Lehman’s Morbid Legacy

Mohamed A. El-Erian

27 August 2013

 This illustration is by Tim Brinton and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

NEWPORT BEACHAs the fifth anniversary of the disorderly collapse of the investment bank Lehman Brothers approaches, some analysts will revisit the causes of an historic globalsudden stop” that resulted in enormous economic and financial disruptions. Others will describe the consequences of an event that continues to produce considerable human suffering. And some will share personal experiences of a terrifying time for the global economy and for them personally (as policymakers, financial-market participants, and in their everyday lives).
As interesting as these contributions will be, I hope that we will also see another genre: analyses of the previously unthinkable outcomes that have become reality – with profound implications for current and future generations – and that our systems of governance have yet to address properly. With this in mind, let me offer four.
The first such outcome, and by far the most consequential, is the continuing difficulty that Western economies face in generating robust economic growth and sufficient job creation. Notwithstanding the initial sharp drop in GDP in the last quarter of 2008 and the first quarter of 2009, too many Western economies have yet to rebound properly, let alone sustain growth rates that would make up fully for lost jobs and income. More generally, only a few have decisively overcome the trifecta of maladies that the crisis exposed: inadequate and unbalanced aggregate demand, insufficient structural resilience and agility, and persistent debt overhangs.
The net result goes beyond the weak growth, worsening income inequality, high long-term unemployment, and alarming youth joblessness of the here and now. Five years after the global financial crisis, too many countries are being held back by exhausted and out-dated growth engines.
As a result, prospects for a rapid, durable, and inclusive economic recovery remain a serious concern.
Given this harsh reality, it is not surprising that the second previously unthinkable outcome concerns inadequate policy responses namely, the large and persistent imbalance between the hyperactivity of central banks and the frustrating passivity of other policymakers.
The big surprise here is not that central banks acted decisively and boldly when financial markets froze and economic activity plummeted. Given their relatively unrestricted access to the printing press and their high degree of operational autonomy, one would expect central banks to be active and effective first responders. And they responded in an impressive and globally coordinated fashion.
What is surprising is that, five years after the crisis, and four years after disrupted financial markets resumed their normal functioning, Western economies still overwhelmingly rely on central banks to avoid even worse economic performance. This has pushed central banks away from their core competencies as they have been forced to use partial and imperfect policy tools for quite a long time.
This outcome reflects domestic political polarization in the United States and the complexity of regional interactions in Europe, which have blocked comprehensive and balanced policy approaches. To appreciate the extent of the problem, consider the repeated failure of the US Congress to pass an annual budget (let alone deliver medium-term reforms) or incomplete eurozone-wide initiatives at a time of alarming unemployment and residual threats of financial disruptions.
Such political dysfunction has undermined the responsiveness of other policymaking entities, including those that possess better tools than central banks. This has compelled central bankers to remain in the policy forefront, building one bridge extension after another as they wait for other policymakers to get their act together. The result has been to expose Western economies to ever-more experimental measures, with considerable uncertainty about the longer-term impact of operating sophisticated market-based systems on the basis of artificial constructs.
The third previously unthinkable outcome relates to how developing countries have fared. Having initially suffered from the financial crisis as much as Western countries did (indeed, more in terms of output and trade), these historically less-robust economies staged a remarkable comebackso much so that they became the engine of global growth. In the process, however, they slipped into an unbalanced policy mix that now threatens their continued growth and financial stability.
Renewed risks of financial instability point to the fourth and final surprise: the failure to recast major contributors to the crisis in a credible, sustainable, and socially responsible manner.
Consider large Western banks. Given their systemic importance, many were bailed out and, with continued official support, returned to profitability quite quickly. Yet they were not subject to windfall profit taxation, nor have policymakers sufficiently altered structural incentives that encourage excessive risk-taking. In the case of Europe, only now are banks being pushed to deal decisively with their capital shortfalls, leverage problems, and residual weak assets.
Call me a worrywart, but I remain concerned by the extent to which our systems of economic governance have lagged in addressing these four outcomes. The longer this unusual environment persists, the greater the risk that the disruptive ramifications of the 2008 crisis will continue to reach far and wide, including to future generations.
Mohamed A. El-Erian is CEO and co-Chief Investment Officer of the global investment company PIMCO, with approximately $2 trillion in assets under management. He previously worked at the International Monetary Fund and the Harvard Management Company, the entity that manages Harvard University's endowment. He was named one of Foreign Policy's Top 100 Global Thinkers in 2009, 2010, 2011, and 2012. His book When Markets Collide was the Financial Times/Goldman Sachs Book of the Year and was named a best book of 2008 by The Economist.

August 26, 2013 5:52 pm

America’s Middle East alliances are cracking
Policy rested on five crucial players but these are pulling in different directions
Ingram Pinn illustration
The pace of events in the Middle East has quickened once again. More than two years since the start of the Arab spring, the facts on the ground can still change so rapidly in the region that western governments struggle to keep pace. Last week Barack Obama had convened an emergency meeting to discuss the violent crackdown against the Muslim Brotherhood in Egypt, only for the US president to find himself confronted with an even more dramatic challengea chemical weapon attack in Syria.
Both events pose obvious and immediate policy challenges. Should American aid to Egypt be cut off? Should the US make military strikes against Syria? The case for military action against Bashar al-Assad’s regime is gathering international momentum: Britain, France and Germany have all indicated support for military retaliation.
How America responds will, in part, be dictated by how firmly Mr Obama decides to stick to his foreign policy strategy: he wants to lessen American involvement in the Middle East, so allowing him to concentrate on domestic reforms, addressing the rise of China and the perfection of his golf swing.
Where possible, Mr Obama has preferred to let allies take more of the strain of unfolding events in the region. He let Britain and France take the lead in military operations in Libyaalbeit with indispensable American help. Ideally, he would also like to respond to turmoil in the Middle East in concert with a group of like-minded regional allies.
But there is a big problem with that strategy. Traditionally, US policy in the region rested on strong relations with five crucial players: Israel, Saudi Arabia, Egypt, Turkey and the Gulf states. Whatever their differences on the surface, all these nations were status quo powers.

However, the old status quo in the Middle East no longer exists – and America’s traditional allies are now all pulling in different directions. The result is that the Obama administration will find it extremely difficult to forge a common regional approach to the turmoil. The situation in Egypt, more than Syria, has created irreconcilable differences between the US’s partners.

If Washington backed the Egyptian counter-revolution, it would delight some of its traditional friends in the region – and appal others. Saudi Arabia is America’s oldest ally in the Middle East and it is also the chief cheerleader and regional supporter for the Egyptian military coup. Israel is also clearly quietly satisfied with the turn of events in Cairo.
The Turkish government, however, is outraged by events in Egypt. Recep Tayyip Erdogan, the Turkish prime minister, is a leader that Mr Obama has carefully cultivated. According to a recent book by Vali Nasr, a former Obama administration official, the US presidentphones [Mr] Erdogan often and has probably conferred with him more than he has with any other world leader”.
Yet Mr Erdogan is behaving increasingly erratically. He seems to fear that the street demonstrations in Turkey against his government are intended to set up a military coup, on the Egyptian model.

Under pressure, he has resorted to increasingly bizarre conspiracy theories, implying last week that the Egyptian coup had been masterminded by Israel. Mr Obama thought that he had brokered an end to the war of words between Israel and Turkey – but that fragile entente is now breaking down again.

Qatar, which has become an influential player in the region through the judicious use of vast quantities of money, is also host to the main US air base in the region. The Qataris are sympathetic to the Muslim Brotherhood – and therefore have been on the opposite side of the Egyptian argument from Israel and Saudi Arabia.
On the surface, there is more regional unanimity about Syria. All of America’s traditional friends in the region want to see the Assad regime go. The Saudis and the Israelis think that it would deal a huge blow to Iran, the regional rival that they fear most. The Qataris are big backers of the Syrian rebels and so are the Turks. The position of the new Egyptian regime on Syria is not yet clear – although it is suggestive that Mr Assad was evidently overjoyed by the coup in Cairo.

Most of America’s regional allies are keen to see the US get more heavily involved on the side of the Syrian rebels. The Israelis worry that if the Obama administration’s red line on the use of chemical weapons in Syria is flagrantly crossed, with no response, then the red lines that the US has set for the Iranian nuclear programme will have no credibility. But the Israelis are also worried by the strong jihadist element in the Syrian rebel movement – and those concerns are expressed even more strongly by western intelligence services.

As for Mr Obama, he fears that if the US responds to the urgings of its allies in the region and beyond, and gets directly or indirectly sucked into the fight against Mr Assad, it will end up being cheered on from the sidelines by allies who will sit out the fight themselves – and then blame America when things start to go wrong. This regional discord probably only strengthens Mr Obama’s initial instinct to back away from the Middle East rather than to rush towards the sound of gunfire.

But sometimes events take on a logic of their own. With an aerial attack on Syria looking ever more likely, it seems as if President Obama will be dragged ever deeper into the Middle East, against his own better judgment.

Copyright The Financial Times Limited 2013.

08/27/2013 01:18 PM

Capital Flight

Currencies Plunge Rapidly in Asian Economies

By Wieland Wagner

 Photo Gallery: Asian Countries Hit by Currency Crisis
As the credit glut in the US nears an end, the currencies of developing countries like India, Thailand and Indonesia are plummeting. Now there are fears that a redux of the 1997 market crash is on the horizon.

Indian customs officials are out in full force these days in their attempt to stop the illegal import of gold. At the airport in Kochi, in the south of the country, officials recently caught a man who had hidden two kilograms (5.5 pounds) of precious metals in his socks -- he was given away by his odd gait. Other customs officers on the border with Nepal stopped a truck with 35 kilograms of gold hidden in its bumper.

Their battle is a frustrating one. For every kilogram of gold seized, it is estimated that another makes it into the country unnoticed.

Gangs pay smugglers up to 50,000 Indian rupees (around €575 or $770) to bring them gold from, for example, Dubai, a favorite source. Indians are obsessed with gold right now -- and not only because of the approaching wedding season.

As the rupee has dropped dramatically in value, many Indians have turned to tangible assets. The government has increased its tax on gold imports as a way of shoring up the country's currency, but that has only caused wary investors to flee further.

The government comes up with new ideas for slowing the rupee's fall almost every day: by imposing customs duties on flat-screen TVs -- which Indians could previously bring into the country unobstructed -- for example, or by making it more difficult for company managers to export capital and invest it abroad.

None of this has helped. Since May, the rupee has lost 17 percent of its value against the dollar.

There are two primary reasons for this crash. The first is that investors have lost faith in India's economic miracle and in Indian politicians. Growth has dropped by nearly half, the country's trade balance continues to slip further into the red, stock prices are practically in free-fall and inflation is deepening the divide between rich and poor.

The second reason, though, is something over which authorities in New Delhi have little control: the coming end of the credit glut in the United States.

No More American "Hot Money"?

Much of the money the US Federal Reserve Bank released onto the market as a way of stimulating the economy eventually made its way to India or other emerging markets, where it drove up property values and stock prices.

In May, Federal Reserve chair Ben Bernanke hinted at a change of course. Since then, investors have speculated about a coming end to quantitative easing -- a strategic program the Americans adopted in an attempt to lower interest rates and push up prices in the US -- and increasingly to pull their money out of emerging markets. Currency value is now dropping in many countries that previously profited from foreign capital, like Brazil, Russia and South Africa, but hardly anywhere is the phenomenon as extreme as in India.

Until recently, the so-called BRICS countries -- Brazil, Russia, India, China and South Africa -- were seen as winners in the 2008 global financial crisis. Economists even predicted that these ascending countries would be able to "decouple" themselves economically from crisis-ridden Europe and the US. Instead, those countries are now quaking at the prospect of an end to the flow of so-called "hot money" from the US.

It is true that the leading BRICS country, China, is not directly affected by the current currency crisis, since the yuan is not freely convertible -- meaning, it cannot be immediately converted into major reserve currencies. But the country's Communist rulers are struggling with their own banking crisis and an urgently needed reorientation of Chinese industry toward more domestic consumption.

Trapped Between Two Economic Giants

As China's economy falters, its imports of raw materials from other newly industrialized countries declines as well, which means China's southeast Asian neighbors in particular are suffering on two fronts. Indonesia, Malaysia and Thailand are now not only exporting less to China, they are also forced to stand by and watch as investors flee en masse from the Indonesian rupiah, the Malaysian ringgit and the Thai baht.

Prasarn Trairatvorakul, head of Thailand's central bank, has tried in vain to calm the markets. The general economic situation is "still okay," he declared, adding that the baht was moving in line with economic fundamentals.

Indonesia's central bank governor, Agus Martowardojo, has likewise played down the seriousness of the situation, saying, "the worst times of capital outflow in June and July are already over. Pressures against the rupiah are unlikely to continue." However, financial experts have doubts about the Indonesian government's ability to combat the crisis effectively. "We do not think there is a magic bullet that can turn things around," stated a team of Barclays analysts headed by Prakriti Sofat.

A Repeat of the 1997 Crash?

All this brings up some unpleasant memories: It is precisely these so-called "tiger economies" that, following a period of artificially inflated growth, triggered the 1997 Asian financial crisis. That debacle began in Thailand, where the newly rich middle class constructed skyscrapers and mansions and purchased luxury cars, all on credit. When this bubble became apparent, hedge funds in London and New York began speculating on a baht crash.

Thailand had pegged its currency to the US dollar. To maintain the exchange rate and fend off speculators' attacks, the country introduced nearly its entire foreign currency reserves onto the market within a very short space of time. Ultimately, the country's central bank had to capitulate to the hedge funds. Thailand abandoned its peg to the dollar and the baht tumbled in value. The country's debts also increased because most loans had been in dollars. Thailand ended up practically broke.
Next, trouble hit a number of banks in Malaysia and Indonesia, where enraged mobs looted shops owned by Chinese businesspeople; Suharto's dictatorship collapsed soon after. South Korea, too, only narrowly escaped national bankruptcy thanks to a $58 billion International Monetary Fund loan.

This time around, newly industrialized countries are better armed against capital flight. Having learned a lesson from the Asian financial crisis, they have increased their foreign currency reserves and partially reformed their banking sectors. Even more importantly, their currencies are no longer pegged to the dollar.

Flimsy BRICS

But the capital flight currently taking place also illustrates how far the BRICS countries and the Asian tigers still are from overtaking Western industrialized countries -- and to what degree these countries' accomplishments are now in jeopardy. According to analysts at Morgan Stanley, the central banks of developing countries, with the exception of China, lost a total of $81 billion between just May and July through the selling of dollars to protect their currencies.
Indonesia's foreign currency reserves have shrunk by 18 percent since the beginning of the year. Until recently, the world's largest Muslim country was a favorite for foreign investors.

Thanks to its boom in raw materials, the country's manufacturing was still growing by over 10 percent in April, faster than almost any other country in the world. Companies from Europe, the US and Japan have built car and electronics factories in the country because, in addition to other factors, they also have faith in Indonesia's impressively well-functioning democracy.

At the same time, nearly half of Indonesia's almost 240 million inhabitants live on less than $2 a day. The rupiah's drop has forced the country's poor to cut back on food even more, while their newly rich neighbors search feverishly for a way to protect their wealth. As a precaution, the central bank in Jakarta has forbidden the withdrawal of dollars from ATMs.

These developing countries are in a tight spot. To curtail rapid capital flight, they would need to raise interest rates considerably, but doing so would cause the country's economy to stall. Indian economist Jayati Ghosh warns that this would lead to social unrest. The governments of India and Indonesia are particularly leery of causing that sort of nightmare scenario: both of these large democracies have elections in the coming year.

Translated from the German by Ella Ornstein

The Struggle for Middle East Mastery

Joschka Fischer

27 August 2013

 This illustration is by Paul Lachine and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

BERLINThe last illusions about what was called, until recently, the “Arab Spring” may have vanished. Egypt’s military coup has made the simple, depressing alternatives for the country’s future crystal clear: The question is no longer one of democracy versus dictatorship, but rather one of (Islamist) revolution versus (military) counter-revolutiondictatorship or dictatorship.
This applies not only to Egypt, but to almost all of the wider Middle East. And, because both sides have opted for armed struggle, the outcome will be civil war, regardless of what well-intentioned European Union foreign ministers decide in Brussels. The Islamists cannot win militarily, just as the generals cannot win politically, which all but ensures the return of dictatorship, significant violence, and a series of humanitarian disasters.
For both sides, full mastery and control is the only option, though neither has even a rudimentary understanding of how to modernize the economy and society. So, whichever side gains the upper hand, authoritarianism and economic stagnation will prevail once again.
In Egypt, the army will be the victor, at least in the medium term. With the support of old elites, the urban middle class, and religious minorities, Egypt’s military leaders have clearly adopted an all-or-nothing strategy. Moreover, financial support from Saudi Arabia and other Gulf states has made the army impervious to outside pressure.
Thus, Egypt is reenacting the Algerian scenario. In 1992, with the Islamic Salvation Front poised to win Algeria’s general election, the country’s military staged a coup and immediately canceled the election’s second round. In the subsequent eight-year civil war, waged with appalling brutality by both sides, up to 200,000 people lost their lives.
Military rule in Algeria continues de facto to this day. But, with the role of political Islam still unanswered, none of the country’s fundamental problems has been addressed seriously, and its leaders have been unable to take advantage of promising opportunities (for example, in contrast to Egypt, Algeria has large oil and gas reserves).
In Egypt, the Muslim Brotherhood’s older generation is accustomed to prison and life underground, but there are many reasons to believe that its younger adherents will respond with terror and violence. Egypt, Syria, Yemen, Tunisia, and soon perhaps other countries in the region will serve as fertile grounds for a new, more militarily oriented Al Qaeda, which will become a more powerful factor in the Middle East’s cacophony of interests and ideologies.
The West in general, and the United States in particular, has little influence or real leverage. So it will complain, threaten, and deplore the horrors to come, but ultimately will follow its interests, not its principles. For example, Egypt, with its control of the Suez Canal and its cold peace with Israel, is too important strategically to be simply abandoned.
Taken in isolation, the Egyptian situation is bad enough; but it is by no means a unique case. Rather, it is part of a regional drama characterized primarily by a massive loss of order. The US-backed order in the Middle East is breaking down, yet no new order is emerging. Instead, there is only a spreading chaos that threatens to reach far beyond the region’s borders.
Following the spectacular failure of President George W. Bush and Vice President Dick Cheney, with their neoconservative go-it-alone illusions, the US is no longer willing or able to shoulder the burden of being the last force for order in the Middle East. Having overstretched its forces in Afghanistan and Iraq, and facing economic retrenchment at home, the US is withdrawing, and there is no other power to take its place.
Withdrawal is one of the riskiest military maneuvers, because it can easily degenerate into panicky retreat and chaos. With the upcoming withdrawal of the US and NATO from Afghanistan, the potential for turmoil in the region between North Africa and the Hindu Kush will increase significantly on its eastern edge.
What we can learn today from the prolonged crisis in the Middle East is that regional powers are increasingly trying to replace the US as a force for order. This, too, will fuel chaos, because none of these powers is strong enough to shoulder the American burden.

Moreover, the Sunni-Shia divide frequently leads to contradictory policies. In Egypt, for example, Saudi Arabia is supporting the military against the Muslim Brotherhood, whereas in Syria the Saudis are backing Salafists against the military, which receives support from Saudi Arabia’s main enemies, Shia Iran and its Lebanese proxy, Hezbollah.
But the region’s struggle for power and its sectarian-ideological antagonisms also create an opportunity for cooperation once scarcely thought possible. Seen from this perspective, any US-Iranian talks over the nuclear issue in the wake of Hassan Rouhani’s victory in Iran’s presidential election could have much broader significance.
In Egypt, the military counter-revolution will prevail, but the Islamist revolution eventually will return as long as its causes have not been eliminated. At the moment, there is virtually no indication of progress on this front. So, when the Islamist revolution does return, it is likely to be even more powerful and violent.
A similar dynamic is evident in European history, particularly in the revolutions and counter-revolutions of the nineteenth and twentieth centuries. Indeed, the legacy of that dynamic was fully overcome in Europe only two decades ago. Now it seems to be recurring, largely unchanged, in the Middle East.
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.