Europe’s Short Vacation

Nouriel Roubini

13 April 2012
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NEW YORK – Since last November, the European Central Bank, under its new president, Mario Draghi, has reduced its policy rates and undertaken two injections of more than €1 trillion of liquidity into the eurozone banking system. This led to a temporary reduction in the financial strains confronting the debt endangered countries on the eurozone’s periphery (Greece, Spain, Portugal, Italy, and Ireland), sharply lowered the risk of a liquidity run in the eurozone banking system, and cut financing costs for Italy and Spain from their unsustainable levels of last fall.


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At the same time, a technical default by Greece was avoided, and the country implemented a successful – if coerciverestructuring of its public debt. A new fiscal compact – and new governments in Greece, Italy, and Spainspurred hope of credible commitment to austerity and structural reform. And the decision to combine the eurozone’s new bailout fund (the European Stability Mechanism) with the old one (the European Financial Stability Facility) significantly increased the size of the eurozone’s firewall.


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But the ensuing honeymoon with the markets turned out to be brief. Interest-rate spreads for Italy and Spain are widening again, while borrowing costs for Portugal and Greece remained high all along. And, inevitably, the recession on the eurozone’s periphery is deepening and moving to the core, namely France and Germany. Indeed, the recession will worsen throughout this year, for many reasons.

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First, front-loaded fiscal austerityhowever necessary – is accelerating the contraction, as higher taxes and lower government spending and transfer payments reduce disposable income and aggregate demand. Moreover, as the recession deepens, resulting in even wider fiscal deficits, another round of austerity will be needed. And now, thanks to the fiscal compact, even the eurozone’s core will be forced into front-loaded recessionary austerity.


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Moreover, while über-competitive Germany can withstand a euro at – or even stronger than – $1.30, for the eurozone’s periphery, where unit labor costs rose 30-40% during the last decade, the value of the exchange rate would have to fall to parity with the US dollar to restore competitiveness and external balance. After all, with painful deleveragingspending less and saving more to reduce debtsdepressing domestic private and public demand, the only hope of restoring growth is an improvement in the trade balance, which requires a much weaker euro.


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Meanwhile, the credit crunch in the eurozone periphery is intensifying: thanks to the ECB long-term cheap loans, banks there don’t have a liquidity problem now, but they do have a massive capital shortage. Faced with the difficulty of meeting their 9% capital-ratio requirement, they will achieve the target by selling assets and contracting creditnot exactly an ideal scenario for economic recovery.

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To make matters worse, the eurozone depends on oil imports even more than the United States does, and oil prices are rising, even as the political and policy environment is deteriorating. France may elect a president who opposes the fiscal compact and whose policies may scare the bond markets.


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Elections in Greecewhere the recession is turning into a depression – may give 40-50% of the popular vote to parties that favor immediate default and exit from the eurozone. Irish voters may reject the fiscal compact in a referendum. And there are signs of austerity and reform fatigue both in Spain and Italy, where demonstrations, strikes, and popular resentment against painful austerity are mounting.


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Even structural reforms that will eventually increase productivity growth can be recessionary in the short run. Increasing labor-market flexibility by reducing the costs of shedding workers will lead – in the short run – to more layoffs in the public and private sector, exacerbating the fall in incomes and demand.


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Finally, after a good start, the ECB has now placed on hold the additional monetary stimulus that the eurozone needs. Indeed, ECB officials are starting to worry aloud about the rise in inflation due to the oil shock.


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The trouble is that the eurozone has an austerity strategy but no growth strategy. And, without that, all it has is a recession strategy that makes austerity and reform self-defeating, because, if output continues to contract, deficit and debt ratios will continue to rise to unsustainable levels. Moreover, the social and political backlash eventually will become overwhelming.

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That is why interest-rate spreads in the eurozone periphery are widening again now. The peripheral countries suffer from severe stock and flow imbalances. The stock imbalances include large and rising public and private debt as a share of GDP. The flow imbalances include a deepening recession, massive loss of external competitiveness, and the large external deficits that markets are now unwilling to finance.


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Without a much easier monetary policy and a less front-loaded mode of fiscal austerity, the euro will not weaken, external competitiveness will not be restored, and the recession will deepen. And, without resumption of growthnot years down the line, but in 2012 – the stock and flow imbalances will become even more unsustainable. More eurozone countries will be forced to restructure their debts, and eventually some will decide to exit the monetary union.


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Nouriel Roubini, a professor at NYU’s Stern School of Business and Chairman of Roubini Global Economics, was one of the few economists to predict the recent global financial crisis. One of the world’s most sought-after voices on its causes and consequences, he previously served in the Clinton administration as Senior Economist for the President’s Council of Economic Advisers, and has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.



What Is The Fair Value Of Gold?

April 12, 2012

Mark Anthony
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All physical assets have intrinsic values that depend not on what people perceive the value of these assets should be, but rather on what it costs to produce and replace such physical assets.

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The fair market value of a physical asset is roughly decided by the marginal production cost, which is the highest cost of production needed to adequately meet demand.

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For example, copper could be produced at $2.00, $3.00, $3.50, or $4.00 per pound, depending on specific mines. If the copper demand is met by mines producing at a cost of $3.50 or less per pound, then roughly $3.50 per pound -- plus a bit of reasonable profit margin -- would be the fair market value of copper. If demand increases and the $4.00-cost copper mines must start to produce as well, then the fair value of copper would be $4.00 plus reasonable mark up. This works well because profitability encourages more production, and vice versa.

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But gold seems to be different. The supply/demand and marginal production cost argument does not work well for gold. This metal is a monetary metal and a hard currency. There is a huge stockpile of above-ground gold in the world. If all the gold mines in the world were shut down today, the existing gold stockpile can last the world for a thousand years. Most gold ever produced still exists today in one form or another: jewelry, coins, and bullion. Since there will never be a shortage of gold, the supply/demand analysis does not work. Investors purchase gold at one time only to sell it at another time, so they could be either on the side of demand or the side of supply. Without certainty in supply/demand, the marginal production cost becomes a moot point.


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So what determines the fair value of gold? Precious metal analysis quotes very different production costs from very different sources. But none of the cost figures quoted are fair to determine gold's value.


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For example, copper producers refine copper using the electrolysis process which produces anode slimes that contain the precious metals gold, silver, platinum, and rare metal tellurium. These byproduct metals can be extracted from the anode slime at minimal cost. U.S. copper producer Asarco regularly extracted and sold tellurium, a metal 10 times rarer than gold, even at a time when tellurium sold for only $7 per kilogram. Asarco would be happy to extract gold from the slime and make a profit even if gold sells for $7 per kilogram. Since there is never going to be a gold shortage, the gold extracted from copper anode slimes is more than the world ever needs. Should gold be fairly valued at $7 per kilogram then? Tellurium, being 10 times rarer than gold, was once only $7 a kilogram. Gold shouldn't be more expensive just because it is rare, right? No one sells one kilogram of gold for $7.


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Looking at another example, if everyone in the world wants to own a few ounces of gold as a safe haven asset, gold produced from all the gold mines won't meet the demand. We could set up factories to extract gold contained in the sea water. The cost will be prohibitively high. It might be profitable if gold is sold for, say, $1 million per ounce. But no one buys gold at $1 million per ounce, either.


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Those are two extreme examples of gold production cost. Gold could be produced dirt cheap or prohibitively expensive, depending on who you talk to. The point I'm making is that gold's fair value is not determined by the production cost of mines. The opposite causal relationship is true. A gold mining company will decide whether a specific mine should be produced profitably or not, depending on the current gold market price. Adding or removing some gold mines, on the other hand, has very little bearing on gold's supply/demand.


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So what determines the fair market value of gold?


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Gold's fair value is determined by its status as the world's most hoarded metal, most trusted hard currency, and best-known safe haven asset. Gold is used as a reliable hard currency and storage of value. Ever since the fiat currency was invented, there have been countless examples of currency collapse. Each time people rush to gold and other physical assets to protect their fortune, gold always holds up its value. The value of gold in terms of purchase power is very stable over the long term because the stockpile of gold is huge and does not vary much over time. Gold is not an investment, but rather an asset insurance during crisis times. Gold's status as a safe haven and asset insurance is what gives it fair intrinsic value.


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The amount of fiat money circulating in the world, including paper money and coins, is estimated at roughly 5 trillion U.S. dollars at the end of 2010 -- and is growing fast. Adding in the nonphysical fiat money, the M2 and M3 money supply, the total amount of money in the world is much higher.


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All fiat money has the potential to collapse and become worthless. Neither an individual, a corporation, a financial institute nor a country can afford to allocate all liquid assets in fiat money or fiat currency denominated debts. Everyone has to allocate a portion of their assets in the hard currency and safe haven, mostly in gold. Likewise, central banks who print fiat currencies cannot afford to leave their currency without the backing of physical assets. They have to have gold reserves that are adequate to the amount of currency in circulation in order to provide at least some sort of backing.

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The need for people to dedicate a portion of their fortunes to the hard currency gold, the need of central banks to allocate a certain portion of their assets in gold to back up and protect their currencies, and the ensuring fight for the finite amount of gold that is available are all precisely what gives gold a fair market value.


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The physical amount of gold is relatively fixed, while the amount of fiat money grows rapidly. So to ensure that gold constitutes a fair percentage of asset allocation, the value of an ounce gold -- measured in fiat currency unit -- must grow in proportion to the growth of the money supply.


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Gold does not become more valuable when the price goes up, it simply reflects that the value of the fiat currency goes down when more money is printed.

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Let's look at some numbers.


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Central banks of the world are hoarding a total of 30,800 metric tons of gold. At the beginning of 2003, the world's total M1 money supply was US$2.0 trillion, gold was about US$400 per ounce. So the central bank gold hoard was valued at US$0.40 trillion. The gold hoard was roughly 20% of the M1 money in circulation. By the end of 2010, the M1 money supply had grown to US$5.0 trillion and the physical amount of gold hoard was little changed, but the per-ounce value of gold had grown to US$1,000, putting the gold hoard at a value of US$1.0 trillion.


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Again it is roughly 20% of the amount of M1 money in circulation, no more and no less.


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The 20% says that it is prudent for people and central banks to put 20% of their assets in physical gold for protection. This is not an unreasonably high percentage; it's really just adequate. The hardly changed percentage also proves that various claims that gold is a bubble or that the gold bull market has ended are baseless.


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Since that percentage hasn't shifted to the higher side, the gold bull market hasn't even started so far. As long as money keeps getting printed, gold will keep moving up in fiat currency prices while it is simply holding up its purchasing power. I would start worrying about gold if I see the allocation percentage begin to move higher than 20%.


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Have you allocated enough of your liquid assets into gold, silver, and other physical assets? Or is all your money in bank deposits? Please think about the 20% allocation figure; do you have enough gold?


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My advice to China's Central Bank Governor Zhou Xiaochuan: China's M2 money supply reached 86.72 trillion yuan in February 2012, up 18% in a year, while China's gold reserve is only 1054 metric tons, worth 0.3478 trillion yuan -- a mere 0.40% of the M2 money supply. That's a far lower than the 20% average central bank gold allocation percentage. China must massively increase its gold hoard or the Chinese yuan is a disaster waiting to happen.


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The M2 of the dollar is about US$9.75 trillion. The U.S. Treasury had a gold hoard of 8133.5 metric tons, or about US$0.426 trillion, equal to 4.37% of the M2 money supply. This is inadequate and tells me that the U.S. dollar has far to fall.


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Since the gold reserve at Fort Knox has not been audited for many decades, there were rampant Internet rumors claiming that all the U.S. gold is gone. Despite repeated requests from elected officials, no one could visit the facility to verify whether the gold is still there or not.


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Consider this: Every other nation and central bank in the world has purchased or sold off some gold and their gold reserve has changed. But the official U.S. Treasury gold reserve has remained a constant over decades. Why? If the U.S. sells or purchases any gold, it must then open the gold vaults to transport gold bars into or out of the vaults. If so, someone would know exactly what's in the Fort Knox gold vaults. If there is a "secret" in Fort Knox, the only way to safeguard that secret is to never buy or sell any gold and never create a need for someone to enter those vaults.

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What that secret may be I will leave to the imagination of readers.


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Some gold and commodity investors are concerned gold could one day become a bubble. It is certainly possible. Is gold a bubble today just because some gold mines might be producing at very low costs? Not at all. When does gold become a bubble? Look at the historic money supply chart, during the famous gold run in 1980; there was no obvious peak of money supply at the time. It might be that the central bank gold allocation at the time far exceeded 20%. That would have been a good indication of a gold bubble condition.


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So let me answer the question I posed earlier: What is the fair value of gold in U.S. dollars? I'll look at 1980 when gold peaked, 2001 when gold bottomed, and today when gold is at $1,660.


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Let's start with the U.S. dollar M1 money supply data, both current and historical. The official U.S. gold reserve is 8133.5 metric tons, or 261.5 million ounces.


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Based on the 20% figure noted above, the M1 money supply amount divided by 1.3075 billion (5*261.5 million = 1.3075 billion) should be the fair price of gold.

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On Jan. 21, 1980, gold reached a peak of $850 per ounce. M1 was $413.2 billion. M1 divided by 1.3075 billion would give a fair gold price of $316 per ounce.
Clearly, gold was overpriced at the $850 bubble price.

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On April 2, 2001, gold reached a bottom price of $256 per ounce. M1 was $1114 billion. This would lead to a fair gold price of $852. Gold was underpriced and the dollar was overvalued at the time.


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Today, gold is at $1,660 per ounce. The M1 is $2221 billion. This leads to a fair gold price of $1,699. That sounds about right.


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Gold has a bit to catch up. But if the Fed keeps printing money, gold prices should keep going up as the M1 keeps expanding. Will M1 stop growing anytime soon? I don't think so. So gold will go a lot higher.



Beating the Drug-War Addiction
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Juan Gabriel Tokatlian

  11 April 2012
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BUENOS AIRES – In January, US President Barack Obama nominated Marine Corps Lieutenant General John F. Kelly to head the United States Southern Command (USSOUTHCOM). Based in Miami, Florida, USSOUTHCOM runs military operations throughout Latin America and the Caribbean, and is the key US drug warrior” in the region. Across the region, the key question, among civilian and military leaders alike, is whether the change in commanders will bring with it a change in focus.


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The top priority for USSOUTHCOM is to fight narcotics trafficking from the Andes to the Rio Grande. With the Cold War’s end, fighting communism was no longer the US armed forces main objective; USSOUTHCOM increasingly concentrated on pursuing coercive anti-drug initiatives, and funds to fight the drug war were plentiful. But the change in commanders is an opportunity for the US to revise, at long last, its regional doctrine in order to address other pressing security needs.


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The terrorist attacks of September 11, 2001 paradoxically reinforced the US military’s focus on countering illicit drug traffickers. While other US forces became heavily involved in the “war on terrorism,” USSOUTHCOM scaled up its “war on drugs,” with its commanders targeting the industry’s bosses in the Andes, Mexico, and Central America.


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That happened in part because, following 9/11, Latin America was the only region of the world that did not witness an attack by transnational terrorists linked to al-Qaeda, so there seemed to be little need to pursue counter-terrorist activity there. And, with the US continuing to be the world’s largest market for illegal drugs, its leaders’ focus on the drug war in Latin America does not appear misguided, at least not on the surface.


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That focus has not only made USSOUTHCOM a major recipient of federal funds, but has also turned it into something akin to an autonomous drug-fighting agency. From the region’s perspective, USSOUTHCOM appears to be a vaguelyindependentmilitary arm of US policymakers’ global anti-drug strategy, with scant accountability or congressional oversight, and with significant resources for aggressive anti-drug operations.


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Indeed, USSOUTHCOM has controlled 75% of the more than $12 billion that the US government has allocated to anti-drug activities in Latin America and the Caribbean since 2000. But, despite this expensive military campaign, all evidence shows that the “war on drugs” has been a fiasco.


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The failure has been dramatic. In Mexico, roughly 48,000 people have been killed in drug-related violence since Felipe Calderón was elected President in 2006. And Mexico is not alone. Drug-trafficking activities have grown significantly throughout Central America and the Caribbean, fueling an unprecedented increase in the murder rate – which has doubled in countries like Guatemala and Jamaica – over the last decade.


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Moreover, the cultivation, processing, and trafficking of cocaine and heroin continues throughout the Andean Ridge, despite tough eradication measures and extradition of traffickers by the US. Simultaneously, new transshipment routes (via Ecuador in the Pacific and Venezuela in the Atlantic) have developed, while drug barons, coca growers, and warlords have proliferated.


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South America’s southern cone – especially Argentina and Chile – has not been immune to the vast expansion of organized crime, money laundering, and demand for narcotics elsewhere in the region. And, throughout Latin America, the situation has only worsened since the 1990’s. Indeed, Latin American countries’ US-backed fight against drugs has had universally destructive consequences in terms of civil-military relations, human-rights violations, and corruption.


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The US cannot deny this disaster. Its drug warriors must reevaluate their position and terminate what has become an increasingly senseless and futile struggle. Thus, the most critical question facing Kelly as he assumes his new command is whether he can redefine USSOUTHCOM’s role in the fight against illegal drugs.


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The military and political challenges are significant, the risks are considerable, and the benefits are uncertain. But if USSOUTHCOM does not implement major changes in how it prosecutes the drug war, the US will find itself facing an increasingly volatile and dangerous set of neighbors to the south.
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Juan Gabriel Tokatlian is Professor of International Relations at the Universidad de Di Tella, Argentina.



. Copyright Project Syndicate - www.project-syndicate.org


April 12, 2012 7:16 pm

The bogus distinction between left and right


In the French presidential elections, François Hollande, the Socialist candidate, who advocates a 75 per cent marginal tax rate, is clearly on the left. But he has been threatened by an opponent further to the left: Jean-Luc Mélenchon, an ex-Trotskyite who has pledged to end globalisation and who trades on suspicions that Mr Hollande, like François Mitterrand before him, will renege on his commitments. Nicolas Sarkozy, the sitting president, often gives the impression that he will say anything to retain office. Nevertheless, he can without abuse of language be described as to the right of these particular contenders.



Clearly there is a range of issues – and personalities – that it still makes sense to describe in left-versus-right terms. But there are many for which it does not. Is an interventionist foreign policy in the spirit of the late US Democrat senator Henry Jackson, designed to promote so-called democracy abroad, a leftwing or rightwing attitude? And what is one to say of Richard Cobden, the great English Liberal statesman, who wrote in 1847, “how much unnecessary solicitude and alarm England devotes to the affairs of foreign countries; with how little knowledge we enter upon the task of regulating the concerns of other people; and how much better we might employ our energies in improving matters at home”?

 

In some sense, both these men were centre-left. But such a classification covers huge differences more important to human welfare than the conventional left-right arguments on economic matters. I would instinctively prefer David Miliband to his brother Ed as leader of the UK Labour opposition; but my doubt is that he might be nearer to Jackson than to Cobden.




I once wrote a book entitled "Left or Right, the Bogus Dilemma", which was quite widely discussed but not much read. I remarked that the left-right distinction had its origins in the seating of the French States-General after the 1789 Revolution, when the nobility took the place of honour on the king’s right, while the ordinary members of the “third estate sat on the king’s left. The issues had nothing to do with the embryonic capitalism of the period. In the 19th century the French left were above all else republicans and became closely identified with anti-clericalism and later with opposition to the anti-Semitism that came to the fore in the Dreyfus affair. As a result of such events, the highly bourgeois Parti Radical Socialiste insisted it was on the left until the eve of the second world war.

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In the UK’s 1923 general election, which brought the first Labour government to office, the main issue was the defence of free trade, on which Labour sided with the Liberals. The association of the left with personal and political freedom, antimilitarism, religious tolerance and general civilised values helps explain why as late as the 1940s and 1950s there were merchant bankers in London and Paris who did not regard themselves as on the right.
However, the enthusiasm with which socialist parties in 1914 voted for their governments’ war budgets – or later when the “socialistgovernment of Guy Mollet fought to retain French Algeria suggests a good deal of wishful thinking.



The usual argument against the spectrum concept is that it put Hitler and Stalin at the right and left extremes, when in fact they had far more in common than either had with middle-of-the-road politicians. My main contention remains that the concept of a left-right spectrum, on which any politically interested person can be placed, obscures more than it illuminates. It muffles important issues and erects barriers between those who should be allies.



To take a topical example, it is mostly politicians on the far left or far right who think the eurozone detrimental to the welfare of its inhabitants and want to dismantle it. Does their political designation make them wrong? And to come to more domestic matters: I suppose that Keynesian opposition to UK prime minister David Cameron’s commitment to eliminate the Budget deficit counts as centre or slightly left of centre. But it is far more radical than the knee-jerk Labour concentration on distributional issues.

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Today the left is best defined by instinctive hostility to capitalism and a hatred of “inequality” (coupled with a peculiar penchant for subsidised manufacturing). It makes all the difference in the world, however, whether this hatred is motivated by a desire to raise living standards for the less well-off, or by envy of those at the top. In many ways left and right are just two tribes. The left, at least until the emergence of Vladimir Putin, had a soft spot for Russia and the right for China.



And I dare not discuss the left’s present hatred of Israel and the alliances of convenience sometimes made with Islamic extremists.



Nevertheless, I become infuriated when those who take a more laisser faire attitude to these questions are described as “to the right of Genghis Khan”. And my main grouse against the USRepublican right” is that it gives competitive capitalism a bad name by associating it with religious intolerance, a chauvinistic foreign policy and a punitive tendency.

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Copyright The Financial Times Limited 2012.