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It is likely that Iran is developing and acquiring nuclear capabilities in order to produce nuclear weapons. Iran's current rulers have been vocal and consistent in their calls for Israel's destruction. Such statements have gone beyond what is considered acceptable in the arena of international relations. Iran actively and openly supports violent activities against Israeli civilians via proxies in Lebanon, Gaza, and elsewhere. Iran undermines Lebanon's sovereignty and national security by funding and supplying a local army not controlled by that country's government; it undermines a potential peace agreement between the Israelis and Palestinians by encouraging and facilitating the latter's choice of violent resistance and denial of Israel's right to exist within any borders. It is possible that Iran will soon enter a "zone of immunity", following which it will not be possible to thwart its efforts to acquire nuclear weapons. 

Israel should not attack Iran. Nor should it solicit American action to that end. Based on historical precedents, if Israel had a surgical way to thwart Iran's nuclear ambitions, it would have done so already. Hence, on the assumption that such an elegant solution is not available, the cost of an Israeli strike does not seem commensurate with the reward. Further, the potential cost, and likelihood, of living with a nuclear Iran does not seem high enough to justify a wager of this kind.

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The rapid growth of the Asian "Tiger" economies gave rise to the idea of an Asian development model, one which consists, perhaps, of a cultural component that is uniquely Asian. Confucianism, an existential and political philosophy that originated in China and spread through east and southeast Asia, is often mentioned as one such possible component. More broadly, the interplay between culture and development has fascinated economists and sociologists for generations and is addressed in many of the classics of both disciplines1. As two relatively closed societies and as Asia's only two large-scale economies to attain the status of developed countries, Japan and South Korea offer an interesting case study for the examination of the importance of Confucianism.

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Japan and Korea are among a "handful of successes among the world's more than one hundred developing countries" (Kuznets 1994:1) and as such offer a successful development model to emerging economies in Asia and beyond. While both countries completed the transition to a fully-developed economy in the 20th century, it is worthwhile to examine the historical foundations of this transition. By surveying the 19th century roots of Korean and Japanese development, we can draw conclusions that may benefit the 21st century modernization efforts of other countries, most notably China. 

It is beyond the scope of this short essay to address the myriad factors that may have influenced industrialization and further economic growth in these two countries. My aim is to provide an overview of, and perspective on, some of the recurring themes in the relevant literature, namely the role of political stability; advances in agriculture; urbanization and proto-industrialization; formation of human and physical capital; and the impact of institutional change.

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"The importance which the certainty of law has for the smooth and efficient running of a free society can hardly be exaggerated. There is probably no single factor which has contributed more to the prosperity of the West than the relative certainty of law which has prevailed here."
Two years into the crisis, the US finds itself with fewer jobs, slower growth, and a higher unemployment rate than expected in the government's worse case scenarios. The current debate concerning America's troubles is focused mainly on monetary and fiscal policy: more or less stimulus, higher or lower taxes, and the expansion or contraction of government programs. 

While the source of America's pain is in monetary and fiscal policy (artificially low interest rates, wars, programs to encourage sub-standard home loans), one of the keys to its recovery lies in a different field: The law.

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The American media is in combative mood: A year and a half after Lehman's collapse, the pundits are finally waking up to the fact that China bears a significant share of the blame for the current financial crisis. And so, the Krugmans of this world are calling for the US government to 'punish' China through a variety of protectionist measures. 

I have been writing about China's role in creating the current crisis for a long time. And still, I think it is wrong to blame China for America's pains - namely, a collapsing credit bubble, rising unemployment, and a ballooning government debt. 

Yes, the Chinese are manipulating their currency. By doing so, they make it easier for Americans to buy Chinese goods for less and make it harder for Chinese citizens to increase their purchasing power. They are also making it more difficult for Chinese companies to move up in the global supply chain and produce better, more innovative products for higher prices. China's currency manipulation, on its own, damages no one other than the Chinese people. 

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'There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.'
The above quote from Ludwig von Mises's Human Action (1949) pretty much sums up where we are and where we're headed. There are two ways out of this mess: Allowing bad banks and bad companies to go bankrupt and take some pain in the short term; or bail them out through government "creation" of more money and cheap credit.  Looks like the world has opted for the second option. 

This means we will experience a period of illusionary recovery, mostly in real estate prices and equity markets, powered by the huge amount of new money created by government(s). This illusionary recovery can last anywhere between 6 months to 10 years - depending on the amount of money being printed and on external triggers - but will eventually come to a painful stop, when all governments are deeply in debt and there's no one left to bail them out. 

Once we reach that point, governments are most likely to choose the only way out that allows them to divert public attention from their failure and get everyone to work together towards a common goal -  war. Until then, enjoy the ride. 
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One of the most popular memes repeated by mainstream media since the collapse of Lehman Brothers last year is the idea that China will manage to avoid the consequences of the economic downturn by shifting from an export-based economy to one based on local consumption. 

Back in the middle of 2008, many publications, most prominently The Economist magazine, suggested that a downturn in developed countries might not have any significant effect on developing economies, since the latter have already "decoupled" and are no longer heavily dependent on demand from consumers in rich countries.

Within a few months, the "decoupling" theory proved to be false: The downturn in the developed world had a significant impact on China's economic well-being, causing a dramatic rise in unemployment and a sharp slowdown in economic growth. The Chinese government, just like the American one, responded with massive stimulus spending and expansion of cheap credit.
 
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National Effort.
We live in a time of immense confusion. Words that used to mean one thing suddenly mean another. The values which made us prosperous and free are being questioned and trampled on. We are in a mess, and our instinctive reactions seem to make things worse. 

In 1989, following the collapse of the Soviet Union, Francis Fukuyama declared "The End of History" and noted that 'The triumph of the West, of the Western idea, is evident first of all in the total exhaustion of viable systematic alternatives to Western liberalism'. Twenty years later, the ideological appeal of classic liberal values  - free markets, property rights, civil liberty, and individual responsibility - is in decline, following an economic meltdown in developed countries and the perceived success of the authoritarian-socialist model, most notably in the People's Republic of China. Capitalism as we know it is dying. Some say it already died a long time ago. 

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'One-party autocracy certainly has its drawbacks. But when it is led by a reasonably enlightened group of people, as China is today, it can also have great advantages. That one party can just impose the politically difficult but critically important policies needed to move a society forward in the 21st century.'
The above was not written by the speaker of China's Communist Party; it was not published on China Daily or the Global Times. It was written by Thomas Friedman and appeared in yesterday's New York Times. Friedman is so in love with central-planning, that he is willing to give up his so-called liberal ideology and dismiss China's ruthless and violent control mechanism - which holds 20% of the world's population under considerable oppression - as a system with some "drawbacks", led by "enlightened people". 

Just to recap, Friedman is talking about a country in which people do not have the freedom to decide how many kids to have, which city to live in, where to spend their holidays, or which web sites to visit. They are also denied the right to voice their opinion on a variety of issues, and are required to register with the authorities if they wish to publish a blog, leaflet, or spend 30 minutes in an internet cafe.

Continue reading PRC 2009 = USSR 1929? >>>.
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USCN Dollar
Earlier this year, Zhou Xiaochuan, governor of the People's Bank of China, called for the establishment of a new global reserve currency to supplant the US Dollar. Zhou suggested that the new currency will be super-sovereign. That is, not belonging to any state. The actual exchange value, according to Zhou, will be determined through discussion between different countries. Zhou claims that his new plan would 'secure global financial stability and facilitate world economic growth'. Sounds like a good idea? In addition, if China wants to undermine the US Dollar's supremacy, why not use it's own currency, the Yuan, as a replacement? Let's put things in context. 

Over the past 60 years, The US Dollar has been the reserve currency of choice for most of the world's major economies. This means that governments chose to hold significant amounts of their currency reserves in US Dollars, and the that Dollar was the main currency used in international trade. It still is.

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Helmates.
Chinese banks gave out more than USD 1 billion during the first 6 months of 2009. This is equal to 25% of China's total GDP. The plan is to boost the economy by sponsoring viable projects that will create new jobs and increase productivity. However, even according to Chinese government sources, about 20% of these new loans already found their way to the stock exchange. Prof. Michael Pettis from Beijing University, estimates that 20-33% of these new loans go directly to the stock exchange, real estate market, or even the gaming tables in Macau. 

This means that a big chunk of the loans are not even going to the projects they are supposed to sponsor and are instead used to inflate prices in other parts of the economy. It is not surprising, then, that the Shanghai stock market went up about 70% since the beginning of the year, and that real estate prices in many Chinese cities are going up, despite declining occupancy rates. 

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As China absorbs the decline in exports created by the global financial crisis, the government is emphasizing the need to increase domestic demand and expedite the development of a local consumer culture. To put it simply - the Chinese government wants local consumers to spend more money in order to reduce the country's dependence on consumers from other countries. China's ability to shift from a production to a consumption-based economy depends on a variety of social and economic factors.  

In 1949, China had a population of 450 million; by 1980, it was close to 1 billion; today, it is over 1.35 billion. The UN's World Population Prospects, updated last year, estimate that China's population will continue to grow slowly during the next two decades and then begin to decline. The number of young people joining the workforce each year is expected to decline from 2010 (see Michael Pettis' blog for more on this). China's population is getting older and might soon begin to get smaller as well. Plenty of commentary is published about the implications this has for China's social security network and economic growth. In addition, it is worthwhile to consider the impact such demographic changes might have on local consumption patterns. 

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Passing.
While the rest of the world is suffering from the most severe financial crisis since the 1930s, it's business as usual for the people who got us into this mess. Two articles from today's Financial Times tell the whole story.

The first one talks about a new plan to give the US Federal Reserve 'extensive powers over all large US financial groups' and create an 'independent body to police risks across the financial sector'. 

The second announces that China's 'foreign exchange reserves reached $2,132bn after rising by $177.9bn in April to June, including a record monthly build-up of $80.6bn in May'.

And so, Chinese currency manipulation is going on at full speed to ensure Chinese exports remain artificially cheap, and the Fed now has even more power to make sure US interest rates remain artificially low. Will that get us out of the current crisis? No. It will only allow China and the US to pretend things are getting better, until the next crash. 

They just can't help it. If China floats the Yuan, more Chinese people will lose their jobs in the short term. If the US lets interest rates rise, more Americans will default on their payments and lose their pants. And since both economies are regulated by politicians and not by a free market, short term is the only thing that counts. 
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PDD Bank.
Below is an excerpt from a wonderful article by James Fallows from The Atlantic. Fallows traces the route of a USD in and out of China as it makes it's way through the country's enforced saving and currency manipulation mechanism. This is a must read for anyone wishing to understand how un-free China's market really is, especially when it comes to trading with other nations. The article was written more than a year ago, and Fallows did not fully grasp how unsustainable the process is. Since then, the imbalance created by China's actions, American's wrong response to it, and a variety of other minor factors brought the global economy to its knees:

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The Fall.
The global financial crisis rekindled the debate about the advantages of central planning as opposed to free markets. Various "experts", including leading American economists, are using the crisis to promote their political agendas and call for increased regulation on, and government intervention in the market , both nationally, and globally through institutions such as the UN and the IMF. I am now working on a longer post regarding the dangers these ideas pose to individual freedom and global stability. In the mean time, it's important to note that such ideas are not new, and have been found wanting by the test of time. 

China is considered by many to be the ultimate example of successful central planning. It is run by a ruthless and totalitarian government and exhibited strong economic growth for three consecutive decades. Previously, I wrote about the assumptions outsiders make when looking at Chinese economic indicators, and the way in which such assumptions affect decision making. However, even those who visit China in order to get a "real idea" of what's going on are often misguided by what they see. Visitors to Beijing, Shanghai, and other cities are impressed with the beautiful airports, highways, and central business districts and deduce that the country is developing well. 

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"People are prepared to obtain order and tranquility by giving up other values such as democracy and freedom. This dangerous temptation has not disappeared, even today." (Mikhail Gorbachev, 1993)
Protests in Beijing and Shanghai


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Twenty years ago, (some) Chinese people took to the streets and demanded the freedom to speak against corruption, to buy western goods, and to manage their lives without interruption (see Wasserstrom's summary ). Twenty years later, the world is in the midst of a financial crisis, waiting for Chinese consumers to pick up the slack of international demand and drive the global financial recovery. 

On the surface, most Chinese people have little interests in the events of 1989. However, taking into account China's role in creating the current crisis, those events might have a bigger influence on current economic matters than we realize.

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Working for the man.
Foreigners often describe China as "different"; a mysterious land whose people have a perplexing way of getting things done. Yet, when it comes to economic data, foreign "experts" look at China as they would look at any other country. I am not talking about those who ignore the fact that China's government tweaks economic indicators to fit pre-defined goals. Enough has been written about that (here, herehere and here, for example). I am talking about the way in which well-regarded western publications look at real indicators, and the assumptions they make in the process.

This morning, for example, I received a newsletter from RGE Monitor, Nouriel Roubini's consultancy firm. Reading it, I learned that 'unlike many global markets, the residential property market in China is showing some signs of stabilization'. The facts are correct. The free fall in residential prices has stopped, and in some places there are even slight increases.  A sign of recovery? not necessarily. 

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"The People have lost confidence in the Government. The Government has decided to dissolve the people and appoint another one." (Bertold Brecht)
We live in times of great darkness and confusion. A new study by the Economist Intelligence Unit provides a good summary of government and corporate attitudes towards the financial crisis, its causes, and the actions that will get us out of it (PDF here). The study is based on the opinions of '400 senior business people in companies around the world', as well as those of experts from the Economist Intelligence Unit and various business schools. Key findings include: 
...almost 60% of respondents agree that the current crisis has "fundamentally changed" capitalism... respondents believe that there will be more government oversight, more economic nationalism... Almost one-half of respondents favour more financial regulation in non-banking industries and a similar percentage favour new regulations that limit risk-taking across the entire private sector... regulation is no longer seen as counter-productive meddling in otherwise perfect markets, but a prerequisite for a functioning global economy...etc...etc...
In summary, the government (and its friends) lost faith in the Market. The Government has decided to dissolve the Market and create a new one. Most executives don't think it's such a bad idea. 

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Tainted Love.
Girl at Beijing's Intro Electronic Music Festival. More here
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Note: The views and observations expressed on this web site are published for the sake of public discussion and do not represent my personal opinion or the opinion of my companies, clients, and/or employers. If you would like to get my opinion on anything, ask me.

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