From Lenin to Lehman — the big lies

Those who want to save capitalism should note echoes of the Russian Revolution

by: Martin Sandbu


© AP


Two anniversaries we mark this year — the centenary of the Russian Revolution and the decade since the start of the global financial crisis — have more in common than is apparent at first sight.

Both events are self-evidently momentous. The October Revolution ushered in a dictatorship that would loom over the 20th century as one contestant for hegemony against fascism (in the first half) and democratic market liberalism (throughout). The global financial crisis, meanwhile, shook to its foundations the model that had emerged victorious from the cold war.

The stultifying communism that the Soviet bloc had evolved to by the 1980s collapsed under the weight of its own economic and political contradictions. The political turmoil of the last year demonstrates that we are now watching to see whether open market economies will suffer the same fate.

But the similarities run deeper than merely the historic scale of the two events. The content, too, of the current threat to democratic market liberalism is the same as that which felled its rival.

Communism failed because it committed two types of lies. The first was to betray the dream that had originally attracted so many millions to it: a society of equality, solidarity and self-realisation through collective purpose. Belief in this dream lived on longer than could be justified even in communism’s heartland — and longer still in the west. It was eventually ground down by reality.

The second lie was an economic system based on deceit and self-delusion. It is mostly forgotten, but a real debate raged for a good part of the 20th century over whether central planning or decentralised markets would secure the most efficient allocation of resources. The case for state control of the means of production was that only planning could overcome the clear waste of resources involved in capitalism’s mass unemployment and recurrent demand deficiencies causing recessions.

In practice, of course, actual central planning has been awful at producing and allocating the goods its citizens wanted. But instead of correcting itself, the planned economy would turn the plan into the great lie around which everyone’s public beliefs had to align, even as they privately knew better. “You pretend to pay us and we pretend to work” was a joke from Rostock to Vladivostok, but also a statement of reality.

Only late in the day did the intellectual consensus endorse Friedrich von Hayek’s insight that flexible market prices contain more information than any planning mechanism can hope to gather centrally; and that dispersed decision-making therefore acts more efficiently than state authorities can do.

This insight goes a long way towards explaining the growing prosperity gap between the capitalist and the communist world towards the end of the cold war. Yet it had a rude awakening in the global financial crisis, which undermined any claim of western financial capitalism to being the best way to organise an economy.

The Hayekian epiphany about the price mechanism is not wrong, but incomplete. Market prices of goods and services are indeed a more powerful informational device than any central plan. But the crisis showed the same cannot be said for the prices of assets.

If the five-year plan was the Soviet bloc’s grand lie, here is that of capitalism: that the market values of financial and other assets accurately reflect the economic value they represent.

What happened 10 years ago this month was the horrifying realisation that financial claims accumulated over the previous boom years did not add up, that the future economic production which they were claims on was insufficient for them all to be honoured in full.

In brief, the wealth that people thought they possessed did not in fact exist. When enough people saw that their perception of their wealth was untrue, the system unravelled. The disorientation and distrust that have followed in both markets and politics was just what one would expect when millions realise they have been living a lie.

One lie spawned another, as market liberalism, in its turn, betrayed the dream it had promised. Western economies are today far poorer than the trend before the crash predicted. The crisis and its aftermath have left the young, in particular, with little reason to hope for the same opportunities to prosper as their parents and grandparents.

Those who want liberal democratic capitalism to thrive again must heed two lessons from this comparison.

First, a social system can survive disillusion for a long time. Communism showed this; as indeed does capitalism, whose promise was broken decades before the crisis for some groups. But when people can no longer count on their livelihoods, support snaps. Even so, the most resilient societies are those that know the truth about themselves. Deceit makes for brittleness. Market liberalism is in peril because its financial system allowed us to tell ourselves lies; and did not reckon decisively with the losses once they were undeniable.

Left and right populists traffic in nostalgia for the heyday of the mixed economy. They are right that the contest between planning and laissez-faire must be resolved by a mix of the two. The biggest lesson from that contest is any social and economic system must be kept honest — not just fair, but truthful. And that’s a radicalism the populists are singularly unqualified to provide.


Seeking the Next Safe Haven

If trouble brews on U.S. debt payments or in Korea, the dollar may not be the refuge it once was

By Justin Lahart

When the world looks stormy, investors first reaction is to flock to American assets. But what will they do when the U.S. is where the tempest is brewing? Photo: Andrew Harrer/Bloomberg News


When the world looks stormy, investors first reaction is to flock to the safety of American assets. But what will they do when the U.S. is where the tempest is brewing?

Maybe just flee to America, nonetheless.

The potential for U.S.-centric risks to rise in the weeks ahead is unfortunately not theoretical. When it reconvenes next month, Congress must in short order raise the U.S. debt limit or put the government at risk of not being able to pay what it owes. At the same time, there are a series of geopolitical risks, including the standoff with North Korea, that directly involve the U.S.

When they get nervous, investors typically buy Treasurys. The Treasury market is large, liquid and backstopped by the U.S. government, which historically made it a safe place to ride out trouble. Buying Treasurys means buying dollars so money that flows into them also flows into the greenback.

But if the trouble is in the U.S., it is easy to imagine that Treasurys and the dollar might not be so appealing. Say, for example, that internecine conflicts make it so House Republicans can’t raise the debt ceiling without Democrats’ help, and the process of trying to hash out a bipartisan agreement takes too long. If the U.S. government guarantee on Treasurys becomes suspect, investors could look for someplace safer for their cash.

Ray Dalio of Bridgewater Associates, the world’s biggest hedge fund, has suggested the best protection against the prospective risks from the debt ceiling negotiations and North Korea isn’t Treasurys or the dollar, but gold. “[I]f you don’t have 5%-10% of your assets in gold as a hedge, we’d suggest that you relook at this,” he wrote in a recent LinkedIn post.

Another option that wouldn’t have been on the table until recently is the euro. The euro counts as the world’s second most important currency, and euro-area financial markets are highly liquid. Plus, with Europe’s economy no longer as fragile as it was a couple of years ago, investors ought to be more comfortable stashing their money there.

Investors may still stick to their old scripts. During the debt ceiling imbroglio in the summer of 2011, when the S&P 500 fell 16% in just two weeks, the dollar gained ground against other currencies, and Treasury prices rose. Similarly, at the height of the 2008 financial crisis, investors flooded into Treasurys and the dollar, even though the U.S. was ground zero for the trouble. Habits can be hard to break.


Korea Standoff Won’t Stop Trump Trade War

By Patrick Watson


What do freight trains, oil supertankers, and the Trump administration’s trade plans have in common? Once they get going, they’re pretty much unstoppable.
 

President Trump wants to punish nations he thinks treat US companies unfairly, and China is first on his list. The North Korean missile situation is complicating matters. Trump openly says his position on trade depends on China’s willingness to help rein in North Korea.
 

It’s taking longer than he’s planned, but rest assured, serious trade actions are coming—and they will have a major economic and market impact.
 

Now is the time to fasten your seat belt.
 

Photo: AP

Opposition Buzz Saw

Last month, I explained how “Trade and National Defense Are Now the Same Thing.” At that point, the Trump administration was threatening to impose steel tariffs and import quotas, using a 1962 law that lets the president do this to protect US national security.
 

The Commerce Department report that would have justified this action was originally due at the end of June. They missed that deadline, for unknown reasons.
 

Did the Trump administration back down because other countries threatened retaliation? Maybe.
 

At the recent Camp Kotok economics retreat, I spoke with someone involved with US trade policy, especially as it affects China. I asked what happened to this “Section 232” action that had seemed so imminent.
 

My source said the White House ran into a veritable buzz saw of opposition, mainly steel-using businesses and their supporters in Congress.
 

The opponents appear to have succeeded, for now, but they haven’t killed the idea.
 
US law clearly gives the president this authority, and he doesn’t need permission from Congress. He can always change his mind. This is a strategic adjustment, not a policy change.
 

And that’s not the only loophole the new White House strategy tries to exploit…
 

Photo: AP
 
Intellectual Infringement
 
On Monday, President Trump signed an executive memorandum asking US Trade Representative Robert Lighthizer to investigate Chinese IP infringements under Section 301 of the Trade Act of 1974.
 

This section might allow the president to retaliate against Chinese intellectual property or “IP” infringements.
 

Presently, China forces foreign businesses to share private business information—like software source code—with Chinese joint venture partners. That confidential information often finds its way into the wrong hands, subsequently appearing in counterfeit products.

 
This is a serious problem, so it’s good that the president wants to stop it. But how he stops it makes a difference.
 
There’s no doubt about the outcome of this “investigation.” This sword of Damocles will hang over Chinese heads as US negotiators demand stricter IP protections. If they comply, the sword will magically disappear. If not, it may drop onto their heads.
 
Distract and Delay
 
Whether it happens under Section 232 or 301 or some other law, the Trump administration clearly intends to crack down on trade practices it considers unfair.
 

For the moment, nothing too serious is happening. North Korea is a higher priority, and the White House has plenty of other distractions.
 

That’s good news for investors because it means we have more time to modify our portfolios so they align with this new landscape.
 

Last week, I told Macro Growth & Income Alert readers to get ready for “Globalization 2.0.”
 
The present international flow of goods and services will soon hit a barrier at the US border.

 
While President Trump may be the one who pulls the trigger, this has been building for a long time. Many countries are unhappy with current trade arrangements. They want something else—and I think they’ll get it.
 

Photo: Ben W. via Flickr

Two Trading Blocs

Globalization 2.0 has some important investment implications.
 

Instead of one big, worldwide “sort of free”-trade zone, I think we will have two trading blocs. They will be:

  • The United States, and

  • Everyone else.

Trade will be relatively free within the US and outside of it. Getting goods across the US border, though, will be difficult and expensive.
 
Right now, the most successful US corporations are exporters that earn most of their revenue overseas. The weaker dollar gives them a tailwind.
 

This will change, for both export- and import-dependent US businesses.
 

Foreign companies with US customers will face a similar problem. As trade barriers rise, US government policies will increasingly put them at a disadvantage to US-based firms.
 

So how do you succeed on that new world map? Here are the two kinds of businesses that should thrive:

  • US companies whose customers and supply chains are mostly within the US.

  • Non-US companies whose customers and supply chains are mostly outside the US.
Any business that depends on goods or services crossing the US border will face real trouble in the coming years, so keep holdings of those stocks to a minimum.
 

The good news: many outstanding businesses are already in position to ride out this storm—and Washington’s political gridlock is giving us more time to find them.
 

Even better news: Companies fitting that profile can outperform even if we avoid a serious trade war. Owning them is an inexpensive hedge.
 

That will be my research focus in the next few months. I suggest you make it yours too.
 
World trade patterns will look much different two years from now.
 

See you at the top,


A Dangerous Game of Chicken

Yoon Young-kwan


SEOUL – So far, the war between US President Donald Trump and North Korean dictator Kim Jong-un over the latter’s nuclear program has been fought only in words. But each turn of the rhetorical screw deepens the risk that, to paraphrase Winston Churchill, “jaw-jaw” could turn into “war-war.”
 

 
Last month, following North Korea’s second intercontinental ballistic missile test of the summer, the United Nations Security Council unanimously agreed to impose new and even stricter sanctions on the tiny country. The response, reported in North Korean state-run media, was a pledge that “strategic steps accompanied by physical action will be taken mercilessly with the mobilization of all [North Korea’s] national strength.”
 
The next day, Trump went off script, asserting that further threats from North Korea would be met with “fire and fury like the world has never seen before.” North Korea immediately did just that, threatening to carry out an “enveloping” strike on the US territory of Guam. Trump shot back that the US military is “locked and loaded.”
 
And, indeed, as this exchange of rhetorical fire has unfolded, the US has reportedly been preparing revised military options for striking North Korea. More ominous, according to a confidential US intelligence report, North Korea has achieved the capability to miniaturize nuclear warheads, and may have as many as 60 bombs. The stakes are rising in Kim and Trump’s game of chicken.
 
It is unlikely that either North Korea or the US actually wants war. But, as the late English historian A.J.P. Taylor concluded, after studying eight great wars since the late eighteenth century, wars have often “sprung more from apprehension than from a lust for war or for conquest.”
 
According to Taylor, many European wars “were started by a threatened power, which had nothing to gain by war and much to lose.” If Taylor were alive to witness the current situation – characterized by fear-enhancing misperception, miscalculation, and overreaction – he would undoubtedly be feeling an alarming sense of déjà vu. The question now is: what can be done to avoid catastrophe?
 
For starters, both the US and North Korea will have to avoid cornering one another. During the 1962 Cuban Missile Crisis, US President John F. Kennedy was firm in his stance that Soviet missiles would not be permitted in Cuba. But he knew better than to pursue a total American victory and a total Soviet defeat.
 
Instead, Kennedy offered a deal that would protect Soviet leader Nikita Khrushchev’s reputation in the eyes of Kremlin hawks: the US would withdraw its missiles from Turkey (which were superfluous already), in exchange for the withdrawal of Soviet missiles from Cuba.

That pragmatic and courageous approach created the necessary space for the two leaders – neither of whom actually wanted a nuclear war – to retreat from the brink without losing face.
 
To bring today’s crisis to a peaceful conclusion, Kim will have to tone down his aggression. But, for that to happen, the Trump administration needs to demonstrate clearly that its goal is not regime change, but policy change – that is, denuclearization – in North Korea.
 
Unfortunately, the signals coming out of the US are still mixed. While Secretary of State Rex Tillerson’s recent remarks on the crisis focused on diplomacy, CIA Director Mike Pompeo has mentioned regime change, and National Security Advisor General H.R. McMaster has raised the possibility of a preventive war.
 
While it is important to put pressure on Kim to bring him to the negotiating table, such pressure must be more carefully calibrated. If the US appears to be seeking regime change or a preemptive war, a panicked Kim will be more likely to lash out. The goal should be relative, not absolute, security for both sides.
 
To this end, it is crucial to maintain rigorous civilian control of the military. World War I broke out largely because of the militarization of the political decision-making process. By not taking national military-mobilization processes off of autopilot, European political leaders allowed for an international chain reaction to occur. Once the march to war had begun, there was not much room left for diplomacy.
 
Yet, far from making space for diplomacy, Trump adviser Sebastian Gorka recently told the press that, “The idea that Secretary Tillerson is going to discuss military matters is simply nonsensical.”
 
But why shouldn’t America’s top diplomat have significant influence over military matters? If this does not change soon, we may, as then-British Prime Minister David Lloyd George wrote of World War I, “[muddle] into war” yet again.
 
South Korean political leaders must also avoid being swept up by this intensifying war rhetoric.

After North Korea’s 2010 sinking of the Cheonan warship and bombardment of Yeonpyeong Island, the South Korean military toughened its rules of engagement. Now, South Korean military leaders are warning that if North Korea attacks again, it will face retaliation not just against the proximate source of those attacks, but against the North’s command leadership. Much like Trump’s threats, this policy is intended to deter North Korea, but it is more likely to fuel a rapid escalation of conflict.
 
China also has a key role to play. On June 10, 1994, at the peak of the first North Korean nuclear crisis, China informed Kim’s father, Kim Jong-il, that it would no longer veto UN sanctions on North Korea, driving the elder Kim to adopt a less antagonistic position. China may be using a similar tactic today, as it declares publicly, via state media, that North Korea should not count on China’s support in a military conflict of its own making.
 
Neither Trump nor Kim seems to have sufficient political capital to spearhead a shift from military threats to diplomatic solutions. Given the far-reaching risks posed by this rapidly escalating crisis, it may well be up to other stakeholders to take the lead. Will China act as the regional stabilizer it so often proclaims itself to be? President Xi Jinping is being tested in this crisis as much as Trump and Kim.