The New Middle East’s New Problems

Joschka Fischer

02 December 2012
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BERLINWhen hostilities flared in Gaza last month, it seemed like the same old story was repeating itself. The world again witnessed a bloody and senseless surge of violence between Israel and Hamas, in which the main victims were innocent civilians maimed and killed on both sides.
 
 
 
 
 
This time, however, things were not what they seemed, because the Middle East has undergone a significant change in the past two years. The political epicenter of this troubled region has shifted from the conflict between Israel and the Palestinians toward the Persian Gulf and the struggle for regional mastery between Iran on one side and Saudi Arabia, Turkey, and now Egypt on the other. In the emerging struggle between the region’s Shia and Sunni powers, the old Middle East conflict has become a sideshow.
 
 
 
 
 
Today, the key confrontation in this power struggle is Syria’s civil war, where all of the region’s major players are represented either directly or indirectly, because that is where the battle for regional hegemony will largely be decided. This much is clear: Syrian President Bashar al-Assad and his Alawite/Shia power base will not be able to maintain control against the Sunni majority in the country and the region as a whole. The only question is when the regime will fall.
 
 
 
 
When it does, it will be a major defeat for Iran, not only entailing the loss of its main Arab ally, but also jeopardizing the position of its client, Hezbollah, in Lebanon. At the same time, a variant of the Muslim Brotherhood will come to power in Syria, as has been or will be the case almost everywhere in the Middle East as a result of the “Arab Awakening.”
 
 
 
 
From Israel’s viewpoint, the rise to power of Sunni political Islam throughout the region over the past two years will lead to an ambivalent outcome. While the weakening and rollback of Iran serves Israeli strategic interests, Israel will have to reckon with Sunni Islamist power everywhere in its vicinity, leading directly to a strengthening of Hamas.
 
 
 
 
The rise of the Muslim Brotherhood and its offshoots has come at the expense of secular Arab nationalism and the military dictatorships that supported it. Thus, the Brothers’ rise has de facto also decided the internal Palestinian power struggle. With the recent war in Gaza, the Palestinian national movement will align itself, under Hamas’s leadership, with this regional development. Palestinian Authority President Mahmoud Abbas and his Fatah party will be unable to offer much opposition all the more so in view of Hamas’s break with Iran (despite ongoing arms deliveries) a year ago.
 
 
 
 
This development most likely means the end of prospects for a two-state solution, because neither Israel nor Hamas and the Muslim Brotherhood has any interest in it. Hamas and the Brothers reject territorial compromise, because, for them, a Palestinian state means a Palestine that incorporates all of Israel.
 
 
 
 
This is by no means a tactical position or an expression of political naiveté. On the contrary, the territorial question has morphed into a religious one, and has thus fundamentally redefined the conflict.
 
 
 
 
 
Hamas is playing a long game. As long as it lacks the strength to achieve its more ambitious objectives, its intransigence in no way precludes negotiations with Israel or even peace treaties, as long as such agreements advance its long-term goals. But such agreements will produce only truces of shorter or longer duration, not a comprehensive settlement that ends the conflict.
 
 
 
 
 
The recent success of Abbas in the United Nations General Assemblysecuring observer-state status for Palestine – will not alter the basic aspects of this trend. Palestine’s promotion is an alarming diplomatic defeat for Israel and a demonstration of its growing international isolation, but it does not imply a return to a two-state solution.
 
 
 
 
Paradoxically, the position of Hamas fits the political right in Israel, because it, too, puts little stock in a two-state solution. And neither the Israeli left (of which little remains) nor Fatah is strong enough to maintain the two-state option. For Israel, a future as a bi-national state entails a high long-term risk, unless the option of a West Bank-Jordan confederation, lost in the 1980’s, is rediscovered. This is again a possibility.
 
 
 
 
Indeed, after the Assad regime falls, Jordan could prove to be the next crisis hotspot, which might revive the debate over Jordan as the “real Palestinian state. Israel’s settlement policy in the West Bank would then have a different foundation and take on new political significance. While I do not believe that a West Bank-Jordan confederation could ever be a viable option, it might be the last nail in the coffin of a two-state solution.
 
 
 
 
Along with Syria, two issues will determine this new Middle East’s future: Egypt’s path under the Muslim Brotherhood, and the outcome of confrontation with Iran over its nuclear program and regional role.
 
 
 
 
The Egyptian question is already high on the agenda; indeed, it spilled into the streets after President Mohamed Morsi’s non-violent coup attempt. Morsi’s timing was remarkable: the day after winning international acclaim for his successful efforts to broker a truce in Gaza, he staged a frontal assault on Egypt’s nascent democracy.
 
 
 
 
The question now is whether the Brothers will prevail, both in the streets and by means of Egypt’s new constitution (which they largely wrote). If they do, will the West withdraw its support for Egyptian democracy in the name of “stability”? It would be a bad mistake.
 
 
 
The question of what to do about Iran’s nuclear program will also return with a vengeance in January, after US President Barack Obama’s second inauguration and Israel’s general election, and will demand an answer within a few months.
 
 
 
 
The new Middle East bodes poorly for the coming year. But one thing has not changed: it is still the Middle East, where it is nearly impossible to know what might be waiting around the corner.




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Joschka Fischer was German Foreign Minister and Vice Chancellor from 1998-2005, a term marked by Germany's strong support for NATO’s intervention in Kosovo in 1999, followed by its opposition to the war in Iraq. Fischer entered electoral politics after participating in the anti-establishment protests of the 1960’s and 1970’s, and played a key role in founding Germany's Green Party, which he led for almost two decades.



December 4, 2012 7:20 pm
 
Beware membership of this elite club
 
Ingram Pinn©Ingram Pinn




A year ago, Brazil, Russia, India and China were the darlings of the world economy. Today, Brazil is barely growing, Russia is struggling and India and China are on course for their lowest growth in a decade. Although they are as different as they are similar, all four of the original Bric countries have contrived to stumble simultaneously. The lessons are that microeconomics can matter as much as macroeconomics – and that belonging to a prestigious economic club is hazardous.




The Brics, and emerging economies generally, deserve enormous credit for their macroeconomic management. In the 1970s and 1980s, one in two emerging and developing economies had double-digit inflation. Today, fewer than one in five do. As recently as the 1990s, the median emerging economy had public debt to gross domestic product of more than 65 per cent.





In the past two years, the median has been below 40 per cent. Add in bulging foreign exchange reserves, debt denominated in domestic currency rather than dollars and (with China the big exception) flexible exchange rates, and the hype surrounding emerging economies seems almost reasonable.
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Since the emerging market crises of 1997-2002, these strong macro foundations have delivered extraordinary performance. As the IMF noted in its October World Economic Outlook, the past decade witnessed the first time that emerging economies enjoyed longer expansions and shorter downturns than advanced economies. When the global financial crisis hit, emerging economies’ budget deficits were small so the fiscal counterattack could be forceful.




Inflation was quiescent so credit could be eased safely. In the 1990s, emerging economies that cut interest rates were punished with capital flight and currency collapse, triggering the bankruptcy of businesses with debts in dollars. This time, ample foreign exchange reserves offset capital flight and the shift away from dollar borrowing insured companies against depreciation.




That is the good news. But, as the rich world discovered in the wake of its ownGreat Moderation”, resilient growth encourages complacency. In the US, households borrowed too much and regulators grew indulgent. In Europe, this pattern was amplified by the “club effect” of euro membership.




Countries that had tightened their belts to meet the criteria for accession went soft once they were admitted. With cheap foreign capital buoying living standards, there was no will to fix microeconomic problems such as sclerotic labour markets.




The Brics are following a version of this playbook. Macroeconomic management remains credible. China, in particular, has dramatically cut export dependence without suffering a hard landing.




But macro success has bred micro complacency. Governments have permitted themselves to meddle destructively in markets. State companies have been allowed to stifle innovative competitors. The upshot is that the resilience of the Brics in the face of the 2008 financial shock has not been matched by resilience to an extended period of weak global demand.




Consider Brazil. It boasts moderate inflation, sober public finances and a partially flexible exchange rate. Its central bank has tried to revive growth by reducing its lending rate by 525 basis points over the past 16 months. But growth this year will come in at barely more than 1 per cent because a blizzard of micro meddling has damaged business confidence. Petrobras, the state oil company that accounts for a 10th of the economy, epitomises this malady. Despite the discovery in 2007 of lucrative offshore oil, it is losing money because of local content rules and irrational fixed prices.




The story is similar in Russia. The current account is in surplus, inflation is modest and the budget is in balance. But microeconomic policy is lousy. Corruption deters investors. State companies elbow out private ones. Plans to diversify the economy have been a failure. Instead of building manufacturing exports, Russia is exporting skilled workers.




In some ways India is the odd one out: it runs a chronic budget deficit but shares the microeconomic weaknesses of its brethren. Corruption is pervasive and dysfunctional regulation inflicted blackouts on 600m consumers in the summer. Supply side rigidities handicap India’s economy so thoroughly that stimulus quickly causes inflation, which is close to 10 per cent. Last year the IMF projected India could sustain growth of 8.1 per cent per year. This year that has been revised to 6.9 per cent.




The IMF’s estimate of trend growth in China has come down from 9.5 per cent to 8.5 per cent. As elsewhere, corruption and distorted prices are the key challenges. State-owned companies account for more than half the capitalisation of the stock market. They hog subsidised credit, hire the best graduates and lobby fiercely against deregulation. Li Keqiang, the incoming premier, recently said that China had used up its “demographic dividend” of plentiful labour and would now have to rely on a “reform dividend”. But China has yet to act accordingly.




For all their macroeconomic resilience, the business climate in the Brics is unreliable. In the World Bank’s Doing Business rankings, China comes in a shameful 91st, Russia 112th, Brazil 130th and India 132nd. By contrast, Rwanda, Oman, Colombia and Kazakhstan are all in the top 60. The Rocks could teach the Brics how to regain momentum.






The writer is a senior fellow at the Council on Foreign Relations and an FT contributing editor



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Copyright The Financial Times Limited 2012.



Do not trust politicians to supervise Europe’s banks

Lorenzo Bini Smaghi

December 3, 2012


 



When the Bank of England was made independent in 1997 it had to surrender its power to supervise the banking system. Parliament used two main arguments to justify this. The first was that there is a conflict of interest between monetary policy and the conduct of banking supervision. The second was that banking supervision cannot be as independent as monetary policy, and therefore needs to be much more accountable to the political authorities.





Both arguments proved wrong, not only in theory but also in practice. And not only in England.




Rather than a conflict of interest between monetary policy and bank supervision, the opposite has turned out to be true in recent years. The lack of information on the solvency of the banking system made it much more difficult for central banks, such as the BoE, to interpret market developments and to provide liquidity to sound institutions only. National supervisors had the tendency to paint a rosy picture of their financial system, which enabled banks to easily qualify as counterparties for central bank operations.





It is also unlikely that independent central banks that are accountable for their monetary policy objective, in terms of price stability, would seek to use monetary instruments for other reasons. Trying to address banks’ solvency problems by extending central bank liquidity support is not very effective over time. Furthermore any attempt to manipulate monetary policy for other purposes would become apparent if there were sufficient transparency of central banks’ operations.




The conflict of interest argument might have been an issue in the old days of politically dependent and non-transparent central banks. It is less relevant today. The opposite may actually be true. Without bank supervision powers the central bank may nevertheless be induced to use monetary policy to resolve problems created by ineffective bank supervision out of fear that those problems might impact on financial stability and, as a consequence, on price stability.




The argument that the prudential supervision of banks requires a “different type” of accountability – in other words less independence – than monetary policy, because taxpayers’ money is at stake is also flawed. The taxpayers’ money argument could also be valid also for monetary policy. A decision to raise the policy rate or cut it at the wrong time might cost the economy – and thus the taxpayerseven more than rescuing a failed bank.




Bank supervisors should apply regulations and take early action, presenting the political authorities with the available options in case of bank resolution, at an early enough stage that the appropriate solution can be taken, with a view to minimise the burden on taxpayers. The Basel principles on banking supervision state that independence is essential in order to perform such a task properly.





Bank supervisory authorities that are not sufficiently independent, and are too closely associated with the political authorities, are generally under pressure to delay the identification of insolvent banks, for the fear that taxpayers would get upset. The problem thus tends to be postponed, and the cost to the taxpayer rises. The experience of the recent crisis has shown that taxpayers have paid most in countries where supervision was less independent and where the political authorities are most closely associated with the banking system.




So why, in spite of this evidence, and the lack of serious analysis, are these arguments still used, for instance in the discussion about the attribution of supervisory powers to the ECB? Why are the proposals which have been put on the table so insistent on the separation between monetary policy and supervisory activity?




Being slave of some defunct economist –to paraphrase Keynes – might be part of the answer. A more likely reason is the fear of creating a too powerful institution at the heart of Europe, with both monetary policy and bank supervision powers, that “nobody can control”. Every time a campaign has started to move responsibilities to the European level, opposite forces mobilised to water down the effort and try retain some powers in the hands of the national authorities.




When the euro was created, several academics and commentators suggested that a single currency and a single market required a single regulator. The issue was analysed by European Finance ministers at least twice over the last few years, on the basis of the Lamfalussy report in 2001 and the De la Rosière report in 2009.




The reform process was each time slowed down by the argument that the existing, decentralised system had worked well and would continue to work well, possibly strengthened by some form of enhanced cooperation. The underlying attitude was: “If it ain’t broke, don’t fix it”.



The crisis has shown that the system is indeed broken.



Had there been a single supervisor from the very start of the euro, independent like the ECB, the truth about some of the most problematic banks would probably have come out earlier. The excess leveraging accumulated in some countries would not have been tolerated for so long. The stress tests conducted since the start of the crisis would have been applied seriously, in a homogeneous way across countries. The cleaning up of banks’ balance sheet would have started earlier.




A single supervisor would probably have confronted several governments at an early stage of the crisis with clear-cut decisions aimed at ensuring an adequate capitalisation of their banking systems, as happened in the US. Maybe that’s what some actually did not want. But that’s what the eurozone needs in order to solve the crisis and avoid new ones in the future.



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The author is Visiting Scholar at Harvard’s Weatherhead Center for International Affairs and at the Istituto Affari Internazionali




December 3, 2012 8:18 pm
 
Why the fiscal cliff will be averted
 
Last Thursday saw the start of negotiations in Washington on a deficit-reduction agreement to be passed by year-end. If struck, a deal would avert the much-feared fiscal cliff $500bn in annual tax increases and spending cuts, which is set to begin in four weeks. Despite the immediacy of this threat, there is widespread fear that the negotiations may fail, triggering this huge fiscal contraction and pushing the fragile US economy back into recession.




Fortunately this fear is misplaced because America will not go over the fiscal cliff and stay there. However bumpy the talks, a deficit agreement will probably emerge just before or a week or two after the year-end deadline. The agreement will reduce deficits without injuring economic growth. And it will boost consumer and business confidence.




Why this relative optimism? First, in the presidential election that just ended, taxes were debated every day. Not only did President Barack Obama win the election decisively but exit polls indicated 70 per cent support for his position on taxes, namely that high earners should pay more, but the middle class should not. In other words, the people have spoken on this issue and members of Congress cannot ignore that without jeopardising their own positions.





Second, capital markets will rebel against stalemate and recession risk. They are the most powerful force on earth, repeatedly forcing global outcomes that normal political processes cannot. The October 2008 congressional vote on the troubled asset relief programme legislation is particularly instructive. At that time, Lehman Brothers had collapsed, credit markets were frozen and fear reigned. The Bush administration proposed Tarp, and the Senate voted to establish it. But the House voted No. Stock prices immediately fell 800 points and, within 48 hours, the House reversed its position. Why? Because constituents were terrified.





Markets are already preoccupied by the fiscal cliff. If negotiations appear stuck, share prices will fall as year end approaches. Then, if the deadline passes without agreement, they will probably plummet. Under that pressure, as in 2008, Washington will probably produce a deficit agreement. At worst, Congress and the president would extend the middle income tax cuts on which they agree. There will be no direct blow to the economy.





Third, the US business community is now pushing for an agreement. Since election day, Mr Obama has spent considerable, productive time with business leaders on this. Most of them will accept moderately higher tax rates, provided that spending cuts and the total savings package are big enough. This flexible approach from business weakens the anti-tax forces in Congress, who are the biggest obstacle to an agreement.





A successful agreement would embody three principles; it will be large enough to stabilise the debt to gross domestic product ratio, meaning about $4.5tn in savings over 10 years; it will include a balance of spending cuts and revenue raising measures; and it will be divided into two phases because, with just four weeks left, there isn’t time to legislate the entire package.




The negotiators already know the main elements of an agreement. Spending cuts should exceed the amount of new revenues. That should not be hard because $2tn of cuts are already agreed; $1.2tn in reduced discretionary spending was enacted last year and an additional $800bn will be realised by ending the Iraq and Afghanistan deployments. But it is also time to restrain entitlement spending, which has been soaring. Steps such as means testing Medicare, modernising cost of living adjustment formulas and others could save another $600bn. When the resultant interest savings are added in, total spending is reduced by $3.2tn over 10 years.




It is also important to include a growth initiative. The 2010 payroll tax cut and bonus depreciation should be extended together with emergency unemployment insurance and other expiring provisions. These would cost $200bn annually, reducing the net spending cuts to $3tn.




That leaves at least $1.5tn of revenue increases to truly solve the debt problem. Two-thirds of that can be achieved by returning to the, slightly higher, Clinton-era tax rates on income and capital for high earners. Those rates coincided with an economic boom in the 1990s. Our income tax system is now less progressive than ever and a big majority favours such a move. Then, to reach the revenue target, the value of most tax deductions could be capped at about 20 per cent, removing the advantage high earners enjoy, where the value of deductions equals their higher rate of tax.




This overall package would fix the debt problem, support the economy and protect middle-income Americans while avoiding the fiscal cliff. It would also spur business investment and hiring and pave the way for eventual positive growth surprises. That’s why these negotiations must succeed.





The writer, who served as US deputy Treasury secretary from 1993-94, founded and chairs Evercore Partners



 
Copyright The Financial Times Limited 2012