June 27, 2013 7:01 pm

Prosperity fuels protest in the new age of unrest
The leaders most likely to survive are those who will act on corruption and inequality
©Ingram Pinn

In Istanbul, the protesters want green space and the right to enjoy a glass of wine. In São Paulo, the demand on the streets is for decent public transport and a crackdown on police corruption.

The placards may be different, but the forces at work in these recent disturbances have been much the same. Politics in the rising world has been left behind by the tumultuous pace of economic and social change. The stresses are not about to go away any time soon. Welcome to the age of unrest.

At a glance, there was little to unite the demonstrators in Istanbul and Ankara with the angry crowds in São Paulo and Rio de Janeiro. The former channelled anger at an authoritarian, albeit elected, prime minister who has challenged secular freedoms. The Islamism of Recep Tayyip Erdogan’s Justice and Development party (AKP) collides with the social liberalism of an urban middle class.

The catalyst for the flash protests in Brazil was a rise in bus fares – and the contrast it pointed up between failing services for Brazilians and the vast sums expended on the football World Cup and Olympics.

Missing, too, has been an obvious read-across from these nations to uprisings against autocrats in the Arab world or challenges to regimes such as those in China or Russia. Turkey and Brazil are democracies. Until recently, the former has been held as a role model for the Arab world – a lesson in how to meld pluralism and economic vibrancy with Islam.

After a century of promise unfulfilled, Brazil has crossed the line between potential and actual power. Between the two nations, tens of millions have been lifted from poverty.

What unites the protests, however, is the challenge to political systems in the rising worlddemocratic as well as authoritarianwhen confronted by economic and social change. It has all happened too fast.

In the west, the stresses and strains of the industrial revolution were spread out over a century. Politics had time to adjust to the demands of a burgeoning bourgeoisie and a more assertive working class. Even then, there were uprisings, revolutions and wars along the way.

Today’s emerging powers have seen extraordinary advances collapsed into a couple of decades. Hundreds of millions of people once locked out of politics have been enfranchised by economic growth, urbanisation and digital technology. Instant communication – from text messages to social media – have handed the educated, and often unemployed, young a powerful tool to mobilise discontent.
Democracy will not grant politicians immunity from unrest. The pressure from the streets will probably be stronger in authoritarian states – it is remarkable how almost any protest anywhere intensifies the fearfulness of Beijing. But one of the striking things about the protests in Turkey and Brazil has been their detachment from familiar political dividing lines.

The protesters have been challenging the systempolitical elites, corrupt public servants, rich business leadersrather than carrying a flag for traditional opposition parties.
The common denominators here are growing middle classes, young populations, overcrowded urban sprawl, poor public services, unemployment, huge income inequalities and widespread corruption.

The ingredients in this combustible mix are present in different proportions from country to country and continent to continent. But they are there in some combination from Cairo to Beijing and Jakarta to Buenos Aires. So too is the instant digital communication that can make a firestorm of a spark.

There are no easy answers for governments seeking to avoid such protests. Authoritarian regimes, most notably China, have traditionally seen growth as the answer. They are mistaken. For one thing, as we have seen in recent months, rising states are not immune to global economic cycles.

Growth in the south and east is slowing. But material prosperity was always an inadequate answer.

Rising affluence in these nations increases more often than it deflects the social and political pressures. The higher people climb above the poverty line, the more they resent corruption and inequality and demand better public provision. The rule of law matters for the middle classes in a way it does not for those locked out of politics by poverty.

Nor, as Mr Erdogan should have learnt by now, is repression the answer. The protests that began in Istanbul’s Gezi Park and Taksim Square might well have been contained had the police not responded with violence and the prime minister with a series of unhinged theories and threats about grand conspiracies. Dilma Rousseff, Brazil’s president, seems to have at least partially understood this lesson by recognising the protesters had a case.

Most likely, though, there will be many more such disturbances across the rising world. On present trends, the ranks of the global middle class will swell by about another 1bn to about 3bn by 2020.

The one thing we can be sure of is that these citizens, newly enfranchised by higher living standards, will be more demanding of their rulers. Governments everywhere will have to find ways to accommodate them.

The world’s new powers have a bumpy road ahead of them. The political leaders most likely to ride out the protests will be those who fill the governance gap by cracking down on corruption, mitigating the excesses of inequality, and responding to demands for modern public services. Even then, the lesson of history is that progress is unlikely to be smooth. Anyone who thinks otherwise would do well to brush up on the 1840s.

Copyright The Financial Times Limited 2013

Risk of 1937 relapse as Fed gives up fight against deflation

The US Federal Reserve has jumped the gun. It has mishandled its exit strategy from quantitative easing, triggering a global bond rout that it did not anticipate, and is struggling to control.

By Ambrose Evans-Pritchard

5:51PM BST 26 Jun 2013 

Federal Reserve Board Chairman Ben Bernanke appears before a House Budget Committee hearing on
 That the Fed should tighten even as it cut its own growth and inflation forecasts for this year is a bizarre state of affairs Photo: Getty Images

It has violated its own counter-deflation strategy, tightening monetary policy even though core PCE inflation has fallen to the lowest levels in living memory and below levels deemed dangerous enough in the past to warrant a blast of emergency stimulus. It is doing so even though the revival of bank lending has faded.
The entire pivot by the Federal Open Market Committee is mystifying, almost amateurish, and risks repeating the errors made by the Bank of Japan a decade ago, and perhaps repeating a mini-1937 when the Fed lost its nerve and tipped the US economy into a second leg of the Great Depression. "It’s all about tighter policy," was the lonely lament by St Louis Fed chief James Bullard.
The Fed seems to be acting in the belief that the US economy will shake off this year's fiscal tightening - 2pc to 3pc of GDP - and that a housing recovery is now entrenched. The sharp fall of Wall Street's homebuilders index would suggest caution. Unlike the surging Case-Shiller index of house prices, it looks forward, not three months backwards.
The Fed could have kept policy steady, welcoming the shake-out in frothy markets over the past month as a useful "fire-drill" for future QE exit, without pushing its point too far. It chose to escalate.
It raised the unemployment target from 6.5pc to 7pc. It concocted feeble excuses to explain why it was ignoring a plunge in 10-year TIPS that serve as a proxy of long-term inflation worries. While still pretending that the pace of QE exit would be dictated by the health of the economy, it in fact set a date that disregards the economy. "Policy actions should be undertaken to meet policy objectives, not calendar objectives," said Mr Bullard acidly in his dissent.
That the Fed should tighten even as it cut its own growth and inflation forecasts for this year is a bizarre state of affairs. "A more prudent approach would be to wait for more tangible signs that the economy was strengthening before making such an announcement. You can communicate it one way or another way, but the markets are saying that they’re pulling up the probability we’re going to withdraw from the QE program sooner than they expected, and that’s having a big influence," said Mr Bullard.

Tim Duy from Fed Watch said the bank seems to be looking for any excuse to extricate itself from QE "as soon as possible". Its reflexes have changed. It aims to press ahead with bond tapering come what may, retreating only if growth really tanks and news is shockingly bad.

This is not just a debate over whether or not to reverse QE, or whether markets have become addicted to Fed amphetamines. It is whether we still knows what is going on in the heads of those who command our destiny, those who have, with other central banks, bought up almost the entire $2 trillion issuance of AAA bonds worldwide over the past year, and therefore have become the market themselves.

The young Fed governor Ben Bernanke warned in his famous 2002 speech - entitled Deflation: Making Sure "It" Doesn't Happen Here - how corrosive it would be if America began to slither down the same slope as Japan. "Sustained deflation can be highly destructive to a modern economy and should be strongly resisted," he said.

Mr Bernanke then said that the Fed should maintain a safe "buffer zone" of 1pc to 3pc inflation to protect against shocks that could push the economy into a deflation vice. The chances of this happening are "remote indeed", he assured us, because the Fed would deploy all means to prevent it ever happening. "The US government has a technology, called a printing press [or, today, its electronic equivalent], that allows it to produce as many US dollars as it wishes at essentially no cost."

Does Mr Bernanke's pledge still hold, now that he is talking down the relevance of PCE inflation at 0.7pc? Or has he taken to heart warnings from ex-governor Frederic Mishkin that the Fed itself risks becoming trapped if QE continues into 2014? Has he buckled to pressure from his own Advisory Council, who now warn that QE is doing more harm than good? Has he simply been outnumbered?
The Left-Keynesians are furious - "A grave error of policy," said Berkeley professor Brad De Long - but so too are the monetarists, usually linked to the free-market Right.

US monetarist David Glasner says the Fed risks a "reprise of 1937", an episode largely forgotten because the re-armament spending soon came to the rescue. Industrial output fell 30pc to 40pc, back to the levels of late 1933. The peak to trough contraction in GDP was 11pc. Unemployment jumped to 19pc.
The Fed Minutes of 1937 are worth reading, a window into error as it unfolded. As late as June that year the Fed still thought "there was little evidence at the present time of a recession, and that it was the general expectation that in any event recovery would be resumed by Fall [Autumn]".

But then again, the Fed Minutes in the Spring of 2008 were no better. Then too they were talking tough - enough to push up long rates by 50 basis points - even though we now know that the US was already in deep recession. Robert Hetzel from the Richmond Fed says in his book The Great Recession that the FOMC's refusal to respond to a collapse in the money supply led directly to the Fannie, Freddie, Lehman, AIG disaster that followed.

But if the Fed has erred again this time, it can't hold a candle to the Bank for International Settlements (BIS). This club of central bankers - now entirely in thrall to the Bundesbank, and the liquidationist doctrines of the Chicago Fed circa 1931 - demanded a halt to QE this week, as well as rate rises, yet more fiscal tightening, and an even faster pace of credit deleveraging for good measure.

The American Nobel fraternity likes to accuse our own George Osborne of holding such views. This is calumny. Britain's fiscal tightening is a calibrated 1pc of GDP each year, and it is offset by £375bn of QE. The Osborne view and the BIS view have nothing in common.

One thing is certain, if such a nihilist cocktail of BIS contraction were imposed on the world in its current condition, it would kill recovery altogether, throw millions more out of work, and probably extinguish a few democracies along the way. Hungary is half gone already.
It would cause debt trajectories to explode, and therefore prove self-defeating on its own terms. The ultimate outcome would be a chain of sovereign defaults and bank crashes. This is one way to achieve a cathartic debt jubilee and wipe the slate clean, I suppose, but by stone age methods, with stone age results. The US whittled down the debt burdens left from the Second World War (120pc) by gentler means, and so did the UK (200pc).

The BIS is, of course, right to warn that QE as currently implemented is fuelling asset bubbles, with junk bond yields falling to record lows, and a new rush into "covenant lite" debt for leveraged buy-outs. But it recoils from the awful implication of its analysis - awful for the BIS and central banks, that is - which is that other forms of QE should be found to inject stimulus directly into the veins of the economy, such as building roads or nuclear power stations.
Takahashi Korekiyo pursued just such a radical expirement in the early 1930s, turning the Bank of Japan into an arm of the treasury and forcing it to fund government spending until the economy was on its feet again. It worked like a charm. Neville Chamberlain tried a lesser variant in Britain, with success. The US Treasury took over the Fed in the 1940s.

Lord Turner, former head of the defunct Financial Services Authority, proposes such a plan today, should recovery falter. His softer version would preserve the independence of the Bank of England, allowing it to decide the right level of fiscal financing.

This is complex territory, and may prove an idle debate if the US does indeed achieve the Holy Grail of "escape velocity". But if it doesn't, and if the reason for abjuring low-inflation monetary stimulus is because it causes dangerous asset bubbles, then for goodness sake do it without causing asset bubbles. Little is beyond the wit of man. Unless you are a defeatist.

June 26, 2013 7:44 am

Flexibility decided by states is a wrong move for Europe’s Banks
Uncertainty about losses will be made worse when a lender goes bust, says Martin Sandbu
When European finance ministers meet on Wednesday, they are already in extra time. Last week they could not agree on how EU countries should handle busted lenders to ensure taxpayers never again have to pay for bankers’ failed bets. They have 24 hours to come to an agreement on “bail-ins” – imposing losses on creditors of banks that run out of money ­– before their bosses meet for the EU summit meant to take the formal decision on Thursday and Friday.

The main stumbling block is some nations’ demand for greaterflexibility” in the bail-in rules. That term should set off alarms. Flexibility can mean two things, both bad.

First, it could mean lots of ad-hoc making: leave governments to decide on a case-by-case basis who to save (bail out) and who to let drown (bail in) when a bank is bust. This would guarantee unpredictability when a liquidity or solvency crisis hits.

Part of what made the Cyprus bail-in more damaging than it should have been was the initial uncertainty about whether supposedly guaranteed deposits would be written down. And Cyprus is just the most extreme case. Every banking crisis in the EU has been made worse by uncertainty about who would take losses on their claims against banks.

If ministers are serious about reducing future financial instability, they must commit to explicit predetermined hierarchies of claims on banks. They must make clear who bears losses, and in which order and to what extent, when their bank runs out of money.

Second, flexibility could mean that a hierarchy of loss absorption is clear in advance but differs between countries. This makes no sense in a single financial market. If rules are different, each type of bank funding will flow to the states that are the most willing to bail them out. Anyone who does not see why this is harmful should remember Dublin’s blanket guarantee of bank liabilities in 2008, thrown back into the spotlight by the release of taped conversations between shameless Irish bankers in those hectic days.

If the Ecofin meeting chooses the public good and not special interests, it will agree explicit common bail-in rules for all. What should these be?

Everyone now surely agrees that guaranteed depositors should be so in reality and not in name only. They should always be the first to get their money back, and states must top up to compensate if any bank fails too dismally even to honour small deposits.

What about the rest of banks’ liabilities? Before now, unsecured creditors above the deposit guaranteeholders of larger deposits and unsecured bonds – have been treated equally unless explicitly subordinated. Some states now want to be allowed to bail out specific larger deposits. If we give them the benefit of doubt, they presumably have in mind widows living off bank savings, families preparing a deposit for a house or small organisations needing access to their working capital.

There is clearly a legitimate need for safe places to put away more than €100,000. But this does not justify picking holes in the bail-in framework the EU badly needs.

Better to follow the US practice of depositor preferences – in which deposits (above the guarantee, which should be ironclad) rank before other senior unsecured creditors. That should meet most of the demand for safety.

For those who want more, banks themselves can offer externally purchased insurance as part of a savings productmini-credit default swaps, as it were. They could even be required by regulators for client accounts used in housebuying, for example. The market should be used to provide – and pricesolutions beyond the minimum protection no one should be permitted to go without.

A safe banking system requires people to understand that higher rewards come with higher risks. That means they must be told clearly and uniformly what risks they take by entrusting their money to banks in various ways. This is what the ministers profess to want and yet seem to find it so agonisingly difficult to do.

Copyright The Financial Times Limited 2013.

June 27, 2013, 1:09 PM

Low Inflation Highlights Fed Dilemma

By Jeffrey Sparshott

The Federal Reserve is facing an inflation dilemma.

Inflation is running well below the Fed’s 2% target. Thursday’s reading on the Fed’s favorite inflation gauge showed prices up just 1.1% in May from a year earlier, matching the lowest pace on record.

Fed Chairman Ben Bernanke and other central bank officials maintain it’ll pick up. But a substantial band of economists outside the Fed is starting to challenge Mr. Bernanke’s diagnosis.

The Fed chief, in his press conference last week, said the downshift in inflation may reflecttransitory factors” that will dissipate. Those include a dip in medical payments and the cost of some services that don’t have traditional market prices, such as free checking accounts.

“These are some things that we expect to reverse and we expect to see inflation come up a bit,” he said. “That being said … we don’t take anything for granted.”

Fed governor Jerome Powell underscored the message in a speech Thursday, saying most Fed officials are looking through the temporary movements and expect inflation to return to 2% over the coming years. But he added, “Continued low or falling inflation could, however, raise real concerns. Inflation can be too low as well as too high.”

How inflation moves in the coming months will shape the central bank’s next steps. If inflation doesn’t rise close to the Fed’s target, Mr. Bernanke said the Fed might rethink its plan to begin scaling back the size of its bond-buying program later this year.

Overall inflation was 1% in May from a year earlier, the Commerce Department said Thursday. Core inflation, the Fed’s preferred measure that strips out volatile energy and food costs, rose 1.1% from a year earlier. That matched the previous month’s reading and equaled the smallest rise in underlying prices on record.

Some economists think more than temporary factors are behind the low inflation readings.

Goldman Sachs economist David Mericle said other components of underlying inflation also are close to historic lows. “This again suggests that low inflation is not confined to the components highlighted in the chairman’s press conference,” Mr. Mericle said in a note to clients this week. The firm’s economists are forecasting a modest recovery in inflation during the rest of 2013.

Medical payments are a key wild card. Automatic federal spending cuts, known as the sequester, imposed a 2% reduction on Medicare payments starting in April, easing price pressures. But other factors could have a longer-term impact, such as cheaper generic drugs coming to market and replacing more expensive name brand products, as well as the potential effects of the Affordable Care Act.

Declining government payrolls and tightening federal spending also could play a role in pushing inflation down.

Government is shrinking and prices are responding,” said Laura Rosen, an economist at BNP Paribas. “I don’t see it as something to not be concerned about. Disinflation is disinflation.”

The latest set of government spending cuts “is the start of further, more structural changes that could influence stickier prices such as medical care,” she said.

Low inflation can help American households that have seen only tiny wage gains. But price increases that are too slow also carry risks, which Fed officials say they’re taking seriously.

Inflation that’s too low is a problem,” Mr. Bernanke said. “It increases the risk of deflation. It raises real interest rates. It means that debt deleveraging takes place more slowly.”

The Fed chairman said the central bank could start to dial down its $85 billion-a-month bond purchase program later this year if the economy expands and inflation gradually rises as it expects.
That has already led to one dissent inside the central bank’s policy committee. St. Louis Fed President James Bullard said talk of winding down the bond buying is premature given low inflation.

Mr. Bullard in a statement said that “a more prudent approach would be to wait for more tangible signs that the economy was strengthening and inflation was on a path to return toward target” before announcing such a plan.