Sunday, June 28, 2015

The myth of stagflation

Oil prices rose fast in the 1973 and 1979 oil shocks. As oil cost more some prices in the Western world rose and this was registered as “inflation” and the Western central banks jumped to the conclusion that they had to raise the interest rates to fight this inflation.

Inflation itself is not as bad as is often claimed. Sure, Weimar type inflation where the money that you receive in the morning has lost most of its value in the evening is destabilizing. But people can very well live with a stable inflation of around 10%. Countries like Italy have industrialized and become wealthy in such circumstances.

The main job of the central banks is not to fight inflation: it is to maintain a stable environment and to prevent bubbles and the resulting disastrous boom and bust economic cycles. And there is no question of bubbles in those circumstances: the driver of those rising prices is not excessive demand but the fact that the prices of some imports are rising due to circumstances that are not related to the national economy.

One could still make the argument that the prices are rising and that those rises will result in other rises and could so cause a standard inflationary cycle: workers are demanding wage increases to correct the inflation and companies are increasing the prices of their products because their raw materials and workers cost more.

Yet there is also another mechanism at work: the terms of exchange have worsened and now the country needs to export more to pay for its imports. This will take time: new trade relations have to be established and new markets have to be conquered. It may also take some time before the newly rich countries - like the oil sheikhs in the 1970s - start spending their new wealth. Over time internal consumption may have to fall to release production capacity for the new exports. However, that will only work once the new export links have been established. Reducing demand before that time by "inflation fighting" will only drive companies into bankruptcy and reduce the capacity of the economy to make those exports.

However, it is very questionable whether rising interest rates to fight inflation is the best way to achieve those results. In the 1970s and 1980s they caused stagflation. The Western economics seemed stuck in stagflation until the mass spending of Reagonomics got it out of the swamp. It looks like the best way to address this kind of situation is to let the price hikes have their course without taking anti-inflationary measures. Initially the government might even spend more to make up for the extra money flowing over the borders - while simultaneously redirecting the economy to export more.

Interestingly we see the same discussion now in oil exporting countries and specially in Russia that immediately following the sinking oil prices saw its currency fall. As a result imports cost more in terms of the local currency and the central bank is signalling rising inflation and taking "appropriate measures" that may well be very inappropriate.

Thursday, June 25, 2015

When friends commit crimes

In its ambition to be world ruler the US always has had its share of misbehaving friends. Mobutu was probably the most famous among them, but there have been many others. Out of fear of losing their support the West tended to ignore their misbehavior.

Nowadays Israel and Saudi Arabia are among the misbehaving friends. And we see the US bending backwards in order not to lose their friendship.

Doing so the US is showing itself a false friend. Good friends occasionally tell each other the truth. Forcing Israel to behave better towards the Palestinians could in the long run be better for Israel's future.

In the case of Saudi Arabia this issue is even more clear. By starting a war against Yemen the royal family has painted itself into a corner. The main initiator of the war is crown prince Muhammad, king Salman favorite nephew. Stopping the war would be a major defeat for Muhammad. This is by excellence an opportunity for the US to show itself a true friend: by stopping all support for the war and starting humanitarian support for Yemen it could force Saudi Arabia to end its war. On the short term the Saudi's certainly would blame Obama - also in an effort to save Muhammad's face. But in the long term they would have to admit that it was the best option.

Yet this kind of behavior takes courage. And until now that has been missing.

Friday, June 19, 2015

The limits of international justice

In traditional societies conflict resolution is done by usually older men who are respected for their wisdom. As their respected status shows they are deeply rooted in their society and subscribe to its values.

In modern society judges are supposed to follow the written law. Judges have become rather anonymous people whose main accomplishment is often just finishing the right education. Yet it is not difficult to see that their verdicts are still highly influenced by the surrounding society. In racist societies verdicts of the discriminated minority tend to be harsher. And when society becomes more tolerant on issues like abortion this is reflected in the verdicts - even when the law doesn't change. Yet one thing has changed: there is now a bureaucracy behind those judges that determines who gets appointed and who gets promoted and this bureaucracy has considerable influence too.

But nowhere are judges less connected to society than in international justice. International judges are very dependent on those who appoint them and that makes their allegiance to neutral justice questionable. Recently this became apparent in two cases: the release of Sudan's president Bashir by South Africa - in spite of an extradition request by the ICC - and the 50 billion dollar verdict against Russia in the case brought by the Yukos shareholders.

Many African leaders face a similar problem that Bashir faces: insurgent regions. They may not like Bashir's bloody approach, but at the same time they know that it is not always possible to solve such problems bloodless. And so they consider that if they consent to Bashir's extradition now they might be targeted next - when Western politicians might find it useful. At the same time they have little trust in the judicial process at the ICC: they have seen the murky process in which judges are selected and they have seen judges schmoozing with Western diplomats. They also see that the US is supporting Ukraine in its use of scorched earth tactics and random shelling against the insurgence in its Eastern regions.

We see similar problems in the Yukos case. The excuse for submitting the subject to international judges and not leaving it to local judges in Russia is that some holding was stationed in Cyprus. But what would happen if the US banks and other financial companies that got a haircut in the financial crisis used their foreign subsidiaries as an excuse to take the US government to an international court? It is well known that many of the judges in those commercial cases previously worked for lawyer firms representing companies in similar cases. And when they quit as a judge these same firms may offer them a well paid consultancy job. Given this context these judges may know their laws well, but their neutrality is questionable.

Traditionally this impossibility of justice was solved by diplomacy. This approach certainly had its defects too. But one has to wonder whether the new approach is better.