May 15, 2012 7:46 pm

Era of a diminished superpower


What will be the role of the US in the 21st century? This is a question I rashly agreed to address last week at the Carnegie Council in New York. In analysing it, I considered a closely related issue that also exercises Americans: is the future role of the US in its own hands? The answer is: yes, but only up to a point. The US can control what it does. But it cannot control what others do.




The historic dominance of the US is the fruit of its exceptional assets. It is a continental power bounded by oceans to the east and west, and unthreatening neighbours to the north and south. It has huge, albeit dwindling, natural resources. It has had the world’s largest economy and the highest output per head since the late 19th century. The market-driven US economy has also been the world’s most innovative since at least the same era.
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The US is home to the world’s most influential financial markets, albeit ones that triggered the Great Depression and Great Recession of recent years. It has been the issuer of the world’s main reserve currency since the first world war. It has offered one of the largest import markets, surpassed only by external imports of the EU.



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The US possesses the world’s most technologically advanced and potent military. Since the second world war, it has also had more of the world’s leading universities and research institutions than any other country. It has the world’s most potent popular culture. Its political values still grip the world’s imagination, even if it has frequently fallen short in practice. Its democratic system has proved sufficiently legitimate and flexible to cope with the many challenges history has thrown up.


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Possessed of all these assets, the US managed to form strong alliances and to win its 20th-century wars, both hot and cold, against Germany, Japan and Russia. It shaped the open world economy, which was born after the second world war then became global after the collapse of the Soviet empire. It has offered the world’s most influential model of modernity. Whether we like it or not, we all live in the world it has made.


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How much of this array of assets will the US retain in this century?



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The obvious threat is to its position as the world’s largest economy. At market exchange rates, its economy is still roughly twice the size of China’s. Yet, according to the International Monetary Fund, it is only 30 per cent larger, at purchasing power parity. Since China’s gross domestic product per head, at PPP, is still only 20 per cent of US levels, this leaves huge room for it to catch up. China’s growth is likely to slow in coming decades but it should still converge further on US productivity levels. The likelihood is that China will have a bigger economy than the US by the early 2020s. Unlike, say, Japan, China has the numbers on its side. If its GDP per head were to reach half of US levels, its economy would be as big as those of the US and EU together.


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China’s gross exports of merchandise products already exceed those of the US. Its imports will soon do the same. Being a relatively resource-poor country, China is likely to remain a bigger trader, relative to GDP, than the US. A more controversial question is how soon the renminbi will rival the dollar as a reserve currency. The rise of China’s trade suggests the answer is: soon. Against this, I would argue that China’s party-state, not being subject to the rule of law and fearing loss of control, will be neither able nor willing to provide the open capital markets that outsiders want if they are to hold their safest assets in renminbi. At least, this shift is likely to take decades, not years.




In principle, the US could also maintain its frontier position in science and commercial innovation. But, as my colleague Edward Luce shows in his thought-provoking new book, the combination of xenophobia with hostility to science, self-inflicted fiscal constraints and weird spending priorities risks robbing the US of its access to the world’s talent and its commitment to world-leading research and innovation.* Nothing captures the point better than this grim quote: “In 1990, [California] spent twice as much on its universities as its prisons. Now it spends almost twice as much on prisons.” That the US has the highest rate of incarceration in the world is not only a social statistic; it is also an economic one. The same is true of the costliness and inefficiency of the US healthcare system, which is the principal reason why long-term fiscal prospects look so grim.



What is needed is serious reform. But this has become impossible, because of the exploding role of money in politics and the rising intransigence of the Republican party. In a system built on divided government, regarding compromise as weakness risks repeated chaos.


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The US economy is also no longer bringing the widely shared benefits it once did. In the last full business cycle, between 2002 and 2007, the top 1 per cent captured almost two-thirds of the rise in incomes, while the top 0.1 per cent captured more than a third. Such a zero sum economy breeds disaffection and despair. The crisis has made the anger far worse.


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All of this will also affect America’s ability to play its historic role in the world. The looming fiscal squeeze will undermine military spending. More important, the financial crisis and other large mistakes have robbed the US political, economic and social models of the prestige they enjoyed. Europe is in no better shape. But that merely means the west as a whole is less credible and so far less able to serve as leader.



Whatever happens inside the US, its influence will be smaller in the 21st century than it was in the 20th. This is largely because others have learnt so much from it. Even so, the US could retain huge, possibly unrivalled, influence, since its main rivals face even bigger challenges. Yet if the US is to be what it can be, it has to rediscover the pragmatism that long marked its policy making, notably in its responses to the many challenges of the 20th century. No democracy can thrive if its citizens view their own government as their greatest enemy. If Americans choose to make their government fail, the US is sure to do so, too.


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*Time to Start Thinking, Atlantic Monthly Press 2012.


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Copyright The Financial Times Limited 2012.



Accidentally Released - and Incredibly Embarrassing - Documents Show How Goldman et al Engaged in 'Naked Short Selling'
.Taibblog
.by: Matt Taibbi
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May 15, 5:39 PM ET




It doesn’t happen often, but sometimes God smiles on us. Last week, he smiled on investigative reporters everywhere, when the lawyers for Goldman Sachs slipped on one whopper of a legal banana peel, inadvertently delivering some of the bank’s darker secrets into the hands of the public.



The lawyers for Goldman and Bank of America/Merrill Lynch have been involved in a legal battle for some timeprimarily with the retail giant Overstock.com, but also with Rolling Stone, the Economist, Bloomberg, and the New York Times. The banks have been fighting us to keep sealed certain documents that surfaced in the discovery process of an ultimately unsuccessful lawsuit filed by Overstock against the banks.



Last week, in response to an Overstock.com motion to unseal certain documents, the banks’ lawyers, apparently accidentally, filed an unredacted version of Overstock’s motion as an exhibit in their declaration of opposition to that motion. In doing so, they inadvertently entered into the public record a sort of greatest-hits selection of the very material they’ve been fighting for years to keep sealed.



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I contacted Morgan Lewis, the firm that represents Goldman in this matter, earlier today, but they haven’t commented as of yet. I wonder if the poor lawyer who FUBARred this thing has already had his organs harvested; his panic is almost palpable in the air. It is both terrible and hilarious to contemplate. The bank has spent a fortune in legal fees trying to keep this material out of the public eye, and here one of their own lawyers goes and dumps it out on the street.





The lawsuit between Overstock and the banks concerned a phenomenon called naked short-selling, a kind of high-finance counterfeiting that, especially prior to the introduction of new regulations in 2008, short-sellers could use to artificially depress the value of the stocks they’ve bet against. The subject of naked short-selling is a) highly technical, and b) very controversial on Wall Street, with many pundits in the financial press for years treating the phenomenon as the stuff of myths and conspiracy theories.


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Now, however, through the magic of this unredacted document, the public will be able to see for itself what the banks’ attitudes are not just toward the “mythicalpractice of naked short selling (hint: they volubly confess to the activity, in writing), but toward regulations and laws in general. Fuck the compliance areaprocedures, schmecedures,” chirps Peter Melz, former president of Merrill Lynch Professional Clearing Corp. (a.k.a. Merrill Pro), when a subordinate worries about the company failing to comply with the rules governing short sales.



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We also find out here how Wall Street professionals manipulated public opinion by buying off and/or intimidating experts in their respective fields. In one email made public in this document, a lobbyist for SIFMA, the Securities Industry and Financial Markets Association, tells a Goldman executive how to engage an expert who otherwise would go work for “our more powerful enemies,” i.e. would work with Overstock on the company’s lawsuit.


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“He should be someone we can work with, especially if he sees that cooperation results in resources, both data and funding,” the lobbyist writes, “while resistance results in isolation.”


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There are even more troubling passages, some of which should raise a few eyebrows, in light of former Goldman executive Greg Smith's recent public resignation, in which he complained that the firm routinely screwed its own clients and denigrated them (by calling them "Muppets," among other things).



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Here, the plaintiff’s motion refers to an “exhibit 96,” which refers to “an email from [Goldman executive] John Masterson that sends nonpublic data concerning customer short positions in Overstock and four other hard-to-borrow stocks to Maverick Capital, a large hedge fund that sells stocks short.”


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Was Goldman really disclosingnonpublic data concerning customer short positions” to its big hedge fund clients? That would be something its smaller, “Muppetcustomers would probably want to hear about.


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When I contacted Goldman and asked if it was true that Masterson had shared nonpublic customer information with a big hedge fund client, their spokesperson Michael Duvally offered this explanation:

Among other services it provides, Securities Lending at Goldman provides market color information to clients regarding various activity in the securities lending marketplace on a security specific or sector specific basis. In accordance with the group's guidelines concerning the provision of market color, Mr. Masterson provided a client with certain aggregate information regarding short balances in certain securities. The information did not contain reference to any particular clients' short positions.

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You can draw your own conclusions from that answer, but it's safe to say we'd like to hear more about these practices.

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Anyway, the document is full of other interesting disclosures. Among the more compelling is the specter of executives from numerous companies admitting openly to engaging in naked short selling, a practice that, again, was often dismissed as mythical or unimportant.


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A quick primer on what naked short selling is. First of all, short selling, which is a completely legal and even beneficial activity, is when an investor bets that the value of a stock will decline. You do this by first borrowing and then selling the stock at its current price, then returning the stock to your original lender after the price has gone down. You then earn a profit on the difference between the original price and the new, lower price.


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What matters here is the technical issue of how you borrow the stock. Typically, if you’re a hedge fund and you want to short a company, you go to some big-shot investment bank like Goldman or Morgan Stanley and place the order. They then go out into the world, find the shares of the stock you want to short, borrow them for you, then physically settle the trade later.


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But sometimes it’s not easy to find those shares to borrow. Sometimes the shares are controlled by investors who might have no interest in lending them out. Sometimes there’s such scarcity of borrowable shares that banks/brokers like Goldman have to pay a fee just to borrow the stock.


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These hard-to-borrow stocks, stocks that cost money to borrow, are called negative rebate stocks. In some cases, these negative rebate stocks cost so much just to borrow that a short-seller would need to see a real price drop of 35 percent in the stock just to break even. So how do you short a stock when you can’t find shares to borrow? Well, one solution is, you don’t even bother to borrow them. And then, when the trade is done, you don’t bother to deliver them. You just do the trade anyway without physically locating the stock.


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Thus in this document we have another former Merrill Pro president, Thomas Tranfaglia, saying in a 2005 email: “We are NOT borrowing negatives. I have made that clear from the beginning. Why would we want to borrow them? We want to fail them.”


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Trafaglia, in other words, didn’t want to bother paying the high cost of borrowingnegative rebate stocks. Instead, he preferred to just sell stock he didn’t actually possess. That is what is meant by, “We want to fail them.” Trafaglia was talking about creatingfails” or “failed trades,” which is what happens when you don’t actually locate and borrow the stock within the time the law allows for trades to be settled.


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If this sounds complicated, just focus on this: naked short selling, in essence, is selling stock you do not have. If you don’t have to actually locate and borrow stock before you short it, you’re creating an artificial supply of stock shares.


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In this case, that resulted in absurdities like the following disclosure in this document, in which a Goldman executive admits in a 2006 email that just a little bit too much trading in Overstock was going on: “Two months ago 107% of the floating was short!”


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In other words, 107% of all Overstock shares available for trade were short – a physical impossibility, unless someone was somehow creating artificial supply in the stock.


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Goldman clearly knew there was a discrepancy between what it was telling regulators, and what it was actually doing. “We have to be careful not to link locates to fails [because] we have told the regulators we can’t,” one executive is quoted as saying, in the document.


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One of the companies Goldman used to facilitate these trades was called SBA Trading, whose chief, Scott Arenstein, was fined $3.6 million in 2007 by the former American Stock Exchange for naked short selling.


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The process of how banks circumvented federal clearing regulations is highly technical and incredibly difficult to follow. These companies were using obscure loopholes in regulations that allowed them to short companies by trading in shadows, or echoes, of real shares in their stock. They manipulated rules to avoid having to disclose these “failedtrades to regulators.



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How they did this is ingenious, elaborate, and complex, and we’ll get into it more at a later date. In the meantime, this document all by itself shows numerous executives from companies like Goldman Sachs Execution and Clearing (GSEC) and Merrill Pro talking about a conscious strategy of “failing trades – in other words, not bothering to locate, borrow, and deliver stock within the time alotted for legal settlement. For instance, in one email, GSEC tells a client, Wolverine Trading, “We will let you fail.”


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More damning is an email from a Goldman Sachs hedge fund client, who remarked that when wanting to “short an impossible name and fully expecting not to receive it” he would then beshocked to learn that [Goldman’s representative] could get it for us.”




Meaning: when an experienced hedge funder wanted to trade a very hard-to-find stock, he was continually surprised to find that Goldman, magically, could locate the stock. Obviously, it is not hard to locate a stock if you’re just saying you located it, without really doing it.


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As a hilarious side-note: when I contacted Goldman about this story, they couldn't resist using their usual P.R. playbook. In this case, Goldman hastened to point out that Overstock lost this lawsuit (it was dismissed because of a jurisdictional issue), and then had this to say about Overstock:
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Overstock pursued the lawsuit as part of its longstanding self-described "Jihad" designed to distract attention from its own failure to meet its projected growth and profitability goals and the resulting sharp drop in its stock price during the 2005-2006 period.

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Good old Goldman -- they can't answer any criticism without describing their critics as losers, conspiracy theorists, or, most frequently, both.


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Anyway, this galactic screwup by usually-slick banker lawyers gives us a rare peek into the internal mindset of these companies, and their attitude toward regulations, the markets, even their own clients. The fact that they wanted to keep all of this information sealed is not surprising, since it’s incredibly embarrassing stuff, if you understand the context.


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More to come: until then, here’s the motion, and pay particular attention to pages 14-19.



America’s G-Zero Moment

Ian Bremmer

15 May 2012
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NEW YORKThe 2008 financial crisis marked the end of the global order as we knew it. In advance of the upcoming G-8 summit, it is impossible to overlook the fact that, for the first time in seven decades, the United States cannot drive the international agenda or provide global leadership on all of today’s most pressing problems.


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Indeed, the US has trimmed its presence abroad by refusing to contribute to a eurozone bailout, intervene in Syria, or use force to contain Iran’s nuclear breakout (despite strong Israeli support).


.President Barack Obama officially ended the war in Iraq, and is withdrawing US troops from Afghanistan at a pace constrained only by the need to save face. America is handing off the leadership baton – even if no other country or group of countries is willing or able to grasp it.


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In short, US foreign policy may be as active as ever, but it is downsizing and becoming more exacting about its priorities. As a result, many global challengesclimate change, trade, resource scarcity, international security, cyber-warfare, and nuclear proliferation, to name a few – are bound to loom larger.


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Welcome to the G-Zero world, a more turbulent, uncertain environment in which coordination on global policy issues falls by the wayside. Paradoxically, this new environment, though daunting, is less troublesome for the US; in fact, it provides fresh opportunities for the US to capitalize on its unique position. The G-Zero world is not all bad for the USif it plays its cards right.

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Many residual strengths take on greater importance in such a world, and America remains the world’s only true superpower and its largest economy still more than twice the size of China’s. Its defense expenditures represent nearly half the world total, and exceed those of the next 17 countries combined.



The dollar remains the world’s reserve currency, and investors’ scramble into US government debt at every peak in the crisis since 2008 has underscored America’s safe-haven status (even in crises that America caused).



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Likewise, the US continues to lead in entrepreneurship, research and development, higher education, and technological innovation. Moreover, it is now the world’s largest natural-gas producer and calorie exporter, which has reduced its vulnerability to price shocks or food shortages.



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No country rivals America’s promotion of the rule of law, liberal democracy, transparency, and free enterprise. While other countries certainly support these values, only the US has been willing, healthy, and big enough to ensure that they prevail. So, as America curtails its global leadership, it will find itself in more demand.


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Consider Asia, for example. As China’s economic importance and regional influence grows, its neighbors are seeking to deepen ties with the US. Japan, Australia, Indonesia, and Taiwan have all recently closed trade and security-related deals with the US. Even Burma has gotten on board, resuming diplomatic engagement with the US while trying to work its way out of China’s shadow.


In other words, in a G-Zero world, an increasingly aggressive global environment makes the US all the more appealing to countries seeking to hedge their bets. As a result, the US has an opportunity to act more precisely in its own interests. Supplying less leadership allows the US to weigh opportunity costs before taking action, and to select the issues and circumstances that suit it the best. In this environment, military intervention in Libya does not necessitate the same in Syria.

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The extent to which the US will capitalize on these opportunities remains to be seen. In fact, America’s short-term advantages pose the biggest obstacle to its long-term outlook. Call this the “safe-haven curse”: as long as the US remains the safest port in any storm, it faces no immediate pressure to address its weaknesses.


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For example, for all of the hand-wringing about America’s national debt, investors will continue to loan the US money. Over the long term, however, US policymakers must make steady progress in restoring confidence in the nation’s fiscal health by cutting politically sacred programs like social security, Medicare, and defense. Officials will have to put aside short-term motives and party orthodoxy to bolster America’s aging infrastructure, reform its education and immigration systems, and pursue long-term fiscal consolidation.


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America’s advantages in the G-Zero world afford it the chance to invest in the future. But, by cushioning against sufficiently calamitous risks, the same advantages allow the US to procrastinate.


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American politicians need to recognize the new G-Zero reality and rebuild America’s domestic sources of strength, even if only incrementally. If they do, the US will have the vigor and flexibility to shape the next world order.

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America’s political system usually works well in crises. But, thanks to its residual advantages in a leaderless world, the US need not rely on a crisis to precipitate action. It need only seize the G-Zero moment.



Ian Bremmer is President of Eurasia Group and author of Every Nation for Itself: Winners and Losers in a G-Zero World.

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Copyright Project Syndicate - www.project-syndicate.org