Monday, July 12, 2010

Soros on the Euro.

Pretty depressing stuff. On the role of Germany:
"And this brings me to the gravest defect in the euro’s design: it does not allow for error. It expects member states to abide by the Maastricht criteria—which state that the budget deficit must not exceed 3 percent and total government debt 60 percent of GDP—without establishing an adequate enforcement mechanism. And now that several countries are far away from the Maastricht criteria, there is neither an adjustment mechanism nor an exit mechanism. Now these countries are expected to return to the Maastricht criteria even if such a move sets in motion a deflationary spiral. This is in direct conflict with the lessons learned from the Great Depression of the 1930s, and is liable to push Europe into a period of prolonged stagnation or worse. That will, in turn, generate discontent and social unrest. It is difficult to predict how the anger and frustration will express itself.

The wide range of possibilities will weigh heavily on the financial markets. They will have to discount the prospects of deflation and inflation, default and disintegration. Financial markets dislike uncertainty. Meanwhile, xenophobic and nationalistic extremism are already on the rise in countries such as Belgium, the Netherlands, and Italy. In a worst-case scenario, such political trends could undermine democracy and paralyze or even destroy the European Union.

If that were to happen, Germany would have to bear a major share of the responsibility because as the strongest and most creditworthy country it calls the shots. By insisting on pro-cyclical policies, Germany is endangering the European Union. I realize that this is a grave accusation but I am afraid it is justified.

To be sure, Germany cannot be blamed for wanting a strong currency and a balanced budget. But it can be blamed for imposing its predilection on other countries that have different needs and preferences—like Procrustes, who forced other people to lie in his bed and stretched them or cut off their legs to make them fit. The Procrustes bed being inflicted on the eurozone is called deflation.

Unfortunately Germany does not realize what it is doing. It has no desire to impose its will on Europe; all it wants to do is to maintain its competitiveness and avoid becoming the deep pocket for the rest of Europe. But as the strongest and most creditworthy country, it is in the driver’s seat. As a result Germany objectively determines the financial and macroeconomic policies of the eurozone without being subjectively aware of it. When all the member countries try to be like Germany they are bound to send the eurozone into a deflationary spiral. That is the effect of the policies pursued by Germany and—since Germany is in the driver’s seat—these are the policies imposed on the eurozone.

The German public does not understand why it should be blamed for the troubles of the eurozone. After all, it is the most successful economy in Europe, fully capable of competing in world markets. The troubles of the eurozone feel like a burden weighing Germany down. It is difficult to see what would change this perception because the troubles of the eurozone are depressing the euro and, being the most competitive of the countries in the eurozone, Germany benefits the most. As a result Germany is likely to feel the least pain of all the member states.

The error in the German attitude can best be brought home by engaging in a thought experiment. The most ardent instigators of that attitude would prefer that Germany leave the euro rather than modify its position. Let us consider where that would lead.

The Deutschmark would go through the roof and the euro would fall through the floor. This would indeed help the adjustment process of the other countries but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative and there would be widespread unemployment. German banks would suffer severe exchange rate losses and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations: pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Let me emphasize that this scenario is totally hypothetical because it is extremely unlikely that Germany would be allowed to leave the euro and to do so in a friendly manner. Germany’s exit would be destabilizing financially, economically, and above all politically. The collapse of the single market would be difficult to avoid. The purpose of this thought experiment is to convince Germany to change its ways without going through the actual experience that its current policies hold in store.

Friday, July 9, 2010

Not Funny.

Instead of the usual "omigod-I-haven't-blogged-in-forever" I will just paste in my new article for Zahranicna Politika that has kept me busy, on a topic that has been a lot on my mind. Arguably I am not an expert on Afghanistan and therefore never had a strong view on what the US should do there, which has historically prevented me from writing about it. But that's really a cop out. If you care about something you can always become more informed and form a firmer opinion. And since the US military involvement in Afghanistan is the longest active war ever, and chances are it will be an increasingly important component of the political discourse, there are plenty of reasons to care about it. So after the recent faux pas with General McChrystal I read a lot of stuff from different people on the war and my article reflects a viewpoint that I formed as a result. Anyway, here it is.

Not Funny

The idea of a top US army general agreeing to be the subject of a magazine profile that ends up getting him fired seems almost comical. The hubris necessary to allow being followed and showcased by a magazine (one with a clear anti-war record, no less) and in the process opening up to a reporter who happily transcribed every incriminating quote - that just seems like something taken out of an episode of M.A.S.H., a black comedy TV show based on the Korean and Vietnam wars.

And yet, when General Stanley McChrystal was forced to resign from his position as Commander of US forces in Afghanistan due to a profile published in the Rolling Stone magazine, no one was laughing. Apart from comments mocking several civilian officials which were the reason why the article attracted attention in the first place and ultimately why McChrystal was replaced, the article offered a rather depressing portrayal of the state of affairs in Afghanistan and a rather scathing criticism of the whole operation, concluding with the following assessment: “So far, counterinsurgency has succeeded only in creating a never-ending demand for the primary product supplied by the military: perpetual war. There is a reason that President Obama studiously avoids using the word "victory" when he talks about Afghanistan. Winning, it would seem, is not really possible. Not even with Stanley McChrystal in charge.

And so, a mere 8 months since President Obama pledged to increase the number of troops in Afghanistan - upon McChrystal’s urging - this episode has forced many to reexamine the operation in Afghanistan.

Whether one agrees with the war or not, there are good reasons to believe that the current strategy of counterinsurgency (COIN) - a two pronged approach of taking over areas from insurgents, replacing them with Afghan government while infusing the local population with monetary aid - is not working. First, judging from the number of troops employed and lost, the vast expense, and the sheer amount of time spent in Afghanistan it seems like the US is simply not getting any smarter in fighting the insurgency. And even in the event of clearing an area from insurgents, the job is not over. One of the key components of the strategy is for the Afghan government to establish administration and ultimately take over security from US and NATO forces. Peter Galbraith, who served as deputy Special Representative of the Secretary-General of the United Nations to Afghanistan in 2009, wrote that this strategy can only work if the Afghan government can provide honest administration to win the loyalty of the local population. However, “in too many instances, the nominal government authorities are powerless, corrupt, working with both sides in the conflict, or all of the above. Karzai’s national government cannot remedy any of this. It is corrupt, ineffective, and widely seen as illegitimate.” Clearly, it doesn’t help that Hamid Karzai came to office through an election that was unmistakably fraudulent. And because the US embraced Karzai they are now relying on his government to fulfill a critical function, something it cannot do due to its shady origins.

The second prong of COIN - pouring aid to the local population - might not be effective and could be making the situation worse. Research by Andrew Wilder and Stuart Gordon on the ground in Afghanistan found “little evidence of aid projects winning hearts and minds or promoting stability.” What they observed was the main reason given by the Afghans they interviewed for the growing insurgency was the “corrupt and unjust government.” Additionally, they observed that “the single overriding criticism of aid was the strong belief that it was fueling massive corruption, which undermined some of the positive impacts it may have otherwise had.”

Still, even if the counterinsurgency strategy is not terribly effective, that doesn’t necessarily mean the US should pack up and leave. It is, however, instructive to ask, why is it that the US is in Afghanistan in the first place. One almost forgets that the answer is not “bringing peace and prosperity to the Afghans” but rather “9/11 and al-Qaeda”. In light of that original objective, it was interesting to hear the CIA director Leon Panetta recently admit that “we're looking at 50 to 100, maybe less” al-Qaeda in Afghanistan and that most of the terrorist network is operating from the western tribal region of Pakistan. Certainly, it seems odd to spend $100 billion in 2010 alone to target such a small group. Indeed the objective of the war seems to have shifted as the primary enemy fled to another country altogether. The US is no longer hunting down al-Qaeda in Afghanistan; instead they are making sure that Afghanistan can never again serve as the breeding ground for terrorism against the US.

For many who insist on US military presence in Afghanistan the need to prevent the creation of a security “vacuum” is probably the most compelling argument. Even those who oppose the war in principle, are hard pressed to advocate a withdrawal, often citing this reason. On the surface the argument makes sense: before 9/11, the Taliban harbored al-Qaeda; if the US were to withdraw from Afghanistan it would be leaving behind empty ground for the enemy to come back to. In other words, the US is stuck. In reality, it is not at all clear that the presence in Afghanistan did not contribute to a greater security threat by potentially destabilizing Pakistan. The last terrorist attempt in the US, after all, seems to have been organized by the Pakistani Taliban. Besides, even in the event of a complete success in Afghanistan (and, by extension, Pakistan) who is to say that al-Qaeda won’t find a new base somewhere - and if they do, how many countries can the US afford to invade, rebuild from scratch and immunize from potential terrorist-harboring - especially when the track record in Afghanistan is as terrible as it is?

In reality, it is hard to envision the US civilian leadership going against the recommendations of the military and suggest a withdrawal from Afghanistan any time soon - the politics of the situation offers little reward for wanting to skimp on counter terrorism measures and high costs for any potential failure. Our best hope, as Matthew Iglesias of the Center for American Progress Action Fund suggested, is that the leadership redefines success: instead of shooting for a full blown transformation in Afghanistan, they need to reframe the problem and stake out smaller achievable goals that will allow them to declare victory at some point in the foreseeable future and put them on track for downsizing the US involvement. Otherwise we might be looking at another Vietnam war - a lengthy expensive and painful conflict with no discernible accomplishment to speak of - except maybe some equivalent of M.A.S.H.