax cheats.

.In another sign of the euro zone’s continuing fiscal troubles, the Greek track and field federation announced Wednesday that it was suspending all domestic competitions indefinitely as a protest against cuts to state financing. While the action will not affect international events, including Greece’s participation in the Summer Olympics in London, it brings to a halt domestic contests planned across Greece, including marathons in several cities.

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It was the second time that the Hellenic Track and Field Federation has suspended operations in recent months. In November, the group suspended its operations for two weeks, but there were few events scheduled at the time. The federation said this suspension was indefinite, but added it would review its decisiondepending on developments.”

      
The head of the group, Vassilis Sevastis, said budget cuts meant that the organization had not been able to pay coaches and suppliers for up to 10 months. In a statement, the federation called on Culture Minister Pavlos Geroulanos “to intervene and avert the financial deadlock and the demolition of the backbone of classic athletics.”


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Tensions in European financial markets have cooled in recent months after the E.C.B. issued €1 trillion in cheap, three-year loans to banks. Mr. Draghi said the loans provided “a window of opportunity for governments to undertake structural reforms.”


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But Jörg Krämer, chief economist at Commerzbank, said the money could have the opposite effect, taking the heat off the leaders of countries like Italy to undertake measures that would initially be unpopular, like reducing job protections, but ultimately improve growth.

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“The success of the three-year tenders took pressure off the peripheral countries to implement the necessary reforms,” Mr. Krämer wrote in a note to clients Wednesday. “But without such reforms the sovereign debt crisis will not be solved and the E.C.B. will be forced to continue to de facto finance peripheral countries by printing money.”

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In what may have been an attempt to assuage German fears about inflation, Mr. Draghi made a point of emphasizing that the E.C.B. would keep a close eye out for signs that higher energy prices were translating into higher overall prices.


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Mr. Draghi may also have been reacting to an agreement last week between Germany and the union representing two million public sector workers that gives them a 6.3 percent wage increase.

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Jens Weidmann, president of the Bundesbank, the German central bank, has been particularly vocal about the need to make sure that measures to prevent a deeper banking crisis do not create an inflationary backlash.


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But Mr. Draghi gave no indication the E.C.B. was likely to tighten monetary policy soon. Mr. Draghi said it would bepremature” for the bank to begin rolling back the special support it had been providing to banks.


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“The E.C.B. still seems to be prepared to keep its exceptional monetary policy measures in place for quite some time,” Peter Vanden Houte, an economist at Dutch bank ING, wrote. “The difficult part will be to keep the Germans in the governing council happy and at the same time putting pressure on peripheral governments not to come back on their promise of fiscal consolidation.”


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Jack Ewing reported from Nicosia. Niki Kitsantonis contributed reporting from Athens.

A Centerless Euro Cannot Hold

04 April 2012

Kenneth Rogoff
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CAMBRIDGE – With youth unemployment touching 50% in eurozone countries such as Spain and Greece, is a generation being sacrificed for the sake of a single currency that encompasses too diverse a group of countries to be sustainable? If so, does enlarging the euro’s membership really serve Europe’s apparent goal of maximizing economic integration without necessarily achieving full political union?



The good news is that economic research does have a few things to say about whether Europe should have a single currency. The bad news is that it has become increasingly clear that, at least for large countries, currency areas will be highly unstable unless they follow national borders. At a minimum, currency unions require a confederation with far more centralized power over taxation and other policies than European leaders envision for the eurozone.


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What of Nobel Prize winner Robert Mundell’s famous 1961 conjecture that national and currency borders need not significantly overlap? In his provocative American Economic Review paperA Theory of Optimum Currency Areas,” Mundell argued that as long as workers could move within a currency region to where the jobs were, the region could afford to forgo the equilibrating mechanism of exchange-rate adjustment. He credited another (future) Nobel Prize winner, James Meade, for having recognized the importance of labor mobility in earlier work, but criticized Meade for interpreting the idea too stringently, especially in the context of Europe’s nascent integration.



Mundell did not emphasize financial crises, but presumably labor mobility is more important today than ever. Not surprisingly, workers are leaving the eurozone’s crisis countries, but not necessarily for its stronger northern region. Instead, Portuguese workers are fleeing to booming former colonies such as Brazil and Macau. Irish workers are leaving in droves to Canada, Australia, and the United States. Spanish workers are streaming into Romania, which until recently had been a major source of agricultural labor in Spain.


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Still, if intra-eurozone mobility were anything like Mundell’s ideal, today we would not be seeing 25% unemployment in Spain while Germany’s unemployment rate is below 7%.



Later writers came to recognize that there are other essential criteria for a successful currency union, which are difficult to achieve without deep political integration. Peter Kenen argued in the late 1960’s that without exchange-rate movements as a shock absorber, a currency union requires fiscal transfers as a way to share risk.



For a normal country, the national income-tax system constitutes a huge automatic stabilizer across regions. In the US, when oil prices go up, incomes in Texas and Montana rise, which means that these states then contribute more tax revenue to the federal budget, thereby helping out the rest of the country. Europe, of course, has no significant centralized tax authority, so this key automatic stabilizer is essentially absent.


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Some European academics tried to argue that there was no need for US-like fiscal transfers, because any desired degree of risk sharing can, in theory, be achieved through financial markets. This claim was hugely misguided.
Financial markets can be fragile, and they provide little capacity for sharing risk related to labor income, which constitutes the largest part of income in any advanced economy.



Kenen was mainly concerned with short-term transfers to smooth out cyclical bumpiness. But, in a currency union with huge differences in income and development levels, the short term can stretch out for a very long time. Many Germans today rightly feel that any system of fiscal transfers will morph into a permanent feeding tube, much the way that northern Italy has been propping up southern Italy for the last century. Indeed, more than 20 years on, Western Germans still see no end in sight for the bills from German unification.



Later, Maurice Obstfeld pointed out that, in addition to fiscal transfers, a currency union needs clearly defined rules for the lender of last resort. Otherwise, bank runs and debt panics will be rampant. Obstfeld had in mind a bailout mechanism for banks, but it is now abundantly clear that one also needs a lender of last resort and a bankruptcy mechanism for states and municipalities.


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A logical corollary of the criteria set forth by Kenen and Obstfeld, and even of Mundell’s labor-mobility criterion, is that currency unions cannot survive without political legitimacy, most likely involving region-wide popular elections. Europe’s leaders cannot carry out large transfers across countries indefinitely without a coherent European political framework.


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European policymakers today often complain that, were it not for the US financial crisis, the eurozone would be doing just fine. Perhaps they are right. But any financial system must be able to withstand shocks, including big ones.


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Europe may never be an “optimumcurrency area by any standard. But, without further profound political and economic integration – which may not end up including all current eurozone members – the euro may not make it even to the end of this decade.


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Kenneth Rogoff, Professor of Economics at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist at the International Monetary Fund from 2001 to 2003. He is one of the world’s premier international economists, with influential publications spanning the fields of global finance, monetary and fiscal policy, and economic development.

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Is it safe to start buying Gold Stocks yet?
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April 4, 2012
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.By Dave Banister





One of the most common questions I field from my forecast and trading subscribers is can we buy Gold stocks yet? We have seen Gold consolidating and correcting following a 34 fibonacci month rally that I discussed last fall was going to top out around 1900 per ounce. This type of rally went from October of 2008 to August of 2011 and we saw Gold rally from $680 to $1900 per ounce during that time.


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In order to work off the bullish sentiment that was at parabolic extremes, Gold is required to spend a reasonable amount of time in relation to the prior 34 month move to wash out the sentiment and create a strong pivot bottom. While this continues, the Gold stock index has taken it on the chin as money rotates out and into other hot areas like Technology and the Internet 2.0 social media boom. To wit, the GDX ETF peaked out last fall around 67 and current trades under 47 as of this writing.




However, there may be a silver lining developing in those dark mining stock clouds very soon. It does appear that we are in the 5th and final wave of this pessimistic decline in Gold stocks per my GDX ETF chart below. A typical bottoming pattern ends after 5 clear waves have taken place, and in this case I have targets between $43-$47 per GDX share for a likely pivot low in Gold stocks. Contrarian investors may do well to begin picking the better names in the sector and “scaling in” over the next short period of time.
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Gold itself has recently corrected from 1793 per ounce to 1620 in the last several weeks. This has spooked the crowd out of Gold and put further pressure on the Gold mining stocks as well. Should Gold hold the $1620’s area and rebound past $1691 you will see the Gold stocks take off just ahead of that and from these 43-46 levels on the GDX ETF provide very strong returns to investors with the iron stomachs.


The drug legalization dilemma

By George F. Will

Published: April 4




The human nervous system interacts in pleasing and addictive ways with certain molecules derived from some plants, which is why humans may have developed beer before they developed bread. Psychoactive consciousness-altering — and addictive drugs are natural, a fact that should immunize policymakers against extravagant hopes as they cope with America’s drug problem, which is convulsing some nations to our south.


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The costs human, financial and social — of combating (most) drugs are prompting calls for decriminalization or legalization. America should, however, learn from the psychoactive drug used by a majority of American adultsalcohol.



Mark Kleiman of UCLA, a policy analyst, was recently discussing drug policy with someone who said he had no experience with illegal drugs, not even marijuana, because he is of “the gin generation.” Ah, said Kleiman, gin: “A much more dangerous drug.” Twenty percent of all American prisoners 500,000 people — are incarcerated for dealing illegal drugs, but alcohol causes as much as half of America’s criminal violence and vehicular fatalities.


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Drinking alcohol had been a widely exercised private right for millennia when America tried to prohibit it. As a public-health measure, Prohibitionworked”: Alcohol-related illnesses declined dramatically. As the monetary cost of drinking tripled, deaths from cirrhosis of the liver declined by a third. This improvement was, however, paid for in the coin of rampant criminality and disrespect for law.


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Prohibition resembled what is today called decriminalization: It did not make drinking illegal; it criminalized the making, importing, transporting or selling of alcohol. Drinking remained legal, so oceans of it were made, imported, transported and sold.


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Another legal drug, nicotine, kills more people than do alcohol and all illegal drugscombined. For decades, government has aggressively publicized the health risks of smoking and made it unfashionable, stigmatized, expensive and inconvenient. Yet 20 percent of every rising American generation becomes addicted to nicotine.


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So, suppose cocaine or heroin were legalized and marketed as cigarettes and alcohol are. And suppose the level of addiction were to replicate the 7 percent of adults suffering from alcohol abuse or dependency. That would be a public health disaster. As the late James Q. Wilson said, nicotine shortens life, cocaine debases it.


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Still, because the costs of prohibitioninterdiction, mass incarceration, etc. — are staggeringly high, some people say, “Let’s just try legalization for a while.” Society is not, however, like a controlled laboratory; in society, experiments that produce disappointing or unexpected results cannot be tidily reversed.


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Legalized marijuana could be produced for much less than a tenth of its current price as an illegal commodity. Legalization of cocaine and heroin would cut their prices, too; they would sell for a tiny percentage of their current prices. And using high excise taxes to maintain cocaine and heroin prices at current levels would produce widespread tax evasion — and an illegal market.


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Furthermore, legalization would mean drugs of reliable quality would be conveniently available from clean stores for customers not risking the stigma of breaking the law in furtive transactions with unsavory people. So there is no reason to think today’s levels of addiction are anywhere near the levels that would be reached under legalization.


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Regarding the interdicting of drug shipments, capturingkingpindistributors and incarcerating dealers, consider data from the bookDrugs and Drug Policy: What Everyone Needs to Know” by Kleiman, Jonathan Caulkins and Angela Hawken. Almost all heroin comes from poppies grown on 4 percent of the arable land of one countryAfghanistan. Four South American countries Colombia, Ecuador, Peru and Boliviaproduce more than 90 percent of the world’s cocaine. But attempts to decrease production in source countries produce the “balloon effect.” Squeeze a balloon in one spot, it bulges in another.


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Suppress production of poppies or coca leaves here, production moves there. The $8 billion Plan Colombia was a melancholy success, reducing coca production there 65 percent, while production increased 40 percent in Peru and doubled in Bolivia.


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In the 1980s, when “cocaine cowboys” made Miami lawless, the U.S. government created the South Florida Task Force to interdict cocaine shipped from Central and South America by small planes and cigarette boats. This interdiction was so successful the cartels opened new delivery routes. Tranquillity in Miami was purchased at the price of mayhem in Mexico.


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America spends 20 times more on drug control than all the world’s poppy and coca growers earn. A subsequent column will suggest a more economic approach to the “naturalproblem of drugs.