Monthly Archives: November 2013

What to make of the deal on Iran’s nuclear programme? Some will judge this interim accord by the response it evokes from Iran’s neighbours, the Israelis and Saudis in particular. If the neighbours don’t feel safe, it must not be much of a deal – or so goes the reasoning.

That’s a mistake, because the Americans and Europeans designed this interim agreement with American and European – not Israeli or Saudi – goals in mind. None of these governments wants an Iran armed with nuclear weapons, but there has always been much more at stake in these talks than that. That’s why one government’s good deal can still become another government’s nightmare.

First, consider how limited this agreement really is. Iran has pledged to eliminate its stockpile of uranium enriched to 20 per cent, to limit its enrichment capabilities, and to allow routine and intrusive inspections of nuclear facilities. In return, Iran will regain access to assets and have sanctions relief in areas of its economy with no potential relationship to its nuclear programme. Sanctions on Iran’s oil exports remain in place and will only be removed if a final deal is reached.

Yet, this is dramatic progress. The crippling impact of international sanctions helped elect a pragmatic new president. More importantly, Supreme leader Ayatollah Ali Khamenei has publicly endorsed Tehran’s more flexible negotiating position. In a short time, US, European, and Iranian negotiators have moved farther than they have in years towards a landmark accord.

The agreement is very good for Barack Obama’s administration. After the international confusion and anger over the US position on Syria and the Assad regime’s chemical weapons, the White House badly needed a win in the Middle East. More to the point, Washington doesn’t need another war in that troubled region. The president needs a way to prevent Iran from developing a nuclear weapons programme without launching a conflict that will take on a life of its own. This is a big step in that direction.

Israel and Saudi Arabia, on the other hand, have worries that extend well beyond Iran’s nuclear programme. As in Syria, the US has pursued limited objectives. In Syria, Washington has limited its goals to the elimination of President Bashar al-Assad’s chemical weapons; there is no active push for regime change. With Iran, Washington wants to stop the spinning centrifuges. There is nothing in this deal that calls on Iran to recognise Israel’s right to exist or to renounce state support for groups like Hamas and Hizbollah.

The Israelis must also worry that even if this interim deal leads to a final agreement that entirely eliminates the nuclear threat from Iran, still a tall order, Iran will still threaten Israel’s security, particularly as the easing and eventual elimination of sanctions provides Iran with more money to spend in the region. Frankly, Tehran’s conventional and covert threat has always been more immediately dangerous to Israel than a nuclear weapon that would draw immediate nuclear retaliation.

The Saudis may be even more anxious than the Israelis. After all, what sort of foundation are US-Saudi relations built upon? The two countries don’t share political values, as Americans and Israelis do. They share interests. There are two factors that bind the Saudis and Americans: the oil trade and the desire to contain Iran. This deal leaves the Saudis to wonder how Iran can be contained once sanctions are eventually lifted.

The US sells the Saudis weapons, but the Arab spring and subsequent events have shown them that partnership with the US is less durable than for Israel. If the Arab spring one day comes to Saudi Arabia, can the royals rely on Washington to back them? After they have defended the elections that produced a Muslim Brotherhood government in Egypt and denounced moves by the Egyptian army, a longtime recipient of US financial support, to remove Mohammad Morsi?

Add to the Saudi agitation an awareness that the surge in US energy production of recent years leaves America less dependent on oil from the Middle East. In short, the US is becoming a less predictable partner in the region.

The Saudis don’t want a breakthrough on the nuclear programme because they don’t trust the Iranians to honour any deal. The Saudis, like the Israelis, want sanctions. That’s the best deterrent against all the various threats that the Saudis believe Iran poses across the Middle East.

That’s why where you stand on this deal will continue to depend on who you are and where you sit.

The writer is the president of Eurasia Group, a political risk consultancy, and author of ‘Every Nation for Itself: Winners and Losers in a G-Zero World’

For all the better-than-expected economic news this year, the volume of economic activity across the developed world remains remarkably depressed. The language of recession and recovery no longer seems relevant. Instead, we are faced with persistent economic stagnation. Those who wonder whether the west risks entering a Japanese-style “lost decade” have missed the point. The question is whether we can escape from the lost decade that is already suffocating our economies.

Wages are depressed; interest rates have every prospect of staying at rock-bottom; government debt is incredibly high (and, in some cases, persistently rising); companies prefer to hoard cash than invest; and, despite the hum of the printing press, inflation is surprising on the downside. Policy makers did well to avoid another Great Depression following the 2008 collapse of Lehman Brothers and the ensuing financial meltdown. They have not, however, prevented the Great Stagnation.

As the Japanese have discovered, escaping from a lost decade is not easy. Too often, Japan’s problems have been seen in the west as “merely macroeconomic” and, by implication, easily solved with an aggressive tweak of monetary or fiscal policy. Yet the west remains stuck in the same kind of rut. Admittedly, fiscal policy has offered little support in recent years but, on the monetary side, central bankers have bent over backwards. The results of their generosity have been disappointing.

A new version of the “macroeconomic failure” story was provided by Lawrence Summers, former US Treasury secretary, just the other day. In a speech to the International Monetary Fund research conference on November 8, Professor Summers talked about the dangers of “secular stagnation”, offering an intriguing explanation for why the developed world may have to get used to a combination of low nominal interest rates and financial bubbles into perpetuity if policy makers are to deliver anything approaching full employment.

His argument is based on a simple observation — namely that inflation over the past two decades has mostly been lower than expected, regardless of cyclical highs and lows. Price pressures were low at the end of the 1990s and lower still in the years preceding the global financial crisis. As a result, Prof Summers believes it makes no sense to suggest that, at any point, there was excess domestic demand. Throughout the period, the danger was always of deficient demand, largely because interest rates – already very low – could not drop to levels that might deliver full employment. Instead, higher levels of activity could be met only by creating or nurturing financial bubbles, from the dotcom boom of the late 1990s through to the madness of the subprime world pre-Lehman.

Prof Summers suggests the level of real interest rates required to generate full employment might be, say, -2 or -3 per cent. In a low inflation environment, that is basically unachievable. Put another way, if Prof Summers is right, he may never be able to prove it. This rather reduces the power of the analysis unless central bankers prove both willing and able to pursue higher inflation than we have become accustomed to, a hard task in societies where populations are ageing and people are keen to hang on to their (nominal) savings.

There are two other problems with Prof Summers’ approach. First, he assumes that the absence of inflation somehow “proves” that there was not a problem with excess demand. This seems odd. Plenty of economies have suffered unsustainable economic and financial booms in the absence of inflation. Think of the US in the roaring 1920s, Japan in the late 1980s or Thailand (by the standards of the time) in the mid-1990s. All of them later suffered the consequences. Too often, persistently low or stable inflation – sometimes the result of favourable external circumstances – creates the false impression that activity can be sustained at too high a level, leading to excessive risk taking, financial bubbles and balance of payments crises.

Second, Prof Summers assumes his “secular stagnation” is primarily a demand problem. That is not at all clear. There are lots of other entirely plausible reasons for persistently lower-than-expected growth. In terms of economic performance, the late 20th century increasingly looks to have been a one-off “golden age” for the developed world, because of an end to the protectionism of the interwar period, a huge increase in labour supply thanks to the increased participation of women in the workforce, a dramatic rise in the numbers in tertiary education, a massive expansion of household debt (which, in turn, paved the way for more mass production) and, most obviously, the impact on labour supply of the baby boomers.

Technology continues to advance, of course, but technology alone does not fully explain the golden age. This one-off adjustment led to a period of unusually rapid economic growth that took the developed world closer to its productive potential. The same process is now happening in the emerging world even as the developed world stagnates.

This provides a completely different perspective on the secular stagnation. There is no magic interest rate (whether or not it can be reached). The absence of inflation over the last two decades may not indicate a chronic shortage of demand. Instead, developed economies no longer offer the supply dynamism of old. Worse, because policy makers have not recognised this new reality, they continue to pretend golden age growth rates may still be within reach, a convenient way to ignore the tough fiscal decisions that will eventually be needed.

A gap is growing between political and financial hope and the new economic reality. That gap will have to close. As it does so, some will lose out. Levels of mistrust will rise. Risk aversion will spread. Growth will remain stagnant. And the developed world is at risk of succumbing to Adam Smith’s “melancholy state” — a world in which one person’s gain is regarded as the cause of another person’s loss — whatever the level of interest rates.

The setting was as bizarre as it was stunningly beautiful – a luxurious seven star resort and spa built on the edge of the Empty Quarter – one of the largest deserts in the world where sand dunes are as high as mountains, falconry is a reactionary sport, dune buggies whizz you around the three-mile-long estate and the seafood is fresh from Gulf waters just two hours away.

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François Hollande took a big risk on Tuesday night. The French president turned up incognito, with only a small company of riot police on hand, to watch the national football team try to overcome a two-goal deficit and qualify for the World Cup finals at the expense of Ukraine. Mr Hollande is regularly accused of an excess of caution, but this was seen by many as a long-odds bet. Luckily for the Elysee, Didier Deschamps’ team turned up to play for the first time in several months, and the president was able to witness a victory and return to the Faubourg St Honore with a smile on his face.

It is about the only piece of good news that has come Mr Hollande’s way this autumn. The latest IFOP poll gives him an approval rating of 20 per cent the lowest for any president since the poll began in 1958. (Even François Mitterrand’s lowest rating was 22 per cent.) Another poll, by YouGov, puts him down at 15 per cent, only 3 per cent of voters expressing a strongly positive view.

The economy has once again disappointed. An expansionary second quarter appeared to suggest that the recession had bottomed out, and that France was on the road to recovery, albeit a slow one. The third quarter dashed those hopes, and the first estimate is of a contraction of 0.1 per cent. There are slightly more optimistic signs for the rest of the year, but the OECD published a politically delayed assessment of the French economy which rehearsed the familiar critique of inflexible labour markets and extravagant levels of public spending and taxation.

Taxation, indeed, has been the hottest of a set of burning buttons this autumn. Football clubs are threatening to strike in response to the government’s attempt to make them pay a tax rate of 75 per cent on high earners’ wages. When the constitutional court ruled against the initial plan for a direct tax of 75 per cent on earnings over €1m, the government dreamed up a wheeze to maintain the headline figure, but impose it on employers instead. Rich footballers may not be “this week’s good cause”, but even they have attracted popular sympathy at a time when voters think the tax burden is simply too high.

A weekend or two without football matches is not likely to topple the state, but there are many other casi bellorum which are bringing people on to the streets. The Le Parisien newspaper has a helpful website called “Actualité Manifestations” – Demonstration News, one might say – which lists the disruptions one can expect across the hexagon day by day. It’s a kind of weather forecast -strong likelihood of perturbations in Brittany and a hot front is crossing Marseille – that sort of thing. The government have been watching it carefully in recent weeks. (Maybe if something similar had been available to Louis XVI in 1789 the course of world history might have been different).

Recent editions have described lycée students protesting against the treatment of a Roma schoolgirl sent back to Kosovo. For reasons obscure to me, I fear, midwives are up in arms and have taken to descending on Paris in numbers. Most importantly, there has been a wave of demonstrations by farmers, blocking roads around the capital. They are especially concerned about a proposed new “ecotaxe” of 20-25 eurocents a kilometre levied on trucks, due to be introduced in January. Even though there are already complex concessions for remote areas, the agricultural community is outraged.

Already, the government have backed off, and suspended its introduction. But, as usual, the opponents have smelt blood and press for abandonment. The government have this week been obliged to concede a bottom-up review of the tax system, led by Jean-Marc Ayrault, the embattled prime minister, whom many see as a weak link in Mr Hollande’s team. But Mr Ayrault has been clear that they are not talking about reducing the tax burden overall, merely finding better ways of levying the almost 50 per cent of gross domestic product the government need to keep France’s enormous public sector in Badoit and Baguettes.

Meanwhile Mr Hollande sought solace in a trip to Israel, where France’s tough stand on the nuclear talks with Iran earned him a favourable press. But his problems are such that one successful overseas trip, or a famous 3-0 win, will not turn them round. All French football fans know their team’s prospects in Brazil remain poor, and almost all economic commentators recognise that France needs a competitiveness makeover.

There is even excitable talk of a presidency, unable to govern and maintain public security, which collapses before the end of its five year mandate. I discount this febrile chat, if only for the reason that the opposition is almost as unpopular. Only 25 per cent of voters think the centre-right UMP would do any better. The National Front is the group most likely to reap this particular whirlwind, an outcome which even Mr Hollande’s fiercest critics on the left and on the centre-right do not wish to precipitate.

But we may be approaching a Mitterrand moment. Two years into his first term, after a social programme which raised the minimum wage and lowered the pension age, Mitterrand was obliged to change course, to remain in the European Monetary System. So in March 1983 came the so-called “tournant de la rigueur” – literally: the rigorous U-turn. Mr Hollande is approaching a similar decision point, if he wishes to rescue his presidency. It will not be easy. The French do not take easily to rigour, or to the smack of firm government. But the evidence is mounting that a policy of drift and concession will not coupe la moutarde, as the French do not say.

Italy’s government just survived another bout of instability, following the splits in Silvio Berlusconi’s People of Liberty party and Mario Monti’s Civic Choice party, which were part of the ruling coalition. However, political instability is unlikely to fade away. The main reason lies in the government’s stated intention to last until the end of 2014.

With slightly more than a year left, it would be difficult for any administration to take policy decisions capable of reversing a trend decline in economic growth such as the one Italy has experienced in the past 15 years. The eurozone’s third-biggest economy is the only one where gross domestic product is now lower than when the single currency was launched in 1999. Household disposable income has fallen to the levels of 20 years ago.

Italy needs major structural reforms in areas such as justice, public administration, education, taxation, the fight against corruption, and the labour and goods markets. These reforms have been repeatedly recommended by international organisations such as the European Commission, the International Monetary Fund and the OECD.

But, while everyone agrees reforms are necessary, they have not been implemented or they have been diluted because they are politically difficult and costly. Legal reform is opposed by judges and lawyers, who are widely represented in the parliament. Reform of the bureaucracy or the educational system is opposed by the unions, who tend to defend incumbents rather than the unemployed. Service sector reform, in particular in the health system, is opposed by local authorities.

An additional obstacle lies in inefficiency of the parliamentary system, which attributes similar powers to the upper and lower houses, so that any amendment introduced by one house has to be confirmed by the other. The result: an interminable ping-pong that provides ample room for filibustering.

Any government serious about reform must expect strong opposition, even within the parties supporting it. Also, as other countries have experienced, the initial impact of structural reforms may be recessionary, which means public opinion may not initially be supportive.

This implies that governments need to implement structural reforms at the very start of their term in the hope that the benefits are felt before the next election. Today’s constraints tend to discourage governments from even starting the process. As Jean-Claude Juncker, Luxembourg’s former prime minister, used to say: “We know the reforms that we need to do. We just don’t know how to get re-elected afterwards.”

The problem is particularly complicated in Italy, where the government is supported by a grand coalition of parties. The closer the expected election date, the less each of these parties has an incentive to share the pain deriving from unpopular actions. The country experienced this problem in 2011-12, when the Monti government was able to start some reforms only at the very beginning of his term under pressure of from markets. After a few months, as the election deadline grew closer, the reform agenda was shelved.

For coalition governments to function properly and remain stable, the supporting parties need to agree from the start on a detailed programme that precisely defines the measures to be adopted and, as a consequence, the length of the mandate. This is the reason negotiations in Germany between the Christian Democratic Union and the Social Democrats are so lengthy and detailed. It will, let us hope, guarantee future stability.

Italy might want to learn from the experience of the past few months and from the Germans. It could take the opportunity of the recent shake-up in several parties to force an agreement on a detailed series of reforms that would be able to turn around the economy, making it competitive again. This would require a programme of least three years.

Without such a change in gear, the economy will probably continue to languish. Even if the recession ends this year – as projected by international organisations – growth in the next two years will barely compensate for the loss recorded in 2013 (-1.8 per cent). Unemployment and the public debt are expected to rise. In such a dire scenario, it is unlikely the coalition parties and their supporters will gain popularity. Extremist, anti-EU and populist movements may gain further at the next elections. The next parliament could be even more fragmented than the current one, making it even harder to form a government and practically impossible to implement reforms.

If the current government has gained any strength from the recent shake-up in its supporting parties, it should take this opportunity to request a stronger mandate. To do so would be to raise the stakes – but, if it does not, it could fall victim to its own short-sightedness.

Federal Reserve Bank of San Francisco President Janet Yellen arrives at the Jackson Hole Economic Symposium in Jackson Hole, Wyoming in this August 21, 2009 file photo©Reuters

Janet Yellen is expected to soften the blow of a bond taper

Janet Yellen’s confirmation hearing last week reaffirmed that the Federal Reserve remains risk markets’ best friend – and not by choice but by necessity.

This is music to the ears of investors conditioned to position their portfolios to gain from steadfast central bank liquidity support, especially in the US. But with Wall Street having already reflected this in asset prices, and with the benefits for Main Street continuing to disappoint, investors may well need an increasingly differentiated approach if they are to continue to benefit from the “central bank put”.


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Ms Yellen’s key views may be summed up in five points:

• Concern at the human toll of continued sluggish economic growth and persistently high unemployment.

• Faith in the ability of unconventional Fed tools to materially improve the outlook, and to do so without triggering inflation.

• Willingness to underwrite the potential “costs and risks” of relying on this untested policy approach, be they domestic or cross-border.

• Belief that sufficient economic growth will be forthcoming to allow for the eventual orderly normalisation of monetary policy.

• To the extent a policy mistake is forced on the Fed, and every effort will be made to minimise this risk, it is better if it were one of excessive accommodation rather than premature tightening.

Asset markets still key

Based on these five points, Ms Yellen left no doubt that she is committed to maintaining the Fed’s current approach – one that places asset markets front and centre in the transmission mechanism linking Fed actions to policy objectives.

Positioning for the impact of Fed policy rather than fundamentals has been a winning strategy for investors – not only in the immediate aftermath of the 2008 global financial crisis, but also in the past three years during which the Fed has pivoted from normalising markets to pursuing much more ambitious macroeconomic objectives. But they now need to be increasingly mindful of the level of prices and the associated (and growing) number of disconnects that the Fed is underwriting.

This year’s impressive performance of risk assets (including the 21 per cent year-to-date increase in the MSCI world equity index as of Friday, powered in particular by US stocks) contrasts with a global economy still stuck in third gear.

Investors now need to be increasingly mindful of the level of prices and the associated (and growing) number of disconnects that the Fed is underwriting

It has materialised in a non-linear fashion, including a particularly rough patch in May-June when questions surfaced about the willingness of the Fed to continue its exceptional support for markets and the economy. It has involved a notable deviation in performance between advanced and emerging markets. And investors have repeatedly “looked through” harmful US political polarisation and Congressional dysfunction.

In reconciling all this, it would be foolish to ignore the role of the Fed in asset price determination – a role that has been direct, large and persistent; and one that has influenced both investor behaviour and companies’ capital structure operations.

Clear message

Looking forward, investors would be well advised to remember Ms Yellen’s correct observation that robust growth is the best way to allow for the orderly normalisation of monetary policy. Indeed, it is probably the only way. And, for investors, durably higher growth is what validates the current prices of most risk assets.

Unfortunately, apart from the Fed, it is hard to point to policy making institutions that are seriously engaged on pro-growth initiatives. Instead, most are sidelined by continued Congressional dysfunction.

In such a world, differentiation within and across asset classes becomes much more important: be it emphasising the front end of the government bond yield curve, seeking solid balance sheet companies with real profit prospects, or positioning for the forthcoming disposal of assets by deleveraging European banks.

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Greater analysis should also be devoted to the extent to which US equities can continue to outperform so sizably the rest of the world. Yes, Fed policy encourages companies to raise debt and give more cash to equity holders via dividends and share buybacks. But there is a limit to relative valuation deviations in today’s globalised world economy.

Ms Yellen’s message is clear: the forthcoming change at the helm of the Fed signals policy continuity. Yet in positioning for sustained Fed support, investors need to remember that Wall Street cannot – indeed, should not – deviate so much from Main Street.

So, pending stronger evidence that higher global growth will indeed materialise, many investors would be well advised to opt for greater portfolio differentiation.

Mohamed El-Erian is chief executive and co-chief investment officer of Pimco

Sadly, the political correctness that has swept western societies has smothered an appreciation of the virtues of cunning. Yet it was cunning that enabled the west to dominate the world. The only way 100,000 British troops could hold down 300m Indians was to use cunning tactics such as divide and rule. Today, as the west seeks to manage its decline gracefully as well as protect its long-term security, the deployment of cunning has grown ever more imperative. And, if the west could deploy cunning once more, it could enhance both its own and global interests. Here is one simple cunning plan US President Barack Obama could try.

First, he should even more enthusiastically endorse Hassan Rouhani’s plan to solve the dispute over Tehran’s nuclear programme. At a small private lunch with New York luminaries, the Iranian president spelt out a simple deal. First, Iran should, as a matter of principle, be allowed access to peaceful use of nuclear energy. This is a right it has under the nuclear non-proliferation treaty (NPT). Second, in a reciprocal gesture, Iran would allow the International Atomic Energy Agency full access to all its nuclear plants to prove it has no nuclear bomb.

Mr Rouhani was being very cunning in proposing such a deal. As he told the New York luminaries, none of Iran’s neighbours now threatens Iran. George W Bush had eliminated the two threats to the country: the Taliban and Saddam Hussein (leading a prominent Indian journalist to comment mischievously in private that the former US president had in effect become the Mahdi for whom the Iranian Shia had long been waiting for to save them). Mr Rouhani made a simple but indisputable point: a nuclear bomb would only enhance Iran’s insecurity. By contrast, the absence of a bomb would allow the nation to emerge naturally as the dominant power in the Gulf: its sheer size would deliver this happy result.

If Mr Obama could be equally cunning and embrace Mr Rouhani’s “no nuclear bomb” plan, he could gain a big geopolitical victory: peace between Israel and Palestine. How? By embracing the proposal, he would drive the leaders of Israel and Saudi Arabia to desperation. Indeed, he has already done so by talking to Mr Rouhani. Now he should ensure both countries realise that, to balance Iran’s growing influence, they have no choice but to co-operate with each other. There is only one problem preventing co-operation: Palestine.

Fortunately, King Abdullah of Saudi Arabia has developed a viable two-state-solution plan that he passed to New York Times journalist Thomas Friedman in February 2002. The Palestinians should also become cunning and actively push this plan, along with one further cunning dimension: acceptance of total demilitarisation of the Palestinian territory. Why? Palestinian weaponry cannot match Israeli weaponry. But the Palestinians have an even bigger trump card: of all the Arab societies, they have the greatest capacity to modernise. The fundamental reason for the acute despair in the Arab world is that it has not one (repeat, not one) modernised Arab society to inspire it, in the way Japan, South Korea, Taiwan and Singapore inspired and uplifted Asian societies. Only Palestine has the potential to become a Singapore — by replicating the best practices of Israeli civilian society, just as Singapore has replicated some of the best practices of Japanese civilian society. And if this, in turn, inspires modernisation and development in the Arab world, both Israel and Saudi Arabia would then have created the critical mass to balance the weight of Iran in the Gulf.

To achieve this outcome, one other party has to deploy cunning: the pro-Israel lobby in Washington. So far it has been sincere but boneheaded in its defence of Israel. By creating an “iron shield” of absolute security for Israel in the short term, it is generating absolute insecurity in the long term by preventing the country from making the careful and sensitive pragmatic adjustments that any small nation has to make with its neighbours. This is why Lee Kuan Yew, former prime minister of Singapore, once said that Singapore had learnt from Israel how to acquire military superiority and had also learnt how not to use it.

If modernisation and development sweep the region, it will also change the local chemistry. This is the reason Myanmar is not suffering the woes of Syria: regional chemistry influences its military leaders. And this would be the ultimate cunning result if Mr Obama cunningly embraced Mr Rouhani’s plan. It would also lead to the gradual transformation of Iranian society. No, it would not lead to the sudden collapse of the theocratic regime; this a futile wish on the part of the west. But yes, it could lead to Iran gradually opening windows to the world. Slowly, it would be nudged into its destiny: to become a great civilisation once more by replicating the opening-up undertaken by China and India. Many Iranians are asking the obvious question: if we were once as great as these Asian civilisations, why are we falling behind?

The moral is clear and simple. The politics of the Middle East and the Gulf region remain byzantine. Detailed technical plans, such as the one the west has been proposing in recent talks in Geneva, will get nowhere. Mr Obama must display unusual cunning and just say “yes” to Mr Rouhani. This will trigger changes that will benefit the west and the world. A little bit of cunning goes a long way.

The writer is dean of the Lee Kuan Yew School of Public Policy at the National University of Singapore. His latest book is ‘The Great Convergence: Asia, the West, and the Logic of One World’

The diplomatic news from the Middle East is disheartening, with roadblocks and detours from Tel Aviv to Tehran.

These setbacks illuminate how global politics places very different regional demands on the formulation and execution of US foreign policy. American statecraft is focused primarily on high-stakes US diplomatic engagement in the Middle East. To be seen as truly effective, Washington must engage seriously on the Middle East peace process despite the fact that the region has long been seen as the graveyard of its diplomatic hopes and dreams.

Still, the seriousness of Washington’s diplomacy continues to be judged largely on whether the US is prepared to expend enormous energy and high-level capital on the quest for a transformative Middle East peace. The US is also leading an intricate, last-chance effort to roll back Iranian nuclear ambitions despite lingering doubts.

Meanwhile the regional context has grown infinitely more complex, with the US focus necessarily shifting from dealing almost exclusively with autocratic Middle Eastern regimes to a much more fluid and challenging terrain involving competing factions vying for political power across a disorienting and unstable area. The bar for effective diplomacy in the Middle East has never been higher, nor the challenges more daunting. Still, the very notion of durable American global power demands an enduring diplomatic ambition for the Middle East.

In Europe, what is required for a successful American diplomacy is evolving. In the past, it entailed focused attention on institution-building on the continent. More recently, it has involved joint efforts in out-of-area pursuits, notably in Iraq and Afghanistan. As Europe has largely withdrawn from these conflicts and struggled with economic crisis, Atlanticist ambitions have receded and are today quite modest.

Then there are the diplomatic tasks for dealing with a rising Asia. It has commonly been said that the most important ingredient in a successful American foreign policy in Asia is just showing up – and indeed a good attendance record matters. There was some concern in Asian capitals about the cancellation of President Barack Obama’s trip in October but, beneath the obvious disappointment, there was understanding about the political necessities and a strong desire for continuing American engagement.

Increasingly, a successful American foreign policy requires more than just pitching up for meetings and wearing garish shirts for the photo opportunity. Engagement in Asia requires greater dexterity across a number of fronts: diplomatic, political, economic, and security. There is a profound need to integrate every element of American power and to deal with matters with nuance and subtlety – not always prominent American diplomatic traits. Indeed, the region expects the US to engage proactively and seriously with a rising China while hedging quietly and carefully with the surrounding region should things in Beijing take a difficult turn.

However, what is interesting about Asia – in contrast with the Middle East and Europe – is that diplomatic achievement is more attainable. This is not a reason for tilting towards Asia but it can serve as a bit of an enticement. Indeed, a sustained engagement strategy in Myanmar, a multifaceted approach to institution-building, high-level and effective dialogue with China, a collective vigilance with respect to North Korean diplomacy and a successful conclusion of a trade round in Asia can have remarkably positive consequences elsewhere, notably on the tougher and more demanding contours of Middle East diplomacy.

This suggests a degree of phasing is in order. It is better to confront the myriad challenges of the Middle East peace process, Iran’s nuclear programme and Syrian diplomacy on a foundation of successful engagement in Asia, rather than turning to Asia after setbacks in the Middle East.

Overall, the global demands for an engaged and creative American diplomacy are growing, not declining. As a consequence, the US can ill-afford fundamentally to favour any one of the dominant diplomatic arenas, and yet Asia offers the best chance for success precisely because our role is so essential. This in turn can translate into diplomatic capital that can be used elsewhere – notably on the daunting challenges of the Middle East.

The champagne (or, under the circumstances, the apple juice) was chilled. The relevant foreign ministers beckoned. It looked as if all was ready to allow the signing of an interim or limited agreement that would freeze elements of Iran’s nuclear program in exchange for a partial relaxation of much of the rest of the world’s economic sanctions.

But then things unraveled. Laurent Fabius, the French foreign minister, appeared to echo the Israeli view that not enough was being demanded of Iran in exchange what was being offered up. The Iranian delegation, for its part, appeared to have had second thoughts after arriving home, wanting more (an explicit acknowledgment of Iran’s “right to enrich” uranium) than the US and others were prepared to provide.

So the only announcements on Friday and over the weekend were of plans to resume more talks at the working level in an effort to resurrect an interim arrangement on terms that would be broadly acceptable to Iran, the US, France, Russia and the EU.

But it is not clear that such an approach is either doable or desirable. Interim agreements are thought to be easier to reach, but they can be harder to sell. There is the fear that steps taken cannot be reversed if things do not work out. This is what the advocates of sanctions suspect and the government of Iran no doubt hopes for. There is also a fear those activities that are not limited will only become more of a problem, a real issue when any freeze of Iranian nuclear activities would be partial. There is also a fear that what is meant as interim or temporary might become permanent.

So, it turns out, interim agreements can be as hard or even harder to negotiate than final pacts and can consume a good deal of political capital, while achieving less in the way of results even if negotiations succeed. So the question naturally arises: why not just skip an interim pact and negotiate final status?

The argument is that it would be too hard and take too much time to do it in one go. But by including everything, a comprehensive approach actually increases the scope for trade-offs. It also increases what each party derives from the accord, making it easier to defend domestically against the inevitable charges of giving up too much. Going directly to final status discussions forces everyone to focus on what was actually agreed on, rather than on the supposed precedents being set and the worst possible extrapolations of what could come to pass.

What might a final status accord look like in this instance? Iran would cease enriching uranium at the 20 per cent level and its existing stockpile would be either shipped out or rendered unusable. There would be significant reductions in the number of centrifuges it would be allowed and even in the amount of low-enriched uranium it could possess. Work would stop on the heavy water plant at Arak, linked to a plutonium project. Intrusive international inspections would become a permanent fixture. The net result would be an increase in the time it would take Iran to produce nuclear weapons if it decided to try to do so, and therefore also increasing the likelihood of detection.

In return, Iran would receive a substantial relaxation in sanctions against it, something much needed if its economy is to recover. Iran’s right and ability to enrich uranium to a low level would be clear so long as it was carried out in a manner consistent with the terms of the accord.

One other consideration is what the two sides would do in the time it takes to negotiate such an accord. Tacit restraint is probably the best way to go about it. The goal would be for each party to avoid creating conditions that make it impossible for the other side to sustain negotiations. The US would likely need to hold off introducing additional sanctions; Iran would likely need to postpone enhancing its capacities.

The best way to render such considerations moot, though, would be a rapid conclusion, in a few months of a comprehensive pact in which all obligations were made specific and lasting. The case for doing so remains strong. Iran needs to do something for its economy if its revolution is to be secure; the US and the other countries involved want to avoid a choice between going to war with Iran or allowing it to acquire nuclear weapons.

The writer is president of the Council on Foreign Relations

Was the outcome of the Third Plenum “unprecedented”, as one member of the standing committee expressed beforehand? Or at least “comprehensively deepening reforms”, as characterised officially? After four days of silence when the only indication that something important was happening was the increased security, the final communique offers both encouragement and uncertainty.

The communique was comprehensive in the tradition of previous statements. Present were both the obligatory homage to the past leadership is there (“the magnificent banner of Socialism with Chinese characteristics”, “Deng Xiaoping Theory”, “the important Three Represents thought”) and the affirmation of the dominant role of the Party. It also managed to mention all the issues without offending any constituency: “establishment of an innovative economy, governing the country according to the law and accelerate the perfection of cultural management.” Continue reading »

It is a sign of the desperate, deplorable times in Pakistan that while the leader of the Pakistani Taliban, recently killed by a US drone, is hailed as a martyr and victim of American perfidy, a true heroine for this age has just had her book banned in Pakistani schools. Continue reading »

File photo of the euro sign landmark outside the headquarters of the European Central Bank (ECB) in Frankfurt on September 2 2013©Reuters

The European Central Bank responded correctly to recent news of very low eurozone inflation by loosening policy further. The big question now is whether its decision – reducing the main financing rate from 0.5 to 0.25 per cent – will have a big enough impact to move inflation from less than 1 per cent a year back close to the ECB’s target of 2 per cent. The answer to this question lies in the foreign exchange markets.

A lower short-term interest rate will certainly not, by itself, raise inflation through increased spending by businesses and households. The primary route from a lower ECB interest rate to higher inflation would be through the exchange rate of the euro. The strength of the euro over the past year has depressed import prices and forced eurozone companies to keep prices down to be competitive at home and abroad.

Eurozone interest rates are still higher than rates in the US, a situation that maintains upward pressure on the international value of the single currency. The US Federal Reserve has reduced the short-term federal funds rate to just 0.08 per cent, and has promised not to raise it while the unemployment rate remains above 6.5 per cent and there is inadequate evidence of strong labour market conditions. Participants in the financial market are now betting that a rate rise will not happen until late 2014 or 2015.

The ECB’s decision has caused a small fall in the value of the euro relative to the dollar and other currencies. The euro fell immediately after the ECB’s announcement by about 1.5 per cent to a dollar exchange rate of $1.33 per euro.

The ECB should seize this opportunity to indicate that it is not worried about a declining euro exchange rate but sees it as a way to move the inflation rate back towards its target of 2 per cent. And an indication that the interest rate could be reduced again in December unless inflation rises back to 2 per cent would reinforce the market’s understanding of the ECB’s relaxed attitude towards a lower-value euro.

A cheapening euro would be an important boost for eurozone countries such as Spain, Italy and France that have very large fiscal deficits. Those deficits, combined with slow growth and very low inflation, are causing the ratios of national debt to gross domestic product to rise. And rising debt ratios increase the risk of renewed increases in their sovereign borrowing rates and even the possibility of pressures to leave the eurozone.

A more competitive euro would strengthen demand in all the eurozone countries by increasing exports, and causing domestic buyers to substitute local goods and services for imports. Although the lower euro would not change the relative prices among the eurozone countries, it would have a powerful effect because nearly half the trade of the eurozone countries is with countries outside the eurozone. So a weak euro can lead to stronger demand and increased economic activity.

Reducing the fiscal deficits in Italy, Spain and other high-deficit countries has been difficult to achieve because reductions in government spending and increases in taxes depress economic activity. Lower economic activity causes increased transfer payments and reduced tax revenue, offsetting the original fiscal contraction. And “austerity” policies generate substantial political resistance, which makes such policies hard to achieve and maintain.

A lower euro can provide the increased demand that makes it politically – and economically – possible to pursue enough fiscal consolidation to put the ratios of national debt to GDP on a sustained declining path. The ECB need not target a weaker euro to achieve these important favourable effects. But a positive ECB attitude about a declining euro in the context of raising the inflation rate will allow financial markets to achieve that goal.

Market participants should recall that the euro began with an exchange value of just $1.13 and dropped at one time to less than a dollar a euro. The eurozone was hurt when the euro rose recently to nearly $1.38 per euro while sterling and the Japanese yen both declined by 25 per cent.

A substantial fall in the euro should be welcomed as an escape from the risk of deflation and the key to improved fiscal policies.

The writer, a former chairman of the Council of Economic Advisers, is professor of economics at Harvard


A year ago, the prospect of a US-Iranian nuclear settlement seemed very distant. Now, top negotiators from Iran, the US and other major powers are convening in Geneva, and may be on the verge of concluding a deal this week over Iran’s nuclear programme. All signs point to a seriousness of purpose and a determination to get to an agreement. While the differences dividing Iran and the US are significant, the more difficult negotiations may well be the one each side faces at home.

Most major international negotiations are, as Robert Putnam, the Harvard political scientist, put it, a two-level game; one set of negotiations take place at the table between the parties and another set back home among different domestic constituencies. The Iran nuclear negotiations are no different, and their success will depend as much on how domestic forces align within the US and Iran as on the direct talks between them.


On this story

IN Opinion

One reason for optimism in Geneva is that Hassan Rouhani, the new Iranian president, seems serious about striking a deal. So far, he appears to have the backing of Ayatollah Ali Khamenei, Iran’s supreme leader. But President Rouhani and his team are clearly operating on a very short leash. They need to secure quick relief from sanctions while minimising any constraint on Iran’s nuclear programme. Failure to deliver on either could strengthen domestic hardliners and torpedo further negotiations.

President Obama contends with similar domestic constraints – but ones that are exactly the reverse of Mr Rouhani’s. Big, bipartisan majorities in Congress remain deeply sceptical of Tehran’s motivations. Rather than relaxing sanctions, congressional leaders favour tightening them still further. While Tehran is seeking to minimise restrictions on its nuclear programme, many in Congress have maximalist demands, insisting that all major nuclear activities inside Iran, including enrichment of any kind, are not only ended but banned forever.

The challenge for Presidents Obama and Rouhani is to find a way to an agreement that takes account of – and ultimately overcomes – these opposing domestic forces. Time will be of the essence. Tehran’s hardliners are eager to demonstrate that accommodation will not work, while Congress is ready to impose new sanctions. Even if ultimately feasible, a comprehensive nuclear deal will take many months to negotiate.

Therefore, rather than seeking to achieve a full-on deal, the most immediate objective of the talks this week should be to achieve an interim agreement that will make a comprehensive one more likely in the future. For example, Iran might agree to halt further enrichment for, say, six months and turn more of its most enriched nuclear material into fuel for its research reactor. In return, Washington could unfreeze some of Iran’s overseas assets. Tehran would, of course, have to agree to more frequent and intrusive international inspections to verify that the enrichment freeze remained in place.

Such a short-term deal could provide the time necessary to get to a more comprehensive agreement. It may also give both sides some room with their domestic audiences. President Rouhani could trumpet the unfreezing of some of Iran’s capital while emphasising that the freeze on enrichment can always be undone. President Obama could point to the freeze as stopping the Iranian programme in place, while underscoring that none of the sanctions had been lifted.

Then again, none of these arguments may assuage those in Iran who want an absolute relief from all sanctions or those in the US (and Israel) who insist on a complete end to the Iranian nuclear programme. To them, an interim deal is only the first step towards an inevitably bad deal.

Yet, even if such sentiment against an interim deal is likely to exist, it is unclear whether these arguments would prevail. In Tehran, the supreme leader has indicated his support for negotiations and he might well give President Rouhani additional leeway to get to an agreement that lifted sanctions.

In Washington, Congress might seek to strengthen sanctions, but such a move will probably meet strong and vocal resistance not only from the Obama administration but also from European allies. Those latter concerns cannot be so easily dismissed. There is no doubt that punitive sanctions have forced Tehran’s hand and brought Iran to the table. While Congress led the charge for ever more stringent sanctions, their ultimate success depended on the US government bringing the Europeans and the rest of the world on board to ensure an airtight regime.

There is a similar need for multilateralism on any relaxing of sanctions. Europe has a major voice on whether and when to unwind key sanctions, and if Europeans believe Congress or the US is acting unreasonably in opposing a negotiated way forward, their willingness to keep sanctions in place will inevitably wane.

None of the optimism should obscure the complexity of this week’s negotiations. While all eyes will be on the table in Geneva, much of the real bargaining will take place in Tehran, Washington, Jerusalem and across the Atlantic.

The writer is president of the Chicago Council on Global Affairs

Change — fundamental change — can be difficult to discern in Asia. Too often it is measured by rapidly changing skylines and cityscapes; change as reflected by new buildings, architectural marvels and ambitious public works projects. In this way, every trip to China is a visit to a new country, with cities sprouting from rural landscapes virtually overnight. These cement and steel structures reflect new trends in Asia’s inexorable urbanisation but they are only one manifestation of change.

Sometimes profound change can take place with little by way of physical structures or outward manifestations. It is measured in evolving mindsets.

Take Japan. A drama is playing out that promises to alter the fundamentals that have guided the country’s policies at home and approach to the world for generations. It manifests itself in a very different way from those changes taking place elsewhere in Asia. Look at the renowned hotel near the Ginza district that has been frequented by western visitors for decades. In one of the long passageways, a small area of carpet was worn through in the early 1990s, and was replaced with a bright green patch. It is still there, strikingly out of place and crying out for renovation, 20 years on.

The change in Japan is reflected more in public attitudes than anything else. Almost overnight, polls reflect dynamic new trends: rising suspicion and even hostility towards China; growing exasperation with South Korea; greater interest in developing more robust defense capabilities; and more ambivalence about the experience and legacy of the second world war in Japan.

The country’s history has been marked by long (sometimes exacerbating) periods of constancy, abbreviated by infrequent episodes of profound change. After recent “lost decades”, we it is likely we are entering one of the latter periods. The fundamental change in attitudes and the attendant politics is best exemplified by the landslide election and return to power last year of Prime Minister Shinzo Abe of the Liberal Democrats, after a brief spell out of office for the party. He and his senior advisers have implemented a bold set of macroeconomic and (it is hoped) structural reforms designed to jolt the nation out of its generation-long lethargy. The short-term improvements in exports and the stock market are encouraging.

Yet Mr Abe’s agenda extends well beyond economic reform. He came to power with a clear and unambiguous determination to change Japan’s international role. The country sees its neighborhood as increasingly unpredictable, even dangerous, with provocations from North Korea and rising regional ambitions in China. Japan has not fired a shot in anger in about seven decades, but Tokyo is gradually shedding the historic inhibitions that have kept it from playing a role in any defence or security effort beyond strict interpretations of self-defence.

While Mr Abe’s motivations are a direct result of 2013 conditions on the ground in Asia (and in the surrounding seas), some of the rhetoric from Tokyo, tinged with suggestions of historical revisionism, have led some in the region (read China and Korea) to interpret Japanese intentions through the lens of 1937 and the rise of Japanese militarism. While pacifism has deep roots in Japanese society, some parts of the elite feel they do not get enough respect. And they want it.

So Japan is changing, and rapidly. The US has essentially two courses of action it can take. It can stand back and let the country change on its own, with little regard for the unique historical role it has played in ensuring Japan’s security. Or it can stay close to Tokyo, providing counsel on how to chart an uncertain course towards the status of what some Japanese strategists longingly describe as a “normal” country. The latter path offers risks and uncertainty, but it is also the best way to help preserve one of the most important bilateral relationships in Asia, the one on which the region’s economic miracle has been built.

It is better for Japan to change and evolve in partnership with the US than to strike out in Asia alone.

The ECB’s recent announcement that it will start a comprehensive assessment of the eurozone banking system is good news. It will provide a uniform evaluation of 130 credit institutions, which should contribute to reducing the uncertainty about the overall health of the eurozone financial system and thus reduce its fragmentation. Continue reading »

Polio has returned to the Middle East in a devastating form as a result of war, terrorism, a collapse of services and a refugee crisis right across the region. Moreover, the strain that is already infecting Syrian children has probably arisen from Pakistan, which is witnessing the same symptoms of war and refugees.

At least 10 children have tested positive for polio in Syria’s eastern Deir ez-Zour province with another 12 suffering from paralysis symptoms, according to the World Health Organisation, which fears a major regional outbreak of the disease is already under way due to the collapse of health services, not just in Syria but also in neighbouring Iraq and even parts of Lebanon and Jordan where local health facilities are overwhelmed by refugees.

Continue reading »

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