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Obama's main mistake in Syria was drawing the Chemical "red line" to begin with. The war there is no more horrible this week than it was last week, regardless of the weapons used. There are several groups of psychopaths fighting each other, and fighting to support one of them will not make things better. It would only serve America's need to "do something" and generate business for the world's military industries. 

What the West should do is set up safe areas along/near Syria's borders where civilians can relocate and be provided for. It would save more lives, cost less, and will not bring about a worst outcome in a situation where all options are bad anyway. It would also carry more moral weight and be more principled than forcing the hand of yet another country and then leaving it in an even bigger mess (Afghanistan, Iraq, Lybia, Egypt, etc.).
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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 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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Big cop, small cop.
In a recent discussion with an American friend, I pointed out the colossal damage caused to America by the accumulation of additional debt and the bailouts of failed financial institutions. 
My friend, who agreed with me in principle, defended Obama's policies by saying that Obama is conducting the bailouts 'under the guidance of... Bernanke, Summers, Geithner' and that he merely 'continued the bailout started by Bush'. This is a common argument. The gist of it is that things are bad, we need to fix them, but there is no need to hurry. In addition, it justifies the errors of the current president by claiming that similar errors were committed by his predecessor. 

For the purpose of this analysis, we can ignore the fact that Geitner, Bernanke, and Summers were appointed by Obama himself. If someone believes that bailing out financial institutions in this way is a good policy - that's fine. What piques my curiosity is that people who think it is a bad policy are nonetheless willing to accept it and even justify it, and do not see any urgency in eliminating it. 

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"People are always shouting they want to create a better future. It's not true. The future is an apathetic void of no interest to anyone. The past is full of life, eager to irritate us, provoke and insult us, tempt us to destroy or repaint it. The only reason people want to be masters of the future is to change the past"
History is written by the winners. The above is taken from Milan Kundera's Book of Laughter and Forgetting and refers to the consistent efforts of Soviet officials in Eastern Europe to rewrite history. Soviet communism is a thing of the past, but the battle to control the future in order to rewrite the past is far from over. 

In the midst of a global financial crisis, it is interesting to see how our understanding of the Great Depression, 80 years ago, shapes current attitudes. It is even more interesting to examine the discrepancies between actual facts and the history currently taught at elementary schools and published in mainstream newspapers. 

We can summarize the common view of the Great Depression as follows:

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"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, Governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some... As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of Society than to debauce the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
John Meynard Keynes wrote the above in 1919, in an essay about Inflation and Deflation. This is the same Keynes whose theoretical work and policy recommendations serve to justify current calls for increased government spending, money printing, and cheap credit. How does one reconcile his views on the peril of inflation with the solutions that are being proposed in his name? More on this next time. 
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"Has it ever occurred to you, Winston, that by the year 2050, at the very latest, not a single human being will be alive who could understand such a conversation as we are having now?...The whole climate of thought will be different. In fact, there will be no thought, as we understand it now. Orthodoxy means not thinking--not needing to think. Orthodoxy is unconsciousness."
In 1984, George Orwell introduced Newspeak, a new language being gradually adopted by citizens of a fictional country called Oceanaia. As Orwell notes, the intention was that once Newspeak had been fully adopted, 'a heretical thought should be literally unthinkable, at least so far as thought is dependent on words'. This was done through the invention of new words and, more importantly, by 'eliminating undesirable words and by stripping such words as remained of unorthodox meanings.'

Words, of course, don't change their meaning by coincidence. As Orwell points out in his 1946 essay Politics and the English Language, the 'decline of a language must ultimately have political and economic causes'. Of course, if we think foolish thoughts, our language would become full of foolish words, but the effect becomes a cause and the new language encourages more foolish thoughts. But what exactly does it mean that the decline of language has political and economic causes? Well, since the civilized world happens to be in the middle a severe ideological crisis, we can use a contemporary example to show how this process works. 

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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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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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Above is a chart of the US Monetary Base - the total amount of currency in circulation and in central bank deposits. As you can see, the total amount of money in the America more than doubled since the end of 2008. This was achieved through the actions of Federal Reserve, in the service of the US Government. It was done in order to create money to pay for the government's bailouts, stimulus package, and other obligations. 

But, can money be created just like this? Yes. Can it maintain its original value? No. So... all the people who are saving in USD were essentially taxed by the US government (through diminishing the value of their savings). 
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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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Looks like the world is going crazy. Yesterday, the Chairman of the Federal Reserve, Ben Bernanke, gave a testimony to the US Senate panel on Fed policy. 

As you may remember, the Fed has a monopoly on printing money and fixing interest rates. Mr. Bernanke tried to explain to the Senators how the Fed would eventually 'let go' of its current policy of 'near-zero' interest rates and flooding the market with newly-printed cash. He noted that things are getting better and that already "many markets are functioning more normally".

Bernanke openly talks about his policy of (i) manipulating interest rates in order to increase borrowing, (ii) printing more and more cash in order to create inflation and 'growth',  and (iii) using public money to bail out banks and other companies that made the wrong choices, instead of letting them pay for their mistakes and go bankrupt. At the same time, he mentions that "markets are functioning more normally". What "market" is there when so many parts of the economy are centrally controlled and manipulated by the Fed?

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I often write about the importance of free markets and the dangers of big government. There seems to be a lot of confusion these days about the meaning of those two concepts, especially when seen through the prism of traditional political left/right divisions.

Yesterday, a friend of mine pointed out that the current crisis was created under George W. Bush. If free markets and small government are really the solution, how come a "right-wing" president who "reduced taxes" brought us into this mess?

That's a great question, and president Bush is a perfect example of all the misconceptions people have about economic policy and the right-left division in US politics. How so? Let's look at the numbers.

Bush may have reduced (some) taxes, but federal spending during his two terms went up 19.7% and 25.3% respectively, not including defense spending. If you include spending on security and other adventures, the growth is almost 50%.

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"Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion....To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection - a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end.... It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression."
Karl Marx once wrote that every historical occurnce happens twice: first as a tragedy, second as a farce. Above is an excerpt from an essay published by F.A. Hayek in 1933, at the height of the Great Depression. It is based on an essay he published in German in 1928. Not much has changed.
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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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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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