The Heart of the US Election
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Raghuram Rajan
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07 September 2012
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CHICAGOA real debate is emerging in America’s presidential election campaign. It is superficially about health care and taxes. More fundamentally, it is about democracy and free enterprise.

 
 
 
 
Democracy and free enterprise appear to be mutually reinforcing – it is hard to think of any flourishing democracy that is not a market economy. Moreover, while a number of nominally socialist economies have embraced free enterprise (or “socialism with Chinese characteristics,” as the Chinese Communist Party would say), it seems to be only a matter of time before they are forced to become more democratic.
 
 
 
Yet it is not clear a priori why democracy and free enterprise should be mutually supportive. After all, democracy implies regarding individuals as equal and treating them as such, with every adult getting an equal vote, whereas free enterprise empowers individuals based on how much economic value they create and how much property they own.
 
 
 
 
What prevents the median voter in a democracy from voting to dispossess the rich and successful? And why do the latter not erode the political power of the former? Echoes of such a tension are playing out as President Barack Obama tries to tap into middle-class anger, while former Massachusetts governor Mitt Romney appeals to disgruntled businesspeople.
 
 
 
 
One reason that the median voter rationally agrees to protect the property of the rich may be that she sees the rich as more efficient managers of that property. So, to the extent that the rich are self-made, and have come out winners in a fair, competitive, and transparent market, society may be better off allowing them to own and manage their wealth, while getting a reasonable share as taxes. The more, however, that the rich are seen as idle or crooked – as having simply inherited or, worse, gained their wealth nefariously – the more the median voter should be willing to vote for tough regulations and punitive taxes on them.
 
 
 
In today’s Russia, for example, property rights do not enjoy widespread popular support, because so many of the country’s fabulously wealthy oligarchs are seen as having acquired their wealth through dubious means. They grew rich because they managed the system, not because they managed their businesses well. When the government goes after a rich oil tycoon like Mikhail Khodorkovsky, few voices are raised in protest.


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And, as the rich kowtow to the authorities to protect their wealth, a strong check on official arbitrariness disappears. Government is free to become more autocratic.
 
 
 
 
Now consider a competitive free-enterprise system with a level playing field for all. Such a system generally tends to permit the most efficient to acquire wealth. The fairness of the competition improves perceptions of legitimacy.
 

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Moreover, under conditions of fair competition, the process of creative destruction tends to pull down badly managed inherited wealth, replacing it with new and dynamic wealth. Great inequality, built up over generations, does not become a source of great popular resentment.


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On the contrary, everyone can dream that they, too, will become rich.
 
 
 
When such aspirations seem plausible, the system gains added democratic support. The rich, confident of popular legitimacy, can then use the independence that accompanies wealth to limit arbitrary government and protect democracy. Free enterprise and democracy sustain each other.


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There is a popular belief that democratic systems support property and enterprise because votes and legislators can be bought, and the capitalists have the money. But that view is probably wrong. As Russia suggests, without popular support, wealth is protected only by increasingly coercive measures. Ultimately, such a system loses any vestige of either democracy or free enterprise.


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Back, then, to America’s presidential election. The recent crisis, followed by huge bailouts of financial institutions, has raised questions about how at least one segment of business – the bankers make their money. As the misdeeds of “banksterscome to light, the system no longer seems fair.
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Moreover, the American Dream seems to be slipping out of reach, in part because a good education, which seems to be the passport to prosperity, is increasingly unaffordable for many in the middle class. This erodes support for the free-enterprise system.

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Obama understands this, which explains his appeal to, and focus on, the middle class. He is the standard bearer for democracy.



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On the other hand, successful professionals and entrepreneurs believe that they have come by their wealth legitimately. They are the working rich, and dislike the growing burden of regulations and the prospect of higher taxes.


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They feel like they are being blamed for their success, and they resent it. Romney understands that America’s strength relies heavily on free enterprise.


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Ordinarily, there would be no contest here. The weight of votes in the middle class would carry the day. The middle class, however, is divided: some want to protect whatever entitlements and property they already have, while others want the government to give them a fairer chance. Moreover, the Supreme Court’s Citizens United decision in 2010, which allows unlimited independent political expenditure by organizations like corporations or unions, has helped Romney more than Obama.


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Whatever the outcome of the election, the tension between democracy and free enterprise that is central to it does not bode well for either. A free-enterprise system that is sustained only by the moneyed power of the successful is not stable, and unlikely to remain vibrant for long.


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The United States needs to restore the possibility of achieving the American Dream for its middle class, even while it reaffirms the historically light regulation and relatively low tax burden that have allowed enterprise to flourish. The virtue of democracy is that debate may lead to just such a consensus. We can only hope.



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Raghuram Rajan is Professor of Finance at the University of Chicago Booth School of Business. He previously served as the International Monetary Fund’s youngest-ever chief economist, and was Chairman of India’s Committee on Financial Sector Reforms. He is the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.



Up and Down Wall Street

SATURDAY, SEPTEMBER 8, 2012

Mario's Magic Put

By ALAN ABELSON

Weak economic data offsets the works of central bankers.

 

Have you heard the one about the old country preacher who had a teenage son he felt should begin to think seriously about choosing a profession? Well, if you haven't heard it, you're about to, thanks to Edward McDermott, a reader whose humorous snippets we've shared with you from time to time.


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The preacher decided that while his son was at school he'd try to get an inkling of which way the boy was leaning by slipping into his room and placing on a table four objects: a Bible, a silver dollar, a bottle of whiskey, and a copy of Playboy. The idea being that he'd hide behind the door of the boy's bedroom when his son came home from school and furtively watch to see which object the lad would pick up.




If it's the Bible, he reasoned, the kid was going to be a preacher like me and what a blessing that would be! If he picked up the silver dollar, the preacher thought, he's going to be a businessman and that'd be fine, too. If he picks up the bottle, the preacher flushed, he's going to be a no-good drunken bum. And -- just to think about it made the preacher shiver with foreboding -- if the boy picks up that magazine, he's going to be a skirt-chasing womanizer.




When his son got home, he casually walked into his room and dropped his books on the bed. Then, he spotted the four objects on his bedside table and studied them a moment or two. He picked up the Bible and placed it under this arm. He picked up the silver dollar and dropped it into his pocket. He uncorked the bottle and took a large swallow, while he gazed admiringly at the magazine's centerfold.


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"Lord have mercy," the old preacher fumed, "he's gonna run for Congress."




In like vein, another reader, John Hayden, a manifestly bright M.D. with a memory to match, reminded us of a reference in our March 1, 2010, column to Thomas Brackett Reed, a native of Maine who served many years as speaker of the House of Representatives in the late 19th century. Possessed of a sharp tongue and a dry humor, Reed famously remarked that any number of his fellow congressmen never "opened their mouths without subtracting from the sum of human knowledge."



We plead guilty of attempting to offer via the agency of our readers a bit of comic relief in an increasingly acidulous election venue. The campaigns being waged by the two parties more and more resemble a tag-team mud-wrestling match, rather than the grunting, groaning, and grappling that usually define political combat in our great nation. Now, don't get us wrong. We enjoy the swipes and swats and the elbows in the gut that are de rigueur in election clashes as much as the next man. But when everyone's going for the jugular 24/7, it becomes literally bloody boring.




Last week was the Dems' turn to strut their stuff, and a visitor from Mars tuning in their convention could be forgiven for thinking that the hoots and hollers from the assembled delegates touched off by his speech were celebrating Bill Clinton's nomination, rather than Barack Obama's. Bill showed he can still turn on that ol' Southern charm that seduced the populace but also darn near got him booted out of the presidency.




That even after a widely publicized scandal, his popularity rating towers above that of either the present occupant of the White House or Mitt Romney can be viewed as proof that this is, indeed, a forgiving nation. Or, perhaps Americans, for better or worse, have a high tolerance for testosterone-driven misbehavior.



More than likely, though -- and forgive us this uncharitable notion -- we suspect it tells you something about the ineptitude of Bill Clinton's successors. In any event, the preliminaries are over and the main event has begun. The applicable cliché, we guess, is may the best man win. But whoever coined that grammatically dubious but enduring phrase never imagined that determining who the best man is would be more chore than choice.



NO SOONER DID OBAMA & CO. wind up the noisy proceedings in Charlotte, N.C., and the delegates head for home abuzz with high hopes instilled by the serial speechifying than fortune dealt them a sobering hand: The August employment report, which showed a not-so-grand total of 96,000 new jobs added to nonfarm payrolls last month.




The tally proved a downer pretty much through and through and was all the more disappointing because recent weeks saw a dip in new claims for unemployment insurance and ADP had somehow conjured up a 200,000-plus increase in their survey of last month's private payrolls. As Gluskin Sheff's Dave Rosenberg quipped, "The ADP survey once again lived up to its reputation as being a reliable head-faker."



Street guesstimates had looked for gains of 120,000-140,000, when the Bureau of Labor Statistics issued Friday morning's report. The miss was even more egregious when you realize that the total includes a good chunk of the supposed 87,000 new jobs generously added by the birth/death computer model. Virtually the sole piece of ostensibly good news was the drop in the unemployment rate to 8.1% from July's 8.3%.



But as Philippa Dunne and Doug Henwood of the Liscio Report point out, that decline in no small way reflects the ugly shrinkage in the labor force. Our data-savvy pair note that there are now some seven million poor souls, or 2.9% of the population, who are not in the labor pool but want a job, a new high for the current cycle.


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They say that the diffusion indexes, which tell how encompassing or restricted is the reach of the gains, if anything were worse than the headline figures. The one-month measure fell nearly four points to a fresh nadir since the employment trough of February 2010.




Last month's work week was flat, and so were average hourly earnings. The yearly gain in hourly earnings of 1.7%, they sigh, is less than half the rate of early 2009. They report we're still 4.7 million jobs below the pre-recession peak and the Liscio pair reckon at current rates of growth, it'll take four years to regain those levels -- and that's not allowing for population growth.



Citing the weak forward indicators like the dip in temp hiring, Doug and Philippa suggest you brace yourself for further tepid vibes from the jobs front.


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NOT SURPRISINGLY, the dreary job numbers took a little of the gloss off the boomer of a rally that sent the markets bounding ahead on Thursday, fired up by the European Central Bank's ambitious plan to pump some life into the ailing euro-zone economy, keep the European Union from fracturing irrevocably, and prevent countries like Italy and Spain from permanent residency on the critical list.



The plan is the handiwork of Mario Draghi, the relatively new head of the ECB and it, temporarily at least, revived not only European bourses but global ones as well, on hopes Mario's inclination to ease would prove contagious when the Fed's Open Market Committee gathers this week. And indeed, although the Dow wavered after the bum employment report, advances outweighed declines by a healthy margin.


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Well to keep in mind before you take the plunge is that a blueprint is not the same as a done deal and the history of rescue efforts by the powers that be in the euro zone have been exercises in futility. We fervently trust this is not yet more of the same. But under the most benign circumstances, Mario's proposals face some tough hurdles and will take months if not longer to put into play.



Another reason to make haste slowly before being swept up by the magnetic pull of a bullish surge is, as Dave Rosenbeg cautions, investors have come under the spell of central-bank magic -- where good news is good news and bad news is good news. This, he contends, is the new normal -- less than salutary turns in the economy will be met by more expansionary balance-sheet activity by the monetary authorities.


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In the current environment, he grumbles, "weak economic data are no match for the Bernanke (or Draghi) put."


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Dave, too, feels the employment report was devoid of any significant rewarding features and gives it a grade of D+. As to where we go from here, he also avers the forward-looking components in it, along with the Institute for Supply Management data released earlier last week, notably the sagging order/inventory ratio, foreshadows more jobs-market weakness. He cites the decline in the factory work week and the 41,000 downward revision in the payroll count for June and July, which, he exclaims, tend to be momentum drivers for future data releases.


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If you think Dave is being too harshly negative in his assessment of the employment report, he asks that you "bear in mind that in the month of August, more people went on the food-stamp program (173,000) than those who managed to find a new job (96,000)." This, he goes on to say, "can scarcely be called a real recovery."


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On that score, he asserts, last month's meager additions were about half the number typical of an economy heading into its fourth year of expansion.

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Did we neglect to mention Dave's a dyed-in-the wool skeptic?


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Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved



Brinkmanship as Spain warns over bail-out terms
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Spain has issued a veiled warning that it will not accept a full bail-out from Europe if the terms are too harsh, a move that would paralyse the European Central Bank and call the euro’s survival into question.
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By Ambrose Evans-Pritchard
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9:14PM BST 04 Sep 2012

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Mr de Guindos said the crisis engulfing the region is larger than any one country and warned north Europe not to scapegoat Spain. Photo: AP




In an escalating game of brinkmanship, Spanish finance minister Luis de Guindos said his country is not yet willing to sign a Memorandum giving up fiscal sovereignty to EU inspectors. First of all, one must clarify the conditions,” he told German newspaper Handelsblatt.


 
Mr de Guindos said the crisis engulfing the region is larger than any one country and warned north Europe not to scapegoat Spain.


 
“My colleagues are aware that the battle for the euro will be fought in Spain. Spain is right now the breakwater for the eurozone,” he said, adding that “solidarity” would be well-advised.


 
The warning comes as German Chancellor Angela Merkel leaves for Madrid for talks with premier Mariano Rajoy to thrash out the conditions of a full sovereign rescue of up €300bn (£238bn), beyond the €100bn bank rescue already agreed.


 
The ECB’s executive board met today to prepare crisis proposals for the governing council’s meeting on Thursday, including a “yield band” to lower borrowing costs for Spain and Italy.
The ECB has tied its hands under an implicit deal with Germany, announcing that it cannot proceed until Spain and Italy request help from the eurozone’s bail-out funds and submit to tough conditions.
Germany now seems fully behind the bond plan of ECB chief Mario Draghi. Jorg Asmussen, Germany’s ECB board member, said today that bond purchases are necessary to save the euro and, therefore, within the bank’s mandate.



“The risk premia of sovereign bonds now reflect not just the insolvency risk of some countries but an exchange rate risk, which should not theoretically exist in a currency union. The markets are pricing in a break-up of the eurozone. Such systemic doubts are not acceptable,” he said.




Two-year bold yields in Spain plummeted by 44 basis points to 2.94pc and Italy’s fell to 2.29pc after Mr Draghi told MEPs that purchases may target debt of up to three years, longer than assumed.



Jacques Cailloux from Nomura says investors should be wary of the political minefield ahead. “We expect Spain and Italy to resist calling for help, promoting renewed market deterioration,” he said.


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There is little doubt that Spain will need a rescue as it struggles to raise €40bn over the next two months. The country’s finances are unravelling on every front, with internal rescues for Catalonia, Valencia, Murcia, and Andalucia fast depleting the €18bn fund set aside for the regions.



It emerged today that Spain’s social security system has raided a rainy-day fund to cover state pensions for the first time as deepening recession erodes contributions.


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Tomas Burgos, social security minister, said the government had drained €4.4bn from the Fondo de Prevencionfinanced from workers’ illness insurance – to  meet the shortfall in July, reducing the account to just €400m.



Mr Burgos said Madrid may have to useall mechanisms at our disposal” to meet payments, revealing that the next step may be a raid on the pension system’s €67bn Reserve Fund. The pension system has been losing contributors as unemployment soars to 25pc. It shed a further 137,000 jobs in August.



Meanwhile, official data shows that the toxic property loans of Spain’s four nationalised banks have reached €75bn and are rising faster than feared. Bankia’s “potentially problematic” loans are €42bn.



The biggest surprise is a 50pc surge in bad debts to €9bn at Cataluyna Caixa since January. Non-payments on mortgages have doubled.



Nomura’s Jens Nordvig said Spain’s crisis has entered a “more dangerous phase”, resembling the sort of currency dramas once confined to emerging markets.



Capital flight has been running at an annual rate of 50pc of GDP, more than twice the rate in Indonesia during the Asian meltdown in the 1990s.



Foreigners have sold Spanish securities worth 19pc of GDP over the past quarter. Spanish residents have shipped funds worth 16.7pc of GDP into foreign bank accounts.


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Net claims on Spain through the ECB’s Target 2 payments system have reached 39pc of GDP.
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“The build-up in central bank liabilities is explosive,” said Mr Nordvik.