Wednesday, 7 May 2014

Obamacare will be vindicated by history: From JFK to FDR, here’s how the nation’s memory works

The following piece originally appeared on Salon

Not everyone viewed the introduction of Obamacare as cause for national celebration, but that doesn’t mean history won’t remember it as such. Time has a habit of changing the perception of presidential initiatives.

The Gettysburg Address may be the most iconic speech made in America, but not everyone shared that sentiment in 1863. Far from being revered as an affirmation on human equality, Lincoln’s words were roundly criticized by the Democrats of the day, while the Chicago Times described the president’s efforts as “silly, flat and dishwatery utterances.” Moreover, Lincoln’s words weren’t even the actual Gettysburg Address; they were brief dedicatory remarks following on from Edward Everett’s two-hour oration.

Many moments that seemingly define American ideals have been repackaged as occurring in a society much different from their time. Often, the prevailing political landscape has been toned down to allow the depiction of a nation unified by positive thought.

Today, John F. Kennedy’s space exploration efforts of the 1960s are rightfully spoken of in the context of the successful moon landing, an effort that confirmed America’s unyielding ambition. Yet the public scorn of the era’s numerous failed rocket launches is long forgotten.

Many commentators unfavorably compare Obama’s foreign policy struggles to Ronald Reagan’s supposedly sterling record. Reagan’s foreign achievements are highlighted by bold initiatives that weakened the threat of the Soviet Union and ultimately brought victory in the Cold War. But the passing of time has faded memories of the clandestine Iran-Contra weapons affair in which the Reagan administration supplied weapons to Iran and aided the contras in Nicaragua.

Such unsavory incidents are inconveniences to a rosy narrative. Instead, it brings great comfort to look back at great achievements of the past and nostalgically reminisce of a time when America cheered on the enterprise of its leaders. Rarely is it mentioned that throughout the 1960s a majority of Americans did not believe NASA’s Apollo project was worth the cost. Nor is attention given to the hawks within Reagan’s own party that lambasted his decision to ease tensions with Soviet leader Mikhail Gorbachev.

While seemingly difficult to imagine, decades from now history will note that the Affordable Care Act symbolized one of the great presidential efforts to fight inequality in America. Long forgotten will be today’s headlines of a temperamental website, deadline delays and mixed messages about keeping existing plans. Instead, it will be heralded that Barack Obama made a superior healthcare service available to the masses.

It may be noted that the initiative was not an instant success and needed retooling in subsequent years, but only one man will be given credit as its instigator.

The short version of Barack Obama’s bio will not reference the failure to implement his intended education and energy reform, or that a reset of Russian relations went sour. Perceptions of the Afghanistan and Iraq withdrawals may change with time, but Obama will still be remembered as a fighter against society’s widening income gap.

Thankfully for Republicans, the manner of their opposition to affordable healthcare will become a minor footnote. History will record that Obamacare passed both houses of Congress, was signed by the president and approved by the Supreme Court. Long forgotten will be the details of how Republicans ignored the legislative process, did everything in their power to repeal the law and bowed to extremist elements who forced a government shutdown for the first time in 17 years.

Romanticism will prevent people from caring about such details. We like to look back on great moments and imagine ourselves as part of a unified society bounded by optimism. Who doesn’t like to think they would have saluted Lincoln’s words, cheered on the bold Apollo missions and admired Reagan’s bravery in opening the Iron Curtain? It can seem incongruous that monumental changes occurred without universal support. But they do because humans are not of one mind. And in a land where ideas can be expressed freely, such a state of unity can never exist.

Moreover, future generations will struggle to believe that one party so vigorously opposed affordable healthcare without presenting a coherent alternative.

The Obamacare system may be flawed, but it is a start. Some people have lost their existing coverage and must enroll in a plan that meets the improved standards demanded by Obamacare. This can incur greater costs for the individual, but subsidies are needed to provide healthcare for those uninsured with low incomes. It will be a moot point in years to come; popular history looks favorably on inconveniences of the few for the benefit of the many.

The only viable conservative alternative to Obamacare is no system at all, but nobody will want to think that such a large portion of the political establishment was happy with such a state. Even if some believe that the previous situation of 48 million uninsured without any prospect of coverage is better, repeal is unattainable. Republicans were aware of this before the government shutdown, but the party bowed to fanatics and went on a campaign for maximum disruption for the sake of an unattainable goal. The current political system, effective for more than 200 years, means that changes to law cannot be made without going through the legislative process.

With more than 7 million enrolled, Obamacare is here to stay. Regardless of future modifications, of which there will be many, affordable healthcare has been instituted in the United States, dragging millions away from the threat of imminent bankruptcy and terminal illness.

Those opposing Obamacare may not be as ignoble as the politicians who opposed the Civil Rights Act of 1964, but the racial significance of affordable healthcare will not be lost. At present 55 percent of the uninsured are non-white. In time Obamacare will help break down the barriers between rich and poor.

Obama will be appreciated as the first black president who also made healthcare a reality for everyone. It will define his legacy, with his political missteps whittled from his narrative. Republicans are on the wrong side of history, but their obstructionism will fade from public consciousness. We like to think that a time will return when the nation supported the conviction of its leader. But great achievements aren’t born from support from the masses, they happen when someone risks derision to surpass the status quo.

As President Kennedy said: “We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard.”

Tuesday, 6 May 2014

A Doctrine of Indecision

He rarely ventures down the back of Air Force One, but during an April visit to Asia, President Obama felt the need to address reporters on recent criticism of his foreign policy. The conversation was presumably intended to be off the record, but the exchange has been widely reported in the media. Regardless, the president’s utterance of one short phrase gave greater insight into his foreign policy approach than countless immaculately delivered speeches. His mantra? “Don’t do stupid s**t.”

Barack Obama came to power with one of the most ambitious agendas of any president and his ideologies were touted loudly. Vows to change the domestic landscapes of healthcare, education and energy have met with mixed success, but his efforts to push a principled vision have not relented. Yet after more than five years, Obama’s approach to foreign policy still seems vague and often inconsistent.

By stopping in Ankara, Turkey on his inaugural European tour, Obama sought to live up to his billing as a worldly leader keen to establish America’s role as a sophisticated, benign global hegemon. He has succeeded in distancing the nation from Bush-era belligerence, but in its place a vacuum has formed, calling into question the President’s appetite to act as a global leader. In essence, it seems the Obama Doctrine calls for not doctrine at all.

Foreign policy doctrines have not always been advertised as such, but presidents have typically established an initiative that defined a stance; effectively outlining the principles that they would go to war for. The first recognized presidential doctrine, by James Monroe, was defined by a warning that any further interference by European states in the American continent would result in US intervention. In more recent times, Reagan’s doctrine set out intentions to aid and arm global resistance movements against the threat of communism. Some presidents have not needed a definitive doctrine. Following the collapse of the Soviet Union, the 1990s was an era of relative calm, meaning that the Clinton Doctrine largely revolved around a brief and successful intervention in Yugoslavia.

Yet the subsequent policies of George W. Bush ultimately shaped the attitude of Obama. Foreign policy received little attention when Bush came to power, but 9/11 necessitated a strong reaction. Irrespective of the popularity of the Bush policies, there was little doubt regarding that administration’s eagerness to depose regimes that harbored security threats. In essence, Obama’s outlook has been a reaction to the Bush administration’s reaction to terror.

Conscious of the subsequent backlash to Bush’s interventionism, Obama seems to think that being different from his predecessor disallows him from adhering to rigid policy. Yet a doctrine need not be systematic nor aggressive; Reagan’s policy did not call for the arming every rebel group that opposed communism. Obama’s outlook seems less a case-by-case approach and rather a disconnected set of actions mired by fuzzy logic.

No obvious upside
Foreign policy has not been a disaster under Obama and perhaps he believes there is little upside to building a clear doctrine. On the surface he may seem correct. Polls during of the 2012 presidential campaign showed that less than five percent of voters deemed foreign policy their priority. Reflecting the public’s consciousness is useful when seeking election, but can be harmful when in power. While foreign policy may not be everyone’s priority, getting it wrong carries great reputational risk. A PEW poll last December that showed Obama had garnered the lowest level of support for an active American foreign policy since Lyndon Johnson escalated US involvement in the Vietnam War in 1964.

Unfortunately for Obama, not every presidential decision is subject to a national vote. In the role of commander in chief he has been eager to point out that he is neither an interventionist nor isolationist. Commentators have subsequently struggled to identify his style, at first portraying him as an idealist and latterly a realist. Obama may believe that he has successfully eschewed extremes and probably expected to receive plaudits for scaling back America’s global presence. He must be disappointed.

Some conservative media outlets have given particular attention to the Bengazhi embassy attack. The administration’s miscommunication on the affair has been loudly condemned as its biggest foreign policy failure. Such rhetoric is hyperbole. The situation may have somewhat damaged his reputation domestically, but the issue of whether the administration initially categorized the attack as an act of terror has done little to harm America’s international reputation. Several other cases have had a far greater impact on the nation’s global standing.

Damaging rhetoric
Trying to avoid mistakes is always sensible, but inaction is not. Even worse is promising action but delivering nothing. Such was the situation with Syria. Drawing a metaphorical “red line” can be an effective tool in defining future policy responses, but brings ridicule at home and anxiety abroad if the line can be freely crossed. The ultimate issue with Syria was not that America failed to pursue military action after Assad used chemical weapons, but that Obama signaled a harsh response and then didn’t deliver. Moreover, in the resulting consternation Russia stepped in to mediate the chemical disarmament, saving Obama some embarrassment while boosting the ego of Vladimir Putin.

Obama’s initial desire for intervention in Syria seemed to mirror his stance with Libya, which was labeled a humanitarian mission. But the protection of humanity now seems to be disregarded as Assad has been allowed to kill with impunity as long as he doesn’t use chemical ammunition. The invention of the “red line” and subsequent ignorance to it indicates not just a lack of clear direction, but carelessness toward setting agendas. In recent weeks the president’s desperation has been evident through plans to arm Syrian rebels; an initiative he rejected three years ago. He may have started with good intentions, but his stance on Syria has descended into a jumbled web of indecision.

Russia’s facilitation of the Syrian chemical disablement may have helped Obama in the short-term, but it likely emboldened Putin ahead of his usurpation of Crimea. Interfering in Ukraine was supposed to be the catalyst that would result in Russia’s “isolation”, according to Obama. The president’s modern method of punitive sanctions worked well with Iran and he must have thought they would have similar effectiveness against Russia. But Iran has long been on the global economic fringes; Russia has not. Ignoring the threat, Putin claimed Crimea and seemingly extended Russia’s influence into eastern Ukraine too. Obama responded with targeted sanctions, but has seemed unable to muster anything damaging as EU and US businesses are too intertwined with the Russian economy. Crimea remained vanquished and the incident served as another example of strong vows but little action to dissuade a rogue nation from serious infractions. Enforceable threats do nothing but weaken the global perception of America.

At least the president’s stance on Crimea was clear, if ineffective. With Egypt, the Obama administration repeatedly flip-flopped, clouding any intended support for democratic stability. When the Arab Spring took hold in 2011, Obama seemed to be in idealist mode and called for the resignation of Honsi Mubarak, a long-time US ally. Obama’s decision went against the more seasoned advice of his security adviser Tom Donilon, Defence Secretary Robert Gates and Secretary of State Hillary Clinton, who were all worried that encouraging the removal of a long-time leader, without any post-Mubarak plan, would bring anxiety to neighboring US allies in the most unstable of regions. Mubarak left and in came the intolerant Muslim Brotherhood.

The new leadership brought even more instability, stopped only by a military coup that the Obama administration somehow described as “restoring democracy”. Obama has welcomed the subsequent ascension of former military chief Abdel Fattah el-Sisi, who came to power in elections that were far from free and fair. Egypt will effectively be under military rule for the long-term; a situation little different to when Mubarak reigned, except with even more brutality. Along the way the US has appeared indecisive and willing to switch allegiances overnight, something that has likely unnerved vital allies such as Jordan, Saudi Arabia and the Gulf states.

With a presidential campaign in mind, Hillary Clinton has sought to clearly distance herself from Obama’s foreign policy. She reportedly took a sturdier stance on most issues, and not just in reactionary events such as Egypt. Recognizing burgeoning developments in the Far East, the then-Secretary of State called for a pivot to Asia. Yet after her departure the Obama administration tried to force more Israel-Palestine peace talks at a time when neither side had any appetite for a deal. The nine-month talks, which ended without a deal in April, involved a Palestinian leadership that was wracked by internal Fatah-Hamas divisions and an Israel enjoying relative calm, expanding settlements and a stable economy that galvanized hardliner sentiment.

In effect, the forcing the Israeli and Palestinian leaderships into talks seemed to heighten animus between the sides and spurred Fatah into closer links with Hamas, boosting the relevance of the latter. The current outbreak of hostilities is not a direct result of the faltering peace negotiations, but they ultimately served to bolster the bravado of Hamas and draw further ire from Israel.

Withdrawals from Afghanistan and Iraq
From day one, Obama’s goal was to withdraw US presence from Afghanistan and Iraq. He cannot be blamed for inconsistency there. Obama always made it clear that he opposed the Iraq war and viewed the whole mission as a blemish on American foreign policy. But his explicit eagerness to remove troops gives the perception that he didn’t try too hard to reach agreement with Prime Minister Nuri al-Maliki to leave behind a residual US force. Undoubtedly, even a lingering US presence would have helped neutralize this year’s turmoil. Moreover, knowing that the American president had a keen aversion to the Iraqi project was a likely boost of encouragement for militants, who were safe in the knowledge that the US presence would be a long-term vacancy. The vacuum could yet allow Iran to save the day, providing an ideal foil to extend influence throughout its oil-rich neighbor.

It is chilling to think that the current state of Iraq might be the future for Afghanistan. Of course, there are some fundamentally different factors, but it is not unreasonable to imagine a battle-hardened Taliban assailing the neophyte Afghan security services. Moreover, the timing of the turmoil is already set. Obama has established a timetable that will climax with all US troops, save for some security personnel at the Kabul embassy, withdrawing from Afghanistan by the end of 2016. By no coincidence this date also corresponds with Obama’s retirement from the White House. Giving a troop withdrawal pledge so far in advance is dangerous enough from a security perspective, but timing this with a departure from office seems naive at best.

Acutely aware of the warmonger stigma attached to George W Bush, Obama has sought to build his image as the antithesis of an antagonistic president. A worthy objective, but everything else in global affairs has seemed to be an inconvenience. Such an attitude can be attributed to inexperience or the boldness of relative youth. He admitted a reluctance to foreign policy earlier this year when he outlined his approach as: “You hit singles, you hit doubles; every once in a while we may be able to hit a home run.”

Even so, that doesn’t mean Obama has always been gun shy. He has presided over a sharp increase in drone strikes against alleged terrorists in Pakistan, Somalia and Yemen. And he approved the military “surge” into Afghanistan in his first term, but this seemed another example of indecisive policy. As former defense secretary Robert Gates concluded three months after the surge: “[Obama] doesn’t believe in his own [Afghanistan] strategy, and doesn’t consider the war to be his. For him, it’s all about getting out.”

False expectations?
Perhaps Obama thought that he could write-off the two wars and then be free to focus on domestic issues. His line of thinking may have led him to believe that with the two wars wound down, his presidency would mirror the international environment of Bill Clinton. Yet history says that the calmness of the 1990s was a rare occurrence; a mere blip within a century of conflict. Scaling back America’s influence in global affairs does not mean it will be left alone by the antagonists of the world. Unfortunately for America, a hegemon is always a target.

Barack Obama is a man of contradictions. He has achieved so much, securing two terms as the first black president, making healthcare more affordable. But he still must feel like an underachiever given the lofty expectations. He has a rare oratory ability to engage with a large audience, yet as president he is known for preferring his own company and being lukewarm to leaders of America’s allies.

Obama underestimated the importance of building a coherent doctrine and has been stung by recent criticism. Domestic agendas may be the preference of voters, but neglecting foreign policy carries great risk and can define a legacy. Inconsistency breeds doubt; something no leader should be associated with. In the twilight of his tenure, Barack Obama seems to be learning that lesson.

The future for America's stagnant incomes: How the US must react to global convergence and technology

It took five years, but the US has finally recovered all the jobs lost following the 2008 recession. Indeed, the economy has been growing since June 2009; its fifth longest expansion in history. House prices have jumped sharply and the unemployment rate has tumbled. Yet it hardly feels like boom times for many Americans.

While stock markets reached record highs and large companies amassed record profits over the last few years, wage growth stagnated. And it is not a recent phenomenon; the inflation-adjusted median household income peaked in 1999 at $56,080. It is now $51,017. Listless wage growth has become such a norm that manufacturing corporation Caterpillar, despite announcing bumper profits, was able to implement a six-year wage freeze on many of its blue collar workers in 2012.

It seems an anomaly that so many important economic indicators have shown such strength while incomes remain static. In the post-recession years consumption has grown about 2% annually, well below its 3.5% long-term rate. That doesn’t bode well for an economy that relies on consumption as its engine. The gravity of the problem was masked in the pre-crisis years as consumers availed of easy credit and could afford to cut back on savings. But with many households now drowning in debt, stagnant incomes will become a bigger drag on economic activity.

An improving job market may bring some relief, but not much. The unemployment rate has reached its lowest rate since September 2008, but the number is flattering. It isn’t so impressive when the labor force participation rate is at a 35-year low due an increase in discouraged jobseekers, retirees, college returners and disability claimants; all categories that are typically boosted when an economy is weak.


But even if more employment is available, entering the workforce may not be attractive when so many jobs provide depressed incomes. The stagnation in wages does not appear to be part of a normal business cycle; it was evident long before 2008. The causes are more than just credit availability and a short-term drop in demand.

Median household incomes rose steadily between 1970 and 1999, but the pace was considerably slower than the 1950-1970 period. The picture gets even worse when the increased participation of women is considered; a strong trend that took off in the 1980s. The full extent of the problem is evident when it’s considered that the median male worker earned an inflation-adjusted 8% less per week in 2013 than in 1979. 

Median-Male-Weekly-Earnings-constant-1982-84-dollars-Wage_chartbuilder (2).png

The forces contributing to wage suppression have been surging for more than two decades and show little sign of abating. Globalization and technology have brought much prosperity to the world economy, narrowing the gap between rich and poor nations. Yet their influence seems to be doing the opposite in America. An interconnected world powered by technological advances means that many labor-intensive jobs have moved to countries with cheaper costs, leaving behind a large supply of lower-skilled workers. It has also provided jobs that bring demand for highly-skilled workers, but there isn't a sufficient supply at home.

The share of American employment in manufacturing has declined precipitously since the 1950s. It housed 30% of the workforce then, but that has now dropped below 10%. The share of services jobs has jumped sharply, but they too are coming under threat from technological advances and alternative markets. As a result the superior wage gains are going to those who can afford exorbitant college fees. The share of wages going to the 1% has more than doubled since 1976.

Such a skewed distribution of income isn’t just bad for the average worker; eventually it will impact the economy as a whole. Theory indicates that the marginal propensity to consume decreases as income levels rise, meaning that wealthy people have a greater tendency to save and invest income, thus spending less per dollar earned than do the less well-off. Moreover, the Federal Reserve’s response to the financial crisis with large-scale quantitative easing has allowed asset prices to balloon, benefiting wealthy owners, but providing little comfort to the average American. Growing inequality can generate social instability too, polarizing political ideologies s and limiting the potential for those not born into wealth to join the powerful elite.

Consumers seem desperate to maintain spending habits, as evidenced by a declining savings rate and sizeable withdrawals from retirement funds (the IRS said about $57 billion was taken out in 2011). But such measures cannot be done for much longer. Moreover, if the 1% continue to eat into the income pie, the corporations that rely on consumer spending will suffer. Corporate profits have been strong in recent years, but much of the gains have come from cost-cutting measures rather than robust revenue growth. Cutbacks can only be reduced so much. Many corporations will soon need to boost revenue and sell more to the consumer if they want to maintain profit margins. Stagnant incomes won’t be much help then.

The ability of American multinational companies to readily move operations between countries poses another risk to US employment. In recent years several corporations, especially high-tech pharmaceutical firms, have sought to relocate their headquarters overseas to take advantage of lower tax rates. A continuation of this trend will lead to the loss of more high-paying jobs and billions in tax revenue. The US will be forced to change its corporate tax structure to prevent the practice from escalating.
Many argue that the overall benefits brought by technology and globalization to modern lifestyles more than offset declining incomes. It is true that the ability to import goods from anywhere in the world and efficiencies from of high-powered machinery instead of back-breaking manual labor have untold benefits to society. Moreover, the cost of home appliances and automobiles has become more affordable in recent decades. But many things have not. College fees have soared and many graduates are suffocated by student loan debt. House prices remain elevated. And the US remains only a political crisis away from a spike in food and fuel prices. 

It may be tempting to propose measures to slow the rapid changes that pose risks to American employment and incomes. Trade barriers could keep jobs at home, while a pause in adopting new high-tech equipment would preserve roles that might otherwise become redundant. Such initiatives may slow the advances of globalization and technology, but they won’t be applicable to the rest of the world and US corporations will simply move their operations to nations that allow greater efficiency. Instead, the global changes must be embraced and the US must adapt to the changes in global wealth.

In recent times, its share of the economy has been reduced by the expansion of China and India, but two hundred years ago those countries were the world’s superpowers. Changing political systems and debilitating wars later saw their shares of global wealth decline, resulting in generations of obscurity. History shows that once-powerful economic leaders lose influence as their attention turns from boosting productivity to enacting laws that focus on preserving wealth, excessive borrowing to finance wars and tighter labor regulations that reduce competitiveness.

Great Britain took over from China and India around the 1850s as the Industrial Revolution drove productivity, but a hundred years later, two World Wars and immense reconstructive spending resulted in over-indebtedness, allowing the comparatively lean US become the global leader. Enjoying debt levels that were low relative to rising income, the US rode the wave of prosperity for decades. But US economic dominance has been in slow decline since the 1970s as Japan and Germany recovered from post-war stagnation, a commodity boom boosted Latin America, China adopted market-oriented policies, and India has opened its economy and lessened bureaucracy.

In the coming years the US may get some respite from the negative pressures of globalization as the catch-up by China and other Far East nations has already resulted in middle classes that demand higher wages. But the rate of technological change shows no signs of diminishing, and may widen America’s inequality gap over the coming decades. Along with manufacturing roles, the numbers of secretaries, bank clerks and even brick-and-mortar retailers look set to dwindle.

History may provide some hope for America. Britain’s Industrial Revolution brought much of the population from low income agricultural jobs to a higher standard of living via manufacturing roles in cities. Yet benefits were not immediate. The industrialization began around 1750, but 70 years later real wages had grown little.


Despite some social resistance, innovation continued and between 1820 and 1870 the average real wage jumped 60% as the supply of skilled workers increased and political reforms saw labor’s share of income rise relative to that of capital owners. Some jobs were lost along the way, but advancements in machinery generated demand for new goods and services, creating new roles that compensated for displaced workers.

Of course, America’s current situation may not signal the second coming of the Industrial Revolution. There are concerns that this is not similar to the transition from physical labor to human-operated machines, but more like an elimination of workers in place of full automation. Such fears are overblown. The levels of automation will depend on economics, not just the ability to automate. The current cheap cost of labor makes laying-off workers in times of stress a more attractive option than the burden of monthly payments for a new tech system.

Yet even if we are entering a new Industrial Revolution, few will take comfort from the prospect of a half century of stagnant income. Again, such a scenario seems unlikely. Eighteenth century Britain underwent a transformation from the type of manual labor that was done for centuries. Physical toil is no longer a significant part of the American economy when so many jobs already involve usage of modern technology. The impact of accelerated innovation figures to be less dramatic, and social reforms are easier to implement today than 300 years ago.

The benefits of globalization and technology can be immense. Relatively low barriers to entry have seen tech startups flourish in recent years, create booming companies in a short period. Moreover, they allow young people who were not born into significant wealth to become wealthy and influential, providing new voices among the nation’s most powerful figures.

Embracing new technology and trading partners has enabled countries such as Ireland and Germany emerge from decades of economic stagnation partly by investing in the skills of their workforce. Neither nation is a perfect economic role model, but their commitment to education and pro-employment initiatives has helped Ireland become a global tech hub and Germany an exporter of high-quality goods.

A more educated US workforce would help tighten labor markets. As job vacancies rise and the supply of workers shrinks, power would shift to employees, enabling them to pressurize firms into higher wages. However, there are many obstacles to boosting employability. In the past decade, the average cost for tuition and fees at a private nonprofit college jumped 25%. To facilitate attendance, government-backed loans have been doled out freely, but that has resulted in a student debt burden of $1.1 trillion, which will have its own drag on the economy. Government assistance must be scaled back, which will limit the excessive spending of colleges. The lack of easy credit will also make many people think twice before enrollment. A study by the OECD showed that less than half of all US college students actually graduate; indicating that many attendees would be better focusing on non-academic skills.

In addition, both colleges and employers must embrace three-year bachelors degrees; the traditional four years is an arbitrary number that just extends the time in education. Institutions can also reduce costs by adapting to the modern age and offer more online learning. Policymakers should also look at Germany’s “dual system” of vocational training, which combines classroom instruction with work experience. Almost half of Germany’s high-school students go on to training in one of hundreds of trades, with many of the courses set by unions and employers' federations.

As economic theory suggests, the best strategy to increase the earnings of low skilled workers is to have fewer of them. Aside from education, other options include tax credits to incentivize lower paid workers to stay in the labor force and increase their skills, and schemes to boost savings accounts that may help more people to purchase assets and benefit from rising prices. Higher minimum wages will be largely ineffectual. While helping some of those workers at the margins, they will not pressurize employers into raising wages further up the pay-scale and may prove a disincentive.

The US is still the global superpower, but its influence is waning. The economic share between the developed and emerging nations is now nearly even as a shrinking world allows easier navigation around the barriers to prosperity. For nearly a century the US has been the center of the economic world due to its ability to consume and produce. The British Empire enjoyed that status for a hundred years before it. Environments change and bring new obstacles that once seemed fictitious. But a global convergence of wealth is underway, with the prospect of a sole superpower gradually diminishing.

The US must compete with the new challenges by moving away from a reliance on credit-fuelled spending and instead focus on innovation as a method for generating economic activity. It has achieved this in the past, but has yet to prove it can do so in the future.

Wednesday, 30 April 2014

Canadian Economy Headed for a Wake-Up Call?

The Canadian dollar, commonly known as the loonie, derives its nickname from the North American loon, an aquatic bird known for diving to great depths. Similarly, the currency has taken a plunge since the start of 2013, falling 10 percent against its American counterpart from parity to C$ 1.1.

The period marks a sharp reversal for the Canadian dollar, which enjoyed a strong rally in the aftermath of the global financial crisis. Last month the loonie declined to its weakest in nearly five years, reflecting an increasingly fragile economy.

Canada proved an attractive safe haven for investors in the post-crisis years, with the currency being viewed as a reliable alternative to the uncertainty surrounding the US dollar and euro. A stable environment underscored by relatively robust banks and a global commodity boom allowed the central bank maintain higher interest rates than the US for much of the past five years, meaning that holders of Canadian assets could obtain a greater yield.

However, in recent years the commodity rally has stalled and despite a pickup over the last few months, prices remain far from the lofty levels of 2010. While a focus on commodities once gave Canada an advantage over other nations, it could now prove a detriment. Too much reliance on exporting its natural resources has resulted in reduced investment in the manufacturing sector.

Over the past decade the number of Canadian manufacturing firms has fallen by 20% and the sector’s share of GDP has shrunk from 16% to 12%. It is a worry trend, possibly indicating that the commodity boom has masked vulnerabilities in the core economy; something that could be painfully highlighted if food and energy prices tumble.

Improving US growth should boost demand for Canadian goods (it takes in about 70% of Canada’s exports) but the central bank recently warned that Canada’s non-commodity exports were becoming uncompetitive, even at C$1.1. The country’s growth outlook isn’t particularly encouraging either, with real GDP expected to increase 2.4% this year after rising 2% in 2013, marking a third straight year of slowing growth.

Canadian policymakers face a difficult challenge in supporting the economy while trying to manage an overheating housing sector. House values have ballooned, with the average price of a home more than doubling since 2002. Moreover, household debt has climbed to record levels of about 100% of GDP, on par with the US at the peak of its housing bubble. Similarly, at 7% of GDP, residential investment has become an unhealthily large part of the economy, outdoing the pre-crash US and rising much faster than population growth. The sector is undoubtedly on an unsustainable trajectory.

While interest rates were kept at 1% last year, the central bank had a tightening bias, intimating that it would raise rates in the near future to cool excessive spending. But new governor Stephen Poloz adopted a neutral stance in October, recognizing weakness in the broader economy. His dilemma is that low rates could add fuel to the housing boom, encouraging indebted households to increase borrowing, while higher rates could strangle business activity.

Inflation pressures are minimal at present, with the consumer price index rising 1.1% in February from a year earlier, well below the central bank’s 3% upper target. This has built up expectations that rates will be maintained at 1% until at least mid-2015. The prospect of no rate hikes should keep the Canadian dollar at relatively weak levels, helping boost the competitiveness of exporters.

This will help with a necessary longer-term goal of shifting the economy’s growth drivers, which have been imbalanced over the past decade. A transition is needed from reliance on debt-driven household consumption and residential construction to an export-led economy boosted by strong manufacturing investment.

Such a goal involves discouraging housing speculation through tighter mortgage conditions and limits on residential investment, hopefully resulting in a gradual stabilization of house prices. Policies targeted at revamping the much-neglected manufacturing sector will also help provide sustainable growth, effectively sheltering the economy from fluctuating commodity prices.

The deleveraging from an excessively indebted economy will take time and be somewhat painful, but that is the consequence of years of largess. Action now can prevent a severe hemorrhage later. For inspiration, policymakers just need to remember what happened to the housing market south of the border.

Monday, 14 April 2014

What’s Behind America’s Soaring College Costs?

Article originally appeared at Quartz and The Atlantic

The growing $1.1 trillion student debt burden in the US has been well documented, yet concerns are subdued. That’s because the burden, unlike the housing crisis, won’t cause a sudden economic crash. Instead, it will prompt a slow strangulation of spending spread over many years. Congress has made some minor efforts to reduce interest rates on debt, but the necessity for such large loans must be scrutinized. And that means confronting the indulgences of colleges.

Tuition costs have soared in recent decades. In 1973, the average cost for tuition and fees at a private nonprofit college was $10,783, adjusted for 2013 dollars. Costs tripled over the ensuing 40 years, with the average jumping to $30,094 last year. Even in the last decade the increase was a staggering 25 percent.

The ability of colleges to raise costs has been facilitated by a sharp increase in federal student aid. Lenders freely dispense credit to students, safe in the knowledge that all loans are guaranteed by the government. Between 1973 and 2012, federal aid (inflation-adjusted) increased more than 500 percent. Looking at a shorter period, between 2002 and 2012, total federal aid to students ballooned an inflation-adjusted 106 percent to $170 billion.

Colleges have effectively been guaranteed an income stream and have used that certainty to partake in an arms race against each other by constructing lavish facilities and inflating administrative processes. The pursuit of education has turned into a vicious circle in which students need bigger loans to pay for higher costs, and colleges charge higher costs because students are getting bigger loans.

Notably, hours spent preparing for classes fell at a similar rate, while there was little change in time devoted to research. Administrative bloat fueled by excessive spending seems to be diminishing the focus on what college is supposed to be about, with the study showing that almost a quarter of professors at four-year universities do not consider teaching their “principal activity.”The apparent escalation in college bureaucracy may be reflected in changing patterns of teaching hours. A national survey conducted by the Higher Education Research Institute found in 2011 that 43.6 percent of full-time faculty members spent nine hours or more per week teaching (roughly a quarter of their time), which is a down from 56.5 percent in 2001 and a considerable decline from a high of 63.4 percent in 1991.

Time spent teaching may be declining, but compensation for those at the top has increased sharply in recent years. Presidents are now paid like the CEOs of successful businesses, as evidenced by the Chronicle of Higher Education’s latest report. The findings showed that 180 presidents at private colleges earned more than $500,000 in 2011, compared with just 50 in 2004. Moreover, the top two highest paid presidents each received more than $3 million.

All this spending has been encouraged by a flawed student loan system that enables unwieldy inefficiencies. Today’s loan model was built with good intentions, tracing its roots back to Lyndon Johnson’s Great Society ambitions, but it was not designed for extended periods of stagnant wage growth and a widening gap in pay scales.

Education is more important than ever, with the comparative return on a degree still high relative to those without college qualifications. But to lower the costs of tuition, government support must be reduced. Lending institutions are too lax in giving out credit, knowing that the taxpayer will support 100 percent of defaulted loans. Without that firm safety net, lenders will be more discerning about borrowers’ fields of study; the expected income for a humanities graduate is not the same as an engineer. Less student aid will also make colleges think twice about their excesses.

Moreover, loans should not be an entitlement. There are too many colleges offering too many places to students. A study last year indicated that more likely to default than graduate, while about 40 percent of students have to take at least one remedial course during their studies, slowing their possible graduation date and increasing debts. These stats indicate that many students are not prepared or capable for college-level academics.

Both colleges and employers must embrace three-year bachelors degrees; the traditional four years is an arbitrary number that just extends the time in education. Institutions can also reduce costs by adapting to the modern age and offer more online learning. But they will only do this is if the government limits the ability of students to pay the prevailing high tuition costs.

The current model has inflated spending beyond the nation’s means, with colleges reaping the rewards while the government takes all the risks and graduates drown in debt. With an abrupt crisis unlikely, hard action may be delayed for years, allowing the noose to tighten on an already fragile economy.

Thursday, 20 March 2014

History Suggests Putin Is Likely To Pause At Crimea

Taking back a gift is frowned upon across the globe, except in Russia. Soviet leader Nikita Khrushchev handed Crimea as a gift to Ukraine in 1954, but 60 years later Russian president Vladimir Putin made a swift reclaim.

After spending the last few years making efforts for recognition as a prominent member of the globalized world, Russia has managed to isolate itself in a matter of days. Fittingly, the Crimean Peninsula also represented Russia’s estrangement from Europe in the 19th century. After building up favorable relations with European allies by cooperating against Napoleon, Russia abruptly alienated itself by launching an unexpected attack on the Ottoman Empire in 1853.

Assuming the role as protector of the Empire’s oppressed Orthodox Christians, Russia attempted to take control of the Black Sea during the three year Crimean War. Its efforts were thwarted after Britain and France intervened, forcing Russia to abandon its plans and accept a peace deal.

Russia no longer uses religion as a mantra for expanding its influence and instead styles itself as a guardian of ethnic Russians, regardless of their location. That was the excuse used in separating two regions from Georgia in 2008; a conflict mirroring this week’s annexation of Crimea.

While Putin targeted Crimea following Ukraine’s ambitions for European Union integration and ousting of its pro-Russian president, desires of joining NATO were the catalyst of his aggression towards Georgia. Putin still views Russia as the empire victimized by the Mongols, Vikings, Napoleon and Hitler, and reacts with alarm whenever one of its former subjects expresses a desire seek relationships with outside powers.

Like Crimea, the Georgian regions of South Ossetia and Abkhazia are primarily populated by ethnic Russians. Similarly, Russia managed to maintain a military presence in the regions following the fall of the Soviet Union. This enabled Putin to easily occupy Crimea and in 2008 helped stir up tensions in Georgia’s troubled territories.

After Georgia took a step closer to NATO membership in April 2008, Putin responded by authorizing official ties with South Ossetia and Abkhazia. The two regions had long endured uneasy relations with Georgia, but the moves from Putin amplified tensions that led to local skirmishes. This provided him with the perfect excuse to send in ‘peacekeeping’ troops to protect the ethnic Russians, emboldening the regions’ separatist movements. When Georgian troops responded to attacks from South Ossetian rebels, Putin sent his army into Georgia-proper, laying waste to any resistance over a five-day conflict that resulted in 850 deaths.

Ultimately, Russia never assumed South Ossetia and Abkhazia into its federation, but did officially recognize their independence from Georgia. The tumult was intended to send a clear message to neighbors that aspired to western relations. Yet the EU and US acted as if unaware that Russia might take action against Ukraine if it sought European integration. When Putin coerced Ukrainian president Viktor Yanukovich to reject the EU’s proposed trade deal late last year, the West stayed silent; neither voicing strong support for Yanukovich against the larger bully nor warning Russia of interference. Of course, Western leaders hoped things would be resolved quickly so that it could maintain the stability of its Russian business interests.

But when Yanukovich was chased out of power, Putin realized he had to take things another step further. The seizing of Crimea was designed to remind the new Ukrainian government that looking west brings headwinds from the east.

Today, Putin seems to be following the template from the Georgian conflict. Things have been calm since ceasefire was reached there in 2008 and Georgia remains outside NATO. As long as Ukraine does the same then Russia will not encroach beyond Crimea.

Putin is likely wary that further provocation in Ukraine could incur additional sanctions from the West, akin to the severe measures on Iran that restricted access to the global financial system and choked its economy. But Western powers will be reluctant given that Russia plays a more important role in global trade than Iran ever did. Moreover, even if sanctions are intensified, Putin’s desire for regional authority cannot be underestimated. Since the days of Peter the Great, Russian rulers have put a high value on the power of the nation, often above the health of its citizens.

Crimea will never be returned to Ukraine, but further Russian expansion is unlikely. As with Georgia, Putin is probably content that his work in Ukraine is done, for now. He has conveyed a stern warning to the new leadership while invigorating the nation’s large pro-Russian population. Calm will be solidified if May’s Ukrainian elections restore power to eastern-leaning politicians; something that will bring relief to Putin, and the West.

Labeling Ukraine’s new government “legitimate” is not endorsement of democracy

The word “legitimate” is given three definitions by the Merriam-Webster dictionary, but it seems like none are known by those in the White House. Earlier this month President Obama declared that “any discussion about the future of Ukraine must include the legitimate government of Ukraine.” Illogically, he was referring to the new unelected leadership headed by acting prime minister Arseniy Yatsenyuk, who was subsequently welcomed to Washington by Obama to send a message that the US “strongly supports… the legitimacy of the new Ukrainian government.”

While the Obama administration is correct in vigorously opposing Russia’s attempt to truncate Ukraine, continually describing the latter’s new government as legitimate is a spurious and damaging pretense. Much of the media has made the same error. Inaction from Western powers allowed Russia intimidate recently-ousted president Viktor Yanukovich and saw a panicked opposition bypass democratic principles in its ascension to power. The US now looks hypocritical as a promoter of global democracy.

Let’s put the current government in the context of the dictionary’s first definition of “legitimate”: allowed according to rules or laws. Yanukovich was overthrown in a single day on February 22nd. Earlier that morning he declared in a televised address that he had no intention of resigning from power. Regardless, with Yanukovich and many of his allies chased out of Kiev, a rushed emergency session vote was held under the specter of violence in which the majority of the parliament agreed to depose the president.

The legality of the move is dubious. The Ukrainian constitution states that there are four circumstances in which a president may be removed between elections. The first three are moot in Yanukovich’s case as resignation, incapacitation and death were not applicable. The fourth, impeachment, is what the new leadership uses as its justification for the president’s removal. Yanukovich’s alleged act of authorizing troops to fire at protesters would certainly be worthy of prosecution, but the parliament alone cannot administer impeachment. A committee investigation and judgment from the Constitutional Court must also be dispensed; neither of which happened.

Even if the US chooses to ignore the legal technics, after all Yanukovich tried to tamper with the constitution for his own gain in 2010, it doesn’t seem to adhere to the dictionary’s second explanation for “legitimate”: fair or reasonable.

The day prior to his removal, Yanukovich signed into law constitutional changes that diluted his powers, formed a caretaker government and allowed early presidential and parliamentary elections in May. While these concessions didn’t bring an immediate step towards the catalyst issue of the EU trade agreement, it was a European-mediated deal expected to ease social unrest. But belligerent mobs of protesters continued to rout the city, effectively taking control of Kiev as police were forced into retreat. Yanukovich didn’t hang around and fled for Russia amid claims his car came under attack from gunfire, allowing the parliament to call the emergency session about the president’s removal. It was in nobody’s safety interest to oppose the motion.

The third explanation for “legitimate” is: real, accepted, or official. As recent years have demonstrated, mass demonstrations can result in constructive political changes. But Ukraine is not experiencing an Arab Spring. Unlike the despotic regimes of Arab nations, Yanukovich was elected to power in 2010 under conditions deemed fair by international observers from the Organisation for Security and Co-operation in Europe (OSCE). Yanukovich won 49% of the vote versus 45.5% for the incumbent Yulia Tymoshenko.

The 2010 and 2004 elections illustrated Ukraine’s political divisions, with the east of the country supporting the traditionally pro-Russian Yanukovich, while most of the west voted for pro-Europe candidates. From afar it may have appeared like there was a mass uprising against Yanukovich in recent months, but Kiev's geographical location in the Western-leaning heartland magnified the negative sentiment against him.

Yanukovich’s ascension to power was real, accepted, and official; adjectives that should not apply to the reigning US-supported government. Of course, a fair election does not give a leader free reign over a nation, but Yanukovich was not a Putin proxy. While depicted as a rigid puppet, last September Yanukovich forcefully vowed to his party at a private meeting that "we will pursue integration with Europe." He was originally in favor the EU trade deal but those plans were spoiled by a combination of Russian trade threats and a $15 billion investment in fragile Ukrainian debt which lessened the attractiveness of Europe’s proposal.

Yet Yanukovich attempted to appeal to both sides of Ukraine by suggesting an arrangement involving trade deals with the EU and Russia. Such notions were quickly dismissed by European Commission President Jose Manuel Barroso who indicated that Ukraine must choose between the EU and Russia. "When we make a bilateral deal, we don't need a trilateral agreement," he said. Yanukovich didn’t sign and so ensued anarchy in Kiev.

Yanukovich received no sign of US backing when Russia pressured him into rejecting the EU deal. The Obama administration only spoke out when it became embarrassingly clear that Russia felt it could do what it wanted with its neighbors. Putin’s boldness grew as the US government struggled with inertia.

Threatening Russia with sanctions, increasing NATO presence in the region and facilitating aid through the IMF will help with Ukrainian security. But while the Obama administration believes that saluting the new government will encourage stability, in reality it is appeasing one mob and breeding contempt in another. The EU trade deal that spurred the unrest was not a unanimous desire. A poll by German group GfK in November found that just 45% of Ukrainians supported the deal.

On Friday President Obama said he “supports Ukrainian democracy and self-determination”, while concurrently throwing his symbolic weight behind a government that came to power via blunt force. While it would be wrong for the US to condemn the current Ukrainian leadership, it should dial back its warmness in the public arena. At the moment the US is trying to make a strong statement to Russia, but the message to Ukrainians is that storming parliaments counts as “legitimate” democracy.

Friday, 14 March 2014

Growing pains for China’s financial system

A corporate default is rarely reason to celebrate, but nor is it always a sign of impending crisis. Last week’s declaration by Shanghai Chaori Solar Energy Science and Technology Co that it could not to make a $14.5 million interest payment is bad for the company and its bondholders, but not for China. Several analysts have erroneously labeled this as the Chinese “Bear Stearns moment” whereby the failing of one entity portends a broad breakdown in the financial system.

As with most matters surrounding China, any sign of stress in the burgeoning nation is treated with fearful hysteria by sections of the Western media. That is not just the fault of the West, but also a reflection of the existential obscurity of information from China. There are reasons for anxiety about the world’s second largest economy, but the recent missed bond payment is not one of them.

While Chaori is the first onshore Chinese corporate default since the regulation of the market in 1997, many more would likely have happened by now if the government had not provided generous assistance to avoid such consequences of a liberalized financial system. But it’s not known for sure. That is why the allowance of Chaori to default should be regarded as an indicator of progress in China’s slow transition to an open marketplace.

The inability of Chaori to make payments reflects weakness with the company and China’s long-struggling solar industry. It does not indicate any weakness with the country. Moreover, the default was not a surprise to analysts. Chaori’s difficulties have been flagged for some time and problems in the sector were highlighted in the past, with China’s formerly largest solar firm, the US-listed Suntech, defaulting on bonds last year.

In a worst case scenario Chaori could default on $163 million, but that is hardly substantial given the scale of China’s $14 trillion corporate debt market. Defaults on corporate debt are not unusual. Even in 2007, before the Western world’s financial turmoil, there were defaults on agency-rated debt in the US that totaled more than $5 billion. Investors take a risk any time they purchase a financial instrument, and the inability of a struggling company to repay its debts is part of the system. It is vital that corporate defaults are allowed to occur so that markets can efficiently weed out zombie companies.

Panic is understandable when defaults become widespread, but there is no evidence of that in China. Instead, there are reasons to think that the Chaori default could strengthen China’s corporate debt process. Until now, the system had never dealt with bankruptcy proceedings or wrangled with the pecking orders of bondholders; aspects of the market that are undesirable but a component nonetheless. The default may also give reckless investors reason for pause, while other struggling companies may disclose their limitations now that it is apparent markets won’t collapse when defaults are announced.

Above all, China’s comfort with the default indicates a growing confidence in opening up its own system. The government didn’t feel the need to offer a bailout and is content to live with the consequences of corporate defaults and the accompanying media hype. Beijing’s acceptance of Chaori’s difficulty coincides with a tolerance for greater exchange rate fluctuations in its formerly rigid currency. The renminbi, which has historically moved within tight ranges, has been allowed to trade with increased volatility over the past month, likely indicating a recent acceptance for market forces.

Of course, as with many aspects of Chinese policy the extent of the government’s role in market operations cannot be determined with certainty. But there is little doubt that some improvement has been made in opening up to outside influences, and it is important than these transitions are done gradually. The government is in the midst of undertaking a profound shift in its economic model, transitioning from a reliance on exporting cheap goods to sustainable consumption in which growth is generated by domestic spending.

Changing an economic model presents challenges and in China’s case they are clearly evident. To rely on domestic consumption, the nation’s finances must be in a healthy position. However, there are signs of an over-reliance of borrowing, with China’s total debt-to-GDP level jumping more than 80% since 2008. The level now stands at 210%, a number lower than many advanced economies, but its rapid increase is cause for concern. History has shown that similar credit expansions in emerging nations have resulted in financial crises as the floods of investments inefficiently distort asset prices.

But there has never been a test case like China. It can be argued that it has the infrastructure and resources to cope with the swathes of borrowed money. This seems to be the attitude of China’s policymakers, as reports this week indicated the central bank was prepared to cut reserve requirement ratios for banks if growth shows signs of falling below its 7.5% target toward a 7% annual rate. If implemented, banks would have to keep less in reserves and will be free to lend more. Facilitating more credit must be done carefully, but the current reserve requirement of 20% is relatively conservative and any cut figures to be limited. Moreover, aside from spurring additional economic activity, this move also aims to dampen demand for the sizeable shadow banking sector.

Encouragingly, China also has plans to liberalize interest rate markets, effectively allowing banks to offer savers more attractive yields. The imposed ceiling is currently 3% annual interest for benchmark one-year household deposits and just 0.35% on demand deposits. Allowing banks to introduce more competitive rates should boost saving and further lessen the shadow banking reliance.

Moving towards open markets is a delicate process that needs incremental steps while trying to maintain a difficult balance between economic growth and sustainable reform. Along with the Chaori default, there will be plenty more hiccups along the way as the increasingly liberalized financial system matures and adjusts to market forces. Some of the obstacles could be potentially damaging, but a missed $14.5 million payment in a $14 trillion market is not one of them.

Wednesday, 12 March 2014

Fannie and Freddie reform is necessary, but not at expense of private sector investment

Private investors and the government don’t always make easy bedfellows and nothing exemplifies this more than the case of Fannie Mae and Freddie Mac. After verging on collapse in 2008, the government-backed mortgage groups are now turning significant profits, but investors are not happy.

Since their inception, the structure of Fannie and Freddie has been a point of contention. Established by government charter, the entities are owned by private shareholders and guarantee the vast majority of US mortgages, buying and selling loans from financial institutions to provide money for the banks to facilitate lending to home buyers. For much of their existence the groups’ configuration has drawn criticism as private investors enjoyed the profits while losses were felt by taxpayers. Things have changed since then.

Even after receiving a $188 billion government bailout during the height of the financial crisis in 2008, the future of Fannie and Freddie seemed precarious. The common shares of both entities, which traded at $60 in 2007, declined sharply and were delisted from the New York Stock Exchange in 2010. By mid-2012 shares were worth just $0.14. But some investors had faith in the companies and as loan delinquencies declined and house prices rose, profits were generated.

Fannie and Freddie shares have now jumped more than 1,000% over the last 12 months. Fannie had a net income of $84 billion in 2013, while Freddie's was $48.7 billion. Yet investors are not reaping any profits. And that’s because the government changed the rules.

During the 2008 bailout the government took preferred shares carrying a dividend of 10%, along with almost 80% of common stock. It also placed Fannie and Freddie in “conservatorship”, meaning the government had administrative powers for the foreseeable future. Nobody seemed to care too much at the time, but interest picked up once the entities started making money. In 2012 the government used its conservatorship powers to change the bailout terms to ensure that all profits from Fannie and Freddie went to the Treasury.

Fannie and Freddie have now paid back more in dividends than they received in the 2008 bailout. Understandably chagrined, investors have launched a myriad of lawsuits against the government alleging that the 2012 amendments constitute a taking of private property without any compensation. A recently revealed 2009 Treasury memo stated that the conservatorship of Fannie and Freddie “preserves the status and claims” of preferred and common shareholders. But illogically, the government doesn’t seem to think future earnings are a claim for shareholders.

Regardless of arguments about the efficiency of Fannie and Freddie (some laud their ability to facilitate 30-year mortgages, others denounce their facilitation of reckless greed), or that most shareholders are hedge funds, it cannot be overlooked that investors who backed the companies’ survival are now being punished. Private investment in government-backed initiatives cannot be discouraged. The government was not in a position to nationalize Fannie and Freddie, the $4.9 trillion obligations were understandably too large, so it had to rely on investors to keep the mortgage groups alive.

Profit-saga aside, there is still the issue of deciding what to do with Fannie and Freddie. The Obama administration has rightly voiced support for overhauling the entities and it is true that the historic structure can no longer work; in the boom times it was overly imbalanced in favor of private investors and now the roles are reversed. Several reform bills are sitting in Congress, with some calling for a complete dissolution of Fannie and Freddie. An alternative proposal was made by a group of hedge funds and private equity companies late last year in which the entities would be replaced with two private firms, backed with an initial capitalization of $50 billion. Yet neither proposal is expected to gain widespread approval.

In reality, the most efficient solution involves a scenario in which the balance of responsibility is shifted so that private investors carry the larger share of the burden. On Tuesday the Senate Banking Committee released a bipartisan plan to unwind the mortgage companies and create a new system in which the private sector would be required to take the first 10% of losses before any government guarantee would be triggered. This is a step in the right direction, allowing the government to take the position of secondary guarantor and spare itself from the role of loss-absorber to private sector bets.

Yet the proposal does not include any provision for investors to share in the companies’ profits. Investors did not back Fannie and Freddie for the good of the US mortgage system; they bought shares with future profits in mind. Even so, private investment is needed for such government-backed entities to function efficiently and should not be discouraged.

Monday, 3 March 2014

Does The Keystone XL Pipeline Still Matter?

Last month it seemed the Keystone XL pipeline was nearing approval, but as with most things surrounding the project, things weren’t as they seemed. A US state department report reviewed the Alberta, Canada–Nebraska pipeline and indicated the project was unlikely to have a significant impact on climate change. This seemed like a significant positive step for pipeline, but within the details of report were critical comments from the Environmental Protection Agency.

Environmental concerns have been the most publicized aspects of the pipeline, with opponents arguing that the project could accelerate climate change by enabling increased production from the oil sands of Alberta, which creates 17% higher greenhouse gas emissions than the average crude used in the US. President Obama will make the final decision on the pipeline and given his campaign to battle climate change, it is difficult to imagine him defying the EPA and his core Democrat base, especially with Midterms later this year. Then again, labor unions will be angered if he blocks the pipeline and the thousands of potential jobs it could create. It is not surprising that he has taken so long to make a decision.

TransCanada first proposed the project seven years ago and a lot has changed since then. Back in 2007 there were still concerns that “peak oil” was imminent and demand for energy was booming in the pre-financial crisis environment. The pipeline was initially viewed by many as a much needed tool to bring down oil from Canada and ease supply concerns. But now the US is apparently nearing energy independence and the Keystone project is seen as an environmentally unsafe method of transferring oil to major refiners in the Texas Gulf (via Nebraska).

But oil companies have not been sitting idly during the prolonged approval process and have been working on other methods of getting the oil from Canada. The refiner Valero signed on to receive oil from the Keystone pipeline early in the project and has spent billions upgrading its equipment to handle the type of heavier crude produced in Canada. So to make good on their investment, the firm has invested in rail terminals at its refineries to help get the oil in. Last month Exxon Mobil announced the construction of a rail facility in Alberta that will be completed early next year.

Oil-by-rail has attracted scrutiny following a series of recent accidents, most notably a crash in Quebec last year that killed 47 people. This might bring additional regulation such as railcar modifications, but such developments will only result in a short-term slowdown in the rail expansion. Companies will continue to aggressively pursue this transportation method as long as the Keystone XL pipeline remains in limbo.

The economic impact of the pipeline has also generated much debate, but despite heated arguments from both sides its effect is unclear. TransCanada claims Keystone XL will support approximately 42,100 direct, indirect and induced jobs in the US and will and provide a substantial increase in tax revenues for local counties along the pipeline route, with 17 of 27 counties expected to see revenues increase by 10% or more. It added that the project will result in “spending $7 billion stimulating the local economy.”

These claims are countered by the Cornell Global Labor Institute which says the project budget that has a direct impact on US employment is between $3 and $4 billion. Moreover, any jobs created would be temporary and between 85-90% of the people hired to do the work would be non-local or from out of state. It also warned of the economic risks from possible pipeline spills, pollution and the rising costs of climate change. But there is no way of quantifying these risks.

Another argument revolves around the possible impact on oil prices. Intuition would say that the more oil that comes into the US, the cheaper prices will become. But the market isn’t so straightforward. Since 2011 refineries in the Midwest have benefitted from a glut of oil produced in the region and Canada which has been easily accessible thanks to an array of pipelines that were granted approval. This has seen US WTI crude oil trade up to $20 less than the global benchmark, Brent over the last year. The spread was about $8 last week.

However, if the Keystone XL pipeline enables the efficient transport of oil from Canada to the Gulf, then more refiners will be bidding for the oil. It is feared that increased competition for the Midwest oil glut will see an increase in prices.

Yet, just like predicting anything in financial markets, there is no certainty about future prices. Nobody knows where how much oil will cost next year but the logical policy is to create the most efficient oil transportation network so that supplies can be maximized, thus lessening the impact of a price shock brought about by unexpected events.

Efficiency involves the full development of the Keystone pipeline. Even if Obama rejects the proposal, companies will pursue other methods of transporting oil from Canada, and as has been evidenced, oil-by-rail is not a risk-free alternative. Rejecting Keystone XL won’t reduce the production of heavy oil in Alberta. That will only happen when better energy alternatives are promoted.

Monday, 6 January 2014

Major Economic Themes for 2014

This time last year, the majority of financial commentators held a downbeat outlook for the global economy in 2013. The potential for instability was seemingly high, but in reality it turned out that the greatest shock was a lack of any major shocks.

In the United States, the Federal Reserve reduced its monetary stimulus measures and stock markets actually rallied on the news. Unemployment fell to a five-year low of 7% and a government shutdown came and went without hysteria. An unfamiliar calm reigned over the eurozone through the year, resulting in a welcome decline in bond yields for the weaker “periphery” nations. China successfully reversed its slowing growth, while Japan’s extraordinary stimulus policies helped reinvigorate an economy that has suffered a quarter century of stagnation.

By year end there was synchronized growth from the major global economies, pointing to an optimistic outlook for 2014. The smooth navigation through so many potential shocks naturally bodes well for this year, but enough headwinds remain to keep growth modest.

US Growth Gaining Momentum

Expectations are relatively high for the US economy, with growth forecasts broadly surpassing the expected final 2013 figure of 2%. The economic drag caused by the sequestration budget cuts will no longer be a factor and significant progress has been made in reducing corporate and household debt. Moreover, developments in shale energy will aid US manufacturing, particularly in the petrochemical sector. A stable environment should bring near-term benefits to rising asset prices and the housing market.

Yet several issues cloud the positive outlook. The Federal Reserve may have begun tapering its quantitative easing strategy without market panic, but the timeline of its ultimate exit from the stimulus program remains unclear. And while there are signs that political gridlock in Congress may abate somewhat, it is unlikely that there will be any development of progressive fiscal policies. Moreover, household income levels are expected to remain stagnant, meaning that a robust increase in consumer spending is unlikely, casting doubt on whether the US economy can make a smooth transition from central bank stimulus to self-sustained growth.

Japan’s Stimulus Measures Fruitful, For Now

The aggressive monetary expansion launched by Japanese Prime Minister Shinzo Abe in late 2012 has delivered on its intention to reverse deflation. The rationale behind the initiative is that sustained inflation will see depressed wages rise and boost consumer spending as households realize that prices will no longer follow a downward trajectory. Growth and inflation both rose last year and 2014 should see a continued increase.

A potential risk to growth exists in the introduction of a 3% sales tax increase which may dampen economic activity. Abe has promised further stimulus to offset any negative impact from the tax; a strategy which should prove successful. But the need for the rise in sales tax is a more serious issue. Japan must ease its huge public debt burden, which is forecast to reach 230% of GDP in 2014. Financing such debt can be treacherous, and a sharp rise in Japan’s sovereign bond yields would make debt-servicing costs unsustainable. Such an outcome would prove disastrous for the Japanese economy.

Eurozone: The New Japan?

While Japan recovers from decades of deflation, the eurozone risks falling into its own trap in 2014. 2013 was good for the eurozone largely because nothing much happened; financial markets interpreted no news as good news. Fears of a breakup have cooled and the 17-country bloc emerged from recession last year. But growth in 2014 is expected to be minimal, inflation is anemic and major structural issues remain.

Eurozone unemployment remains stubbornly high at 12.1%, with several of the bigger nations hampered by a lack of competitiveness due to high labor costs and a strong currency. The leadership may be moving away from the ideology of severe austerity measures, but public debt levels remain elevated and nations will need to continue to improve their financial balances to attract foreign investors. Similarly, banks will remain in deleveraging mode, especially following region-wide stress tests, resulting in a continuation of tight credit conditions.

Some support should come from the ECB through easier monetary policy, aiding market sentiment over the near-term. But progress on a banking union shows signs of remaining painfully slow and developments on fiscal union are nonexistent.

Economic and Debt Growth in China

Ballooning debt growth in China has been a burgeoning issue over the last couple of years. In 2012, China’s central bank made efforts to tighten credit, but these initiatives slowed economic growth. That was an undesirable outcome for the leadership, so last year credit conditions were eased and infrastructure investment was increased. Chinese economic growth rebounded quickly, calming fears of a “hard landing.”

Creating more debt will not help China in the long-term. Beijing is attempting to change its model from a reliance on foreign demand for its exports to an economy driven by sustainable domestic consumption. But households do not have adequate wealth to drive the economy, and have therefore relied on debt to maintain growth. The Chinese leadership will need to introduce significant economic and political reforms to reduce its reliance on debt. However, during the transition it must be careful to maintain growth and avoid any crash that would have a far-reaching impact.

2013 turned out to be a pleasant surprise for global markets, spurring optimistic forecasts for the year ahead. 2014 will likely be a better year for global growth and many near-term risks have dissipated. Yet such upbeat sentiment should not distract from the political dysfunction and absence of progressive reform policies in some of the world’s most significant economies.

This piece was written for 

Sunday, 15 December 2013

Why The Fragile US Economy Isn’t Impacting Stocks - Yet

There is a reason why asset management firms don’t employ legions of economists to do their investing. Providing accurate economic forecasts is very useful, but financial markets generally don’t reflect the state of the world.

US stock markets have rallied strongly over the last two years, while economic growth has been weak. Appetite for stocks has been driven by central bank action, not forecasts of skyrocketing consumer demand. The Federal Reserve has held its interest rates close to zero for the last five years while implementing vast amounts of quantitative easing - printing money to buy government bonds.

These purchases effectively lower bond yields, resulting in lower financing costs for companies while simultaneously encouraging investors to buy assets such as stocks since the return on fixed income is so low.

Moreover, when economic news does noticeably move markets, it is typically due to “surprises” in data releases rather than the absolute level of growth. So if the economy is weak, but a GDP figure is unexpectedly strong, markets will often rally and appetite for riskier assets increases. A longer-term rally can ensue when an economy appears to be on a turning point; transitioning from recession to a period of growth.

In recent years US markets have also been boosted by upbeat corporate earnings that have continually surpassed estimates. While this is clearly beneficial for stock market performance, it does not necessarily reflect well on the economy.

The focus on quarterly results has led to aggressive cost-cutting, aiding corporate profits. Earnings per share have also been augmented by a large number of stock buybacks, in which repurchases by companies lead to fewer shares. This can be beneficial for shareholders, but is not an indication of improvement in a company's performance.

Worryingly, earnings have been rising but revenue has remained little-changed. Hence, earnings have grown while actual demand for a company’s product has not. Moreover, there has been no increase in private sector capital expenditure in 2013; something that will be necessary to fuel economic growth when the Fed reduces its monetary stimulus.

Strong momentum and near-zero central bank rates may see the stock market rally continue into 2014, but without an active consumer the longer-term picture is not so optimistic. While the US unemployment rate has declined to 7%, much of the job creation has been in low income roles, and the rate is enhanced by a fall in labor force participation to its lowest level since 1978. Notably, real median wages (adjusted for inflation) have fallen just over 3% since the start of 2009.

There was a better-than-expected retail sales number for November and consumer confidence improved, but Morgan Stanley forecasts that this year will see the weakest holiday spending since 2008. In addition, projected gift spending per person will decline for first time since 2009. The possibility that a reduction in the Fed’s bond-buying program may lead to rising yields is not a good sign for the housing market. This year’s jump in long-term yields, spurred by the Fed’s first mention of “tapering” in May, has resulted in a slowdown in US housing activity as higher borrowing costs make homes less attractive. For example, in May a $1,000 mortgage payment could attain a house worth $225,000, while the same payment now buys a $195,000 house.

However, an important milestone was reached this week following the release of Q3 data showing the first rise in outstanding mortgage debt since the beginning of 2008. Over the last five years, the US has been in a deleveraging phase in which the private sector focuses on minimizing debt, thus sacrificing spending. But the recent rise in mortgage debt indicates that US households are making some progress in their deleveraging efforts and are demanding more credit. This is good news, but the growth in credit demand is from extremely low levels.

Some additional optimism has been fueled by a rise in US household net worth in Q3 to $77.3 trillion, an increase in approximately $2 trillion from the previous quarter. Proponents of the “wealth effect” theory assume that an increase in households’ net worth will lead to a rise in consumer spending. However, the source of last quarter’s increased wealth should temper cheer.

Rising stock markets were attributable for $917 billion of the wealth increase, while $428 billion came from higher house prices. Essentially, most of the increased in wealth is going to the population that invests heavily in stocks - the wealthy. They will likely use this new wealth to re-invest in stocks, helping to fuel the bull market momentum. Since rising house prices accounts for a much smaller percentage in added household wealth, most Americans will not feel much wealthier and consumer spending will unlikely see a sizable increase.

The outlook for US economic growth remains positive for 2014, but not strong. Most forecasts fall below 3%, yet the absolute level of growth won’t impact the stock market. Instead, momentum, central bank action, earnings and data surprises will likely dictate movements. For the rally to sustain beyond next year there will need to be more consumer spending, otherwise companies will have to increase their own expenditure as they run out of methods to artificially boosting earnings.

Monday, 9 December 2013

Eurozone: A story of stability in 2013, but aggressive action awaits

It all started in October 2009 when George Papandreou’s new Greek government revealed a black hole in their accounts that was vastly underestimated by the previous administration. Several years of tumult followed, bringing the eurozone project to the brink of failure. But 2013 proved to be a lucky year for the 17-nation group. Relatively few economic surprises and heightened attention on events elsewhere brought a welcome calm to European financial markets.

This year the eurozone emerged from six quarters of economic contraction and the weaker nations enjoyed a strong rally in asset prices. Stock markets in the so-called PIIGS (Portugal, Ireland, Italy, Greece, Spain) have all rallied more than double figures year-to-date, while demand for each nation’s sovereign bonds has risen strongly, resulting in a significant decline in their borrowing costs.

Structurally, notable progress has been made on the enormous budget deficits that plagued the region. Optimism has been augmented by the imminent exit of Ireland and Spain from their respective EU/IMF bailout programs, with both countries set to make the transition to self-financing without the safety net of an emergency EU credit line.

The catalyst for positive sentiment came from the European Central Bank in July last year when president Mario Draghi said the phrase: “the ECB is ready to do whatever it takes to preserve the euro”. Those words were soon supported by a conditional bond-purchase program called OMT ( Outright Monetary Transactions) - a facility that has yet to be used.

The ECB’s actions signaled to financial markets that the central bank would indeed be a “lender of last resort”, effectively acting as guarantor for assets if the eurozone did verge on collapse. With that reassurance, markets have instead focused on the probable unwinding of the Federal Reserve’s bond-buying program and the slowdown in emerging market economies. 

Yet even though there is less likelihood of a eurozone breakup, eventually markets will demand to see evidence of a return to eurozone prosperity. Incongruously, that objective is being hindered by the nation currently driving growth. Germany, the region’s largest economy, is expected to grow by 1.7% in 2014, which should lead to a 1.1% eurozone increase. However, Germany is vastly imbalanced - it has a huge current account surplus of 6.3% of GDP, meaning that it exports far more than it imports from the rest of the world. (A current account surplus of more than 6% is deemed excessive by the European Commission, but this limit is not enforced).

The strong influence of Germany on eurozone policy directives has resulted in the weaker nations enduring strict austerity and relying on export-led growth. The austerity has somewhat succeeded in reducing labor costs, thus boosting the competitiveness of eurozone products in global markets. Subsequently, most periphery nations are now running current account surpluses, but instead of stable economic models, these imbalances highlight worrying vulnerabilities. An over-reliance on exports may work for a strong economy such as Germany, but it is impossible for the whole eurozone to rely on such a model; the region is simply too big. There can not be enough continuous demand from the rest of the world to provide prosperous stability for all individual eurozone economies. 

An absence of strong domestic demand makes eurozone growth extremely fragile. Additionally, austerity without stimulus leads to weak consumer spending and risks facilitating a deflationary environment. The eurozone is nearing this scenario. The ECB predicts eurozone inflation of 1.1% in 2014, significantly below its 2% target. The weak number is a symptom of high unemployment and stagnant household income growth, highlighting the fragility of the region’s recovery.

Deflation is harmful to an economy as expectations of falling prices make consumers less inclined to spend. Moreover, deflation is particularly damaging for the periphery economies since it is difficult to further enhance competitiveness by cutting depressed wages, while the value of debt burdens cannot organically erode. 

The ECB reacted to the deflation concerns in November by cutting its benchmark interest rate (at which banks have to pay when they borrow money from the ECB) from 0.5% to 0.25%. This cut has come too late. The move was opposed by the German, Austrian and Dutch central banks, illustrating the divide between the sturdy and struggling eurozone economies. Germany’s resistance to an easier monetary policy comes from a fear of hurting their exporters’ competitiveness and perhaps lingering ghosts from the nation’s struggle with hyperinflation in the 1920s. 

Such was Germany’s influence over the ECB in 2011 that the benchmark rate was increased 0.5% over the year to 1.5%. Mario Draghi’s presidential appointment in late 2011 has resulted in a much-needed decline in rates, greater ECB commitment to eurozone stability and a decline in Bundesbank influence. 

Now the ECB must do more than prevent a eurozone collapse. The region cannot export away its problems; real growth must be spurred from within. The delay in reducing its benchmark rate may now force the ECB into unconventional action. Among the options are quantitative easing (creating new money to lower bond yields and borrowing rates), negative deposit rates (effectively charging banks to keep excess cash at the ECB) and long-term refinancing operations with strict lending conditions (providing cheap funding to banks that agree to lend to companies). 

Financial markets should maintain a favorable view of the eurozone into 2014 as exports help steady, if slow, growth. But the time will come when slow growth is not enough, forcing the ECB into a standoff with Germany over aggressive stimulative actions. It may have been avoided if smaller measures were made earlier.