Trump and North Korea: the perils of a pre-emptive strike

As North and South Korean governments meet, US rhetoric about military action on Pyongyang is escalating. Is the president bluffing?

Demetri Sevastopulo in Washington


© AFP


Days before his inauguration, Donald Trump dismissed the claim from North Korean leader Kim Jong Un that he would soon test an intercontinental ballistic missile. “It won’t happen,” Mr Trump tweeted.

But over the past year Pyongyang has made big advances in being able to strike the US with a nuclear weapon. It has tested three intercontinental ballistic missiles and conducted a sixth nuclear test by detonating what may have been its first hydrogen bomb. The result has been a sharp escalation in talk about a US military response.

Just before Christmas, Jim Mattis, defence secretary, warned that “storm clouds are gathering”. General HR McMaster, the adviser who has been the most bellicose of the Trump national security team, says it would be “intolerable” for North Korea to be able to attack the US with a nuclear weapon. After Pyongyang in November tested a rocket with the range to reach anywhere in the continental US, he said the odds of war were “increasing every day”.

Governments around the world are trying to ascertain if the rhetoric is designed to underpin diplomatic efforts, or if Mr Trump genuinely believes Mr Kim cannot be deterred from using nuclear weapons and, therefore, is serious about preventing him from crossing the finishing line.

US Navy aircraft carriers during a training exercise in the Sea of Japan last June © Reuters


“If he means it, we are going to war,” says Michael Mullen, chairman of the joint chiefs of staff under presidents George W Bush and Barack Obama. “What does nuclear war look like? We haven’t had that debate in this country . . . I still don’t put it past Kim Jong Un to use a nuclear weapon in retaliation against us.”

The Trump administration’s rhetoric is the backdrop for the inter-Korea meeting on Tuesday, where North Korea offered to send athletes to next month’s Winter Olympics in Pyeongchang and South Korea said it would consider temporarily lifting some sanctions on the North. Officials in Seoul acknowledge they have been looking for ways to ease the military tensions, an overture that could create difficulties for Washington’s efforts to impose greater pressure on Pyongyang over its nuclear programme.

As US officials try to determine how close Mr Kim is to crossing the nuclear threshold, the Pentagon is updating its plans. At one end of the spectrum, Mr Mattis has said the US has options that would not necessarily spark retaliation against Seoul — a claim that has been met with much scepticism — while Gen McMaster has talked about the possibility of a “preventive war” aimed at eliminating the North Korean missile and nuclear weapons programmes.

In a private briefing for former national security advisers over the summer, Gen McMaster outlined the options, which led some — but not all — of the participants to conclude that the US was more serious about military action than they had thought, according to two people familiar with the event.


North Korean leader Kim Jong Un, right, celebrates what was said to be the test launch of an intermediate range missile at an undisclosed location in North Korea © AP


Military planners have started using phrases such as “kick in the shin” and “bloody nose” to describe action they believe would send a strong message to Mr Kim, but not one so strong as to spark serious retaliation, according to two people familiar with the internal discussions.

Dennis Wilder, a former top CIA analyst, says there are many options that could be interpreted as a kick in the shin or a bloody nose. They include striking an air base or naval facility not associated with the ICBM programme, destroying one of Mr Kim’s homes, hitting a key part of the missile programme or targeting a missile during a test launch.

“Presumably, such a strike would be a one-off attack that is immediately followed-up by a presidential announcement that this is a warning shot and nothing more,” says Mr Wilder.




Many former officials are sceptical, however, that the US could take such limited military action. James Stavridis, former Nato supreme allied commander and now dean of the Fletcher School at Tufts University, who puts the odds of nuclear war at 10 per cent, sees “no military options which would result in fewer than several hundred thousand casualties and perhaps as many as 2m to 3m”.

Mr Mullen says Mr Trump’s team would be taking a huge gamble if it assumed Mr Kim would not respond to an attack. “Our intelligence is not great, so how do we know that they would not respond?” he says. “If I was Japan or South Korea, I would be asking ‘what are we, chopped liver?’ The US is supposed to be protecting them.”

Dennis Blair, a retired admiral who in his former role as head of the US Pacific Command had experience dealing with war plans for the Korean peninsula, argues that the US has three possible options for military action.

Mr Blair, who also served as director of national intelligence, says the second category entails moving significant military assets to the region to scare Mr Kim into thinking that an attack was imminent. In addition to an uptick in aerial exercises over the peninsula, the US recently conducted joint exercises with three aircraft carriers in the western Pacific Ocean that some interpreted as training for an attack.

In 1994, Mr Blair was commanding the Kitty Hawk carrier battlegroup when he was ordered to sail to the peninsula while the Clinton administration was considering a strike on North Korea. “We steamed around for three months. We were pulling out the war plans, checking our targets every day,” he says. “I always thought that had a strong effect on the North Koreans.”

The third category would be a pre-emptive strike, ranging from targeting a test missile during launch to the kind of major attack outlined by Gen McMaster. Mr Blair says the latter was the riskiest as there was no guarantee the US could find and destroy the whole nuclear programme. “The chances that you’re able to destroy everything in an air campaign of three to five days are low. It would be a brave director of national intelligence who stood in front of the president and said we know where it all is.”





North Korea has made it harder for the US to locate its weapons by storing many of them underground. “North Korea has been the world’s greatest importer of mining equipment,” says Wallace Gregson, a retired general and former top Pentagon Asia official. It is also making progress building mobile missiles that are harder to detect.

William Fallon, another former head of Pacific Command, worries about the loose talk about military action. “Air strikes are essential [to a military operation] . . . the idea that you can do that and nothing else is nonsense — that has been proven again and again,” he says. “If we’re serious that we will not allow North Korea to have a nuclear capability, then you better be prepared to go all the way, and I don’t know how you can do that without sending ground tropos.

Given the risks, some analysts are sceptical that Mr Trump would launch the kind of attack that could spark a big conflict. General Joseph Dunford, chairman of the joint chiefs, said in July that war on the peninsula would lead to “a loss of life unlike any we have experienced in our lifetimes”. But he also said that it was “unimaginable” to let North Korea have the capability to hit the US with a nuclear weapon.

Gen Dunford and Mr Mattis have both warned North Korea about the kind of military response that would follow any attack on the US, but they have also stressed the strong need for diplomacy.

“I can see a lot of bluster . . . but when the North Koreans don’t back off, I can’t imagine Dunford and Mattis in the Situation Room saying the risk of nuclear, chemical and biological weapons is worth it,” says Michael Green, a former Asia adviser to George W Bush.



The critical question for the Trump administration is to assess whether Mr Kim would risk using nuclear weapons in the knowledge that it would trigger the end of his regime and, probably, his life. However, North Korea has long been an incredibly tough place for US spy agencies to glean intelligence.

Jung Pak, a North Korea expert at the Brookings Institution who until recently was a CIA North Korea analyst, says one problem in analysing Mr Kim was that he had shown no interest in talking to foreign leaders. “He hasn’t travelled, as far as we know, in the past six years,” says Ms Pak. “It has been pretty much Fortress Korea.”

In 2014, James Clapper, then director of national intelligence, went to Pyongyang to seek the release of two Americans, but did not meet the North Korean leader. In 2012, the year after Mr Kim assumed power, Michael Morell, then deputy CIA director, made a secret mission to North Korea, three people familiar with the previously undisclosed trip told the Financial Times.

One of the people says Mr Morell wanted to establish an intelligence channel that would provide insight into the new leader, but he was not given a meeting with Mr Kim. The CIA declined to comment.

US officials have also been grappling with the question of what is Mr Kim’s real goal in pursuing nuclear weapons. While some argue that he simply wants a deterrent to prevent a US attack, others argue that he sees the weapons as a tool to unify the Korean peninsula.

Chris Hill, a retired diplomat who was the US negotiator in six-party talks with North Korea during the Bush administration, says the Kim dynasty had been trying to develop nuclear weapons for decades, but the idea that North Korea would launch a nuclear strike was “ridiculous” since it would be suicidal. “This is not about Trump or Bush hurting their feelings. This is a long-term effort to create the capacity to mould the peninsula into what they want.”

Ms Pak says that because Mr Kim’s father and grandfather had pursued nuclear weapons so assiduously, they were “part of his DNA”. But she says he was also conscious of the case of Muammer Gaddafi, the Libyan leader who was killed by opposition rebels several years after he gave up his nuclear weapons programme. “The fact that he is so personally invested means on multiple levels that he can’t give it up,” she says.





Richard Fontaine, president of the Center for a New American Security, says he hoped that the US military talk was simply a rhetorical form of gunboat diplomacy. “If I’m wrong and they mean all these things when they say Kim is not rational or deterrable, then it almost certainly leads to war, because I don’t think the North is willing to give up its entire nuclear weapons programme.”

Tim Keating, another former head of Pacific Command, says Mr Mattis and secretary of state Rex Tillerson were “doing a wonderful job” tamping down the more bellicose rhetoric coming from some officials. “I wouldn’t have said what McMaster said,” Mr Keating says. “I hope that calm heads would prevail and explore any and every diplomatic option short of military activity.”

While some hope Mr Mattis will stave off a catastrophic conflict, he toohas given pause for thought. After warning troops in December about gathering storm clouds, he urged them to read This Kind of War, a book about how the US was unprepared for the 1950 Korean war. But after saying there was still time for diplomacy, he ended on a solemn note: “There is very little reason for optimism.”


View from Seoul: South Koreans worry over ‘erratic’ US leader

Long accustomed to threats from north of the border, South Koreans in 2017 found a new source of concern in an unlikely location: the White House.

The bellicosity of President Donald Trump and his top advisers has unnerved South Koreans, particularly the roughly 25m who inhabit the Seoul metropolitan area — only 50km away from Pyongyang’s amassed artillery and ballistic missile launchers. For them, Mr Trump — not North Korean leader Kim Jong Un — presents the real threat to the Korean peninsula.

“His comments about a military option against the North are troublesome to ordinary South Koreans, who are strongly opposed to any kind of war on the peninsula,” says Kim Yong-hyun, a professor of North Korean studies at Dongguk University.

“South Koreans think Trump is too explicit about placing US interests first without considering South Korea’s position in dealing with North Korea . . . the overall perception is not friendly or positive,” he adds.

Such remarks are likely to cause concern for both US and South Korean officials. South Korea has a history of anti-American sentiment. When Mr Trump visited Seoul in November, protesters turned out in force. The public pressure was undoubtedly a factor on the mind of Moon Jae-in, South Korea’s president, when he sought public assurances from Mr Trump that Seoul would be not be excluded from planning on North Korea.

A rise in anti-US sentiment could complicate the job of General Vincent Brooks, commander of US Forces Korea, which maintains about 30,000 troops in South Korea as a buffer against aggression from the north.

Nam Sung-wook, professor of diplomacy and security at Korea University, says Mr Trump’s tweets have caused South Koreans to doubt his capacity as a leader and that his comments are often viewed as gossip.

“South Koreans see him as an erratic leader, different from most US presidents. Even if he keeps talking about a military option against the North, such comments do not carry a lot of weight as he has lost some credibility here,” he says.


Bryan Harris in Seoul


Technology

What’s Blowing Up the Bitcoin Bubble?



Investors and speculators are biting into bitcoin — in a big way. The price of the cryptocurrency surged by nearly 1,900% in 2017, to an average high of $19,499 on December 15 across major bitcoin exchanges, before plunging down to just under $14,000 by year’s end, according to blockchain.info. The ascent is striking especially since bitcoin emerged just eight years ago, the creation of a mysterious person or group of people named Satoshi Nakamoto. In 2009, bitcoin was worth zero.

Bitcoin’s popularity persists even though it has no intrinsic value per se. It is not backed by gold or physical assets, nor does it pay interest or dividends. Bitcoin cannot be used as money in most places. That’s why its skyrocketing price is causing concern. Fed Chair Janet Yellen called bitcoin a “highly speculative asset”; JPMorgan Chase CEO Jamie Dimon said it was a “fraud” although he has since softened his stance; billionaire Warren Buffett called it a “mirage,” while Vanguard founder Jack Bogle told investors to “avoid bitcoin like the plague.”

“There has been a lot of hype and excitement, and that clearly has driven the price possibly away from the real utility value of the network and much more into the speculative realm,” said Christian Catalini, a professor of technological innovation, entrepreneurship and strategic management at MIT, on the Knowledge@Wharton show on SiriusXM channel 111. “The floor value of bitcoin is zero. Bitcoin only has value because people believe and agree it has value.”

Much of bitcoin’s stratospheric rise was achieved this year. For years, bitcoin traded in a much lower range due to its novelty, a spate of negative news such as the 2014 hacking of the now-defunct Mt. Gox bitcoin exchange, and early link to criminal activities (Silk Road). Those same concerns are still around — a South Korean digital currency exchange recently closed down after suffering its second cyberattack. However, bitcoin’s adoption by major institutions gives it a sheen of market credibility.

This month, the CME Group (Chicago Mercantile Exchange) and CBOE Global Markets (Chicago Board Options Exchange) began trading bitcoin futures. Nasdaq also plans to launch bitcoin futures in the first half of 2018, according to The Wall Street Journal. The New York Stock Exchange and the Cboe have filed with the Securities and Exchange Commission to list bitcoin ETFs (exchange-traded funds). “What you’ve been seeing recently [in bitcoin’s price increase] is fostered by a lot of momentum around institutional investors getting more into bitcoin,” Catalini said.

Institutional Players

The participation of these major exchanges in bitcoin “suggests a legitimacy of this technology, which I think is a valuable and important thing,” said Kevin Werbach, Wharton professor of legal studies and business ethics. Crytocurrencies represent “potentially a new investment asset class, and the way that it becomes … legitimate and the way investors are protected against fraud and so forth is to have traditional institutional structures and mechanisms like derivatives available.” (Listen to the full podcast of the SiriusXM show featuring Werbach and Catalini using the player above.)

However, even with institutions boosting bitcoin trading, it doesn’t fully explain the size of the price increases. “It’s not clear to anyone why bitcoin and some of these other cryptocurrencies have spiked this year,” Werbach continued. Possibly it could be people’s “fear of missing out, or fraud and manipulation. There’s evidence that there are various kinds of funny business going on at some exchanges that trade bitcoin, especially outside the U.S.”

While the NYSE and Cboe have applied to list bitcoin futures-based ETFs, the SEC has rejected bitcoin ETFs in the past. “Not because the organizations proposing the ETF in the U.S. did not do good enough governance, but because the price was so dependent on things outside their control,” Werbach said. But whether bitcoin prices are up due to good or bad actors, the rate of the ascent should give people reason for concern, he added.

Cryptocurrencies are “highly speculative assets,” Catalini added. “Here you’re investing not only in very early stage projects but also in very early stage technology. Many of these assets may not exist five or 10 years from now, but some may be large successes.… We’re really witnessing the dawn of a new industry.”

Contrarian View

But some believe that bitcoin is not in a bubble. Bitcoin magazine argues that it has “very different fundamentals than early internet stocks and a much more promising growth trajectory.” The October 2017 article cites the following reasons for a bullish view: Bitcoin is gaining acceptance as legal tender, such as in countries like Japan; more merchants are taking it; bitcoin is becoming a way for people to store their wealth in troubled economies such as Venezuela; bitcoin has just gone mainstream with most people likely having heard of it; and bitcoin has a limited supply of only 21 million, which restricts dilution.

However, bubbles are often only recognized in hindsight. “A bubble is only a bubble when it pops,” Werbach said. “Early investors only see it going up. We could see it go down very quickly as well.” As such, the big swings in the price of bitcoin makes it tough to use as money. “If you want to use the currency for payment, you don’t want the price to go up and down a lot.” Imagine holding currency worth $100 that dives to $70 in a day. It would create all sorts of instability.

“It remains to be seen how much of a function bitcoin itself will serve,” Werbach added. “It could be a reserve currency asset or it could be something volatile or it could eventually be tamed by these traditional financial mechanisms, which exist to bring more liquidity into the market.” So is bitcoin a good investment? “I don’t know the answer to that,” he said. But “long term, is this basic technology of cryptocurrencies something real that’s going to be a core part of the financial system? Absolutely.”

Global Standing of Cryptocurrencies

Meanwhile, regulators, central banks and countries are ramping up their scrutiny of cryptocurrencies. France wants the world’s top economies to debate bitcoin regulation at the G20 summit next year, according to Reuters. Countries that have banned cryptocurrencies or initial coin offerings include China, Iceland, Ecuador and Bolivia. Those that have accepted or are regulating them include Canada, Japan, Poland, Ukraine and Australia.

Central banks around the world are testing their own digital currencies. China has completed its trial run while Japan, Sweden and Estonia are developing their own as well, according to CNBC. Japan has J-coin, Sweden has E-krona and Estonia’s is called Estcoin. Also, the U.K., Uruguay and Kazakhstan are interested. Singapore is wrapping up its own digital currency trial in 2018. In the U.S., the president of the Federal Reserve Bank of New York said the Fed is exploring the same idea but it is still “very premature.”

Is there room for multiple digital currencies? “I think so,” said Wharton visiting professor Shimon Kogan, who teaches a course on fintech that includes the blockchain and cryptocurrencies. However, “clear winners haven’t emerged yet.” As for consumer adoption, it all depends on how user-friendly the interface is on top of the technology. “If you’re a customer of Citibank and Citibank now uses this technology to allow you to transfer money to your friend in Europe in real time and a lot cheaper,” he said, “you don’t care how they do that necessarily, right?”

Blockchain over Bitcoin?

Kogan said the cryptocurrency community is divided on whether bitcoin is a “side show or the show.” However, he believes that the “fundamental breakthrough is not necessarily bitcoin but the blockchain technology,” which is the distributed ledger that tracks these transactions. Entries cannot be changed and are transparent to all parties involved. Typically, there is no central authority like a government or a bank controlling it.

“Serious players are investing” in blockchain technology, Kogan said. “It’s hard to point to a serious financial services company or consulting company or technology company that is not already investing quite a bit into this.” Some are doing it through bank consortiums, he added.

One such consortium is R3, Kogan said. It works with more than 100 banks, financial institutions, regulators and other stakeholders worldwide to develop its own distributed ledger called Corda. R3 and other groups are all experimenting with different protocols that are independent of bitcoin, Kogan said.

The blockchain’s biggest impact on financial services is to make back office functions more efficient. “It’s pretty clear that this kind of almost 19th century way that [back office tasks are] being handled is just way too slow and way too expensive,” Kogan said.


Saving America from Trump’s Tax Reform

Laura Tyson , Lenny Mendonca

Pedestrians look at diamonds in a window display along 5th Avenue

BERKELEY – US President Donald Trump and congressional Republicans had an opportunity – and a responsibility – to reform the US tax code to address three major economic challenges: slowing growth, rising inequality, and a looming fiscal crisis. Sadly, they shirked their responsibility by passing a bill that squandered this opportunity.

At a time when US public debt as a share of GDP is already at a post-war high, the legislation will add another $1.5-2.2 trillion to the deficit over the next decade. At a time when income and wealth inequality is soaring, an estimated 80% of the tax cuts will go to the top 1% by 2027. And at a time when the economy has been growing steadily for 33 quarters and is approaching full employment, the legislation will have only a modest effect on growth.

To be sure, a significant cut in the corporate tax rate was long overdue. The legislation will likely stimulate investment and encourage domestic and foreign companies to do business in the United States. But, by an overwhelming majority, economists predict that the increase in the growth rate will fall far short of the annual gain of one percentage point (or more) hyped by Trump and his economic advisers.

Moreover, there is no credible evidence to support the Trump administration’s declaration that the trickle-down benefits of faster growth will “increase average household income in the United States by, very conservatively, $4,000 annually.” A large body of economic research shows that, at most, 20-25% of the benefits of corporate tax cuts will accrue to labor; the rest will go to shareholders, about one-third of whom are foreign. The biggest beneficiaries will be the top 1% of domestic households which own about half of outstanding shares.

Nor is there evidence to support the administration’s claim that the legislation will pay for itself. As many of those who voted for it well know, the expected gains in growth will yield at most about one-third of lost revenues. But they are playing a cynical game. By reducing revenues now, they will be in a position to justify cuts to services benefiting lower- and middle-class Americans down the road – all in the name of “fiscal responsibility” and “entitlement reform.”

Worse yet, the tax legislation is riddled with provisions that will dramatically increase inequality and limit economic and social mobility. By cutting the top income-tax rate, doubling the threshold at which inheritances are taxed, and lowering taxes on pass-through businesses, the legislation amounts to a handout for the wealthy, paid for by the middle class and future generations.

The legislation also prioritizes investment in physical and financial capital over what the US really needs: more investment in human capital and lifelong learning to help workers and communities cope with the disruptive effects of automation and artificial intelligence. Instead of expanding the earned income tax credit to encourage work, the legislation will, for the first time in American history, impose a higher tax rate on employment income than on income earned by proprietors and partnerships.

In addition, the legislation is an unabashedly partisan attack on Democratic-leaning states and cities. For example, the bill imposes an across-the-board limit on mortgage deductions, which will have a disproportionately adverse effect on people living in high-cost Democratic strongholds such as New York and California. Currently, the median price for a home in San Francisco is $1.5 million; in Kansas, a reliably Republican state, it is $187,000.

And if that weren’t bad enough, the bill intentionally penalizes higher-tax states like California and New York, by capping the federal deduction for state and local income and property taxes. Ironically, this provision will hurt growth, by raising the marginal tax rate on millions of workers in the country’s most productive locales and industries. And it will make it harder for state and local governments to finance necessary investments in innovation, infrastructure, and higher education – investments that are largely the states’ responsibility but are pillars of overall US competitiveness.

A majority of Americans already recognize that the tax law is deeply flawed and full of false promises. After failing to repeal the Affordable Care Act (Obamacare), congressional Republicans rammed through a complicated tax package that will please their wealthy donors, but disappoint many of their voters. Given the tax law’s unpopularity, it will be interesting to see what happens in the midterm congressional elections this November.

In the meantime, progressive federalists in forward-looking states and cities must get to work picking up the pieces of the wreckage the federal government is leaving in its wake. Keep an eye out for the many ways states will re-orient their tax regimes away from income taxes, and toward property and sales taxes, including on services, which account for more than 70% of economic activity but have traditionally been taxed lightly at the state and local level.

In some states, there is even talk of reclassifying state taxes so that they qualify as tax-deductible charitable contributions. Similarly, some have proposed replacing state income taxes with payroll taxes that employers can deduct at the federal level. Keep an eye out as well for a sizeable increase in outcome-oriented state and local funding for efforts to reduce homelessness and reform the criminal-justice system.

Owing to its high marginal income tax rates and constraints on residential property taxes, California will likely be at the forefront of fiscal innovation. Already, multiple reform proposals are circulating, including a ballot initiative to amend Proposition 13 that would dramatically ease existing restrictions on commercial-property taxes. And with the Democrats in full control of the state’s government, measures to counteract the federal law are almost certain to be adopted.

California Governor Jerry Brown, for his part, has called the Republicans’ legislation a “tax monstrosity.” He’s right: it’s dreadful policy. Other countries that have reduced taxes on mobile corporate capital have paid for the cuts by increasing value-added taxes and taxes on carbon, dividends, capital gains, and inheritances. Trump and the Republicans, by contrast, chose to cut taxes on both businesses and their owners, while blowing an unsustainable hole in the federal budget, exacerbating inequality, and imposing new burdens on the most productive parts of the country.

Still, necessity is the mother of invention. For progressive federalists in US cities and states – the laboratories of democracy – it is now more necessary than ever to step up and start innovating.


Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley, and a senior adviser at the Rock Creek Group.

Lenny Mendonca, Senior Fellow at the Presidio Institute, is Senior Partner Emeritus at McKinsey & Company.


The Global Economy’s Output Gap Has Closed

For the first time in a decade, the global economy appears to be operating at its potential, according to World Bank economists

By Josh Zumbrun

Commuters board a train in Berlin. The euro area saw better-than-forecast growth in 2017, part of a broader international uptick. Photo: Krisztian Bocsi/Bloomberg 



A broad uptick in economic growth around the world in 2017 has led economists at the World Bank to conclude that, for the first time in a decade, the global economy is operating at its potential.

“The year 2018 will likely mark a turning point for the global economy because, for the first time since 2008, the negative global output gap is expected to be closed,” the World Bank said in its flagship report on the global economy, known as the Global Economic Prospects report.


At the root of this observation is a calculation that the world economy performed far worse than its potential in the decade after the global financial crisis that sent most of the world’s economies into severe recession. This difference between the economy’s actual performance and its potential is known as the output gap. When output gaps are large, as they have been the past 10 years, it indicates weak economic demand, spare capacity of businesses and factories, widespread unemployment and a major drag on inflationary pressures.


CLOSING THE GAP
The output gap, defined as the difference between actual global output and
potential output, has closed for the first time in a decade.

GLOBAL OUTPUT GAP AS PERCENTAGE OF POTENTIAL GROSS DOMESTIC PRODUCT



Although the overall global output gap has closed, some countries are still operating below potential, especially commodity exporters. Others, especially the world’s advanced economies, appear to be somewhat “above potential,” meaning that the economy has more demand than is sustainable in the long-run. Excess demand is likely to lead to inflationary pressures, an increase in asset prices and pressure on central banks to raise interest rates.

Closing the output gap could trigger a broad change in economic conditions around the world.

For much of the past decade, inflation around the world has been weak, with many nations fearing they could slip into deflationary spirals. A large global output gap meant that countries faced little price pressure from the rest of the world. Central banks such as the Federal Reserve or European Central Bank have had the luxury to move slowly in reversing years of unprecedented expansionary monetary policy, because inflation pressures were so low. Now, international inflationary pressures could be on the return.

“Slack in the rest of the world forces firms to keep costs at a certain level,” said Ayhan Kose, the director of the World Bank’s Development Economic Prospects Group. “In 2018, that is disappearing.”

With the gap only narrowly closed, and uncertainty around that estimate, Mr. Kose cautions that the inflationary pressures could remain modest in 2018.


BEATING EXPECTATIONS
Growth around the world has come in higher than forecast.

Percentage change in real gross domedtic product vs estimates for the year made in june






The closing of the gap owes to a broad-based improvement in growth around the world.

In the World Bank’s latest estimates, U.S. and Japanese economic growth in 2017 came in 0.2 percentage points stronger than in the previous round of estimates in June. China’s growth beat June’s estimates by 0.3 percentage points. Growth in the euro area came in 0.7 percentage points stronger.

Overall, the world’s economy grew 3% in 2017, the World Bank said, up from the June estimate of 2.7%, and a considerable strengthening from the 2.4% growth that was logged in 2016. The World Bank forecasts that growth will pick up a bit more in 2018, rising to 3.1%.

Despite a growth surge and closing output gap, however, the report’s authors caution that risks to the economy remain significant, with potential growth slowing in many economies due to aging demographics, slowing productivity growth and less investment than in the past. Adding to those risks are global central banks shifting to tighter monetary policies, and many governments around the world with unsustainable fiscal outlooks.


Donald Trump and Brexit are no longer identical twins

Britain’s approach to the world more closely tracks the EU than America

Gideon Rachman


Images from Theresa May's early visit to the newly annointed US president became a symbol of the closeness of Trump’s America and Brexit Britain - but the countries have drifted apart over time © Getty

The Brexit vote and the election of Donald Trump will forever be linked in history. The two events took place within a few months of each other. Both were populist revolts that appealed to similar constituencies.

After Mr Trump’s election, Theresa May, Britain’s prime minister, was the first foreign leader to visit the new US president. A photograph of the two leaders walking hand in hand quickly became a symbol of the closeness of Trump’s America and Brexit Britain. For mainstream politicians in Europe, “Trump and Brexit” became shorthand for the forces that they were trying to combat.

But, as the months have passed, it has become clear that Trump and Brexit are not, in fact, identical twins. They are more like distant relations who are growing further apart with the passage of time.

The differences between the Trump phenomenon and Brexit are a matter of both style and substance. Mr Trump violates the conventional expectations of how a US president should behave on a daily basis. Mrs May, by contrast, is scrupulously correct in her behaviour. She is about as likely to attend an EU summit in her pyjamas as to tweet that she is a “very stable genius”.

Early in her period in office Mrs May suggested hopefully that she might get on with Mr Trump because “opposites attract”. But that pretence has now been dropped. When the president retweeted posts from a British far-right group, Mrs May was forced to condemn him. Predictably Mr Trump lashed back, although he initially directed his ire at the wrong Theresa May, lambasting a British housewife with just six Twitter followers.

The slapstick comedy of this incident obscured a serious political difference. In office, Mr Trump has embraced anti-Muslim rhetoric that Mrs May has carefully avoided. That difference is part of a broader divide between the radical nationalism of Mr Trump and the cautious and conventional globalism of Mrs May.

For although many Europeans and Remainers are convinced that Brexit is a nationalist spasm, and little else, the May government is determined to present it in a different light. The prime minister’s argument is that leaving the EU is an opportunity to forge a new future as “Global Britain”. She has emphasised her support for the international, rules-based, liberal order. By contrast, Mr Trump remains a proud, “America First” nationalist who is deeply suspicious of all international institutions, from the UN to the World Trade Organization.

These very different international visions have led to policy disputes between Brexit Britain and Trump’s America. Neither side has much interest in playing up these differences. But on a succession of issues, Britain has sided with the EU rather than the US. When the Trump administration repudiated the Paris climate accord, the UK stuck with the agreement and the European consensus. The same pattern repeated itself when the White House announced its intention to move the US embassy in Israel to Jerusalem. And while Mr Trump is itching to rip up the Iran nuclear deal, Britain has joined the rest of the EU in supporting it.

Perhaps the most consequential policy division is over the WTO. The Trump administration is quietly hobbling the world trade body by blocking appointments to its court. But a functioning WTO is critical to Mrs May’s plans to make Brexit work. The UK has stressed that, if it cannot strike a new trade deal with the EU, it will fall back on WTO rules. Mr Trump’s agenda could wreck the body that Britain is relying upon as its insurance policy.

Some of the ideologues behind Brexit remain wedded to the idea that Britain is part of an “Anglosphere” of English-speaking nations, with the US and the UK at its heart. But Britain’s foreign policy choices since the Brexit vote suggest that the UK is actually more comfortable with the Franco-German worldview than the American one. The repeated low-key clashes between the May government and the Trump administration emphasise the extent to which Britain is now “in play” as a foreign policy actor. If the Brexit negotiations come to a reasonably amicable conclusion and Mr Trump remains in the White House, post-Brexit Britain could easily end up closer to the EU than the US.

The more ardent Brexiters would argue that this is simply because the British establishment has failed to understand the populist moment. But opinion polls suggest that Mrs May’s policy decisions reflect wider sentiment in Britain. A Globescan survey last year showed that only 33 per cent of Britons believe that the US has a “mainly positive” impact on world affairs; compared with 84 per cent positive ratings for Germany and 66 per cent for France. Some 79 per cent of Brits trusted President Barack Obama’s judgment, compared with 22 per cent who trust President Trump.

These numbers underline the differences between Brexit Britain and Trump’s America. British political debate since the Brexit vote has been bitter, but it has been conducted in largely conventional terms. By contrast, Mr Trump’s White House increasingly feels like a deranged episode from a reality TV show. The vote for Brexit and the election of Mr Trump may have sprung from similar instincts. But they have ended up in very different places.


Moderate Voters, Polarized Parties

The author of ‘Unstable Majorities’ argues that if the electorate seems fickle, it’s because the politicians are too ideological.

By James Taranto


Most observers of American politics predict 2018 will favor the Democrats. The party has a good chance of taking control of the House in November, and even a Senate majority is within reach, although Democrats are defending three times as many seats in the upper chamber as Republicans are.

Here’s a safer prediction: If the Democrats do triumph on Nov. 6, they and their supporters will emerge triumphalist, proclaiming their majority permanent and President Trump a lame duck. Ten months in advance, Morris P. “Mo” Fiorina has a bucket of cold water to throw on such claims.


Mr. Fiorina—no relation to 2016 presidential candidate Carly Fiorina or her husband—is a 71-year-old Stanford political scientist and author of a new book, “Unstable Majorities: Polarization, Party Sorting and Political Stalemate.” As the title suggests, he believes the U.S. has entered an era in which no party can hold a majority for very long. “We can change our pattern of government every two years,” he tells me on a recent visit to the Journal’s offices, “and we started doing that.”

Did we ever. The party controlling the House, Senate or White House changed in seven of the nine elections between 2000 and 2016—the only exceptions being the presidential re-election years, 2004 and 2012. “I sort of trace it back to ’92, the end of the Republican presidential era, and then ’94 is the end of the Democratic congressional era,” Mr. Fiorina says.

Those were long eras. Republicans held the White House for 20 of the 24 years following the 1968 election. The Democrats dominated Congress for the better part of a lifetime: During the 62-year period after the 1932 election, the party had a majority in the House for 58 years and the Senate for 52 years. The Democrats took the House in 1954 and held it for 40 years straight.

                    Illustration: Ken Fallin 



Those old enough to remember the decades before the ’90s, then, may tend to see permanent majorities around the corner because they expect a return to normalcy. Mr. Fiorina, by contrast, argues that frequent shifts in political control are now the norm because of the way the parties have changed. He rejects the common view that American voters are “polarized.” Instead, he says, the parties have become polarized, in a process he calls the “sorting” of the electorate.

“We have these two now cohesive, different parties,” he says. Democrats and Republicans today are as ideologically distinct as “the Social Democrats and the Christian Democrats in Europe at the height of their power in the 20th century. And the problem is, we’ve got a much more heterogeneous country, and there’s only two of them, and they just don’t fit the electorate.”

He arrives with a PowerPoint presentation that visualizes the data behind his theory. A pair of bar graphs show the ideological distribution of lawmakers in the 87th Congress (1961-63) and the 111th (2009-11). In both eras Democrats were the liberal party and Republicans the conservative one. But the pattern is markedly different: In 1961-63, both parties’ lawmakers tended to cluster in the middle. In 2009-11, there were two clusters—Democrats to the left, Republicans to the right. “There’s no longer any overlap at all,” Mr. Fiorina says. “The center is empty. That hasn’t happened in the electorate.”

A line graph illustrates the electorate’s continuity. The share of Americans identifying as politically moderate has remained fairly constant—around 40%, and usually a plurality—since at least 1974. In the same period, another chart shows, independents overtook Democrats as the biggest partisan grouping. As the parties drifted from the ideological middle, centrist voters disaffiliated from the parties.

That creates what Mr. Fiorina calls “the ping pong pattern” of unstable majorities. One party manages “to win, narrowly, and then they immediately respond to their base. So Bush says we’re going to have personal Social Security accounts, and voters—some say, ‘I didn’t vote for that.’ Or Obama says we’re going to do government health care, and a lot of them say, ‘I didn’t vote for that.’ ” Lawmakers from the party in power “suffer for it in the next election, when they lose the marginal voters,” as Republicans did in 2006 and Democrats in 2010.

That seems plausible enough, but there’s an obvious complication: Most legislation that makes it through Congress, even on a party-line vote, is not all that extreme ideologically. Take health care. Mr. Fiorina pulls up a chart titled “Issue Centrists Still Dominate,” based on data from the American National Election Studies. It shows that in five issue areas, the centrist position is by far the most popular.

“This would be single payer right here—these 12%,” Mr. Fiorina says, pointing to one end of the health-care distribution. At the other end, the “leave-everything-to-the-market people” are approximately as numerous. The peak, at 28%, is right in the center. “On issue after issue, it doesn’t matter what you ask, people sort of clump up in the middle,” he says. “Goldilocks—they want some of both.”

But isn’t that what they got with ObamaCare? The Affordable Care Act shifted policy leftward, but nowhere near the extreme of single payer. Its central element, the recently repealed individual mandate, was first proposed by the Heritage Foundation in 1989 as a “market-based” alternative to more-statist approaches, including outright socialization.

Similarly, the tax reform Congress enacted last month won only Republican votes, but it was hardly an exercise in ideological extremity. Even Barack Obama had said corporate rates should be lower. (As for George W. Bush’s Social Security idea, it was never written into legislation.)

Mr. Fiorina answers this conundrum by referring me to the work of another political scientist, Frances Lee of the University of Maryland. She has a theory to explain why the minority party balks. “Frances talks about how if you have two closely balanced parties that are fighting for the majority in every election, they change their strategy, and this all becomes position-taking and trying to embarrass the other party, and it’s not about legislating,” he says. “They’re perfectly prepared to shift positions on a dime if it embarrasses the other party, because the payoff now is the electoral victory and not legislative.” To judge by their book titles, Mr. Fiorina and Ms. Lee are kindred spirits. His is “Unstable Majorities,” hers “Insecure Majorities: Congress and the Perpetual Campaign.”

If unstable majorities are a problem, what might be the solution? In parliamentary systems with proportional representation, a multiplicity of parties represent a spectrum of views and often govern in coalitions. That won’t work in the U.S., Mr. Fiorina says, because “the majoritarian electoral system and the Electoral College” ensure that “only two parties can really compete.”

What should a party do if it aspires to an enduring majority? “Go back to being a more sort of open—no litmus tests,” Mr. Fiorina advises. “The Democrats are all talking about their chances of winning next time, but if you keep trying to run antigun and pro-choice candidates in areas like West Virginia . . . you’re committing suicide.”

This advice has one crucial shortcoming, Mr. Fiorina acknowledges: “They can’t do it.” One reason has to do with money. “The donors are most ideological of all,” he says. In the 1970s and ’80s, “a big majority of contributions to congressional races came from individual contributions within your district, and now the money is coming from outside. Texas is an ATM for Republicans, California and Manhattan for Democrats.”

He adds that “30 years ago, an Ohioan Republican and an Oregon Republican would have faced very different primary electorates that run different kinds of races. Now, you look at their campaigns—they’re going to be the same. They’re getting their money from the same kinds of people.” The Republican in Oregon, a more liberal state, is likely to prove unelectable. For this problem there is probably no remedy. “The only thing I can see mattering would be unconstitutional,” Mr. Fiorina says—to wit, a law requiring that “all campaign contributions have to come from within the jurisdiction of the race being held.”

Then again, there is Donald Trump. He won the Republican presidential nomination against several opponents with more money and far stronger ideological credentials. His victory demonstrates, according to Mr. Fiorina, that partisan sorting “at the Bill Kristol level”—meaning among pundits and intellectuals—“is way higher than the sorting at the level of even the primary voters.”

Mr. Fiorina holds out some hope that Mr. Trump will break the ping pong pattern. “In the book, I characterize Trump first as a de-sorter and then as sort of a disjunctive president, and in Silicon Valley terms a disrupter,” he says. “I thought if there’s a positive on Trump, it would be his potential to disrupt both parties.”

So far, though, Mr. Fiorina finds the president’s policies too conventionally conservative. “My ideal scenario originally was that Trump would come in and propose a big infrastructure bill, which would split the Republicans and split the Democrats,” Mr. Fiorina says. “He didn’t do that.”

When I ask what Mr. Fiorina thinks will happen this November, he demurs: “I could make a case for a Democratic wave, a Democratic disappointment, or anything in between, but I don’t put high probability on any of the scenarios.”

One of his observations, however, is suggestive of a wave. “The incumbency advantage is all but gone,” he says. “The incumbency advantage has been declining in House elections since the ’80s, and it was at 2% in the last election. People are voting—however they vote for president, they vote for the House as well.”

That doesn’t mean all incumbents are vulnerable. A Democratic lawmaker in a heavily Democratic district, for example, will almost certainly win. The diminution of the incumbent advantage simply means that, all else being equal, a Democrat in an open-seat race would likely win by almost as wide a margin as an incumbent. In the 1980s, Mr. Fiorina says, incumbency per se was good for 10 to 12 points on average. Nowadays, “how your president is doing” matters much more.

In 2017 there were special elections for five House seats vacated by Republicans—in Kansas, Montana, Georgia, South Carolina and Utah. The GOP held all five, but all its candidates underperformed the previous incumbents’ 2016 margins of victory, by between 5 and 25 points. If Mr. Fiorina is right about the diminution of the incumbent advantage, these results would seem to bode ill in November for Republicans—incumbent or not—in marginal districts.

On the other hand, if the Republicans do get wiped out this year, there’s a good chance they’ll stage a comeback in 2020. Or 2022 at the latest.


Mr. Taranto is the Journal’s editorial features editor.


Longer Cycles for Gold and the Dollar

By: Surf City


By now you know that my swing trading approach is to focus on the 5-6 Month Intermediate Cycle Low (ICL) to establish positions.  It seem’s that everything that I track has the 5-6 month low to low cycle.  Sometimes the ICLs come sooner at 4 months or later at 7+ months but the average is 5-6 months.

Everything also has a Yearly Cycle Low (YCL) which is nothing more than two 5-6 mont ICLs.

Cycles longer than one year, however, vary by asset. The USD and Bonds have a 3 Year Cycle low to low and Stocks have a 7 Year Cycle low to low.  Gold’s longer Cycles include a 4 Year Cycle and an 8 Year Cycle, which is simply two 4 Year Cycles back to back. Remember that longer cycles typically dominate shorter ones, meaning that if the longer cycle is in a bullish phase, most of its 5-6 month Intermediate Cycles will be right translated in terms of Time while making a higher high and a higher low (i.e. stair stepping up so to speak).

My first chart is a 28 year Gold weekly that shows Gold’s 8 Year Cycle pattern using the Purple Cycle tool on StockCharts. Cycles, however, are not exact, in terms of Time so I have added my Blue Arrows showing you that I believe Gold’s last 8 Year Cycle low came in early 2016 closer to the 7 year mark.  The chart also shows a Blue Fork, that while not technically correct (handle does not attach), it does show you the long term Price channel I am tracking out of the 2001 low.

Why is this important?  If Gold’s 8 year low to low pattern holds, the next one should be in the 2024 time frame. I also believe the USD’s longer 15 year Super Cycle has topped in Year 9 in early 2017.

If correct, we should see downside price action in the USD for another 5 years, give or take a year.

While the inverse correlation for the USD and Gold does not always hold, my expectations are that it will for much of the next 4-5 years as the USD moves into its longer term 15 year low. If correct, my expectations are that Gold will easily take out its previous high from 2011.



sábado, enero 20, 2018

BREAKING BANNON / PROJECT SYNDICATE

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Breaking Bannon

ELIZABETH DREW

Donald Trump and Stephen Bannon

WASHINGTON, DC – The just-released book about Donald Trump and his dysfunctional presidency (Fire and Fury: Inside the Trump White House) has left much of Washington reeling. Despite the White House’s constitutionally dubious threat to try to quash the book, the publication date was moved up four days. But the bulk of Fire and Fury’s disclosures, though deeply disquieting, aren’t all that surprising.

It’s not yet clear how Michael Wolff, the book’s controversial author, obtained some of his information, but it must be assumed that he taped many of his interviews, particularly those used for the long conversations found throughout the book. What Wolff has achieved is to get attributed quotes from high officials about how the president functions, or doesn’t.

But the book mostly tells us what most of political-journalistic Washington already knew: that Trump is unqualified to be president and that his White House is a high-risk area of inexperienced aides. The only surprise is that more calamities haven’t occurred – at least not yet.

A good portion of what was released before the book’s publication concerns a battle between two of the most talkative, argumentative, self-regarding braggarts US politics has ever seen: Trump and his one-time chief strategist, Stephen Bannon. In the summer of 2016, with his campaign lacking a leader, Trump made Bannon – a scruffy, scrappy former businessman who was then the executive chair of Breitbart News, a website preaching white nationalism – the campaign’s chief executive. Bannon was full of big ideas about what a right-wing “populist” campaign would look like.

In many ways, however, Bannon’s ideal campaign closely resembled what Trump was already saying and doing: appealing to blue-collar workers by attacking immigration – for example, saying that he’d build “a big, beautiful wall” along the border with Mexico, for which the Mexicans would pay – and trade agreements that Trump alleged were unfair to the US. These voters came to form the core of Trump’s base, and his success in wooing them, combined with Hillary Clinton’s stunning failure to do so, goes a long way toward explaining why he is president and she is not.2

The problem for Trump is that the citizens he was wooing have never added up to a near-majority of voters. His famous “base” is well under 40% of the public. But Trump and Bannon apparently preferred not to think about that.

Trump is prone to taking out his frustrations on others – he is never to blame for his failures – and inevitably these landed on Bannon, who bragged more than was good for him about his power in the White House and asserted more than he should have. Bannon was ousted from the administration and left in August. Though he and Trump stayed in touch, in retrospect, an eventual falling out seems to have been inevitable.

Trump and Bannon were like two overweight men trying to share a single sleeping bag. Their political world wasn’t big enough for both. They disagreed bitterly over whom to back in the race to fill a Senate seat from Alabama; but, at Bannon’s urging, Trump ultimately backed the erratic former state Supreme Court judge Roy Moore, who’d been removed from the bench twice, and who lost the race. Bannon was seeking to shake up the Republican “establishment” by backing similar “outsider” candidates in this year’s midterm elections, which, if successful, could make it all the harder for Trump to obtain victories in Congress.

Despite his denials, it was Trump who more or less agreed to allow Wolff, whose reputation for slashing his subjects Trump presumably would have known from his years in New York City, to interview the White House staff for a book. Some aides say they believed they were talking to Wolff “off the record,” meaning that they wouldn’t be publicly associated with their remarks. But, even if that were true, it was hardly soothing to a furious president: they had said these things.

In Trump’s view, Bannon’s great sin with regard to Wolff’s book was to say highly negative things about the president’s family. Trump was particularly infuriated by Bannon’s description of a now-famous meeting that his son, Donald Jr., and other senior campaign staff held in Trump Tower in June 2016 with some Russians who said that they had “dirt” on Hillary Clinton. Bannon told Wolff that the meeting was “treasonous.” But, depending on what actually transpired in that meeting, Bannon might not have been so far off. (Trump himself participated in a meeting aboard Air Force One, as he returned from his second presidential trip abroad, to draft a statement to cover up what happened in that Trump Tower meeting.)

Trump was also reportedly furious that Bannon had described the president’s favorite child, Ivanka, as “dumb as a brick.” Wolff also reports that Ivanka and her husband, White House senior adviser Jared Kushner, had agreed that after their expected smashing success at the White House, it would be Ivanka who would run for president.

Overstating matters, as is his wont, Trump claimed, in effect, that Bannon had had nothing to do with his election victory, and that the two had almost never talked one on one. And, as is his wont, Trump threatened to sue Bannon. Trump has a long track record of threatening lawsuits without ever filing them, but even the threat can be costly to the putative target.

Yet the momentary obsession with the feuding within the Trump camp shouldn’t obscure other realities. Behind the drama, Trump has certain clear goals, and cabinet and agency heads who share them – and who don’t get distracted by the publication of a juicy account of the president’s behavior.

While much of Washington and its press corps were discussing the latest revelations, the Department of Justice, which is supposed to be somewhat independent of the White House, was being turned into a partisan instrument for pursuing the president’s grudges. Indeed, last week, it was disclosed that the DoJ was reopening an investigation into the already thoroughly investigated matter of Hillary Clinton’s emails. The FBI, it was also disclosed, would be looking into the Clinton Foundation.

The use of a government agency to punish a president’s previous opponent recalls the behavior for which Richard Nixon was impeached, and suggests a very different form of government than a democratic one.


Elizabeth Drew is a contributing editor to The New Republic and the author, most recently, of Washington Journal: Reporting Watergate and Richard Nixon's Downfall.


The American Void

Time for Germany to Learn to Lead

By Christiane Hoffmann



Washington's move to abandon its global leadership role marks the end of Germany's foreign policy innocence. Berlin will soon be faced with difficult choices that could dent its moral standing.

It is often a single sentence that goes down in history, one that epitomizes an idea, a movement, an era or a personality. Two sentences from Angela Merkel come to mind. One, focused on domestic politics, was an entreaty: "We can do it." It was a pledge and a plea to all Germans in the face of the huge influx of Syrian refugees who entered Germany in 2015.

The other, focused on foreign policy, was earthshaking. "The times in which we could completely depend on others are, to a certain extent, over," Merkel said on May 28 during an appearance in Munich. She did everything she could to make the sentence seem as offhand and trivial as possible. She wasn't speaking in front of the Brandenburg Gate in Berlin -- she was at a festival in Munich, the smell of beer hanging in the air. She hemmed and hawed, she relativized, toned down her language and spoke of "others," even though it was clear that she was referring to the United States.

Still, the sheer impact of her words was undeniable. The German chancellor had essentially announced the end of an alliance that had guaranteed Germany's security for half a century and shaped its politics and values. When she made the statement in May, Germany was in the middle of an election campaign, which informed the manner in which it was interpreted and discounted. Even today, its radicality has been largely ignored -- perhaps because to do otherwise would be too painful or unsettling. Germans prefer to avoid such introspection. The U.S. remains our most important partner, government officials are fond of saying, and the NATO alliance is still intact. That may be true. But for how much longer?

Germany has been busy with its own affairs since May, when its election campaign started in earnest ahead of a September vote that has yet to produce a new government. But once Berlin again has a governing coalition capable of conducting international affairs, it will face circumstances that have changed dramatically. The liberal world order that the United States spent seven decades building is disintegrating. The U.S., meanwhile, is withdrawing from the global stage on three different fronts: militarily, morally and a key leader of the international community. It is withdrawing from its role as a reliable guarantor of European security, as a shaper of global policy and as the leading power of the free West. What does a future hold without the U.S. at the helm? What does a future hold when the most important constant of German foreign policy is no longer there? What will a future look like if all countries seek to emulate "America First?"

For Germany, it means the end of what has essentially been a sheltered foreign policy, one in which others have often made the most difficult decisions for us. In recent years, Germany has shown a greater willingness to take on the responsibility commensurate with a country that is the most economically powerful and populous in Europe. Thus far, however, Germany has preferred reaction over (pro)action, as seen in Ukraine and the euro crisis.

For years, Germany was able to get away with a foreign policy that didn't call for it to assume much responsibility. West German sovereignty was limited and German reserve was understandable for historical reasons. The divided country was also too small to play a role in international politics. Looking ahead, though, Germany will have to lead. But where to? The most radical consequence of the new state of global affairs is that Germans now have to become clear about what it is that they want. That may sound banal, but it isn't.

Germany's global abstinence has permitted it to have the luxury of basing its foreign policy largely on values, while others took care of the realpolitik dirty work. Merkel's refugee policies, which placed humanitarian principles over the cohesion of the European Union, is only the most radical example of this German tradition. The new global situation will also mean a departure from the good Germany. When principles collide with pragmatism, when values clash with interests, Berlin will be forced to make difficult decisions. But how far should we go? What means are we prepared to employ in order to defend Europe, to bring the Middle East closer to peace or to stabilize Africa?

America

German foreign policy experts are still debating how radically the estrangement between the U.S. and Europe has become. Atlanticists are calling for optimism, even though Trump, so far, has served to affirm the worries of the pessimists. They continue to cling to the illusion that, Trump aside, trans-Atlantic relations are actually still entirely intact. They see the U.S. president as a painful, but temporary illness. They believe that once America returns to health, the status quo will return to trans-Atlantic relations.

The problem with that view, however, is that America's retreat from its role as a shaper of global politics began before Trump -- and it won't end with his departure, either. German Foreign Minister Sigmar Gabriel went even further in reiterating Merkel's beer-tent sentiments in an important foreign policy speech a few weeks ago in which he stated that Germany might also have to get by without America if need be.

Leadership

What does it mean when the U.S. abandons its global leadership role? The idea that Germany might assume that role was nonsense from the beginning. The notion that the German chancellor would step in as the leader of the free world and that Germany, as actor and philanthropist Richard Gere put it, would be the "wise, stable, forward-thinking moral country on the planet" was the desperate hope of a handful of American romantics. They flattered Germany and fueled the naïve illusion that values can be upheld without having to defend them.

Germany may view itself as a major moral power, but politically and economically, we're not nearly strong enough -- and militarily, we possess only moderately equipped armed forces without any nuclear deterrent.

Furthermore, Germany's inability to form a governing coalition this fall and winter has shown that Berlin is not immune to the crisis of liberal democracy. Germany cannot rescue the West but, together with France, it could do a lot more in Europe and its backyard than it has previously done. Four years ago, Joachim Gauck and Frank-Walter Steinmeier, Germany's president and foreign minister at the time, both called for such a focus four years ago, saying that Germany must act "earlier, more decisively and more substantially."

Values

In his works, the German historian Heinrich August Winkler has described the triumph of the West, its values and its ideas. But even he has been at a loss since America ceased upholding these values. His most recent book, "Is the West Crumbling?" can't even answer the question it asks. Winkler has become a chronicler of an historical even that he is no longer able to interpret.

The crisis of the West is particularly painful for Germany. The country's long journey to the West described by Winkler ended as the West's decline began, like some train that has arrived at a station that has just been decommissioned.

As the West's position of power eroded, it's claims of moral leadership only grew louder. This divergence was particularly apparent to those watching from outside of Europe. There, the West had long since been viewed as presumptuous and arrogant. It was a tone they didn't care for, and they reacted with rejection and defiance.

Authoritarian systems have now entered into open rivalry with the West, pitting their models against ours. The narrative -- disseminated by China, above all -- is one of efficient, benevolent half-dictators who promise prosperity and progress in contrast to cumbersome, inefficient and crisis-plagued democracies.

Strategy

Europe must stand up for its values. To that end, it would be helpful if it changed its attitude and tone and shed its arrogance, shifting away from gestures of finger-pointing and rebuke. Europe must allow its virtues to speak for themselves. It has to stand its ground in the competition with other societal models. With Emmanuel Macron at the helm of France, we now have an opportunity to make Europe attractive again.

One of the favorite bits of wisdom adhered to by Merkelism is that politics begins with observing reality. But that's not so easy these days. Germany's foreign policy lacks a strategic approach that describes, analyzes and shows possibilities. So long as the most critical coordinates had already been set, Germany didn't have to think so critically. Others used to do this for us, but those times have passed. A few years back, the Foreign Ministry set in motion a review process and the Defense Ministry also began working on a new policy "white book." That's all fine and good, but it doesn't go far enough. Germany needs more foreign policy minds who in turn have greater influence. The smartest thinkers in politics should not be entering the corporate sector as many have done. They should instead be going to foundations and think tanks.

It's also no longer sufficient for each nation to plan and think for itself. If Berlin and Paris want to lead together, then they will also need to think together. The German Institute for International and Security Affairs (SWP), Germany's most important foreign policy think tank, recently proposed the creation of a joint German-French "white book." That, at least, would be a start.

Interests

Values and interests aren't mutually exclusive by default. It's in Germany's interest to promote rule of law, human rights, multilateralism and the adherence to global agreements. Even so, it can still be necessary to accept limitations to achieve foreign policy goals. German foreign policy must weigh morals and interests against each other. For example: The EU Association Agreement with Ukraine represented a sovereign decision by Kiev to link itself more closely with the European Union. But was it in the European interest given the ultimate cost -- a war in Ukraine and a row with Russia? In the end, the unwillingness to budge served neither Ukraine nor the EU.

Another example: Was it right to insist to Britain that the principle of freedom of movement was non-negotiable, thus paving the way for the Brexiteers? Surely the free movement of labor forces is a central principle of the single market. But out of fear that the principle would be abandoned, there was never even a discussion over whether a compromise could be made.

Yet another example: In the conflict over Catalonia's quest for independence, Germany and the EU have held strictly to the principle of not intervening in a member state's domestic politics. But it would indeed be in Europe's interest if Berlin or Brussels -- or whoever -- could find a way to serve as an intermediary between Madrid and Barcelona.

Part of our consideration has to be accepting things that we do not have the power to change. Germany must prepare for the fact that democratic developments are unlikely in Russia in the foreseeable future. And yet we still need policies that bind Russia and Turkey to Europe. In the Middle East, we need to come to an understanding with a Russia that has filled the void left by the U.S. And when it comes to China, we need a European policy that limit's Beijing's influence.

And, finally, there's Poland. The question could soon rise there about what's more important? That Poland remains in the European Union or that it complies completely with the principles of rule of law. It may be unrealistic to expect both. In such a situation, it might be in Germany's interest to ensure that the Eastern Europeans remain in the EU, even if they do not conform to its standards on every value.

Germany will have to endure these conflicts in the future while at the same time making decisions that could be decisive. It's a mistake that there is little in terms of honest discussion about them. We should have much sharper debates -- and they should be as pointed as they are public. Instead, however, German politics is still focused on the illusion of being a moral power. If Germany wants to lead, then it also needs to have a realistic view of the world. The era of foreign policy innocence has passed.


Painting the map green

As China gets tough on pollution, will its economy suffer?

The received wisdom was that greener growth would be slower. So far, that hasn’t happened



LEO YAO thought he had nothing to fear from the environment ministry. Before, when its inspectors visited his cutlery factory, he says, they generated “loud thunder, little rain”. After warning him to clean up, they would, at worst, impose a negligible fine. Not so this time. In August dozens of inspectors swarmed over his workshop in Tianjin, just east of Beijing, and ordered production to be halted. His doors remain shut today. If he wants to go on making knives and forks, he has been told that he must move to more modern facilities in a less populated area.

Mr Yao’s company, which at its peak employed 80 people, is just one minor casualty in China’s sweeping campaign to reduce pollution. For years the government has vowed to go green, yet made little progress. It has flinched at reining in dirty industries, wary of the mass job losses that seemed likely to ensue. But in the past few months it has taken a harder line and pressed on with pollution controls, hitting coalminers, cement-makers, paper mills, chemical factories, textile firms and more.

Tens of thousands of companies—mostly smaller ones, like Mr Yao’s—have been forced to close, according to Chen Xingdong, an economist with BNP Paribas. In the region around Beijing this winter, the government has ordered steel mills to run at half-capacity and aluminium-makers to cut output by nearly a third. Implementation, half-hearted in the past, has if anything been heavy-handed. In Hebei, a northern province, a ban on coal heating left thousands of residents shivering because the replacement, a switch to natural gas, was not yet ready.

For the wider economy, the question is how steep the cost will be. A sharp tightening of environmental rules in the world’s biggest polluter has the potential to be a shock, both to China and the global economy. Two worries are commonly heard: that it will drag down growth; and, at the same time, cause inflation as production cuts boost prices. Jiang Chao, an economist with Haitong Securities, a broker, says it could end up making for “classic stagflation”. So far, though, these worries are unfounded: growth has been solid and inflation subdued. A possible explanation is that the economic impact is lagging behind the pollution controls. Another is that, contrary to received wisdom, China may be able to raise its environmental standards without paying a high price.

One thing is clear: China’s shift on pollution is real. True, some extreme measures are temporary, especially those aimed at keeping Beijing’s sky blue this winter. But many others will be lasting. As part of a “war on pollution” declared in 2014, China has detailed targets for cleaning up its air, water and soil. On January 1st it introduced an environmental-protection tax, replacing a patchwork of pollution fees. Last month it launched a market for trading carbon emissions, which, though scaled back from early plans, will be the world’s largest. Most crucially, the environment ministry, previously a political weakling, has clout at last—as Mr Yao’s cutlery business found to its chagrin. Besides fining companies, inspectors have disciplined some 18,000 officials for laxity over pollution.

The tougher tactics have already made a big dent in specific industries. Just 60% of steel blast-furnaces are now in use, down sharply since October and near a five-year low. Thermal-power output is now actually declining year by year, evidence of weakening demand. Companies are also feeling the pinch. Schaeffler Group, a German car-parts maker, warned in September that pollution controls would knock out its supplier of needle bearings. Taiwanese chipmakers in the city of Kunshan, an electronics hub not far from Shanghai, say the abrupt tightening of water-quality rules may lead them to move.

Upward pressure on production costs has been intense. A surge in coal and steel prices has attracted most attention, as China has pushed companies to cut capacity (see chart). But similar trends affect a range of smaller industries. In July China banned imports of 24 kinds of waste such as paper and plastic; the ban came fully into effect on January 1st, but demand (and prices) for raw pulp quickly jumped. Restrictions on the chemicals industry have fuelled a 50% increase in the price of glyphosate, a popular weedkiller, over the past few months. Prices of rare-earth metals, notably two used in electric magnets, have also soared.



Yet the biggest economic surprise of China’s environmental campaign so far is not that it has had an impact; it is how muted that impact has been. Yes, industrial production has recently been weaker than forecast, but it is still expanding at more than 6% year on year. And yes, some commodity prices have shot up, but this has had very little effect on general inflation.

Three factors suggest that this benign trend may endure. First, despite the common assumption that industries such as steel or coal are vast, they in fact account for a small, shrinking share of the Chinese economy. Minsheng Securities, a broker, calculates that the full complement of industries affected by the pollution measures adds up to just 7% of total national investment.

China has reached a stage of development where manufacturing is fading in importance.

Nearly 4m people may lose jobs as a result of cuts in industrial capacity, but strong demand for labour in the services sector, from restaurants to health care, is cushioning that blow.

Second, price increases have been concentrated and show little sign of spreading widely. Prices of coal and steel, the first to heat up, are already levelling off, making the increases seem big one-off changes rather than the start of inflationary spirals. For the economy as a whole, it amounts to a redistribution of resources. Companies that use commodities as inputs face higher costs. But producers benefit. And since metals and mining companies are heavily indebted, the rebound in revenues is helping to fortify their balance-sheets and, in the process, easing Chinese financial risks.

Lastly, green restrictions can themselves generate growth and jobs. China’s drive for cleaner energy sources has gained momentum. Estimates suggest it installed nearly 55 gigawatts of solar-power capacity in 2017, more than the existing capacity of any other country at the start of the year. China accounts for about two-fifths of global production of electric cars. And in more established industries, companies feel pressure to upgrade. To stay in business, Mr Yao says he will move his cutlery factory to a new industrial park, where waste-disposal standards are higher.

If the economic downside from China’s clean-up remains relatively mild, it prompts an obvious question: why did it take the government so long to get tough on pollution? One big reason is surely the uneven distribution of pain. Smokestack industries are based in a small number of provinces such as Shandong in the east and Shanxi in the north. So long as enforcement was in local hands, officials had little incentive to act. None wanted to throttle companies in their own backyard. But from a national perspective, the economic trade-offs of greener growth ought to be easier to stomach. China will both pay a price and reap dividends.