Liberals, nationalists and the struggle for Germany

A surge of populist sentiment is part of a broader shift in international politics

Gideon Rachman

Right-wing demonstrators confront riot police on Saturday in Chemnitz, a town in eastern Germany that has become a flashpoint for protests © Getty

In 1989, the chant “we are the people” excited people all over the world. It was the slogan of the popular demonstrations in East Germany that brought down the Berlin Wall and ended the cold war.

Almost 30 years later the same chant is once again being heard on the streets of eastern Germany — but in a new and disturbing context. It has become the rallying cry for anti-immigration demonstrators, linked to the far-right.

In Chemnitz, a small town in eastern Germany that has become the flashpoint for the protests, one retired teacher and demonstrator explained to me last Thursday: “I was on the frontline in 1989 and it’s exactly the same spirit today. The same deep anger against the government.” Another retiree recalled that in 1989 the East German government had called the demonstrators “an out-of-control mob” and added, “the Merkel government is using exactly the same language now”.

These comparisons between the democratic revolution of 1989 and today’s anti-migrant rallies will strike many as grotesque. Mainstream German politicians are instead warning of similarities with the 1930s, pointing to the fact that some demonstrators have given Nazi salutes on the streets. But the 1989 parallel is thought-provoking in one important respect.

The upheaval in East Germany was triggered by profound changes outside the country — above all in the Soviet Union. In a similar fashion, the current surge of nationalist and populist sentiment in Germany is part of a broader shift in international politics.

In 1989, the rise of a reformist leader of the Soviet Union, Mikhail Gorbachev, fatally undermined the East German government, which was essentially a Soviet client. Today, a German government once again feels shaken by a fundamental change in the politics of the country that it has traditionally looked to for leadership — except that this time the change has taken place in Washington, not Moscow.

The great influx of more than 1m refugees and migrants into Germany took place largely in 2015. Donald Trump was elected president of the US a year later. Just as in 1989 Mr Gorbachev was widely assumed to be in sympathy with pro-democracy demonstrators in East Germany, so now Mr Trump is in sympathy with Germany’s anti-migrant movement and with broader nationalist forces across Europe.

In a series of tweets and snide remarks, the US president has made it clear that he regards Chancellor Angela Merkel’s refugee policies as disastrous and that he both expects and welcomes political upheaval in Germany. Mr Trump’s preferences are so clear that Sigmar Gabriel, who was Germany’s foreign minister until earlier this year, accused the US of seeking “regime change”.

But the 1989 parallels should not be pushed too far. The panic that gripped the East German politburo back then has no counterpart in today’s Berlin. Government ministers are concerned by events in Chemnitz. But nobody has any fear of being swept from power.

Nonetheless, events in Chemnitz are the rough edge of a broader shift in German politics. The official opposition in the German parliament is now the Alternative for Deutschland, a populist, anti-migrant party. Some of its leading figures encourage extra-parliamentary action and vigilante justice.

When support for the far-right was at less than 5 per cent, German authorities had no difficulty in monitoring and repressing it. But government officials now reckon that in areas such as Chemnitz about 25 per cent of the population supports or sympathises with the AfD. This has created anxiety about support for the far-right in the police and other arms of the state.

The rise of the AfD and the visible anger on the streets of Germany has contributed to the sense that an era is coming to a close. Ms Merkel struggled for many months to put together a coalition government. Even some supporters describe her as exhausted and shaken by the hatred she encountered in eastern Germany during the last election.

The challenges to Ms Merkel also now come from within the EU, which Germany has long nurtured as a bastion of liberal values. The entrance of nationalists and populists into government in Italy, Hungary, Poland and Austria means that Germany’s nationalists are part of a broader European backlash against liberal orthodoxy.

When Ms Merkel looks around the EU council table, she now sees a number of ideological foes. The most articulate of these is Viktor Orban, the prime minister of Hungary. He was a leader of the country’s anti-communist, pro-democracy movement in 1989 but now champions the new style of nationalist authoritarianism that places anti-refugee sentiment at the very centre of politics. Mr Orban said recently: “In 1990, we saw Europe as the future. Now we are the future of Europe.”

The Berlin political establishment has no intention of ceding the future of Europe to nationalists like Mr Orban and the AfD. But German officials and politicians know that they are once again in a fight.

In 1989, liberal and nationalist causes were allied in the struggle for democracy in eastern Europe. Now the two ideologies are opposed. The battle between liberalism and nationalism is being waged internationally. It is also unfolding on the streets of small towns in Germany.

Fed Raises Interest Rates, Signals One More Increase This Year

Benchmark federal-funds rate increased to a range between 2% and 2.25%

By Nick Timiraos

Federal Reserve Chairman Jerome Powell spoke Wednesday after the interest-rate vote.
Federal Reserve Chairman Jerome Powell spoke Wednesday after the interest-rate vote. PHOTO: ANDREW HARRER/BLOOMBERG NEWS

The Federal Reserve said it would raise short-term interest rates by another quarter-percentage point, and central-bank officials signaled they expected to lift them again later this year and through 2019 to keep a strong economy on an even keel.

The policy makers voted unanimously Wednesday to lift their benchmark federal-funds rate to a range between 2% and 2.25%. Most expected to raise rates one more time this year, according to new projections released after the conclusion of their two-day rate-setting meeting

The increase, which drew a rebuke from President Trump, is the third this year and the eighth since the Fed began to lift rates in late 2015 after keeping them pinned close to zero after the 2008 financial crisis. The Fed’s action marks the first time it has lifted its benchmark rate above 2% since 2008.

It also is the first time in a decade the fed-funds rate will rise above inflation, measured by the Fed’s preferred gauge, which excludes volatile energy and food categories. So-called core prices rose 2% in July.

“These rates remain low,” Fed Chairman Jerome Powell said in a news conference. “This gradual return to normal is helping to sustain this strong economy for the longer-run benefit of all Americans.”

Mr. Trump, in a press conference later Wednesday, said he was “not happy” about the Fed raising rates. But he added, “They are raising them because we are doing so well.”

Mr. Powell said the central bank made its policy decisions guided by economic theory and evidence—not politics. “That’s who we are. That’s what we do. And that’s just the way it’s always going to be for us,” he said.

Stocks erased gains and closed lower Wednesday. The S&P 500 fell 0.3%. The yield on the benchmark 10-year U.S. Treasury note fell 3.059% from 3.102%. Yields fall as bond prices rise, and Treasury yields are near their highest levels in seven years.

The Fed’s actions ripple through the economy over time by raising borrowing costs for businesses and consumers. Rising mortgage rates appear to have contributed to a somewhat slower pace of home sales this year. Higher borrowing costs steal pricing power from sellers, who have benefited from strong price gains in recent years.

Even if the Fed raises its benchmark rate to 3% next year, “we don’t think that’s a hindrance to the economy,” said John Augustine, chief investment officer at Huntington Private Bank in Columbus, Ohio. “We don’t see that lifting mortgage rates substantially. We don’t see that as a threat to credit line borrowing.”

The big question now is how much higher officials think they need to raise rates to keep the economy from overheating. The Fed targets a 2% inflation rate, which it sees as a sign of healthy demand. It wants to avoid economic growth that becomes unsustainable, leading to a boom and then bust.

Projections released after Wednesday’s meeting show that most Fed officials expect they will raise rates by one percentage point through next year, and most officials penciled in at least one more quarter-point increase for 2020.

That would leave the benchmark rate slightly higher than 3.25%. Because this is modestly above the so-called neutral rate most officials project is required to balance supply and demand over the long run, such a setting would deliberately restrict growth.

Mr. Powell has stressed the uncertainty of estimating this neutral setting. To that end, the Fed dropped from its postmeeting statement on Wednesday a sentence that for years had described its rate stance as “accommodative,” meaning officials were pressing on the gas pedal to spur more growth.

Dropping the language doesn’t signal that officials believe rates are no longer low enough to stimulate growth, Mr. Powell said. Instead, the change reflects how Mr. Powell wants to move away from providing overly precise estimates of inherently uncertain settings.

Economic projections released after the meeting envision an unusually favorable set of conditions, in which the unemployment rate holds below 4% over the next three years but inflation never rises far beyond the Fed’s 2% target.

Whether the Fed realizes this “Goldilocks” economy that is neither too hot nor too cold could depend on whether inflation behaves as expected.

The risk that inflation climbs higher and faster than anticipated could require the Fed to raise rates “a little bit quicker,” Mr. Powell said Wednesday. He quickly added, “We don’t see that. We really don’t see that.”

Wednesday’s interest-rate projections show two different schools of thought about how the Fed might proceed.

One camp of officials says so long as unemployment keeps falling farther below the level they project is consistent with low and stable inflation, the Fed will need to raise rates to prevent the economy from overheating. This is an uncontroversial strategy, because it is what the central bank always does at this point in an expansion.

Another camp argues for a relatively radical departure from this norm. These officials say if inflation doesn’t appear to be accelerating beyond 2%, the Fed could stop raising rates after reaching a neutral setting that neither spurs nor slows growth.

The Fed’s projection that the economy could stay in a sweet spot for years also depends on forces outside of its control, including trade policy. The Trump administration has promised to ratchet up tariffs on Chinese imports.

“If this, perhaps inadvertently, goes to a place where we have widespread tariffs that remain in place for a long time, a more protectionist world, that’s going to be bad for the United States’s economy,” said Mr. Powell.

A separate risk is that strength in the U.S. economy forces the Fed to push rates higher even though growth elsewhere slows, sending the dollar up and putting more stress on emerging markets.

“I worry…less about the risk of a trade war and more about the financial strains that mount with widening economic and policy divergence among advanced economies,” said Mohamed El-Erian, chief economic adviser at Allianz SE, the German insurance giant.

One such peril is that turmoil in emerging markets spills into China amid rising trade tensions with the U.S. In 2015 and 2016, officials held back planned rate increases due to upheaval in global markets, mostly emanating from China.

Mr. Powell didn’t say whether problems in emerging markets could derail the Fed’s rate-increase plans, but neither did he dismiss such worries. Given their large share of global output, “the performance of the emerging market economies really matters to us in carrying out our domestic mandate,” said Mr. Powell.

Rising Oil Prices Are Bad News for Saudi Arabia

A windfall will compound the kingdom’s economic and social malaise.

By Karen Elliott House

Saudi Aramco oil tanks and pipes in Ras Tanura, Saudi Arabia, May 21.
Saudi Aramco oil tanks and pipes in Ras Tanura, Saudi Arabia, May 21. Photo: ahmed jadallah/Reuters

Oil prices are on their way up. Iranian sales have declined under pressure of a U.S. embargo. Venezuelan production is disintegrating apace with the country. Saudi production is nearing its limit, and the Organization of the Petroleum Exporting Countries shows no sign of increasing production. Brent crude futures topped $80 a barrel Tuesday and may reach $100 before the end of the year.

Good news for oil-rich Saudi Arabia? In the very short run the answer is yes. But an increase in oil revenue only compounds the kingdom’s larger problems of economic and social malaise.

Crown Prince Mohammed bin Salman took power last year with a dazzling set of promises to overhaul Saudi dependence on oil by privatizing the government-controlled economy and getting young Saudis off the dole and into jobs in the private economy. He vowed to stimulate new industries such as tourism and upend religious strictures against entertainment, women’s driving, and mixing of the sexes. Saudi Aramco, the kingdom’s oil company, was to float 5% of its shares in an initial public offering expected to raise some $100 billion. That money in turn would be invested at home and abroad to create new opportunities for Saudis outside of oil.

Instead, the Aramco IPO, a cornerstone of the crown prince’s Vision 2030 reform plan, has been put on permanent hold by his father, King Salman. Private-sector growth has stalled as the imposition of a 5% value-added tax, coupled with sharply higher consumer prices for energy, electricity and water earlier this year, has curbed consumer spending. A further depressant has been the exodus of some 750,000 foreign workers, who left the kingdom rather than pay newly imposed government levies on expat workers.

Small-business owners face reduced revenue at a time when government is demanding they hire Saudis at higher wages than the foreign workers they displace. But Saudi workers are hard to find despite a rising official unemployment rate of 12.8% that is almost surely higher in reality. Many young Saudi men remain unwilling to work in the private economy, where they can be fired. Better, many Saudis feel, to wait and seek a government sinecure. As a result, the vision of transforming Saudis from recipients to participants remains largely a mirage.

The government’s plans to attract large amounts of foreign direct investment also haven’t materialized. The crown prince’s decision last November to arrest several hundred prominent princes, ministers and Saudi businessmen on corruption charges certainly damped enthusiasm. Their imprisonment in the Ritz-Carlton Hotel, the government says, resulted in the recovery of $100 billion of ill-gotten gains. Most of the Ritz inmates were released after they pledged various amounts of money demanded by government.

But given the specter of the rich and famous locked for months in hotel rooms without doors or cellphones, even higher oil revenue hasn’t restored foreign investors’ confidence in the kingdom. Meantime, capital outflows from Saudi Arabia have increased as some Saudis with money are reluctant to invest inside the kingdom and risk triggering government scrutiny. Foreign and domestic investors are put off by high unemployment, high interest rates, slow government spending and doubt about the country’s economic future.

Despite all this, and thanks largely to higher oil revenues, the Saudi economy is expected to grow 2.2% this year. That’s an improvement from negative 0.9% in 2017, according to estimates by Jadwa Investment, one of the kingdom’s most reliable forecasters. Oil-sector gross domestic product will grow 3.3%, compared with a 3% decline last year. Non-oil GDP is forecast to grow 1.4%, paced by revenues from the VAT, expat fees and levies, and domestic energy price hikes. All these are good for government revenue but have suppressed consumer spending and private-sector growth, leaving Saudi citizens skittish.

Transforming a government-controlled economy into one paced by private enterprise and individual initiative is hellishly difficult, as Mikhail Gorbachev discovered when his reform efforts led to the demise of the Soviet Union. Neither those citizens long accustomed to dominance nor those resigned to dependence readily adjust.

Rising oil prices now reinforce both groups’ resistance to change, compounding Crown Prince Mohammed’s leadership challenge. Too many Saudis continue to say that painful change isn’t necessary because “the government has money.” Jadwa projects oil-export revenue will reach $223 billion this year, a 31% increase from last year. That projected increase, plus the $100 billion the government claims to have recovered from the Ritz-Carlton detainees, leads many Saudis to see little reason for them to sacrifice.

To the crown prince’s credit, he, unlike his predecessors, is not passing this bounty back to restive citizens in the form of new handouts and subsidies. Instead he is using much of the oil windfall to reduce the government’s deficit. That said, leaders rarely get credit with their publics for fiscal responsibility.

The challenge for the crown prince now is to hang tough on handouts, end the government’s decades-old penchant for building megaprojects, and let the private sector lead the economy. So long as the government picks winners and losers, the private economy will remain stunted, unable to employ those seeking jobs now or the 300,000 Saudis entering the job market every year.

Ms. House, a former publisher of The Wall Street Journal, is author of “On Saudi Arabia: Its People, Past, Religion, Fault Lines—and Future” (Knopf, 2012).

The Three Tribes of Austerity

Yanis Varoufakis  

austerity woman sitting on street

ATHENS – No policy is as self-defeating during recessionary times as the pursuit of a budget surplus for the purpose of containing public debt – austerity, for short. So, as the world approaches the tenth anniversary of the collapse of Lehman Brothers, it is appropriate to ask why austerity proved so popular with Western political elites following the financial sector’s implosion in 2008.

The economic case against austerity is cut and dried: An economic downturn, by definition, implies shrinking private-sector expenditure. A government that cuts public spending in response to falling tax revenues inadvertently depresses national income (which is the sum of private and public spending) and, inevitably, its own revenues. It thus defeats the original purpose of cutting the deficit.

Clearly, there must be another, non-economic, rationale for supporting austerity. In fact, those favoring austerity are divided among three rather different tribes, each promoting it for its own reasons.

The first, and best known, “austerian” tribe is motivated by the tendency to view the state as no different from a business or a household that must tighten its belt during bad times. Overlooking the crucial interdependence between a government’s expenditure and (tax) income (from which businesses and households are blissfully free), they make the erroneous intellectual leap from private parsimony to public austerity. Of course, this is no arbitrary error; it is powerfully motivated by an ideological commitment to small government, which in turn veils a more sinister class interest in redistributing risks and losses to the poor.

A second, less recognized, austerian tribe can be found within European social democracy. To take one towering example, when the 2008 crisis erupted, Germany’s finance ministry was in the hands of Peer Steinbrück, a leading member of the Social Democratic Party. Almost immediately, Steinbrück prescribed a dose of austerity as Germany’s optimal response to the Great Recession.

Moreover, Steinbrück championed a constitutional amendment that would ban all future German governments from deviating from austerity, no matter how deep the economic downturn. Why, one may ask, would a social democrat turn self-defeating austerity into a constitutional edict during capitalism’s worst crisis in decades?

Steinbrück delivered his answer in the Bundestag in March 2009. “It’s democracy, stupid!” would be an apt summary of his tortured argument. Against a background of failing banks and a mighty recession, he opined that fiscal deficits deny elected politicians “room for maneuver” and rob the electorate of meaningful choices.

While Steinbrück did not spell it out fully, his underlying message was clear: Even if austerity destroys jobs and hurts ordinary people, it is necessary in order to preserve space for democratic choices. Oddly, it did not occur to him that, at least during a downturn, democratic options are best secured without fiscal tightening, simply by increasing taxes for the rich and social benefits for the poor.

The third austerian tribe is American and perhaps the most fascinating of the three. Whereas British Thatcherites and German social democrats practiced austerity in an ill-conceived attempt to eliminate the government’s budget deficit, US Republicans neither genuinely care to limit the federal government’s budget deficit nor believe that they will succeed in doing so.

After winning office on a platform proclaiming their loathing of large government and pledging to “cut it down to size,” they proceed to boost the federal budget deficit by enacting large tax cuts for their rich donors. Even though they seem entirely free of the other two tribes’ deficit phobia, their aim – to “starve the beast” (the US social welfare system) – is quintessentially austerian.

In this sense, Donald Trump is a Republican in good standing. Aided by the dollar’s exorbitant capacity to magnetize buyers of US government debt, he feels certain that the more he boosts the federal budget deficit (via tax giveaways to his ilk), the greater the political pressure on Congress to cut Social Security, Medicare, and other entitlements. Austerity’s usual justification (fiscal rectitude and public-debt containment) is jettisoned in order to achieve austerity’s deeper, political objective of eliminating support for the many while re-distributing income toward the few.

Meanwhile, independently of establishment politicians’ aims and their ideological smokescreens, capitalism has been evolving. The vast majority of economic decisions have long ceased to be shaped by market forces and are now taken within a strictly hierarchical, though fairly loose, hyper-cartel of global corporations. Its managers fix prices, determine quantities, manage expectations, manufacture desires, and collude with politicians to fashion pseudo-markets that subsidize their services. The first casualty was the New Deal-era aim of full employment, which was duly replaced by an obsession with growth.

Later, in the 1990s, as the hyper-cartel became financialized (turning companies like General Motors into large speculative financial corporations that also made some cars), the aim of GDP growth was replaced with that of “financial resilience”: ceaseless paper asset inflation for the few and permanent austerity for the many. This brave new world became, naturally, the nurturing environment for the three austerian tribes, each adding its special contribution to the ideological supremacy of austerity’s appeal.

Austerity’s pervasiveness thus reflects an overarching dynamic that, under the guise of free-market capitalism, is creating a cartel-based, hierarchical, financialized global economic system. It prevails in the West because three powerful political tribes champion it. Enemies of big government (who see austerity as a golden opportunity to shrink it) coalesce with European social democrats (dreaming of more options for when they win government) and tax-cutting Republicans (determined to dismantle America’s New Deal once and for all).

The result is not only unnecessary hardship for vast segments of humanity. It also heralds a global doom loop of deepening inequality and chronic instability.

Yanis Varoufakis, a former finance minister of Greece, is Professor of Economics at the University of Athens.

The Dow Can’t Handle the Fed’s Truth

By Teresa Rivas

The Dow Can’t Handle the Fed’s Truth
Michael Haddad

Told ya so. The Dow initially added to its gains after the Federal Reserve raised rates but the good mood didn’t survive Fed Chief’s Jerome Powell’s press conference. All three major indexes fell, much as we warned they could. In today’s After the Bell we…

…puzzle over the Fed and where things went wrong;

…go a whole post without mentioning tariffs;

…and explain why Alexion Pharmaceuticals soared to the top of the S&P 500.

Post-Fed Flip Flop

Stocks tried to break a two-day losing streak Wednesday but sank in the last hour of trading, following the Fed’s press conference.

The Dow Jones Industrial Average lost 106.93 points, or 0.40%. to 26385.28 while the S&P 500 slid 9.59 points, or 0.33%, to 2905.97 and the Nasdaq Composite fell 17.11 points, or 0.21%, to 7990.37.

It isn’t as if the market was spooked by the long-expected 25-basis-point interest rate hike, which everyone was expecting, and talk of a December increase also was far from a shock. Yes, the Fed has been giving us interest rate increases this year that are “slightly above the market’s original projections,” writes Glenmede’s Jason Pride, but the pace is “justified,” given the strong economy, full employment, and rising inflation. “An additional rate hike may be coming this year, but the economy and markets can handle this pace since policy has yet to truly turn tight,” he adds.

Fair enough. But perhaps it isn’t surprising investors were felling skittish. After all, it was the first time the Fed has raised rates at a September meeting since the cycle began, notes Allianz Investment Management’s Charlie Ripley, and it’s the first time that the fed-funds rate is above core inflation since the crisis.

Moreover, there’s “much less certainty” about what happens after next summer, if the Fed raises interest rates in 25-basis-point increments until it reaches its target date, writes AllianceBernstein’s Eric Winograd. “The Fed’s dot plot illustrates both the near-term consensus and the longer-term uncertainty,” he notes.

So it isn’t surprising, then, that investors were eagerly parsing Powell’s language and the so-called dot plot—the graph that is a visual representation of the Federal Open Market Committee’s economic projections.

UBS’sSeth Carpenter notes that the longer-run median dot plot was revised up to 3%, rather than the downward revision to 2.75% that he expected. The change was the result of just one dot, but on balance, he writes, “the dots show an FOMC that plans to hike past neutral and send the funds rate into modestly restrictive territory.”

More worrisome may have been the removal of the word “accommodative” from the committee’s statement. The committee previously included the word to signal that short-term interest rates were still low enough to be stimulating economic activity. Although committee members have said that the fed-funds rate would move into neutral territory—that is, neither hindering nor helping the economy—and recent robust data shows that the economy doesn’t need the help, some may have hoped that the removal of this language would perhaps also signal a slowing of rate increases. The dot plot showed that wasn’t the case.

Carpenter thought that the Fed would signal the removal this time, waiting until December before actually taking it out, he writes: “We never thought that the removal of the word would imply that hiking would end soon. Removing the word and still having a dot plot that continues to have meaningful overshooting of neutral should put paid to that view of the word.”

Of course, at the press conference Powell dismissed concerns about the language change, going so far as to say that monetary policy is still accommodative. (All things are possible when truth isn’t truth.) His explanation is that the phrase, introduced three years ago, was no longer needed.

In addition, there’s plenty of time between now and 2020, notes Wells Fargo’sJay Bryson. He thinks growth will slow enough “to lead the Fed to reverse itself by cutting rates 25 basis points at the end of 2020.” So while the end of the tightening cycle isn’t over, the language change may signal “the end of the beginning.”

Then there’s another layer to consider: We know growth has to slow, but the idea that it will slow enough by late 2020 to get the Fed to cut rates could also cause investors to fret. Or cheer? No one ever said Goldilocks was easy to please, or maintain.

In the end, there may be plenty of debate about what exactly caused stocks to slide into the close, but at the press conference, Powell also said that given the strength of the U.S. economy, it may be a good time to address the deficit, given the “unsustainable fiscal path” the country is on. No matter how good a party is, no one wants to think about paying the bill.

Accommodative or Not, Rates Are Going Up

The Fed’s policy statement means more rate increases are on the way

By Justin Lahart

Federal Reserve Chairman Jerome Powell
Federal Reserve Chairman Jerome Powell Photo: jim lo scalzo/epa-efe/rex/EPA/Shutterstock

Worried about the Federal Reserve’s rate-raising campaign? With the economy strong and unemployment extremely low, it would have been more worrisome if the Fed had left rates where they were.

In a well telegraphed decision, the Fed on Wednesday raised its target range on overnight rates by a quarter point, marking its third rate increase of the year. And it signaled that it plans to raise rates once more this year, and three times next year.

But despite its plans to keep on raising rates, policy makers in their postmeeting statement removed a phrase describing policy as accommodative. On the face of it, that seems strange. When rates increase to the point they aren’t accommodative, they would first become neutral, meaning they aren’t juicing or slowing the economy. So if they are neutral, why would the Fed be planning to raise them by a full point over the next year?

The truth is Fed officials dropped “accommodative” not because they don’t want to use the word “neutral,” but because they, and Fed Chairman Jerome Powell in particular, are trying to get away from the idea that they precisely know where neutral is. Mr. Powell took pains to explain that during his postmeeting news conference, pointing out that every policy maker said that they expect interest rates over the long run to be above current levels—an indication that, policy makers think the current level of rates really is accommodative.

Not that investors should need the Fed to tell them that. Pushed along by growing confidence, lower taxes and increased government spending, the economy is growing strongly. Absent more rate increases, it is easy to imagine the unemployment rate falling through 3%, and for inflation and financial-market excesses to start causing serious problems.

So the Fed is going to keep raising rates, and will stop not when they reach some preconceived right level but once the increases start to affect the economy and the dangers of overheating are allayed. One risk is that by the time those signs emerge, the Fed will have raised rates by too much, but at this point that might be better than the alternative of keeping rates too low.

Italy: The EU’s Next Big Test

If Brussels tries to treat Italy the way it did Greece, there might not be much of an EU left to govern.

By Jacob L. Shapiro        

The recently minted Italian government has made headlines for its harder stance on migration issues – and its willingness to go toe to toe with the EU to fight for what it sees as a more equitable distribution of burden sharing when it comes to welcoming refugees. But it’s the underlying problems in the Italian economy that are more problematic. These are by no means new problems, but what’s changed is that an Italian government has come to power that is more Euroskeptic than any previous government. Now the government, an admittedly weak one in terms of domestic support, is in the process of drawing up its first budget – and in doing so, it may pose a fundamental challenge to the European Union.

Like previous Italian governments, the governing alliance between the Five Star Movement and the League wants more control over monetary policy and government spending so that Italy can address its chronically mediocre growth rates and its high stock of nonperforming loans. (We would be remiss if we did not note that the rate of NPLs has decreased from a high of 16.8 percent of total loans at the end of 2015, when we thought it might set off exactly the sort of crisis we are describing here, to 11.1 percent as of the first quarter of this year.) What sets the new government apart is its more populist tendencies, for lack of a better word. The Five Star Movement, the single-largest vote-getter as a party, campaigned on a promise of a universal monthly income of 780 euros ($910). The League, meanwhile, catapulted to power on its promises to address immigration issues. The tragic collapse of a bridge in Genoa is a ready-made populist platform for government spending to overhaul Italy’s literally crumbling infrastructure – and the government is already singing that tune as well.

Both of these issues bring Italy into conflict with Brussels. On immigration, the Italian government has already threatened to withhold its contribution to the EU’s annual budget or to veto the EU’s seven-year budget if the bloc cannot come up with a better plan to redistribute the burden of welcoming migrants to Europe. The EU has threatened sanctions in response. Italy is even flirting with making common cause with Hungary and other anti-immigration stalwarts should the EU not bend to Italy’s demands. The spending issue, however, is more serious. In order for the Italian government to come close to delivering on some of its campaign promises, it has to be able to spend money. But the EU has a rule that annual budget deficits for EU countries may not exceed 3 percent of gross domestic product. (This rule doesn’t apply to all member states equally – just ask France, whose budget deficit exceeded 3 percent for almost a decade.) The Italian government cannot possibly stay below that threshold and spend the way it wants to.

Italian Deputy Prime Minister Luigi Di Maio’s interview with il Fatto Quotidiano on Tuesday was the latest sign that Italy may be preparing to flout this EU regulation. Responding to a question about whether Italy would abide by EU regulations on budget deficits, Di Maio, the leader of the Five Star Movement, made it clear that the Italian government was considering ignoring them. A day earlier, an Italian Cabinet undersecretary also said a budget deficit of greater than 3 percent of GDP was on the table. Bloomberg reported on Tuesday that some estimates show the government going as high as 5 percent of GDP. This would abrogate previous EU-Italy understandings, which have the deficit falling to 0.8 percent in 2019 before reaching a balanced budget in 2020. Last month, the Italian government indicated it had raised its target to 1.4 percent in 2019, but in the weeks since, rumors of higher figures have persisted. (There should be clarity on what Italy will do by the end of September.)

Of course, the EU has a reason to fear irresponsible spending by the Italian government. It was just that kind of spending that got Greece into its predicament – and it is increasingly hard not to see the similarities between Greece and Italy. After all, Italy is sitting on a mountain of debt. Its debt as a percentage of GDP is 133 percent. In the EU, only Greece (180 percent) has more – and only Portugal (126 percent) and Belgium (106 percent) also sport figures over 100 percent. The major difference between Italy and these other European profligates is size: 133 percent of Italy’s GDP amounts to 2.3 trillion euros – almost double the next three debt offenders combined. The travails of Greece, which recently graduated from the EU’s austerity program and will remain a pauper for decades as it pays back its loans, nearly broke the European Union. The EU’s biggest fear of late has been that if Italy goes the way of Greece, it won’t be too big to fail – it’ll be too big to save.

That is, if Italy wants saving at all. Paolo Savona, who published a book on how Italy might go about exiting the EU, was considered too radical to be named economy minister – but he is still in the government as European affairs minister. Savona’s plan involved defaulting on some public debt, redenominating other public debt in a new currency and, most frightening to the EU, defaulting on official debt to the EU, including Italy’s Target2 balances, which give a sense of what’s at stake here. Target2 is a eurozone payment system, and Target2 balances account for the claims and liabilities of eurozone central banks. As of June 2018, Italy had a negative balance of 481 billion euros, 21 percent more than the next largest negative balance (which belongs to Spain). Germany, on the other hand, sports a positive balance of 976 billion euros, almost 30 percent of Germany’s GDP. No other country is even close to Germany in this regard. That is why even the threat of an Italian default sends the coldest shivers down Germany’s spine.

To be clear, this is far from the most likely scenario. The Italian government, stitched together of various parties with different political aims, will likely collapse if it tries to take too aggressive a stance against the EU. Some Five Star Movement lawmakers have already expressed frustration with the antics and attention-getting of Matteo Salvini, the leader of the League. And there is still significant support for the EU inside Italy – the latest polls reported by Reuters showed that 44 percent of Italians said the benefits of the EU outweighed the disadvantages, as opposed to 41 percent who felt the opposite – so there are limits to how far Rome can push. Instead, the most likely scenario is the most boring one: that Italy uses its leverage as the EU’s biggest debtor to secure adequate compromises from Brussels to save face at home. That will no doubt rankle other EU countries, but for Brussels, and particularly Germany, that will be a small price to pay. After all, many EU countries are already rankled, and a major Italian default crisis would inflict far more pain than making compromises with Rome.

Even so, the potential that Italy might go the way of Greece – and might not consent to suffer austerity if it came to that – cannot be dismissed. And that such a scenario is even plausible speaks to how precarious the current situation is. It is, for instance, not difficult to imagine Brussels taking a hard line on Italy’s desire to increase deficit spending and its demands on immigration policy. This could, in turn, spark a new wave of europskepticism in Italy, forcing the Italian government to follow through on its threats – or at least forcing the EU to cave on its demands in such dramatic fashion that it would undermine what’s left of Brussels’ credibility in the rest of the bloc. And that works only if it isn’t already too late to get Italy to put off the apocalypse.

It is not a stretch to say, then, that the next chapter in the EU’s history has begun. It opened with the formation of this Italian government in May, and it will reach a critical point when Italy unveils its budget in September. If Italy takes a hard line and its government can survive the resulting faceoff with the EU, it will put Brussels in a difficult position, one that could undermine the very fabric of the EU itself. That is a lot of “ifs,” but none of them is particularly outlandish, even if unlikely. In the meantime, Brussels must decide just how tough it means to get with Italy. If the EU gives in, its authority may be weakened. But if it tries to treat Italy the way it did Greece, there might not be much of an EU left to govern. It is those impending negotiations – not Brexit, or any others – that will shape the EU’s immediate future.

The Tax-Cut Con Goes On

Why Social Security and Medicare are on the ballot.

By Paul Krugman

CreditCreditStephen Maturen/Getty Images

What will happen if the blue wave in the midterm elections falls short? Clearly, at this point it still might: Democrats will surely receive more votes than Republicans, but thanks to gerrymandering and population geography, the U.S. electoral system gives excess weight to rural, white voters who still have faith in President Trump. What if, thanks to that excess weight, the minority prevails?

One answer, obviously, is that the unindicted co-conspirator in chief will continue to be protected from the law. And for those concerned with the survival of American democracy, that has to be the most important issue at stake in November. But if the G.O.P. hangs on, there will also be other, bread-and-butter consequences for ordinary Americans.

First of all, there is every reason to believe that a Republican Congress, freed from the immediate threat of elections, would do what it narrowly failed to do last year, and repeal the Affordable Care Act. This would cause tens of millions of Americans to lose health insurance and would in particular hit those with pre-existing conditions. There’s a reason health care, not Trump, is the central theme of Democratic campaigns this year.

But the attack on the social safety net probably wouldn’t stop with a rollback of Obama-era expansion: Longstanding programs, very much including Social Security and Medicare, would also be on the chopping block. Who says so? Republicans themselves. 
In a recent interview with CNBC’s John Harwood, Representative Steve Stivers, the chairman of the National Republican Congressional Committee — in effect, the man charged with containing the blue wave — declared that, given the size of the budget deficit, the federal government needs to save money by cutting spending on social programs. When pressed about whether that included Social Security and Medicare, he admitted that it did.
And he’s not alone in seeing major cuts in core programs for older Americans as the next step if Republicans win in November. Many major figures in the G.O.P., including the departing speaker of the House, Paul Ryan, and multiple senators, have said the same thing. (Meanwhile, groups tied to Ryan have been running attack ads accusing Democrats of planning to cut Medicare funding — but hey, consistency is the hobgoblin of little minds. So, apparently, is honesty.)

Now, Republicans who call for cuts in social spending to balance the budget are showing extraordinary chutzpah, which is traditionally defined as what you exhibit when you kill your parents, then plead for mercy because you’re an orphan. After all, the same Republicans now wringing their hands over budget deficits just blew up that same deficit by enacting a huge tax cut for corporations and the wealthy.

So it might seem shocking that only a few months later they’re once again posing as deficit hawks and calling for spending cuts. That is, it might seem shocking if it weren’t for the fact that this has been the G.O.P.’s budget strategy for decades. First, cut taxes. Then, bemoan the deficit created by those tax cuts and demand cuts in social spending. Lather, rinse, repeat.

This strategy, known as “starve the beast,” has been around since the 1970s, when Republican economists like Alan Greenspan and Milton Friedman began declaring that the role of tax cuts in worsening budget deficits was a feature, not a bug. As Greenspan openly put it in 1978, the goal was to rein in spending with tax cuts that reduce revenue, then “trust that there is a political limit to deficit spending.”  
It’s true that when tax cuts are on the table their proponents tend to deny that they’ll increase the deficit, claiming that they’ll provide a miraculous boost to the economy and that tax receipts will actually rise. But there’s not a shred of evidence to support this claim, and it has never been clear whether anyone with real political power has ever believed it. For the most part it’s just a smoke screen to help conceal the G.O.P.’s true intentions.
The puzzle is why Republicans keep getting away with this bait-and-switch.

Fifteen years ago I wrote a long piece titled “The Tax-Cut Con,” describing what was even then a time-honored scam; it reads almost word for word as a description of Republican strategy in 2017-18. Yet I keep reading news analyses expressing puzzlement that men who were strident deficit hawks in the Obama years so cheerfully signed on to a budget-busting tax cut under Trump. To say the obvious: These men were never deficit hawks; it was always a pose.

And the gullibility both of the news media and self-proclaimed centrists remains a remarkable story. Remember, Ryan, who was utterly orthodox in his determination to cut taxes on the rich while savaging programs for the poor and the middle class, even received an award for fiscal responsibility.

Which brings us back to the midterm elections. Rule of law is definitely on the ballot. So is health care. But voters should realize that the threat to programs they count on is much broader: If the G.O.P. holds its majority, Social Security and Medicare as we know them will be very much in danger.

Paul Krugman has been an Opinion columnist since 2000 and is also a Distinguished Professor at the City University of New York Graduate Center. He won the 2008 Nobel Memorial Prize in Economic Sciences for his work on international trade and economic geography. @PaulKrugman

Riding the rollercoaster

How to put bitcoin into perspective

The best-known cryptocurrency has been a failure as a means of payment, but thrilling for speculators

THE PRICE chart at CoinDesk, a cryptocurrency news site, begins on July 18th 2010, when a bitcoin could be had for $0.09. By November 2013 it had reached $1,124. In the summer of 2017 it started to take off, reaching over $19,000 in December. By end-March 2018 it was back down below $7,000 and in late August it was hovering between $6,400 and $6,500 (see chart). That has made a few people very rich (just 100 accounts own 19% of all existing bitcoin), encouraged others to play for quick gains and left some nursing substantial losses.

Bitcoin was never meant to be an object of speculation. When the pseudonymous Satoshi Nakamoto published a short paper outlining his plan for bitcoin a decade ago, it was as a political project. Bitcoin’s roots lie in the “cypherpunk” movement, a philosophy that combines an anarchic dislike of governments and large companies with the techno-Utopian belief that computers and cryptography can liberate and protect people. Much of the early development of the internet was informed by similar ideas.

Bitcoin was intended as a computerised version of cash or gold, a “censorship-resistant” alternative to online payment systems run by companies such as Visa and PayPal. If trust in a central authority could be replaced with trust in computer code and mathematics, users could cut out the middleman and deal directly with each other, rugged individualist to rugged individualist.

Electronic cash is not a new idea. In a paper published in 1982 David Chaum, a computer scientist, had suggested using cryptography to create electronic cash, and the cypherpunks had been kicking such ideas around since the late 1990s. What made Mr Nakamoto’s invention stand out was that he had found a solution to one of the biggest problems with computerised money—how to keep users from spending the same digital coin repeatedly without relying on a trusted authority to check every transaction.

With a physical currency, this problem mostly takes care of itself. Once a coin or note has been handed over, its original owner can no longer spend it. But digital currencies are just wisps of information on a computer, and computers are designed to move and copy information easily. Mr Nakamoto solved the problem by handing the job of policing the system to its users. Bitcoin is designed to generate a permanent, constantly growing list of every transaction ever performed with the currency—the “blockchain”. Since all users have a copy of the system’s records, they would spot attempts to spend the same bitcoin twice.

A centralised institution like a bank can simply update its internal records every time its customers perform a transaction. Since bitcoin is decentralised, though, all transactions must be broadcast to everyone on the network so that they can update their local copies of the blockchain. When two parties want to make a transaction, they alert everyone else of their intention. Those proposed transactions are bundled into blocks by a subset of users called “miners”, whose job is to maintain the records and ensure their integrity. Every block is connected to its predecessor by a chain of cryptographic links, which makes it next to impossible to alter records once finalised.

In order to prevent malicious miners from subverting that process, bitcoin requires something called “proof of work”, in which miners demonstrate their commitment by competing to crack mathematical problems that are hard to solve but whose solutions are easy to check. Only the winner of each competition is allowed to add a block to the chain. The network aims for an average block-generation rate of one every ten minutes. If blocks come in faster than this, mining is made harder to slow things down.

All that computation takes a lot of electricity, and hence money (see article), so each new block earns its miner a reward, starting off at 50 bitcoin in 2009 and programmed to halve every four years. It is currently 12.5 bitcoin, or around $80,000. These block rewards are the only source of new bitcoin in the system. Mr Nakamoto argued that central banks cannot be trusted not to debase their currencies by printing money, so he set a hard limit of 21m for the number of bitcoin that could ever be mined.

All this may sound complicated, but the system generally works. Bitcoin can be used to make payments between any two users of the software, and though the experience is not exactly like using cash, it is a reasonable electronic analogue. Even so, bitcoin has failed to become an established currency, let alone—as its more ideological supporters had hoped—to flourish as an alternative to the traditional financial system.

One reason is that it is still not user-friendly. All participants have to download specialist software, and getting traditional money into and out of bitcoin’s ecosystem is fiddly. Moreover, although the lack of a central authority makes the system resilient to attempts at coercion, it also means that if something goes wrong, there is no one who can fix it.

The original idea was that bitcoin users would “be their own banks”, responsible for the security of their own funds, says David Gerard, a cryptocurrency-watcher and systems administrator. But that is harder than it sounds. If you lose access to your stash of bitcoin—say, by mislaying a USB stick or accidentally overwriting a hard drive—it can be impossible to recover. Many users therefore store their bitcoin on exchanges (companies that let users trade ordinary currency for the cryptographic sort). But many exchanges are amateurish operations and have an unenviable record of being hacked. And when bitcoins are stolen, there is no insurance scheme to make the owners whole. Nor are there any other protections of the sort that modern consumers take for granted. Mr Nakamoto’s original paper proudly points out that with bitcoin, chargebacks (used when a credit-card holder disputes a transaction) are impossible.

There are structural problems, too. The size of an individual block of transactions is fixed, and the network enforces an average block-generation rate of one every ten minutes. In practice, that limits bitcoin’s throughput to around seven transactions per second. (Visa’s payment network can manage tens of thousands.) So when demand for bitcoin transactions is high, the system clogs up. Users have to accept that their transactions may be delayed or not go through at all, or offer miners extra fees as an incentive to prioritise their payments. Mr Nakamoto had hoped that bitcoin’s transaction fees would settle at fractions of a cent, but at the height of the boom in late 2017 they briefly reached $55. They have since come down to about $0.65.

Faster, faster

Bitcoin’s developers have tried various tweaks and workarounds to ease the jam. A scheme called SegWit, first introduced in August 2017, has provided a little extra wiggle room. A more ambitious proposal, called the Lightning Network, hopes to take the bulk of transactions off the ponderous blockchain system and getting users to trade directly with each other, but after a couple of years in development it remains plagued by reliability problems. One recent evaluation by Diar, the cryptocurrency-research firm, found that Lightning transactions became increasingly less likely to be completed successfully as they got bigger.

Volatility, insecurity and occasional congestion make for a poor currency, so bitcoin has done best on the economic fringes. One use is for buying drugs and other dodgy items from online black markets, where buyers and sellers are prepared to put up with the downsides because they want to cover their tracks. It can help citizens of countries with currency controls get around them, says Alistair Milne, a financial economist at the University of Loughborough. And some cyber-criminals have turned to it for ransom demands.

Legitimate businesses, with a few exceptions, have proved more cautious. A report from JPMorgan published in 2017 found that, of the top 500 online retailers, only three accepted bitcoin, down from five the year before. Among those that have stopped supporting it are Expedia, a travel agency, and Valve, which runs Steam, an online video-games shop (which cited “high fees and volatility” as the reasons). Chainalysis, a research firm based in New York that tracks data from 17 different bitcoin merchant-payment processors, found that monthly transactions peaked in September 2017 at $411m, and had declined to $60m by May this year.

The South Sea bubble redux

The volatility that makes bitcoin unattractive as a currency also makes it an exciting target for speculation. “If we’re being honest,” says Tim Swanson, the founder of Post Oak Labs, a firm that provides technology advice, “the majority of people are buying [cryptocurrencies] because they hope the price will go up, rather than for any great philosophical reason.”

Condemnation from prominent figures has only added to the currency’s allure. Warren Buffett, a wealthy American investor, has called bitcoin “rat poison”. Jamie Dimon, the boss of JPMorgan—the sort of financial institution that bitcoin fans dislike—has described it as “a fraud”. A research note from Goldman Sachs, a bank, published in July, describes cryptocurrencies as “a mania” and concludes that they “garner far more…attention than is warranted”. Still, back in May the same bank announced its intention to open a cryptocurrency trading desk, citing demand from its customers. Autonomous Next, a financial-research firm, reckons that 175 cryptocurrency funds were set up in 2017, up from just 20 the year before.

Would-be punters will need a strong stomach. Bitcoin is thinly traded and barely regulated, and rumours of large-scale price manipulation have been supported by unusual trading patterns on exchanges. A paper published by two researchers at the University of Texas at Austin asks whether Tether, another cryptocurrency, is being used to prop up the price of bitcoin.

Governments are beginning to take notice. In May South Korean regulators raided Upbit, that country’s largest cryptocurrency exchange. In the same month America’s justice department began a criminal investigation into manipulation of bitcoin’s price.

Official scrutiny, and the recent drop in prices, have spooked many investors. Goldman Sachs argues that bitcoin remains overvalued. But for every bear there is a bull. Tim Draper, a venture capitalist who made his fortune backing technology companies, has forecast that by 2022 a bitcoin will be worth $250,000.