Britain is overexposed to its ruling class

If government is weak, or strong but wrong, little stands between us and its doings

Janan Ganesh

In London on Monday, a man with no ministerial experience began his first full week in charge of the world’s fifth-largest defence budget. Gavin Williamson’s predecessor quit over stories of sexual harassment that have stained the British parliament even more than the liberties it used to take with expenses. Across town, corporate leaders sat through the “modern industrial strategy” of Theresa May, who has spent most of her now-frail premiership blanking them and lacks the votes to do much of anything after the third consecutive general election with a tight result.

Despite this tour of familiar ailments — amateurism, scandal, electoral indecision — Britain is not unique in its political dysfunctions. But it is almost unique in its vulnerability to them. The ancient concentration of power in national government, and within that the executive branch, and within that the prime minister, makes for a weirdly all-or-nothing system for a country that, right down to its gentle official religion, seldom commits when it can hedge.

In Britain, an effective government can build a welfare state, as the Labour party did after 1945, or free an economy, as the Conservatives did from 1979. Poor ones, such as most of those elected in between, can maim the economy and bring the basic governability of the kingdom into doubt. Britain is exposed like almost no other nation in the rich world to the strange human variable that is politics.

When they voted for populist propositions in the same year, Britain and America became entwined in political analysis. It was useful to think of Brexit and the presidency of Donald Trump as parallel experiments with national sovereignty in the two countries that had all but evangelised for globalisation since the 1980s. When France, Germany and the Netherlands took a different course in their own elections this year, the anglophone pair stood out even more as a distinct, coherent bloc.

The difference is that America is designed to prosper despite its politics. Even a president whose party runs the legislature must contend with the hard-wired fragmentation of power within Washington, and between Washington and the states. This institutional balance, which acts like the stop-loss on a headstrong trader’s account, is now strained as at no time since the civil war. It might yet buckle. But at least there is something there to buckle.

I used to believe that Britain, too, could succeed irrespective of its politics. I grew up in the mid-1990s, when economic and cultural life bloomed despite the agonies of government. Looking back, however, the nation’s resilience hinged on an artful prime minister, Sir John Major, and an opposition that sought more continuity than change. The human element stabilised a fraught structural situation.

The mistake is to see America, rather than Britain, as the international exception. Most mature democracies have codified balances, this set against that, to limit the reach of mere politics into the authentic life of the nation. In recent times, Australian politics has become an extended series of I, Claudius, all intrigue and the dagger, with four prime ministers in a five-year period. In September, Australia completed its 104th consecutive quarter of economic growth — the longest expansion in modern times anywhere in the world. Canberra may as well be on the moon.

Even France, with its Jupiterian presidency, has strong mayors, extra-parliamentary actors such as the trade unions and a bureaucratic class that is trained to within an inch of its life. Wading through these force fields to change the country is, for good or bad, beyond most leaders. And what centralisation there is only goes back to 1958, when Charles de Gaulle established the Fifth Republic. Britain’s is deeper, an uninterrupted legacy of the absolute monarchs.

America’s ragged infrastructure, French resistance to change, the lack of reforms in Italy: the absence of a decisive centre comes with costs the British might not be willing to wear. But our own system errs the other way. It trusts the life of the nation to a few offices and prays for worthy occupants. If the government is weak, or strong but wrong, little stands between us and its doings. Without EU membership, which restrains government in ways that pro-Europeans should celebrate not deny, that concentration of power intensifies.

Ostensibly dry and abstract, constitutional reform should be viewed as a practical hedge against bad government. If any good comes from the rolling fiasco of British public life, it will be a resolve to limit the nation’s exposure to its own ruling class. The country that can least afford to get its politics wrong is getting its politics wrong.

Donald Trump’s Federal Reserve


Project Syndicate

CAMBRIDGE – With the appointment of Jerome Powell as the next Chair of the United States Federal Reserve Board, Donald Trump has made perhaps the most important single decision of his presidency. It is a sane and sober choice that heralds short-term continuity in Fed interest-rate policy, and perhaps a simpler and cleaner approach to regulatory policy.

Although Powell is not a PhD economist like current Fed Chair Janet Yellen and her predecessor, Ben Bernanke, he has used his years as an “ordinary” governor at the Fed to gain a deep knowledge of the key issues he will face. But make no mistake: the institution Powell will now head rules the global financial system. All other central bankers, finance ministers, and even presidents run a distant second.

If that seems hyperbolic, it is only because most of us don’t really pay attention to the Fed on a day-to-day basis. When the Fed gets it right, price stability reigns, unemployment remains low, and output hums along. But “getting it right” is not always easy, and when the Fed gets it wrong, the results can be pretty ugly.

Famously, the Fed’s efforts to tame a stock-market bubble in the late 1920s sparked the Great Depression of the 1930s. (Fortunately, of the candidates Trump was considering for the Fed post, Powell is the one least likely to repeat this mistake.) And when the Fed printed mountains of money in the 1970s to try to dull the pain of that decade’s oil shocks, it triggered an inflationary surge that took more than a decade to tame.

At times, the rest of the world seems to care more about Fed policy than Americans do. Little wonder: perhaps more than ever, the US dollar lies at the heart of the global financial system. This is partly because much of world trade and finance is indexed to the dollar, leading many countries to try to mimic Fed policies to stabilize their exchange rates.

Powell will face some extraordinary challenges at the outset of his five-year term. By some measures, stock markets look even frothier today than they did in the 1920s. With today’s extraordinarily low interest rates, investors seem ever more willing to assume greater risk in search of return.

At the same time, despite a strongly growing US and global economy, inflation remains mystifyingly low. This has made it extremely difficult for the Fed to normalize policy interest rates (still only 1%) so that it has room to cut them when the next recession hits, which it inevitably will. (The odds of a recession hitting in any given year are around 17%, and that seems like a good guess now.)

If Powell and the Fed cannot normalize interest rates before the next recession, what will they do?

Yellen insists that there is nothing to worry about; the Fed has everything under control, because it can turn to alternative instruments. But many economists have come to believe that much of this is smoke and mirrors.

For example, so-called quantitative easing involves having the Fed issue short-term debt to buy up long-term government debt. But the US Treasury owns the Fed, and can carry out such debt purchases perfectly well by itself.

Some argue for “helicopter money,” whereby the Fed prints money and hands it out. But this, too, is smoke and mirrors. The Fed has neither the legal authority nor the political mandate to run fiscal policy; if it tries to do so, it runs the risk of forever losing its independence.

Given that monetary policy is the first and best line of defense against a recession, an urgent task for the new chair is to develop a better approach. Fortunately, good ideas exist, and one can only hope that Powell will quickly move to create a committee to study long-term fixes.

One idea is to raise the Fed’s inflation target. But this would be problematic, not least because it would breach a decades-long promise to keep inflation around 2%. Moreover, higher inflation would induce greater indexation, ultimately undermining the effectiveness of monetary policy. Paving the way for effective negative-interest-rate policy is a more radical – but by far the more elegant – solution.

Bank regulation is also part of the Fed’s mandate. The 2010 Dodd-Frank financial-reform legislation, which has spawned 30,000 pages of rules, has been a boon for lawyers. But the massive compliance costs ultimately fall on small and medium-size businesses. It would be far better simply to require banks to raise much more of their resources in equity markets instead of through bonds. That way, shareholders, not taxpayers, would take the big hit in a crisis.

I have not mentioned the elephant in the room: the threat to the Fed’s independence posed by a president seemingly intent on challenging all institutional norms. When President Richard Nixon was intent on being re-elected in 1972, he put heavy pressure on then-Fed Chair Arthur Burns to “juice” the economy. Nixon was re-elected, but inflation soared and growth collapsed. No one should be wishing for a replay – even if Nixon eventually was impeached.

Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. The co-author of This Time is Different: Eight Centuries of Financial Folly, his new book, The Curse of Cash, was released in August 2016.

China, Trump and the North Korean nightmare

Beijing could get drawn into a war on the península

Gideon Rachman

With the threat of another Korean war looming, this week’s US-China summit in Beijing could be the most important in decades.

Most western commentary on North Korea has focused on President Donald Trump’s warnings of “fire and fury” to combat the regime’s nuclear threat. But the Korean crisis also poses a huge risk to China. If a war breaks out, China will literally be on the frontline — potentially exposed to nuclear fallout, refugee flows and dramatic shifts in the regional balance of power.

These acute risks have produced a startling variety of opinions among Chinese experts about the best way forward. There are some who even argue that China and the US should co-operate in joint military operations against North Korea. Others take a completely different line — contending that Washington’s policy is leading to disaster, and that it is time for Beijing to break publicly with the US.

Beijing’s official position avoids either of these dramatic alternatives. Instead, the government of President Xi Jinping is pressing to restart diplomacy through a “freeze for freeze” policy.

The idea is that North Korea would freeze the development of its nuclear weapons, in return for the US freezing military exercises that alarm Pyongyang.

In principle, this sounds like a decent idea. In practice, neither North Korea nor the US seem willing to take the steps needed to make the policy work.

Given this reality, the Chinese are having to consider other more radical alternatives. One senior official argues that by agreeing to US demands for tougher sanctions on North Korea, China has lost its influence in Pyongyang. So, the official argues, China should now attempt to rebuild ties with the Kim Jong Un regime — even if that means antagonising the US administration.

But, among Chinese academics, there are eminent figures who take a radically different position. These hawks argue that a nuclear North Korea is a profound threat not just to South Korea, Japan or the US — but to China itself. In strategic terms, the growing North Korean threat may well persuade both South Korea and Japan to acquire their own nuclear weapons — which would sharply increase tensions within East Asia.

Chinese experts also fret about the dangers of a North Korean nuclear test going wrong, or of an accident at the Yongbyon nuclear facility, near the border. Any such development would pose serious environmental risks to China. “Yongbyon could be our Fukushima,” worries one academic — referring to the 2011 nuclear accident in Japan.

North Korea is now estimated by the Chinese to have 40-60 nuclear weapons. If any were used during a conflict, the risks to China would be enormous.

All of this leads some Chinese experts to consider a radical alternative — perhaps Beijing should co-operate with the US, in a joint military action, aimed at toppling the Kim regime and seizing its nuclear weapons. Such a strategy would allow China to take active steps to defend its own security — rather than helplessly watching a conflict unfold from the sidelines. Offering to ally with the Trump administration might also allow China to secure a new “grand bargain” over postwar arrangements. The Chinese could, for example, look for guarantees that US troops would withdraw from a unified Korea — and might also seek concessions on other regional security issues, such as the status of Taiwan or the South China Sea.

Any joint military operations, however, would be fraught with risk. Above all, there is the fear that North Korea could launch a devastating retaliation — using either nuclear weapons or conventional artillery. To avoid this, one Chinese expert speculates that an attack on the Kim regime could begin by using an electromagnetic pulse weapon (EMP), designed to disable all electronic communication in North Korea — so making it impossible to co-ordinate defences or launch nuclear weapons.

However, while the US and China are both known to have worked on EMP weapons, they have never been used. It would be extremely risky to rely on an untried weapons system to disable the North Korean nuclear threat.

Given all these considerations, an alternative school of thought argues that, if the Trump administration launches a strike on North Korea, the sole Chinese military response should be to advance 50km into North Korea, to protect its border, and to prevent uncontrollable flows of refugees. One nationalist academic argues that a US pre-emptive strike might ultimately benefit China. America’s allies, such as South Korea and Japan, would be appalled and would break their ties with the US, destroying American influence in the Pacific, or so the thinking goes.

But there would also be costs if China tried to watch a conflict from the sidelines. The humanitarian consequences would be horrendous. And even a limited advance into North Korea would risk drawing Chinese troops further into the conflict. But if China sat the fighting out completely, it would risk looking like an impotent bystander as the US fought a war in a country that remains a Chinese ally and neighbour.

In Washington, there is a saying that “North Korea is the land of bad options”. It looks that way from Beijing, too. The problem is that, with North Korea’s nuclear weapons programme advancing fast, doing nothing may not be an option, either.

Has Trump Captured the Fed?


Jay Powell and Donald Trump

NEW YORK – One of the important powers of any US president is to appoint members and heads of the many agencies that are responsible for implementing the country’s laws and regulations and, in many cases, governing the economy. Perhaps no institution is more important in that regard than the Federal Reserve.

In exercising that power, Donald Trump has broken a long-standing pattern, going back almost a half-century, whereby the president reappoints (on a non-partisan basis) the incumbent Fed chair, if he or she has been seen to be doing a good job. Probably no chair has done a better job, in a particularly difficult moment, than Janet Yellen.

Whereas her two immediate predecessors greatly tarnished the Fed’s reputation by looking the other way as massive risk was accumulating – and massive fraud occurring – within the financial sector, Yellen restored the Fed’s reputation. Her calm and balanced hand nurtured broad consensus among a Federal Reserve Board characterized by divergent economic philosophies, and she navigated the economy through a slow recovery in a period when fiscal policy was unnecessarily constrained, as duplicitous Republicans hyped the dangers of deficits.

The Republicans’ shallow commitment to fiscal rectitude is now being exposed as they advocate massive tax cuts for corporations and billionaires that will add one and half trillion dollars to the deficit over the next decade.

To be fair, Trump chose a moderate, when many in his party were pushing for an extremist.

Trump, never shy about conflicts of interest, has an uncanny ability to embrace economic policies, such as the proposed tax cuts, that benefit him personally. He realized that an extremist would raise interest rates – any real-estate developer’s worst nightmare.

Trump broke with precedent in another way: he chose a non-economist. The Fed will face great challenges in the next five years, as it reverts to more normal policies. Higher interest rates could give rise to market turmoil, as asset prices undergo a significant “correction.” And many are expecting a major downturn in the next five years; otherwise, the economy would have experienced an almost unheard-of decade-and-a-half expansion. While the Fed’s tool kit has been greatly expanded in the last decade, the Fed’s low interest rates and huge balance sheet – and the possibly massive increase in debt, should Trump get his tax cuts – would challenge even the best-trained economist.

Most importantly, there has been a bipartisan (and global) effort to depoliticize monetary policy. The Fed, through its control of the money supply, has enormous economic power, and such power can easily be abused for political purposes – say, to generate more jobs in the short run. But lack of confidence in central banks in a world of fiat money (where central banks can create money at will) weakens long-term economic performance, owing partly to fears of inflation.

Even in the absence of direct politicization, the Fed always faces a problem of “cognitive capture” by Wall Street. That’s what happened when Alan Greenspan and Ben Bernanke were in charge. We all know the consequences: the greatest crisis in three quarters of a century, mitigated only by massive government intervention.

Yet, somehow, the Trump administration seems to have forgotten what happened less than a decade ago. How else to explain its efforts to rescind the 2010 Dodd-Frank regulatory reforms, designed to prevent a recurrence? The consensus beyond Wall Street is that Dodd-Frank didn’t go far enough. Excessive risk taking and predatory behavior are still real problems, as we are frequently reminded (for example, by reports about the growing volume of subprime auto loans). In one of the more insidious recent instances of malfeasance, bankers at Wells Fargo simply opened accounts on behalf of customers, unbeknownst to them, so that it could collect additional fees.

None of this bothers Trump, of course, who as a businessman has been no stranger to nefarious practices. Fortunately, it appears that Powell recognizes the importance of well-designed financial regulations.

But politicization of the Fed should be viewed as just another part of Trump’s battle against what his former chief strategist, Steve Bannon, has referred to as the “administrative state.”

That battle, in turn, should be viewed as part of a larger war against the Enlightenment legacy of science, democratic governance, and the rule of law. Upholding that legacy entails employing expertise as needed, and creating, as Edward Stiglitz of Cornell Law School has emphasized, trust in public institutions. A large body of research now supports the idea that societies perform more poorly without such trust.

Every few days, Trump does something to rend the fabric of US society and inflame its already-deep social and partisan divisions. The clear and present danger is that the country is growing so accustomed to Trump’s outrages that they now appear “normal.” For more than seven decades, America has fought – often fitfully, to be sure – to redeem its stated values, taking on bigotry, fascism, and nativism in all their forms. Now, America’s president is a misogynist, racist xenophobe whose policies embody profound contempt for the cause of human rights.

One may approve or disapprove of the Republicans’ tax proposals, efforts to “reform” health care (oblivious to the tens of millions who might lose insurance coverage), and commitment to financial deregulation (ignoring the consequences of the 2008 crisis). But, while the Fed may be safe for now, whatever possible economic benefits this agenda could bring pale in comparison to the magnitude of the political and social risks posed by Trump’s assaults on America’s most cherished institutions and values.

Joseph E. Stiglitz, recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979, is University Professor at Columbia University, Co-Chair of the High-Level Expert Group on the Measurement of Economic Performance and Social Progress at the OECD, and Chief Economist of the Roosevelt Institute. A former senior vice president and chief economist of the World Bank and chair of the US president’s Council of Economic Advisers under Bill Clinton, in 2000 he founded the Initiative for Policy Dialogue, a think tank on international development based at Columbia University. His most recent book is The Euro: How a Common Currency Threatens the Future of Europe.

Is This the Top of the Market?

The investing nirvana that has driven markets in recent years is under attack as central banks scale back stimulus

By Ken Brown

    The rally has driven up valuations, though strong economic performance has meant assets are pricey but not at extreme levels. Photo: European Pressphoto Agency 

A da Vinci sells for $450 million, one bitcoin is worth $7,700 and 99-year-old Austria issues a 100-year bond at an interest rate of 2.1%. Clearly there is too much money in the world.

That isn’t new, but how long can it last? With central banks scaling back stimulus, investments that appear attractive when interest rates are near, or below, zero suddenly look silly. And silly investments usually lose money, often bringing down less silly assets along with them.

The end may come soon, or the current investing nirvana could go on. Heard on the Street walks through the risks and likely scenarios for markets in the coming months.

Some of the best performers of past three years
Total return

The rallies have driven up valuations, though strong economic performance has meant assets are pricey but not at extreme levels.

S&P 500 cyclically adjusted Price/earnings ratio

Investors are more confident than at any time since the tech bust, and high confidence typically means markets don’t perform well in the future.

Wells Fargo/Gallup Investor and Retirement Optimist Index

The biggest and most widely acknowledged risk is in the bond market where central bank stimulus has driven yields to record lows. But as economies have picked up, investors haven’t demanded higher yields to compensate for the risk that rates will rise.