Thursday, 18 November 2010

What do the American Election Results mean?

The results will, I fear, make it difficult for the United States to pursue a coherent policy. While the new Republican Speaker John Boehner is a pragmatist, the ideological and support base gap between his party and the Democrats in control of the White House is quite wide.
Republicans did better among older voters. Many of these depend on Federal programmes, like Medicare, so it will be hard for Republican to live up to their promise to cut the Federal deficit.
The Republican Party won at least sixty-one House seats and six Senate seats. They gained five governorships and control of several state legislative chambers.
There are now fifty-five legislative chambers controlled by the Republicans compared to thirty-six before the elections. All US states have two legislative chambers, except Nebraska, which has only one. The Republicans now control a majority of all state legislative seats for the first time since 1928.
Generally speaking, state legislatures draw the district or constituency boundaries for the US House of Representatives, and while they must respect population numbers, they shape the District lines on party political grounds.
There are many bizarrely shaped districts, as the majority in the state legislature try to maximize the representation in Washington of their own party. Many districts have the shape of a snake with a very long body but a huge head and a huge tail. One district runs down the base of the Grand Canyon, with either bank in other districts. Sometimes districts are shaped in a way that it would be impossible for one to drive from one end of it to the other. One would have to swim!
The new Republican dominance in state legislatures gives them control over congressional redistricting for 195 House seats, compared to 108 seats in states where the drawing of these boundaries will still be controlled by Democrats.
Unlike most states, California will now have a neutral commission to reapportion its congressional seats after a long period of Democratic dominance. It is a pity that every state does not adopt the new Californian system. It would make US politics less polarized because it would force candidates to compete for the middle ground voters. The present system creates districts which lean so strongly to one party or the other that the real contests take place in the primaries where the winner tends to be someone who would have little interest in the ideas of the opposite party and a heavy concentration on the interests of his/her own party supporters.
The success of Republicans in so many state legislatures will make it very difficult for the Democrats to regain the majority in the House of Representatives that they have just lost.
The story is similar in the Senate. Republicans will have to defend only ten Senate seats in 2012 compared to twenty-three being defended by Democrats. Most of these Democratic Senate seats are in states which voted Republican earlier this month.
The election has also increased the ideological divide between the two parties because twenty-four conservative Blue Dog Democrats lost their house seats while four others retired or sought higher office. Among those who will be particularly missed are Bart Gordon, Jim Marshall and Jim Oberstar. The Republicans have several new members affiliated with the Tea Party movement who will be less willing to compromise with the other party.

The Republican victory resulted from their ability to gain votes across the board.
They won the support of 55% of male voters and 48% of female voters.
They won over half the votes of people aged over thirty years and got 57% of voters above the age of sixty-five years.
The Republicans won 57% of the votes of people earning over $100,000 per annum, and 53% of those earning over $50,000. But they obtained only 43% of the votes of those earning less than $50,000. But people claiming to be in a better financial position voted 58% Democratic while those claiming to be worse off voted 63% Republican, which seems to contradict the evidence based on actual income levels of voters.
Unlike previous occasions, educational attainment did not influence voting. The Republicans won 52% of the vote of both college graduates and non-graduates.
The Republicans won 59% of rural voters and 54% of suburban voters, but only 41% of urban voters.
The Republican success with elderly voters will constrain their ability to curtail entitlement programs, like Medicare and pensions. In fact, many Republican candidates criticized President Obama for threatening to reduce Medicare benefits in order to finance his health care program for the uninsured. In fact many voters seemed not to realize that Medicare, which provides health cover for the elderly, is a Federal Government programme. The potential unwillingness to curtail entitlement programs will make it politically difficult for Republicans to vote any meaningful deficit reduction. That will mean that the US will continue to borrow a lot of money, which will make life difficult for other countries, like Ireland, who also need to borrow on the international markets.

The Republican victory increases the risk of deadlock on many issues, unless President Obama can show real imagination and craft a new agenda that it would be difficult for Republicans to oppose. So far, he has shown little sign of doing this. But he may be waiting until new majority takes over before making any moves.
The outgoing House will still have one session, the so called lame duck session, before the new one meets. I think President Obama could find common ground with Republicans in promoting free trade and legal reforms to curb big damages awards which push up health costs.
Many US state governments are in severe financial difficulty. Much of President Obama’s stimulus programme went to prop up the finances of state governments. Now that Republicans have more power in both Washington and in the individual States, it will be interesting to see if they will support bailouts for the State governments in financial difficulty, something they were previously reluctant to do. Republicans will continue to be reluctant to bail out big cities, because they have few voters there.

Friday, 12 November 2010

Is the panic justified?

The  recent panic in the markets about the sovereign debt of peripheral euro zone countries , like Ireland and Portugal, lacks objective  justification.
Bondholders are afraid they will not be repaid in full because of a proposal by Germany to amend the  EU Treaties to allow for bondholders of  euro zone countries , that  get into difficulties and have to get EU help, to have haircut or discount applied to the amount they are repaid. This would be part of a new crisis mechanism(ECRM)
Markets seem to be reacting as if this proposed mechanism could be applied to existing bonds or to bonds issued before the proposal  became law.  I believe they are wrong.
The Brussels based think tank, Breugel, has produced a paper on the subject, which is worth reading.
It says
“The creation of the of the ECRM would likely need to be established by a treaty. The mechanism would, therefore, only apply to future debt issuance”
I believe the European Commission and the German  Government would do themselves, and everybody else, a  big favour by making this clear.
It is a fundamental principle that laws cannot be applied retroactively, and the markets need to be told that.

Thursday, 11 November 2010


I was in San Antonio, Texas, this week to speak to a conference of the Association of Equipment Manufacturers The members make equipment for use on building sites and farms around the world. Among the prominent members are Caterpillar, JCB, Volvo, John Deere and Liebherr, the family owned German company, that was one of the first ever foreign owned firms to invest in Ireland in the modern era. It came to Killarney in Kerry in 1959 to make cranes, and it is still there.
The Association is a very internationally oriented. The two speakers before me were both also from Europe. One of them complained about excessive regulation by the EU of matters like noise, dust and vibration on European building sites. He said differing global standards made export development more difficult for European firms.
The post before this one on this website contains the gist of my own remarks at the conference.
Another speaker was an old friend of mine, Bob Young, the Chief Economist of the US Farm Bureau, the major organisation of American farmers.
He said that American tillage farmers have had four or five very good years.
The extra demand for farm land to produce corn for ethanol has reduced supply of other crops and driven up prices . Almost as much corn is now being produced for ethanol as for animal feed. The excise duty exemption for ethanol is due to expire, but could be renewed.
Cattle production in the US peaked in 1975. Cattle numbers have been falling since, and are now back to their 1958 level. Cattle prices are low and are not likely to rise soon. Dairy farm incomes have been very volatile, more so than in Europe.
I also had the chance to meet with my third cousin, Jim, who lives in Texas and whose great grandfather, also Jim, emigrated from Dunboyne in 1856 and eventually settled in Festus, Missouri. His brother, my great grandfather, John, stayed at home on the farm in Dunboyne.
I first got to know Jim 15 years ago, we have kept in touch, and it was great to see him again. I originally traced my American relatives thanks to responses to a letter I wrote to a newspaper in St. Louis, giving details of an 1893 wedding notice I had found at home, and asking if any readers knew and descendents or relatives of the couple. It was very exciting to renew transatlantic family contacts that had been lost for more than half a century.

Sunday, 7 November 2010



The current economic crisis has brought forward some changes that were inevitable or were already taking place at a slower pace. The credit boom in western countries, that was fuelled by Chinese savings, was an anaesthetic that prevented the symptoms of underlying difficulties from emerging. We need to redesign global capitalism so that it faces up to long term problems of the kind the credit boom shielded from our view
In that sense, we would have been better off if the crisis had occurred sooner, because we would then have been forced to deal with the underlying problems sooner.
The underlying problems, which the credit crunch has laid bare are
the ageing of our societies,
the failure of some of our education systems,
the chronic vulnerability of our western patterns on energy and food consumption
the distorted allocation of resources by capital markets,
and our inadequate means of supervising flows of capital across borders.
The fact that people are living longer has meant that the pension systems of most western countries are unviable. People are living too long, and qualifying for pensions too long, to be supported in retirement by the contributions they made during their working lives. This was made worse by mistaken “early retirement “ schemes introduced to create jobs for younger people, or to solve short term public finance difficulties.
The ageing of societies has also contributed, along with law cases and incentives to over use of drugs and tests, to an explosion in health costs. David Walker. Former Comptroller of the United States, says
“If there is one thing that could bankrupt the United States, it is out of control health costs”.
The United States is the worst case here, but other countries are heading in the same direction.
While the US Federal debt $13 trillion, unfunded commitments under entitlement programmes related to ageing come to $55 trillion.
All these problems were known during the credit boom, but there was no apparent necessity to do anything about them, because money was artificially plentiful. Indeed it was nearly impossible to do anything because the availability of revenues made anyone who proposed unpopular changes appear to be heartless, or politically unrealistic. All that has changed now.
Education systems have also been failing to respond to challenges. A significant proportion of students continue to drop out of school with few or no qualifications. This is the case all over the western world. One of the reasons for this is that our educational systems have been designed for those with academic aptitudes, but not to nurture other forms of intelligence. It is too easy to drop to the back of the class. Extra help needs to be given when children are still very young, if it is not to be too late . The only jobs some of those leaving school without a qualification are able to do were ones that can be done more cheaply in Vietnam or China.
Young unqualified males were particularly vulnerable. 75% of the recently unemployed in the US are male. Young females could find jobs locally in traditional female occupations in the service sector, but the jobs that unskilled males did were either in sectors that migrated to the Far East or in volatile sectors like construction.
Income inequality has risen, especially in English speaking countries. In 1965, American CEOs earned 24 times the average employee. In 2007 they earned 275 times as much. Since 1970, productivity in the US has risen five times as fast as wages have.
Long term unemployment is on the increase, and the longer people are unemployed, the more their skills and aptitudes for work deteriorate. The new jobs are not being created in the sectors for which many of the unemployed are able to qualify.
The underlying failure in all these developments was a failure of education to prepare people for economic reality, but the social consequences make people angry and unwilling to accept leadership when it is most needed.
The financial crisis has also laid bare the fundamental unsustainability of our patterns of energy and food consumption in the western world.
There is not enough oil, nor enough fertile land, nor enough unpolluted atmosphere, in the world to cater for a situation in which Indians, Chinese and Brazilians consumed oil, coal, and livestock products at the rate we do in Europe and America. It take far more acres to produce food off the back of an animal than if it is consumed straight from the ground.
The legacy of colonial intervention in China and India held those countries back for two centuries. That era is now over. They will look for the same meat and dairy intensive diets we take for granted. Energy and food prices will inevitably rise because of increased demand for energy and for meat intensive lifestyles by the growing middle class of the emerging economies. It is the same with energy. On present trends, China’s oil imports will double in the next twenty years.
We have only been able to maintain the present patterns of consumption because there was less competition for these resources than there will be in the future and because,in the past , we controlled the rules of the economic game. We were able to write world trade and intellectual property rules in our interests.
The United States, with its vast coal reserves and fertile lands, can resist the effect of these trends longer than Europe can. But even the United States will have to adjust. If US oil consumption per head was reduced to average European levels, the saving would be equivalent to China’s entire present oil consumption. The money that is spent in Europe and America on subsidizing energy extraction needs to be diverted to research into energy conservation.
The price paid for letting carbon go off into the atmosphere is too low to make carbon capture at coal plants economically worthwhile. It must be increased. Decarbonising transport will be even more difficult. Perhaps the US deficit could be bridged in its entirety by gradually increasing gasoline taxes to European levels. Perhaps that will be one of the ideas the bipartisan Deficit Reduction Commission will come up with when it presents its report in December.
But we need long term solutions too. We must find radically more efficient ways to transform the energy the sun sends our way every day, into food on our tables, and fuel in our motor vehicles.
Reducing our dependence on oil would bring big long term political benefits as well. It would reduce our vulnerability to blackmail of the kind that OPEC imposed in the 1970’s. By 2030, OPEC will produce 52% of the available oil, as against 42% today.
The capital markets have not covered themselves in glory in recent years.
Thanks to financial innovations, shares in companies could be bought and sold again with much greater frequency than ever before. Hostile takeovers became easier to mount. This meant that companies were judged, and executives rewarded, on the basis of short term movements of share prices.
The scale and speed of capital movements around the world also overwhelmed those trying to keep track of it in the public interest. Foreign investment was 20% of global GDP in 1980, by 2000 it was 100%. Foreign Exchange reserves went from 5% of global GDP in 1995 to 11% in 2008.
Failure to monitor the consequences of these rapid movements had its most devastating effect in banking, but it infected the rest of the economy too. The freeing up of global capital markets has outdistanced the supervisory capacity, and even the understanding, of national financial regulators.

It fuelled a housing bubble. It allowed banks to be runs as “workers cooperatives” wherein the short term financial interests of senior employees were given preference over the longer term interests of shareholders.
The frequency with which shares changed hands increased dramatically. Individual shareholders were replaced by institutions, who bundled portfolios of share together, and whose executives were often rewarded on the basis of short term results. Quick productivity gains were thus preferred to longer term innovations. The human capital of companies was often valued less than it should be.
We have not even begun to consider the remedy to this problem. One suggestion, to give preference to longer term perspectives, might be to enhance the voting share of shareholders that hold their shares for a longer period. Another might be to impose a small fee to slow down foreign exchange transactions a little, to give time to supervisors to see where the trend is leading.
This has led to the build up of unhealthy imbalances in the world. Half of the debt of the United States is now held by foreigners, particularly by the Chinese central bank. The Chinese have bought these dollar denominated assets in order to keep the value of their own currency artificially low. Meanwhile the US is printing more dollars through Quantitative Easing. The Carnegie Foundation said last month
“The United States should cease pursuing what is increasingly seen as a policy of currency depreciation against the rest of the world”
The net effect of these political decisions is that both the Chinese and American currencies are now being artificially devalued against other currencies like the euro. That is unsustainable.
It introduces a lot more uncertainty and tension, into a world that is already uncertain and tense. It is reminiscent of the behaviour of nations during the 1930s.
Politically created problems need political solutions. The venue in which these political solutions should be found is the G20. But it has not yet found its feet, and is governed by a rotating Presidency, a system the EU has found to be unsatisfactory.
Anatole Kaletsky, in his recent book, “Capitalism 4.0”, says
“International coordination of economic policies will be inevitable if the world economy is not to degenerate into a new financial crisis”.
To sum up, if free movement of capital across borders is to continue, the world probably needs to institute, what the EU itself is trying to grope its way towards for the euro, a system of cross border economic governance that highlights imbalances and distortions long before they become bubbles about to burst
Any system of global economic governance will, of course, mean a pooling of sovereignty, something that both the United States and China would be very reluctant to agree to. But is one is to preserve complete free movement of capital across the world, you have to have a global rule maker and enforcer. Capitalism only works when there are rules that are enforced. That applies within nations. It also applies between nations.
If complete freedom from rules was the answer, Somalia would be the richest capitalist country in the world!
Fines and penalties may not be necessary. So long as information is shared and published in a timely way, markets will discipline delinquent behaviour. The job of supra national supervisors is to ensure that the information is obtained and published in good time and is interpreted intelligently and courageously. The IMF can do this work, so long as it is allowed to. It should be given the full range of supervisory functions over all countries, including the United States and China. If disputes arise, we already have, in the WTO panels, a system of adjudication.
The crisis has created the sense of urgency. It is for political leaders now to come up with the vision.

Thursday, 4 November 2010

Speculators betting on our default will lose

By Donal O'Donovan and Thomas Molloy

FORMER Taoiseach John Bruton warned the bond markets in strong terms that speculators betting on an Irish default will lose a lot of money.
The comments came as the cost of sovereign debt hit a record 7.59pc yesterday. The former Taoiseach was speaking at IBEC's CEO conference in Dublin.
Meanwhile, two Russian sovereign wealth funds were instructed not to invest in Irish bonds. The instruction came from Russia's finance ministry yesterday and also applies to debt from Spain, another so-called peripheral economy.
In a mostly off-the-cuff speech, Mr Bruton told the IBEC conference that speculators betting on an Irish default were going to lose money.
Ireland remains a rich country, well capable of repaying its debts, he said.
Mr Bruton said sovereign rights fought for by previous generations come with sovereign responsibilities including repaying sovereign debt in full and on time.
Mr Bruton backed Finance Minister Brian Lenihan's insistence that Ireland will repay its debt.
"If this generation fails to repay its debts it would be a betrayal of the history of the country since the Act of Union in 1801," Mr Bruton said.
He added that politicians on all sides were now doing a good job to stabilise the situation.
"In Ireland in the run-up to an election, all political parties are prepared to set out the hard and difficult things that must be done to bring the public finances under control. How many other countries in the world can say that?" he said.


The price of Irish bonds fell for a seventh day yesterday; driving the yield paid to investors to 7.59pc.
The continued weakness means Irish 10-year bonds paying 5pc interest changed hands at just 82.36pc of face value. The rise in yields on Irish bonds came as the yield on German bunds was falling.
That meant the risk premium for holding Irish bonds, the spread over German bunds, widened to more than 5pc. Bloomberg said it was the widest spread since the information company began collecting the data in 1991.
Mr Lenihan said moves by Germany and France to introduce a new bailout regime are causing the spike in Irish yields.
Speaking at the same IBEC conference as Mr Bruton, he said this week's spike was due to concerns about a possible new restructuring mechanism for the eurozone. The proposals were unhelpful, he said.
He said he would not move the date of the December budget forward to reassure the bond markets. He would tell the opposition and the markets how much the Government intended to save later this week.
The cost of insuring Irish bonds with credit-default swaps (CDS) contract also hit a high yesterday.
CDS rose by 0.36pc to 5.54pc. That means it cost €554,000 to ensure €10m of bonds against losses within the next five years.
CDS controversially allows investors to buy more insurance than they hold bonds, incentivising them to push for defaults.

- Donal O'Donovan and Thomas Molloy

You can read this article in