Monthly Archives: December 2011

A key theme of 2012 will be freedom and control on the internet. As demonstrated in Egypt, social media can be the most disruptive of revolutionary tools. But as we have seen in Iran, it is also a potent mechanism of state repression. The battle between digital liberation and autocratic limitation is playing out today around the globe – in Syria, in Cuba and, most crucially, in China and Russia.

Never have individuals and small groups had such potential for political leverage – something apparent to followers of the Chinese artist Ai Weiwei’s Twitter account, Alexei Navalny’s blog about Russian corruption, or the “We are all Khaled Said” Facebook page that became the staging tent of Tahrir Square. This is not to say, though, that the wired activists are destined to triumph.

The technologies of tracking and control, often supplied by western companies, are aiding dictatorships in their own innovative efforts at cyberwar, surveillance and censorship. The coming year is sure to see new showdowns, with outcomes shaped in part by the policies and practices of international technology companies.

In the west, the conflict revolves around a different set of issues – piracy, privacy and monopoly. It pits the giants of technology against the creators of media, who are demanding stronger protections for their intellectual property. Facebook, whose business model lies in the collection and use of personal information, will continue to push the boundary of acceptable snooping against the notion of a “right to be forgotten”. In Brussels, Google faces an antitrust investigation into whether its domination of internet search has led to favoritism toward its own properties. Wrapping it all up is the broader societal question of whether we are approaching media nirvana or filtering ourselves into solipsistic oblivion.

The chief factions in this struggle are not a conventional left and right, but three groups that can be drawn from either side: the digital utopians, the cyber-sceptics, and the techno-peasants. The digital utopians expect the internet to cure all of society’s ills. The cyber-sceptics see it making all of our familiar problems even worse. The techno-peasants watch bemusedly as technology remakes our world in ways they cannot understand.

The writer is chairman and editor-in-chief of The Slate Group and author of ‘The Bush Tragedy’

Sovereign risk was a principal theme in 2011 – most visibly in Europe and, to a lesser extent, in America’s loss of its triple A rating. Along with poor growth and rising inequality, it will continue to raise serious questions next year about the functioning of the global economy. As this occurs, one institution – the International Monetary Fund – will attract special attention. The key question is whether it can finally step up to the role of global conductor, rather than suffering yet more erosion of its credibility.

The sovereign risk crisis has not been kind to the IMF, especially when it comes to Europe. There is no denying that too many of the adjustment programmes it has overseen have fallen short of their objectives. Whether it jumped or was pushed, the institution sacrificed some of its own rules, including those previously deemed sacrosanct.

For two years, the IMF agreed to a series of programmes that were partially designed, inadequately funded and, in some cases, even threatened its preferred creditor status. In each case, the IMF ended up supporting a weak attempt to muddle through, rather than a plan sustainable in the medium term.

This shortfall has accentuated prior concerns about the IMF’s governance, representation and legitimacy. The damage has been material, though fortunately not irreversible.

Don’t get me wrong. This is not about the IMF’s ability to be an agent of good for the global economy. After all, it is endowed with considerable influence, global standing and talented staff. Rather, it is due to political pressures from Europe.

Many countries interpret the IMF’s actions in Europe as confirmation that they are members of an institution that speaks about uniformity of treatment but makes large exceptions for its historic masters. As the institution’s credibility and balance sheet suffer, its programmes are less effective in attracting co-financing from the private sector.

The world needs a strong and legitimate multilateral institution if it is to avoid costly fragmentation; and Europe needs a credible IMF to help it overcome a deepening crisis. This will only be achieved if there is a change next year in the overly cosy relationship between Europe and the IMF.

What is required goes beyond enlightened restraint on the part of European leaders. The IMF must find the courage to resist European bullying; and the rest of the world must help by making a collective effort to accelerate reform of the institution’s governance and representation. Only then would an enhanced IMF be able to help the global economy back to growth and jobs.

The writer is the chief executive and co-chief investment officer of Pimco.

In choosing “the protester” as their Person of the Year, Time Magazine had in mind anti-corruption crusaders in India and the “Occupy” movements in North America and Europe, but above all the young men and women who surged into the squares of Tunis, Cairo, Damascus, Sana’a and Benghazi; protesters who gave a whole new meaning to the term “Arab street”. Long used to denote a sullen, inchoate, unfocused rage, it now came to mean a yearning for democracy, for a political form long identified with the western world alone.

What will happen, in 2012 and beyond, to the quest for democracy in the countries of the Arab world? Will it be further deepened by the establishment of representative government, a free press and an independent judiciary? Or will it be aborted by new forms of authoritarianism or a return to older tribal rivalries?

A transition to democratic consolidation will depend in part on the models the protesters seek to uphold. Rather than looking west, Arab democrats should study the experience of the newer democracies that lie to their east. Consider India, where every general election (there have been 15 thus far) represents the largest expression of the democratic franchise in human history; where the military is kept firmly away from politics; and where people of all faiths have equal rights under the constitution and in law.

Even more relevant than India is Bangladesh. Once written off as a basket case, this country now has an average annual economic growth rate close to five per cent. It is self-sufficient in food and has a large manufacturing sector that employs more than a million women. The military has retreated to the barracks, the Islam on display is more ecumenical than literalist, and there is a vigorous civil society.

Bangladesh’s turnaround is the subject of a fine recent book by David Lewis, which went to press before the Arab Spring and now acquires great salience because of it. Can a culture steeped in Islam respect women’s rights? Can a polity dominated by the army break free of it? Can a desperately poor country assure decent education and health care at the same time as promoting economic growth? These are all questions pertinent to the Arab protesters – who might find answers in a country to their east that does not yet appear to be on their horizon.

The writer holds the Philippe Roman Chair in history and international affairs at the London School of Economics

Next year is not going to be better, and one might just stop there. Whatever temporary economic fixes are applied to the eurozone, American deficits and unemployment, the overheated Chinese real estate market, petering Indian reforms or stalling Brazilian growth, the downward slide will continue. This is because all are symptoms of a structural global economic dislocation that is becoming increasingly disorderly. Yet the second half of this prediction is that politics may be deceptively calm in 2012 – calm before the storm.

To start with the economics. Two trends are underway that have drawn much comment. One is between the old western economies and the formerly emerging economies, notably those in Asia. The second, which heightens the pain of the first, is that the globalisation of markets that enabled the first trend (by giving Asia access to western markets) has also created two new classes of winners. The first is a global super-rich, made up of the innovators, traders and bankers. The second is made up of the Asian and other emerging market manufacturing and service sector workers, who have undercut western labour costs.

The big losers are western middle class and blue collar workers, who (with notable exceptions such as Germans) have lost out dramatically. The real source of this crisis is a decades-long loss of competitiveness and income for these groups that politicians have tried to cover up with unserviceable levels of sovereign and household debt. Now the bill is due and, as the global economy is so interlinked, nobody will be left unscathed. Chinese developers will struggle as much as western business leaders with turbulence and recession.

So why will the politics be calmer? Because at least during 2012, it will be driven by tactical and electoral timing. The great revolt, despite the sit-ins on Wall Street and outside St Paul’s cathedral, will come later. The old prediction that incumbents cannot survive high unemployment and recession is likely to be replaced next year by the lesson that tactically adept incumbents can survive, by offering stability during a time of chaos and so slipping back in under the claim that ‘the devil you know is better than than the devil you don’t’. Their chances are particularly high if they can identify with their citizens’ pain more effectively than weak challengers. Presidents Nicolas Sarkozy and Barack Obama may slip through their elections on these terms, while Angela Merkel and David Cameron may survive the year better than the economic facts would appear to warrant.

The writer is chairman of global affairs at FTI Consulting, and former UN deputy secretary-general. He is author of ‘The Unfinished Global Revolution’

History will look back on 2012 as the year when China anointed its “fifth generation” of leaders and shifted to a slower growth trajectory. This transition will take place against a backdrop of daunting internal challenges -increasing social unrest, widening income disparities and both ecological and man-made disasters - and of escalating external tensions stemming from America’s “pivot” to Asia and simmering regional worries about China’s economic rise. While the political system will be fixated on preserving stability as new leaders take the helm, reduced economic flexibility could thwart Beijing’s intentions to do so.

In truth, slower growth of around 8 per cent could be better for China and the world. More environmentally sustainable and equitable outcomes would ease popular concerns and higher consumption would improve global trade tensions.

But many foresee an economic collapse, arguing that a prolonged eurozone crisis coupled with a property bubble could render vast swaths of industry unprofitable. This would reveal hidden financial vulnerabilities and feed  a downward spiral. Others believe that Beijing has ample resources to avoid a crisis, but argue that with a growth model based on infrastructure and land sales, and with exchange and interest rates rigidly controlled, it may not have all the necessary tools at its disposal.

Domestically, an increasingly active middle class is generating pressure for more accountable governance. Mounting inequalities have nurtured a sense of injustice, 200m migrant workers remain second class citizens and corruption is worsening. Tackling these problems is urgent, but China’s economic successes have fostered an unwarranted self-confidence. Instead, motivated by the Arab Spring, the system has moved aggressively to contain any social discontent that might spark more politically sensitive movements.

China’s economic prowess is also seen by outsiders as having stimulated nationalism in a generation removed from the Cultural Revolution. Beijing’s belligerent responses to overlapping maritime claims have heightened worries about its security objectives in a region already wary of its economic clout. This is one factor in Japan’s decision to relax its ban on weapons exports; to China’s dismay, it has also driven its neighbours to support a stronger US presence in Asia and complicated regional trade integration initiatives.

The potential for conflict will force China and the US to redefine their respective roles in a shifting environment that neither is comfortable with. Tensions will be further aggravated by anti-China trade sentiments during the American elections. Asian countries are in a position to delineate the boundaries of influence for these two powers but, given their varied interests, alliances will shift depending on individual concerns.

China must walk a very narrow line at a time when its outgoing leadership is reluctant to take any far-sighted decisions.

 The writer is a senior associate at the Carnegie Endowment and a former World Bank country director for China.

This year inequality became the issue driving democratic politics. 2012 will be the year when voters in America have to decide what to do about it.

The economic battle will be about whether to increase taxation on top earners and what this will do to incentives and innovation. The cultural battle will be about what government should do to protect the American Dream for a disillusioned middle class. The ideological battle will be about the role of government as guarantor of equal opportunity in a market society.   Socially, the election of 2012 will be about class as no election has been since Franklin D. Roosevelt.

The politics of class are devilishly complex for both parties. Republicans have to oppose higher taxation on the rich without appearing captives of an arrogant business elite, while Democrats have to support higher taxation without appearing to threaten the middle class. Both have to hold onto their ideological base while gaining votes from the moderate middle. The rhetoric will alternate between rousing appeals to the base and moderate appeals to the middle, but there is no doubt that this will be the most ideologically polarised election in a generation.

The victor in November 2012 will inherit not just an economic mess at home and abroad but a gathering crisis of public faith in the fairness of society. Wealth itself is not the issue, rather it is wealth that ducks responsibility for financial chaos and wealth that buys political privilege.  The fairness problem in capitalist societies is compounding their economic problem. The new president will discover that societies where millions feel the deck is stacked against them are tough to govern.

The writer teaches at the university of Toronto

There is something very awkward in the idea that still-poor Asia will help rescue the still-rich euro area. Asia remembers very well that when in trouble in the late 1990s, it was ruthlessly advised to turn to the International Monetary Fund.

Yet it may happen. Europe is bound by an extraordinary series of self-imposed constraints – no common taxation, no mutual guarantees, no monetary financing, to name the main ones – and European countries have now pledged to contribute to the IMF so that it can intervene in Europe. The desire for matching contributions from the rest of the world was unequivocally expressed by the European leaders on 9 December. The questions are: should Asia follow suit, and what would be the consequences?

Asia has two reasons to offer such support: to protect itself from Europe, and to protect itself from the US.

In the short term, the fallout in Asia of a further aggravation of the European crisis would be serious. This is partly because Europe is a large export market but also because European banks are big players in Singapore and Hong Kong, as well as major providers of trade finance. The IMF’s Spillover Report reckons that through these channels financial stress in Europe could seriously dent Asian growth. 

In the medium term, financial turmoil in Europe would also deprive China and the rest of Asia from an important hedge against a depreciation of the US dollar. Furthermore, before the outbreak of the crisis, the euro was a successful regional currency en route to becoming the second global currency. For those in Asia who believe that the world’s natural evolution is towards a multipolar global economy, it provided a natural building block for a multipolar currency system. Should it disappear, the transition to a multi-currency system would be lengthier and bumpier.

But Asia does not trust Europe enough to invest much directly, so it is likely to opt for the detour through Washington. The IMF is certainly still viewed with much suspicion in Asia, where its failings in Indonesia or Korea are vividly remembered. But at least it is equipped with a governance system in which Asia has a voice, and is bound to gain weight faster if it becomes a major contributor.  

It may well take a European crisis to reconcile Asia with the IMF. And ironically, we may well soon be hearing Asians lecturing Europe on the need to turn to the Fund.

The writer is a French economist and director of Bruegel, a Brussels-based think-tank focusing on global economic policy-making

This coming year may well be a significant one - the year that world leaders fell asleep just as the world cried out for more leadership.

They will not literally fall asleep. Instead, they will remain active and engaged with domestic concerns - especially the challenges of surviving in office – while ignoring the  many global challenges that demand their urgent attention.

Barack Obama will focus on only one issue in 2012: winning re-election. Like his predecessors, he will not allow external challenges to distract him from the campaign, unless, of course, a potential collapse of the euro threatens to derail it. This is the main reason he finally sent Tim Geithner to give the Europeans a helping hand in December 2011.

Mr Obama will not try to restart the Doha round of trade talks. Free trade has become an untouchable subject in American politics. Nor will he push for more action on climate change. Americans are not clamouring for action in this area. In 2007, when Al Gore won his Nobel Peace Prize, 63 per cent of Americans said global warming posed a “somewhat serious” or “very serious” threat. In 2010, only 53 per cent did so. More dangerously, as Americans become more economically despondent, China will naturally emerge as scapegoat number one. It would be politically suicidal for Mr Obama to tell Americans the hard truth: that China has focused on becoming economically competitive for almost three decades. America, by contrast, assumed that it would remain competitive as a God-given right.

Sadly, China’s leaders will also be in no position to provide global leadership. They too will remain focused on their own leadership transition. It is now more or less known that Xi Jinping and Li Keqiang will succeed Hu Jintao and Wen Jiabao. That is the easy part. The hard part is deciding who will be No. 3, 4, 5, and so on. Chinese leaders’ top preoccupation will be to ensure that all goes well with this transition. Too much is at stake here for global challenges to take priority.

The European Union, another traditional global leader, will need at least another year or two to sort out the euro mess. The huge debts of Greece, Portugal, Italy and Spain have to be rolled over. There will be detailed negotiations on new governance arrangements for the eurozone. The EU’s leaders, who seem to lurch from one crisis summit to the next, will have no capacity left to focus on global challenges.

So all the world’s most powerful leaders will have strong reasons to press “pause” and defer dealing with global challenges. The problem is that history is already playing on fast-forward. The rapid pace of change unleashed by technology and the desire of billions to join the march to modernity mean that we have to adjust faster and faster to all the challenges of living in a small, complex, interdependent world. Hence the demand for global leadership will grow apace in 2012. And no global leader will emerge. It does not take a genius to predict that this is a prescription for continued turbulence and uncertainty.

The writer is dean of the Lee Kuan Yew School of Public Policy at the National University of Singapore and author of ‘The New Asian Hemisphere’

While the financial and business world continue to hang on every twist and turn in eurozone politics, I think the biggest issue for the world in 2012 will be whether China can successfully manage a soft landing.

In recent years, China has become crucial to the world economy: in 2011, it probably added around $1tn in US dollar terms alone, equivalent to creating half of a new Italy. Since the 2008 global credit crisis, each subsequent year in China has had its particular theme: 2009 was about preventing a postcredit crisis collapse and recession; 2010 about controlling the power of the expansion; 2011 about stopping inflation rising too much.

2012 will be all about trying to ensure a soft landing. Growth, under downward pressure from weakening exports and a fall in government-sponsored investment, will have to be led by stronger personal consumption if the economy is to grow by more than 8 per cent.

The rest of the world is increasingly relying on China importing from it, and so helping those economies still suffering hangovers from 2008 to overcome them. With a bit of luck and active decision making, China will pull this off successfully. If not, the switch to new leadership in China will be much more tricky, which will add to the world’s woes.

To succeed, China will need to be able to bring inflation back down to a 3-4 per cent range, and stop the strong price increases of last year reversing into price declines. More stable domestic prices, especially for food, will allow the policy of rising wages to boost real growth in personal incomes: with other targeted policies, it will help the shift to an economy fuelled by stronger, broader growth in domestic consumption.

Let’s hope, for their and all of our sakes, that they pull it off.

The collapse of relations between the US and Pakistan and between Pakistan and Afghanistan in 2011 will become much worse in 2012 and will jeopardise the western withdrawal from Afghanistan, as well as the stability of both Afghanistan and Pakistan.

The Pakistan army’s orders to treat the US as an enemy and attack any planes intruding into its territory indicate what could happen in 2012 – a serious fire fight on the border between the two sides; Pakistan turning a blind eye as the Afghan Taliban based in Pakistan continue to attack the Afghan government; more spectacular terrorist attacks in Afghanistan by the Haqqani network; possible terrorist attacks in Europe or the US, which will be traced back to the Pakistani Taliban hideouts in Pakistan’s tribal areas; the assassination of top leaders in both Afghanistan and Pakistan. The list of ways in which the situation could worsen is endless.

The first casualty of escalating violence will be the peace talks between the Americans and the Afghans. At present it is also difficult to see how or on what terms the US and Pakistan can renew their relationship.

The US relationship with Pakistan will become a hot foreign policy issue in the US elections and loose statements by Republican candidates will further widen the divide between the two countries. The US will pledge to seek an even stronger partnership with India, which will further annoy Pakistan.

Afghanistan faces difficult days in 2012 as the transition to Afghan forces takes place: the Taliban will step up violence and conduct an assassination campaign that will further unnerve Afghan officials and force many to send their families out of the country. The global economic crisis will mean that future aid and cash to support the Afghan economy and armed forces will not be easily forthcoming.

The US will have a hard time rallying international support for Afghanistan at the Nato summit in Chicago in May. Several countries will start withdrawing their troops from Afghanistan early, possibly led by the US – which could set off a stampede resulting in the 2014 exit date being brought forward by a year. That will further demoralise the Afghan government.

The writer is author of several books about Afghanistan, Pakistan and Central Asia, most recently ‘Descent into Chaos’

Sadly, the eurozone’s uncertain future will continue to cast a huge shadow over the global economy next year.  Surely there are other concerns, including the risk of a not-so-soft landing in China, of pre-electoral paralysis in the US, and of a large, unexpected geopolitical shock. Even in the most benign scenario, the massive overhang of global public and private debt will hinder any robust recovery in the advanced economies.  But the eurozone remains far and away the greatest source of vulnerability.

There is no easy solution. The eurozone needs a new constitution that creates powerful, centralised fiscal and regulatory authorities, with corresponding political integration.  Substantially greater integration probably means ousting some of the less developed states until they are sufficiently economically advanced.  Unfortunately, such a course is politically unacceptable, not least to France, a core member.

Therefore the only realistic medium-term solution is an expansive interpretation of the European’s Central Bank’s charter, ideally prefaced by a huge restructuring of public and or private debt in several periphery countries.  The ECB is understandably nervous of losing vast sums by pouring money into a leaky bucket, especially without an automatic fiscal backstop vast enough to absorb losses.  Germany, in turn, is understandably worried about having to pay a disproportionate share of any future recapitalisation, not to mention about being gamed into tolerating much higher inflation as a back-door solution.

To make matters worse, the upshot of the latest EU negotiations seems to be that private sector burden-sharing is off the table for everyone but Greece.  This is an absurd position if there ever was one.  A system that does not allow for bankruptcies is no system at all.

The euro problem could still be fixed in the medium term with a combination of tough debt and economic restructuring in the periphery, combined with very expansive central bank policy. An implicit northern Europe debt backstop could prevent inflation exploding, at least for a while.  Ideally a few weaker countries would leave the single currency, to regain competitiveness and pave the way for tighter union among the rest. The long run consequences might not be pretty, and the eurozone would still need a new constitution to avoid perpetual stagflation.

For now, 2012 looks set to be another year of floundering towards an uncertain future for the euro-system.

The writer is is a professor of economics and public policy at Harvard University and co-author of ‘This Time Is Different’.

For the last three years the world’s biggest economies - the US, eurozone and China - have been living up to the infuriating euphemism so beloved of policymakers: ”kicking the can down the road”. They have been avoiding the tough decisions that are required to address their fundamental economic, financial and fiscal problems.

The US has postponed its fiscal consolidation and avoided the other structural reforms - investments in infrastructure, education and skills and changes to energy policy - that are required to restore its potential growth rate. The eurozone has been in denial of the fact that some of its member states are insolvent, as well as unable to survive and grow in a monetary union.  China has persisted in its weak currency, to support its export and investment-led growth model where savings are too high and consumption too low.

In all cases political constraints - the approaching elections in the US and leadership transition in China at the end of 2012, and the inability of the eurozone’s 17 governments and coalitions to coordinate policies coherently while staggered elections and changes of government take place – have led leaders to avoid the short-term pain and political costs of tough decisions that will yield benefits only over the medium term.

It will become clear in 2012 that this game of “kicking the can down the road” is a zero-sum game. When domestic demand is weak, and either deleveraging or structural constraints are holding back private and public consumption, every country would rather have a weak currency to restore growth by boosting net exports. But if one currency is weaker another needs to be stronger; and if one country’s trade balance is improved another is worsened. So currency tensions can lead to currency wars and eventually to trade wars.

So in 2012, the combination of market pressures and conflicting political constraints will make it more difficult to kick the can down the road. A few eurozone members may need to coercively restructure their debts and even consider exiting the currency union. A slowdown in China’s growth may come close to being a hard landing. Markets in the US may become more concerned about the political gridlock that stops policymakers taking the necessary actions and maintains the unsustainable US twin deficits.

If the world’s biggest economies continue to play the same game and try to kick the cans further down the road for another year, the cans will become bigger and heavier and eventually hit a brick wall. By 2013 at the latest, but possibly already in 2012, a perfect storm of a double-dip recession in the US, a disorderly scenario in the eurozone and a hard landing in China could materialise.

The large current account deficits of Italy, Spain and France can be reduced without lowering their incomes or requiring Germany to accept inflationary increases in its domestic demand. The key is to expand the net exports of those trade deficit countries to the world outside the eurozone.

Those current account imbalances are the result of imposing a single currency on 17 eurozone countries. If their exchange rates were free to vary, normal market pressures would cause the currencies of Italy, Spain and France to decline relative to Germany’s, stimulating exports and reducing their imports while also shrinking Germany’s trade surplus.

The politicians who planned the euro, generally did not think about future current account imbalances or other economic problems. They wanted the euro as a means of accelerating political integration.

Although the exchange rates at which countries entered the eurozone were negotiated to avoid initial trade imbalances, different future rates of wage increase would inevitably lead to trade imbalances. Those politicians and bureaucrats who recognised this problem believed that the single currency would somehow eliminate it by causing productivity trends to converge.

But convergence clearly has not happened. Productivity in Germany rose much faster than it did in Italy, Spain and France. Germany also placed limits on wage growth. Those two factors mean that labour costs in Germany’s tradable sector have risen some 30 per cent less since the start of the euro than labour costs and prices in those countries with slower productivity growth. The result is that Germany has a current account surplus of 5 per cent of gross domestic product while Italy, Spain and France each have current account deficits of about 3.5 per cent of GDP.

Some economists and officials in countries with trade deficits argue that Germany should expand to increase demand for their products and allow a faster rise in wages to reduce its trade advantage. Not surprisingly, Germany rejects these suggestions.

German officials and the European Central Bank argue that the trade deficit countries need an “internal devaluation” – cutting wages and prices to make their products competitive. Estimates differ but many suggest this would require a 30 per cent wage cut followed by permanently slower wage growth than in Germany. This would mean a decade or more of high unemployment and declining GDP – an economically wasteful and politically dangerous strategy.

An alternative proposal might be to reduce consumer spending in countries with trade deficits, since each nation’s current account balance is the difference between its national saving and investment. But reduced consumer spending would just cause GDP to decline unless there was also a fall in the exchange rate to stimulate exports – something precluded within the eurozone.

So this brings me to the action that can shrink the current account deficits of Italy, Spain and France without austerity, internal devaluations, or German expansionary policies. The solution is a lower value of the euro leading to an improved trade balance with countries outside the eurozone.

The overall trade-weighted value of the euro has already declined 12 per cent since the beginning of 2010. Although fundamental factors imply that the euro should eventually appreciate relative to the dollar, concern about the euro and the European economy more generally have caused the currency to decline relative to the dollar by 10 per cent in the past six months.

Further declines of the euro’s trade-weighted value will cause the exports of all eurozone countries to rise and the imports from outside the region to decline. More specifically, the lower value of the euro will help Italy, Spain and France because about 50 per cent of their imports and exports are with countries outside the eurozone. Germany’s export surplus will rise, giving Germany the opportunity to increase financial or real foreign investment or to increase domestic consumption.

It is not clear how much further the euro would have to fall to eliminate existing current account deficits but it might take a trade-weighted decline of 20 per cent or more. That could imply a euro-dollar exchange rate below its initial value of $1.18 per euro.

What might cause such a substantial decline of the euro? The recent momentum alone might cause that to happen. So also could the ECB’s increased supply of euros to deal with credit and banking problems. Even statements by Mario Draghi, ECB president, expressing a lack of concern about the declining euro might cause the financial market to drive the euro lower.

A decline of the euro cannot be a permanent solution to differences in productivity trends within the eurozone. But it would give those countries time to improve productivity growth before the euro’s fundamental strength returns. If those relative improvements in productivity do not happen, there may be no choice but to end the eurozone as we know it today.


The writer is professor of economics at Harvard University and former chairman of the Council of Economic Advisers and was chief economic adviser to president Ronald Reagan

Asked at a recent press conference whether he still considered Iraq to be “a dumb war”, President Barack Obama carefully replied: “I think history will judge the original decision to go into Iraq.”

Now that the last US combat soldier has departed Iraq, thereby bringing to an end almost nine years of American fighting, it is not too soon to take the president up on his challenge and to start writing history.

The most salient point is that this was not a war that had to be fought.  It was a classic war of choice.  American interests were arguably less than vital, and even if one disagrees with this assessment, there were alternative policies available for safeguarding those interests.  Shored-up sanctions and limited applications of military force would have been enough to contain Saddam Hussein – someone who was not involved in the September 11 2001  attacks or terrorism and who, we now know, no longer had weapons of mass destruction.

The fact that the 2003 Iraq war was a classic war of choice does not automatically make it a mistake; it does, however, raise the bar.  Unlike wars of necessity, which by definition must be fought no matter what the costs given the stakes and the absence of alternatives, wars of choice are only justified when the benefits clearly outweigh the costs.

The main accomplishment of the war was the overthrow of the Saddam Hussein regime and, after a violent and expensive interlude, the achievement of progress toward an Iraq that was at peace with both itself and its neighbours.  Such an Iraq could become a major oil producer; an open as well as stable Iraq could also set a valuable political example for the peoples and countries of the region experiencing their own version of an Arab awakening.

Some have suggested that an additional benefit of the war was that it helped bring about the so-called Arab spring.  This assessment does not bear scrutiny.  It is way too early to assume that what is unfolding in the Arab world will with time prove to be spring-like, ie, positive.  Even if it does, there is no evidence that those who rose up in Tunisia or Tahrir Square in Cairo were inspired by Iraqis.  More likely is that Sunni Arab leaders were even more resolute in their determination to resist calls for reform lest it lead to scenes of chaos that characterised post-Saddam Iraq.

One has to be careful too not to be overly optimistic about Iraq’s future.  If past is prologue, Iraq could witness a return to sectarian violence, an authoritarian political system or both. Iranian influence could well become extensive, while that of the central government in Baghdad quite limited.  Indeed, the most likely future for the next few years is one that reflects all of these features and results in an Iraq that resembles today’s Iraq, a country that functions poorly and at times violently.

The costs of nine years of American military presence in Iraq are not in doubt.  More than 4,500 Americans lost their lives; another 30,000 were injured.  The financial cost of the war was at least $1tn and will go up over time given mounting medical costs.   There was also the difficult to measure but no less real cost to America’s reputation stemming from the failure to find weapons of mass destruction, Abu Ghraib and the breakdown of order in post-Saddam Iraq.  Also important to weigh was the time and attention of policymakers.  Iraq proved to be an expensive distraction.  It would have been wiser to attend to the US economy and to build the foundations of a more robust presence in the Asia-Pacific region, the part of the world where much 21st century history will be written.

So much of the criticism of the Iraq war has missed the mark.  Many, for example, have focused on how the war was fought.  The critics are correct to be hard on those who chose to fight with inadequate forces.  But this overlooks the first-order question of whether the war was right or necessary to wage in the first place.

Others are now criticising the Obama administration for its decision to withdraw all military forces from the country.  It is not clear there was an alternative, although it is also true that the administration could have pressed harder to stay. But again, the bigger decision to question was the decision to go to war in the first place.  And again, it is far from clear that the war was warranted.

Like all wars, the Iraq war holds any number of lessons, but I would highlight one above all others.  It is that local realities matter far more than global or geopolitical abstractions.  This was true in Vietnam; it is no less true now in Afghanistan.  What is called for is awareness of what we do not know and humility in what we try to bring about.

What about the war’s legacy?  It is hard to avoid the irony.  The ultimate result of the Iraq war will be to make such large, discretionary undertakings less likely in the future.  The challenge will be to think twice before committing to future wars where interests are limited and alternative policies exist – but not to over learn the lesson and shy away from acting when interests are truly vital and there is no alternative.

The writer is president of the Council on Foreign Relations and author of ‘War of Necessity, War of Choice: A Memoir of Two Iraq Wars’

The American economy reached a watershed 30 years ago when Ronald Reagan came into office.  While Europe decided to boost its tax-to-gross domestic product ratio in the 1970s and 1980s to fund an expanded range of education, training, labour market and family support programmes, the US did not.  Reagan insisted that less, not more, government was the key to prosperity and growth, and put emphasis on lowering tax rates on top incomes.  Federal revenues in the fiscal year 2011 amounted to 15 per cent of GDP, less than the 19 per cent of GDP of 1980.

Outlays on public services and investments other than health care and pensions have been badly squeezed.  Non-security discretionary programmes, including education, early childhood development, energy, environment, roads, power, ports, dams, training, science, Nasa, technology, the judiciary and much more, have been hard hit. In the late 1970s, 5-6 per cent of national income was directed to these areas.  Reagan slashed that to a mere 2-3 per cent of national income.  Spending has remained at that lower level ever since, apart from a short-lived blip due to the Obama stimulus.

America is unilaterally ceding its global leadership in education, science, and infrastructure.  Much of today’s young workforce lacks the education and skills to sustain middle-class living standards, and unemployment rates are high and stuck as a result.  Yet in 2008, as a candidate, Mr Obama said that he too would aim for the same tax-GDP ratio as during the Reagan years!  Mr Obama’s promise of continued low taxation may have helped him to electoral victory, but it also planted the seeds of his policy failures.

Mr Obama speaks of investing in education, infrastructure and technology to restore America’s jobs and competitiveness, but lacks the financial space to do it.  The result is an utterly dispiriting contradiction between Mr Obama’s soaring rhetoric about the role of government and the grinding cuts that he has agreed with Congress.  Mr Obama’s entire economic programme rests on a fiscal fallacy.

According to the July debt agreement between the White House and Congress, non-security discretionary programmes will be further squeezed to below 2 per cent of GDP by the end of this decade. Other than war and a few transfer programmes, government programmes are being asphyxiated.  Republicans claim that America’s low taxes and small government have spared it from the European disease.  This claim is utterly false. The US is vastly outperformed by the high-tax-and-spend countries of northern Europe: Denmark, Finland, Germany, the Netherlands, Norway and Sweden.

These countries tax heavily but also spend efficiently.  They buy superb public health, quality childcare, proficient public education, quality infrastructure, and remarkable social equality.  The results are lower unemployment rates, smaller budget deficits, much lower poverty and smaller trade deficits than in the US.  These countries also enjoy higher intergenerational social mobility, life expectancy and life satisfaction than the US.

Nor have they suffered slower growth in per capita incomes.  Between 1980 and 2009, US per capita income grew by an average of 1.7 per cent.  Northern Europe averaged about the same: Denmark (1.6 per cent), Finland (1.8 per cent), Germany (1.4 per cent), the Netherlands (1.8 per cent), Norway (2.3 per cent) and Sweden (1.6 per cent).  In the US, most of the gains accrued to the top of the income distribution.  Median male earnings in the US have not risen since 1973.

America’s greatest shortcoming – a massive failure both of efficiency and fairness – is the way it treats its poor children.  While northern Europe amply helps poorer families to raise their children – through generous income support, paid day care, maternity and paternity leave, public pre-school and uniformly high-quality public schools – America increasingly leaves its poor kids to fend for themselves.  Affluent families get their kids through college; poor families do not. America’s underclass is bulging, with roughly one third of the population either poor or near poor (defined as household income less than 50 per cent above the poverty line).

The Republicans propose to strangle government once and for all.  Obama’s policies suffocate federal programmes slowly.  His favoured tax measure is to allow the Bush-era tax cut on the top income tax rate to expire, thereby lifting the top marginal rate from 35 per cent to 39.6 per cent.  This would boost revenues by around 0.5 per cent of GDP, when the underlying cyclically adjusted deficit is around 6-7 per cent of GDP.

To finance the outlays needed on education, infrastructure, family support and technology, taxes on high incomes will have to rise by several per cent of GDP, far beyond what Obama has dared to acknowledge.  America requires a combination of higher personal, corporate, estate, net-worth and financial-transactions taxes, with improved tax enforcement, to collect around 4 per cent of GDP more in federal revenues.  A brave presidential candidate, following in the footsteps of Theodore and Franklin Roosevelt, will win office some day soon and put the US back on a path towards high employment and recovery of the middle class.

The writer is the director of The Earth Institute at Columbia University, a special advisor to UN secretary-general Ban Ki-moon and author of ‘The Price of Civilization’

Lawrence Summers, A-List columnist and former US Treasury Secretary, and Martin Wolf, the FT’s chief economics commentator, discuss the worrying income gap that is growing between the top 1 per cent of earners and the middle class

Required reading for the directors of all large companies: the chapter headed “Management, governance and culture” in the Financial Services Authority’s report on the failure of the Royal Bank of Scotland. What this tells us is that the collapse was not just the result of buying ABN Amro at the wrong price and the wrong time, disastrous though that was. Rather, this bid was just one of a whole series of bad boardroom decisions which taken together point to substantive failures of board effectiveness at RBS. And the lessons from what went wrong are relevant well beyond the banking system.

On the face of it, the RBS board’s composition and formal processes met acceptable standards.  Sir Tom McKillop, the chairman, had familiarised himself with the bank’s business, made sure that everyone had a chance to speak their mind and improved the transparency of the chairman’s committee.

And although Sir Fred Goodwin, the chief executive, was a forceful and sometimes terrifying figure, the FSA concludes that the picture was “clearly more complex than the one-dimensional ‘dominant CEO’ sometimes suggested in the media”. He could come across as “somewhat cold, analytical and unsympathetic” but he could also be courteous and professional and would only intervene infrequently in board meetings.

So why were things allowed to go so badly wrong? The answer is that the bank only did what most of its competitors were doing at the time, but took its excesses to greater extremes. The starting point was the extraordinarily successful takeover of National Westminster Bank, which made RBS think it could walk on water. It did almost no due diligence ahead of the ABN Amro bid, which does not appear to have been challenged by anyone on the board. Sir Fred “is and was an optimist”, one of his colleagues said. “And he tended to take an optimistic view of what was likely to happen, and had often in his life been proved right.”

This view permeated the whole business, and was reinforced by incentives that made it rational for Sir Fred and his colleagues to concentrate on increasing revenue, profits, assets and leverage rather than on capital, liquidity and asset quality.  The RBS experience shows yet again what madness it is for banks to focus on the returns on equity, rather than on their overall assets.

With 17 directors, the board was too big for effective discussion and challenge, and seems to have been badly infected by group think.  The non-executive directors were mostly establishment figures, unlikely in the main to be boat-rockers.

The view seemed to be that if others were pushing ahead in one direction – the structured credit market, for instance – then RBS should push even harder. Hence the disastrous decision to expand this business hugely at just the wrong moment and to keep charging on even when the wheels started to fall off. And of course the board was urged on its way, especially in the case of the ABN bid, by advisers who had a direct interest in the company taking on more risk: the fees paid to the investment banks were dependent on the takeover succeeding.

The FSA asks whether it might have helped if there had been more banking experience on the board, but concludes that perhaps not: the same overoptimistic assumptions were shared by many other bankers at the time. And the RBS bankers themselves did not have all the answers: Johnny Cameron, the executive responsible for this part of the business, told the FSA: “I don’t think even at that point (2007)… I had enough information.  Brian (a colleague) may have thought I understood more than I did… And it’s around this time that I became clearer on what CDOs (collateralised debt obligations) were, but it’s probably later.”

The authority frankly recognises its own failings and argues that had the current regulatory system been in place, the bank would not have failed. That may well be true. But since the underlying problem was about governance, it is vital that the broader lessons are learnt.  These are that a forceful chief executive in a complex business and with the wrong incentives is unlikely to be constrained by an over-large board of directors drawn from the same establishment pool – and that the results can be disastrous.

The writer is chancellor of the University of Warwick, a former head of the Confederation of British Industry and previous editor of the Financial Times

Are we on the verge of a Russian spring? Not likely. Angry citizens have taken to the streets to protest the lack of genuine democracy in their country and the economic opportunities they hope it might bring. But the ability of Russia’s party of power to weather this storm is much stronger than in Hosni Mubarak’s Egypt. Russia’s government holds more than $500bn in hard currency reserves – $120bn of which can be injected quickly into popularity-enhancing social projects. Nor is there the sort of division within Russia’s military or security forces that we saw in Cairo, or the Arab world’s demographic swell of unemployed young men.

The country’s political opposition does not pose much of a threat to the current system. In fact, A Just Russia and the Liberal Democratic party – the parties that ran third and fourth in the December 4 parliamentary elections and captured almost one quarter of the vote – are Kremlin-created. Their leaders may begin to push for a semi-independent legislative agenda, but they will not become a focal point for any co-ordinated challenge to Vladimir Putin’s rule. He will again be elected president in March and take office in May.

Much more likely is a slow erosion of Mr Putin’s longer-term legitimacy. The dissent is real and the protesters have demonstrated some backbone. His pivot back to the presidency leaves them worried that if nothing has changed in Russia’s politics, nothing will change in its economy. An explosion of social media inside the country has made vote-rigging much more visible.

But Mr Putin can still rise to the occasion. Once re-elected, will he undertake real reform, the kind he allowed outgoing president Dmitry Medvedev to promise but not deliver? The return of Alexei Kudrin, a respected former finance minister, would be a hopeful sign. So would an honest effort to tackle Russia’s endemic corruption and to streamline its bloated bureaucracy. Or will Mr Putin simply appease some Russians with increased social spending and bully others with the heavy hand of the state?

The signs are not encouraging. Without a credible opponent, Mr Putin apparently feels little need to make new promises. Since announcing his return to the presidency, he has used speeches and interviews to boast of past accomplishments rather than to offer a vision of the country’s future. But Russians want more than stability; they want progress.

Perhaps worries that turmoil in the eurozone will weigh on trade flows, oil prices and Russia’s immediate future have increased Mr Putin’s aversion to the risks that come with change. But the need for economic modernisation and diversification is becoming more urgent. Social spending and defence now account for 60 per cent of Russia’s budget, and reform of taxes and pensions is fast becoming a priority. Gross domestic product growth next year is forecast at about 4 per cent. That is not bad, but it is not enough to keep pace with more dynamic emerging countries such as China, Brazil or Indonesia. It is also probably not enough to satisfy an increasingly restive electorate.

Mr Putin can still turn this around, but so far he has provided no plan. He will not need one to win the next election. But he will if he is to provide Russians with the change they have begun to demand.

The writer is the president of Eurasia Group, a political risk consultancy, and author of ‘The End of the Free Market’

So we have two crises now. A still-unresolved eurozone crisis and a crisis of the European Union. Of the two, the latter is potentially the more serious one. The eurozone may, or may not, break up. The EU almost certainly will. The decision by the eurozone countries to go outside the legal framework of the EU and to set up the core of a fiscal union in a multilateral treaty will eventually produce this split.

I wrote in October that a time will come when the interests of the eurozone will not only collide with those of the non-eurozone, but with the EU itself. We are now at that point. On Thursday night, Angela Merkel and Nicolas Sarkozy clashed with David Cameron in a familiar Britain-versus-the-rest diplomatic standoff. That itself is not new. But a determination to go outside the treaty to overcome the disagreements adds a new dimension to this long-lasting dispute.

The fiscal union likely to be agreed in March may not initially be very effective in resolving the crisis. It focuses on all the wrong issues, mostly fiscal discipline, which is not the real reason why the crisis has spread to Spain or Belgium, for example.

But the eurozone nevertheless made an important political statement. It will not allow outsiders to stand in the way when it needs to act. For the monetary union to survive, its one-sided, ill-conceived fiscal union will have to become more effective. Over time it will have to usurp central EU roles, especially in the internal market. I would expect it to create its own internal market inside the existing one. It will have to develop a highly integrated financial market with a single financial supervisor. In particular, I do not believe that the eurozone will allow a situation to persist where its main financial centre is located offshore. It will also want to set labour market rules and co-ordinate tax policies. In all of those areas, the eurozone and the EU will get into a permanent legal and political conflict, in which the EU acts as a brake on the eurozone’s development.

One way or the other, this conflict is bound to lead to an eventual split of the EU. I have no idea when or how this will happen. The technicalities are not all that important. Of course, no member can be ejected from the EU. But there is nothing that can stop others from taking action that protects their interest. The new Lisbon treaty makes it possible for countries to leave the EU voluntarily, which means that legally it is possible for the eurozone plus the aspiring members to set up their own rival organisation – in theory. In pratice, that is not likely to happen, but the mere existence of a divorce procedure is probably sufficient to bring about this eventual outcome.

Thursday’s European Council meeting has demonstrated that a monetary union cannot co-exist with a group of permanent non-members in unified legal framework. The EU with its current treaties and institutions has proved to be an insufficiently flexible framework to run a monetary union and a disastrous framework for a monetary union in crisis.

These latest developments have reaffirmed my conviction that the only way to save the eurozone is to destroy the EU. But European governments may, of course, end up destroying both. All they did in the early hours of Friday morning was to create a new crisis without resolving the existing one.

The writer is an associate editor of the Financial Times and president of Eurointelligence

With the renminbi depreciating for six straight days starting last Wednesday, debate about its value has been renewed. Markets are fixated on whether Beijing will allow or even encourage the renminbi to depreciate further although diplomatic pressures remain strong for continued appreciation.

While attention is focused on the value of the renminbi, more important for China is to promote greater flexibility, as I have previously argued. The challenge has always been finding the right opportunity. A pre-ordained nominal appreciation of three to six per cent annually only encourages speculative capital inflows. Thus the recent build-up in the country’s reserves has come as much from money pouring in as from trade surpluses. China must find a way out of this dilemma.

Although the global economy has deteriorated, paradoxically, conditions are better than a year ago for moving to a more flexible exchange rate system. A prolonged and volatile slowdown in global economic activity from the eurozone crisis, coupled with a sluggish US recovery, is now likely. With China’s key export markets under stress, its trade surplus will decline to about 1.5 per cent of gross domestic product this year from around five or six per cent several years ago. Coupled with recent efforts to liberalise imports, China’s trade surplus may soon evaporate. If so, fluctuations in China’s $3,200bn of reserves will be shaped largely by capital movements and currency valuations since most of its holdings are denominated in US dollars and the euro.

Recent moves to discourage property speculation, declining domestic economic growth, and signs that Chinese firms and individuals are investing more abroad, net capital inflows are likely to shrink, thereby reducing pressures for the renminbi to appreciate.

These dynamics are already showing up in the offshore renminbi markets where the trading premium points toward further depreciation. Similarly, the central bank has had to prop up the renminbi in the official market over the past week lest it decline even more than it has. Other east Asian currencies have become more volatile in recent months and on balance have depreciated significantly. Given the strong interlinkages in regional currency movements due to their shared production network, China will also be pulled into greater flexibility. And since inflation in China will remain relatively higher than its key western trading partners, its real exchange rate may appreciate marginally even if nominal rates decline.

All this will create a conducive environment for China to develop a more flexible exchange rate system where the prospect of a decline is the same as of an increase – as it should be.

The writer is a senior associate at the Carnegie Endowment and a former country director for the World Bank in China.

European leaders will meet on Thursday and Friday for yet another “historic” summit at which the fate of Europe is said to hang in the balance. Yet it is clear that this will not be the last meeting convened to deal with the financial crisis.

If public previews from France and Germany are a guide, there will be commitments to assuring fiscal discipline in Europe and establishing common crisis resolution mechanisms. There will also be much celebration of commitments made by Italy, and a strong political reaffirmation of the permanence of the monetary union. All of this is necessary and desirable, but the world economy will remain on edge.

Given that Europe is the largest single component of the global economy, the rest of the world has a stake in helping to avoid major financial accidents. It also has a stake in aiding continued growth in Europe and ensuring that the European financial system supports investment around the world – particularly as cross-border European bank lending dwarfs that of banks from any other region.

Now is also a historic juncture for the International Monetary Fund. The focus of the policy response to the crisis must now shift from Brussels and Frankfurt to the IMF’s boardroom.

From the problems of the UK and Italy in the 1970s, through the Latin American debt crisis of the 1980s to the Mexican, Asian and Russian financial crises of the 1990s, the IMF has operated by twinning the provision of liquidity with strong requirements that those involved do what is necessary to restore their financial positions to sustainability. There is ample room for debate about the precise policy choices the fund has made in the past. But, the IMF has consistently stood for the proposition that the laws of economics do not and will not give way to political considerations. At key points the IMF has offered prescriptions, not just for countries in need of borrowed funds, but also for those whose success is systemically important for the global economy.

Christine Lagarde, the head of the IMF, highlighted the seriousness of problems in Europe to members of the international financial community assembled in Jackson Hole in August. She pointed to capital shortfalls in the European banking system and the need for adjustment to be carried on in ways that were consistent with continuing growth. Now the IMF needs to speak and act on several fronts.

First, it is essential that Italy’s adjustment be carried out within the context of an IMF programme. After European authorities emphasised that Greece was fully solvent and able to service all debts in full, it is unlikely that they, acting alone, have the capacity to reassure markets. Moreover, there are profound intra-European political problems if northern Europe either does or does not impose conditions on Italy. It would be much better to outsource those traumas to the IMF.

Second, as the IMF deals with individual European countries, it needs to recognise more than it did in the past that they are embedded within a monetary system and community of nations with an increasing number of common institutions. It would be inconceivable that the IMF would lend money to a country whose central bank was not committed to an appropriate monetary policy, or that was ignoring contingent liabilities in the banking system. IMF support for any European country should be premised on understandings with the European Central Bank that controls that country’s monetary policy.

Third, when engaging with individual members of a monetary union, the IMF cannot assess the prospects of one member of the monetary union in isolation. If some countries are to enjoy reduced trade deficits, others must face reduced surpluses. If there is no clear path to reduced surpluses there is no clear path to reduced deficits and hence to solvency. More generally, the sustainability of any programme must be assessed in the context of realistic projections of the economic environment. The IMF must be careful not to approve adjustment programmes that are not realistic.

Fourth, the IMF has a responsibility to speak clearly about threats to the global economy. Even if debt spreads in Europe fall and modest growth is reattained, the global economy is threatened by the large-scale deleveraging of European banks. An improvement in the fiscal position of sovereigns will help but this is insufficient. If banks are not recapitalised on a substantial scale soon, there will be a large contraction of credit in the global economy.

After the summit attention will and should shift to the IMF. It must act boldly but no one should ever forget a fundamental lesson of all past crises. The international community can provide support but a nation or a region’s prospect for prosperity depends ultimately on its own efforts.

The writer is Charles W. Eliot university professor at Harvard and was Treasury secretary under President Bill Clinton

The European Central Bank responded on Thursday to the eurozone’s deepening crisis but fell short of a game change. Instead it handed back this responsibility to European leaders who are gathered in Brussels for yet another summit.

The central bank is attempting to strike a delicate balance between three agenda items: respond to a weaker economic outlook, counter the fragility of the banking system, and sequence actions appropriately with European governments, other European institutions and the International Monetary Fund.

The ECB is clearly worried about Europe’s darkening economic outlook, and rightly so. Talk of a “mild recession” is accentuated by recognition that the balance of risks has shifted, especially given the possibility of “disorderly corrections”. This, coupled with a calming inflation outlook, warrants the 25 basis point cut in interest rates, and would have even supported a 50 bps point cut.

A worsening economic situation translates into even greater asset quality problems for banks, as well as growing concerns about the adequacy of their capital cushion. Accordingly, the ECB expanded its use of “non-standard” tools to bolster the sector.

The ECB is boosting banks’ ability to get cash in two ways: by expanding the range of acceptable collateral and by increasing the term of liquidity loans. These steps go well beyond the scope of traditional central banking. By moving the ECB further along the road from a monetary institution to a quasi-fiscal one, they expose its balance sheet to greater risk.

Markets welcomed the increased support for banks. But the initial enthusiasm disappeared once they realised that the ECB’s intentions did not include the third agenda item – that of directly helping European countries struggling with debt issues.

Rather than act at this stage, the central bank decided just to re-iterate the importance it places on governments doing the right thing – namely, better policies to enhance growth and competitiveness, and stronger rules to ensure debt and deficit discipline.

It went further in disappointing the expectations of those that had hoped for an “all in” policy response. Mario Draghi, its president, said he was surprised at how his remarks last week were interpreted to imply greater ECB sovereign bond buying once governments agree on a “fiscal compact”.

Thursday’s move will now be debated fiercely. Those who believe in Colin Powell’s doctrine of “overwhelming force” will argue that, at a time of great crisis, the ECB is being too measured, too timid and too refined. Others will congratulate the institution for positioning itself for success in a marathon rather than an exhausting and disappointing sprint.

But it is clear that the ECB has shifted the burden of solving this crisis back to Europe’s heads of state. It has reminded them, and all others, that its willingness to provide a bridge is dependent on greater assurances that this would be a path to stability, not another bridge to nowhere.

This is Europe’s moment of truth. For the sake of the region and that of the global economy, its leaders must come up with a solution at a time when, to use Nicolas Sarkozy’s phrase, the “euro needs to be refounded”.

The writer is the chief executive and co-chief investment officer of Pimco.

Francis Fukuyama tells Alec Russell, the FT’s comment and analysis editor, that half of leading candidate Newt Gingrich’s are ‘crackpot’

The Indian government announced the opening up of the retail sector to foreign direct investment late last month. This led to an intense and sharply polarised debate. Passionate editorials for and against the plan appeared in the Indian press. The Bharatiya Janata party, the major opposition group, said it would oppose the policy in the streets and in parliament.

The critics had their say – and, within a week, their way. As of Wednesday the policy has been put on hold, perhaps indefinitely. It was striking how soon the government capitulated, abandoning a policy that Manmohan Singh, the prime minister, was himself deeply committed to. This move points to some deeper structural features of the Indian political system, which may mean that – at least in the near future – other major reforms proposed by the government will not be implemented.

Mr Singh had seen the opening of the retail sector as a continuation of the economic reforms he supervised as finance minister in the 1990s. He believes that the entry of companies such as Walmart will generate a boost in employment, and better connect farmers to urban markets.

On the other side, critics of FDI draw on deep historical memories, dating to the days of the East India Company, the foreign group that came to trade but stayed on to rule and plunder. They now fear the wiping out of neighbourhood stores and a restriction in consumer choice. The BJP’s opposition is partly explained by the fact that small traders have for them been a reliable source of votes.

Yet the Indian National Congress’s coalition partners also opposed the move. Mamata Banerjee, chief minister of West Bengal whose Trinamool Congress has several representatives in the union cabinet, even refused to take the phone when the prime minister called her to explain why the change in policy was necessary. Faced with opposition within and without, the government capitulated.

A critical factor in this is the complete breakdown of relations between the Congress and the BJP, the two main parties. For more than a decade their leaders have poured abuse and scorn on one another. Even on matters of vital national interest – as with terrorism or relations with Pakistan – the two parties cannot even begin a conversation, let alone arrive at agreement. The partisanship is so poisonous that relations between Republicans and Democrats in the US seem almost courteous by comparison.

In this context, the timing of Mr Singh’s announcement on retail was surprising, to say the least. When it was made, parliament had already been stalled for more than a week. The BJP insisted that it would let normal business resume only when a senior minister charged with corruption resigned. The new retail policy provoked further hostility and even louder protests.

Since 1989 every Indian government has been composed of fractious and unstable coalitions. To secure a parliamentary majority, the Congress, like the BJP before it, had to take in many smaller parties into a coalition. These parties have great powers of blackmail that they use sometimes to secure ministerial posts with greater avenues for corruption, at other times to stall policies that they fear will affect their potential voters.

There has for some time now been a sharp disconnect between dominant western perceptions of Mr Singh and how the prime minister is viewed within his own country. Barack Obama called him a sage among statesmen. World leaders and international newspapers have attributed qualities of leadership to Mr Singh that have been less visible to his fellow citizens.

Within India it was always known that the authority to make senior appointments and to push through public policies lay principally with Sonia Gandhi, the Congress president. Mr Singh was once admired for his personal honesty; now his inability to dismiss corrupt colleagues has gravely dented his image among the middle classes. The prime minister’s failure, even after eight years in office, to seek direct election to parliament means that he cannot even bring his own colleagues into line, still less command the trust of the opposition.

The writer is Philippe Roman chair in history and international relations at the London School of Economics. His most recent book is Makers of Modern India

Any proposed resolution to the European crisis over the next few days will have to be economically viable as well as politically palatable to both the rescuers and the rescued if it is to restore confidence to the sovereign bond markets. This means paying attention not just to the technical details but also to how it is presented.

There is growing consensus about the key elements of any resolution. Italy and Spain will have to come up with credible medium term programmes that will not just boost their fiscal health, but also improve their ability to grow their way out of trouble. While any plan will involve pain for the citizenry, the markets must also deem the pain politically tolerable, at least relative to the alternatives. It is important that the plan be seen as domestically devised, although voters will have no illusions about the external and market pressures that have forced action. At the same time, the plan’s credibility could be bolstered by an external agency, such as the International Monetary Fund, if it evaluates the plan for consistency with the country’s goals, and monitors implementation.

Some institution – either the IMF or the European Financial Stability Facility with funding from countries or the European Central Bank – has to stand ready to fund borrowing by Italy, Spain, and any other potentially distressed countries over the next year or two. There is an important detail here which has largely been papered over in public discussions. If this funding is senior and therefore higher priority to private debt – as IMF funding typically is – it will be harder for these countries to regain access to markets. For the more a country borrows in the short term from official sources, the further back in line it will push private creditors, making them susceptible to larger haircuts if the country eventually does default.

Private markets need to be convinced both that there is a low probability of default and that there is some additional loss-bearing capacity in the new funding so that outstanding or rolled over private debt does not have to bear the entire loss if there is a default. This may seem unfair. After all, why should the taxpayer accept a loss when they are saving the private sector’s bacon by providing new funding?

In the best of worlds, distressed countries would default as soon as private markets stopped funding them, and they would impose the losses on private bondholders. In the world we live in though, if the view is that Italy and Spain are solvent, or are too big to fail, then official funding should be structured so that it gives these countries their best chance.

Does this mean that official funding should be junior to private debt in a restructuring? Probably not, for that will require substantially more loss-bearing capacity from the official sector for any given amount of funding – capacity that is probably not available. Of greater public concern, official funding, if junior, will then be providing a greater cushion to private creditors and thus bailing them out to an even greater extent.

The simplest solution is that official funding should be treated no different from private debt – best achieved if official sources buy country bonds as they are issued (possibly at a predetermined yield) and agree to be treated on par with private creditors in a restructuring. As the country regains market confidence, the official funding can be reduced, and eventually the bonds sold back to the markets.

The key point is that official funding must be have loss-bearing capacity. If the IMF is the organisation through which funding is channelled to the countries, and if its funding is to be treated on par with private debt, it will need a guarantee from the EFSF, or the eurozone that it will be indemnified in any restructuring. Of course, the community of nations that compose the IMF may be willing to accept some burden sharing once a sufficient buffer provided by the eurozone is eaten through, but that cannot be taken for granted.

If the first two elements of the plan are in place, there should be little need for the third – an ECB willing to buy bonds in the secondary market in order to narrow spreads, and provide further confidence. Indeed, if the ECB intends to claim priority status for any bonds it buys, it is probably best that it buy very little. Of course, the ECB will have to continue to provide support to banks until confidence about their holdings returns.

There is, however, one more element that is needed to assure markets that the resolution is politically viable. Citizens across Europe, whether in rescued countries or rescuing countries, will be paying for years for a mess that no one feels they are responsible for. Banks may not all have voluntarily loaded up on distressed government bonds – some were pressured by supervisors, others by governments – but many have made unwise bets. If they are seen as profiting unduly from the rescue, even as they return to their bad old ways of paying for non-performance, they will undermine political support for the rescue, and perhaps even for capitalism.

So a final element of the package ought to be a monitored pledge by the banks in the eurozone that they will not unload bonds as the official sector steps in, that they will be circumspect about bonuses till economies start growing strongly again and that they will raise capital over time instead of continuing to deleverage – if this hurts equity holders, they should think of this as burden sharing. Cries that this is not capitalism should be met with the retort: “neither are bail-outs!”.

The writer is professor of finance at the University of Chicago’s Booth School

The end of the eurozone crisis could now be in sight. One day, the euro verges on collapse. The next, a comprehensive solution is within reach. With sky-high Italian, Spanish and even French bond yields, we want a final answer: is the eurozone to be or not to be?

But what if it doesn’t sink or swim – what if it just bobs? Leaders of the 17 member states, the European Commission and Council will convene on Friday for what is set to be a climatic meeting. They will reaffirm their common goal: a united eurozone with prospects for sustainable growth. They are also likely to signal, more so than at any previous moment in this crisis, agreement on a systemic solution: a more robust economic framework to govern the euro. Near-term crisis management will be backstopped by the European Central Bank.

But over time these bright signals will dim as the leaders’ battle over priority, sequence and scope. We’ll get a grand bargain in theory, but a reality that does little more than muddle through. The eurozone will not fragment in the next year – and it is unlikely that it ever will. But that does not mean the problems have been solved. Instead, expect continued uncertainty, volatility and macro headwinds as we wait for the yes or no answer that isn’t coming. Welcome to the most turbulent status quo in economic history.

Just days ago, many were predicting a collaps of the eurozone. But last Monday, Mario Draghi, president of the ECB, delivered a game-changer. If there is agreement on a “fiscal compact” between member states that leads to a more unified eurozone macroeconomic policy framework, then “other elements might follow”. So on Friday eurozone leaders will do enough to allow the ECB to step in and manage near-term volatility, while also making a tentative road map toward fiscal centralisation. Importantly, progress can come without treaty reform, at least in the near future. This means proposals small enough to avoid a messy ratification process in European Union’s 27 legislatures could, in fact, prove big enough to justify ECB support. Down the road, the fiscal compact will progress through a reworking of the EU’s charter. There is light at the end of the tunnel.

Often when things look bad, they’re not as bad as they seem. But when things look good, they’re not nearly that rosy. This is the essence of ‘muddling through’. An overwhelmingly resilient force, ‘muddling through’ blunts systemic solutions, but also cushions against grand failures.

Yet by the same token, ‘muddling through’ blunts comprehensive reform. As lofty as Friday’s proposals toward fiscal union may be, their adoption will prove acrimonious and protracted. Each member state will grapple to minimise the infringement on its sovereignty. Germany and France will aim to set the rules for weaker states that will push back against asymmetric adjustment. European institutions will look to reinforce their own role in the new framework. It will be a case of incremental reform that won’t end debate, but rather engender more of it.

Although this may be ugly, it does constitute progress. Look at how far we have already come with the creation of the European Financial Stability Facility, the European Stability Mechanism and now, potential treaty change. And while this is no way to win a race, the eurozone will reach the finish line. Merkel’s “marathon” analogy speaks to this.

Just as ‘muddling through’ kills the best and worst of outcomes, expect the German approach to do the same. After all, it already has done. In the late 1990s, Germany, with Europe’s strongest economy and institutions, had the most to lose with the euro’s creation. As a result, it disproportionately influenced the bloc’s design. The Delors report, which set up the EMU blueprint, mirrored German preferences for a more decentralised system of economic policy – one of the reasons for the current mess. Fast forward a decade: Germany is once again ascendant and will once again have outsized influence on the design of the rules going forward. This will prevent the optimal solution being implemented. The burden of adjustment will fall on deficit countries, while the beneficial role the EC could play as guardian of the treaties will be limited. Check back in a decade for a full damage report.

The eurozone has come a long way, even if its leaders fail at every stage to get ahead of its problems. Look for good news on Friday: a systemic solution will be outlined, but its realisation will be more ‘muddle through’. It won’t be pretty, but neither will the eurozone experiment fail. Call us optimists, for lack of a better word.

This article was co-written with Mujtaba Rahman, a Europe analyst at Eurasia Group. Ian Bremmer is president of Eurasia Group and author of ‘The End of the Free Market’

News that the US unemployment rate has fallen 0.4 percentage points and that we have created 120,000 jobs is better tidings than of late, but we need to do much better: just to match population growth we need to create at least 150,000 jobs a month.

For hiring to occur at a pace that would support recovery, we would need at least 500,000 more hires per month. Instead, payrolls today are more than 7m shy of where they were when the Great Recession began.

For American workers, these are the worst times since the depth of the Great Depression. The unemployment rate, the highest and most sustained in seven decades, improved last month primarily because more than 300,000 people left the labour force. And the situation is even grimmer than suggested by the dismal statistics, calculated from a base of only 60,000 families. Analysts have concluded that the combined unemployment and under-employment rate is slightly above a staggering 20 per cent of the labour force.

Worse, 40 per cent of the jobless have been out of work for six months or more, compared with 10 per cent in 2007. The average period of unemployment now exceeds 26 weeks, well above the previous peak in July 1983 of just 21.2 weeks. This is critical because the longer that people of any age are out of work, the less likely they are to find another job.

Most of the activity in the labour market today reflects “churn”, the continual process of replacing workers, which is not the same as expansion. High churn generally means that workers are moving from declining sectors to better jobs in growing sectors that pay higher wages. That sounds good, but here is another dismaying trend. In previous recessions, around 1m more Americans every month moved to better jobs. This means that almost 35m Americans are trapped in jobs they would have left in better times.

But what of the recent headlines suggesting job growth has recently improved? Again, there is no silver lining. The apparent improvements result primarily from the decline in the number of layoffs – down from 2.5m per month in February 2009 to 1.5m two years later – rather than from increased hiring.

The Great Recession has shown employers they can do with fewer workers than before, aided by technology and by agencies that allow them to hire temps almost instantly – reducing the need to hire in anticipation of a pick-up in business. Companies know they need to come up with a newer business model to weather a long-term downturn. Predictably, a lot of jobs have also gone overseas.

The outlook is bleak. Over 20 per cent of companies say that employment in their firms will never return to pre-recession levels. Another 40-plus per cent say revenues would have to rise around 40 per cent to return to pre-recession employment levels. Moreover, most of the new jobs available don’t match the pay, the hours or the benefits of the positions that vanished during the recession. Millions of Americans face a lost decade, living from paycheck to paycheck, struggling to pay their bills, having to borrow money and go deeper into debt.

Who, among the contenders for the White House, has a remedy for this catastrophe? Clearly, this dysfunctional Congress offers no hope until after 2012. Yet we must reverse the decline in American education that has left workers less able to compete in the new world. Skills, not muscle, are the only reliable path to high-wage jobs, in an era when technology and globalisation allow companies to make new investments in regions where labour is cheap.

We also need to approve many more H1B visas to permit highly educated science graduates to take work in engineering and technology. Contrary to popular perception of immigrants, these are people who would create jobs rather than take them. And we should rationalise the stumbling process of certifying patents in order to unleash thousands of start-ups, the single greatest source of new employment.

Greater certainty over policy would also help the economy. A metric devised by economists at Stanford University and the University of Chicago shows that policy uncertainty accounts for about 2.5m jobs lost. They assert there is a widespread view in business that the healthcare bill makes it burdensome to hire, underscoring how political uncertainty has made it more difficult to plan ahead. The National Federation of Independent Business asked small businesses their biggest problem. Sixteen per cent of small businesses cited “government requirements and red tape”.

Finally we need to invest in a national infrastructure bank. We ought to undertake new projects of the kind that built America. But we are not even keeping up with repairs – which will cost much more when our bridges, roads, dams, schools and sewage systems collapse. We look askance at the Europeans, but Washington is a graveyard of American dreams.

The writer is editor-in-chief of US News & World Report and chairman, chief executive and co-founder of Boston Properties, a real estate group.

Everyone is on tenterhooks in the countdown to next week’s critical European summit. The outline of the grand solution being pursued is becoming clearer as a growing number of officials take to the air waves. What is emerging seems to be a pretty good approach, provided – and this is vital – Europe agrees on the details while avoiding some highly pernicious traps.

To be clear, it is now the region’s moment of truth. To avoid a very costly and disorderly fragmentation, Europe may well be embarking on the road to embracing a smaller, stronger and less imperfect monetary union in the future. And it is down to just four carrying the heavy burden of responsibility of offering a credible hope for stabilising Europe’s crisis, namely German chancellor Angela Merkel, French president Nicolas Sarkozy, Mario Draghi, president of the European Central Bank, and Mario Monti, Italy’s prime minister.

Over the next few days, these leaders need to unite on ways to enhance the institutional underpinnings of the union, to reduce the risks imposed by the banking sector, to delineate clearly between solvency and liquidity cases, and to stop the latter from tipping into insolvency.

Should they fail, the probability of a disorderly collapse of the eurozone would increase materially. Accordingly, six key risks must be managed proactively.

They need to agree quickly on the anchor for a stronger zone. As indicated in her powerful speech to the German parliament on Friday, Ms Merkel insists on a strong legal and institutional basis. Mr Sarkozy seems to favour something less rigid, while Mr Draghi speaks of “fiscal compacts”. There is absolutely no room for differences of views or interpretations.

Second, as he puts the finishing touches on the economic programme scheduled to be announced on Monday, Mr Monti must combine fiscal adjustment with concrete steps to increase actual and potential growth in Italy. If he fails, he will lack the legitimacy needed for sustained implementation. And he must avoid a repeat of the flawed programmes that continue to predictably disappoint on virtually all fronts in countries such as Greece.

Third, armed with assurances of these two points, Mr Draghi should show no hesitation in taking the ECB “all in” and, thus, provide a credible balance sheet bridge. Discussion of the ECB lending to the IMF in order for it to lend back to European countries is intriguing but potentially detrimental. There is no substitute to direct and forceful engagement by the ECB as part of a holistic and durable solution.

Fourth, the banking system will need to play, or be made to play a more constructive role. Injections of exceptional liquidity from the official sector should be used to encourage in new private capital rather than finance its continuous exit. In some cases, this could happen endogenously; in others, it will require more forceful intervention by both national and regional authorities.

Fifth, Ms Merkel will need to be brutally honest in its engagement with its European partners. To be part of a proper solution, other leaders must be credibly able and willing to commit. Germany needs to call out those that cannot, and also to proceed without them.

Finally, communication must not be bungled yet again. Domestic and global audiences should be informed in a consistent and clear manner. This means conveying a clear vision along with accompanying steps. It is certainly not the time for the type of conflicting and competing remarks from European officials that have undermined virtually every recent attempt to halt this crisis.

There is a lot of work to be done in the next few days, and quickly. Leaders will need to resist the natural tendency to cut corners and please each other with unsustainable compromises.

If they again succumb to shortcuts and partial answers, history will mark this as an enormous failure to deliver on one of the last, if not the final, opportunity to save a union that is key to the region’s wellbeing, as well as that of the global economy.

The writer is the chief executive and co-chief investment officer of Pimco

Iran’s challenge to global order has been among the most complex and confounding tasks for international diplomacy since that country’s 1979 Islamic revolution. A regime with declining domestic legitimacy has increasingly sought to channel discontent towards foreign enemies, imagined and real, and preserve its hold on power by any means. As surprised and disoriented by the Arab awakening as everyone else over the past year, Tehran has been scrambling to respond to the shifting sands of regional geopolitics, amid intensifying rivalries within the leadership itself.

This is the critical context for the escalation in the nuclear crisis now threatening to replace diplomacy with war as the west’s response to the Iranian threat. The recent comprehensive International Atomic Energy Agency report on Iran’s nuclear programme; public debate in Israel about the wisdom of a military strike, without much pushback from outside the country; private mutterings about the best “window” for such an attack; and now the serious diplomatic consequences of the assault on the British embassy and its staff, are combining to deepen the chasm of distrust to new and dangerous levels.

We subscribe to the view that the price of a nuclear-armed Iran would be very high – unacceptably high. Iran’s capacity to destabilise the region would increase considerably. The response from Saudi Arabia, Turkey and others would mean the end of the non-proliferation treaty. The chance that nuclear weapons would actually be used would be much closer.

But that is not an argument for military action now or in 2012. We are not talking about a discrete – or discreet – strike here. Avowed Iranian nuclear facilities are numerous and the regime does not lack for ammunition or targets in return. In addition to its own missile stores, Iran is invested in regional proxy armies, such as Hizbollah. All the war games show that targets as diverse as Saudi Arabia and the Emirates, Israeli and US facilities, and the Straits of Hormuz would come into play.

For these reasons we must avoid military action becoming a self-fulfilling prophesy. Diplomacy must take the lead in preventing a major war with Iran – for that is what it would be. What is more the regime faces at least four serious challenges of its own. First, it is clear that sanctions, cyberwar and covert operations have impaired Iran’s progress towards a nuclear weapons capability, with most estimates holding that the regime is at least two years away from achieving it. To be clear, no one has made the case that such an achievement is imminent.

Second, IAEA inspectors continue to monitor key installations and operations, providing a tripwire presence able to signal any dramatic change in policy or practice by Tehran. It would be disastrous if the fallout from the Iranian storming of the British embassy included the harassment or expulsion of inspectors by the regime.

Third, Iran’s strategic influence in the region is waning. Its sole ally in the Arab world, the Syrian regime, is badly weakened, and more likely entering an end game. Among the Arab public, Iran’s popularity has plummeted since the highs of the 2006 Lebanon war.

Fourth, and too often neglected, are the aspirations of the Iranian people. They have often showed that they do not share the regime’s hostility to the world, and instead aspire to the same kinds of open government that the youth of the Arab world are reaching for.

At a time like this, diplomatic drive and creativity are needed more than ever. Now is the time to support, directly and indirectly, the pressures on a regime currently fractured on all matters except the nuclear programme. And in this endeavour, war talk weakens our hand – strengthening the most uncompromising forces within Iran and corroding global cohesion in opposition to the programme.

Non-military options have not yet succeeded, but nor have they failed. However exasperating the diplomatic track, growing talk of a military option risks creating a logic all of its own, where the appalling consequences of a military strike are set to one side and a precipitate and unwise move to war becomes acceptable wisdom.

Nature abhors a vacuum and so does international politics. It cannot be filled by nudges and winks about military options. A concerted diplomatic effort on Iran is needed now to prevent the world sleepwalking into another war in the Middle East.

This article was co-written with Nader Mousavizadeh, who is chief executive of Oxford Analytica and was special assistant to former UN secretary-general Kofi Annan. David Miliband, MP for South Shields, was British foreign secretary from 2007-10

Over the past year Beijing has been caught between sticking to restrictive policies to achieve a ‘soft landing’ and switching gears to deal with the repercussions of the eurozone crisis. The cut in China’s bank reserve ratio by 50 basis points, which came as a surprise to some, signals that the risks of a major economic slowdown are now of greater concern than an overheated economy. Data showing that Chinese manufacturing activity contracted last month for the first time in almost three years only added to those fears.

China has been doing well in moderating inflation while moving to a more sustainable, but still robust growth rate. Inflation has fallen steadily to 5.5 per cent and should continue to slow. Growth has also slowed from 10.6 per cent in last year, to an estimated 9.3 per cent this year and eight to 8.5 per cent next year. But Beijing has been hesitant in moving to more accommodating policies for fear that the underlying forces that could lead to an overheated economy have not been fully addressed.

The leadership is particularly keen on reducing speculative activity in the property sector. Modest declines in house prices would be welcome, but a widespread collapse would foster serious problems. Recent statements that the property bubble and the debt servicing problems faced by local authorities still needed attention raised doubts that less restrictive policies were imminent.

Two things have changed to accelerate the timetable. On a broader scale, the seemingly intractable financial crisis in Europe has convinced the leadership that the consequences could be much worse than envisaged just a few months ago. On a more limited, but possibly more alarming scale for this political system, the slowdown in manufacturing activity, as well as reports of dramatic falls in exports and the immediate impact it has already had on firms in Guangdong have raised the prospect of labour unrest.

Beijing has handled economic downturns reasonably well, but it will be hard pressed to deal with something bigger than the crash of 2008. It has not yet fully dealt with the negative repercussions of the 4,000bn renminbi stimulus package implemented largely through the financial system. While that programme is credited with preventing a major downturn, it has weakened confidence in the banking sector. Thus there would be little support for another stimulus package of a similar nature.

While further monetary relaxation is likely, given the six increases in the reserve requirements over the past year, China has less flexibility in using either interest or exchange rate adjustments to support its objectives. Although the benchmark interest rate has been raised three times this year, the adjustments were small and deposit rates remain strongly negative. Ironically at a time when the US is putting pressure on China to let the renminbi appreciate, the concern now is that exports are falling too fast. China’s trade surplus may total only 1.5 per cent of gross domestic output this year and could even disappear in the near term.

While market forces might suggest a stable or even depreciating exchange rate, China could feel uncomfortable diplomatically in deviating from its stated intentions for a gradual appreciation. Beijing may be forced to resort to fiscal policies to deal with downside risks this time around, even though budgetary options are far more cumbersome to work with.

The writer is a senior associate at the Carnegie Endowment and a former country director for the World Bank in China.

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