Voyons-potsdemiel

The Coming Congressional Gridlock

2010-08-22T10:07:00.000-07:00

Two observations can be made about the U.S. Congress, which many voters will agree with.

First, the approval rating of our Legislative Branch is abysmally low. Second, the legislative process is out of control.

The Republican dominance under President Bush made such a mess of things that the 2006 and 2008 elections produced that rare occurrence, a veto-proof Congress with both chambers controlled by one party. One could have hoped that this new arrangement would have produced decisive, effective legislation addressing the country’s numerous problems. Instead the Democrats produced two gargantuan bills vastly expanding the federal bureaucracy; a number of slush funds or bailout funds; and unheard of budget deficits.

The very size and complexity of the “reform bills” amply demonstrated that the current members of Congress are no longer capable of performing their main function, which is to produce meaningful and coherent legislation.

During the process of assembling the “major achievements” of this Congress it became painfully obvious members were voting on bills they had neither written nor read, larded with a variety of provisions favoring special interests, and creating a web of new functions, obligations and duties the national government cannot hope to discharge with any degree of effectiveness.

Hence the statement, repeated by many prospective voters concerning their intentions for the coming elections: “Anything but an incumbent!”

Such intentions have been voiced before in our election history, and were often revealed to have more bark than bite. There were times, however, when the electorate did in fact “throw the bastards out”. This might be one of those.

If political frustration was the only factor, voter anger could be dismissed as inconsequential. But this time there is real economic hardship as well. Unemployment, stagnant wages and rising income inequality are still in full force, and the “recovery” from the Great Recession is proving more questionable every month that passes. In fact the start of an economic “double dip” may well coincide with the election campaign.

This, paradoxically, may help.

The two established parties are too entrenched to be easily gotten rid of, and each will end up with, approximately, a third of the seats. The remaining third might well end up, if things get bad enough, in the hands of the new ABI (Anything But Incumbent) crowd. A number of those will still belong, nominally at least, to the traditional parties. But the mandate they will receive from constituents will no longer be satisfied by the old methods and ideologies.

This diversity of mandates, together with the lack of any strong majority, will preclude the passage of “monster bills” such as those over health care and finance. Even a pure pork “stimulus” will not make it, because of the fiscal rectitude stance that many in Congress are now adopting. In fact the long accepted legislative approaches might now be inadequate to pass anything at all.

The only exception is what could be called the “one-liner bill”.
Congress’ inability to deal with issues does not eliminate them. The electorate will still demand that something be done. To achieve both congressional consensus and electoral support such legislation must be simple, clear, targeted and effective immediately. It must not deal with broad, complex domains but with a single, obvious problem. Once properly formulated, such “one-liner” legislation will pass, take effect and deliver visible results. From there more similar initiatives will flow, and the now broken trust of the voters in their representatives could begin to heal.

Some examples of “one-liners”:

A progressive countervailing duty or sales tax on imports from countries engaging in predatory trade practices.

In parallel, a domestic investment tax credit for corporations setting up job-producing facilities in the United States (similar to John Kennedy’s 1961 initiative)

A transaction tax on excess leverage and trading frequency to prevent more Wall Street crashes.

A full freeze on the hiring, salaries, and other benefits of federal employees.

Each such bill will chip away at our problems and move Congress away from its current dysfunctional state. Later, if emergency conditions no longer prevail, such single items can be integrated into wider frameworks.

Job Destruction Through Mercantilism

2010-03-31T16:48:00.000-07:00

You can’t keep water in a leaky bucket.

If there is a hole in the bottom, the water will run out. You cannot fetch and use water until the hole is plugged.

It is the same with jobs. One can create employment, but if jobs leak out of the country the effort is ultimately fruitless. One must prevent job destruction before attempting job creation. There are two causes, in the area of trade, for the disappearance of U.S. jobs: mercantilism and outsourcing. Here we will deal with mercantilism.

What is mercantilism? It is a policy through which a government uses trade to extract wealth from other nations and accumulate it in its own economy and treasury. This is achieved through government-imposed policies which make exports cheap, so other countries will buy them; and simultaneously making imports expensive, so that one’s own citizens will not purchase foreign goods. The difference between the value of imports and that of exports is called a trade surplus if positive, or trade deficit if negative.

Mercantilism seeks to maximize the trade surplus, which requires more goods to be produced domestically and less obtained from abroad. There are numerous ways to achieve this: currency undervaluation; high import tariffs; subsidies and other facilities for exporters; deliberate lowering of wages; removing restrictions such as environmental and workplace safety rules; disregard for patent rights; “buy national” legislation; targeted taxes and tax exemptions; and many other.

Other than some targeted duties and agricultural subsidies, the U.S. has few mercantilist policies. Its main commercial doctrine is free trade, which stands for the unencumbered circulation of goods, services and capital. Other nations, led by China, are highly mercantilist, using all the above methods to achieve a massive trade surplus and accumulate wealth within their borders. China’s trade surplus with the United States varies, but on the average it amounts to hundreds of billions per year.

This means that jobs tied to the production of goods are migrating from the U.S. to China, as well as to other countries where the costs of production have been artificially reduced through government action. These are not only “assembly-line” jobs, but all positions and careers associated with industrial production: research, engineering, product design, logistics, accounting, quality control, inventory and supply, and management. All of these are well-paid and involve skills that have been developed over generations. Once lost, such know-how can be extremely difficult to develop again. Also gone with it are product designs, technology and patents.

The U.S. has with its trade partners treaties and agreements aimed at preventing mercantilism. But these arrangements require good will from all the partners and can be circumvented if such good will is absent. In addition they require policing by international bodies requiring complex, time-consuming and expensive redress procedures, and lacking powers of effective enforcement. None of these agreements have been effective against determined mercantilist practices such as implemented by China.

Conventional redress is therefore costly, and involves lengthy, expensive and ultimately unreliable procedures. In such a situation more direct and effective measures are needed.

Current methods are in part ineffective because they focus on products. It must, for instance, be proven that automotive tires, or copper wire, or video game boxes are sold at an excessively low price. The success of the resulting investigations depends on the good will of the host country, which is unlikely to volunteer assistance against its own industries. In any case, a product-by-product approach leaves the rest of the economic field wide open to abuse. To use a sports-related analogy, it is pointless to discipline a single player when the entire team and its coaching staff are breaking the rules.

The redress policy must therefore be applicable across the board and be independent of the cooperation of the mercantilist party. It must address not only individual industries or products but the end result of mercantilism: the excessive trade surplus enjoyed by the practicing nation.

Such a policy is called a countervailing duty or an equalization tax. It is a levy, which can be paid at the border or, preferably, at the point of sale on all products originating from the mercantilist country, including those which are “recycled” through a convenient third party. It must have the following characteristics:

• Be applicable only if the trade deficit with said country rises above a pre-determined limit, to be set by the United States.
• Be progressive: for example, start at 5% and increase by an additional 10% every year after that. It should be conditional and subject to reduction if the trade deficit falls below the originally set limit.
• Be payable by the importer, who is in effect the agent of the mercantilist country
• Apply equally to all products from the designated country. This allows trade to shift over time to products where said country possesses a genuine and objective advantage.

The progressive nature of the duty provides for a period of adjustment during which trade flows can be rerouted. It is probable that once the duty is in place mercantilist policies will begin to be abandoned, as their future failure will rapidly become evident. It will also allow for investment in domestic industries to be restarted.

This duty can be established immediately by executive order or a simple act of Congress. It will therefore have instant impact, both psychological and material.

The Outstanding and Urgent Issue: Economic Activity Means Employment

2010-03-27T13:19:00.000-07:00

The United States is facing many challenges, both domestic and foreign. All the major ones will be addressed within the scope of the National Interest Platform. But some are more urgent than others, and heading the list are the two that can, and will if left unattended, unravel the collective life of the country. Those are: the state of the economy and immediately after that the unchecked growth of government spending.

The economy takes priority.

Let us first dispel an illusion. Officially, the U.S. economy is said to be “recovering”, albeit slowly. This statement is based on two gratuitous assumptions.

The first concerns the definition of “recovery”. Our economic life is still based on the concept of free enterprise, where economic developments are the result of initiative and productive work within the private sector. This gives the economic sector a life of its own, which proceeds in cycles. The economy will expand, contract and then recover as a result of individual and collective decisions by producers and consumers, after which the cycle eventually repeats.

By contrast the current “recovery” is almost entirely an artifact of large-scale government intervention and deficit spending. Such massive manipulation is bound to have some impact, hence the advertised “signs of recovery”. But it is more likely that this very intervention has both dampened and biased market mechanisms to the point where a spontaneous recovery cannot occur. The economy thus remains in a continued state of suspended animation, requiring a never-ending series of government actions just to keep limping along.

The second dubious assertion is summarized in the phrase “jobless recovery”. State intervention has indeed produced, at enormous expense, a recovery of sorts involving the financial sector and larger corporations. But the improvement in corporate balance sheets has been achieved through relentless cost cutting, of which large-scale unemployment is the primary consequence.

Economic health is not based on corporate balance sheets, which can be easily manipulated. It is much better expressed as the sum of the economic situations of individual wage-earners and consumers. And this, in turn, rests on one fundamental reality: the abundance or lack of gainful employment.

The individual paycheck is the heart of the economy: it provides for taxes paid at all levels of government, for consumption which supports corporate profits, for the growth of pension funds, for all kinds of insurance. It feeds the creation of new businesses, the provision of education and health care. Without individual income banks will close, houses are foreclosed, and enterprises fail. An economy without employment is a contradiction in terms.

Without growth in employment there is no recovery. We are still in a recession, or even depression, depending on the numbers one believes in. Corporate statements achieved through relentless lay-offs, and the transfer abroad of American jobs, are only bright paint hiding a rotting wall.

On that basis the current priorities of the national government, be it bank reform, health care or carbon taxes, are wrong. Our primary concern should be to increase employment. And such employment should be the self-sustaining, not government-supported sort.

Here an important caveat must be made. The government cannot create self-sustaining employment, unless this happens under a full socialist system with state majority ownership of the economy. Such a system is not, and never has been, a realistic alternative for the United States. Recent moves in that direction, labeled as “stimulus spending”, have so far been a resounding failure.

The current bust is not a plain business cycle, but a structural crisis that was years in the making. The last administration’s response was to cover up its ineptitude in supervising the economy with a taxpayer-funded rescue of the financial sector. In a court of law this would amount to forcing the victim to pay for the bail costs of the perpetrator.

The current administration has done no better, instead engaging in a series of massively wasteful legislative distractions. These will not only have little impact on employment, but greatly increase the government’s liabilities, reducing its future freedom of action.

Other policies are thus needed.

Such policies must aim at providing leadership, direction, and confidence for the private sector, particularly medium and small enterprises. They must also provide a framework within which the private sector can plan, invest and operate. It is with such initiatives that we will concern ourselves here.

These must achieve two goals. One is to foster job creation. The other is to prevent job destruction. Unless measures in both areas are in place no policy will be successful.

Specific measures for both will be outlined in the following articles of this series.

Approaching Politics in a New and Effective Way

2010-03-24T07:58:00.000-07:00

The ongoing political battle over the creation of a national health care system is both sign and symbol of the current state of U.S. politics. The congressional majority is making use of questionable tactics to pass legislation that the majority of voters by all appearances do not want. This is both an absurdity and a huge waste of energy, time and resources at a time of national crisis.

The nation currently faces crises in several areas, of which the main, but not the only, ones are the state of the economy and a government budget crisis at all levels. In addition to those, the country is engaged in a series of drawn out foreign wars, running a huge trade deficit and faces ongoing terrorist threats.

Looming beyond those questions is the long-term issue of developing and building the infrastructure needed for the long-term sustainability of the national energy supply.

Each of the above problems closely affects every citizen and requires a concerted national effort so as to achieve resolution. Yet all are pushed aside for the sake of a bitter fight over an issue which, while important, poses no immediate threat to national life. Why?

If one avoids as fruitless the criticism of persons and factions, the main cause of discord appears to be partisan ideology. As outlined in Viable Energy Now, our politics have, since the Industrial Revolution, been largely determined by the struggle between capitalism and socialism. While this conflict has dominated the 20th century, both ideologies have by now lost most of their relevance, while their flaws have been exposed in the collapse of the USSR as well as the successive crises of global capitalism in the years following that landmark event.

As the opposed ideologies were gradually losing their relevance, governments over time became hybrids incorporating elements of both systems. While this initially blunted the intensity of the ideological conflict, these hybrids were neither very manageable nor particularly efficient. But each side continues to blame the other for these shortcomings so that, paradoxically, the gradual blending of the two approaches has actually sharpened their theoretical opposition.

Resolving our current problems or crises therefore demands first of all a change of attitude, leading to the relinquishing of obsolete positions. Those on the left must admit that government, while it can and should provide leadership, is in fact a poor and wasteful manager and provider. The right must be ready to admit that huge, globe spanning corporate entities are not the highest form of free enterprise and the ideal incarnation of economic efficiency. Each side must recognize that both the state and the market are imperfect and fallible and function best in cooperation, not conflict.

Such an attitudinal change will allow for approaching our problems on the basis of objective fact rather than from the perspective of a preordained template. While ideology brooks no compromise and always needs an enemy to damn, facts provide ground for understanding, agreement and collective action towards a resolution. Furthering the interests of the nation and its component communities then becomes the overriding goal.

Our “National Interest Platform” is an attempt to redefine the issues we now face on such terms: what is the problem, what means are available for its solution, and how one should proceed towards that end. Its purpose is to reduce or eliminate these problems on the basis of cooperation rather than through unilateral application of ideological principles.

Its purpose is to heal our rifts through common effort in each area where our country faces a crisis, current or potential. We believe all of these difficulties can be overcome and that this approach will lead to a stronger, more confident and more united nation.

This article is the first of a series, with each succeeding one focusing on a specific issue, detailing its underlying causes and a potential solution. We hope it will generate comments and discussion and result in a widening effort towards cooperative solutions.

Complexes Can Be Dangerous, But Also Mortal

2010-03-08T18:59:00.000-08:00

In his 1961 farewell speech, President Eisenhower warned the nation against the potential rise of a “Military-Industrial Complex”, a potential alliance of ambitious officers and defense-oriented corporate chiefs with the capacity to become a “state within the state”, and take advantage of the Cold War to exert undue influence on American politics.

Possibly thanks to his warning, this never occurred in the U.S. But such a complex did arise in our Cold War adversary state, the USSR. There elements within the government, the military and the armaments industry cooperated in the creation of a privileged sector, which gathered to itself the lion’s share of state revenues, scientific talent and political influence.

The Soviet industrial-military complex not only sucked the economy dry, it also involved the Soviet Union in a number of questionable foreign ventures, both expensive and dangerous, and which distracted the leadership from pressing issues of internal governance and productive investment.

While the USSR acquired world-class armed forces, it also locked itself in a military doctrine based on past wars and neglectful of future threats. Despite having contributed to the U.S. failure in Vietnam, the Soviet military leadership ignored the potential of asymmetric warfare and thereby dug their army’s grave in Afghanistan. The end result of their hubris was the collapse of Soviet power and the dissolution of the USSR.

The Soviet Union was a tyranny, and its end a blessing for all mankind. But the errors of other states, even enemy ones, can provide a useful perspective for evaluating our own policies.

And the question is worth asking: Are we in the U.S. making a similar mistake?

As the Cold War ended and our brand of capitalism was declared triumphant, we allowed our own “complex” to build itself: not a military one, but a Financial-Political entity of equal reach and power.

For the last two decades the growth of the financial sector has far outpaced that of the economy. A close alliance has developed between Wall Street executives and Washington politicians, reinforced by revolving-door appointments and backed by intense lobbying and massive campaign contributions. What is good for Wall Street is now accepted as being good for the country.

The question here is not one of moral equivalence between Soviet and U.S. conditions, but of political wisdom: Is it prudent for any state, be it democratic or authoritarian, to allow within itself a privileged entity that is, by its very position and the power it wields, at least partially above, or to put it more accurately, “aside of the law”?

The growth of the Financial-Political complex has appeared benign until recently. Indeed many have praised and encouraged the “new financial capitalism” that the complex created, the growing economic activity that followed and the huge tax revenues that flowed from it.

Until, of course, the bill came due.

As the “New Financial Capitalism” acquired global reach it brought a series of bubbles and crashes in its train: the Asian crisis, the dotcom bust, and finally the current Great Recession. Connected to these were other disturbing phenomena: large and growing trade deficits, the decay of U.S. manufacturing, increased reliance on foreign lenders. Income inequality has skyrocketed while the wages of the majority stagnated.

The last crisis also gave us the Great Unemployment.

When the New Capitalism crashed worldwide, saving the financial sector was the government’s primary concern, and it was accomplished regardless of cost. Trillions were deployed to provide the banks with liquidity. The general population got extensions in unemployment compensation.

The financial sector, supported by taxpayers, is back to New Capitalism activities, profits and bonuses, which appear to be necessary for the general welfare. The rest of the population is unemployed, under-employed, or hanging on for dear life.

Is there something unequal here?

This is not a sound foundation for growth and stability. Neither were the long queues in Soviet groceries while well-financed and protected industries were building more submarines and advanced jet fighters.

The people eventually caught up and disposed of the status quo.

What happened there could also happen here. We should take heed.

The U.S. Economy – On the Edge

2010-03-08T18:53:00.000-08:00

There is no question that, barring a major unforeseen event, the state of the economy will be the main determinant in the November election.

The official line is that despite issues with employment, mortgages and credit the overall picture is improving. Should this be so, the political map is not likely to be drastically altered in the fall. The Democrats will lose some seats in both houses of Congress, but with a stronger economy they will make up for it in 2012.

If such improvement, on the contrary, does not materialize, all bets are off.

This then leads to two questions: first, is the current recovery for real; second, if it is not, why? If the current recovery falters, whoever has the answer to the second question might emerge from the election a winner, possibly for the long term.

First then comes the analysis of the “recovery”, and that raises an important caveat: that whatever improvement there might be in economic conditions is not the result of “normal” economic forces.

In the past it has been assumed that the economic cycle had a “natural” life of its own, fed by investor and consumer psychology, supply and demand, speculative excesses and panics, and so on. Governments could influence this process to a degree, but not abolish or replace it.

The current “recovery” on the other hand is unique, due to a massive and coordinated intervention by governments across the globe. Left to themselves the markets, the current theory goes, would have crashed into a “second Great Depression”. To avoid such an outcome a massive bail-out of the financial system was needed, following which restored credit availability and consumption would lead to an economic revival.

In other words, the current economic cycle is a manufactured artifact. As this has never been attempted on such a scale, we have no past experience to tell whether it will succeed or not.

At the present time, that question is still unanswered. The financial bailout and unprecedented government spending have for the time being arrested the downward slide and in places brought some improvement. At the same time warning signs of further trouble abound: still rising mortgage delinquencies, state deficits and unemployment in the U.S.; real estate inflation and excessive credit expansion in China; sovereign default risk in Europe, and so on. Underlying it all is the often expressed warning that the “recovery” could collapse if government support is withdrawn at any time in the foreseeable future.

Also troubling is the fact that the financial sector, the practices of which have precipitated the crisis, has gone back with a vengeance to these very same activities. This is particularly true of the stock markets, the rise of which is out of all proportion to the improvement in the underlying economic data. A market panic, even a limited one, would bury whatever “recovery” there might be. What if one took place this month or next?

This leads to the second question asked above: why would the remedies currently employed not work?

The question itself generates another query: What was the focus of the measures put in place to fight the crisis? The crash originated within the financial sector, which had undergone extraordinary development over the last two decades. The remedial measures taken were, for the most part if not exclusively, aimed at rescuing the financial system from its own misdeeds, at very high cost to governments and, ultimately, taxpayers.

The key justification for this effort and expense was the assumption that the financial system in its current state was essential to the economy and therefore had to be rescued. This applied particularly to the largest financial institutions, which were the main recipients of governmental largesse, and were, unlike a number of smaller banks, duly bailed out by the state.

These large institutions were the primary culprits regarding the risky financial practices which caused the crash. These activities were, as mentioned by Lord Turner, head of the British Financial Services Authority, of questionable, if any, social value. That is, they contributed little or nothing to the overall economy.

To put it plainly, was the rescue aimed primarily at the financial system and its large banks? Was the fate of the overall economy only a secondary consideration, as well as a convenient cover for spending public money on institutions that in actuality deserved to fail?

The question is important because if the economy was secondary in the scheme, then its recovery is far less likely than if it had been the primary target, particularly with a financial system still dysfunctional and at the same time still hogging the attention and resources of government authorities.

And if that is indeed the case, we are in for a long, hot summer, and a messy, unpredictable election.

Globalization: The Twilight

2010-02-15T16:11:00.000-08:00

The financial crisis has now been with us for well over two years, and going on three. A variety of exceptional measures, never before attempted, have been taken by government authorities around the world. For most of the second half of 2009 it seemed that these had their effect: some small, but consistent signs of recovery were appearing.

This tentative improvement is now being brought into question. As many commentators have pointed out, the primary policy of governments has been, through deficit spending and a series of liquidity enhancing measures, to rescue and “reset” the global financial system. This has in effect transferred the financial institutions’ liabilities to sovereign governments, some of which are now looking at the possibility of default.

At this time, default threatens only those countries with the weakest finances. The large countries such as the U.S. are assumed to be still immune. This argument, however, has been heard before: in the summer of 2007 the collapse of a few over-leveraged hedge funds was declared to be “contained” with no further threat to the rest of the system.

This proved an illusory assurance, as one institution after another was shown to be a house of cards and the crisis grew to its full extent.

It is therefore worthwhile to probe deeper, and to ask whether there is not a more fundamental issue at the heart of this apparently continuing crisis. Is the globalized financial system, with or without government support, basically viable? And, if not, what is to be done before the crisis deepens?

The goal of the measures taken to date, particularly in the United States, has been “to avoid a second Great Depression”. This assumes that the situation, now and then, is in the main similar, and would respond to the same remedies. These have now been applied, so problem solved.

The hitch is that in the 1930’s economies were national, whereas now they are globally interconnected. In other words, the lessons of the 1930’s are irrelevant, our situation is different, and a new analysis is required, one taking full account of globalization.

Globalization has been taking place on two levels: finance and trade.

Financial integration is the most advanced, and at this time can be considered to be nearly complete. This has two major consequences in the way the financial system operates: synchronicity and overwhelming mass.

Synchronicity means that financial movements propagate instantaneously throughout the planet. A sell-off of equities in favor of commodity futures, for example, can begin in Asia and be repeated everywhere else within 24 hours, often even faster.

Mass means that, as all financial assets worldwide tend to become fungible, the entire monetary mass in the world can theoretically be put to use at a single point.

Furthermore that mass can be multiplied several times over through the use of leverage and derivative products. This amplification, coupled with the separation of money from any fixed standard such as gold, means that the amounts available for financial operations tend towards the infinite.

The globalization of trade, on the other hand, goes in the opposite direction. Because it tends to locate fixed assets in the area of lowest cost, it gradually decreases the total value of these assets. Globalization thus has the specific effect of increasing the amount of money or equivalent instruments in circulation while simultaneously reducing the total amount of assets this money can buy or be otherwise applied to.

Within a national economy the monetary mass and the amount of fixed assets must remain in rough balance for the economy to keep operating. Within a globalized economy they tend to diverge. One increases while the other diminishes. A systemic unbalance is created. As the profit motive continues to operate, this unbalance directs it along the path of least resistance, favoring speculation over productive investment and further increasing instability.

A sufficiently globalized economy will therefore tend to be unstable, alternating between boom and bust with an increasing amplitude and a quickening periodicity. These fluctuations will overwhelm any attempts to control them since the global monetary mass will in every case swamp the resources available to national governments.

Theoretically, such worldwide instability could be dampened and controlled through the use of truly global measures implemented through a supra-national institution. But neither the necessary knowledge nor the means to apply it are even remotely available. The world is still structured on the basis of the nation-state or its various equivalents, and power is distributed accordingly. Within that real, as opposed to theoretical, context, globalization is a vast and dangerous overreach.

The continuing crisis is a manifestation of this very overreach. It leaves the government authorities with a stark choice: reducing globalization down to the level where national means of control can effectively operate; or continuing on the present course and eventually driving over the cliff at an ever greater speed.

The current crisis is the hinge, or the point of critical choice. It is the third one of its kind, after the 1997 Asian meltdown and the dotcom bust. A realization is growing that somehow control has to be improved, that some blind force is shaking the current global arrangement, and that a decisive step must now be taken.

There are two paths to choose from. One is to continue driving half-blind with the hope that globalization is indeed the next stage in the development of economic man. The other is a return to the manageable, to sanity and logic within the framework of viable national economies.

The choice is ours.

The Breakout from the Ideologies of Right and Left

2010-01-22T17:51:00.000-08:00

Summary:
The success of Scott Brown in the recent Massachusetts election has been attributed to the popular reaction to economic hardship and government arrogance. While this is certainly true, there may also be a more fundamental issue: the growing obsolescence of the ideological templates from both Right and Left.

Many reasons have been given for the successful election of Massachusetts Senator Scott Brown on January 18th . The commentaries are likely to keep flowing for a while.

The cause most commonly suggested is public anger at the political arrogance of the Democratic leadership, together with the political class’ indifference to the economic plight of the citizenry.

Without criticizing any of the explanations provided now or in the future, it is our belief that something even more fundamental is at work here, which might well make the 2010 campaign a historical turning point. That basic factor is the breakdown of longstanding political ideologies.

“Longstanding” is chosen deliberately, for we are talking about capitalism and socialism.

Both of these are usually seen as purely economic models, but in fact they are complete thought systems aimed at organizing all social activity. They lie at polar opposites to each other, one emphasizing the power of the state, the other the supremacy of the individual.

It is interesting to note that free enterprise and state authority were never, prior to the advent of the Industrial Revolution, considered to be fundamentally inimical to each other. Both were deemed necessary to the conduct of human affairs, and a balance between the two was always considered the best guarantee of material prosperity and political stability.

The Industrial Revolution ended this traditional compromise. The huge increase in material production and wealth, itself made possible by the use of fossil fuels, was thought to require a new approach. Who would benefit from this unprecedented cornucopia became a philosophical question that would influence political thought and economic principle for the following two centuries.

On the one side was the capitalist theory, which claimed that if the creators of the new industrial economy were left alone to work their entrepreneurial magic, maximum prosperity would follow, profiting everyone and guaranteeing continuous progress. The state should step aside and reduce its role to supporting capitalist creativity and allowing free reign to market forces.

Opponents pointed to social inequality and economic exploitation in order to discredit the above view. They claimed that the new prosperity was the fruit of everyone’s labor and should be shared equally. This demanded an increase of the power of the state, which would become the supreme arbiter of material development and of the fair distribution of the wealth produced.

The conflict between these two ideologies occupied most of the 20th century, with its revolutions and wars. By the end of 1900’s it had become clear that both systems had inescapable flaws.

Capitalism was indeed immensely dynamic, but its development proceeded in a succession of booms and busts. Booms enriched primarily the upper classes, while the brunt of busts was born by the lower income population. The unwanted but very real consequence was a trend towards economic inequality and social conflict.

Socialism had matching flaws. While the state managed to distribute wealth more or less equally, there was not much to distribute, due to the inertia and inefficiency of the state-run socialist economy. In addition the socialist system showed a disturbing tendency to turn into a police state.

To avoid the most glaring shortcomings of each, the two systems were over time blended into hybrids. These constructs, however, lost the advantages of both concepts while magnifying their defects: they were neither efficient nor fair, neither stable nor dynamic.

Instead what appeared was the unwholesome combination of an unaffordable, unmanageable government with highly concentrated economic oligopolies: inequality with inefficiency, economic exploitation with bureaucratic arrogance.

This combination is exactly what, according to many commentators and analysts, the Massachusetts voters were angry about. They also happened to have an early election to voice their frustration. The rest of the country is not far behind, some nine months to be precise.

Neither the political class nor the economic elite, now locked into an embrace of mutual preservation, can deal with the situation. Policies outside the old progressive and conservative frameworks are required: solutions that actually solve problems, plans that can be implemented, sound-bites that catch the reality of our situation.

Anything else will bring out more “torches and pitchforks”, town hall meetings and tea parties.

This is the year of the awakened voter. It is likely to be, just as well, the beginning of the end for the old Right and Left. Failed theories must, from now on, be replaced with practical leadership.

The Next Wave of the Global Economic Tsunami

2010-01-08T10:36:00.000-08:00

A pivotal article by John Kay appeared in the January 6th edition of the Financial Times. The word “pivotal” is used on purpose, because the piece breaks new ground.

Mr. Kay is the first commentator (to our limited knowledge at least) to connect the last three major crises (the 1997 Asian bust, the dotcom crash and the current Great Recession) to a common denominator. In addition he squarely points to the current globalized financial system as the common cause of these three events.

He also points out that each downturn has been more severe than the preceding one, indicating an escalation in size and intensity. The current recession has “maxed out” the capacity of central banks and governments to deal with the situation. The next one will be worse and possibly beyond anyone’s control.

We regret that the author did not, in our opinion, define more clearly the underlying causes of this sequence of booms and busts. These, as we see, are as follows:

The first cause is the creation, through unrestrained trade and budget deficits, of a large unanchored monetary mass beyond the control of any government or international institution. Because the U.S. is the primary provider, this mass consists mostly of dollars exported from America to finance U.S. private consumption and government spending.

The second cause lies in the globalization of finance and the removal of nearly all previously existing controls on currency and capital flows. This allows the large monetary mass mentioned above to move relatively freely around the globe in pursuit of the best returns, concentrating wherever such opportunity arises.

These capital flows are now so large that they overwhelm the ability of even the richest states to react and bring about the necessary corrections. As long as financial globalization remains an article of faith, neither governments nor international organizations will be able to prevent another financial tsunami.

As Mr. Kay points out, governments barely contained the devastation caused by the latest wave. However, they have done so not by starving and weakening the “financial beast”, but by feeding it additional mountains of money through bail-outs and deficit spending, all under the cover of financing a “recovery”.

Such a recovery is posited by Keynesian theory, according to which government spending replaces private outlays during an economic downturn. This has, in the past, worked to a degree. But we are not living in the past. The present is different.

Keynesian theory was created during the Great Depression, when the bulk of national economic activity took place within national borders. In addition, capital flows and exchange rates were controlled by regulation, and trade was limited by tariffs. Under such constraints government spending would remain concentrated within the national economy.

This is no longer the case. Current government outlays are funneled through a transnational system, within which money flows wherever the returns are highest and speculative activities most profitable. In addition, the expansion of the welfare state guarantees that a large portion of government spending goes to cash transfers, which, while maintaining a subsistence level of economic activity, result in no productive investment.

The amount of stimulus spending needed to generate a “recovery” is therefore far greater than what would have been considered adequate during the 1930’s, which have provided the model for current policies. In the meantime a large portion of the money leaks out and increases the loose global monetary mass, guaranteeing that the next boom-and bust cycle will be more intense than the last one.

This is a situation for which there is no historical precedent, because such conditions have never existed until today. As Mr. Kay writes, we have created a “monster”. In fantasy stories, monsters are feared and eventually destroyed. We are feeding ours instead, making it bigger and stronger.

Our current policies thus lead directly to another crisis, worse than the current one.

The remaining ray of hope is that the “recovery” will prove so weak and unstable (which is likely) that political pressure will require to abandon present policies in favor of more effective measures. The upcoming U.S. congressional elections may turn out to be a test case in this area.

2010 - The Political Unknows

2010-01-01T09:44:00.000-08:00

Summary: The American political system has a built-in capacity to regenerate itself. Such a change occurred in 1854, with the creation and rapid growth of the Republican Party. We may be approaching a similar episode of political realignment.

There are two ways to look at the politics of 2010.

The first is the conventional approach. Under this scenario the economy will improve somewhat, helped by delayed spending of the remaining stimulus funds and continued support from the Federal Reserve. The opposition to health care reform will gradually fade. Unemployment will edge down. The Democrats will lose a dozen seats or so in the House, and one or two in the Senate, as is normal in mid-term elections.

In other words, things will go back to what, in the eyes of the political establishment, is considered “normal”.

The alternative scenario would overturn that conventional wisdom. Yet from a historical perspective it could be more logical or “normal” than the first one. Which one will be the real one depends on the balance of two sets of forces: the first set could be termed “system inertia”; the second, “popular aspirations”. The two are increasingly at odds, leading eventually to a political crisis. The longer the resolution is delayed, the more intense the crisis will be.

In order to gain historical perspective, let us go back some 150 years. In the 1850’s the USA was a nation is transition, both economically and politically. The economy was transitioning from the colonial model (commodities exchanged for manufactured goods) to a self-sufficient and self-funded system based on diversified agriculture and a budding industrial sector. Politically we were moving from an elitist system favoring the landowning and merchant classes to a full-fledged democracy.

Both economic and political transitions generated a set of practical issues such as the construction of railroads, the distribution of Western lands and the provision of mass higher education. And through it all ran the burning problem of slavery.

The parties of the time, Whigs and Democrats, were tied to the status quo. As the issues became more urgent, the do-nothing approach led to the rise of a large uncommitted and/or dissatisfied mass of voters. Parts of this floating electorate coalesced around single issues and formed third parties, but none of these attained critical mass.

None, that is, until the Republicans appeared in 1854.

The original Republicans were a motley crew of frustrated Whigs, angry abolitionists and land-hungry Free-Soilers, with a few Democrats thrown in. They founded the party almost in desperation, but it was desperation mixed with strokes of genius.

The first stroke was their platform, incorporating simple, practical and feasible solutions to the issues facing the country. The second was their invitation to anyone liking that platform to join them, regardless of past political affiliation.

It was a triumph of realism over ideology. In six years the Republicans took over the U.S. Within another six they passed a legislative program that made America a continent-sized nation and a top-rank industrial power.

Do we hear an echo here?

Many of the same elements are present today: a stuck political system invested in the status quo; an economy in transition from the industrial to the post-industrial; a large disaffected segment of the electorate, today called “independents”; a general conviction the country is headed in the wrong direction; and many single-issue groups and factions ready to be integrated into a common framework, if such a platform could be defined.

Does this mean a third party? Not necessarily. What is needed is a platform that transcends the current ones, either on the right or on the left. Such a platform can be conceived within one party as long as it is willing to expand its horizon. It can also be born out of the fragmentation of the current parties, with compatible factions combining into a new majority.

2010 could provide such a beginning. As Mark Twain observed, “History does not repeat, but it does rhyme.”

A Leap Into the Unknown – Next Year’s Economy

2009-12-15T09:27:00.000-08:00

As 2009 ends, the official word is out: thanks to a massive financial bail-out and zero interest rates, we have escaped a second Great Depression. The economy is on the mend, growth is back, and all that remains is fixing some lesser problems, such as bankers’ excessive bonuses.

“Greedy bankers” make convenient whipping boys, but if banks are making profits again, why should their executives not get paid accordingly? Every other industry rewards its winners. On the other hand, if bankers are guilty and need to be punished, it behooves us to first determine what they did wrong.

As was found out once the current crisis hit, banks had invested large amounts of money in questionable assets. When these assets turned out to be less valuable than originally assumed, the financial system faced worldwide bankruptcy, from which it was saved by huge, and still continuing, provisions of government money.

The key question to be asked is why so many dubious assets were created and purchased in the first place.

The iron rule of economics is the law of supply and demand. Greed plays a part as well, but the supply and demand rule underlies everything else.

The assets in question were created and sold because there was demand, meaning money looking for assets to invest in. If there was more money than available assets, new ones had to be created to satisfy the demand, and created they were, sometimes out of thin air. This asset creation fed a speculative bubble. When the bubble popped, the system crashed.

So the initial problem was not the dubious assets, but the excessive abundance and availability of money. Funds were abundant because interest rates were low, but also because the U.S. government had pumped the global financial system full of dollars through large and continuous budget and trade deficits. This mass of money then was freely available because the financial system was globalized, and funds could move around in huge amounts, seeking the best returns.

Finding solid investment opportunities is hard work, and returns are often slow to materialize. Creating phony assets is easy and brings an immediate financial reward. A financial system loaded with piles of freely moving money is an open invitation to speculate. In the short run, speculation generates more profit than sound investment. As it stands now, the financial system is structured to maximize both speculation and greed, while short-changing valid investment.

Bankers and traders may be greedy, but the system set-up encourages them to be. The last fifteen years have seen financial crises of increasing gravity: the Asian crisis, the Russian default, the dotcom bust and the 2007-2008 crash. All flow from the dynamic outlined above: too much money moving too freely and too fast.

This situation has now been aggravated by the “remedial” measures taken by governments and central banks to mitigate the current crisis. These measures translate into increased deficits and the wholesale printing of money, and have vastly increased the monetary mass in the global system.

The logical consequence of this would be the formation of more speculative bubbles, followed by new crashes. It is questionable, however, whether any asset category can by now absorb even a fraction of the money in circulation, old and/or newly created. This is all the more true as the “real” economy is weak and has little inherent dynamism aside from government stimuli. If the floating monetary mass then remains unabsorbed, the probable outcome will be a monetary collapse, led by an imploding dollar.

The consequences of this are hard to imagine. There is no precedent for a global monetary crash. Yet this is where we are, in all probability, heading if current policies are maintained.

The above “if” suggests an alternative approach. Such a shift is not ruled out because the U.S., the country at the core of the issue, is heading for a crucial election, the stakes of which are extremely high.

Alternative policies could therefore be embraced by a political challenger to the status quo. These policies would include:

- Budgetary tightening aimed at the elimination of fiscal deficits
- Measures to promote investment in the real economy
- Tariffs applied to major trade imbalances
- Taxation of speculative activities within the financial system

There is no guarantee that these measures will produce a smooth transition to a more viable system. Any induced shocks will nevertheless be much easier to handle than a wholesale monetary collapse.

We have a choice between a deteriorating status quo and a new start. This choice must be clearly articulated as we move towards the 2010 elections.

The Case for Economic Sovereignty

2009-12-14T09:00:00.000-08:00

The word “sovereignty” is derived from “sovereign”, which means supreme ruler. At the time the principles of Western political thought were being elaborated, the sovereign was in most cases a king, and sovereignty was understood as the king’s right to act as he pleased within the territory he considered his own.

In the 18th century this right was gradually transferred to the people as a whole. Under a democratic government, national sovereignty is the implied right, shared by all citizens, to order their life as they please without outside interference.

Sovereignty has always been looked upon as a political concept. At the time the U.S. Constitution was written, economic sovereignty was a given. The overwhelming majority of goods used for daily life were produced locally, usually within the immediate vicinity. Only a small portion came from outside the national territory, and those were mostly luxury products that the majority of the population had no use for.

In an agrarian economy everything needed for physical existence is under the population’s de facto control. This gradually changed as the Industrial Revolution took hold. As the standard of living rose, a greater proportion of the goods needed to maintain life and prosperity came from distant locales, where industrial facilities were concentrated.

Who controlled these facilities gradually became a major issue. The struggle between capitalism and socialism was over the “control of the means of production”, and brought to the fore the people’s right to control the basis of their material existence.

Until the middle of the 20th century, however, the bulk of such goods were produced within the national territory. The energy “oil shocks” of the 1970’s were the first public sign that this was no longer the case. At least some of the “necessities of life” were now coming from outside the national territory.

The globalization of the oil market was followed by a similar evolution in many other fields. The U.S. today is deeply enmeshed in trade networks spanning the entire planet, and a host of vital supplies, ranging from drugs to clothing to fertilizer, are no longer produced domestically. Two major justifications are offered for this process of increasing dependence on foreign supply sources.

The first is the lower cost obtained by going to the cheapest supplier, wherever he may be. Global markets are said to be more efficient, providing the greatest amount of goods at the lowest expense.

The second justification is that this evolution represents “progress”, that it is the next phase in the general development of mankind, and is therefore by definition both beneficial and inevitable.

That the development of mankind is linear and irreversible is of course an unproven assumption. That this particular manifestation of it, namely economic globalization, is entirely beneficial is also debatable.

In a democracy, the citizenry controls the government, at least in theory. Foreign suppliers of goods to U.S. citizens are controlled by their respective governments, be they democratic or not. They are the suppliers, and to that extent they control us. We, as their market, have some control over them. But each side is also dependent on the other, implying in the end a loss of freedom and sovereignty.

This loss is amplified by the fact that the terms of trade and exchange are usually set by persons and organizations with no formal responsibility towards the citizenry: multinational corporation executives, international institutions, and the managers of the globalized financial system. All these persons and entities pursue their own interests and are not bound by a popularly approved charter such as the U.S. Constitution.

The question of whether the citizenry approves or disapproves of this state of affairs has never been mooted, even though the populace has to bear the consequences, as in the course of the current crisis.

The essence of democracy is that the people should control the circumstances of their own life, be they political or economic. In the United States, at this time, they do not, in the economic sphere, have such control. While political sovereignty still stands, its economic counterpart is eroding away.

This issue is as vital as the causes of the revolutions of the 18th and 19th centuries. It will lead to similar upheavals if it is not addressed.

Synopsis: The Cooling of the Planet

2009-11-29T16:33:00.000-08:00

The coming climate summit in Copenhagen has been the occasion for calls to do something quick to reduce carbon emissions. While the issue is serious, the single-minded focus on carbon keeps us from developing a more balanced and inclusive view of climate-altering factors.

The Rush to Cool the Planet

2009-11-29T16:31:00.000-08:00

The climate summit in Copenhagen is fast approaching and the global warming debate is rising to a high pitch. As usual in such situations we are being told that unless we take drastic measures now disaster will follow in short order, and then it will be too late.

Now our purpose here is not to dismiss the climate change issue, which is a serious one, but to question the rush to take action, any action. While the accumulation of greenhouse gas in the atmosphere certainly has an impact, the global warming hypothesis is still just that: a hypothesis.

No one has proved global warming in terms of demonstrating that if A (greenhouse gas accumulation) occurs to such and such a degree, then B (a specified rise in global temperature) will take place within a given time span. Such proof of causality is the hallmark of any accepted scientific theory. Until it can be done, global warming remains a working hypothesis, though a plausible one.

The recent controversy over hacked e-mails supports the above. The fact that a key group of scientists feel a need to silence opponents and manipulate data clearly shows that the politics of the issue have gotten ahead of the state of scientific knowledge; in other words, that critical components of the greenhouse gas theory are still in doubt.

Besides, there are other plays in town.

Greenhouse gas accumulation is only one of several factors acting on the climate. Two others at least merit special attention.

Of these, orbital variations are the best documented. Such variations in the earth’s orbit and axis inclination have been correlated with ice ages, and according to one theory at least the earth is due for a significant cooling period, possibly a new ice age.

The other variable is the sunspot cycle. Normally sunspots wax and wane over an 11-year cycle, but at times, for reasons we do not know, the cycle weakens or even shuts down. The last such episode, which lasted from 1645 to 1715, is known as the Maunder Minimum or the Little Ice Age.

This should not overly concern us, except that the last solar cycle had an unusually long tail, much longer than normal. The sunspot count has been near zero for a couple of years. There is some indication that the cycle is restarting, but the trend will not be clear for two or three years. Current projections for the next cycle make it the weakest in nearly a century.

Sunspots generate solar storms, sending charged particles towards the earth. These warm the atmosphere when they hit. In the absence of solar storms our atmosphere cools and contracts. If the cycle weakens over the coming years, or decades, the atmosphere will tend to cool.

Objective research on all the above, as well as other factors affecting global climate, is urgently needed. The funds spent on such research will be far less than the cost of various schemes aimed at reducing greenhouse gas accumulation, commonly known under the designation Cap and Trade.

The Cap part is a tax on carbon dioxide emissions, aimed at limiting the use of fossil fuels. Since roughly 90% of our energy comes from this source, it amounts to a tax on energy. Such a tax will be highly regressive, hitting the lower-income part of the population the hardest.

The Trade components allows energy producers to buy and sell carbon emission permits, which amounts to a new public subsidy for the financial sector, through which such transactions will be performed. In summary, the scheme will result in a transfer of wealth from the poor to the already rich.

This is objectionable to begin with, but there is another fundamental reason why the implementation of such schemes should be postponed.

As outlined above, a number of separate factors influence climate, and we know little concerning their respective impacts and their interactions. To date the climate debate has focused almost exclusively on greenhouse gas emissions, without regard to how this factor fits in the wider scheme of things. What if we implement a burdensome cap and trade program only to find out, a few years down the line, that it was unnecessary or even counterproductive?

A more prudent and effective approach would be to abandon the current growth-by-any-means paradigm in favor of a national program aimed at energy efficiency and the long-term development of a sustainable energy supply. This would reduce carbon emissions by a much larger amount the current tax-based schemes.

It would also be a boost for economic activity, domestic investment and technological innovation, all of which are urgently needed.

A Crisis Without Exit

2009-11-24T15:46:00.000-08:00

For several months now we have heard or read statements to the effect that the recession is over. There is so far very little evidence, if any, that this is indeed the case. At this point it would be useful to take stock and review what has happened to date and what the future may hold.

The recession started as a financial crisis that transferred to the real economy, in the process generating massive unemployment. As the downturn became more severe unprecedented measures were taken to stop and reverse the downward slide.

These measures were inspired by the analysis of the Great Depression. The main conclusion reached by the Federal Reserve was that in the 1930’s the government had not provided sufficient liquidity to the banking system. Had this been done, the reasoning went, financial activity would have returned to normal, providing enough credit for economic growth to resume.

The prescribed cure for the current crisis was thus to insure that abundant liquidity was provided to the banking system. This was done through the printing of money, zero interest rates coupled with deficit spending, and a variety of programs and devices that provided abundant and cheap funding to the financial sector.

The expected result of these measures was to be a rise in the availability of credit, which in turn would lead to increased borrowing, spending, investment and other business activity.

To-date this has not happened. While the financial sector is awash in money, credit to the general economy has in fact significantly contracted. Except when temporary government subsidies have been available, economic activity is still at a very low level, with no sign of a significant improvement.

The above analysis of the Great Depression might have been correct as far as the nineteen thirties went, but in applying it to current circumstances a critical point was overlooked. Whereas the 1929 economy was national, the present one is integrated within a globalized financial system.

The key characteristic of this system is that capital can freely and instantaneously circulate around the globe. Under such conditions it will naturally move to where it will generate the highest return. U.S. authorities have injected trillions into the system, on the presumption that these funds would be mainly put to work in the United States, as they would have been in the thirties.

Conditions in the U.S., however, are not favorable to high returns on capital: interest rates are near zero, the economy is depressed, and growth is sluggish at best. Assets offering far better returns, be they foreign stocks, commodities, or currencies, are to be found all over the planet. That is where the money naturally flows.

The immense funds disbursed by the U.S. government and central bank have essentially leaked out of the country, leaving the national economy struggling, unemployment at high levels and prospects poor. But that is not all. Another pernicious effect is building up.

Budget and trade deficits, liquidity enhancements and the massive creation of money depreciate the currency, while all assets offering the best returns inevitably rise in value. Because of the sheer size of the U.S. economy and monetary mass, the outward flow of money generates dollar inflation wherever it finds something to acquire.

If the U.S. economy were strictly national, the wholesale increase in liquidity would produce internal inflation. The global financial system sees to it that this inflation instead occurs wherever our dollars end up: in foreign stock markets and property values, for instance, or in the dollar price of commodities such as oil and metals.

Since the U.S. imports far more than it exports, this outside inflation will eventually be imported as well. As the dollar depreciates and imports rise in price, domestic consumption will be choked off just at the time it begins to grow again. The U.S. consumer, being and feeling poorer, will further reduce spending, and the economy will remain stalled.

The entire anti-recession effort would have been for nothing. In fact that very effort will have ensured that the recession will continue into the foreseeable future. The only tangible results will be a much higher national debt, a devalued currency, and a financial industry even more addicted to short-term speculation.

What the country needs to recover is a strong emphasis on domestic investment, which alone will create employment. This is perfectly attainable, but requires a radical departure from the current policies.

The Economic Break Point

2009-11-09T14:29:00.000-08:00

In the November 6th opinion piece in the Wall Street Journal, Kimberley A. Strassel suggests that U.S. politics have reached a tipping point: voter dissatisfaction with administration policies is now undermining Democrat party support to the point where members of congress are increasingly unwilling to vote the party line.

A similar situation is developing in the economic arena.

As the current recession started in 2007, government policy under President Bush focused on rescuing the failing financial sector. The Obama administration picked up and amplified that policy. Several trillions in taxpayer money have now been spent by the Treasury and the Federal Reserve to bail out banks and other financial entities.

The sums spent to prop up U.S. finance dwarfed those dedicated to the real economy. The main priority has been, and still is, to keep the globalized financial system from crashing and to set it back on its feet.

This policy ignored or fudged the fact that global finance had collapsed through its own imbalances and excesses. Thus restoring the status quo ante provides no guarantee of stability. On the contrary, it reinforces and extends the risk of a relapse into crisis.

The globalization of finance has been a major tenet of U.S. economic policy for three decades. Safeguards erected against a coordinated global crash, such as the Glass-Steagall Act, have gradually been removed. Controls over capital movements and exchange rates are gone as well, eliminating all restraints on world monetary flows.

At the same time, U.S. fiscal and trade deficits have vastly increased the amount of money in circulation. This floating, unanchored and anonymous mass of money moves freely around the globe, seeking the highest returns. In the process it generates massive financial bubbles, as no asset class is large enough to absorb it.

Globalized finance has generated the Asian crisis, the dot.com bust, the U.S. mortgage disaster, and the 2008 spike in commodity prices, including oil at $148 a barrel. The latest ongoing episode is the current stock market bubble, fed and amplified by massive government cash injections and ultra-low interest rates.

The economic impact of this situation is, first, a shift from productive to speculative investment, with a bloated financial sector and a shrinking real economy; second, a series of economic dislocations caused by the boom and bust cycle, with the burden falling on the majority of the working population.
With the U.S. unemployment rate now at 10.2 percent, with another 8 percent or so under-employed, the justifications for propping up the financial sector ring increasingly hollow.

The trillions of dollars disbursed by the Federal Reserve and Treasury were meant to support bank lending capacity and restore the credit available to the real economy. Instead lending has been curtailed everywhere and the economy is flat on its back while Wall Street is looking at a banner year.

The stock market has shrugged off the rising U.S. unemployment numbers, and for good reason. With a global sandbox to play in, U.S. taxpayer money, provided at zero interest, can be much more profitably invested in Hong-Kong real estate, Brazilian stocks, or oil and copper futures than in struggling American businesses.

In other words, as long as Uncle Sam keeps shoveling money at the banks, the financial sector does not need the rest of America. The government so far appears to agree.

From the political viewpoint, as Ms. Strassel points out, the administration policy has been a disappointment. From the economic angle, it depends from who profits. For the financial industry, it is a godsend. But for the general population it is a resounding failure.

It remains now to be seen how long the stock market bubble can keep inflating when there is no economy supporting it, the government is broke, the central bank is printing money and the currency is losing value.

Once it pops, and stocks go back to a justifiable valuation, there will be little left to protect the Washington-Wall Street alliance from a very angry Main Street.

The Tax Tsunami

2009-11-02T19:15:00.000-08:00

This week the Federal Reserve holds its Open Market Committee meeting, and speculation is rife about how long the current policy of ultra-cheap money will be maintained.

A realistic answer could be phrased as follows: current policy will probably be maintained for a while, but in the end it does not matter all that much.

The cheap money and stimulus exertions of the current administration have had some effect in goosing up the economy, and will probably continue to support it to some degree. How much and how long is a moot point, because whatever recovery eventually occurs will be drowned in a tsunami of taxes.

This new flood of taxation will inevitably be generated by the legislative initiatives now in the works: cap and trade legislation, national health care and unrestrained deficit spending.

Let us look at each in turn.

The cap and trade legislation is a tax on the carbon emissions resulting from the use of fossil fuels. Since fossil fuels at this time provide close to 90% of U.S. energy consumption, it is equivalent to a tax on energy. As agriculture is a major energy user, it will also translate into a tax on food.

Cap and trade, in other words, will institutionalize the food and energy price spike that occurred in 2008. As a tax it will also be highly regressive, hitting the lower income segment of the population the hardest. For both reasons it will kill consumption, which accounts seventy percent of the Gross Domestic Product, making the recession permanent.

This effect will be immediate because once the legislation becomes law both energy suppliers and energy users will have to initiate the necessary adjustments immediately, so as to be ready when the program is actually implemented. Energy prices will rise to pay for the required investments and/or financial penalties.

The same will occur once the proposed health care reform becomes law. While the system may not be implemented for several years, the taxes to support it will take effect immediately. These levies will hit businesses the hardest, in particular the small businesses which are responsible for a large percentage of employment.

Owners will reduce the number of employees to the minimum, letting workers go instead of hiring and dashing any hopes of seeing current unemployment numbers go down.

Thus the main programs now being worked on in Congress will result in new taxes specifically targeting consumption and employment. To these will then be added a miscellaneous burden of taxation needed to cover the deficits currently projected into the indefinite future. Already programmed is the expiration of the Bush tax cuts, but that will not be nearly enough. More will certainly be added, possibly some version of the Value Added Tax that has already been mentioned.

The impact of the above on the economy and individual well-being will be severe.

One might consider such a scenario overly pessimistic, but it is only a linear extrapolation of policies and programs the current administration and congress appear determined to implement.

There are two main reasons why they could fail. One is a breakdown of communications and discipline within the reigning Democrat party, a failure of will in the face of the obvious consequences of their legislative goals.

The other is a wholesale taxpayer revolt.

This is not as farfetched as it may seem. The American Revolution was in great part caused by tax abuses, and the rebellious stream it embodied still runs below the surface. The increasing recourse to referendums and popular initiatives of all kind points to a growing disconnect between politicians and voters.

The political tea parties and town hall meetings of the past summer might just be steam blowing off. They can also be a portent of much deeper discontent.

Such discontent does not need outright tyranny to become prevalent. The 18th century British government, compared to some modern states, was far from truly tyrannical. Britain already had, after all, a solid democratic tradition. Its fault was of another order.

The British lost America because the English Establishment could not countenance a challenge to its authority and to the status quo which upheld it. Our own government may suffer from a similar malady: an exaggerated belief in its own power and legitimacy, detached from the will and interests of the population. It sees itself as both self-sufficient and infallible.

The Gettysburg Address says otherwise. The American experiment still goes on, with leaders ultimately being seen as representatives of the people, not as a self-perpetuating elite.

Last Chance In Bamyan

2009-10-29T09:06:00.000-07:00

In 1979, in what promised to be an easy military operation, the Soviet army invaded Afghanistan.

Six years later, with his forces bogged down in a costly and open-ended guerilla war, Mikhail Gorbachev gave his generals a year to win, with whatever means they needed to succeed. They failed, and the Soviet government spent the following three years extricating its forces. The Afghan failure was a major factor in the collapse of the USSR.

The Soviets had been in Afghanistan for seven years when they gave up and decided to withdraw. By now the US has been there almost a year more.

There is no intention here to establish a moral equivalence between the US and Soviet campaigns. The Red Army was brutal and ruthless, killing up to 15 percent of the Afghan population, and driving half of the remainder out of the country.

By contrast, the US went into Afghanistan to get the man who had gratuitously murdered nearly three thousands American citizens. The Afghans fought on our side against the hated Taliban. We were welcome.

Yet, from the military point of view, we have done no better than the Soviets. After nearly eight years we face a growing insurgency that is established in nearly half of the country, and reaching into the other half. We need to understand why.

Clausewitz defined war as the pursuit of policy by other means.

The means here are our military forces. They are professional, well trained, extremely well armed, and they have fought honorably and well. They cannot be blamed.

If the fault is not with the means, then the policy must be wrong. We started out with all the advantages on our side and won a quick victory. It was downhill from there. Why?

Let us go back to the Afghans for a while. They are not a nation, but a confederation of ethnic and tribal groups. They are poor. They practice various forms of Islam, which in the West are mostly considered retrograde.

Nevertheless they are a proud people and they can fight. In the 19th century they took on the British Empire and kept it out of Afghanistan. They fought the Soviets and chased then out. They fought with us against the Taliban and won. Then we somehow lost them, and now the Taliban is back.

The reason is very simple: by our own choice, we changed from liberators to occupiers. Instead of giving Afghanistan back to its people we decided to keep and remold it to our own liking.

In a country that begs for a federal system, we set up an artificial central government with no popular support or power base. We disbanded the militias that fought for us and removed their leaders from power, and then proceeded to create our own Afghan army from scratch. We ran the place and still run it as if it belonged to us.

In other words, we left very little to the Afghans that they could call their own. We gave them freedom and democracy, but on our terms, not theirs. They don’t own it, and people will not fight to keep what they do not own.

We do, however, have one opportunity, which may well be our last chance.
The local government we so laboriously created and propped up has disqualified itself by rigging an election. This gives us a brief window to change tack, rework our policies and possibly start again.

There are still places in Afghanistan that the Taliban has not penetrated, like Bamyan province. This is where we should focus first and foremost; provide whatever economic aid is needed; arm, train and support the locals, so they can defend what they have; promote local leaders and let them run their show. All in all, we must show that we will promote Afghan interests as they see them, rather than according to our own concepts.

Whenever this approach has been tried, as in Khost province for a while, it worked. If we applied it across the board, we could start pulling out our troops within a year or two.

It will require us to admit our mistakes and give up some cherished, if questionable, myths. But that is a small price to pay for a real victory.

If There Is No Bread, Let Them Eat Cake

2009-10-19T15:50:00.000-07:00

Nearly everyone has heard or read that famous quote, generally attributed to Queen Marie-Antoinette of France.

True or false, the quote is so pithy that it has survived both controversy and the passage of time. By now it has become the most common expression of the indifference of rulers to the plight of their subjects or citizens.

It might well be given new life in our current circumstances.

Our economic situation is not unlike that of late eighteenth century France. For a generation or so the income gap between the elites and the bulk of the population has been widening. Government debt is heading for an all-time high and budgets are out of control. Trust in government competence is falling and its ability to face growing challenges is in question.

In addition there is a developing dichotomy in economic perception: for the political and economic elites the present economic crisis has been taken care of, while for the mass of the population it only appears to be getting worse.
Are we, like Marie-Antoinette’s France, headed for an upheaval? We asked that question on this blog (“The Coming Political Collapse”) http://www.viableenergynow.com/site/?p=64 nearly four months ago, but on much more limited grounds.

At the time we simply put in doubt the government’s ability to manage massive new programs such as cap-and-trade and national health care.

Now, in addition to the above, one can question not only the state’s administrative abilities, but its understanding of, and dedication to, the interests and welfare of the population.

The strongest reasons for such doubts are provided by the government efforts to stabilize the financial sector. This is the very sector which first bankrupted itself through speculation on mortgages and other assets, and then proceeded to hobble the rest of the economy through speculation in commodities, including fuel and food.

Both the last and current administrations have rewarded these gigantic failures with multiple bailout programs and trillions in interest-free money, all funded by the taxpayer. In return the taxpayer got a few months of extended unemployment insurance.
If the economy is truly on the mend as advertised such use of public funds might be tolerated. If on the contrary it is not, there will be an increasingly negative perception of the government’s role, with much anger and resentment thrown in.

In the past, free market countries have appeased public anger by taking a page out of the socialist definition of the provident state: social safety nets, public health programs, public works, and subsidies of all kinds.

This was effective in a society that was mainly capitalist. But socialist mission creep ultimately leads to stifling inefficiency. We have now reached the point where the cost of additional statist programs outweighs their benefits, and where further increases of the deficit threaten to collapse the entire structure.

This situation raises the possibility of a deadlocked, us-versus-them stand-off with potentially uncontrollable outcomes. To avoid this we must channel our energy into constructive rather than adversarial channels, and establish grounds for cooperation rather than antagonism.

Fortunately there is ample opportunity for this.

In our book, Viable Energy Now http://www.viableenergynow.com we have designated energy supply as the key challenge of this century. This challenge does and will demand governmental action. But we do not need to wait for this to happen. The field of energy supply is so vast that immediate action is possible in many sectors and at every level.

Energy efficiency can be improved by individual and small-group action, be it conservation, information, communal food production or the purchase of efficient hardware. Collective understanding and organization vastly increases the impact of such initiatives. Each individual has only one vote and limited material means, but an organized group of individuals equals a market as well as a voting bloc.

Markets motivate corporations, and voting blocs move politicians. Corporations have technical talent as well as financial means. Politicians are open to demands from their base.

However, under current circumstances, both politicians and the heads of corporations are still followers rather than leaders. Action must begin at the grass roots. This is not unlike what happened at other key periods of American history such as the Revolutionary and Pre-Civil War times.

In the end it will be up to all of us.

Stimulus Programs - The Good, the Bad and the Ugly

2009-10-01T16:47:00.000-07:00

Keynesian economic theory states that, in case of recession, the government must jack up spending to compensate for the weakness of the economy. Under that assumption, any and all government spending makes a positive contribution and constitutes an economic “stimulus”.

In fact, such interventions fall into several categories, each of which has different effects.

Before doing any analysis, however, it is necessary to state that government operations do not create wealth.

Every dollar the government injects into the economy is taken out of the economy through taxation or borrowing. External government spending equals taxation minus the cost of government operations, so that the economic multiplier is always less than one. And since the cost of operations rises with size, the multiplier shrinks as the government gets bigger.

While government spending as a whole costs the economy more than it contributes, some government programs can have positive effects, particularly if certain intangibles, such as social or environmental benefits, are taken into account. The positive effect is the highest for activities which take advantage of the government’s specific strengths.

The main advantage the state has over the private sector is the ability to pursue long-term strategic objectives without the need to obtain results within a short time frame, as is the case with private profits. Therefore investment by the government will be most useful when it fits within the framework of a long-term strategy.

Thus the first and most potentially profitable area for state investment will be scientific research, particularly when it involves time frames which the private sector cannot afford. Such funding of research will be most effective within a clearly defined policy framework. Current sectors where such intervention would be very beneficial would be energy supply, resource substitution, environmental science and climate change.

The next area where government spending can be beneficial involves infrastructure projects which due to size, cost and duration are not affordable for the private sector. The Tennessee Valley Authority provides a good example of such work. The advantage here is not only the financial strength of the state, but also the ability to provide social and environmental benefits which are essential but cannot be provided at a profit.

Spending relating to the above two categories can and often will have a positive impact, the impact becomes negative for the following two categories.

The first negative spending area includes subsidies. These are counterproductive, not only because they skew the operation of the private sector towards inefficiency, but also for their effect on technical progress. A subsidized technology will not evolve because it favors a safe status quo over the riskier process of discovery and development.

The last and most wasteful category of government spending covers straight cash transfers. Their effects are always negative because of the principle formulated above: cash given to Peter must first be taken from Paul, with the state first taking its cut. In addition, the flow will inevitably be from the more productive sectors of the economy, which generate more tax revenue, towards the less productive ones.

In addition, cash transfers are an inevitable and self-sustaining source of political corruption.

It is true that the state is at times obligated to provide cash as part of a safety net, aimed at mitigating the effects of economic upheaval or natural disaster. The defining criteria of a safety net operation are specificity and limited duration. A safety net operation indefinitely extended in time inevitably becomes a cash transfer program. Before this happens it must be replaced with a more productive form of state spending.

Even a cursory analysis under the above criteria shows that the current stimulus programs, including the enormously expensive rescue of the financial system, fall mostly in the two lower categories, rather than in the more productive ones. Their economic impact will therefore be mostly negative, prolonging the current downturn and preventing a true recovery.

The Return of Inflation

2009-09-10T16:53:00.000-07:00

OPEC has just concluded its latest ministerial meeting, having decided to keep production quotas as they are.

The oil cartel must be commended for their able management of the market. 2008 saw an extraordinary price spike which contributed significantly to the global recession. It was followed in short order by a price collapse threatening to bankrupt some of the oil producers. OPEC successfully weathered both, bringing oil prices back within a range tolerable for both oil sellers and users.

But the road ahead remains tricky. The global recovery is so tentative that even a small drop in supply could strangle it, while an increase could result in a new price collapse. OPEC members are fully aware of the immense liquidity pool created by central banks, with mountains of cash ready to flow into speculation on oil futures.

With such potential even a small tightening of supply can cause another massive spike, possibly higher than last year.

And this brings us back to inflation.

According to the U.S. Federal Reserve, inflation will not be an issue for a year or two, despite the huge recent increase in money supply. The recession has created so much spare manufacturing capacity that the price of goods cannot rise. In parallel, high unemployment will prevent labor costs from increasing.

There are, however, two ways to look at inflation.

One is to see it as a rise in the cost of goods and services. The gage preferred by central bankers to measure it is the so-called core inflation, which measures the price of a basket of such items, but excludes food and energy, considered too volatile.

The low expectation for future inflation is based on this definition.

The other way to understand inflation, however, is as a reduction in the value of money and, consequently, of purchasing power. This is the definition the average consumer lives by. This person is not particularly interested in core inflation, which deals with price changes in the longer term. But he or she is highly sensitive to the cost of food and energy.

In a nutshell, the prices which really impact the consumer, and particularly the U.S. consumer, are those of gasoline, beef, milk and eggs. They do so all the more if they become volatile. Prices of other items are less important because their purchase can always be delayed.

The volatility of food and fuel prices will not go away, because the gap between global supply and demand of both oil and foodstuffs has been steadily narrowing, and will close even faster if a true economic recovery occurs.

At that point the global liquidity so freely pumped up by governments will flow into commodities and almost instantly amplify any price increases caused by demand. We will then have 2008 all over again: the cost of essential items rises disproportionately, the consumer takes a major hit and retrenches, and the economic recovery goes into reverse.

After a few such episodes, the consumer will hunker down for good and deflation will set in.

In other words, there is a strong likelihood that the current policies will cause a series of narrowly focused inflationary spikes leading in the end to a deflationary situation. Because of the cognitive disconnect between the monetary authorities and the average citizen, the measures designed to fight deflation will instead result in entrenching it.

The problem lies with the almost exclusive focus of the central bankers on the financial system. In theory, the purpose of this system is to steer available funds towards productive investment opportunities. But the system has become so large and convoluted that its internal activities now trump investment in the real economy.

Speculation in oil futures is much more profitable than investment in a new oil field or refinery. The fewer refineries are built, and the fewer oil fields are developed, the more profitable speculation becomes, as it thrives on demand-supply imbalances.

If central bankers want to avoid a long and painful deflationary period, they need to understand that shoveling money into the financial system is only an initial step. What is critical is to push the money through the financial system and into productive uses.

Printing money is easy. Investing it well is the difficult part, but also the one that powers the economy.

The Bush-Obama Continuum

2009-09-09T15:09:00.000-07:00

Much is made, in the U.S. right-wing media, of the alleged socialist tendencies of the current administration. According to this view Barack Obama is an avowed Marxist hell-bent on turning the Republic into a European-style socialist state.

The current occupant of the White House certainly has some leftist leanings, as do many members of the Democratic Party. But it might be more accurate to see his agenda less as a pursuit of socialism than as an extension of policies already initiated under his predecessor.

Let us review these policies, starting with foreign affairs.

As far as the Bush-initiated military conflicts are concerned, little has changed. The withdrawal from Iraq has not been accelerated and proceeds as the previous administration left it. A repeat of the Bush surge policy is being attempted in Afghanistan. Operations in Pakistan and Somalia are being pursued along previous lines.

China remains the predominant partner, with the Sino-American relationship now being extended beyond the economic realm to the strategic one. North Korea is allowed to fester so long as Beijing allows it, while Russia is being treated as a quasi-pariah, just as before.

The Bush policy of globalization remains in force. The remedy to the economic meltdown is, as previously, seen in government spending and various bail-outs rather than in investment in job-producing activity.

The primary emphasis remains on the financial sector, seen as the foundation and heart of economic activity, as opposed to the real economy. The provision of liquidity to the financial industry, at enormous cost to the taxpayer, remains the primary priority. At the same time domestic investment, which provides employment and income to the taxpayer, remains neglected.

It can certainly be argued that long-established policies cannot be changed within the space of a few months, or even a year. But the continuity between the two administrations reaches further then the above.

In domestic politics the main priority common to both is the continued increase and reach of the power of the executive branch.

Under the previous administration the doctrine of the unitary state was used to enlarge executive power in all areas relating to national security. In parallel the independence of the executive from legislative control was fostered by the generalized use of signing statements, through which the president took exception from many provisions of the bills he signed.

While the previous president used the War on Terror as the justification for increasing executive reach, the current one has relied primary on the economic crisis.

The financial meltdown has not only allowed to extract huge budget increases from a willing congress, but to extend executive reach into many sectors of the national economy. This extension has been accompanied by the creation of various offices and functions, collectively referred to under the term tsar, under exclusive White House supervision.

These offices, and the individuals who occupy them, are outside the regular cabinet structure as well as outside congressional supervision.

The development of such an extra-constitutional governing structure, erected hastily under the cover of economic urgency, potentially leads to the creation of a parallel government hierarchy, free from constitutional checks and balances, and loyal only to the chief executive and his immediate circle.

Such a parallel hierarchy would be similar to the one erected in the Soviet Union by the Communist Party, with cells supervising government departments at all levels. The Communist Party, of course, was loyal only to the Party General Secretary, the de facto sole ruler of the USSR.

A development along similar lines in the U.S. does not necessarily signify the rising of a Marxist conspiracy, as some commentators have suggested. But it does signal a drift away from the principle of separation of powers supported by constitutional checks and balances. As such, it raises two red flags.

First we need to remember that the increased reach of the central government will further lower its efficiency. A bigger government with more extensive powers will not give us a better economy or a more efficient administration, but drifts instead towards the discredited Soviet model, which collapsed not because it was Communist, but because it was massively inefficient.

The second and more important point is that the U.S. constitution is not a quaint, antiquated document. It is one of the towering achievements of human political thought. This nation has been, through the kindness of fate and the wisdom and heroism of its early citizens, been blessed with this extraordinary code of political conduct. It behooves us not to discard it lightly for the sake of ill-guided expediency.

Economy on Track for the Next Bust

2009-09-08T08:52:00.000-07:00

The central bank heads in Jackson Hole, Wyoming, appeared reasonably satisfied with themselves. The common policy of flooding the financial markets with money was assumed to have prevented a major economic depression, and the global economy to be bottoming out. The chief proponent of this policy, Mr. Bernanke of the U.S. Federal Reserve, set the tone with an optimistic assessment.

Stock markets and commodity prices have shot upwards since March. Fundamentals, however, are still bad if not awful. Unemployment continues to rise; whole industries, such as housing, automotive and shipping, are at depression levels; foreclosures are setting records, and the consumer is pulling back. The stock market rise of 50 percent is way ahead of a real economy still bumping along the bottom.

Such discrepancies raise a key question: are the positive news inconsequential ripples in a still deepening crisis, or a sign of basic improvement?

The answer depends on the explanation given for the crisis. The conventional wisdom assumes that financial markets were struck by a crisis of confidence leading to a liquidity freeze. A flood of cheap money provided by governments has addressed the issue, and we are back on track to renewed economic growth.

We prefer another explanation, under which the cause is not a lack of liquidity, but a growing excess of it.

A vast and growing pool of loose money has been created worldwide, in particular by large and continuous U.S. trade and budget deficits.

At the same time investment opportunities have been restricted through the migration of entire industries to countries such as China, which severely limit foreign corporate ownership. Share buy-backs and private equity takeovers in the West further shrank the pool of available assets.

The result is a growing unbalance between supply and demand: too much money chasing too few opportunities, leading to asset inflation, rampant speculation and an intensifying boom and bust cycle.

The first warning bell was the Asian crisis of 1997, caused by over-investment followed by catastrophic capital flight. The second bust was the Wall Street dot.com bubble in 2001.

The third was the 2002-2006 U.S. housing boom in which the value of U.S. real estate was wildly inflated. In addition a whole class of assets of dubious value was created to soak up the flood of money seeking returns. These assets were the true cause of the financial crisis.

The fourth boom was in commodity futures, leading to the 2008 spike in oil and grain prices. Fuel and food prices followed, chilling U.S. consumption and transferring the financial bust to the real economy.

Each boom came right on the heels of the preceding one, fed by the ever growing pool of global liquidity.

Under this scenario the current central bank and government policy of flooding the financial system with money actually aggravates the fundamental supply and demand imbalance and leads to an intensification of the cycle. Whatever temporary recovery it may create will be followed in short order by a larger bust.

This is already apparent in stock markets around the world. There is no way that a depressed real economy can absorb the funds shoveled out by central banks and governments. Very little of it reaches the general population. Most of it is already finding its way into stocks, commodity speculation and real estate.

In the meantime massive government intervention has impaired market mechanisms and productive investment. In the current climate financial speculation is far more profitable.

In essence the prevailing policies are turning instability from a cyclical to a permanent condition, with any number of possible events capable of precipitating a new crash.

When and where such a crash would occur is difficult to predict, but we expect it to be soon, most likely this year. We also think it likely that it will be triggered by events in China, where government intervention to stimulate the economy has been most intense.

Stimulus spending and government-ordained credit expansion amount to roughly 40 percent of Chinese GDP. There is no way such sums can all be turned into productive investments, and speculative bubbles have already formed in the stock market and in real estate.

Remedial action by the government is limited by the need to present a positive façade during the 60th anniversary celebrations of the Peoples Republic of China.

Beyond that loom the factional struggles leading to the next leadership change.
A similar situation exists in the U.S., with the 2010 congressional election looming on the horizon. The Beijing-Washington axis is in for a bumpy ride, and until effective policies are implemented it will only get bumpier.

The Recession Is Not Over, Only Delayed A Bit

2009-08-18T09:05:00.000-07:00

The prevailing news from the stock market, and from growing chorus of economists and forecasters, is that the current recession is, for all practical purposes, a thing of the past. A few annoyances, such as high unemployment and massive indebtedness, still remain, but these should take care of themselves as soon as economic growth resumes later this year.

These assertions a worth examining.

The general consensus is that the crisis was caused by an excess of liquidity, provided by the US Federal Reserve. This led to an over-expansion of credit and a bubble in US housing, with the attendant creation of complex mortgage-based securities, which investors and banks eagerly acquired.

When the bubble popped, the securities lost their market value, making many banks holding them technically insolvent. Interbank lending stopped and the financial system went into collapse.

Almost simultaneously, rampant speculation in oil prices, within this same financial system, drove the price of gasoline through the roof. This extended what was at first a financial sector problem into a crisis of the real economy.

Up to then nothing had kept U.S. consumers from spending money they did not have. But gas at four dollars a gallon did. The consumer clamped down, sending the economy into a tail spin. Gross Domestic Product tanked and unemployment shot up. Consumer spending, which is the main driver of the U.S. economy, remains in the pits.
So how come the recession has been declared over?

It is because it is over, at least temporarily, on Wall Street.
The response of the U.S. government to the crisis has been to rescue the financial system from its mistakes with massive injections of taxpayer money, and some smoke and mirrors thrown in.

First the toxic asset problem was dealt with by changing accounting rules. Such assets no longer have to be priced at their market worth, but at whatever their holders declare the value to be. This immediately improved major bank balance sheets.

Second, the Federal Reserve has been providing banks with unlimited amounts of money at a zero interest rate, leading to easy and substantial profits. The Fed also provides a number of additional guarantees, and has promised to keep this up for a long time, so confidence is back and the stock market has rallied.
Recession over!

There is only one hitch. All of the above is strictly financial. There has been no investment whatever, other than a few corporate bail-outs, in the real economy. Jane and Joe are still scrambling to pay their mortgage and other bills while looking for a job.

Wall Street got trillions in tax money. The rest of the country got an extension in unemployment insurance.

In the end, it does not matter who gets the money, as long as it is well spent. But it is doubtful this is the case.

The current policy of excessive liquidity only repeats what was done earlier in this decade to fix the previous recession: drown the financial system in cheap cash. But this time it is done with much greater intensity and on a coordinated global scale. In all likelihood the end result will be a crisis even more severe than even the present one.

A wholesale change of priorities is urgently needed. Without it the U.S. financial sector is in danger of becoming the modern American equivalent of the 18th century French court at Versailles: an expensive tax-funded playpen for a small, wealthy and influential minority, whose activities are less and less relevant to the country at large.

The Versailles courtiers thought themselves to be indispensable. History showed they were not. In the same vein it is probable that the U.S. financial sector, in its current form, is far less critical to the economy than it is made out to be.

Unless reform is undertaken quickly and on an all-encompassing scale, we might find this to be true in the not too distant future. Let us hope we do not find out the hard way.

The Crumbling Sino-American Axis

2009-08-18T09:03:00.000-07:00

The July meeting of the U.S.-China Strategic Economic Partnership ended with the usual polite speeches and pledges of continuing cooperation. This disguised but did not entirely covered the fact that the partnership is headed for collapse.
The immediate cause is that the respective policies of both partners are mutually incompatible.

The Americans are determined to go on printing and spending money by the boatload while the Chinese are adamant about preserving the value of their huge trove of dollar-denominated assets. There is not one square inch of common ground. As a result both parties are remaining very civil while simultaneously playing chicken as to who can intimidate the other.

There is a remote possibility that the global recession will end quickly and the old status quo restored to general satisfaction. But current reality points to massive U.S. deficits stretching far into the future and leading inexorably to the dollar depreciation the Chinese adamantly oppose.

But even the most optimistic economic scenario will at best gain only a short respite. Beyond the immediate issue of dollar value lurks the fact that key economic policies on both sides are nearing the end of their useful life.
Let us look at China first. The fiction here is that a thriving economy can be built without enriching the great mass of the population.

Aware of the collapse of the Soviet Union under the weight of its economic inefficiency, the Chinese government has created a semi-capitalist sector within its own command economy. But this sector is based on the export model, which requires other states to pay for China’s development while simultaneously creating massive financial imbalances.

Worse, it requires China to keep the bulk of its population poor in order to maintain its labor cost advantage. While some wealth has trickled down to the bottom, social and economic inequality has risen much faster. This is the very formula that has led to massive revolts and government collapses throughout Chinese history. China is not stable and getting less so.

The U.S., for its part, has bet that manufacturing and industrial activity can be replaced by finance. To that effect it has allowed its financial system to grow far beyond its original role as intermediary between providers and users of capital.

This policy has over the last decades made the U.S. financial system a world and an industry unto itself, with operations only tenuously connected to the real economy. Because of the potential of high profits resulting from speculative operations much of the investment capital needed by the real economy is siphoned into the purely financial sector.

Speculative financial operations produce both huge profits and enormous losses, making an autonomous financial industry inherently unstable. The U.S. government has chosen to ignore this fact during the current crisis, bailing the financial sector out at enormous expense, borne by taxpayers.

This by itself guarantees that the hoped for economic recovery will be deprived of the funding needed to generate economic activity and increased employment. It is thus likely that the vast and expensive rescue effort undertaken by the government will achieve little or nothing, with a severe political backlash leading to major policy changes.

If current policies on both sides are maintained, the probable outcome for the U.S.-China axis is that both partners will become increasingly dysfunctional, gradually rendering the axis irrelevant. And if the fundamental policies are changed the symbiotic relationship between the United States and China will fade, and with that the Sino-American axis will dissolve into thin air.

In either case the much hyped relationship between the two powers and their economies has little or no future. History will most likely judge that it was a bad idea from the start.

China Creates Its Own Credit Bubble

2009-07-01T11:32:00.000-07:00

Economic commentators have often praised Chinese banks for the prudent lending policies that protected China from the excesses of the Western financial system.
That was then. Now is very different.

The recession that simultaneously hit Japan, Europe and the United States strongly reduced demand for Chinese exports, which account for a third of the national Gross Domestic Product. With unemployment rising and social unrest always close to the surface, the government needed to react quickly.

Simply raising consumption would not be enough. First, internal consumption in China, in terms of percentage of GNP, is less than half of the U.S. figure. Second, only a small fraction of the Chinese population can consume on the Western scale, and this is not enough to absorb the mountain of goods America and Europe no longer buy.

Only infrastructure investment, meaning housing, railways, airports, roads and the like, would permit spending on the scale required to compensate for the fall in exports.

China has in recent years made huge strides in infrastructure development, but it is still a command economy, meaning that major projects are funded and implemented according to a central plan. Running a massive spending package through the normal state planning process would have taken far too long.

So the banking system was chosen as the fast-track channel. Banks were told to lend, lend, lend, and lend some more. Convinced that the government would cover losses, the banks did just that, handing out close to a trillion dollars in new loans in the first six months of 2009.

That is over one fifth of the GNP within half a year. The money has gone to individuals, corporations, state-owned enterprises, real estate developers, and local and provincial governments.

Even with the greatest good will and talent, it would be hard to invest that much money in bona fide projects. Much of it has gone back into bank deposits, which pay interest rates higher than those due on loans. Another portion feeds into the stock market, which has risen over sixty percent since the lending spree began.

In other words, much of the money is either diverted or used in speculation. Even if it is actually invested in infrastructure, it is impossible to guarantee the long-term viability of the projects. And the longer the money spigots stay open, the less the value of such projects is likely to become, and the greater will be the share of total spending diverted to speculative activities.

With some differences due to local circumstances, the Chinese government is thus creating the same kind of speculative bubble as developed in the U.S. between 2002 and 2007, with the same consequences. The primary difference is that the Chinese bubble is inflating much faster than ours did.

The result, however, is likely to be the similar: a financial free-for-all for a year or so, followed by a wave of defaults, a stock market crash and an abrupt economic downturn, with the Chinese population left holding the bag.

The hope of the leadership may be that before such a crash occurs, Western economies will have recovered enough to start the Chinese export sector growing again. This would be a neat trick but is becoming less likely with each passing month. The Western consumer is tapped out and will not resume past free-spending ways for a long time, if ever.

The eventual bursting of the Chinese credit bubble will have a significant impact on the global economy. It will prolong the current recession, lower the price of energy and raw materials, and further shake up the world financial system. It shall also to quash any remaining notion that economic globalization was ever anything more than a very expensive mistake.

The psychological impact will be just as important. China is currently looked upon as the motor and hope of global recovery. If China succumbs to an acute case of the Western credit disease that it was supposedly immune to, current economic thinking will be left without any support.

Finally, the crisis in China will leave the United States without its preferred political and commercial partner of the last twenty years, and force a complete realignment of its trade and foreign policy.

China's New Threat to the Dollar

2009-06-10T08:17:00.000-07:00

Current Chinese and American monetary policies are diametrically opposed.

China has based its growth and rise to economic prominence on an export-led economic model, with the United States as a primary destination for Chinese-made goods. The result of this policy is a two trillion dollar foreign exchange reserve, of which roughly 60% is denominated in dollars.

The US, on the other hand, has chosen a policy of monetary easing in to fight the current recession. It is running huge budget deficits, part of which is financed through money creation by the Federal Reserve. Such a vast increase in money supply can only lead to a devaluation of the dollar, which reduces the value of Chinese reserves.

The Chinese cannot allow thirty years’ worth of currency accumulation to evaporate as a result of inflationary US policy. They have sent US authorities repeated messages to that effect, including: top-level statements of concern; massive purchases of strategic metals; announcing their gold reserves are twice the size previously thought; reducing purchases of longer-term Treasury bonds.

The most recent Chinese move has been to start negotiations with Brazil to cut the dollar out of their mutual trade relations, which would rely on national currencies instead.

In response US Treasury Secretary Tim Geithner traveled to Beijing in late May to reassure the Chinese concerning US policies. Perfunctory statements of agreement were exchanged as he left China. But on the day after Mr. Geithner’s departure, China announced negotiations with Malaysia similar to those with Brazil: no more dollar-denominated trade there either.

In other words, the visit by Mr. Geithner solved nothing. However, it goes way beyond that. The announcement is not just another message to the United States. It can well be the start of a new monetary strategy.

The type of economic transaction under negotiation with Brazil and Malaysia is essentially a barter deal based on the relative values of the two national currencies involved. As China has a large economy involving many buyers and suppliers, such a type of transaction can be expanded to any number of its trading partners, thereby creating a fairly large dollar-free economic zone.

This would in the short term reduce the importance of the dollar as the dominant world currency. The ultimate effect would be much more far-reaching.

The global primacy of the dollar is to a great extent based on the assumption that there is no available substitute for it. The above strategy of dollar-free transactions, which is quite workable, undermines this assumption by showing that in many cases such a substitute is not needed. All that is required is agreement on the relative value of two national currencies.

Furthermore, if demonstrated successfully between, for example, China and Brazil, such a bilateral commercial strategy could be applied to transactions between countries other than China. Russia and Germany, for example, could in the same manner exchange energy products for engineering goods and services.

Finally, this approach to trade would gradually extinguish the dollar’s key role in pricing commodities, such as oil, sugar, copper or grains. These commodities would de facto come to be priced in terms of a basket of currencies, based on the actual volume of transactions in the various national units of account.

The dollar would then be then reduced to being the national currency of the United States, with significant consequences for this country and for the rest of the world. The US, no longer able to rely on the dollar’s global role, would like any other country be fully responsible for the value of its own currency.

The Chinese initiative is therefore no idle threat. Whether the Chinese government will implement this new strategy across the board or even on a large scale is unknown. Very possibly they have no definite plan at this point. But a whole realm of possibilities has been opened.

What is certain is that the US government must now face the fact that its policies, so far dictated strictly by domestic concerns, may in the very near future have a major and lasting impact on the status of its currency.

Global Warming Update

2009-06-03T10:36:00.000-07:00

In the general public discourse the climate change debate has been, so far, confined almost entirely to the greenhouse gas issue. Our economy’s carbon footprint utterly dominates all climate change discussions.

In actual fact there are several major influences acting on the global climate in terms of raising or lowering atmospheric temperatures.

The warming induced by greenhouse gases, such as carbon dioxide and methane, is the first such influence. However, while the physics of the greenhouse effect are clear, the chain of causality between greenhouse gas accumulation in the atmosphere and specific weather patterns is not fully understood. At this time the actual consequences of such accumulation cannot be accurately predicted in terms of timing and impact.

The second influence comes from periodic variations in the earth’s orbit around the sun and in the inclination of its axis. These cyclical variations have been relatively well correlated with past ice ages and warmer inter-glacial periods. According to some recent published research in this area our planet would currently be sliding into another cold period or ice age, although the timing is hard to pin down.

The third influence, which has come into prominence only recently, is solar activity as manifested through the sunspot cycle. For the earth, a high sunspot count means warming, a low count cooling. Although the basic cycle has an average periodicity of eleven years, there are also long term variations which are not well understood. Sunspot activity has just reached a low which may or may not be significant. But if this low persists, significant cooling can be expected.

One can conclude that the overall picture is becoming increasingly ambiguous. Greenhouse gas accumulation due to the use of fossil fuels is no longer the only story in town, nor is warming the most likely future outcome.

The purpose here is not to claim that greenhouse gas accumulation is not significant. It is to warn that other influences are in play which can be equally important, and that our scientific understanding must be increased before major economic measures, such as a tax on carbon emissions, are implemented.

One such measure, a so-called “cap and trade” scheme, is currently under discussion in the US Congress. Such a scheme has considerable drawbacks.

First, it amounts to a highly regressive tax on energy, which will disproportionally affect the lower income fractions of the population. Second, it introduces huge market distortions which vastly complicate efforts to deal with the gradually increasing price and reduced availability of petroleum.

To be successful, such efforts require first and foremost a realistic and workable long-term energy strategy, the elaboration of which must precede any large-scale government intervention in the energy area. The US government at this time does not have such a strategy, which, as far as its impact on climate is concerned, must rest on a much better scientific understanding of the various influences on climate listed above.

Funding to increase and test this understanding will have a far greater impact than any of the currently proposed schemes to reduce carbon emissions. Until such understanding is on more solid footing, there is no valid justification for major initiatives in economic policy on climate change grounds.

Are the Wars on Terror Winnable

2009-06-03T10:31:00.000-07:00

Any serious analysis of the status of the the so-called war on terror brings up an apparent contradiction.

On the one hand, any opinion survey in the affected areas clearly shows that terrorist entities or radical groups allied with them, such as Al Qaeda and the Taliban, are deeply unpopular. On the other is the fact that despite a major outlay of resources and the superiority of US forces, the various conflicts drag on and the final outcome is far from certain.

US troops are not to blame. Aside from a few isolated cases they have performed with dignity, honor and professionalism. They also have undeniable superiority in firepower and organization.

Also to be set aside is the argument that the enemy benefits from the support of rogue states such as Iran. Such support, when it exists, is very limited in comparison to the huge US effort. In addition Iran or other states might provide some weapons and training, but not the rank-and-file fighters willing to face US firepower.

The vast majority of these fighters are not members of terrorist organizations, which by necessity are always small and secretive. Nevertheless they fight alongside them, thereby providing true terrorists support, cover, and the opportunity to recruit members and raise funds.

True terrorist numbers are too small to account for anything except focused, showcase operations. If they could be isolated from the much larger numbers of combatants who do not share their goals or tactics, their elimination could be achieved with a relatively low expenditure of resources. This separation between true terrorists and the much larger numbers of those who could simply be called insurgents is therefore the key to winning the various conflicts we are currently involved in.

What are these insurgents then fighting for? There are two answers to this question, and both involve basic US policies.

The first fundamental issue is that no population easily accepts foreign occupation. The standard US policy within the war on terror has been the invasion and occupation of suspect territory by large conventional forces. This is then followed by some form of what we call nation-building, or the restructuring of the subject society according to a model we define. Such an approach will inevitably provoke resistance, supported by appeals to defend traditional culture and values.

The second issue is the US preference for unitary government, ignoring the fact that many of the countries subject to the war on terror are not nations, but fairly artificial states comprising a variety of ethnic, religious and cultural entities. Such entities have legitimate grievances and needs which generally cannot be met within a centralized government structure, however democratic it is in theory.

Neglect of legitimate aspirations for cultural and political autonomy breeds discontent, which is compounded by the humiliation and collateral damage brought by occupation. This creates a fertile ground for insurgencies of various kinds, within which genuine terrorists can pose a sympathizers and allies.

Such insurgencies can be kept down by brute force, but they will continue to smolder underground, ready to explode as soon as force is removed. Their resolution requires a basic reassessment of our policies along the following lines:

We must recognize that it is counter-productive for the US to attempt to shape foreign states and cultures according to our own concepts, particularly is this is accomplished through military force.

The United States government must recognize and support the principle of self-determination for ethnic, religious and cultural communities.

The recommended policies would not only be in accord with the values on which our own nation is built, but it will provide with far more leverage than the strategies we currently use.

The Green Shoots Illusion

2009-06-03T10:29:00.000-07:00

There appear to be two camps forming among financial and economic commentators. The more numerous faction, which also includes most stock market players, the Federal Reserve and the Administration, flies the “green shoots” flag. Its prevailing opinion is that thanks to timely government action “another Great Depression” has been avoided, the national and global economies are now reaching bottom and renewed growth is not far away. Hopes and analyses along these lines have fueled the world stock market rally which began in early March.

The other and smaller group is more cautious and less optimistic. To them the “green shoots” are wiggles in the charts and the basic economic numbers do not support the above conclusions. In fact, the data still points downward and the bottom is not in sight, much less any kind of recovery.

The bullish party rests its analysis on the effectiveness of government intervention, which would have prevented total disaster and is now “turning the economy around”. To test this assumption it is worthwhile to reflect on the nature and purpose of government intervention in the economy.

For the sake of clarity one can fit such interventions in either of two categories. One is a process of nationalization of the whole or of certain parts of the economy. Such action is based on the assumption that the government will do a better job of running the economy, or selected parts of it, than the private sector . This is the fundamental assumption of socialism.

The other category of state intervention is regulation, through which the government acts to correct private sector excesses, but without assuming either full control or ownership.

What we have seen in the United States since 2007 fits neither category, but falls right between them.

First, no nationalization has been implemented. Now, whatever can be said about the benefits and shortcomings of socialism, it is a coherent economic philosophy that has been extensively tried, and in certain cases has achieved the goals set for it. It is therefore a valid model for certain purposes, but it is not being applied here.
Modification of economic parameters and activities through regulation has also been largely absent.

In fact government intervention in the last two years, although massive, has been primarily aimed at the maintenance and restoration of the status quo ante: getting the “financial system to function again”, “saving the banks too big to fail”, “restoring the auto industry”, returning to growth, and so on. Vast sums of money have been expended or pledged, but no activities have been forbidden or outlawed, no management purges have taken place, and no new economic strategy formulated. What has happened is not so much an overhaul of the economy, but a sudden and vast expansion of government into the financial and economic spheres, proceeding mostly on an ad hoc basis.

Because such intervention, while not being a shift to true socialism, nevertheless has a considerable distorting effect on market mechanisms, it is right to ask whether it will ever actually “fix” the economy. It is quite possible that it has, in fact, achieved the opposite effect. On the one hand the market has been shackled and is no longer free to work its way and purge the economy of accumulated dross.

On the other hand the government is far from having the level of control needed to implement a coherent economic strategy. The two influences basically cancel each other out. Aside from being extremely costly, the kind of state intervention we have seen to date is most likely to lead to paralysis, with and an economy that is not so much “fixed” as frozen in place and unable to move.

To return to the botanical analogy, there are “green shoots” to be observed in every situation. The question to be asked is whether they are productive plants, weeds or parasitic growth. In our present economic situation the latter two appear to dominate.

The Coming Confrontation Over the Dollar

2009-05-07T06:45:00.000-07:00

An interesting article was published in the Financial Times on May 5th. Titled “If China Loses Faith the Dollar will Collapse”, written by Mr. Andy Xie, an economist in Shanghai, the article clearly points to the next phase of the global financial crisis.

In many ways the US and China are the main actors in the developing financial crunch. The US, through its trade and budget deficits, has pumped huge amounts of dollars into the global system. China, on the other hand, has soaked up these dollars through its large trade surpluses, accumulating over a trillion and a half in foreign currency reserves, most of which are dollar-denominated.
In the recent past this arrangement has served both countries well, allowing them to pursue their chosen economic and fiscal policies. But it has also created the huge financial imbalance which is at the root of the current crisis. And because of the crisis the collaboration between the two powers is quickly morphing into confrontation.

On the Chinese side, the accumulated dollar reserves are critical to the country’s further development. As the Chinese economy grows it needs increasing amounts of foreign currency to purchase the raw materials, such as oil and industrial metals, it no longer produces in sufficient quantities. It also needs the money to acquire the technologies, equipment and armaments it is not yet capable of developing on its own. To pursue its industrial growth and its strategic expansion China therefore needs its monetary reserves to keep their current value. In practice, this means a strong and stable dollar.

The US, on the other hand, is in the grip of a financial meltdown and a severe recession. The Federal Reserve has chosen to cure the financial problems by vastly increasing the amount of liquidity in the financial system, printing or creating money by fiat if necessary. The Obama administration is fighting the recession by the same methods: huge budget deficits and stimulus programs to “jump start” the economy and revive private consumption. To put it simply, the US is attempting to inflate itself out of the crisis. As this is rapidly increasing the amount of money in circulation, the dollar will inevitably lose value.

The economic and fiscal policies of China and the US are thus incompatible: if the US policy is maintained, Chinese dollar reserves will decline in value with respect to the goods China needs; but the only way for the dollar to remain stable is for the US government to abandon or sharply curtail its anti-recession policies. At this point neither side is giving in. In fact they do not appear to even be talking about this major issue.

The Chinese government has, for the last six months, attempted to draw American attention to the problem, through official statements as well as large purchases of gold and strategic materials. Mr. Xie’s article has no overt tie to Chinese government policy, but its publication in the world’s premier financial newspaper gives food for thought. As written, it is a clear warning to the United States. It is doubtful the Chinese government would let such a statement go by unless they at least tacitly approved of it.

It is unlikely that the US government will pay attention, being preoccupied with the domestic situation and believing the Chinese do not really have a choice but to continue buying dollar-denominated US government debt. But the Chinese have already made their position clear: they will not tolerate a devaluation of the US currency and of the dollar reserves they already hold. They are thus likely to ratchet up both rhetoric and action, with the intensity of the dispute quickly escalating.
The danger here is not an overt confrontation or an “economic war”. More likely, in the absence of mutual understanding and compromise, one of the parties will try to make its point through a move – the consequences of which have not been foreseen. Such a move could roil the markets sufficiently to initiate a run on the dollar, potentially crashing the entire world financial system.

The world financial situation is still extremely unstable. It could take only a minor miscalculation to start another major panic, with consequences far more severe than anything that has happened so far.

The Issue the Bail-outs do not Address

2008-12-15T15:59:00.000-08:00

The financial crisis or “credit crunch” has triggered a series of rescue operations on an unprecedented scale. The Federal Reserve and the Treasury have spent and lent trillions of dollars, and committed trillions more. The financial situation has barely improved, which raises the question: Are these efforts aimed at the wrong target?

It is assumed, and widely reported, that this is a “liquidity crisis”. The banks are not lending to each other and to other entities because they are uncertain that the loans will be repaid. This is so because no one knows the state of the potential borrowers’ financial worth. And indeed, a number of prominent financial institutions have gone under in record time. Therefore the government is acting as a bank, providing capital, loans and rescue packages to just about everyone who asks, or even before they ask.

Such measures may be inevitable in the short term to avoid an immediate collapse, but the question remains: Why are balance sheets in such terrible shape after years of apparent prosperity and record profits? What has happened to create such rot?
The answer to the first question is simple: Balance sheets have accumulated a mountain of dubious, worthless and otherwise “toxic” assets, which cannot be sold because no one will buy them.

Why then were such assets created in the first place? The answer holds in one word: globalization.

Over the past twenty years, nearly all barriers to the free and global circulation of money, such as capital and currency exchange controls, have gradually been removed from the western financial system, creating a global financial market far larger than any national market had been before. This market was then tapped by a number of countries to fund large and growing fiscal and trade deficits. The US was particularly tempted to do this as the dollar was the world “reserve currency” and much of global financing transactions were done in dollars.

US trade and government deficits pumped up the amount of loose, unanchored money floating around the globe, looking for the highest possible returns. Since supply always tends to meet demand, an increasingly varied palette of “financial instruments” was created to absorb this growing monetary mass. The demand for ever higher yields led to these “assets” acquiring an increasingly speculative character, incorporating growing amounts of poorly defined risk. Thus was the stage set for a series of investment bubbles, with the growth in bubble size going in parallel with the amount of loose money looking for ever higher yields. The mortgage and commodity bubbles were only the latest to inflate and to pop. More are sure to follow.

The amount of money sloshing around the system is now so large that its movements overwhelm national safety and control systems. Calls for the creation of some kind of supranational monetary authority are possibly laudable but useless. No government will tolerate the surrender of sovereignty implicit on the creation of such a body.

In short: too much floating money creates inflated demand for “assets”, which are then created in a vacuum without corresponding collateral. At some point the value of such assets is questioned, their lack of worth is recognized, and the bubble pops. National institutions try to pick up the pieces while the stateless capital goes looking for another bubble opportunity.

Increasing liquidity might help locally and in the short term, but in the end it exacerbates the problem as it only adds to the loose monetary mass. There are only two ways to escape from this global cycle of ever increasing monetary oscillations.
One is to restore previously removed barriers and buffers: controls on capital movements and currency exchange rates, as well as customs duties. This was done with great success by Malaysia during the Asian crisis of 1997.

The other is to “mop up” the excess global liquidity by reducing fiscal and trade deficits, and creating opportunities for real, as opposed to purely financial, investment.

The second approach deserves more detailed analysis, and we will address this in a coming article.

What Happened to Change

2008-12-03T15:04:00.000-08:00

Barack Obama campaigned on “change”, whereas his opponents, both in the primaries and the election, stressed “experience”. The President-elect is now forming his cabinet, and by all appearances experience is back in fashion. All selections are long-time Washington insiders with substantial records in the Clinton, and even Bush, administrations.

When asked how such DC veterans could stand for “change”, a staffer replied “Obama is the change”. In other words, the President-elect carries within himself a vision that is radically different from politics-as-usual, as well as the power to impose his vision on a group of seasoned political operatives.

The effectiveness of the US President rests on two pillars: first, on the powers given him by the Constitution, and, second, on popular support. Constitutional prerogatives are the same for all Presidents, but the degree of popular support he enjoys affects the ease which with they will be exercised, as well as the results achieved. A popular President will find it much easier to implement policy, obtain cooperation from Congress, and rule over his own Cabinet.

In respect to popular support, it is clear that Obama has received a mandate for “change”, but it is difficult to define what “change” means to Obama voters. One can surmise that it entails, first, directions and approaches substantially different from those of the outgoing Bush administration, both in foreign affairs and on domestic issues; second, it suggests that the way the Obama administration will operate will not perpetuate the “business-as usual” attitude that has given the government, and Congress in particular, abysmally low approval ratings. Instead, the people would expect action, clear, decisive and effective.

Such action is essential because without popular support, the President’s leverage with Congress and within the government apparatus deteriorates rapidly. This is particularly true when the Congress has a clear majority, as is now the case. It is equally true when the cabinet is made up of experienced politicians with their own Washington connections and power base, as the Obama cabinet is likely to become. In such a situation the President needs both a compelling vision to inspire his popular base and a strong hand to keep his administration in line.

Since Barack Obama has no executive experience, the “vision thing” becomes paramount. He must be able to articulate policies that are bold enough to fire up the base, yet sufficiently practical and realistic to allow his cabinet as well as Congress to rally around them and implement them successfully. Due to the urgency of the issues, both strategic and economic, facing the nation, such policy formulation must occur soon after inauguration, if not before.

So far the only specific program mooted by the President-elect is his proposed stimulus package. The very size of 600 billion makes it look bold. Nevertheless a spending program focused on public works and aid to the states also runs the risk of becoming a massive pork barrel, an amalgamation of earmarks and “bridges to nowhere”. If priorities and objectives are absent or vague, the program will disappoint.

As the ongoing bailouts are showing, spending alone is not sufficient. A policy framework is needed to give it purpose. In this area Obama has, so far, played close to the vest, and revealed little of his vision except for broad generalities.

The cards now need to be put on the table.

The Bailout Will Fail

2008-11-11T14:27:00.000-08:00

THE BAILOUT WILL FAIL

Five weeks ago, as the $700 billion Wall Street bailout was being debated in the Congress. Much has happened since, and the subject needs to be revisited.

First the bailout, as originally presented, never happened. The Treasury is still setting up the facilities, and hiring the personnel, through which the proposed purchase of “toxic assets” is to be implemented. In the meantime the focus has shifted, and roughly 40% of the authorized funds have been allocated to the re-capitalization of the country’s ten largest banks. How much will be left to purchase assets, and what assets (if any) will be acquired, is still an open question.

While the Treasury and Federal Reserve were making up their minds on how to use the funds, the markets went into a nose dive (20 to 30%, depending on the day) and the credit situation deteriorated further. Only a much larger, multi-national effort, this time involving between $2 and 3 trillions, managed to halt (at least temporarily) the threatening financial collapse. We will never know how the initial bailout – now subsumed in much larger and continuing efforts – would have fared, but it certainly was not a success. If anything, it might have accelerated the crisis, like the loose stone that starts a rockslide.

One fact that clearly emerged from last weeks’ events was that the crisis we are dealing with is truly global. What is not yet recognized is that the crisis is a direct, natural and logical consequence of financial and economic globalization.
The theory of globalization asserts that if all barriers and constraints to the movement of capital, goods and services are removed, the world will become a single market within which economic activity will attain its greatest efficiency, resulting in the production of the maximum amount of goods and services at the lowest possible cost. This (again according to theory) will bring about the highest level of prosperity to the greatest number.

The theory includes two major assumptions: first, that the removal of barriers will achieve a “level playing field” for economic activity; second, that the markets will act rationally, allocating resources for maximum economic efficiency.

To answer the first question: the playing field is not level. There are different levels of national wealth, development and growth. Besides, even if globalization should (in theory) smooth out these differences, economic forces do not act in a vacuum. Political factors intervene as well. China, for instance, has played the globalization game to its strategic advantage, with highly effective capital, currency and fiscal controls favoring the accumulation in China of foreign exchange reserves while preventing any control of Chinese industries by foreign entities.

Second, the markets behave rationally only to a degree – primarily when it comes to short-term gains, but not necessarily for long-term benefit. This trend has been accentuated by US policy: taking advantage of the dollar’s position as main reserve currency, the US has pumped huge amounts of money into the financial system through equally huge trade and budget deficits. This un-anchored, stateless monetary mass is constantly looking for opportunities to invest - which usually means “investment” of a highly speculative character. Because this “global capital” can flow nearly instantaneously it tends to rapidly concentrate in favorable sectors, generating financial bubbles which form and burst at ever increasing speed – witness the US housing crash or the 2008 oil price spike. As one bubble after another bursts, and the attached “investment” opportunity shuts down, we see more and more money chasing fewer opportunities, insuring further implosions. The global financial system has thus become inherently unstable, and increasingly so as time passes.

There are two ways to correct this state of affairs: to remove liquidity from the global financial system, and to create barriers to the unrestrained movement of capital. On the first count financial authorities have been doing the opposite, vastly increasing the monetary mass in the false belief that this will “fix the system”. The second method (barriers) is currently anathema, as it contradicts the globalization doctrine (even though capital and exchange controls worked exceedingly well for Malaysia during the 1997 Asian crisis).

As long as the financial authorities will persist in trying to “save the system” without realizing that the system is the problem, the situation will get worse and instability will increase: wild and irrational stock market fluctuations; currencies losing much of their value within weeks or even days; rapid swings in the price of essential resources; banks sitting on cash instead of lending; and entire sectors of the economy being dislocated by financial shocks, leaving behind bankruptcies, unemployment, misery, and increasing the likelihood of an economic depression.

Hopefully, before that occurs, someone will realize (like the government of Malaysia did in 1997) where the real problem is, and act accordingly. In the meantime any bail-out, no matter how costly, will only postpone the reckoning.

The Root Cause (of the Financial Crisis)

2008-10-27T13:53:00.000-07:00

There is a striking pattern in the roughly 40% plus fall of the US stock market since October 2007: downward slides followed by bounces, in turn followed by further slides, similar to the path of a ball bouncing down a stair. The pattern shows a remarkable consistency: each move downwards results from events internal to the economy: drops in employment, reductions of economic activity, bankruptcies, massive losses and write-offs. Each bounce follows a government intervention: reduction in interest rates, bank rescues, liquidity injections, government takeovers.

Each successive intervention has been larger than the preceding one. Each time the resulting bounce has been smaller and shorter. After the latest “rescue” – a coordinated multi-national effort involving $2 to $3 trillion of taxpayer money, the weak “rally” lasted all of two weeks.

Many technical explanations for this state of affairs have been offered, none of them fully convincing. The fundamental fact is that something – an unknown force, a special set of circumstances, a poorly understood structural problem – counteracts and/or overwhelms government efforts of unprecedented intensity and magnitude. Since governments are national while the “crisis” apparently knows no boundaries, one must conclude that the phenomenon at the root of it is global in scope and nature.

When measures and remedies that were once effective no longer work, the first question to ask is “What has changed?” What, for instance, has happened since the successful resolution of the Savings and Loan collapse (in the 1980's) – a problem that was defused and then liquidated using far less resources than those deployed, so far unsuccessfully, in the current crisis?

The answer comes readily to mind: the current problem is global. Put simply we now are dealing with the logical consequences of "globalization".

The theory of globalization (also referred to as “free markets”) holds that if all barriers to the worldwide movement of goods, services and capital are abolished, a fully efficient global economy will result, producing the greatest possible amount of goods and services at the lowest cost. Under such conditions economic activity would gravitate to locales where it is most efficient, maximizing economic benefits for all.

Despite its seductive optimism, there are two problems with this view. First, historical experience shows that while “free markets” do generate economic growth and efficiency, they also have negative effects: boom-bust cycles, labor exploitation, environmental damage, wealth disparity. Such effects have been found, particularly in democratic societies, to be intolerable. National governments have therefore taken, over time, a number of measures to control and restrain the markets’ operation. Such measures however extend only to the national population, institutions and territory. While any country can direct its own economy, it has very little power over the global one, where the negative effects listed above can occur on a far greater scale.

Second there is the issue of “oscillation”. To use a nautical analogy: ships such as oil tankers are internally partitioned by watertight bulkheads, and their holds are similarly divided into separate chambers. In theory a ship with no bulkheads and a single hold would be cheaper to build, lighter, faster and would hold more cargo. It would also be unsafe – since a single hull breach would sink it – and inherently unstable – as the internal movement of the cargo would amplify wave action. For those reasons, and regardless of the potential benefits, there are no such ships on the ocean.

A fully globalized economy has the same drawbacks. It is, theoretically, efficient and low-cost. It is also vulnerable to a local breach (think US mortgage problems) and subject to potentially destructive oscillations (think of energy prices, exchange rate fluctuations and “hot money”).

So far all efforts have aimed at “fixing the global financial system” (and, by implication, the global economy). The financial system is, by far, the most “globalized” sector of the world economy. It is also the sector closest to collapse and currently on (very expensive) life support. This raises two fundamental questions.

First the very globalization of the financial system might be the primary cause of its current disastrous state. If so, then attempting to “save” the system will only result in prolonging its agony, while at the same time throwing vast sums of money into an insatiable black hole.

Second, if globalization is, as suggested above, the root cause of our current financial and economic predicament, then the right approach would be to reverse it, restoring in the process some of the safety “bulkheads” such as capital controls, customs duties, and currency constraints.

To this must be added another alternative approach: to shift the focus from the financial system to the “real” economy (almost completely neglected so far). This economy is still in far better shape than the financial sector, and can probably be jump-started at significantly less expense, to the benefit of all.

Corportism Return

2008-10-24T16:27:00.000-07:00

In theory, corporatism is an alternative to the socialism vs. capitalism conflict. The corporatist approach is to have the main social and economic partners – such as labor unions, business large and small, farmers, professional organizations – work together to determine the national priorities, which are then implemented by the government. Under corporatism democracy is participatory rather than representative, and the government is the final arbiter of the national destiny.

Corporatism as a political and economic system was favored by the authoritarian regimes of the 1930’s, as it fitted well with their exalted view of the nation as an organic entity, and of the nation’s leader as head of the national body (Duce, Fuhrer, Caudillo). In historic practice, however, corporatism was reduced to a mutually beneficial alliance between large business concerns and authoritarian governments. This alliance allowed the political leadership to concentrate on its strategic goals without the burden (as was the case in the socialist Soviet Union) of managing the economy. For business it offered both government support as well as protection against the menace of militant labor and other “subversive” elements.

The mass of the people accepted this arrangement for two reasons. First because, after the disaster of WW I, the instability of the Twenties, and the misery of the incipient Great Depression, it provided a hope of stability. Second, because in the early years it proved successful: in Italy the trains ran on time, in Germany unemployment disappeared between 1932 and 1938, and everywhere there was authority and order. It appeared to all that both prosperity and national greatness were on the mend. The end result, however, was negative. Economies revived only through massive public investment in military expansion backed by strategic projects. Free commerce was never restored, but instead choked by ever tighter government control. Politically, the capital provided by popular acquiescence was wasted in the imperial adventures of WW II.

There is more than a whiff of a corporatist revival on our current national scene. Not only has government grown more authoritarian under the “unitary” concept of the exiting administration, but the current bank bailout weds Big Government with Big Finance in a way the corporatists of the 1930’s would have approved, if not admired. While trillions are being spent on “fixing the financial system” (and more may well be spent on corporations “too big to fail”) and government control over the economy grows, the private citizen and the small entrepreneur are left to fend for themselves in an increasingly threatening economic climate.

Maybe this confluence of government and business interest (at the expense of the taxpayer) is only an isolated case, but in view of the constant growth and reach of the federal government, it could just be the first clearly visible manifestation of a long-term trend. In that case the coming election takes on particular importance with regards to the country’s future course.

Of the two current presidential candidates, Barack Obama best fits the corporatist/authoritarian mold. His “above the crowd” persona, his high-flying oratory, his taste for imperial-looking settings, and his populism, all exhibit a definite resemblance with the political style of the 1930’s. Both his background and the tone of his campaign show an inclination towards major change (should one read “regime change”?) achieved through radical solutions.

John McCain, by contrast, whatever his faults and shortcomings, is a died-in-the-wool parliamentarian – less likely, despite his military background, to put his trust in an authoritarian state. He is more likely – and his political career shows it – to muddle through discussion and compromise.

Because of the current economic instability and the severe downturn that may be coming, the choice before the American electorate may be much more than that between two individuals. It may be about two very different approaches to government as well. The coming election results will tell a great deal about the American people’s instincts, preferences, and innate wisdom.

Is China Crashing (Installment 2)

2008-10-21T12:47:00.000-07:00

In March, , (http://polzoo.com/content/view/207/49/ ) our Polzoo entry of the same title raised serious doubts about the future of the Chinese “economic miracle” In view of recent developments an update of the subject is in order.

In the six months since the above-referenced entry, Western economies have markedly deteriorated. In regards to China, the conventional wisdom has so far embraced one or the other variation of the “decoupling” theory. This view holds that while the rapid growth of “emerging” economies (such as India, China, Russia or Brazil) would be somewhat affected by the slowdown in exports to the developed world, their internal growth and consumption will shield them from the downdraft and their rapid development would continue apace, thereby supporting global growth.

In particular, it has been stated that China would compensate for the potential fall in exports through increased internal consumption and infrastructure spending.
The most recent data (October 08) shows that Chinese economic growth has fallen, year on year, from 11.9 to 8% on an annualized basis – worse than the most pessimistic estimates. China’s major export markets, the US and the EU, are now in recession mode, so demand for Chinese exports is likely to drop sharply. While internal consumption is still rising (at least according to official Chinese statistics), there are a number of factors raising doubts on this score: a Shanghai stock market decline of 68% in the last twelve months; slumping demand for housing; a sharp fall in car sales and air travel, and reductions in official interest rates.

The Chinese are savers, not only by tradition but also because the “economic miracle” has been paralleled by the dismantling of nearly all national and local safety nets set up under the socialist system. That they would go on a spending spree even as the economic climate becomes less expansive is questionable. In addition, most of the disposable wealth is concentrated in the developed coastal provinces, where the effects of an export slump already are, and will continue to be, felt.

As for infrastructure, there is certainly room to improve it, but it must be remembered that for the last several years the government has already been expanding infrastructure on a massive scale. Most of that has been in the export-oriented coastal areas, so there is little left to invest in just as those areas begin to suffer from the export slump. Infrastructure spending in the interior might absorb some surplus labor but will do little for the vast and impoverished rural areas.
The potential for stimulating the economy through internal spending is therefore limited. In addition, there is the issue of the reliability of official statistics.

Anyone familiar with the Soviet economic system knows how economic statistics were systematically inflated as they worked their way through the bureaucracy, providing an overly positive picture of the economy’s status. In China local officials are basically graded according to the level of economic growth in their respective areas. During the years of rapid growth there was little temptation to falsify development data, because actually implementing development projects (even if these were not viable in the long run) was far more profitable than tinkering with statistics. But in a tighter economic setting, opportunities for growth will diminish while many of the completed projects will struggle or fail. At that point the temptation to cover up becomes powerful if not irresistible, and the gap between the official story and the situation on the ground grows. Just how much such potential tampering is already in the works is difficult to answer, but it would explain a number of discrepancies between the official data and reports from other channels.

Because of the abuses of the current regime and the pervasive corruption, there is already throughout China considerable discontent and social unrest in spite of the rapid pace of development. Should growth falter such unrest could escalate exponentially, not only among minorities but among the great mass of Han Chinese.

Has Obama Peaked

2008-10-20T14:50:00.000-07:00

Eight months ago we ran an article (Is Obama Qualified - http://polzoo.com/content/view/57/49/) covering Obama’s qualifications for the presidency, and concluded that they were incomplete. A good question now is: “Will he make it?”

The appearances are favorable, yet they leave room for an undercurrent of doubt. As the campaign enters the final stretch, there are two points at issue.
The key one, and the one that, in the final analysis, will decide the outcome, is the gut feeling of the American people about this candidate. Regardless of what the polls might say, has the populace bought the hope, the hype, the certainty and the rising triumphalism of the Obama camp? Have they made up their minds, or are they still asking: “Do I know this guy?”- “Do I really like him?”- “Do I trust him to run my country?” There needs to be a fundamental, instinctive connection here. Otherwise the remaining doubt will be carried into the voting booth and there trigger a reaction that no pollster can quantify or control, but that can easily swing the election one way or the other.

The other factor is the way the Obama campaign team understands the “connection” described above, or to the lack or incompleteness of it. There is no question that the campaign is coasting and exudes a near certainty of victory. But apparent certainty does not necessarily translate into confidence. If doubt remains, it can quickly turn into fear and paralysis as the decisive moment approaches. The people will feel this doubt (even if they do not consciously realize it) and it will amplify their own. That kind of subliminal interaction can be decisive in a close election.

A secondary issue is the emerging triumphalism – the 150 million collected in September, the bold forays into “red” states, Nancy Pelosi’s “I am 100% sure”, the planning of the victory party. Voters do not like to be taken for granted before their minds are made up, and they might yet pull a Truman on Obama’s Dewey-like assurance of victory.

Added to the above factors are the deficiencies that were mentioned in our February article. Since then the situation in the country and the national mood have undergone considerable change, yet the Obama platform has not. Regardless of position papers and election promises, a concrete strategy has yet to emerge. “Change” and “hope” become less convincing as the economic situation deteriorates, the Afghan war turns sour and Iraq is still in the balance. Obama talks better than ever, but can he lead? And can he unite the people in a common purpose, as FDR did at the start of WW II? So far neither question has been decisively answered.

On the other side is little John McCain, taking a page from “Give them hell!” Harry.

It’s not time yet to print the November 4th front page.

McCain's Missing Link

2008-10-13T06:56:00.000-07:00

Four weeks to go until November 4th, and so far Senator McCain has been a disappointment.

This is all the more surprising that the Republicans have, in all likelihood, picked the right man to represent them in the election. And the senator has, most definitely, made the right choice as to his running mate.
The nation is facing a challenge. While the financial “crisis” has dominated the headlines, there are deeper, and far more real, issues at hand. The chimera of globalization and the resulting mismanagement have wrecked the economy and threaten the currency; multi-culturalism has weakened the national identity; rashly started wars are draining both the national will and the treasury; and a political establishment focused on self-preservation has left the country devoid of direction and leadership.

There is little chance that such times would produce a national leader. Yet Senator McCain has what it takes to fit the bill. His first and foremost asset is a profound love for his country. Without this he would not have survived his captivity in Hanoi, and that experience will remain with him for the rest of his life. He has gone through the fire, for the right reasons. He stood the test.

He is no novice at leadership either. Whatever may be said about Washington, DC, he has been there. He knows the business of the nation and how it is transacted.
Why then does such a man come across as vacillating and indecisive, as he did in the matter of the “Wall Street bailout” – which he half-heartedly signed on to while the majority of voters was, and still is, strongly opposed?

It is simple: there are two parts to the man: the genuine war hero serving his country and the veteran politician serving … what do Washington politician serve? -- Lobbies, negative advertising, compromise, the perpetual obsession with re-election? The political establishment that led the country into the current morass has little to commend itself to the electorate, and its abysmal approval ratings are proof of that.

It is very likely that the hero and the politician are still locked in a struggle. One genuinely wants to tell the country where it needs to go – the other to continue talking in clichés, rely on hired operators and avoid responsibility. It is the first that needs to come out on top, and quickly. The country needs him, and the voters are waiting.

Though the word “crisis” is by now shopworn, the country does stand at a crossroads. It does not need the appearance of leadership but real leaders; straight talk, not generalities; positive, constructive policies rather than blame. And most of all, a president who wants to serve for the right reasons, and carries the proof of that in his soul.

The Bailout Will Fail

2008-09-25T16:35:00.000-07:00

The $700-billion rescue of the financial system is dead on arrival.
As already pointed out by the press and media commentators, there are many unresolved issues with the proposed financial bailout: how to select the assets to be purchased; their price; the structure of the proposed holding entities or funds; their administration and supervision. And not least, the likelihood that for an enterprise of this size, brought into being by fear and constructed in haste, the likelihood of success is not high.

The overriding reason, however, why this bailout should not be attempted, and will fail if implemented, is simple: $700 billion is not nearly enough.

To explain this, let us backtrack a few years to the origins of the current situation. For several years now the US has run huge trade and budget deficits, flooding the world with dollars. In earlier years such outlays were recycled through foreign investments in US debt and assets. Two new developments, however, have vitiated this process.

The first was the low interest rates which the Federal Reserve maintained for most of the period under consideration. This created an acute demand for investments with higher yields. The second was the fact that even as the amount of money to be recycled was increasing, investment opportunities in the US economy were actually decreasing, due to corporate outsourcing, share buybacks and political and security limitations. The money flowed into Wall Street, but little of it went any further.
Nevertheless demand for high-yield investment generated a corresponding supply. Since the availability of assets in the “real” economy was limited, new assets were created within the financial system itself. They were of various kinds, but can be covered by the loose designation of “derivatives”. Unlike the tangible assets of the “real” economy, all backed by some sort of actual collateral, the value attributed to the new financial assets had only a tenuous, if any, connection to any kind of collateral at all. Save for model-based valuations and the good faith of “counterparties” no objective valuation was possible.

This process of “asset inflation” was accelerated and magnified by the fact that, thanks to leverage (a fruit of the over-abundance of money), investment within the financial world produced, for a time, yields far superior to those obtainable in the real economy. These yields led to the myth “the new financial capitalism” which, basically, created huge wealth out of nothing.

As the size of this financial asset market grew into the tens of trillions, the value of the instruments being created was bound to be questioned at some point. The fall in house prices was the trigger, with mortgage-based derivatives the initials victims. Ironically this is the one asset class within the new financial universe which still has a connection, however convoluted, with existing and tradable collateral.

The $700 billion requested by the Treasury might, with a great deal of luck, somewhat sanitize this asset category. But cleaning up the remainder of what has been created within this financial bubble would require sums beyond anyone’s reach.
This brings us to the primary and most fundamental issue. While all attention has so far been given to “fixing” a financial system that has bankrupted itself, almost none is paid to the needs of the real economy. Even the banking system, outside of New York, is left to fend for itself – as are the major industries and the entirety of small business.

A fraction of the sums involved in the various financial bailouts (past, present and future) would have far greater impact, in terms of employment and economic activity, if invested in the real economy. The most pressing needs are in the areas of energy and infrastructure, where the fruits of (intelligent) investment would be immediately felt by the general population.

The Palin Dilemna

2008-09-16T06:52:00.000-07:00

The Republican campaign got its post-convention bounce, courtesy of Alaska Governor Sarah Palin. It now has a choice to make.

The “safe” alternative is to maintain the present course: have the two nominees campaign together. The benefit here is that John McCain – not a particularly charismatic candidate, partakes of Sarah Palin’s aura of energy, youth and “newness”, as well as of the enthusiasm she seems to generate. With Governor Palin in the supporting role, he runs little risk of being upstaged.

The negatives of this approach, however, are substantial. Once reduced to a secondary role – a position she never occupied before – Sarah Palin runs the risk of losing the novelty, originality drive which made her so valuable in the first place. In addition, there is the danger that she will gradually get boxed in McCain’s ideological position. And, let us face it, John McCain’s policy preferences on national security, immigration, trade, the economy and foreign affairs are not far apart from those of President Bush, with whom he “voted 90% of the time. At the end of that road we are still looking at a “third Bush term”, with an attractive Vice-President as the main distinguishing feature.

This gives Barack Obama a great opening. He and his team just got clobbered. But the campaign is still undecided, with eight weeks to go. In close games the team that scores first does not necessarily win. First quarter momentum does not automatically translate into fourth quarter domination. The Democrats have plenty of time to regroup, adjust, and go back on the offensive.

But there is a deeper issue here. The election is playing out in a national context where roughly 80% of the population believes that the country is on the wrong track. Neither party is addressing this gap between the political class and the electorate. On the contrary, they are using the same playbooks as in the last few elections, with the same nostrums and arguments – and the same reliance on negative ads. While this may satisfy the hard-core base, it does little to attract the floating mass in the middle.

It is here that Governor Palin provides the Republicans with a potential advantage. She is not a standard Washington politician. She made it on her own, against the establishment, and in Alaska – as far from Washington as you can get (except for Hawaii). Her career reminds one of the original 1854 Republicans, founded in a similarly distant Wisconsin, and with a party platform that became immensely popular because it answered the aspirations and needs of the country.

The source of Governor Palin’s success to date has been her extraordinary rapport with the voters. She instinctively knows their concerns and aspirations and they, just as instinctively, trust her to deliver the answers. This is a tremendous talent, and one the Republicans can use to much greater effect than by just making her an attraction at McCain rallies.

In other words, Governor Palin could provide the hereto largely missing channel between the voters and the self-contained Washington establishment – to which Senator McCain does belong despite his protestations. In such a function she would generate a much greater impact and enthusiasm than in the conventional context to which she is currently confined.

The potential benefits to the Republican of allowing her to connect to the broad electorate are huge. The challenge is that if she truly connects and then passes on the information, some of the cherished Republican notions might have to be modified and discarded. This is where Senator McCain can truly earn his “maverick” title. He left the beaten path to pick his running mate. Will he now be able – and willing – to use her political abilities to the full?

The Campaign as Minefield

2008-09-12T16:26:00.000-07:00

The party conventions focused almost exclusively on the candidates, almost forgetting the platforms. In speech after speech, night after night, the perspective parties’ nominees were lifted up and praised, their opponents put down. There was very little else. We are going into the final eight-week stretch with a sharp focus on personality and little substance, if any, in terms of policy.
This would be understandable if the nation were at peace and secure, with prosperity at its height, the currency sound and optimism in the driver’s seat. In reality it appears to be otherwise. Major issues lurk behind the façade, serious enough that any one of them – or even several – could blow up before the election. Neither will they go away afterwards. The candidates are walking into a minefield, with few precautions being taken.

Here is a short list of some of the issues:

The wars are not going well. Somalia is a growing disaster, with the opposition radicalized and our Ethiopian allies weary and eager to leave. Pakistan, with growing anti-Americanism and a resurgent Al Qaeda, is in the danger zone. Afghanistan, after six years of western occupation, is sliding into open rebellion. Iraq is relatively tranquil, but the Maliki government’s apparent refusal to integrate the Sunni militias into the security forces bodes ill for the future. The entire policy of direct military intervention, with its huge cost in lives and resources, is in precarious balance and in danger of collapse.

Domestically, the economy is sliding downward, slowly but surely. The financial system is on virtual life support, with one major component after another failing and requiring ever larger bail-outs by federal authorities. Such government intervention (which this week-end prevented the largest bankruptcy in US history from becoming official) lies behind every stock market rally that occurred since the crisis began. So far there is always hope, but no shadow of a solution or an upturn, so the prospect is for more tremors until the Big One – most likely an implosion of the derivatives market.

Despite the economic retrenchment the trade deficit continues to be huge, and will widen as US exports diminish due to the global slowdown. The federal budget deficit is probably beyond counting at this point. Eventually, regardless of short-term exchange rate movements, the huge amount of money being printed will pull the dollar lower and push borrowing costs higher, threatening the credit rating of the US government.

And on top of it all, we have neither caught nor killed Osama bin Laden, and the prospects of this happening are poor (though I certainly hope to be wrong on this one). Osama might not be so important any more, but the failure is significant in itself.

Despite all the above, doomsday is not at hand. The United States has been in trouble before, and shown amazing powers of imagination, inventiveness and recovery. But for such powers to awaken and start working there needs to be a national consensus, basic agreement on solutions and a firm hand on the tiller. There is not much sign of that yet. Right now the two parties and their candidates are going forward mainly on the basis of slogans and old ideologies. These might not work when push comes to shove.

A More Productive Policy Towards Russia

2008-09-03T15:49:00.000-07:00

The wave of criticism of Russia by western governments and the western press has become a tsunami after the Georgian affair. Yet this criticism ignores two fundamental realities.

The first is the role of the Russian people and its leaders in the liquidation of one of the most oppressive tyrannies of human history – the Soviet communist state. While there were many reasons and causes behind the collapse of the Soviet system, the role of the Russian people in that collapse is paramount. Not only did Russia’s population and government manage in a few short years to deconstruct three generations of communism, they also managed it with minimal strife and bloodshed. By contrast the elimination of Nazi and Japanese totalitarianism required all of WWII, followed by military occupation of both countries.

Instead of giving Russia credit for this extraordinary achievement, the West seems bent on castigating and punishing the Russians on the grounds that they did become, in the space of half a generation, a perfect democracy – ignoring in the process the extreme difficulty of such a task. It is certainly easy to write a western-style constitution, and Russia has done a fairly good job of that. But practice is another matter. The fact that the Soviet Union collapsed 17 years ago means that all Russians above forty today have spent their formative years within the communist system. Asking them to forget everything and start from scratch is, to say the least, impractical. Some transition time is needed, and the progress made since 1991 is, on the whole, remarkable.

Instead of providing support and collaboration in the areas where progress has been made, the US seems intent on treating Russia like a dangerous convict that somehow managed to get parole. The Russian policy under the current administration has been, on one hand, to cut off all possible Russian influence beyond its borders through the support of pro-western (and anti-Russian) regimes in former Soviet republics; on the other, to ring Russia with military bases established in the same territories.
Whether a “democratic” Russia agreeable to western policies can be fostered by this type of military pressure is open to question. Given, however, that, most members of the Russian ruling class still have a solid Soviet upbringing (as mentioned earlier), it is much more likely that they will react in the opposite way: by stiffening up and playing hardball in return. In that case our policies are motivating Russia to indeed regress to a position closer to its communist past. And this brings up the second major disregarded fact.

America’s justification for its policies in the ex-Soviet world is the establishment of “democracy and freedom” – to which could be added the fostering of economies open to western penetration. It is doubtful, however, that such policies will be ever more than peripherally successful if Russians remain hostile. Russia is, after all, the core and principal power of the entire ex-Soviet region. No regional policy in that area will succeed unless Russia is agreeable. If we win Georgia, the Baltic States and even the Ukraine and lose Russia in the process, our “success” is likely to prove both ephemeral and extremely expensive.

The risk of failure is all the more weighty as the US is now vastly overextended. It has no strategic reserve to speak of (as the Georgian example amply illustrates). Its European allies are addicted to Russian oil and gas and their economies dependent on exports to the Russian Federation. There are also other problem areas – particularly Iran – where no real solution can be reached without active and willing Russian participation. If a serious crisis occurs in the Middle East, Russian oil and gas production, by their sheer size, could become extremely important to western economies.

Prudence would require scaling back our current anti-Russian offensive. Achieving stability in Eastern Europe and western Asia would require us to abandon our current Russian policy, and seek a more amicable modus vivendi with Moscow, so as to consolidate the gains made since the end of the Cold War.

Georgia: Where is the Strategy?

2008-08-24T10:35:00.000-07:00

The press and air waves are full of comments about the Russian occupation of two ethnic enclaves –Abkhazia and South Ossetia – within the former Soviet republic of Georgia, now an independent state. The vast majority of opinions expressed are virulently anti-Russian. Regardless of where “right” and “wrong” lie here – and it is best to let history decide that issue – the Georgian imbroglio offers a great opportunity to review the US strategy in the Caucasus and other similar regions, a strategy which appears to be deeply flawed.

The first flaw is inherent in the current concept of NATO, versus the purpose for which NATO was originally founded – the military containment of the then-expanding Soviet empire. The key word is “military”. In Cold War days NATO was a highly credible military alliance, with a clear objective, and with each member state making substantial contributions in terms of armed forces for the fulfillment of the common goal. The military strength of NATO kept the Soviets at bay in Europe and significantly contributed to their eventual downfall.

Today NATO no longer has an army to speak of. Only two of the European members – the UK and France – have any capability for projecting military power beyond their borders, and both are already stressed by their contributions in Iraq and Afghanistan. The other European members have, since the end of the Cold War, reduced their armed forces to the absolute minimum, and cannot carry operations abroad without massive assistance, which can only come from the US.
The result of these military shortcomings is that NATO has become a primarily political organization used to pursue the policies of its member states. Unlike what was the case in Cold War days, these policies now cover a range of objectives, not necessarily compatible and often divergent.

The primary objective of the US remains a military one: to use NATO to extend US reach – through the admission of new members and the establishment of bases – into Eastern Europe, the Middle East and Central Asia – much of this territory being former Soviet possessions or zones of influence. By contrast the objective of the major European members of NATO – such as Italy or Germany – is mostly economic. They see the above areas primarily as markets for their goods and services, and are fundamentally reluctant to engage in military expenditures, and even less in political or military confrontations. This divergence of objectives makes decisive and concerted action by NATO nearly impossible, as the Georgia case clearly illustrates.

The second flaw lies within the current US policy of indiscriminate military expansion. A major principle of military strategy is that of the “economy of force”, which states that available resources must be concentrated first and foremost on the principal and most important objective, with secondary objectives receiving only the strict minimum until the main goal has been achieved. Another fundamental principle is the need to maintain at all times a strategic reserve, to be committed only in cases of utmost necessity.

Current US strategy flouts both principles. US armed forces are currently engaged in four conflict areas (Iraq, Afghanistan, Somalia and Pakistan), plus covert or semi-covert operations around the globe. The US is simultaneously establishing bases in Eastern Europe, the Middle East, Central Asia and Africa – bases which have to be built, supplied, manned and defended. The stress and shortages imposed by those multiple objectives are such that key operations have had to be subcontracted: the invasion of Somalia to Ethiopia; the training of the Georgian army partially to Israel; and the attempt to control the autonomous areas of Pakistan to that country’s very reluctant army. The result is loss of control, evident in all three cases.

It is obvious that the current strategy needs urgent review. Under the overall umbrella of the “war on terror” the US has doubled its military budget, occupied large swaths of foreign territory, and engaged in a number of conflicts, none of which is close to resolution. It has suffered thousands of casualties and spent trillions. Yet, 7 years after 9/11, Osama bin Laden is still alive. By our own admission his Al Qaeda organization is recovering and is planning further mayhem. This is a strategic failure of the first order.

To Drill or not to drill...That is not the question

2008-08-05T15:03:00.000-07:00

The Republican minority in the House is in revolt. They are occupying the House chamber and intend to stay put until Speaker Pelosi calls a special session and a vote on the ban on offshore drilling.

It is a good political ploy, since all us citizens are suffering from the high gas prices. But the real issue is whether lifting the ban on drilling will send the price down.

There is really no good justification for banning offshore drilling. The main reason for the ban was the potential for environmental damage, and this no longer holds. The oil industry’s environmental offshore record is stellar, with only a few minor spills despite the recent spate of hurricanes and the resulting (often severe) damage to platforms and pipelines. Their record on land might be somewhat worse, but these issues are negotiable.

Producing more oil will certainly improve our trade balance, which is woefully in the red, and thereby weakens the dollar. But it is doubtful that, all other factors being the same, the price will be reduced by much.

This price of oil has been rising steadily for a decade, driven mainly by the supply-demand equation. On the supply side, oil is getting gradually harder and more expensive to get out of the ground. There is plenty of oil still to be found, but the cost of extraction projects, as well as their time-to-production, is increasing. Older fields are declining, so supply cannot grow very quickly.

On the other side of the equation, demand is rising much faster, due to accelerated industrialization in developed countries, mainly India and China. As long as China maintains its policy of 10% plus yearly GDP growth (and it shows no sign of giving it up) China will buy every barrel of oil to be found on the market. With a $1.8 trillion foreign currency reserve it will outbid and outlast all other potential buyers – including the US.

The oil market is global. Any new oil – no matter where it comes from – is simply added to the pool and is directed where the price and delivery terms are the most favorable. As long as global demand outpaces supply, the price will rise, for Americans as for everyone else (except for the consumers of the producing countries where the price of fuel is subsidized). Bringing more oil to the market – unless the quantity is truly huge – will merely slow down the rate of price increases, and that only if other producing countries do not curtail their own production to keep the price up. Since the vast majority of oil reserves are now under the direct control of national governments, such curtailment is entirely possible, if not probable.
Producing more oil within the US will thus not lower the price of gasoline, which is proportional to the price of crude. To achieve this goal a more comprehensive policy is needed.

Roughly two thirds of the US oil consumption goes to produce transportation fuel – gasoline, diesel and jet fuel (kerosene). It is the fuel, not the oil, that the consumer pays for. The key to lowering the price of fuel (“the price of gas”) is to separate the domestic price of fuel from the price of oil (and do this without subsidies, which we pay for through taxes). This essentially means increasing the supply of fuel which is not made from oil. There are two ways to do this.

One involves so-called “renewable fuels”, which are currently made from agricultural products. The main ones are bio-diesel and ethanol. Neither of those is currently viable without subsidies and /or mandates, which skew the law of supply and demand. But even leaving that aside, we have already seen the effects of a rising ethanol production on the price of food, which we need even more than we need transportation. Pressure is therefore already building to repeal the ethanol mandates, and it will soon become irresistible. Once the mandates and subsidies are abandoned bio-fuels (in their present form) will be reduced to niche applications.

The other alternative is synthetic fuel made from coal, of which the US has the world’s largest and most accessible reserves. The production technology is well-developed and has been tested on an industrial scale. It is competitive with oil beyond $60/barrel, and is currently being embraced by a number of countries(including, you guessed it, China). It should be seriously considered by anyone who is truly seeking the US national interest in the energy area.

Introduction - The Paradigm Shift - Part 4

2008-07-14T17:07:00.000-07:00

Renewable sources

Electricity generation from renewable sources includes geothermal, wind and solar. Geothermal generation most closely resembles generation from fossil fuels (using heat) and can deliver energy on demand. It is therefore a ready replacement, but for the time being its use is limited by the availability of suitable locations.

Solar thermal generation offers similar potential, with a greater choice of locations, although the best ones are located in desert areas away from population centers. The technology, however, needs to be developed on an industrial scale and the cost of the power that would be produced is still to be determined.

Wind has been used extensively since early times and is a well established technology. The key problem lies in scaling up power generation because of the intermittent character of the wind source. If wind power comprises less than 10% of the total power fed into the grid, the variations induced by weather can be compensated by generation from other sources. As the fraction of wind power grows, however, the weather-induced variability creates larger and larger problems, forcing unpredictable cutbacks in consumption.

The general problem with all renewable generation is of course cost. None of the above methods would be under consideration if their use was not heavily subsidized. The need for subsidies is not only a financial issue. It also suggests that the capital inputs into renewable energy sources are high, which raises the issue of the “energy margin” already discussed with respect to petroleum: If one calculates the total amount of energy invested in manufacturing, installing, running and maintaining a renewable generating facility, how much of an energy surplus does that facility produce over its expected lifetime? Exact numbers are not available, but the market situation appears to indicate that the “energy margin” of renewable generation is considerably less than that of generation based on fossil fuels. That in turn means that a number of current economic activities, powered by electricity, would become unaffordable (from an energy balance point of view) as more renewable power came on stream. The value of those activities for our overall economic life would then need to be determined, and the changes resulting from their elimination outlined, before a large-scale effort to develop renewable generation is undertaken.

Since increased reliance on electricity (for instance for transportation, as with “plug-in” vehicles) would increase overall power requirements, such evaluation and planning are needed before specific policies are decided upon. It is of no use to add generating capacity if the cost of power rises to levels where significant sectors of the economy are priced out of the market, with the resulting loss of employment. Or, at the very least, such effects should be foreseen and provision be made for them.

Transmission

Electrical power cannot be stored on a large scale (if a means to do this were found, many of our energy problems would disappear). It must therefore be transmitted, more or less instantly, from the point of generation to the point of use. Power is lost along the line, proportionally to the distance the current travels. For this reason generating plants are sited as close as possible to the point or area of use. With fossil fuel plants this is nearly always possible. With nuclear plants somewhat less, due to the need for large quantities of cooling water. Renewable generation is tied to the most favorable natural locations, which tend to be away from population centers.

Transmission losses raise the cost of power to the end-user, but there are other issues. Long transmission lines are vulnerable, both to disruption by natural phenomena such as violent storms and heavy snows, and to human action. It is far easier and faster to bring down a power line than it is to cut an underground pipeline, and the damage will take longer to repair (during which time the power is not available). The more economic activity relies on electrical power, therefore, the more such potential disruptions, be they from natural causes, internal sabotage or enemy actions, must be taken into consideration. Not only measures must be taken to protect the lines, but the grid must be capable of compensating for transmission interruptions to at least a minimal degree.

Storage

As mentioned above (and unlike fossil energy) electrical power cannot be stored in large quantities. All storage devices will deliver continuous power for a limited time only, and their energy content per unit of weight is far lower than that of coal or diesel fuel. Recharging a battery pack takes far longer than filling a fuel tank or feeding coal into a furnace. Thus while electricity is well suited for static applications where a connection to the grid is possible, fully mobile ones present major challenges in terms of both range and power delivered. This is especially significant in the case of long-distance, heavy duty transport, used by the bulk of strategic and essential goods. Electric transportation is possible and even advantageous within areas of high population density, but its potential rapidly falls off with distance. An economy powered by electricity would only be possible with much higher population densities, such as existed in the early 20th century within cities internally connected by rail and tram lines. Moving back from our current suburban sprawl into such densely packed cities would imply a major cultural change and require a complex new set of policies.

Control

Our current power supply and utilization is based on a close to optimal compromise between the respective advantages and drawbacks of electricity and direct fossil fuel consumption. The more functions are turned over to electrical power, the more foolproof, redundant and reliable the power grid must be. Because we now can use both energy sources interchangeably (as in having a gasoline-powered generator should our home power fail), our economy is more tolerant of grid breakdowns and black-outs, and we can do without electrical power for limited periods. But as one moves from such a mixed to an all-electric system such breakdowns become far more significant and potentially dangerous, not only is peacetime but even more so in a wartime (or internally disturbed) situation.

The design and building of such a power grid, with its built-in redundancies, fail-safe features, and abilities to match variable power inputs (such as the input from wind farms) to changing demand will present significant challenges in terms of control technology as well as investment. Aside from the issues connected with controlling the grid, the key challenge is that of distance. Electricity and distance are essentially inimical. Therefore the closer our economy comes to being “all-electric”, the more economic activity will need to be physically relocated, as well as re-programmed in time so as to balance power supply and demand. This issue must not be underestimated as it will have not only an economic impact, but a social one as well, affecting population distribution and density, the relationship between home and workplace, and many aspects of our lives that have been around so long that we no longer question them.

Renewable fuels

Transportation would be the weakest link in an all-electric economy, and the one area where fossil fuels – particularly those derived from petroleum – offer truly unique advantages. To overcome this difficulty the use of renewable fuels has been suggested. “Renewable” fuels would be those derived from plants, algae and other living organisms. The fuels currently under consideration to replace oil-based ones are biodiesel (derived from vegetable oils) and ethanol (derived from corn in the US and from sugar cane in tropical countries.

One of the major arguments for the development of these fuels is that the feedstock is renewable. This, in theory would eliminate or reduce the CO2 emissions associated with fossil fuels and held responsible for “global warming”. This is a questionable benefit as significant inputs in terms of fossil energy are needed to produce the original feedstock used as well as for processing it into finished fuel. This makes the CO2 reduction much smaller than originally expected possibly eliminating it altogether. But the primary issue with “renewable” fuels is not there. Even if more efficient production processes are developed, yields are raised and land otherwise unsuitable for agriculture is used, the rate at which these fuels can be produced will in the end be limited by the growth rate of the plants or organisms providing the raw material. Renewable fuels thus can provide some relief from a total reliance on petroleum, but they will allow only for a static level of economic activity, not the constant increase hitherto made possible by the use of fossil energy sources. In the final analysis “renewable” is equivalent to “sustainable”, and sustainability is a limitation as well as a benefit.

Conclusion – There is no ready substitute

We are left with two conclusions:

First, that there is a fundamental contradiction between the concept of sustainability and the way our economy has operated for the last century and a half. An economy fueled primarily by the burning of fossil fuels – as ours has been and still is – offers the potential of continuous material growth as long as the fossil fuel reserves remain large and accessible. By contrast, a “sustainable” economy is limited in its energy use by the rate at which such energy can be extracted from cyclical natural processes, which proceed at a set rate. The only way a sustainable economy can grow is by increasing the efficiency with which energy can be extracted from the natural processes which surround us. This is the new paradigm.

The growing constraints on the availability of petroleum (and related products such as natural gas) mark the beginning of the end of the era of pure quantitative growth. I want to insist on the word “beginning”, because those constraints have grown, and will continue to grow, in a gradual manner. There will be times when they will be relaxed, due to lulls in demand or other circumstances. In addition the restrictions applying to petroleum have not yet been generalized to other fossil fuels, of which the main one is coal. We are not yet, whatever might be said to the contrary, “running out of energy. Nevertheless the warning bell has been rung, and it will continue to ring, louder and louder as time passes.

We are thus entering a transition period, similar to the one which saw the early development of the industrial economy between 1750 and 1850. How smooth the coming transition will be depends on our choices. We can deny the reality facing us and attempt to maintain the current growth paradigm – and succeed temporarily, at the expense of suffering more severe shocks later. Or we can shift to the new energy efficiency paradigm and willingly face the future. That is the first and major choice.

A second set of decisions concerns the manner in which we will manage the transition. I have no doubt that human creativity is quite up to the challenge, and that doomsday scenarios do not need to be contemplated. A successful transition will require both some form of overall planning and a large allowance for inventiveness and initiative at all levels. Which means that the old political paradigm, based on the opposition between the Right (standing for maximum individual freedom) and the Left (maximizing the role and power of the state) must be abandoned as well. To face the challenge both the individual and the state will need to exercise their proper functions with the maximum degree of harmony.

This book is an attempt to outline (in very broad terms) the challenge now facing us, and to propose a set of policies which will facilitate the initial steps in facing it. No one at this time can truly predict the political and economic shape of the society which will eventually emerge from the process of change. But we can, and we should, begin to look for the right direction.

In this election year (and in the four years of the coming administration) we are and will be faced with major issues, all of which are strongly connected with the central subject of energy. The following chapters will outline what these issues are and suggest policies to deal with them.

Introduction - The Paradigm Shift in Energy - Part 3

2008-07-11T11:54:00.000-07:00

The new paradigm – No substitute

We have outlined above how the exploitation of fossil energy has provided the foundation for both the economy and the politics of the industrial age. We have also pointed out how the most flexible and widely used of these resources – petroleum – is becoming limited in terms of both availability and affordability. While the fundamental constraints stem from what was called the “energy margin” or the equivalent measure termed the “cost of extraction”, these limitations have been amplified by a factor rooted in politics.

One of the enduring legacies of socialism (and this despite the “victory” of free market capitalism in the 1990’s) has been the growth of both the reach and power of the state. No government today intends (or even considers) a withdrawal from the economic sphere. The vast majority of states manipulate economic trends to their national advantage, whatever lip service might be paid to “free markets”. This trend is growing, not fading away, a reality which flies in the face of all globalization theories. The temptation for governments to increase their economic influence is further enhanced by the consequences of the clash (already referred to above) between finite resources and accelerating economic growth – a clash which the process of economic globalization has brought forward and exacerbated. The result of this collision between growth and resource limitations, between concept and reality, is the phenomenal rise in raw material costs we have witnessed over the last few years (the years, incidentally, in which globalization has appeared triumphant.

Governments are, of course, interested in economic growth. But their first priorities are in the fields of finances and national security (or, to put it more bluntly, taxes and guns). No government can operate without a budget, and a major part of that budget will always be allocated to the maintenance (and often expansion) of military forces. In a time of intense economic competition such as globalization has engendered, the value of military strength rises considerably.

The petroleum industry has been created and developed by entrepreneurs and later by oil companies, which in the process acquired extraordinary expertise and know-how relating to locating and exploiting oil deposits. For these corporations oil was a product to be extracted, processed and sold. In order to grow the business and supply their customers they looked for oil wherever it could be found. Through the hazards of geology, this was often in states that were politically weak and considered “backward” by westerners. The “modus operandi” of the oil companies was to buy an exploitation license from whatever government was there, pump the oil out and pay the state a limited royalty. They had no interest in raising the price of the product as long as they made a decent profit. In fact, the oil majors long kept the price low in order to expand their market.

While some institutions (particularly the British navy) quite early became aware of petroleum’s military value, it was only after WW II that its strategic importance became clear. Between 1945 and 1970 the vast majority of colonies became independent, and from then on it was only a matter of time until the oil-producing states realized that the petroleum deposits within their borders were much more than just a useful commodity.

The following years saw not only the first major rises in oil prices but also the gradual nationalization of oil deposits worldwide. Today between 80 and 90 % of world oil reserves are in the hands of state-owned corporations, with the oil majors being progressively reduced to the role of exploration and drilling contractors.

While the take-over of the Russian oil industry by the state under Vladimir Putin has generated many negative comments in the western press, the fact remains that Russia only did what the vast majority of oil producing states (including US ally Saudi Arabia) had already done years ago. And since the most promising areas left to explore for oil and gas are within the countries where energy is under state control, the trend state ownership of oil fields is irreversible.

This trend represents more than a simple change in ownership. The attitude of governments towards energy resources differs from that of private corporations on two major counts. First, states do not look on oil (and gas) revenues as a source of profits to be distributed to shareholders, but as a source of cash to be included in the national budget. For this reason they will drive the price to the highest level the market will bear, and beyond that if feasible. Since it is now becoming clear that oil is a “scarce” resource, they have no interest in lowering the price so as to broaden the market, as the oil majors used to do in the past. The higher the price, the fuller government coffers will be, and that is the state’s first priority.

Second, governments think more strategically than corporations do. They not only have, in general, a much longer planning horizon, but in addition they take into account political and strategic considerations, and not just economic ones, when determining policy. Energy resources, therefore, once in the hands of the state, will inevitably become a strategic tool. Russia has been (correctly) accused of using its oil and natural gas resources in such a fashion. But every state in Russia’s position will do so, maybe less blatantly, but with the same desired results in mind.

State ownership of resources does not fundamentally change the energy resource equation, but it complicates it, since politics as well as economics and technology must now be taken into consideration. In a theoretical free market all customers are equal, and availability and price are (again theoretically) determined only by supply and demand. The petroleum market is no longer, even remotely, free, ideal or theoretical. It has been heavily invade by politics, which only adds urgency to the energy issue.

There are two ways to deal with an essential resource the availability of which is becoming restricted. One is to obtain more of it (by whatever means are thought necessary), or to make better use of whatever one can get. The second is to find or develop an alternative. We will deal with the second approach first.

What are the alternatives?

The immediate question is “What are the alternatives to petroleum?” because that the urgent issue. The broader one is “Are there alternatives to fossil fuels in general?” The answer to both is ultimately the same, but the time scale is different, which is of major importance in practice.

Before an attempt to provide answers (however incomplete) is made, one key concept needs to be clarified, namely what “sustainable” means. It is often said or implied – particularly in the context of the climate change (”global warming”) debate – that the alternative to an economy powered by fossil fuels would be a “sustainable” one. In other words, that the “alternative” economy would only use such energy as is delivered by ongoing natural processes (sunlight, wind, plant growth, and so on).
Here it is good to repeat what has already been stated earlier: that the pre-industrial economy was fully “sustainable”, as defined above. It used only “natural” inputs, and “recycled” just about everything – since all goods were made to last as long as possible, there was very little to recycle. The industrial economy, by complete contrast, was and still is an escape from sustainability, made possible by the expenditure of energy stored in fossil fuels.

A return to sustainability as existed in the past is therefore not even conceivable at this time. There is no way the current world population could be fed, clothed, and provided with the bare necessities without still significant inputs of non-renewable (fossil) energy. Whatever formula eventually emerges from the incipient shortage of some sources of fossil energy, it will in all probability involve methods of generating and using energy which do not exist today, and which will have to be invented. And they will be, as necessity is the mother of invention, and the current alternatives are simply not adequate.

Can fossil fuels be replaced by other (currently known) forms of energy?
There are currently two candidates: electricity and “renewable” fuels.

Electricity

Before even starting, it must be remembered that ever since electricity was developed, the dream of an “all-electric” civilization has been promoted and pursued without ever being attained. Current proposals in that direction must therefore be taken with a measure of skepticism. When something long predicted and hoped for does not materialize there usually are good reasons for it, be they technical or economic, or both.

The primary drawback of electricity with respect to fossil fuel (coal, oil or gas) is that it cannot be stored in large quantities. It must therefore be generated according to demand, or used according to supply. This requires an active power grid, involving four major components: generation, transmission, storage (whenever unavoidable) and overall control.

Generation

The bulk of electricity used is currently generated in plants burning fossil fuel (mostly coal, with natural gas and some oil used as well). As far as fossil fuel is concerned, the only potential to substantially increase electricity generation lies in using more coal. This is both economically and technically feasible, but may run into constraints due to concerns about climate change, since burning coal is a major source of atmospheric CO2. While the theory of human-induced climate modification through greenhouse gas release is still a working hypothesis and has not been conclusively proven, it nevertheless has considerable support within the scientific community and should induce prudence with respect to large increases in coal consumption. Should the impact of CO2 on climate come to be fully demonstrated, this avenue will quickly become a dead end.

The nuclear alternative

The generally proposed alternative to coal, for the purpose of electricity generation, is nuclear energy. This alternative, however, is one of those “solutions” that work wonderfully on a small scale and become progressively more impractical as the scale is increased. Leaving aside security of operation (which can be improved through design) and the NIMBY (“Not In My Back Yard”) issue (which will fade if the need for energy is dire enough), the two insurmountable problems are proliferation and waste.

Nuclear power plants use (and produce) the same materials as are used in nuclear weapons. Controlling where these materials are produced and how they are used is already a serious issue today – witness the ongoing (and so far unsuccessful) US attempts to shut down Iran’s and North Korea’s nuclear programs. These attempts rest on the premise that only “responsible” and well-governed states should be allowed to possess nuclear technology, criteria which will always include a good deal of subjectivity.

If, however, nuclear power is generally recognized as a major and legitimate alternative to power generated by the burning of fossil fuels, the possession of nuclear technology essentially becomes a universal right, since all states can be said to have equal rights to a basic supply of electrical energy. Once this is established, then the spread of nuclear technology will become general, and the few hundred reactors now operating (and concentrated mostly in the developed states of the northern hemisphere) will become thousands dispersed over the entire globe. With that number of facilities in operation it will become practically impossible to control either the fuel production pathways or the ultimate uses of the technology beyond power generation. With that many facilities in operation there will inevitably be leaks and lapses of control, and fissile materials and weapons technology (not even speaking of easy-to-make “dirty bombs”) will inevitably disappear and start circulating underground. With reactors and nuclear fuel facilities having a useful life measured in decades, there will be no way to determine which government is (and will remain) “responsible” and which is (or will become) “rogue”, since governments and political parties can shift several times from one category to the other within the lifetime of a nuclear facility.

The risks of “misuse” of nuclear technology and materials (and the results of a single such incident could be catastrophic) will rise in direct proportion to the number of nuclear facilities built and to the extent and complexity of fuel processing networks. We can, of course, choose to ignore this problem (as the Soviet government chose to ignore the problems inherent in the “Chernobyl” reactor design) and let our descendent sort the situation a generation from now. It would however be far more prudent to face up to it while we still have the opportunity to make our decision at leisure.

The radioactive waste problem runs in parallel to the proliferation issue, with a delay in time of a couple of decades. Nuclear materials (including the components of decommissioned reactors) remain dangerous for extremely long periods, and the quantities to be disposed of safely will vastly increase if nuclear power is accepted as a bona fide mass energy solution. The US has been searching for a solution for decades, so far fruitlessly, while radioactive waste keeps accumulating. The Soviet Union was far less scrupulous in this matter – large amounts of waste were simply buried on land or dumped at sea – but such “disposal” methods are now recognized as unacceptable. If we have that much trouble dealing with the limited amounts of waste generated today, how will the world deal with quantities which are larger by an order of magnitude? Where will those huge quantities of dangerous waste be stored, how will they be transported to that location, and what authority will supervise the disposal? The question is not simply practical, but is an ethical one as well: who will take the responsibility of imposing that burden on future generation, and on what grounds will such a decision be justified

Introduction - The Paradigm Shift in Energy (Part 2)

2008-07-07T16:00:00.000-07:00

The Left against the Right

It took roughly one century for the two camps to develop their respective ideologies and to get organized. The struggle between the socialists and the capitalists, between the defenders of the free market and the proponents of state power, gradually became the main reason for existence of the revolutionary and reform movements that came to dominate the political life of the 19th century. In this contest of ideologies both sides appropriated elements of earlier political debates – the structure of government, the issues connected with human rights, the role of religion and culture in political life – and incorporated them into their respective world outlooks. The 19th century thus produced the ideologies around which the wars and struggles of the 20th would be fought.

Both sides firmly believed they had right on their side, so the contest gradually became an all-or-nothing struggle. Ideological positions hardened, and compromise as a means of peaceful resolution was largely abandoned. As the 19th century progressed the divide between Left and Right widened, with each side attempting to crush and destroy the other. Over time ideology (be it of the left or of the right) gradually replaced nationalism as a political motivator. The failed revolution of 1905 in Russia was the first major battle of a contest that would last until the end of the century.

The struggle culminated in 1949 when China fell into the socialist camp. The world was now roughly divided between the two alliances, one of socialist, the other of capitalist states. Both were armed with nuclear weapons and capable of fielding massive armies. On the socialist side every human activity was under the control of the state. On the other the capitalist market system was preserved. The socialists had control, the capitalists retained private initiative.

The Cold War was a massive waste. Enormous energy and resources were expended in a military and economic stand-off that should never have existed. It might have been otherwise had the dependence of the industrial economy on the consumption of fossil energy been better understood. The myth, however, of the limitless riches it offered together with the promise of a new (and final) era of endless prosperity was too attractive to allow for rational analysis.

The above is not meant to suggest that there was some kind of moral equivalence between Stalin’s Soviet Union and the western democracies. Stalin (as Lenin before him) was a tyrant and as such the West had no choice but to resist him. But it must also be said that Marxism, which provided the philosophical foundation for the Soviet system, was ultimately based on the belief in indefinite human progress which originated in Western Europe. Marx as well as the other seminal socialist and communist thinkers were born and educated in the West and their ideological work is inseparable from the extraordinary success of the Industrial Revolution.

The Cold War ended with the collapse of the Soviet Union as a political entity, and the capitalist system was declared the victor. “Free markets”, then, were the true answer and the superior formula, and capitalism was given, just as at its beginnings, free reign to expand, enrich its practitioners and solve mankind’s problems

There was a double error in this conclusion. First, the triumph and worldwide spread of the consumer culture developed in the West only exacerbated and brought forward the inevitable clash between finite energy resources and the promise of indefinite economic growth. Second, it was not the wild and unbridled capitalism of the 1800’s that had won the “victory” – a capitalism which was western industrialists and financiers, assisted by Russian oligarchs and Chinese billionaires, were attempting to resurrect. The “victor” was in fact a highly socialized political and economic system, where the power and reach of the state had grown enormously, and industrial activity was hemmed in by numerous constraints involving labor conditions, safety nets, pensions, environmental regulation, private and corporate taxes, and so on. Capitalism had not defeated socialism, nor had socialism vanquished capitalism. They had, in fact, blended.

Each state (or federation of states, like the European Union), now had its own hybrid system, differing only in matters of degree. Even Lenin, in the midst of the Russian Revolution, had come to realize that the state could not control everything, and as a result had set up the New Economic Policy, which allowed a limited amount of private enterprise. Though Stalin quashed this policy (in the process condemning the Soviet economy to perpetual inefficiency), private enterprise never entirely disappeared from the Soviet system, and in fact grew (though always unofficially) as the economy became more complex and the limitations of central planning were exposed. Private plots, industrial “fixers”, underground businesses and all kinds of “off-plan” initiatives multiplied. Unable to control these developments, later Soviet leaders such as Andropov and Gorbachev realized they might as well make room for some form of capitalist efficiency and modify the system accordingly, as other socialist states, such as Hungary or Yugoslavia, had already done.

A similar assimilation process had been at work in the West since the late 1800’s. Labor unrest on the one hand, and simple humanity on the other, convinced both industrialists and government officials that workers could not be treated like abused pack animals. This trend was reinforced, after 1917, by the threat of communist subversion; and, after the crash of 1929, by the evident failures of laissez-faire capitalism. Even though the resulting reforms were initially decried as “Marxism in disguise” they did promote social harmony. More importantly (from the business point of view), by enriching the working class they eventually resulted in the development of an ever widening number of potential consumers and the creation of new markets. While entrepreneurs and business executives attended to the new opportunities, politicians came to realize that offering various government-funded benefits was a handy way of securing votes. Whatever purists might say, however evil socialism might be in theory, in practice its milder forms it sell rather well. The United States, the world’s greatest bastion of free enterprise, today has more (and better funded) entitlement programs than ex-Soviet Russia.

For many this gradual blending of left and right, and the resulting bridging of the centuries-old divide between warring economic and political systems, is all for the better. And so it would appear, except for a new convergence of problems.

The new paradigm - Neither right nor left

The merging of capitalism and socialism into hybrid systems of slightly different flavors can be seen as a welcome development, since it is putting an end to a struggle for world domination that has been both costly and, when it turned into open warfare, violent, bloody and destructive. Indeed few wars in history can rival, in terms of intensity as well as human and material losses, the revolutions and conflicts of the 20th century. The fading of the left-right divide has, however, negative consequences as well. These are at work in both the political and the economic spheres.

The development of modern industry was paralleled by the birth and growth of the political system known as representative democracy. Whether the two are or not interdependent would be a fascinating subject of study, but would go well beyond the scope of this book. Let it be said, however, that as western society went from primarily agricultural and rural to mostly industrial and urban, representative democracy made parallel and nearly simultaneous strides. Thus the political development of the modern western world, which has been primarily the development of democracy, has from the very arising of that form of government also been concerned with, and to a great extent dominated by, the issues created by the industrial revolution.

Modern democracy was nurtured in England and the United States of America, and within those two states it developed its most stable form, which is based on the two-party system. The great advantage of this system is that it allows for the easy formation of a stable majority with a clear mandate to rule. At the same time, however, it also enables the opposition party to gain power through a relatively small shift in voter preferences. The two-party system avoids the complexities, compromises and potential paralysis of multi-party coalitions, and yet is remarkably responsive to changing patterns and preferences within the electorate. It has proven itself to be the most practical form of representative democracy.

A party needs a distinctive platform in order to attract potential members, and to support discipline and commitment among the members that have joined. Such a platform in turns needs to be founded on a clear set of philosophical principles around which the voters’ interests can be organized into a coherent whole and translated into policy. Within a two-party political structure there must be two such sets of principles, different enough to allow the voters to distinguish between parties, but not to the point of being mutually exclusive – in which case the political structure would split into hostile halves, as happened in the US on the eve of the Civil War.

It was almost inevitable that once the basic issues connected with the nature of the US political system had been dealt with (that is, after the Civil War had been fought), the parties would eventually define themselves according to the great questions raised by the industrialization of the country the choice referred to earlier as the one between Left and Right. This alignment took time to crystallize, because up to roughly 1870 the key preoccupation of the nation was with westward expansion. It was only after the Frontier had been closed that full attention could be given to “the control of the means of production”, which were now replacing land and agriculture as the main source of employment and wealth.

The industrialization of the US began almost a century after that of Europe. America was isolated from Europe both physically, by the Atlantic, and mentally by the westward orientation of US expansion. These factors tended to mute the ideological intensity of the American version of the debate between Right and Left, but the same issues had nevertheless have to be dealt with. For a time both American political parties borrowed ideas from the Left and Right simultaneously and interchangeably. After the presidential election of 1912, however, their paths were set: the Democrats became identified with the “Progressive” approach (closer to the Left), while Republicans took the “Conservative” side (leaning to the Right).

These orientations have defined the two parties in the public mind since the New Deal, and the resulting perceptions were reinforced by the policies of later presidents, particularly Lyndon Johnson and Ronald Reagan. Even today many think of the Democrats as “the party of the people” and of the Republicans as “the party of business” – and for a long time the respective platforms have been shaped accordingly.

As capitalism and socialism drifted towards a common hybrid form, however, the differences between the parties have faded. In order to maintain their distinctiveness and their appeal both parties have looked for, and embraced, new causes which were compatible with the interests and leanings of their respective voter bases. The Republicans thus embraced “values” while the democrats went for “openness” and “tolerance”. The parties also sought to recruit newly defined fractions of the electorate (women, Hispanics, urban professionals, blue collar males …) whose views were more or less compatible with the each party’s fundamental orientation. None of the new “causes”, however, could generate the dedication, interest and intensity of the old Left-Right divide. At the same time the addition of new groups or factions, while providing a numerical gain, also diluted and enlarged the party platform. With the loss of their ideological soul (through the working of history, not any fault of their own), the parties over time morphed from organized and disciplined entities into amalgams of disparate lobbies and interest groups.

Many of the negative features of today’s politics derive from this “loss of political soul”. When there is no higher cause to serve, dedication and service can no longer be counted on; they must be purchased, hence the growth of the power of lobbies and interest groups. When there is no clear party identity, one must rely on an artificially created image (positive for oneself, negative for the opponent), which implies an ever increasing use of manipulative advertising, with the associated escalation in election campaign costs. With no overriding purpose to achieve, political activity becomes dominated by self-preservation, even if that means satisfying every interest group in sight at the expense of the nation as a whole. At the end of this dilution process politics becomes a game played by professional operatives willing to hire out out to the highest bidder.

The most telling signs of this political dissolution are the ever lower approval ratings of the governing institutions and, more importantly, the growing numbers of independent or uncommitted voters. There was a time, not so long ago, when one would be either a Republican or a Democrat, and that was it. Switching allegiances was rare and considered a mild form of treason. Being “independent” was an incomprehensible concept. There could be no point to it because the issues were clearly defined. One could be on one side or the other, not in the middle.
With the political elite preoccupied with its own self-preservation on the one hand, and on the other an ever increasing number of disenchanted voters sitting on their political hands, the political machine is now both directionless and paralyzed. Effective action, however, is urgently needed, and this on two levels:
The first need stems from the contradictions inherent in the blending of capitalism and socialism within a single political and economic envelope. The second involves the looming long-term issue of the collision the concept of indefinite material growth with the reality of finite energy resources: in other words, the definition of the “post-industrial” world.

First the short term: we have stated earlier that capitalism and socialism have merged into hybrid systems. But a merger does not necessarily mean reconciliation or integration. In this case it is a compromise of convenience, with both the Left and the Right still convinced of the superiority of their respective ideologies (although no longer willing to die for them). The Right interprets the collapse of the socialist block as a license to return to unbridled free markets. But markets are no longer free, with the old industrial economy now shackled by numerous, government-imposed, constraints and controls. The solution to this dilemma is the escape into a globalized economy where capital and goods can move (at least in theory) without interference from governments. But the power and reach of states have grown, and with that their ability to tilt the economic playing field according to their national interests. As a result globalization has not created a free world market, but a confused arena where the free market policies of some states collide with the blatantly mercantilist practices of others. These differences have led to major economic imbalances without a supreme arbiter to set them right.

On the other hand the general acceptance of at least some socialist principles has saddled the governments with ever greater obligations without giving them the necessary resources. These resources escape into an uncontrolled global economy even as states are required to do more for their respective populations. At some point something has to give. For the US right now, the weak point is the currency. Excessive and ever increasing trade and budget deficits are creating a situation where a “run on the dollar” – sudden or gradual – would have the potential to undermine both the US and the global financial systems.

This growing problem, as well as a number of others which will be dealt with later in this book, will not be solved without a firm national policy. The pre-condition for such a policy to emerge is a political realignment of the two-party system around a new set of issues, so as to offer the electorate a range of options around which a national dialogue can take place. These options will be provided by the energy issue.

Hello Friends,

2008-07-02T13:31:00.000-07:00

There have been no postings on our blog for a good three months, and the reason for this is simple. We have felt that many of the concepts and ideas presented here should be tied together in a coherent whole, connected to current reality. From this came the project of a book, now in an advanced stage of realization.

The book focuses on what we believe to be the greatest challenge facing our country: the supply and use of energy. We are convinced that all the other issues will not find a resolution until this one challenge is met, and soon. The book therefore outlines a set of major policies – all connected to energy – which we believe the next administration needs to implement with the highest priority.

We intend to “self-publish” this work, but as the project proceeds it is necessary to obtain some initial feedback. We intend therefore to “serialize” the draft on this blog – at least through the introductory chapter, and possibly further. The first installment appears below.

All feedback and suggestions welcome!

Introduction: The Paradigm Shift in Energy

2008-07-02T13:27:00.000-07:00

The paradigm of infinite growth

Our current economy and material way of life are rooted in the fundamental change that took place in the 18th century and which has become known as the Industrial Revolution. Up to roughly 1750 all human economic activity had been strictly of the sustainable kind, and this was not by choice but by necessity. All available inputs used in economic activity – such as forests, fields and domesticated farm animals were what we would call today renewable (with the exception of metals, which were hard to produce and therefore expensive. The only power used was human or animal, with water and wind added whenever feasible. The resulting scarcity of energy resulted in slow (by modern standards) and uneven development, with the bulk of production dedicated to human and animal subsistence. Whatever surplus could be produced was mostly invested – usually is highly durable assets such as buildings, defensive fortifications, mills, and a range of high quality goods produced by skilled and experienced craftsmen. The preference given such long-term investment was the natural response to the vagaries of weather, poor crops, wars and plagues. With luck such durable assets would slowly accumulate and contribute to a gradual rise in the standard of living, which is what occurred in Europe between the 9th and the 17th centuries, leaving behind a legacy of fertile fields, superb buildings and magnificent art.

This age-old pattern of slow wealth accumulation was radically changed in the 1700’s through introduction and development of mechanized manufacturing. The use of machines in the production of goods allowed for a quantum leap in the amount of goods and by the same token lowered their price. While advances in engineering and the mechanical crafts were critical to this development, the fundamental difference with the past and the change which made the Industrial Revolution possible was the large scale use of fossil fuels to power the new mechanized industries as well as the associated means of transportation. Without the introduction of this “new” source of power the large-scale use of machines would have been impossible.

The use of fossil fuel had two advantages: first, it was available in (apparently) limitless quantities, thus eliminating the constraints associating with the renewable power sources that had been used before. Wood needs to grow, and the rate at which this happens limits the amount of wood that can be harvested in any given year. Coal, on the other hand, can be dug up at any rate one chooses. Second, fossil fuel delivered far more energy than was needed to procure it. It is this energy surplus which in the end made mechanization possible, and with it the vast increase in material production brought by the Industrial Revolution. The shallower and more accessible the coal deposits, the greater the amount of disposable energy the extracted coal provides, and the greater the rate of growth of the associated industrial development.

In the course of the second half of the 18th century the constraints that had both shaped and limited material development from time immemorial were thus removed, at least in theory. Everything that in the past had been laboriously produced by hand could now be made much faster and in larger quantities by machines that were in turn powered by fossil energy. Whereas in the past economic development meant the slow accumulation of high-value assets, it now gradually shifted to rapid production of goods that could be consumed. Growth, rather than accumulated wealth, became the new paradigm of economic success. The (apparently) limitless availability of fossil-based physical energy allowed the economy to expand significantly within a matter of years, rather than generations as had previously been the case. Growth meant higher incomes for the producers and greater comfort for the consumers. For governments it meant a constant expansion of tax revenue, with which armies could be equipped and empires acquired. Growth was desirable for all concerned and became the paramount goal of all economic activity.

Increased production, however, required both greater and faster consumption in order to be profitable. Thus the logic of growth for its own sake led to the fostering of the mass market and of the consumer economy. The economic growth paradigm demands that every individual constantly increases his or her consumption of the goods that are produced. Within this economic model even waste (as in the case of disposable containers and packaging) is useful, since it contributes to growth. The value, quality and usefulness of goods produced will also suffer. The growth paradigm of the modern era is thus the complete opposite to that of the previous historical periods, which favored the slow accumulation of goods having both great value and long life.

The fact that goods are of lesser quality and more transient value does not of course matter under the growth paradigm, as long as the energy provided by fossil fuels is both available and inexpensive. And so it has been for approximately two centuries, after the Industrial paradigm became established in the late 1700’s. The 19th century saw a vast expansion of industrial production based primarily on the steam engine fired with coal. This expansion continued during the twentieth century, with the emphasis shifting to the internal combustion engine, and later the turbine, burning petroleum and its associated or derived products.

Petroleum is the king of fossil fuels. It has high energy content, can be stored at room temperature, cheaply transported and safely handled. It is (or at least has been) available in huge quantities, and in addition to its use as a fuel it serves as raw material for a variety of chemical processes (as coal did before). Today’s transportation infrastructure is almost entirely based on petroleum, with the United States (once the world’s greatest oil producer) in the lead.

In summary, the discovery and large-scale exploitation of fossil energy have been the foundation of the modern economy. They shape both our material way of life and the way we think about it. At economic policy they underlie all commonly accepted the assumptions, including the primary one that GDP must expand constantly and indefinitely, as must individual and collective consumption. Because fossil fuel is available in such extraordinary quantities, these assumptions have never been questioned.

The dawning limitations

It has been stated above that all pre-industrial economic systems were, by necessity, sustainable. They could not use renewable resources at too fast a rate without destroying their economic foundation – which some civilizations in fact did, and perished as a result. But even when a state or empire drifted into this form of economic suicide, it took decades, if not generations, for the resources (such as forests or fertile topsoil) to become exhausted. These resources might, to the populations of the time, have appeared so large as to seem inexhaustible, and their exploitation did not appear to have destructive effects until close to the end, when it became evident that something was amiss, and it was too late to fix it.

We are in a somewhat similar situation with respect to fossil fuels and the various forms of energy derived from them, except that we still have a choice. The reserves accumulated during a good part of earth’s geologic history are indeed enormous, and the progenitors of the Industrial Revolution were excusable when they considered them to be, for all practical purposes, inexhaustible. But it was impossible for them to predict that the new industries they had created – which many at the time regarded as the dawn of a new age – would be the foundation our current economic growth paradigm. In the end everything on the globe is finite, including fossil energy resources. Economic growth however, as understood today, is on the contrary assumed to go on indefinitely. This is not feasible when resources, however abundant, are still finite in the end. Sooner or later one will run into some kind of limitation, and this is now happening with our most valuable energy resource, petroleum.

There has been, and still is, considerable discussion about whether we have reached “peak oil”, or the level of maximum production that will ever be feasible. While the timing of “peak oil” is an interesting subject to debate, it is probably not the most useful concept when attempting to determine the cost and availability of petroleum. There are too many variables in play, such as the probability of new discoveries (which are still occurring); the development of new recovery techniques (in constant progress); the improved ability to locate deposits; the effects of economic conditions on demand; the response to higher prices, and so on. A more useful concept would be the cost of extraction (how much it costs, on the average, to get one barrel out of the ground); or, more fundamentally, what could be called “the energy margin”: the fraction of the energy in each barrel extracted that remains available for consumption after subtracting the energy used to get that barrel out of the ground.

This “energy margin” was extremely high – close to 100 %- for many of the early oil finds in the US, such as the giant East Texas field. It probably still is very high for a number of oil producing areas such as Kuwait. But even a cursory analysis of new fields now coming on line (such as the Kashagan field in the Caspian, the Khurais field in Saudi Arabia and the new “Pre-salt” discovery off the Brazil coast) shows that this margin is dropping while the cost of extraction is inexorably rising. The two measures are to some degree interchangeable. The cost of extraction affects the price of oil, while the “energy margin” essentially determines how much “net” energy the oil will provide. The cost imposes a market limitation (for example, how much a flight from New York to London will cost) while the energy margin determines an absolute quantitative limit (how many flights from New York to London are possible).

Both the rising cost and gradually decreasing physical availability of petroleum undermine the “indefinite growth” paradigm in place since the beginning of the Industrial Revolution. While there are at this point no such limits for the other major fossil fuel, coal, the gradually tightening constraints on petroleum price and availability will require substantial changes in the way we use, and think about, the role of energy in our economy. As stated before, petroleum is the king of fuels. There is no substitute for it, as will be explained in some detail later in this book. Its gradual fading from the energy scene will cause a cascade of adjustments, and will in the end require the development of a new paradigm for economic activity. Defining this paradigm will one of the major challenges faced by society in the 21st century.

The formulation of this alternative outlook and approach will take time. It will be a collective undertaking, just as the Industrial Revolution was a collective endeavor that required a couple of generations to pass before its results could be seen and understood. The emergence of a new paradigm will have major consequences, for not only our economy, but also our social organization and our political systems, which have been profoundly affected by the Industrial Revolution. It is to this political aspect that we will turn next.

The old paradigm – Political alignments

The control of the means of production

The Industrial Revolution did not only influence economic thinking, but it initiated a political revolution as well. Before the changes brought about by the availability of surplus energy from fossil sources, economic development was based on gradual wealth accumulation. Political stability was a prime requirement for such accumulation to be possible, so the necessary counterpart of the sustainable economy of previous periods was a political system that was static or evolved only slowly. War or political upheaval on the modern scale – revolutions or total war involving mass mobilization – would have been suicidal in those times, for they would have rapidly exhausted the economic resources available. Therefore conflicts tended to be settled within the existing political structure under rules aimed at minimizing collateral damage. When the rules broke down – as in the case of the Thirty Years War in Germany (1618-1648) the resulting devastation took generations to repair.

The pre-industrial political system was based on an interdependent structure within which the leading components of society (the “orders” of aristocracy, bourgeoisie and church) were balanced against each other, but at the same time bound by a set of mutual duties and obligations. The structure, elaborated by trial and error during the Middle Ages, was designed for stability and held together by a set of beliefs and rules assumed to be heaven-ordained, eventually culminating in the concept of “divine right” hereditary monarchy. It was a coherent and eminently practical system, and over seven centuries it allowed the nations of Western Europe to rise from the status of barbarian backwaters to that of ruling global powers.

This elaborate structure of duties and privileges was thrown out of balance by the relatively sudden increase of wealth created by the Industrial Revolution. With it a new social component was born out of the merchant class – the industrial capitalists whose wealth, within the space of a couple of generations, surpassed anything that had, up to then, be thought possible. Simultaneously the new machine age brought about the belief in continuing human progress and in the potential of a new “golden age” of science and prosperity. How this new era would be managed became not only a practical, but a philosophical issue as well.

Since the promised material abundance was based on the new mechanized factories where the flow of goods originated, the key question centered on how and by whom these facilities would be owned and managed. To phrase it in the words used at the time, the key political question arising from the Industrial Revolution was that of the control of the means of production. The answers given to that question as it arose have defined the political alignments of the following two centuries (and they still do, though most of us are not aware of it).

The sudden potential to provide apparently infinite wealth did not fit within the old system based on gradual evolution and slow accumulation of resources. There was no question, as the Industrial revolution began to unfold, that a new way of dealing with the distribution of wealth had to be designed, and a new political structure set up to manage it.

Two schools of thought arose out of this quandary. The first – which eventually became the “conservative” approach, was to leave control to the originators and creators of the new abundance: the industrial capitalists. Since this group, through its talent, willingness to take risks, and creative management, had brought about this increase in human fortunes, they should be entitled not only to lead it into the future, but to enjoy its fruits, meaning that the bulk of the new wealth being created should remain the property of the capitalist class.. This wealth would be best left in the hands which had initially made its creation possible, and who were therefore most qualified to invest it further.

The second school took the opposite position. The new wealth, its proponents argued, was not produced by the industrialists but by the masses of workers who toiled (often in abject conditions), in the newly created production facilities. Allowing the industrialists and bankers to keep and enjoy the fruits of this labor was not only unjust but wasteful, since the proceeds would then be spent on useless luxuries rather than on the general improvement of mankind. The social order that allowed such abuse had to be overturned. The exploited masses had to be organized, and the reactionary governments colluding with the capitalists were to be overthrown by revolutionary action. The new political structure emerging from this process would then take over and insure fair distribution to all.This fundamental dichotomy – the division of political thought in two opposed and inimical camps, the capitalist and the socialist – became the dominating political issue within western political life. The split was, of course, not exclusively about economics. There were social and cultural influences as well. But at the core of the debate was the disposition of the new industrial economy and of the wealth it produced. Without this wealth the debate would not have taken place, at least not in the form it took throughout modern history. And the ultimate foundation of the new industrial system was fossil energy, which powered it and made it possible.

Secularism - The Political Impact - Summary

2008-03-20T17:50:00.000-07:00

SECULARISM – THE POLITICAL IMPACT
SUMMARY

The 20th century has seen the rise and fall of particularly brutal and ruthless totalitarian regimes, a phenomenon not seen in history before the French Revolution. Some historians have linked the genesis of such regimes with specific national traits within the populations of the countries in which such regimes developed. This approach, however, cannot explain the fact that the similarities between totalitarian governments are much greater than their differences. This suggests the existence of a common factor and/or set of circumstances leading to the birth of such regimes.

This common factor is the rise of secularism. Before the modern era all political and social organization was based on what can be termed “traditional belief systems”, which had one property in common: all assumed and took it as an article of faith that there are transcendental laws and ethical standards against which human behavior can be evaluated in terms of right and wrong.

The essence of secularism is the denial of the objective existence of such laws or standards. Within the secular outlook, man alone determines which actions are correct or incorrect, beneficial or destructive. By its very nature secularism undermines traditional belief systems and seeks to replace them with a new framework, which is what is commonly called an ideology.
Ideology has two primary characteristics. First it is a totally coherent construct, providing ready answers to all questions. Second, it always states or implies that once the ideology is implemented, mankind will reach an ideal, and possibly final and complete, state of existence. This gives those who create, interpret and implement the ideology a superior status: that of leaders anointed to lead mankind to the ideal state, and therefore endowed with the power and right of final decision and judgment. By contrast those who would oppose them are enemies of human progress and therefore doomed to elimination.

From the above it follows that ideology is a powerful tool for political organization and the acquisition of political power. It allows ambitious leaders to create a highly organized, motivated and disciplined militant group ready to use all means necessary for such acquisition. Under normal circumstances such a group would be repressed or at least marginalized. But is a “time of troubles”, a situation of social, political and economic collapse – such as occur periodically in history – such a group will have definite tactical advantages over the existing government and might be able to take power.

The three factors described above – secularism, ideology and social dislocation – have been present to a high degree in before the rise to power of every totalitarian regime. They provide the common thread that ties them together, explain their similarities, and allows, hopefully, to predict and prevent their future rise.

Secularism: The Political Impact

2008-03-20T17:43:00.000-07:00

Introduction

This essay is an attempt to determine what is the root cause (and/or primary facilitating circumstance) of the rise and the nature of modern totalitarian governments – such as Soviet Russia or Nazi Germany. It is in a sense a continuation of the debate concerning the causes of the rise of communism in Russia, which at one time involved A.I. Solzhenitsyn. In this debate the opposing views were as follows: on the one hand some historians argued that Russia’s past, which included such despots as Ivan the Terrible and Peter the Great, predisposed her to fostering authoritarian and brutal regimes. Against this view A.I. Solzhenitsyn asserted that Russia’ past governments, even at their worst, were far from the level of ruthlessness and brutality experienced under the Soviet regime. The oppressive and destructive character of this regime, he argued further, was attributable to Marxism itself rather than to the national Russian character as manifested in history.

The argument connecting an assumed predisposition to totalitarianism to traits specific to certain nations is not new. It has been used to explain the rise of Nazism in Germany and that of military imperialism in Japan. While it is true that totalitarian regimes have used national traditions as a cover and a motivator, the theory fails to explain a more fundamental fact: that the similarities between totalitarian regimes are far greater than their differences, which implies that a common factor is at work. The identification of this common factor (or combination of factors) would allow to for a “general theory” of modern totalitarianism, explaining its genesis, rise to power, and further evolution. It would be able to explain not only the rise of Soviet power but that of similar dictatorships – such as Nazi Germany and Mao’s China, and would be generally applicable, give or take some local variations.

The thesis outlined in this essay is that the key underlying cause of modern totalitarian episodes is the rise of secularism as a primary component of modern culture, coupled with specific political and economic circumstances which are identical, or very similar, in all cases. Both elements are present in the genesis and development of radical totalitarian regimes, and both have worked in concert to produce, in every case, the same destructive results.
Three regimes will be taken as examples: the French revolutionary Terror, Soviet Communism, and German National Socialism. A final section will examine the possibility that another such a regime could develop in the foreseeable future.

Secularism and ideology

What is the causal relationship between secularism and the totalitarian state? Once we assume, as suggested above, that all totalitarian regimes have one or several key elements in common, one such element that immediately stands out is the critical role of ideology.
As far as the historical (and even archeological) record goes, all human societies have been organized on the basis of what can be called “traditional belief systems”, which are philosophical and ethical constructs explaining the nature of the universe and outlining mankind’s place in it. All such systems, without exception, include a set of transcendental ethical standards, or moral values, which define the worth of human actions and behavior. These standards are not considered to be man-made, but are accepted on the basis of higher authority. They are seen as eternal, divine, beyond human reach or explanation. From these values and standards derives the power that binds society together and allows for coherent behavior and rule. To abide by these standards is to obey the “heavenly order”. To challenge them is the way to chaos and destruction.

In the last few centuries of Western civilization (and particularly since the Enlightenment) the belief in transcendental standards has been challenged by the development of secularism, the essence of which is the negation of any super-human authority and of the associated transcendent standards of morality and behavior. Secularism posits no authority above man, and no absolute code of conduct against which man’s action are measured and judged. Within the secular concept, man is the sole authority over his destiny and his deeds, and the only arbiter of “right” and “wrong”.

This negation of a supra-ordinate order has fundamental political consequences. The vast majority of societies, even today, are still organized according to a generally accepted social and moral order, which ultimately rests on a base laid down before the age of secularism. Such a foundation will have considerable historical inertia, and will continue to support habitual behavior for a long time after secularism has replaced it as the leading cultural template. As the foundation is, however, challenged and ultimately eroded over time by secular thought, social and political necessity requires that the old order be replaced through the formulation of a newer one. A “traditional” organization of the universe (and of our place and behavior within that structure) is based on acceptance and belief rather than on rational formulation. If such belief is rendered obsolete a new mental organization of our surroundings must be developed. Since secularism does not leave room for faith or mystery (both of which imply powers or realms beyond our control) this organization must be intellectually airtight. Life, history and the workings of society must be explained in a way that leaves no room for doubt or error. A system of thought designed for that purpose is what is commonly called an ideology.

Two characteristics of ideology make it into an ideal foundation on which to build a totalitarian society. First, it is man-made, and therefore requires that the men in charge of its maintenance have total authority – and authority ascribed to the divine realm in earlier, “traditional” thought systems. Second, it is reductive. Because the human mind is finite a rationally developed ideology will never be able to answer all questions. Once the ideology has been constructed, any new question will be reduced to what is already established and will be answered accordingly, even if “what is established” is objectively incorrect. Those who question the ideology’s tenets will be labeled as intellectual and social misfits (or rebels, or saboteurs) and therefore enemies of society and of the state. Their destruction will be de facto justified on the grounds that the guardians of orthodoxy are the ultimate authority (by definition no higher authority exists to which they could be answerable) and therefore masters of the fates of everyone and all.
The creation and practical implementation of ideology will therefore inevitably follow the establishment of a secular outlook (whether this process is gradual or rapid). The amount of control the ideological masters will come to exert will in turn be directly proportional to the degree to which secularism has replaced the pre-existing belief system. This control will, in the end, be totalitarian and complete (in principle at least) because once secularization is complete everything must be reduced to ideology, or else the state will fall apart into a dust of rival groups and disagreeing individuals. In a fully secular society and under the rule of ideology one is either a docile sheep or one does not (and often should not) exist.

Many will say that such control is incompatible with human nature and the inborn yearnings of the human spirit. This, in the belief of this writer, is true, and it explains why modern secularism has not engendered an airtight totalitarian world, such as the one pictured in George Orwell’s “1984”. Yet pieces of such a world have been created and have lasted years if nor decades – 12 years for Nazi Germany and roughly 70 for the Soviet Union. The leaders of such endeavors, as Orwell’s fictional party members, intended them to last forever – witness Hitler’s Thousand Years Reich or Lenin’s Workers’ Paradise. The question then arises: if the human spirit is indeed resistant to ideological control, then what, other than a general secular attitude, brings such totalitarian entities into being; and what, other than war, brings about their demise?

The role of historical circumstance

As suggested above, it is an axiom underlying this analysis that the human spirit and human society will spontaneously produce a transcendent ethical system if left long enough to their own devices. While imperfect, such efforts will be expanded and refined over time, giving rise to what can be termed a “traditional” philosophical and/or religious system. Secularism, however, denies the human capability to reach a transcendental level, because it asserts a priori that no such level exists. This assumption is the basis for the claim to superiority over “traditional” belief systems. There is therefore an inevitable and enduring tension between the secular approach and the innate tendencies of the vast majority of mankind. This tension is most in evidence in the case of revealed religions, who directly oppose, based on divine authority, the claim of secular man to reduce all truth to what he can comprehend and formulate.

The equilibrium between secular and “traditional” thought is therefore a dynamic and unstable one, and the two opposing forces have ebbed and flowed through the course of modern history. The balance between secular ideology and traditional belief systems will, however, shift with circumstances. If war, economic collapse or some other combination of calamities, reach, in their effects, a level beyond what a given population is habitually capable of enduring, a window of opportunity will open for secular ideology and its supporters. In such times, when society is overwhelmed by chaos, dearth, danger and despair, the coherence and simplicity of ideology, together with the implied license to acquire and retain power through whatever means man chooses, will offer a definite tactical advantage. Such opportunity was evident in 1917 Russia, depression-era Germany and revolutionary France (with the respective ideologies being Marxist communism, National Socialism and radical Jacobinism). In the chaos and confusion resulting from war, famine and the disintegration of the state, relatively small but highly disciplined groups armed with a simple and coherent ideology can exert a power far above what their numbers would suggest, and recruit followers animated by the same single-minded enthusiasm.
Here it important to note that in order to hold on to their new-won power the aspiring totalitarian groups need not only to seize such power but also, in order to consolidate it, to maintain an atmosphere of crisis and struggle, be it internal or external. Only in such an atmosphere can the temporary tactical advantage provided by ideology be maintained. Hence the massive mobilization to rearm and remilitarize Germany under Hitler (followed, of course, by territorial expansion and war); the extraordinary effort to industrialize Russia and create a socialist society under Stalin; and, in revolutionary France, the massive internal purges, followed by the long cycle of conflicts which culminated in the Napoleonic wars. The huge waste and destruction involved in these undertakings (think of the Soviet Gulag, or of the 1812 annihilation in Russia of Napoleon’s “Grande Armee”) were not only secondary, but in fact “beneficial” for the regime. They prolonged the urgency, disorder and confusion which kept the victim populations from catching their moral and spiritual breath, and realizing how inhuman and wasteful the “new order” in fact was.

In summary, the genesis of a totalitarian movement follows a simple and logical progression: the secular worldview attacks the traditional ethical system and replaces it with ideology. The audacity and potential reach of this new “creed” then attracts individuals ready to sacrifice their pre-existing morality for the sake of power and what is presented as “human progress” or “historical necessity”. Once such a group is formed, ideology offers the leaders the potential of imposing total discipline on their organization.

To take power, however, the group needs a “revolutionary environment” (meaning a time of massive social, political and economic disruption). Such circumstances will occur periodically in history, and often radical groups will provide an extra push to make matters even worse. In such circumstances radical ideology and total discipline provide an advantage in both action and recruitment, particularly among the most vulnerable and most oppressed segments of society. If political power can be secured, the new leaders will then deliberately extend the time of trouble and struggle in order to further justify and consolidate their rule.

The historical evidence

So far we have posited that the presence of a powerful secularist wave trend, coupled with circumstances causing a partial or near total breakdown of society, will produce a totalitarian movement that is ideological in concept and ruthless in execution. Does the historical evidence justify such a view?

The three examples listed above do indeed verify this hypothesis. Before reviewing each one in some detail, it is useful to point out that the political structures in place before each “revolution” did not appear to make a difference:

Before the revolution of 1789, France was an absolute, “divine right” monarchy. By contrast, Germany in the 1920’s was a parliamentary democracy, whereas 1917 Russia was somewhere between representative democracy and autocracy. The type of political system in place did not seem to have made much difference.

It is significant, however, that all three governments appeared incompetent and were unable to meet the challenges at hand. Governments can, of course, fail for many reasons. But in the above cases the failure might have been compounded by the secularizing trend. In all three cases this trend was most pronounced among the elites. These were, on the one hand, the most receptive to the new ideas (at least in theory and as long as their position was not threatened). At the same time they stood to lose the most from the potential breakdown of traditional social structures. When the breakdown occurred, the leadership class of all three nations was a house divided: intellectually seduced by secularism and its ideological implications and yet obliged to defend the status quo in order to protect its own privileges and vital interests. Such a situation is not conducive to clear, unequivocal leadership, in sharp contrast to the decisiveness and total dedication of the revolutionaries.

Now for the historical facts of each case:

· France

France had been, before the revolution of 1789, the active center of the European Enlightenment, which was the major force behind the secularization of Western culture. Through the 18th century the rationalist “Philosophes” led a concerted attack on traditional French culture and on the country’s major institutions, including the Church, the monarchy and the existing social order. A new order, based on “enlightened reason” was proposed to replace the existing one.

Simultaneously the national finances gradually disintegrated over the course of the 18th century; the monarchy and the ruling aristocracy became isolated from the common people; wars were lost; a number of French colonial possessions had to be given up and the country was hit by famine and plague. France’s spirit and leaders were weakened just as circumstances demanded strength and decision. The stage was set for a totalitarian revolution and the replacement of the old value system by a nationalistic-patriotic ideology.

· Russia

Following Russia’s opening to the West in the 17th century the ideas of the French Enlightenment were adopted wholesale by the ruling classes. The westernization of the upper layers of society had the additional effect of separating the elite (the westernized “Rossijski”) from the mass of the people and the remaining traditional leaders (the “Russki”). This horizontal cleavage was similar to the gap previously created in France, but in Russia’s case the separation was magnified by the absence of a strong and established middle class, which could have provided a bridge. With the intellectuals looking west for inspiration secular ideas took hold, disrupting and weakening traditional culture. When the social upheavals, war, famine and social dislocation of the early 20th century weakened the country the opportunity was there for the Bolsheviks to attempt a takeover, and they took full advantage of it.

· Germany

While Germany was somewhat peripheral with regard to the 18th century Enlightenment, it became the leader of the secular rationalist movement which dominated philosophy and culture during the 19th. This secularist wave opened the door to ideology, and the successive disasters of World War I and the Great Depression provided the circumstances within which the most radical one, National Socialism, could gain the power to lead and reshape the German nation.
A similar situation developed at roughly the same time in both Japan and China, with the difference that in their case secularism was entirely a foreign import, adopted because of the apparent superiority of the Europeans over indigenous culture and technology. In both countries the chaos and confusion of the 1920’s and 1930’s provided the background for the totalitarian cycle to run its course as it had in Europe.

In all five of the above examples there are, despite differences in dates, locations and cultures, the same elements and the same cycle, as follows:

- The introduction of European secular humanism and its adoption by the elites, resulting in both a weakening of traditional beliefs and a separation between the “enlightened” elites and the still tradition-minded mass of the population.

- The development of a simplistic, aggressive ideology to replace the traditional ethical system

- A combination of circumstances which weaken the existing economic, political and social structures, providing the opportunity for a radical cultural shift

- A forcible takeover of the state by an organized minority professing the new ideology, and the consequent organization of a totalitarian entity based on that foundation. Because the massive cultural shift this process requires an atmosphere of emergency and struggle, the new regimes created and maintained such an atmosphere through a mixture of internal struggle (supported by terror) and outside aggression.

This process is what makes the similarities between totalitarian states far greater than their differences, and it also explains why these similarities exist in the first place. They are all based on the same foundation: secularism, which generates the need for ideology, which provides the motivational and organizational tool for political take-over; to maintain and enlarge its power the new ruling minority then creates the need for continuous struggle, aggression and militarization leading to total control (hence terror). These elements are not born out of specific national traits, but out of a common characteristic of the modern world culture and the modern mind. In fact, totalitarian movements (and militant Marxism is a prime example of this) seek to ultimately dissolve cultural and national differences within a single universalist template.

How totalitarian regimes end

It can be concluded from the above that modern totalitarianism is an essentially unnatural phenomenon. Its spiritual roots are in a modern trend that is probably unique in human history – the denial of any transcendental standard against which human behavior can be measured. It is then born and created in the midst of exceptional circumstances, and maintained through the deliberate extension of these circumstances and the institution of systematic terror. Such a regime will either burn itself out or quickly exhaust its human capital.

The historical record supports this “burnout” concept. Both the German National Socialist experiment and the Japanese imperialism of the 1930’s and 40’s were consumed by the conflicts initiated by their adherents. The much earlier experiment of the French “Terreur” simply ran out of revolutionary fuel, though its fire continued to smolder underneath the political and military trappings and policies of the Napoleonic empire.

The case of the Soviet Union turned out somewhat differently. World War II was the turning point in its evolution, because for Russia it was not simply a defense of Soviet Communism, but a war of national survival. Nazi Germany fought not so much to destroy the Soviet Union as to destroy Russia itself (Slavs were in its eyes an “inferior” race). The Russian nation that fought for its life was led by communists, but this was the only leaders it had, and there was no time to look for others. In that sense WW II “legitimized” the Soviet leadership. This leadership, however, while left in place, was at the same time crippled by its own ideology.

As explained earlier in this essay, ideology is a human construct that provides only limited answers to the problems of human nature and society, as well as the challenges of history. In addition, once an ideology has been created, it remains in its original state and does not evolve and adapt. The answers it provides are flawed and in certain areas outright wrong. It therefore exerts a limiting and paralyzing influence, which results in a built-in lack of realism and efficiency within any government structure based on its tenets. These effects gradually overcame the Soviet Union’s ability to act, and despite its immense power and resources it was gradually left behind by the march of history. In the 1980’s the General Secretary M. Gorbachev attempted a gradual and seamless move from Marxist ideology and structures to a more realistic approach, but such a move was impossible without an open denial of major parts of the ideology, which meant a clean break rather than a gradual transformation. The attempt at change was probably an honest one, but the end result was a collapse caused by the interplay of incompatible principles.

Communist China appears (so far) to have made a more successful transition. However, while the Soviet victory in WW II legitimized the Soviet leadership, the abandonment by the Chinese communists of Marxist ideology has had the opposite effect, leaving the government without an intellectual foundation other than a highly flawed “pseudo-capitalist” material prosperity ensconced within a political dictatorship. While this experiment still continues – to the great (and misplaced) admiration of Western elites – its long-term success is questionable, as argued in this author’s earlier essay “The Chinese disaster”. Let history decide.

What of the future?

Totalitarianism has been the great scourge of the 20th century, causing untold human suffering and material destruction, reducing nations to ashes and trashing the cultural heritage of many peoples. It is reasonable to ask whether it will it arise again in the 21st.

As mentioned above, secularism has a double effect: on one hand it weakens the spiritual fiber of the people (particularly of the leadership, which seems most attracted to it); on the other hand it gives rise to a reliance on ideology - the man-made replacement for the pre-existing belief system secularism undermines. A “time of troubles” then allows a militant minority, motivated by the new ideology, to take power and construct a totalitarian state.

It is doubtful that this process can be repeated in the same location within a historically short time span (less than several generations). The damage done by totalitarianism to the collective soul and body is too great, and the energy and material resource expenditure too exhausting. If it survives the totalitarian experience, a people needs time to heal and restore its spiritual and physical life, and such life as can be rebuilt is likely to contain some safeguards against a repeat of the totalitarian episode.

As long, however, as secularism remains part of the modern culture, the totalitarianism phenomenon will continue to lurk as a beast that can materialize anywhere, whenever the necessary conditions are present. The question then becomes: where are such circumstances present (or likely to become present) today?

A totalitarian state is still breathing in China, although it is being gradually overcome by its internal contradiction. The same can be said on North Korea and Cuba, remnants of the once mighty Marxist sphere. What of the near-term “potentials”? There are two:

· Radical Islam?

There has been a large amount of talk, in US right-wing circles in particular, about “Islamo-fascism” and the menace of militant Islam to Western civilization. According to American “neo-conservative” theory, terrorist organizations such as Al Qaeda, and similar “jihadist” groups, are the vanguard of a radical transformation of Islam from a relatively peaceful religion into an aggressive totalitarian entity, aiming at the destruction of Western culture and a world dominated by a puritanical form of Islam.

It is certainly true that Osama bin Laden in particular fits into the totalitarian mold, as demonstrated by the Taliban regime he supported in Afghanistan. But bin Laden’s call for the recreation (according to his personal blueprint) of the Islamic caliphate has never taken root in the Muslim world in general, even after the spectacular “success” of the World Trade Center attacks in September 2001. And whatever support he might have had has, by all indications, significantly dwindled since, aside from those areas where American military intervention has awakened a mixture of national and religious resistance movements, among which the Al Qaeda terrorists have managed to infiltrate themselves. The general trend among Islamists has definitely been away from radical Jihadism and towards more moderate approaches.

The key factor, however, is that Islam has so far proven to be very resistant to western-style secularization, and still is very much a living faith. A radical ideology has very little chance to take root in such ground, and only some comparatively small terrorist organizations have succeeded in developing isolated nuclei of fanaticism. Some are remnants of former Marxist groups, other offshoots of the new “Jihadism”, but they are comparatively small and isolated, and often motivated more by ethnic and territorial grievances than by some pan-Islamic political concept. Political pan-Arabism has in fact been much more powerful among the previous generation, when it was promoted by secular dictators such as Nasser and Saddam Hussein, who have now passed from the scene.

· The United States

The United States of America may appear as an unlikely location for a totalitarian episode, but in this context it must be remembered that the violence of the secular revolutions in France, Germany, Russia and elsewhere was in its time totally unexpected. The totalitarian terror and oppression these nations experienced seemed to materialize out of nowhere and came as a complete surprise for the rest of the world. The fact, therefore, that the United States has been a functioning democracy for over two centuries should not blind us to possible danger.

The conditions that would make such an episode possible are in fact present to a degree: first, the United States has been in the grip of a powerful secularizing trend for well over a generation. The result of this trend has been a loss of spiritual direction which is (as in the previous cases of France, Russia and Germany) made manifest in the increasing inefficiency and paralysis of its central government. There are other disquieting signs: the reach for greater power by the executive; the increased militarization of foreign policy; the systematic magnification of foreign and domestic threats; the characterization (particularly in the right-wing media) of entire categories of citizens as despicable and benighted enemies (a common practice under totalitarian regimes). Ideological currents are developing on both the right and the left: on the right an aggressive “neo-conservatism”, on the left a pervasive, socialist-like call for greater government power and reach.

At the same time the United States is entering a period of great economic difficulty (greatly underestimated or even ignored by politicians), due to the confluence of factors both systemic and cyclical. This economic and financial crisis (the word is not too strong to describe the developing downturn) will last much longer than anyone currently expects, and is likely to result in substantial unemployment, loss of benefits, declines in the standard of living and other hardships. While the US population is energetic and resilient enough to overcome the challenge in due time, there will be much confusion until this is done.

The conditions, therefore, pointing to the potential occurrence of a totalitarian episode, are present to a growing degree, though he probability of such an event actually occuring is hard to determine. There are powerful moral forces still at work in American society, and the democratic tradition is well ingrained. While there will certainly be strong and numerous calls for “radical solutions” and “necessary changes”, they might end up swaying only part of the population. But the danger should not be underestimated, as has unfortunately been the case too many times in the past.

Conclusion

The achievements of Western civilization have been admirable, but many among the highest of them have been shattered and consumed in conflagrations fueled by the pride of individuals and nations setting themselves as sole arbiters of their destiny – and unfortunately of that of others as well. This pride, which is contained in the word “secularism”, has led to wars without precedent for their intensity and destructive rage; to tyrannies more ruthless, cruel and brutal than any in past history; to the ravaging of our natural heritage, and to the suppression of our noblest thoughts and endeavors. The monuments to secularism are the Soviet Gulag, the Nazi concentration camps and the guillotine on the public square.

Secularism is one of the jewels in the crown that modern mankind has forged for itself. It sets the modern period apart from earlier ages, all of which, though often imperfectly, acknowledged a higher law ruling over untrammeled human will. To declare that one is free from such constraints is indeed a form of freedom, but it must then be asked what the consequences of this “liberation” will be. For the nations which fell under the rule of totalitarian regimes, the unrestrained freedom of the few men in power turned into abject and deadly slavery for the multitudes over which they ruled. Is this a price we are willing to pay?

There is only one way to escape the trap we have set for ourselves: to admit that we are not gods, and to return to the recognition of a law higher than ourselves.

The Real Campaign - At The Starting Line - Summary

2008-02-06T17:27:00.000-08:00

February 5th has been a watershed on two planes: on the political scene the political field was clarified and winnowed down to the candidates pulling real weight. In the economic sphere the stock market dropped 3%, which is taken by many as a sign that recession is near or upon us. The political sphere and the real world are thus beginning to intersect, which means the “real campaign” is beginning – hence the reference to the starting line.

The front runner on the Republican sign is Senator McCain, but he has a long way to go before he can unite the splintered Republican electorate. The Democrats have two strong candidates – Senators Clinton and Obama – virtually tied. On both sides the race is far from over, meaning the candidates will have their attention focused on the nomination rather than on the issues facing the nation.

The issues, however, are becoming more pressing. The economy is foundering, the budget is likely to result in huge deficits, terrorism is alive even while the wars initiated by the current administration, despite some successes, are proving inconclusive, exhausting and increasingly expensive. The electorate is aware of the above, will be looking for answers, and jacking up the pressure on the political establishment.

The pressure from below and the candidates’ ambitions will meet in the middle. The candidates who respond positively will gain loyalty and support, while those who avoid the issues will lose and possibly be swept aside by voter discontent, even before the conventions. The next three months will be crucial, not only for the candidates themselves, but for the political system as a whole.

The Real Campaign - At The Starting Line

2008-02-06T17:21:00.000-08:00

We have stated previously on this blog that the political election campaign which started at this time last year was not the “real” one. It was rather a positioning and image game played within the confines of the political system, with only superficial regard for the issues facing the nation. At some time the real campaign has to kick in, and “Super Tuesday” provides a convenient starting line.

The reasons for setting the starting line on February 5th are two. First, by now the field of candidates has been winnowed down to those having a real chance (within the political system as it now stands). Second, more did happen on February 5th than just primaries and caucuses – the stock market dropped by 3% while the voting was going on. This conveniently symbolizes the fact that the real issues – of which the economy is currently the foremost – are beginning to invade the political landscape. From now on they will no longer be avoidable.
It is therefore a good time to take stock of where the race is at, and where it is likely to go.

The Republicans

The Republican party is badly splintered. This is due primarily to the single-minded pursuit by President Bush of two major policies. On the one hand, in foreign affairs, a policy of unilateral military intervention, resulting in the pursuit of several inconclusive, exhausting and increasingly expensive wars. Domestically, on the other hand, the administration took an attitude of complete laissez-faire in economic matters, allowing free reign to globalization and multiple forms of financial engineering, both trends leading to the current financial crisis and looming economic downturn. In both the above policy the administration received enthusiastic support from the right-wing “talk radio” community, many members of which took, and still hold, positions far to the right of the President.

As a result the hard-core Republican base ended up in a fairly isolated position, while a large number of Republicans peeled off into the independent and moderate camp. This explains the remarkable rise of Senator McCain. With George Bush and his core support far to the right, Governor Huckabee still an unknown, and Governor Romney too close to the business elite, the Arizona Senator comes across as the potential unifier with whom many traditional Republicans feel at least modestly comfortable.

We write “comes across”, because there is still a considerable distance between image and reality. Even should Governor Romney drop out of the race, Senator McCain faces severe challenges before he can be the Republican unifier. The core “conservative” base does not like him, yet he must win their approval in order to have a chance at winning the national election. And that approval must be obtained without alienating the moderates and independents. This is not far from squaring the circle in terms of policy and platform, and is likely to keep the Senator fully occupied in the coming months. It is unlikely there will be time and attention left for the crafting of “real” presidential policy.

The Democrats

The Super Tuesday results have, in a way, turned the Democratic race on its head. It started nearly a year ago with Senator Clinton as the “inevitable” candidate, and, just in case something went wrong, there was the “Clinton machine” to deal with any problems. It did not then appear that Senator Obama had much of a chance.

Instead, the Illinois senator proved to be a formidable opponent himself. He is young, charismatic, highly likeable and an inspiring speaker. With his theme of “change” he has cleverly exploited the latent discontent with the political and economic elites, even while being more than successful in collecting campaign contributions. Right now he has the momentum and glamour on his side.

Mrs. Clinton, however, will not concede. There will be a drag-out fight to the finish, which will fully absorb Democratic attention, energies and resources. So here, even more than in the Republican camp, the political game will trump the issues.

While there are differences in their respective situations, both parties are still in the “political” mode: the primary purpose of the candidates is to secure their nominations, with national issues being secondary to that. This leads us to review how these issues have been evolving.

The issues

In the previous essays on this subject, the urgent issues for this election cycle were listed as follows:
- The wars
- The problem of terrorism in general
- The economy
- The federal budget
The status of each is summarized below:
- The wars

This covers not only Iraq, but other conflicts initiated under this administration (Afghanistan, Somalia, Pakistan) as well as conflict situations in Lebanon and Palestine. While the surge of troops in Iraq has achieved tactical successes, it has neither produced a viable government nor destroyed the insurgencies. A similar pattern prevails in the other conflicts, except that in general the situation has mostly deteriorated. In other words, due to the lack of an appropriate strategy, there is no end in sight, and no change can be expected while President Bush is in office.

The wars will surface again as an issue by summer. First, the Iraqi surge will then be ending. Second, the constantly increasing cost of the conflicts will become an issue as it will compete with other funding needs.

- Terrorism
While some successes have been achieved, the heavy emphasis on military occupation of “suspect” territories has allowed terrorist organizations to broaden both their operations and their recruiting. This may eventually jeopardize the gains achieved in the last six years in terms of national security.

- The economy
As suggested in the previous essays, the economy is becoming a major concern, and the attempts to deal with it through reductions in interest rates have not had the desired effects. This is due in great part to the fact that the current downturn is not only cyclical, but also structural or systemic, being caused by imbalances and problems in trade and finance. As a result the coming “recession” is likely to be both severe and long (4 years rather than the hoped for “couple of quarters”), injecting considerable stress into the political scene.

- The budget
The 2009 budget just released posts a $ 410 billion deficit. Since the underlying assumptions are highly optimistic it is likely to be higher, particularly when the rising cost of war and the recession-induced fall in revenue are taken into consideration. Since a deficit of such magnitude will endanger US borrowing abroad and accelerate the devaluation of the dollar, it will have to be reduced, raising political tensions to an unprecedented level.
The above are immediate issues. Longer-term ones such as the future of entitlements, immigration, medical care and energy use and supply must be added.

Forecast for the first lap

The formal election cycle can be divided into 4 parts. Using the race metaphor, we will refer to them as laps:
- Lap 1: Primaries and caucuses
- Lap 2: Election platform development, conventions
- Lap 3: Campaign from conventions to election day
- Lap 4: Planning and public relations in the time between election and swearing in

We add lap 4 because it is the link between the election platform and policy in office. We will also assume that the campaign up to now has been mostly positioning, and that the real race has just begun. So what is likely to happen between now and the conventions?

Events will unfold on two levels. Within the political sphere, the candidates will each seek to be accepted by the party base and to be nominated under the best possible conditions. For this they will use all the means offered by the political system. By contrast, within the “real life” sphere, voters will try to communicate to the candidates their real concerns, with the hope that the candidates will understand and respond. In other words, there will be pressure from above to convince the voters of the appeal and qualities of the candidate, and pressure from below to make the candidate aware of the voters’ situation.

Our current political process is not built to deal with realities, but with appearances and images. Therefore there will be increasing tension between the candidates and the base as the issues grow larger and more pressing – particularly if the economy continues to deteriorate and voter anxiety grows accordingly. This leads to two possible outcomes:

- The candidate responds to the voters’ concerns by formulating the appropriate policies (which, in our opinion, has not happened yet to any significant degree)

- The candidate does not respond, in which case opposition develops, which could go as far as to produce a rival candidate.

Over the next three months, the pressure and tension will increase. The candidates who respond will receive loyalty and support. Those who do not could at the extreme be disavowed by the voter base, a development that could lead to a voter rebellion and an open convention.
Stay tuned.

Democracy and State Structure - Summary

2008-02-01T16:31:00.001-08:00

In reference to the earlier posting “Russia and democracy” we were asked is what was referred to as “empowerment democracy” currently exists. This posting was written to answer the question.

There is no working example of “empowerment democracy” today, which is due in great part to the fact that representative democracy is the prevailing concept and thus crowds out other potential forms of democratic control. There is however a major issue which is currently undermining representative government: the growth, size and structure of the modern centralized state.

In Western history, the centralized state (supported by a standing army and a professional administration) was created at the end of the Middle Ages in order to insure the stability of dynastic rule. It was backed by the doctrine of divine right monarchy and led to the replacement of the feudal system by a highly centralized administration with power concentrated at the top. After the demise of the kings through the revolutions of the 19th century this centralization was further extended under the ideology of nationalism and socialism.

Despite efforts at democratic control, the power and size of the state continued to grow until it affected nearly every aspect of the citizens’ lives. Its growth and reach gradually acquired their own internal logic, leading to further growth. The expansion of state power and size also gradually created a permanent political class, the interests of which coincided with further expansion of government size and power, rather than with the interests of the citizenry.
The size, power and continuity in time of the state and its functions are thus becoming the main drivers of policy, regardless of whether the state is formally democratic or not. A major modification of the existing state structures is therefore needed if democracy is to be more than a veneer on the edifice of government.

Such a change is inevitable because the current situation is no longer tenable. Regardless of political ideology, the cost of the modern state is increasing much faster than the population’s ability to support it. This growing gap can lead either to breakdown or to reform – most likely a mixture of the two. It is most probable that from this conflict and its resolution a form of “empowerment democracy” will emerge.

Democracy and the Structure of the State

2008-02-01T16:23:00.000-08:00

This posting is a response to a question, relating to the earlier article “Russia and democracy”. The reader asked whether there were any actual examples of “empowerment democracy” – as opposed to the formal representative type which is common in Western countries.

The question is a very pertinent one, for it goes to the core of the problem. In Western political thought, representative democracy is considered as the optimal system and the end-point of political evolution. Yet it can be observed that this form of government has experienced numerous failures, and the earlier article asserts that these failures are due to the lack of certain pre-conditions in the absence of which representative democracy will not function. That article further states that these conditions have been the product of a historical evolution extending over many centuries. If one accepts this premise, then the rise of representative democracy is historically determined rather than inevitable. In other words, it is a historical phenomenon (possibly temporary), and not the necessary result of human political evolution. It could, in the future, disappear as conditions and background change, as it has in the past (in ancient Rome, for instance).

The above suggests that the answer to the initial questions should be given in three parts, pertaining respectively to the past, the present and the future. In other words: has the form of political organization referred to as ”empowerment democracy” existed in the past? Does it (or can it) exist now? And could it exist in the future? The question is a valid one because representative democracy, despite being generally regarded as the optimal form of government, has failed dramatically in many states where it has been introduced. It has even nearly failed in the European heartland (where it originated) during the decade of the Great Depression, being replaced by a variety of authoritarian regimes. As there are reasons to believe we are presently heading for a somewhat similar time of economic and political turmoil such failures could be repeated on a large scale in the near future. It is therefore quite logical to ask whether a more robust democratic system can be devised and put in place where the representative one does not fit well.

So let us return to the initial question, that is, whether “empowerment democracy” currently exists, has existed in the past, or could exist in the foreseeable future.

The current alternatives

In the 18th and 19th centuries, as the European colonial empires were being extended and consolidated, European culture became the dominant one on the globe. Even though Europe faded as a political power after the two World Wars, the cultural dominance of Western thought was maintained and extended during the half-century of American hegemony , from 1945 to today. With this dominance went the Western concept of representative democracy as the optimal political system, and after the failure of the Soviet experiment this concept has reigned supreme, numerous failures notwithstanding. To question representative democracy is to question freedom and human rights.

Within the prevailing conceptual framework, therefore, alternative forms of political organization are, almost automatically, placed in one of two categories: either archaic (such as tribal organizations or the remaining monarchies); or authoritarian/totalitarian. Forms of democratic organization differing from the classic Western model are not considered to be either possible or desirable, hence such forms have not been developed and do not currently exist. This answers the first part of the above question.

If that is the case, why bother to search for, or define, an alternative form of democracy? Is this not an exercise in designing one more utopia? Possibly yes, but there are several reasons why the effort could be worthwhile.

First, if we accept the hypothesis that democracy’s current form is historically determined, there is no reason why a form better suited to current and future times could not be developed.
Second, there is the problem of failures. In a way, the West has foisted on the rest of the world a system of political organization that only works under certain conditions. If the system fails, there is price to be paid. Russia is a good example. Liberal democracy (the Western kind) was tried there twice: first between 1905 and 1917, and the second time after the dissolution of the Soviet Union. Both attempts were dismal failures, and the price paid for both (for the first in particular) was huge. There is no going back in time, but had the Russian liberals of the 19th century had been less keen to imitate the West Russia might have taken a less costly path in the 20th. And Russia is not alone: there are numerous European ex-colonies struggling with imported democratic forms, and usually ending with corrupt, authoritarian and dysfunctional governments.

Third, there are the issues representative democracy now faces even within the states where it has long been functioning. In the US in particular, the growing disconnect between the political class and the mass of the population is a warning sign that not all is well, and that institutions long taken for granted could, should economic conditions deteriorate, be put to a severe test – as was the case in Europe during the 1930’s. Tweaking these institutions to make them more responsive and robust might be a worthwhile undertaking.
There is therefore good reason to believe that democratic institutions could be modified to make them both more widely applicable and more responsive. To do this, it is useful to go back to where we came from, the historical past.

Historical background

There are two parallel trends in modern Western history in what concerns political organization. On the one hand there is an evolution (not always smooth) from autocracy to democracy. On the other there is a continuous increase in the centralization of state power as well as the influence of the state on the daily life of its citizens.
In Europe during the Middle Ages the state as we know it did not exist. Under the feudal system society was organized (due to harsh necessity)into basically autonomous units, and both political authority and control over economic resources were diffused over all levels of the social hierarchy. For all practical purposes both the medieval manor (the basic political and economic unit at the time) and the medieval city ruled over , and provided for, themselves. Other than taxes (levied primarily on the city) and occasional military service (required of the lord of the manor) neither owed the king anything but an allegiance that little affected their daily affairs. Conversely, the reach of the throne was short and its power limited by the power held by the great vassals.

This wide distribution of power made for the fact that the crown was always in play even though, as mentioned above, who wore it mattered little at the lower levels. In order to insure their position, the winners of the dynastic struggles of the late Middle Ages developed two advantages over potential contenders: a professional army and a permanent administration. Both were staffed by appointment rather than according to birthright, which made rank- and officeholders loyal to the crown rather than to their families and region of origin. The power of the monarchs and the loyalty of their subjects were further bolstered by the political doctrine of divine right monarchy, which claimed that the position and power of the king were willed by God and that opposition to it was against the divine order.

The combination of dynastic stability and growing power resulted in the abuses which brought down monarchic rule. But those who succeeded the king at the head of the state were caught in a dilemma: either restore de facto freedom through a controlled unwinding of the centralized state, or maintain the state as it was, while attempting to control it through a system of democratic checks and balances.

The removal of the monarch as the head of the state left, however, and ideological void. With divine right monarchy gone, a new ideology was needed to provide the state with moral legitimacy, and nationalism answered this need. But nationalism, by its very nature, demanded a coherent and disciplined population, and to build and fashion this national spirit the state needed new inroads into the domains of education, culture and religion, thus vastly extending its reach. At the same time the fading away of the aristocracy (the ”first estate”) and of the influence of the church (the ”second estate”) left the preponderance of power with the professional and merchant class (the “third estate”), which used its position to maximize both its power and its wealth. This combination of the priviledges and power of the bourgeoisie with the growing reach of the centralized state it controlled gave rise to a powerful and organized opposition, with the new working class led by revolutionary intellectuals. From there came the extension of the revolutionary spirit, originally born out of democratic aspirations, into communism and socialism, which sought to overthrow the entire established order.

In the socialist ideal, the state was eventually to disappear, but in the intermediate phase (the “dictatorship of the proletariat”) its power was to be extended into the social and economic spheres so as to make possible the elimination of the “old” ruling classes (church, nobility and bourgeoisie )until only the proletariat ( workers and peasants) remained. Even though pure socialism eventually collapsed with the dissolution of the Soviet Union, many socialist concepts were adopted in the West and incorporated into state functions. As a result the centralized state continued to grow and expand its reach even under democratic regimes.

Looking at this evolution, we are left with the conclusion that the most important and most enduring trend of modern political history is the growth of the centralized state. The state now affects every aspect of the lives of its citizens, and its size and nearly universal reach provides the leaders with enormous power, both political and economic. Thus the question of what kind of democracy we have or want to have is contingent not only on how these leaders are selected, but on how large and powerful the state apparatus is, and on how it operates.
This issue is complicated by the fact that as it increases in size the state gradually generates a separate political class. It does not matter whether the members of this class are selected by election, appointment or some form of administrative recruiting. Once the number of those who work for, within and around the government becomes large enough, they will gradually but inevitably lose contact with the general population and identify with their own peers. This does not result from political ideology but from the size and function of the government. It is now so large that those who work for and within it relate primarily to other persons working in the administration, and see the outside world through the lens of government objectives and functions.

As a result he US political class or the European Community bureaucracy have many things in common with the socialist “nomenklatura” or administrative elite of the socialist states (much of which, by the way, has shifted seamlessly into the administration of the new “democratic” administrations. This is so because the administrators perform basically the same functions, have the same interests and enjoy similar privileges (such as the best pensions and highest quality medical care). As the political class expands and becomes increasingly concerned with its own world, the gap between the general population and the rulers and administrators grows too, whichever way the state might define itself (democratic, liberal, socialist, corporatist, etc … ).
The size and reach of the modern state will therefore be the “elephant in the room” in all modern discussions concerning political organization. One can walk a dog on a leash, but not an elephant. The dog will go (most of the time) go where its master wants it to go. The elephant will go where it wants to go, and drag its “master” along. It goes the same way with the modern centralized state. It has its own internal logic, which in the end defies any attempt to truly control it, whether the attempt is based on democratic principles or on an authoritarian reach for power. The only way to truly control the state is through terror, which is ultimately self-defeating as it chokes all political and economic life. This was the logic of G. Orwell’s “1984”, and it might be the only valid conclusion.

There is therefore a paradox within the Western democratic concept. On the one hand it aims at maximum individual freedom and at the control by the citizens of their own fate. On the other it has inherited from the “Ancien Regime” a concept of the state which was designed to maximize power at the top. The Founding Fathers of the United States were well aware of this issue, and they crafted an extraordinary compromise in order to create a state that is both functional (in the sense of having a working administration) and under the control of the citizens. The system they created has endured remarkably well, and yet it suffers, like all modern governments, of the hypertrophy of the center at the expense of the periphery, of the surfeit of power at the top versus its paucity at the bottom. And, in addition to the above, there is the huge financial burden of maintaining the centralized state with all its functions and prerogatives, a burden which no current polity, democratic or otherwise, is able to bear without mortgaging the future.
The continued existence of democratic government is therefore inexorably linked to the issue of the size, cost and function of the state. Unless the growth in size and cost is brought under control, and the appropriate functions put back under the control of the citizenry, current democratic institutions will gradually become decorative window dressing, just like the Roman Senate became window dressing for the Roman Empire.

The way the state is structured determines the difference between formal democracy and real or effective democracy. The question then becomes: Is there an alternative to the way the state is structured today, giving the citizen more direct control over the issues which affect him/her the most?

Past and future

Governments and political institutions are living organisms, and they cannot be fitted to an intellectual blueprint. One can nevertheless seek to determine the principles which would allow to resolve the above dilemma.

It has been stated above that one of the reasons for the development of the centralized state was the desire of the monarchs to subdue their vassals, in other words to eliminate the risks inherent in the feudal structure, insofar as that structure was made up of parts with a large degree of autonomy. The feudal system was of course not a “democratic” one in the sense this is understood today. The environment of the Middle Ages, seen from our perspective, was in a perpetual state of emergency, as the population faced a range of threats – invasions, wars, famines, plagues and so on – which could strike at any time and with little warning. This environment required, if communities were to survive at all, a strong and authoritarian rule with a major military component. But the challenges of that environment had another consequence as well: in order to face these challenges each social unit needed to have full control over the resources necessary for its survival.

The polity was therefore constituted of autonomous sub-units, within which all resources necessary for survival and local development were essentially within the control of the community. The smaller units were grouped into larger wholes, which again controlled their own resources and territory, and so on all the way to the top. There was both wide distribution of political authority and considerable local autonomy. The political system was autocratic, but the structure of the state was in principle much more amenable to democratic control than the centralized state which arose later.

Despite the autocratic character of the political organization, there existed at the same time strong tendencies which could be called “proto-democratic” as they sought to protect and reinforce local control. Autonomy and independence were, in the Middle Ages, often fiercely defended against the royal attempts to extend central power. The foundational document defining the rights of subjects versus the crown – the Magna Charta, from which our Bill of Rights is derived – was foisted on King John by a rebellious nobility, jealous of its feudal rights and resenting the interference of the crown. In similar manner towns demanded to be granted charters and jealously defended their liberties and system of government, with urban militias willing to wage war against overbearing nobles. In similar manner the Church defended its spiritual prerogatives and the sanctity of ecclesiastical premises and domains.

Those historical precedents illustrate a fundamental principle of democratic organization: that local autonomy and control of resources (at whatever level one chooses to define “local”) are an essential foundation of real (as opposed to formal) democracy. In essence democracy is the form of social organization which maximizes the ability of the individual and the community or control its own fate.

Western political thought has assumed to-date that the above objective will be achieved if the operation of government is subject to officials or representatives chosen by the people. While this has been a legitimate assumption in the past, the modern state has grown way beyond the ability of an elected parliament or executive to control its multiple and far-reaching functions. One can take the national budget as an example.

The principle of “no taxation without representation” demands that an elected congress or parliament vote for state expenditures on a yearly basis, so as to submit these expenditures to the judgment of the people and prevent their waste or misuse. But in the US as in many other states this vote is by now more of a ritual than an actual decision process. To begin with, roughly 70% of the expenditure is allocated to programs or purposes (such as interest payments and entitlements) which are renewed automatically and cannot (by law) be cut or significantly modified. The remaining 30 % is designated as “discretionary” but in reality consists of items which require multi-year commitments (such as military procurement) or cannot in practice be easily reduced (such as civil service payrolls and maintenance of government property). For all practical purposes it is the machinery of the state which determines its own needs, not the representatives of the people, even though the representatives were originally responsible for setting up this state of affairs. The political leadership, regardless of rhetoric to the contrary, acquiesces to this situation, and the taxpayers pay. The leaders are, after all, the ones “riding the elephant”, a situation requiring little effort and in any case far preferable to the difficult and perilous task of getting off, forcing the elephant to stop and (God forbid) putting it on a diet. It is the voters who have to feed the beast and watch it trample their property.

The democratic states are therefore faced with the very same conflict – that between the interest of the leadership and that of the masses – which eventually brought down the Soviet Union (and will in the near future bring down China as well). This conflict is rooted in the fact that the ever increasing size, reach and cost of the state have by now not only reached the point of diminishing returns, but have actually become a stifling burden threatening both freedom and prosperity. There are two approaches to resolving this issue. At one extreme it is to fiddle with the system without attacking the basic problem, until inefficiencies, popular discontent and financial bankruptcy result in a breakdown that will force change. The other is to tackle the problem at its root and start reducing the state to its proper size and functions. The second approach is obviously preferable and should be the concern of all who are desirous to defend, and foster the growth of, genuine democracy. Given, however, how far things have gone, what is likely to happen will be a mixture of the two above approaches, with a commensurate price to be paid.

Directions for the future

The major illusion to avoid is to believe that “democracy will take care of itself” – on the grounds that this form of political organization is the end-product of an irreversible evolution. Democracy, more than other forms of government, is the result of individual and communal effort, and without effort to maintain it (and when necessary repair and restore it), it can easily die out as it has previously, both in the distant past and in the modern era. Given the situation outlined above with respect to the excessive growth of the administrative state, action to preserve democracy is required.

For this purpose passing laws and making speeches is not sufficient. What is needed is a critical look at the structure of the state and at how that structure makes effective – as opposed to purely formal – democracy difficult, and in some cases impossible. Then this structure must be modified, in some areas dismantled, and rebuilt (if and when needed) according to a scheme more suited for allowing citizens to control essential areas of their lives.
No single person or group can fully define such a scheme. It will be arrived through a combination of thinking, debate and action by many (provided the will is there), as was the case when representative democracy was developed in the 18th and 19th centuries. Only some general principles can be enunciated here:

· Only those functions which are (and by their very nature must be) “national” in scope should be assigned to the central government. All other functions should be delegated to a lower level where they can be performed most efficiently, and remain more accessible to the citizens whose lives such functions affect. That level should have full autonomy and responsibility in the performance of these functions.

· Each level of political organization should retain and control the resources necessary for the performance of its responsibilities and functions. These resources should be controlled at their point of origin, not appropriated first by the central government and parceled out afterwards.
Disregard of the above principles is the primary cause of the gradual loss of efficiency of, and citizen control over, the government.

Such a system would be composed of a hierarchy of political and economic units, each of which would be autonomous to the maximum possible degree. In that respect it would resemble the European feudal structural model, except that the internal organization of each unit would be democratic, in the manner chosen by the citizenry, rather than autocratic. It could be argued that such an organization would be a further step in the development of democracy, going beyond the current representative model.

It can be argued that such a system, because of the inherent autonomy of its constituent units, would be by definition unstable. Such potential instability would, however, be a proof of true democracy, since it would imply that the stability of the state would be subject to the agreement of its citizens. Freedom implies the ability to choose. If that ability is eliminated because of the way the state is structured, then freedom is reduced. It is further constrained when the needs of the state take precedence over those of the citizens.

The Real Campaign - Update

2008-01-13T18:09:00.000-08:00

In the blog entry “The real campaign”, posted in September, we questioned the relevance of a presidential campaign begun a full 18 month before the actual vote. This was based on two factors:
- First, it is very difficult to predict, that far in advance, what the issues the electorate considers important at election time will be. Not knowing in advance the position of the voters in the crucial months before the actual election, the candidates will find it difficult to commit to anything specific, and will therefore be confined to irrelevant generalities.
- This enforced vagueness about the issues will reinforce the already strong tendency to focus on the workings of the election process such as image, electability and fund-raising, rather than on the issues facing the nation.
The conclusion was that the 2007 campaign period would be, in the words of a recent commentator, a “campaign about nothing”. We also stated in the blog entry that it would take until the end of 2007 before the “real” issues begin to crystallize. We are there now, and it is a good time to review where things stand and where we are headed.
In the blog entry mentioned above we also attempted to identify the issues which would eventually come to define and dominate the “real campaign” of 2008. These were:
- The economy
- The budget
- The fight against terrorism ( “war on terror”)
- Iraq ) and the other conflicts initiated by the current administration).
Let us review these issues in turn:
Iraq (and the other wars)
The US is currently engaged in several of conflicts, of which Iraq is the largest. Their current status is as follows:
· Iraq
The issue has (temporarily) gone underground, but has not gone away. While the US commanders are to be commended for having achieved a substantial reduction in daily violence, problems are likely to resurface in the second half of the year:
o Insurgents and guerillas usually go to ground when faced with overwhelming force, only to reappear when the pressure is withdrawn. Based on past experience in such conflicts, the Iraqi insurgents ( and sundry armed groups and militias) will attempt to re-occupy the lost ground once the US troop surge begins to be drawn down this summer.
o The current policy of relying on local militias to keep order (particularly in Sunni areas) is sound, but it runs against the original “unitary state concept and further undermines the already dysfunctional central government.
o The various insurgent or anti-US entities might stage an offensive and/or escalation in violence escalation in order to influence the US elections – in fashion similar to what the Vietcong did in Vietnam with their “Tet” offensive.

In other words, the Iraqi issue is very likely to resurface in the months preceding the election, and a strategy to deal with it will be needed. Any candidate counting on the current lull to continue through November might be rudely surprised, and should at the very least have a “plan B” in his/hers back pocket.

· Afghanistan
The situation in Afghanistan is slowly deteriorating. Insecurity is rising, corruption is growing, violence is increasing and the narcotics business is expanding. Commanders in the field want more troops. If these troops can be found, the best that can be achieved will be an Iraq-like scenario, such as described above, and similarly requiring a clear strategy.
· Pakistan
As in the Afghan and Iraqi theatres, the US policy of using large conventional forces (in this case the US-funded Pakistani army) against ethno-religious insurgencies has had the same results as elsewhere: a degradation of security, a strengthening of insurgent forces of all kinds, and political gridlock. The situation in Pakistan is increasingly unstable, with no resolution in sight. Together with the other conflicts it requires the development of a workable strategy other than indefinite escalation.
· Somalia
The US-supported invasion by Ethiopian forces has resulted in a humanitarian crisis, the hardening and radicalization of the Somali insurgency, and the possibility of the conflict widening to the entire Horn of Africa region, requiring a new and broad strategic approach.
To the above must be added the Israeli-Palestinian conflict, the deepening crisis in Lebanon, and the latent conflict with Iran. In each case the US reliance on unilateral action and military solutions has only brought failure upon failure. A new and very different set of policies is urgently needed, and the candidate who does not address this issue is likely to be caught unprepared.

National security vs. terrorism – the “war on terror”
With the exception of the initial intervention in Afghanistan, which was needed in order to destroy the sanctuary offered to Al Qaeda by the Taliban, all the above conflicts are being waged on the basis of the “war of generations” theory. This approach postulates that Islamic radicalism is a powerful, growing and organized movement aiming at the destruction of the US (and Western) way of life. The political formulation of this theory is “If we don’t fight them over there, we will have to fight them over here”.
This theory and the policies based on it ignore a number of important facts. First, that violent Islamism – or “Jihadism” as it is more commonly called – originated as a reaction to the Soviet occupation of Afghanistan, not as a spontaneous product of Islam. Thus the US military interventions in the Middle East might well produce more Jihadists than they destroy. Second, that the Muslim world is too fragmented by ethnic, cultural and religious differences for such a wide movement to be able to arise. Third, that terrorist organizations are by nature limited both in numbers and means, and that no such organization has ever achieved a significant political or military goal. Fourth, that many of the conflicts we designate as Jihadist have in fact ethnic and economic dimensions, which are in great part legitimate, and which we must understand and deal with if we want to have any influence on the ultimate outcome.
Jihadism is in fact not much different from earlier terrorist “waves”. Rather than being a coherent organization with considerable means and powerful popular and/or political support (as were, for instance, the Communist and Nazi parties in their heyday), it is loose network of underground cells, with hardcore members numbering, at most, a few thousands (once fighters motivated by ethnic and cultural causes are counted out). Around these fighters is a “halo” of sympathizers providing logistical support, the numbers within which must, for reasons of secrecy, be kept low.
To be effective, a campaign aimed at destroying such networks needs a two-pronged approach: first, intelligence work to identify the network’s members, bases, supporters, and so on. Coupled with this work will be strikes by highly skilled professional forces aimed at destroying the cells and networks the intelligence work has uncovered. The second prong consists of economic and political measures to further the legitimate interests of the population within which the terrorists are embedded, so as to “turn” this population against the terrorists.
Such an approach (for details, see blog entry “Terrorism and national security” of 09/27/2007) will be much more effective and far less expensive than the one taken by the current US administration, which relies on military occupation by large numbers of conventional forces, an approach which has been, on the whole, both inconclusive and extremely expensive. Because this approach is based on an inadequate strategy, the conflicts which the US is currently involved will not go away, the strategy will have to be changed, and the candidates running for office will have to articulate an alternative approach.

The economy
In the original blog entry (posted in September 07), we stated that “a recession is gradually becoming more probable”, and pointed out the significant difference that exists between campaigning in economic good times and campaigning during an economic downturn. This issue is now coming into the foreground. At the time the blog entry was posted the economic consensus was that though growth might slow somewhat in 2006 no recession would occur. Today a recession is very much in the cards – indeed some experts in the field state that it might already have begun.
Here it is important to note that cyclical economic downturns have benefits. Although they impose material hardship and financial pain, they also flush out of the financial system the imbalances and abuses that tend to accumulate in “good” times. This is already happening in the financial sector and in the housing market. The problem is that no one can predict how far this correction process still has to go.
The US economy has experienced only two recessions in the past two decades, and both were short and shallow. It is therefore likely that many more distortions and potential problems have accumulated than in past cycles, which tended to be shorter and more pronounced. In addition, potential problems are compounded by the globalization of markets and a host of quasi-speculative practices which have emerged during the past quarter-century. Neither globalized markets nor much of the new “financial engineering” are amenable to control by national institutions (such as the Federal Reserve). Global markets can amplify a local disturbance (as is already the case with securitization), and in an economy that is leveraged (indebted) to an unprecedented degree even a small reduction in employment or spending can generate a downward spiral, turning a cyclical downturn into a systemic debacle.
It is therefore not only possible but likely that the looming “recession” will be both deeper and longer than anyone estimates at this time, and require measures more comprehensive and far-reaching than anything seen since WW II. The political establishment, and specifically those running today for office, seem not only unprepared for, but completely unaware of, this possibility. How they would react to a population asking hard questions and demanding comprehensive action and solutions is difficult to imagine in the present campaign context.

The budget
The US federal budget has been in deficit since the start of the current administration. Although the deficits have been (officially) reduced in the last three years, this is at best a temporary phenomenon, due to the following factors:
- Until the current fiscal year, starting 10/01/2007, war expenses for Iraq and Afghanistan have been off-budget as “extraordinary appropriations”, even though they were still funded by government borrowing.
- The last three years have seen an extraordinary rise in corporate taxes, based on unusually high profits. These profits (a large fraction of which came from the financial sector) are now quickly disappearing, and with them will go the taxes they generate.
For the current fiscal year, therefore, the deficit is likely to increase by $200 billion or more. In past years the deficit has been financed by foreign purchases of US bonds as well as other inflows. The accelerating depreciation of the dollar, however, together with the looming economic downturn, makes the US a less interesting location for investment than was the case in the past. The federal government may therefore experience difficulties in securing sufficient revenue, and such difficulties will be exacerbated by the demands of various safety nets as the economic downturn reduces the income of the population.
As a result of the above trends, the federal government is likely to face, come election time, both a rapidly depreciating currency and a shortfall in revenues, both of which will require decisive measures. Braking the fall of the dollar will require a reduction of the trade deficit. Since imports of oil and of Chinese goods represent two thirds of this, both will have to be curtailed in some way.
As there is no easy way to raise government revenue in the middle of an economic downturn, the only solution will be to cut spending. The one area where this will be politically feasible is the military budget. The current concept of the “war on terror” will have to be replaced by a much more modest (and, as outlined above, most likely more effective) plan of action. The picture of the US as a military superpower dominating the globe will have to be, at least temporarily, abandoned as well.

Conclusion: the impact of reality
None of the above issues and potential outcomes are being adequately addressed in the current state of the election campaign. If the forecast outlined above is anywhere near the truth, the campaign is on a collision course with a harsh reality which is only a few months away. It is difficult at this time to predict the outcome. Ideally, the campaign would change direction and increase in substance over the next few months, resulting in a movement towards national unity and purpose, similar to what happened after the attack on Pearl Harbor in December 1941. At the other extreme, the already broad rift between the population and the political establishment will continue to widen until some kind of collision or crisis results in a major political shake-up. One way or the other, the US will pull itself together and move on, but the political scene, come November, will look very different.

Russia and Democracy - Summary

2007-11-26T12:57:00.001-08:00

In Western political thought, representative democracy – as practiced in Europe and the US, is considered not only the optimal form of government but also the end goal of political evolution. Governments and regimes are evaluated and graded on how well they conform to the Western democratic model.

In the case of Russia, the recent reconstruction of a strong central government has therefore been seen as “backsliding” towards an authoritarian system, possibly a prelude to the restoration of the Soviet Union. In this mode of thinking any departure from the democratic model a potentially dangerous step.

This thinking does not take into account the high rate of failure of representative democracy outside of its area of origin. Such failure is explainable by the fact that representative democracy needs, in order to function, a number of pre-conditions which were present in Western countries but are very often absent in other regions. An analysis of the extent to which these conditions are present in any given state allows to predict what chances of success representative democracy has in that locale.

In the case of Russia these conditions are present only to a limited degree, if at all. Representative democracy is therefore not expected to function well there, and indeed it has not. There is, however, an alternative mode of democratic control, which we call “empowerment”.

This is based on the concept of “feedback loops”, which are mechanisms (other than representation) through which the population has the capability to control the major factors influencing the conditions of its life. In an empowerment-based system the democratic nature of the government structure is not determined by the ability to hold elections, but by the built-in capacity to effectively control one’s own fate.

Just like representative democracy, this type of system has its own set of rules and pre-conditions, some of which are sketched out in this paper. It is likely that such a system would be more suitable for Russia than the Western representative model. It might also be better adapted to the conditions of many other states and countries where formal democracy has been imported, only to fail repeatedly.

Russia and Democracy - Introduction

2007-11-26T12:55:00.000-08:00

There are two forms of democracy: the representative and the participatory.

“Democracy” means “people’s power” or “power to the people”. In Western Europe and states founded and peopled by Europeans – such as the US or Australia – the “ power of the people” has taken the form of the representative republic, a government of elected representatives structured according to a written constitution. It is an unquestioned assumption in the Western world that this form of government is not only the best but also the culmination and end goal of political evolution. Under this assumption the history of government is seen as a one-way street, progressing from authoritarian to “democratic” ( or, in the Western mind, representative republican ) systems of government.

Western political theory sees the representative political system as the only possible form of democracy. Without elected representatives, the theory sees no possibility for the people’s will to be made clear to the governing bodies. The theory assumes, of course, that the elected representatives will always ( or at least most of the time ) do the people’s will and act in the population’s best interest. As long as this assumption remains correct, the government will indeed be “democratic”. No consideration, however, is given to the possibility that the elected representatives may at certain times put their own interests, either as individuals or as a class, before those of the population, using their position to impose their will. The occurrence of such an event would mean that representative democracy can fail, and such a failure would put in question the belief that this form of government is the best that mankind has ever designed.

The historical reality is, in fact, that representative democracy has failed more often than it has succeeded. Between 1918 and 1939 most European democracies morphed into totalitarian regimes. A similar evolution took place in China and Latin America. After World War II representative democratic regimes were set up in the newly independent ex-colonial states, and most of these rapidly turned into dictatorships as well. The latest experiment in representative democracy is now taking place in eastern Europe, and it remains to be seen whether it will survive any test the future might bring – particularly a time of difficult economic conditions.

The spotty historical record of representative government raises two questions. The first is whether representative democracy will work under any and all circumstances, and, if not, under what conditions it will have the best chance of success. The second is derived from the first. If western-style representative democracy will work only under specific circumstances, is there another principle or formula – other than election-based representation, which will provide the subject people with a sufficient degree of democratic control? In other words, is there an acceptable alternative to representative democracy as practiced in Europe and the United States.

Western political theory recognizes no such alternative, and it measures the extent to which a state is “democratic” according to its degree of conformity to the Western model of representative government. If a state or nation closely imitates this model, it is labeled as a democracy. If not, it is ruled by an “inferior” type of government and needs to be led towards Western-style governing institutions. If it moves away from this Western model towards another form of government – particularly one which can be described as “authoritarian” – it is moving backwards and needs to be corrected.

Seen from this Western angle, the recent evolution of Russia in terms of government powers and style fits into this definition of a retrograde move, and there have been many statements to that effect by politicians and in the media. The fact that the current policies of the Russian government appear to be supported by a solid majority of Russians – about 70 % of Russians supporting President Putin’s policies versus under 30 % of Americans supporting those of President Bush – is generally dismissed as either an anomaly or a proof of the political immaturity of the Russian populace. Russia, many warn, is returning to the ways of the Soviet Union.

The alternative between a Western-style and a Soviet-style system is, however, a false one: it presumes that either a fully working representative government ( US style, which equals “good” ) or a “totalitarian” regime ( anything else, which is seen as bad ) are the only possible options. There is, by assumption, no room for an in-between position which could combine some of the positive features of both – sufficient authority to deal with national disorders and emergencies together with structures providing for adequate popular initiative and control. The implicit error here is the assumption that the popular will can be channeled only and exclusively through a Western-style parliamentary system.

Although in theory such a system can in certain cases provide a great measure of democratic representation and control, the theory is, as stated above, only partially supported by actual experience. Western-style representative systems have been set up in a large number of states since the end of WW II and the collapse of European colonial empires, but only a few, if any, of these “democracies” are actually working as intended. A similar evolution took place in Europe before WW II (as mentioned above), when a number of new “democracies” rapidly turned into dictatorships – mostly of the fascist variety. A search for, and definition of, alternative political structures would therefore be beneficial, and Russia, because of its unique position and history is a good a place to start.

Pre-conditions for representative systems

When attempting to implant a representative political system in a given area or state, it is easy – as well as sometimes convenient – to disregard to fact that such systems, in the countries where they do operate, are the result of a long historical development. Such a historical evolution, which in actual fact lasted centuries, cannot be readily duplicated, within the space of a few years, in another location. This is the first major flaw in the concept of “spreading democracy”, and it is the reason why so many well-intended democratic experiments turn out to be dismal failures.

From the study of the history of the states which have developed representative systems we can determine the pre-conditions that must be fulfilled for such a system to be or to become functional. These pre-conditions are:

National identity

The first and essential condition is the pre-existence of a “nation”, a population or community having a common history, language and culture, and occupying a well defined geographical area it considers its home (it helps if this area has, on the one hand, natural boundaries such as seas or mountains, and on the other a geography which allows for easy internal communication). The shared history, culture and language provide a bond between individuals and subgroups. At the same time they generate a commonality of interests (and of potential threats to these interests) which allows for a political consensus to emerge from the grass roots instead of being imposed from above.

Such a consensus and commonality of interests have, historically, preceded the establishment of formal democratic structures. It is in fact when the previously existing government acted against the popular consensus that democratic resistance arose. The result of such resistance was that which formal representative structures were eventually set up, as in the case of the American and French revolutions. If a foundation of common interests is not already present, imposing or importing a representative system will not create it. On the contrary, it might instead accentuate and solidify the pre-existing disagreements and rivalries, which will be channeled into the political structure and sabotage its intended operation. A perfect example of this is the current and largely unsuccessful American experiment in “creating democracy” in Iraq.

Citizenship

The second essential ingredient for representative democracy is the concept of citizenship. Citizenship as defined here goes beyond ethnic identity or geographical residence within a given set of borders. A “citizen” is here understood to be a politically aware individual, having its relationship to the state based on a well-defined set of duties and rights. This relationship supersedes – and particularly so in periods of emergency or war – the loyalties of the citizen to the other sub-groups he might belong to – family, clan, ethnic or religious community or economic interest group.

The Western concept of citizenship – which members of established representative democracies tend to take for granted – is, like national identity, the fruit of a long historical evolution. The original model developed in the Roman world was blended with the concept of man of the Christian culture of the European Middle-Ages. Later it was filtered and modified through the templates of the Renaissance and the Enlightenment, and then finally refined in the modern era over the course of several generations of democratic trial and error. This evolution took place over a number of centuries, and its history provides a good guide for evaluating whether the essentials of citizenship are, or can be, present in any given region or state.

Communication

Representative democracy is based on the possibility of debate and consensus within the mass of the citizenry. This implies the ability to communicate in both intellectual and physical terms. There must therefore be a common language, a minimum level of education and literacy shared by all, a material ability to communicate, (which will be a function of population density as well as the size of the national territory), and a political culture not only allowing but promoting discussion and debate.

Communication must be both “vertical” and “horizontal”. Ideas, concepts, proposals and policies must be transmitted from the elites, where they usually originate and are formulated, to the mass of the people. The reactions they generate must then be conveyed from the citizens to their representatives. At the same time there must be communication across the general population. Social and economic stratification will act as a damper on vertical communication, and excessive political, ethnic or cultural diversity will have a similar effect in the horizontal plane. Therefore a population that is traditionally divided along class and ethnic lines will experience great difficulty in achieving a democratic consensus.

Stability

Political discussion and debate are only meaningful in periods of stability and at least minimal prosperity. They are usually set aside in times of war, famine, natural disaster or other emergencies, when individual or collective survival takes precedence. Thus a democratic political system requires, in order to develop and to function, a nation that is generally stable, enjoys a sufficient standard of living, and has experienced significant periods of internal peace. By contrast, the form of government activity most suitable during national emergencies is often not compatible with the democratic process, and this process will not develop if stability and material sufficiency cannot be provided for substantial periods of time.

Applying the above criteria to a state, region or ethnic entity at any given time will quickly reveal whether and why representative government will or will not work there. The effective operation of such a government is not just a matter of good will and good intentions, but will always depend on a set of conditions which might or might not be present. The degree to which these necessary conditions are fulfilled will determine the probability that a representative democracy will be successful as a political system, and whether it is worthwhile to attempt to set up such a structure in the region or state under consideration.

Conditions in Russia

Russia is an extremely interesting case with respect to the above criteria. It is not – unlike many ex-colonial states where representative government is basically a non-starter – a country where the pre-conditions for representative democracy are basically absent. These conditions are there to a degree, though not at a level that can be considered “optimal”. There are significant problems, and deviations from the “ideal” norm, which make Russia special, if not unique. Briefly, this is how the criteria defined above can be said to apply:

Nationhood

Russians are definitely a nation – by history, culture, language and profoundly shared experience, much of it tragic. There is some question, however, whether Russia, as a state and political entity, is a nation in the Western sense. This is due to both geography and history.

The only natural borders Russia has are its Arctic seashore and, in the northeast, the northern Pacific and the Bering Strait. There are, however, no other states or populations in those directions, so these borders are purely geographical and have little or no political or military meaning. In the south and west, on the other hand, where there are concentrations of potentially hostile populations or states, there are in many locations no geographical obstacles to stop an invasion, and by the same token no significant land features on which to anchor a border. Thus the only way Russia has had in the past to protect its borders has been, in the words of Catherine the Great, to expand them.

Such expansion, while it provided Russia with strategic depth, a vast territory and abundant natural resources, also had unintended political consequences. It has not only created communication problems due to the sheer size of the state, but also has included within “Russia” a number of non-Russian populations. Even if many of the non-Russian subjects of the former tsarist empire are now – at least nominally – autonomous or independent, a substantial number of non-Russians remain within the Russian Federation, and there is no way to disentangle the population mix. Russia is therefore a nation, but not a homogenous one, and the variations within the population, ethnic, cultural or economic, are substantial.

Citizenship

It has been mentioned above that the Western concept of citizenship rests on a historically layered foundation: initially a Roman concept; then the Christian notion of man within a hierarchical state; to this was added the Renaissance ideal of the autonomous individual; and superimposed on the whole was the rationality of the Enlightenment. This model of the citizen was then further refined and molded through the democratic practice of the last two centuries.

Only the first and second of these layers were ever established in Russia (the Roman concept being transmitted through Byzantium). The Renaissance, with its concept of the autonomous, self-directed individual, was largely missed due to the Mongol conquest and the “Time of Troubles” which followed the death of Ivan the Terrible. The Enlightenment reached the upper classes only, resulting in an enduring split, still extant today, between the masses and the westernized elite (“ruski” and “rossijski”). Furthermore the practice of representative democracy, which allowed Western states to refine and perfect this form of government, has never been established in Russia, where it remains an imported concept.

History has made Russia into a nation not so much of citizens as survivors. Survivors take very little for granted. Russia lacks the clearly formulated relationship between government and the governed, with its mix of rights and duties, which Westerners consider to be normative. There certainly exists in Russia a bond between the people and the government, as the people have demonstrated at numerous times (usually coinciding with some major national emergency), but this bond is more instinctive and emotional than rational, and subject to change with historical circumstances. It must be mentioned here that the relationship of Russians with their government is probably far deeper and complex than the rational concept common in the West, but a formulation of this relationship is still a work in progress, and to-date the attempts to fit it within a constitutional framework borrowed from the West have not been successful.

Communication

Russia is roughly twice the size of the United States with half the number of inhabitants. While the population west of the Urals is relatively dense, that in the East is spread over a long strip of territory covering seven time zones. Distance alone is a major impediment to communication, not even counting ethnic diversity and the tendency of separate communities to develop distinct needs as well as their own internal culture.

In addition, Russia has a very limited experience of political discussion and debate. Mass literacy arrived roughly a century later than in Europe and the USA, some form of political censorship has been in place over the past two centuries. Political discourse was constrained under the tsars and non-existent during the Soviet era (1917-1987). Historical circumstances have tended to give Russian politics a conspiratorial character, and to prevent the permanent establishment of a free marketplace for political ideas.

Stability

To put it bluntly here has been no stability for the last three generations (not to mention the emergencies, invasions and other disturbances during previous centuries). Since 1900 Russia has known two revolutions ( 1905, 1917 ); one civil war and two major foreign wars (all these conflicts were fought on Russian soil); Stalinism with mass deportations, purges, liquidations and police terror; the collapse of the Soviet system and the wholesale looting of the state by the oligarchs. The economy has limped from one crisis to another. Population losses to war, “class struggle”,famine and population displacement have been in the tens of millions.

In this respect it is useful to compare the modern history of Russia and the US : in the 230 years of its existence, the US has been under some form of “emergency rule” three times (War of Independence, Civil War, WW II), amounting in total to less than 20 years, or 7% of the country’s existence. By contrast, during the 19th century Russia has been under continuous stress, and during the 20th it was in an emergency situation all the time.

Given this historical background and the current situation, it is highly unlikely that representative democracy, Western-style, could be implanted in Russia overnight. However attractive such a goal might be in theory, its pursuit is likely to result in considerable disappointment as well as much wasted effort. More importantly it might detract from the development of a government system that is both adapted to Russia’s specific requirements and at the same time offers an adequate degree of democratic control. Such a goal is likely to be heresy to Western political theorists. But, given the poor record of representative system implants in states other than those populated by Westerners, it is worthy of consideration.

Before entering into such a discussion, however, it needs to be stated that this is neither useless speculation nor a uniquely Russian issue. As already mentioned, the representative model of government is, within the Western states where it originated, considered as the highest form of government and the end-all of political evolution. Because of the preponderance of French, and later Anglo-Saxon culture, this view has been generally accepted throughout the world. The fact is, however, that Western representative democracy, when transplanted outside of its area of origin, has failed far more often then it has succeeded, and continues to do so despite many interventions, by the United Nations and other powers, to set it back on its feet.

Such failures have led to political corruption, economic inefficiency, massive violations of fundamental human rights, and numerous armed conflicts. In addition, failed democratic experiments have spawned a number of totalitarian systems, including Soviet and Chinese Communism, Italian Fascism, German Nazism and numerous other dictatorships large and small. The question of whether a decision and sustained effort should be made to install representative democracy in an unfavorable environment is therefore not an academic one, but is fraught with real and serious consequences for the subject population, Iraq being the latest (and tragic) case.

Russia has considerable historical experience in dealing with the importation of Western political ideas and practices, and with both the benefits and drawbacks that result from such a transfer. At the same time Russia is a technically and economically advanced state which has, at this time, achieved relative political and material stability, giving it the ability to decide its future course. If Russia can develop an alternative governmental structure which is functionally democratic without being a carbon copy of Western systems, the benefits of this effort would apply not only to Russia itself, but potentially to may other struggling states and nations. This is particularly noteworthy in view of the massive challenges facing humanity in the 21st century, such as dealing with the consequences of human-induced climate change, energy supply and other global problems. Such challenges will only be met if there is a workable form of government that can mobilize and organize the energies of the people without becoming totalitarian.

Formal representative democracy vs. empowerment

Let us therefore assume that it is questionable whether a representative government (this understood in the Western sense) can at the present time function in Russia – a conclusion which appears warranted by recent developments. These developments, which include the increase and consolidation of state power, have led many Western commentators to the conclusion that Russians are willing to surrender their political rights for the sake of stability and relative comfort, thus heralding a possible return to a Soviet-style government.

This is far from a foregone conclusion. Russians certainly yearn for a time of relative stability after the upheavals of the last century, but this does not mean they are, as a nation, uninterested in basic freedoms, and thereby willing to surrender to their rulers all control over their lives. On the contrary, they have demonstrated both during the building of the Soviet Union and during WW II that they will accept great deprivation and sacrifice for the sake of the nation and its political ideals.

A simpler and more plausible explanation is that it is not democracy per se, but a specific form of it, that is not workable in the current Russian context. For Westerners the form of democracy they have – the representative republic – is the only one they can conceive of. This form, however, is the result of a specific historical experience. A nation with a different experience may arrive at a democratic formulation which is no less satisfactory for being different.

This raises the question of what “democracy” really means in practice. As mentioned above, the Greek expression means “power to the people” or “the power of the people”. The key requirement then is not the formal government structure, but that the people have power – in other words their empowerment.

The terms “democracy” and “empowerment” are fundamentally equivalent, but whereas “democracy” brings up, within the modern context, the image of a specific method of government and a historically defined political structure, “empowerment” refers more to the ability to influence one’s fate, whether individual or collective. Such ability would come to play in any sphere, be it the political, economic, cultural or religious, or any combination thereof. A population or group, whatever its size, is empowered if it is capable of controlling the forces that affect the lives of its members. In the most fundamental sense, the type of political structure does not matter. What does matter is whether the structure in place does or does not invite, facilitate and maintain the empowerment of the people. If it does, it is in essence democratic.

The key to empowerment in any field – social, political, economic or cultural – is the presence of open and efficient control or feedback loops. A simple example will illustrate the concept: if a member of a village has a need or problem which he cannot solve by himself, he will take the case to the headman or to the village council. If the village authorities act promptly and effectively to answer the need and solve the problem, then it can be said that in that village the political feedback loop is short and efficient. On the other hand, if the villager, in order to find a solution, has to travel to the provincial capital and spend weeks wading through a bureaucratic maze, the political feedback loop is weak or non existent, and the forces molding the villager’s life are beyond his control. In the first above instance he is empowered, in the second he is not. Whether the position of headman, elder or bureaucrat is elective, hereditary or by appointment in the end does not matter – what does matter is that the feedback loop works and produces acceptable results. The villager may have elected a representative to some legislative assembly, but if a bribe or family connection is needed to get attention, the election process – from a democratic standpoint – is effectively meaningless and guarantees nothing.

It is easy to see that feedback loops in the Soviet Union were long and inefficient, when they existed at all. What had to be planted, manufactured or mined by Soviet farmers and workers was decided in Moscow by party committees and bureaucrats, without regard to the local circumstances or the talents, desires or suggestions of the local workers, even when those were fervent communists and willing to work hard to “build socialism”. But feedback loops can be dysfunctional or non-existent in a “democratic” setting as well. An employee working for a US-owned plant in Guatemala may provide great work, skills and ideas, but if executives in the US decide to move production to China he will lose his job without recourse, and in this regard he is even more powerless than a Soviet collective farm member, who at least had some influence over local production and work conditions.

For a large state such as Russia, with its mosaic of “nationalities”, long communication lines, and diversity of physical conditions and resources, the existence and effectiveness of feedback loops is probably a better criterion of democratic control than a formal representative structure, which would need to be both complex and highly flexible in order to take into account the great diversity of interests and needs. Feedback loops built into the political system would provide de facto control without relying on the indirect route of representation. Such an approach would be more consistent with Russian history, during which many areas and regions were, for reasons of distance and poor transportation, more or less isolated from the central government, and had to make their own decisions within a broadly defined range of central policies. It also could fit much better with the Russians’ “can do” attitude and mentality, developed to deal with the inefficiencies and shortcomings of central planning and decision making. Even with better communications and a stronger government, Russia is still a huge place, and a lot falls through the cracks between Moscow to Khabarovsk.

Electing a representative to make decisions for one is good. Having the ability to make or influence the decisions oneself, whenever possible and applicable, might be better.

Elements of an empowerment-based system

The subject of democracy in Russia raises a fundamental issue: the fact that the citizens’ legitimate demands on their government, just as the reciprocate demands of the government of its citizens, do not remain constant in time (except only in the most general and theoretical sense). In practice they vary according to the historical circumstances.

If stability and prosperity are the general norm, then the citizen, having his basic needs satisfied, will aim at acquiring the greatest possible freedom and power to direct his life as he wishes, and to remove obstacles that would prevent such freedom. Thus representative democracy was initially the result of the demand by the European middle class (the bourgeoisie) for a political voice commensurate with its economic contribution to the state, according to the principle of “no taxation without representation”.

At the other end of the scale, when the survival of the individual, the group or the nation are threatened, the population will demand urgently that the government provide security and the means of physical survival. The structure or system that provides such security and the assurance or hope of survival will be the one preferred by the population (and it can be, in essence, considered to be “democratic” to a degree, since it responds to the wishes of the people).

The above explains the apparent contradiction between the popularity of the current Russian government, as led by Mr. Putin, and the “authoritarian” and “anti-democratic” tendencies attributed by Western commentators to the same government. In Russia, security, stability and the means of subsistence have been in short supply since the end of the 19th century. The current government – which was, by the way, legitimately elected under the current constitution – has responded to this need and answered the major wishes of the population, hence its popularity. It is ironic that the US government, from which much of the criticism of Russia currently emanates is pursuing policies which are opposed by a strong majority of the American public – and at the same time blaming Russia for “anti-democratic” tendencies.

It can be answered by the critics of the Putin government that it is “buying off” the population while preparing for a return to totalitarian rule. This is possible, but not necessarily the case. It is more logical to assume that Russia is currently searching for a balance, in terms of government operation, between previous authoritarian systems and the chaos that followed the dissolution of the Soviet Union. This chaos, it must be noted, reigned while Western-style democracy was in full swing. A return to a stronger state is a logical expectation, and such oscillation between the centralization of power on the one hand, and its wider distribution on the other, can be expected to continue until a system of government that is both stable and adapted to Russian conditions is in place.

It is to be hoped that the current phase towards a strengthened government authority will prove to be a step towards the gradual introduction of such a stable system. As mentioned above, the degree to which such a system is democratic would best be measured not by how much it imitates Western models but by the effectiveness of its feedback loops. These loops must operate in the following domains:

Religious, ethnic, cultural

This translates into the freedom and ability to practice one’s traditional or chosen religion, and to maintain ethnic solidarity, language and culture. These freedoms imply the absence of religious or cultural coercion, and also the ability of the community concerned to use its resources – particularly the portion of taxes normally dedicated to schooling and cultural activities – according to the wishes and priorities of its citizens.

Political

There must be citizen control over the territory they inhabit and the institutions needed for the maintenance of law and order – police, militias, courts – within that territory, together with the resources necessary for their operation ; similarly, the form and structure of government within the territory should conform to the wishes and traditions of the population.

Economic

The population must exercise control over a reasonable portion of the resources located within the territory, as well as over the form of economic activity taking place there. This applies particularly to the ownership of land, in the sense that the land is considered to belong to the population and cannot, for instance, be expropriated for the benefit of a foreign entity.

Environmental

The population is guaranteed freedom from environmental damage originating outside the territory, and authority over environmental regulation within the territory so as to avoid such damage.

The primary difference between the Western democratic model and the system sketched out above is that whereas the western model focuses on elective representation (on the assumption that the elected persons will act according to the will of the people), a system based on feedback loop concept emphasizes the actual degree of control of any given population or community over its own affairs, whatever the overall political structure might be. In other words, the primary concern is functionality rather than structure. It does not preclude (in fact it requires) a strong central government to deal with the issues which are national in scope – such as national defense, energy, scientific research, and the higher levels of education – but at the same time does not establish a uniform, top-down framework for dealing with issues which are local in character.

A feedback-based political system, in order to operate, also requires a set of pre-conditions. The most important of such conditions are :

Fundamental charter

Basic document outlining the respective duties and obligations of the government (at all levels) and those of the populations governed. This is different from a traditional constitution, which outlines the structure of government and the mode of popular representation. The charter mentioned here deals more with function and purpose rather then structure. It lists the services the governing body is to provide, and the duties and activities of the population with respect to the governing body. It will also specify the means and channels through which the population can participate in setting the priorities for government action, as well as the means and channels of recourse and control that will be available.

Ethical code

Duties and responsibilities – particularly on the side of the government – will not be efficiently discharged without a public ethical code. Such a code must be more positive (actions to be performed) than negative (actions to be avoided)

Resource sharing

A fundamental tenet of an empowerment-based system is that the national resources are to be shared by the different layers of government and the appropriate portion retained at every level as a matter of principle and inherent functionality – rather than as a result of budgetary allocation from the central authority.

National strategy

The system will work if there is a coherent and clear strategic framework, within which priorities can be set from the national to the local level.

It is clear from the above that an empowerment-based political system will be particularly well suited for maintaining democratic control in times of greater demand and challenge, whereas a representative system will be suited for times of stability. The times we are facing will provide considerable challenges at the national and global levels, and therefore such an empowerment-based system would be ideally suited for the near future. It will be particularly so in states such as Russia, where the need for restoring prosperity, national cohesiveness, basic services and a strong and flexible government is particularly urgent.

Conclusion

The choice that the Western media and politicians have outlined for Russia – namely between a copy of Western democracy on the one hand and an “authoritarian” government on the other – is a false one. The first option is probably not workable, the second less than ideal. The option that is both workable and full of promise lies in a different direction: to use the current favorable situation to begin setting up an empowerment-based system and continue development in that direction as the benefits of the system materialize.

This option excludes neither a strong central government (which is needed in a number of areas), nor the ability of the people to make and implement, at their own level, a number of decisions which will substantially affect (and improve) their living conditions.

What such a system would look like is up to the Russian nation – including their embedded minorities – to design. The chances for success are high. Not only have the Russians a direct experience of the potential abuses and limits of state power, but they have an unmatched ability to devise solutions to apparently insoluble problems, and to do so in a communal fashion.

Such an endeavor would not only benefit Russia, but many other states which are experiencing similar problems and challenges. It would make a major contribution to facing the national and global challenges on the 21st century.

ECONOMIC POLICY - BEYOND GLOBALIZATION - Summary

2007-10-13T14:41:00.000-07:00

Economic policy is hardly mentioned in the current election campaign dialogue. It is assumed or implied that the expansion of the last six years will continue and the economic climate remain positive. In fact a decisive economic policy is urgently needed to deal with two major factors: first, the growing impact of globalization and, second, the high probability of a US economic downturn.

The goal of the globalization process supported by the last two administrations (Clinton and Bush) is in theory to create one single global market with free flow of capital and goods. The US has contributed to this through tariff reduction and through the creation of global liquidity by means of large trade and budget deficits. There was however no reciprocal flow as much of the outflow of US funds has been retained by governments. This has reduced opportunities for investment and created demand for new assets.

In response to demand, new types of assets have been developed through financial engineering. These classes of assets, however, are “off-market”, meaning that their real value is unknown. They have been priced within an expanding economy, which implies that the valuations may be too high. This valuation problem results in a “risk overhang”, through which even a mild economic contraction can turn into a major collapse.

This situation requires an aggressive economic policy, with the following goals:

- Reducing the outflow of US funds through fiscal discipline and a targeted tariff policy
- Boost both domestic US investment and economic activity

This can most easily be achieved through a national program aiming at maximizing energy efficiency and reducing the use of fossil fuels. Such a program would not only achieve the objectives stated above, but satisfy the strategic requirement of energy independence.

Such a program would also require cooperation on a national scale between government and private industry. The nation once managed a massive effort of this kind when it needed to mobilize for WW II. This effort was not only hugely successful, but it put an end to the Great Depression and laid the foundation for half a century of prosperity and economic dominance.

We are today facing a challenge of similar magnitude, both economically and politically. The nation has done it before, and it can do it again.