Macro-prudential regulation and the false promise of Basel III

Financial regulation goes global - Risks for the world economy
Legatum Institute
http://www.li.com/attachments/20101228_LegatumInstitute_FinancialRegulationGoesGlobal.pdf
Dec 29, 2010

Excerpts with footnotes:

4. How internationalised regulation can lead to a new crisis

We are witnessing a movement towards tighter regulation of world financial markets and also towards regulation that is more closely harmonised across the leading industrial economies. That is no accident, as the G20 communiqué pledged that:

“We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires.”

Policymakers seem to believe that insufficient regulation, not just ineffective regulation, is to blame for the financial crisis. Moreover, they also want regulations to be more consistent across different countries and intend to further internationalise financial regulation.

However, there are a number of weaknesses, in principle and practice, with the regulations that have been proposed, that might mean they exacerbate future periods of boom and bust.

4.1 Global regulations create global crises

The central argument in favour of supranational regulation is the possibility of financial contagion. Policymakers do not want their own financial systems put at risk by regulatory failures elsewhere. However, with the present crisis emerging in major developed economies, it is hard to justify the sudden focus on the possibility of contagion. Many countries, such as Canada, did maintain stable financial systems despite collapses elsewhere. The contagion from the subprime crisis in the United States was a serious problem only because financial sectors in other major economies had made similar mistakes and become very vulnerable.

To be sure, an economy will suffer if its trading partners get into trouble. There will be a smaller market for their exports, imports might become more expensive or more difficult to get hold of, and supply chains can be disrupted. But that can happen for a range of reasons: a bad harvest, war, internal political strife, a recession not driven by a financial crisis. The financial sector is not unique in that regard.

There is also concern about a “race to the bottom”. As Stephen G. Cecchetti – Economic Adviser and Head of Monetary and Economic Department at the Bank for International Settlements – wrote, it is felt to be necessary to “make sure national authorities are confident that they will not be punished for their openness”.18 Concerns that countries will be punished for proper regulation are overblown. There are powerful network effects in financial services that mean many institutions are located in places like New York, London and Frankfurt despite those locations having high costs. While smaller institutions like hedge funds may move more lightly, big banks and other systemically important institutions need to be located in a major financial centre. At the same time, they do attach some importance to a reliable financial system. Countries are more likely to be punished for bad policy – e.g. the new 50 percent top tax rate in the United Kingdom – than for measures genuinely necessary to ensure financial stability.

At the same time, the coordination of regulatory policies creates new risks and exacerbates crises.  Common capital adequacy rules, while increasing transparency, also encourage homogeneity in investment strategy and undertaking of risk, leading to a high concentration of risk. That means that global regulations can be dangerous because they increase the amplitude of global credit cycles. If every country is in phase, systemic risk is higher than in situations where there are offsetting, out of phase, credit booms and busts in individual countries. The situation is akin to a monoculture, a lack of diversity makes the whole crop more vulnerable.

The Basel rules use a similar risk assessment framework across a broad range of institutions which encourages them to hold similar assets and respond in similar ways in a crisis.19 Consequently, instead of increasing diversification of assets and minimising risk, herd behaviour is amplified.20

The recession that followed the financial crisis was undoubtedly sharper because it was global. That meant countries were hit simultaneously by their own crisis and a fall in global demand hurting export industries. There were also more simultaneous pressures on global financial institutions. Global regulations, reducing diversity in investment decisions and behaviour in a crisis, will tend to produce global crises when they go wrong. As a result, internationalising regulations increases the danger to the world economy.

The objective should be to strike a proper balance between standardisation and diversity in regulations. Unfortunately, there are reasons why politicians might go too far in standardising regulations. Politicians in countries with burdensome regulations are tempted to force others into adopting equally burdensome measures, in order to prevent yardstick competition and limit the ability of firms and individuals to vote with their feet. A well known example of this is attempts to curb tax competition by organisations such as the OECD and the European Union. Finally, for some, international summits are more comfortable than messy, democratic domestic politics.

4.2 Macro-prudential regulation and the false promise of Basel III

The economic profession’s understanding of the role of financial regulation is shifting from an insistence on micro-prudential regulation to measures which take into account the systemic risks involved in finance.  The new paradigm suggests that a policy approach that tries to make the system safe by making each of the individual financial institutions safe is doomed to fail because of the endogenous nature of risk and because of the interactions between different financial institutions.21

Many of the proposed regulatory changes seem to be inspired – at least in part – by the idea that macro-prudential regulation will require a move away from a regulatory regime that does not take into account the endogenous nature of risk. Unfortunately, the form that the international harmonisation of regimes of financial regulation is taking fails to mitigate excessive leverage in good economic times.

A related question is whether the endogenous nature of risk enables this new regulatory paradigm to succeed at all. Most importantly, caring about systemic risk requires the regulator to identify – explicitly or implicitly – those financial institutions that are systemically important – either individually or in “herds”. Provided that this information can be discovered by the banks or becomes common knowledge, systemically important institutions will know that they will not be allowed to fail.  This would create a large moral hazard problem and could represent a key structural flaw that compromises the whole idea of macro-prudential financial regulation.

At the same time, there might be no need for shifting regulations in the macro-prudential direction, especially if the crisis is the result of regulatory and policy failure as set out in Section 1. Policymakers would just need to abstain from policies similar to those that fuelled the boom leading to this crisis. Of course, a greater need for macro-prudential policy and avoiding specific regulatory and policy failure are not mutually exclusive. It is easy to imagine a regulatory environment that combines more attention to the macroeconomic dimension of financial markets; a more prudent monetary policy that becomes contractionary during periods of rapid economic expansions, and sectoral policies that do not encourage asset bubbles.22

However, the regulation of financial markets is taking a path that could exacerbate future booms and busts – in sharp contrast both to the declared intentions of policymakers and to the underlying idea of macro-prudential regulation.

Our criticism of the Basel rules and of the harmonisation of financial regulation needs to be distinguished sharply from the concerns raised by the banking community, which usually point out the costs that would be involved in raising capital adequacy standards. The Institute of International Finance, for instance, has conducted a study of the effects of likely regulatory reform on the broader economy.23 The models used by the study are based on a relatively simple logic. Higher capital ratios require banks to raise more capital, putting an upward pressure on the cost of capital. In turn, this increases lending rates and reduces the aggregate supply of credit to the economy, lowering aggregate employment and GDP.

On that basis, the paper estimates the costs of adopting a full regulatory reform at an average of about 0.6 percentage points of GDP over the period 2011-2015 and an average of about 0.3 percentage points of GDP for the ten year period, 2011-2020. With a different set of assumptions, the Basel Committee estimates the costs to be much smaller. But whether this is a cost worth bearing depends on what the regulatory reform would achieve. If the output gap is a price to pay for an adequate reduction in the likelihood of future crises – and a reduction in the amplitude of business cycles – then it might be worth paying. Unfortunately, the regulatory reform which we are likely to get is unlikely to achieve that.

Firstly, in spite of claims to the contrary, much of the re-regulation simply increases the procyclicality which was characteristic of banking regulation under Basel II. Indeed, Basel III increases the requirements for tier 1 capital to a minimum of 6 percent and the share of common equity to a total of 7.0 percent.  And on top of that it introduces a countercyclical buffer of 0-2.5 percent. Yet, that buffer cannot offset the procyclical effect of the increased capital requirements.

We should stress that the problem with Basel III rules is not the absolute size of capital adequacy requirements but the fact that they are based on the borrower’s default risk. Hence, riskier assets need to be backed by a larger capital buffer than less risky ones. During times of crisis, the overall riskiness of extending loans increases and banks will therefore have an incentive to increase the amount of capital which they are holding relative to the total size of their risk-weighted assets. An extreme reaction to economic downturn would thus consist of dumping the riskier assets on the financial market, in the hope of restoring the required capital adequacy ratio, exacerbating the economic downturn and possibly triggering a credit crunch. Conversely, in good economic times, when the measured riskiness of individual loans has decreased, banks will be tempted to hold less capital relative to their other assets and will thus be tempted to fuel a potential lending boom.

A related issue is that current measures of risk – which are used as the basis for the risk-weighted capital adequacy rules – are highly imperfect. In a nutshell, highly-rated assets can be leveraged much more heavily than riskier assets, which is a problem if those ratings are not necessarily accurate. Lending to triple- A-rated sovereigns still carries a risk-weight of zero. As the present fiscal crisis in Europe suggests, exposure to triple-A-rated debt is certainly not risk free.  Basel III complements the capital adequacy rules by simple – not risk weighted – leverage ratio limits.  However, looking at the past data, there is little reason to believe that these will be effective in preventing future crises. In fact, risk-adjusted and simple balance sheet leverage ratios both show stable bank leverage until the onset of the crisis.24

Similarly, mark-to-market valuation practices are very problematic for assets where markets have become illiquid, and yield valuations that are both very low and uncertain. In times of crisis, this can give rise to serious consequences for companies that report mark-to-market valuations on their balance sheets. For that reason, mark-to-market valuations can exacerbate the effects of economic downturns.

Furthermore, Basel III will contain new, stricter, definitions of common equity, Tier 1 capital and capital at large. In principle, there is nothing wrong with being pickier when selecting the capital assets to use as a buffer when running a bank. It might indeed be prudent to use only common stock and not preferred stock and/or debt-equity hybrids that are permissible under Basel II. However, imposing a common notion of capital on banks and financial institutions worldwide is more likely to make their por tfolios similar and will therefore increase the co-movement existing between their liquidity – or lack thereof – at any given point in time.

A common definition of capital and a similar composition of bank capital across the world will also create incentives for regulators to synchronise monitoring. Such moves are already on their way within the EU – especially in the light of the establishment of common institutions for financial regulation – in spite of the fact that the business cycles in different parts of Europe are not synchronised.

Finally, we should recognise that tighter financial regulation has its unintended consequences. In the past, we have witnessed companies’ moving complex, highly leveraged, instruments off their balance sheets. Much of the financial activity moved – both geographically and sector-wise – to areas which were less heavily regulated. This included moving activities away from the banking industry into, say, hedge funds. And this also includes moving financial activities to jurisdictions that are friendlier to the financial industry. According to the Financial Times25, in the past two years, almost 1,000 hedge fund employees moved from the UK to Swiss cantons, seeking regulatory and fiscal predictability.  Insofar as the move towards harmonised financial regulation is imperfect – and so long as there remain jurisdictions and areas of finance that are regulated less heavily – there will be a relocation of financial activities towards these jurisdictions and areas of activity. The corollary is that overly tight regulation can create a situation in which much of the actual financial activity is taking place outside of the government supervision which is intended to curb their alleged excesses.

4.3 Crisis as alibi, symbolic politics

Many of the measures that are part of the G20 agenda are completely irrelevant to any ambition one could possibly have to mitigate systemic risks in the world economy. For instance, the idea that “tax havens” and banking secrecy are among the issues that contributed to the financial crisis is completely unfounded. If anything, tax competition could curb some of the excesses of the big, fiscally irresponsible, welfare states by making it difficult for governments to impose too onerous fiscal burdens on mobile tax bases. It is thus clear that for politicians in high-tax countries, the present crisis has served as an alibi to push forward a variety of measures which they have demonstrated an interest in implementing but lacked a plausible justification.26

In many respects, regulating short-selling is similar. Short-selling cannot be blamed for the financial crisis, just as it cannot be blamed for the Greek debt crisis that occurred earlier this year. Indeed, short-selling is critical in reflecting new, often pessimistic, information about the asset in question into a market price. Enabling European regulators to prohibit short-selling in specific situations – presumably in situations when doubts arise about the ability of a European country to repay its debt obligations – will do nothing to address the underlying problems of fiscal irresponsibility. It is just an illustration of a mentality that pretends that shooting the messenger is an appropriate response to the fiscal problems of the Eurozone. The direct cost of this policy is that it will introduce noise into the functioning of financial markets and will make them process new information less efficiently.

Besides taxation and short-selling, there have been coordinated moves to regulate hedge funds, both in the United States and in Europe. While this might make sense from a macro-prudential perspective, particularly if it is the case that some of the hedge funds are of systemic importance, we should recognise that hedge funds were the victim, not the perpetrator, in the recent crisis.  There have been a series of measures that governments have been eager to take for a long time and for which the crisis provided a convenient ad hoc justification, that are now part of the coordinated re-regulation of financial markets in the United States and in Europe. This includes, for instance, the creation of systemic risk boards – as if creation of such institutions would in itself be an improvement over the present situation. Creating a new bureau does not endow the regulators with a superior model of the economy and certainly does not mean that they will be able to do better forecasts than the regulators of the past.

Likewise, the creation of consumer protection boards is unlikely to have a significant effect, besides creating a false sense of security among the general public. After all, the crisis was not caused by uninformed consumers’ falling prey to – say – credit card companies. While instances of individuals making bad decisions regarding their indebtedness certainly exist, they were in most cases a rational response to the wider institutional environment in which they were operating, and which made it worthwhile, for instance, to use one’s house as a piggybank. Furthermore, there is evidence that some of the measures aiming at protecting consumers can in fact exacerbate moral hazard and strengthen the incentives for irresponsible behaviour.27

Finally, the issue of executive pay is high on the list of priorities for policymakers across the globe, again without a credible explanation of how that would contribute to the prevention of future crises. Major proponents of macroprudential regulation – such as the authors of the Geneva report – argue that there is very little reason for regulators to get involved in the decisions of private firms over executive compensation. Rather, as Charles Wyplosz says, “macro-prudential regulation will push banks to develop incentive packages that are more encouraging of longer-term behaviour.”28



Footnotes:

18 Cecchetti, S. G. “Financial reform: a progress report.” Remarks prepared for the Westminster Economic Forum, National Institute of Economic and Social Research, 4 October 2010.
19 Eatwell, J. The New International Financial Architecture: Promise or Threat? Cambridge Endowment for Research in Finance, 22 May 2002.
20 Daníelsson, J. & J.-P. Zigrand. What Happens when You Regulate Risk? Evidence from a Simple Equilibrium Model. April 2003.
21 For an exposition of the ideas behind this approach to financial regulation see Hanson, Kashyap and Stein (2010): “A Macroprudential Approach to Financial Regulation.” Journal of Economic Perspectives, forthcoming.
22 In this endeavour, targeting nominal GDP instead of inflation might be instrumental, as Scott Sumner, David Beckworth, George Selgin and others have argued.
23 IIF (2010). Interim Report on the Cumulative Impact on the Global Economy of Proposed Changes in the Banking Regulatory Framework. http://www.ebf-fbe.eu/uploads/10-Interim%20NCI_June2010_Web.pdf
24 See Joint FSF-CGFS Working Group (2009). The role of valuation and leverage in procyclicality. http://www.bis.org/publ/cgfs34.htm
25 FT. “Hedge funds managers seek predictability.” October 1, 2010. Available at: http://www.ft.com/cms/s/0/557f55d4-cd93-11df-9c82-00144feab49a.html
26 Indeed, the OECD has been running its program on harmful tax practices since 1998.
27 We discuss the specific case of the CARD Act in the United States in Rohac, D. (2010). “The high costs of consumer protection.” The Washington Times, September 3, 2010.
28 Wyplosz, C. (2009). “The ICMB-CEPR Geneva Report: ‘The future of financial regulation.’” VoxEU, January 27, 2009. http://www.voxeu.org/index.php?q=node/2872

Press Briefing

Dec 30, 2010

Statement by the Press Secretary, 12/29/2010
http://goo.gl/fb/uKPBH

President Obama Announces Recess Appointments to Key Administration Posts
http://goo.gl/fb/mkY4s

Top 10 Democratic Accomplishments of 2009 and 2010
http://goo.gl/fb/YNmjH

Behind the Scenes Video: Signing Repeal of Don't Ask Don't Tell
http://www.whitehouse.gov/blog/2010/12/29/behind-scenes-video-signing-repeal-dont-ask-dont-tell

The Right Way to Balance the Budget. By ANDREW G. BIGGS, KEVIN HASSETT AND MATT JENSEN
The experience of 21 countries over 37 years yields a simple truth: Cutting spending works, and raising taxes doesn't.
WSJ, Dec 29, 2010
http://online.wsj.com/article/SB10001424052970203513204576047370292186758.html

The federal debt is at its highest level since the aftermath of World War II—and it's projected to rise further. Simply stabilizing debt levels would require an immediate and permanent 23% increase in all federal tax revenues or equivalent cuts in government expenditures, according to Congressional Budget Office forecasts. What's clear is that to avoid a crisis, the federal government must undergo a significant retrenchment, or fiscal consolidation. The question is whether to do so by raising taxes or reducing government spending.

Rumors have it that President Obama will propose steps to address growing deficits in his next State of the Union address. The natural impulse of a conciliator might be to split the difference: reduce the deficit with equal parts spending cuts and tax increases. But history suggests that such an approach would be a recipe for failure.

In new research that builds on the pioneering work of Harvard economists Alberto Alesina and Silvia Ardagna, we analyzed the history of fiscal consolidations in 21 countries of the Organization for Economic Cooperation and Development over 37 years. Some of those nations repaired their fiscal problems; many did not. Our goal was to establish a detailed recipe for success. If the United States were to copy past consolidations that succeeded, what would it do?

This is an important question, because failed consolidations are more the rule than the exception. To be blunt, countries in fiscal trouble generally get there by making years of concessions to their left wing, and their fiscal consolidations tend to make too many as well. As a result, successful consolidations are rare: In only around one-fifth of cases do countries reduce their debt-to-GDP ratios by the relatively modest sum of 4.5 percentage points three years following the beginning of a consolidation. Finland from 1996 to 1998 and the United Kingdom in 1997 are two examples of successful consolidations.

The data also clearly indicate that successful attempts to balance budgets rely almost entirely on reduced government expenditures, while unsuccessful ones rely heavily on tax increases. On average, the typical unsuccessful consolidation consisted of 53% tax increases and 47% spending cuts.

By contrast, the typical successful fiscal consolidation consisted, on average, of 85% spending cuts. While tax increases play little role in successful efforts to balance budgets, there are some cases where governments reduced spending by more than was needed to lower the budget deficit, and then went on to cut taxes. Finland's consolidation in the late 1990s consisted of 108% spending cuts, accompanied by modest tax cuts.

Consistent with other studies, we found that successful consolidations focused on reducing social transfers, which in the American context means entitlements, and also on cuts to the size and pay of the government work force. A 1996 International Monetary Fund study concluded that "fiscal consolidation that concentrates on the expenditure side, and especially on transfers and government wages, is more likely to succeed in reducing the public debt ratio than tax-based consolidation." For example, in the U.K's 1997 consolidation, cuts to transfers made up 32% of expenditure cuts, and cuts to government wages made up 21%.

Likewise, a 1996 research paper by Columbia University economist Roberto Perotti concluded that "the more persistent adjustments are the ones that reduce the deficit mainly by cutting two specific types of outlays: social expenditure and the wage component of government consumption. Adjustments that do not last, by contrast, rely primarily on labor-tax increases and on capital-spending cuts."

The numbers are striking. Our research shows that the typical successful consolidation allocates 38% of the spending cuts to entitlements and 25% to reductions in government salaries. The residual comes from areas such as subsidies, infrastructure and defense.

Why is reducing entitlements and government pay so important? One explanation is that lower social transfers spur people to work and save. Reducing the government work force shifts resources to the more productive private sector.

Another reason is credibility. Governments that take on entrenched, politically sensitive spending show citizens and financial markets they are serious about fiscal responsibility.

While tax hikes slow revenue growth, policies that credibly reduce government spending in the long run boost economic growth by more than their simple effects on deficits might imply. Any attempt to address the federal government's budget shortfall that relies on less than 85% spending cuts runs too large a risk of failure. The experience of so many other countries shows that it's crucial for the U.S. to get this right.

Mr. Biggs is a resident scholar, Mr. Hassett is the director of economic policy studies, and Mr. Jensen is a research assistant at the American Enterprise Institute.

Jihadology presents forthcoming Books of 2011

Jihadology presents forthcoming Books of 2011
Dec 27, 2010
http://jihadology.net/2010/12/27/jihadology-presents-books-of-2011

Assaf Moghadam and Brian Fishman (ed.) – Fault Lines in Global Jihad: Organizational, Strategic and Ideological Fissures (7/12/11)

Camille Tawil – Brothers In Arms: The Story of al-Qa’ida and the Arab Jihadists (4/1/11)

Fawaz A. Gerges – The Rise and Fall of Al-Qaeda (9/1/11)

Jean-Pierre Filiu – Apocalypse in Islam (1/10/11)

Jeevan Deol and, Zaheer Kazmi (ed.) – Contextualising Jihadi Thought (6/1/11)

J.M. Berger – Jihad Joe: Americans Who Go to War in the Name of Islam (4/30/11)

Khaled Hroub – Political Islam: Context Versus Ideology (6/1/11)

Laurent Bonnefoy – Salafism in Yemen: Transnationalis​m and Religious Identity (5/31/11 in the UK)


Michael Scheuer — Osama Bin Laden (2/15/11)

Peter Bergen – The Longest War: The Enduring Conflict between America and Al-Qaeda (1/11/11)

Stéphane Lacroix – Awakening Islam: Religious Dissent in Contemporary Saudi Arabia (4/15/11)

The World Almanac of Islamism (2/16/11

 

 

A Sampling of the Drivers of Change That Will Shape our World Between Now and 2050

40 for the next 40. Toffler Associates' Future States Forum
A Sampling of the Drivers of Change That Will Shape our World Between Now and 2050


http://www.toffler.com/docs/40%20for%20the%20Next%2040%20101011%20FINAL.pdf

Macroeconomic Effects of Public Pension Reforms - Net Effect is Positive

Macroeconomic Effects of Public Pension Reforms. By Karam, Philippe D ; Muir, Dirk ; Pereira, Joana ; Tuladhar, Anita
IMF Working Paper No. 10/297
Dec 22, 2010

Excerpts with no footnotes:

INTRODUCTION
The fiscal impact of the global crisis has reinforced the urgency of pension and health entitlement reform.2 Staff projections suggest that age-related outlays (pensions and health spending) will rise by 4 to 5 percent of GDP in the advanced economies over the next 20 years, underscoring the need to take steps to stabilize these outlays in relation to GDP. With the economic recovery not yet fully established, this paper emphasizes their short-run macro impact in order to address concerns that these reforms can undermine short-run growth.3

We examine the preferred set of public pension reforms using the IMF's Global Integrated Monetary and Fiscal (GIMF) model parameterized on data for five regions as representing the entire world. We consider three policy reform options relating to pay-as-you-go public pension systems that are commonly discussed in the literature. This analytical framework allows us to approximately gauge the effects of these reforms on labor and capital markets and growth in the short and long run.4 (i) Raising the retirement age: this reduces lifetime benefits paid to pensioners. Encouraging longer working lives with higher earned income may lead to a reduction in saving and increase in consumption during working years. In addition, increased fiscal saving will have long-run positive effects on output through lowering the cost of capital and crowding in investment. (ii) Reducing pension benefits: this increases agents‘ incentives to raise savings in order to avoid a sharper reduction in income and consumption in retirement. It would reduce consumption in the short to medium run, but would increase investment over the long run. (iii) Increasing contribution rates: this leads to distortionary supply-side effects for labor, which combined with a negative aggregate demand on real disposable income, depresses real activity in both the short and long run.

We assess how the policies compare in attaining the twin goals of strong, sustainable, and balanced growth and fiscal stability (i.e., stabilizing the debt-to-GDP ratio against rising pension entitlements). The key results show that increasing the retirement age has the largest impact on growth compared to reducing benefits, while increasing contribution rates as approximated by an increase in taxes on labor income has the least favorable effect on output. Besides boosting domestic demand in the short run, lengthening working lives of employees reduces the pressure on governments to cut pension benefits significantly or to raise payroll and labor income taxes. Reducing such benefits can lead to an increase in private savings and an unwarranted weakening of a fragile domestic demand in the short run, while raising taxes can distort incentives to supply labor. We also found that if regions cooperate in pursuing fiscal reform, the impact will be greater than if only one or some of the regions in the world undertake reform separately. In all, early and resolute action to reduce future age-related spending or finance the spending could improve fiscal sustainability over the medium run, significantly more if such reforms are enacted in a cooperative fashion.

[...]

CONCLUSION

We considered reforms to the pension system that can help ensure the long-run viability of public finances, while mindful of their short-run effect on economic activity in the midst of a global financial crisis. This is carried out within a dynamic general equilibrium model (GIMF) that captures the important economic interrelationships at a national and international level. We emphasized measures to contain and fund the rising costs of age-related spending in the medium to long run. We find that reforms which lead to short-run adverse effects on real GDP (i.e., benefit reductions) are largely outweighed by the benefits of declining real interest rates and the positive effect on future potential productive capacity. The reform which has the most positive effects in the long run is lengthening the working lives of employees, effectively raising the size of the active labor force relative to the retiree population. It helps boost domestic demand in the short run but also eases off the pressure on governments to cut pension benefits alone—which can lead to additional private savings and cause fragile domestic demand to fall in the short run—or to raise payroll and labor income taxes—which can distort incentives to supply labor. We also found that the impact on real GDP of a cooperative approach to age-related fiscal reforms is greater compared to a case where one but not all regions undertake reform.

In terms of public finances, our results generally show that stabilizing the GDP share of age-related expenditures leads to a sizable decline in the debt-to-GDP ratio. Early efforts and resolute action to reduce future age-related spending or finance the spending through additional tax increases and other measures (preferably through an increase in retirement age) could significantly improve fiscal sustainability in several countries over the medium run, and more so if such reforms are enacted in a cooperative fashion.

Link: http://www.imf.org/external/pubs/cat/longres.cfm?sk=24536.0

Europeans are approving important new drugs more rapidly than we are

The FDA Is Evading the Law. By SCOTT GOTTLIEB
Europeans are approving important new drugs more rapidly than we are.
WSJ, Dec 24, 2010
http://online.wsj.com/article/SB10001424052748704034804576025981869663212.html

This year, the Food and Drug Administration rejected the only medicine capable of treating the rare and fatal lung disease known as idiopathic pulmonary fibrosis. Pirfenidone, which has been available in Japan since 2008 and was just approved in Europe, was spurned by the FDA because the drug only showed efficacy in a single big trial—not the two large studies the FDA now requires. The decision to ban the drug is one of a rash of recent decisions that shows the FDA is making it more and more difficult for promising drugs to reach severely ill patients.

Last week, the FDA revoked an approval for the cancer drug Avastin because it said that evidence supporting its use in breast cancer wasn't strong enough. (The drug was judged ineffective because it merely stalls the spread of tumors.) European regulators, looking at the same data, made the opposite decision.

It wasn't supposed to be this way. In 1997, Congress passed the FDA Modernization Act, which gave the FDA broad discretion to reduce the quantity and rigor of clinical data needed to approve drugs targeting grave illnesses. The purpose of the law was to save lives by reducing the cost and time needed to launch such medicines.

But the FDA has steadily disregarded many of the law's provisions. Longer, larger trials that require drug makers to evaluate "hard" endpoints (like how long a cancer patient lives) rather than "surrogate" endpoints (like a drug's ability to shrink tumors) give FDA reviewers more statistical confidence. Reviewers prefer these drawn-out trials because they insulate the FDA from critics who say that it isn't focused enough on safety. But bigger trials increase the time needed to develop a drug, keeping it out of the hands of patients.

The Modernization Act also allowed the FDA to conduct drug trials in which patients are treated with an experimental medicine in a single group or "arm," and the trial can be completed in less than a year. But the FDA doesn't often opt for such trials. The agency commonly requests more complex, "multi-arm" and "placebo controlled" studies, which can take three years to finish and are much more expensive. Each patient enrolled in a trial adds over $30,000 to drug-development costs.

Of 76 cancer drugs approved since 2005, the FDA gave only 13 "accelerated approval"—another process created under the Modernization Act to expedite drug development. From 2001 to 2003, 78% of the novel cancer drugs approved were granted accelerated approval. Since then only 32% got the designation.

What's more, the clinical trial requirements that the FDA is imposing on cancer drugs with accelerated approval are now as burdensome as the requirements imposed on regular drugs. So, practically speaking, having "accelerated approval" doesn't mean anything.

Europeans are now approving novel drugs an average of three months more rapidly than we do. Of 82 novel drugs that were submitted for approval in both the U.S. and Europe between 2006 to 2009, 11 were approved only in Europe. One is for relapsed ovarian cancer, another for bone cancer.

To reverse these discouraging trends, Congress should reaffirm the provisions of the Modernization Act. It should spell out in legislation that the FDA "shall"—rather than "may"—approve drugs for severe conditions on the basis of a single study, or a more lenient statistical orthodoxy than "two, randomized, placebo controlled trials."

While Congress may not want to get into the business of establishing the FDA's analytical methods, it can call on the agency to convene an advisory panel to cultivate principles that are more permissive when it comes to very bad diseases. And it could go a step further, empowering patient groups with a mechanism to seek review of FDA decisions.

Congress also needs to modernize the way the FDA's review process is organized in order to increase efficiency and enable more cooperation. The science embedded in the most novel drugs is increasingly complex, requiring collaboration across many disciplines, including clinical medicine, pharmacology and statistical modeling.

But in recent years, the FDA has carved out each scientific discipline into its own distinct office. In addition, new work rules allow drug reviewers to spend two days each week working from home. The result is that FDA scientists don't collaborate well. Reviewers rarely meet as full teams, so they struggle to resolve internal debates and provide timely feedback to drug makers. The FDA's scientists should be organized around areas of therapeutic expertise—not broken into discrete offices based on what degree they have.

Finally, the FDA should be required to disclose its reasons for rejecting a drug.

The next Congress will reauthorize a user fee program that funds the FDA's review process. It should use this legislation to revive the FDA's fundamental mission: giving very sick Americans the best medical options available.

Dr. Gottlieb, a former deputy commissioner of the Food and Drug Administration, is a fellow at the American Enterprise Institute and a practicing internist. He invests in and consults with drug companies.

Taxes and the Top Percentile Myth

Taxes and the Top Percentile Myth. By Alan Reynolds
A 2008 OECD study of leading economies found that 'taxation is most progressively distributed in the United States.' More so than Sweden or France.
WSJ, Dec 23, 2010
http://online.wsj.com/article/SB10001424052748703581204576033861522959234.html


When President Obama announced a two-year stay of execution for taxpayers on Dec. 7, he made it clear that he intends to spend those two years campaigning for higher marginal tax rates on dividends, capital gains and salaries for couples earning more than $250,000. "I don't see how the Republicans win that argument," said the president.

Despite the deficit commission's call for tax reform with fewer tax credits and lower marginal tax rates, the left wing of the Democratic Party remains passionate about making the U.S. tax system more and more progressive. They claim this is all about payback—that raising the highest tax rates is the fair thing to do because top income groups supposedly received huge windfalls from the Bush tax cuts. As the headline of a Robert Creamer column in the Huffington Post put it: "The Crowd that Had the Party Should Pick up the Tab."

Arguments for these retaliatory tax penalties invariably begin with estimates by economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of U.C. Berkeley that the wealthiest 1% of U.S. households now take home more than 20% of all household income.

This estimate suffers two obvious and fatal flaws. The first is that the "more than 20%" figure does not refer to "take home" income at all. It refers to income before taxes (including capital gains) as a share of income before transfers. Such figures tell us nothing about whether the top percentile pays too much or too little in income taxes.

In The Journal of Economic Perspectives (Winter 2007), Messrs. Piketty and Saez estimated that "the upper 1% of the income distribution earned 19.6% of total income before tax [in 2004], and paid 41% of the individual federal income tax." No other major country is so dependent on so few taxpayers.

A 2008 study of 24 leading economies by the Organization of Economic Cooperation and Development (OECD) concludes that, "Taxation is most progressively distributed in the United States, probably reflecting the greater role played there by refundable tax credits, such as the Earned Income Tax Credit and the Child Tax Credit. . . . Taxes tend to be least progressive in the Nordic countries (notably, Sweden), France and Switzerland."

The OECD study—titled "Growing Unequal?"—also found that the ratio of taxes paid to income received by the top 10% was by far the highest in the U.S., at 1.35, compared to 1.1 for France, 1.07 for Germany, 1.01 for Japan and 1.0 for Sweden (i.e., the top decile's share of Swedish taxes is the same as their share of income).

A second fatal flaw is that the large share of income reported by the upper 1% is largely a consequence of lower tax rates. In a 2010 paper on top incomes co-authored with Anthony Atkinson of Nuffield College, Messrs. Piketty and Saez note that "higher top marginal tax rates can reduce top reported earnings." They say "all studies" agree that higher "top marginal tax rates do seem to negatively affect top income shares."

What appears to be an increase in top incomes reported on individual tax returns is often just a predictable taxpayer reaction to lower tax rates. That should be readily apparent from the nearby table, which uses data from Messrs. Piketty and Saez to break down the real incomes of the top 1% by source (excluding interest income and rent).

The first column ("salaries") shows average labor income among the top 1% reported on W2 forms—from salaries, bonuses and exercised stock options. A Dec. 13 New York Times article, citing Messrs. Piketty and Saez, claims, "A big reason for the huge gains at the top is the outsize pay of executives, bankers and traders." On the contrary, the table shows that average real pay among the top 1% was no higher at the 2007 peak than it had been in 1999.

In a January 2008 New York Times article, Austan Goolsbee (now chairman of the President's Council of Economic Advisers) claimed that "average real salaries (subtracting inflation) for the top 1% of earners . . . have been growing rapidly regardless of what happened to tax rates." On the contrary, the top 1% did report higher salaries after the mid-2003 reduction in top tax rates, but not by enough to offset losses of the previous three years. By examining the sources of income Mr. Goolsbee chose to ignore—dividends, capital gains and business income—a powerful taxpayer response to changing tax rates becomes quite clear.

The second column, for example, shows real capital gains reported in taxable accounts. President Obama proposes raising the capital gains tax to 20% on top incomes after the two-year reprieve is over. Yet the chart shows that the top 1% reported fewer capital gains in the tech-stock euphoria of 1999-2000 (when the tax rate was 20%) than during the middling market of 2006-2007. It is doubtful so many gains would have been reported in 2006-2007 if the tax rate had been 20%. Lower tax rates on capital gains increase the frequency of asset sales and thus result in more taxable capital gains on tax returns.

The third column shows a near tripling of average dividend income from 2002 to 2007. That can only be explained as a behavioral response to the sharp reduction in top tax rates on dividends, to 15% from 38.6%. Raising the dividend tax to 20% could easily yield no additional revenue if it resulted in high-income investors holding fewer dividend- paying stocks and more corporations using stock buybacks rather than dividends to reward stockholders.

The last column of the table shows average business income reported on the top 1% of individual tax returns by subchapter S corporations, partnerships, proprietorships and many limited liability companies. After the individual tax rate was brought down to the level of the corporate tax rate in 2003, business income reported on individual tax returns became quite large. For the Obama team to argue that higher taxes on individual incomes would have little impact on business denies these facts.

If individual tax rates were once again pushed above corporate rates, some firms, farms and professionals would switch to reporting income on corporate tax forms to shelter retained earnings. As with dividends and capital gains, this is another reason that estimated revenues from higher tax rates are unbelievable.

The Piketty and Saez estimates are irrelevant to questions about income distribution because they exclude taxes and transfers. What those figures do show, however, is that if tax rates on high incomes, capital gains and dividends were increased in 2013, the top 1%'s reported share of before-tax income would indeed go way down. That would be partly because of reduced effort, investment and entrepreneurship. Yet simpler ways of reducing reported income can leave the after-tax income about the same (switching from dividend-paying stocks to tax-exempt bonds, or holding stocks for years).

Once higher tax rates cause the top 1% to report less income, then top taxpayers would likely pay a much smaller share of taxes, just as they do in, say, France or Sweden. That would be an ironic consequence of listening to economists and journalists who form strong opinions about tax policy on the basis of an essentially irrelevant statistic about what the top 1%'s share might be if there were not taxes or transfers.

Mr. Reynolds is a senior fellow at the Cato Institute and the author of "Income and Wealth" (Greenwood Press 2006).

The Physics of Terror

The Physics of Terror. By Miller Haederle

After studying four decades of terrorism, Aaron Clauset thinks he’s found mathematical patterns that can help governments prevent and prepare for major terror attacks. The U.S. government seems to agree.

http://www.miller-mccune.com/culture-society/the-physics-of-terror-25955/

Medvedev seeks to boost India arms sales

Russia Is Chasing Delhi Arms Sales, by TOM WRIGHT
WSJ, Dec 21, 2010
http://online.wsj.com/article/SB10001424052748703886904576031351139805830.html

Excerpts:

NEW DELHI—Russian President Dmitry Medvedev arrives Tuesday in India on a two-day trip aimed at solidifying Moscow's role as New Delhi's largest arms supplier in the face of increased competition from the U.S. and Europe.

Mr. Medvedev is the fifth and final leader of a member nation of the United Nations Security Council to visit India in 2010, underscoring New Delhi's rising importance as a global political and economic power.

India's fast-expanding economy and growing military budget offers Russia enormous potential to increase sales of military equipment. A U.S.-India nuclear deal in 2008, which paved they way for civilian nuclear exports to India, also has opened the door for Russia to sell civilian nuclear technology to New Delhi.

New Delhi, meanwhile, is hoping Moscow will allow Indian oil and gas companies a larger role in developing Russian energy assets. India is a net importer of crude oil.

Russia and India will sign agreements in defense, economic and space sectors during Mr. Medvedev's visit, Indian officials said, without giving details.

India is one of Russia's largest customers for military equipment, accounting for a third of the sector's exports—a legacy of the Cold War when New Delhi sided with Moscow against Beijing. About three-quarters of India's current military hardware is of Russian origin.

But in recent years, India has begun courting other suppliers of military hardware from the U.S., France and the U.K., all of whose leaders have used visits here this year to clinch deals.

"Russia's defense industry is not as capable as it used to be during the Cold War," said Laxman Kumar Behera, an expert on India's military at the New Delhi-based Institute for Defense Studies and Analyses. "India is trying to diversify its supply sources."

The U.S., during a visit to India by President Barack Obama in November, announced a $4 billion deal for Boeing Co. to supply the Indian air force with 10 C-17 Globemaster III military transport aircraft.

In July, U.K. Prime Minister David Cameron used a trip to the country to announce a $1.1 billion deal to supply 57 Hawk trainer jets.

French President Nicolas Sarkozy visited India in December, during which the two nations signed a deal for France to supply two nuclear reactors valued at $9 billion.

Mr. Sarkozy also lobbied for France to win an $11 billion deal to supply 126 fourth-generation fighter jets to India's air force. Moscow is competing for that deal, which New Delhi is scheduled to award next year.

Russia wants India to chose the MiG-35 fighter, made by RSK MiG, but has to compete against a number of other suppliers including U.S.'s Boeing and Lockheed Martin Corp., France's Dassault Aviation, and a consortium of European bidders.

To boost its chances next year, Russia has been emphasizing how it is jointly developing military equipment with India.

Both nations are planning to build a fifth-generation fighter aircraft, which could be valued at tens of billions of dollars, but is unlikely to enter production until 2020. Indian media have reported one of the deals likely to be signed this week could include details of this joint production.

"Russia and India have moved to a new level of cooperation in the military-technology area, from the relationship of buyer-seller to joint development and production of modern weapons," Russian Defense Minister Anatoly Serdyukov said in late 2009 after a regular meeting of an intergovernmental commission.

But Russia also has disappointed India on some orders. An aircraft carrier, due for delivery in 2008, has been delayed until 2012, while the cost has doubled to $2 billion. Spare parts for Russian planes also have been hard to come by.

Russia—like the U.S., U.K. and France—also is keen to help India develop its civilian nuclear industry to meet growing power needs.

Russia and India in December 2009 signed a civilian nuclear-cooperation agreement, much like the U.S.-India deal. Moscow already is helping to construct two power plants in India's southern Tamil Nadu state, which are nearing completion.

The stakes are high for Moscow, whose trade with India is skewed toward military sales. While other countries, notably China, have tapped in to India's booming economy, selling a range of manufactured goods from power equipment to telecoms hardware, Russia's trade has remained relatively small.

Russia's two-way trade with India in the year ended March 31 stood at $4.6 billion, a decline of 16% over the previous year, and only about a tenth of China's bilateral trade.

Chinese Premier Wen Jiabao spent three days in New Delhi last week, during which India and China agreed to boost trade to $100 billion by 2015.

Still, India continues to see Russia as an important counterweight to China, says Naresh Chandra, chairman of the National Security Advisory Board, which advises India's prime minister on security matters.

[...]

India and Russia have targeted to grow bilateral trade to $20 billion by 2015, of which military sales to India will play an important role.

New Delhi is planning to spend $32 billion on the military in the current fiscal year, almost double the amount five years ago, as it modernizes its armed forces as a deterrent to Pakistan and China.

India is hoping greater access to Russia's oil and gas fields will reduce its dependence on imported energy. India's state-run Oil and Natural Gas Corp. said this month it is in talks to take part in the development of Russia's massive Trebs and Titov oil and gas in northwest Russia.

ONGC already has a 20% stake in a consortium led by Exxon Mobil Corp. which is developing Russia's Sakhalin-1 oil and gas field.

—Gregory L. White in Moscow contributed to this article.

Western companies expect to resort to M&A to drive growth - in Asia and LA will be able to grow organically

Europe, North America expect M&A to fuel growth. By Joe Light
WSJ, Dec 21, 2010
http://online.wsj.com/article/SB40001424052748703395904576025791526387806.html

Many North American and European companies expect to resort to mergers and acquisitions to drive growth next year, while companies in Asia and Latin America are more optimistic that they will be able to grow organically, according to a survey by human-resources consulting firm Towers Watson.

The September survey of 743 companies found that 37% of HR executives in North America and 36% in Europe believe that M&A will be one of their three top strategies for driving growth.

That might indicate executives in those markets see few other promising ways to expand their businesses. Such moves "may well be more of a defensive play to consolidate market position or gain sufficient scale to weather continuing tough times than an aggressive expansion strategy," the study said.

By contrast, only 20% of Asian-Pacific companies and 23% of Latin American companies believed M&A would be a key way to drive growth. Instead, companies in those markets said that hiring staffers who deal with customers, such as salespeople, would be among their most important growth drivers. Under the total global tally, 27% of respondents checked off pursuing a merger or acquisition as a top priority for driving growth.

"Executives in emerging economies are far more willing to invest in hiring new salespeople because the growth of those markets assures you that the investment will pay off," said Ravin Jesuthasan, global practice leader for talent management at Towers Watson. Only a quarter of North American executives picked hiring in roles that deal with customers as a top strategy. Nearly 40% of companies said so globally. "India and Asia really think about growth differently than in the U.S. They'd much rather grow capabilities from within than acquire them," said Peter Cappelli, management professor at the University of Pennsylvania's Wharton School and co-author of "The India Way."

http://www.towerswatson.com/assets/pdf/3371/Towers-Watson-Strategies-Growth.pdf

Avoiding Technology Surprise for Tomorrow's Warfighter

Avoiding Technology Surprise for Tomorrow's Warfighter, by Admiral James R. Hogg
In: Avoiding Technology Surprise for Tomorrow's Warfighter--Symposium 2010. Committee for the Symposium on Avoiding Technology Surprise for Tomorrow's Warfighter--2010; Division on Engineering and Physical Sciences; National Research Council
December 10, 2010
http://www.nap.edu/catalog.php?record_id=12919


I think we can agree that [avoiding technology surprise] is a terrific objective and an enormous challenge, both in importance and complexity. Especially so, given that we know little about avoiding Technology Surprise today, no matter how hard we try, let alone tomorrow. Yet, more so than others, this group is composed in a way that gives it a chance. We have here today Warfighters, Technologists, and Intelligence experts, joined together.

Among you, we need linguists. Linguists who understand the cultures of the ethnic groups whose languages they translate. So, a show of hands, please. How many of you are culturallyaware linguists in the Muslim or Asian languages and dialects? Numbers are small. That's no surprise! And that explains a fundamental weakness in our Western approach to problem solving.

I say that because we will only be able to avoid Technology Surprise by thinking differently than what I will call the "Western norm." We will only do it by thinking the way a Muslim or an Asian thinks, not the way we in the West "think they think.”

If we can't figure out how to get inside, way inside, their cultural mind-sets, then for sure, we will not recognize Technology Surprise until it is too late. For example, how many of us in this room ever thought a large commercial passenger jet aircraft could generate Technology Surprise? Probably none of us. Let's just say few, if any. Why? Simply because Technology Surprise is generated by two things: disruptive technology and disruptive thinking or, even more challenging, a combination of the two!

I am going to focus now on disruptive thinking, because nations or radical groups that are incapable of developing disruptive technology will continue to "take us to the edge" through disruptive thinking. It goes like this: We in the West, in the main, tend to solve problems in a deductive manner, with precision, definition, and rule sets. This is prevalent among engineers, for example, who are taught to "bound" problems in order to define and then more easily solve them. That makes sense.

Muslims and Asians, on the other hand, tend to approach problems in an inductive manner.  With logic, based on ethnic and cultural beliefs, and without rule sets as we understand them. No rules. Anything goes! This inductive approach is amenable to continuous exploration. It is not bound by anything—in any way, in any dimension.

A rationale conclusion is that a combination of the two is the best approach. To think inductively at first for exploration and discovery; then, to think deductively in order to come up with practical solutions. This sets up a balance between the open space that spawns creative thinking, and the defined space that enables construction of solutions.

So, with all this in mind, and returning to the challenge of avoiding Technology Surprise, there is no immediate solution, but there is a way ahead. Every significant military command needs an "innovation cell" dedicated full-time to an inductive-deductive thinking process that is focused like a laser on Technology Surprise. By that, I mean Technology Surprise that might be generated by either disruptive technology or disruptive thinking. The composition of these innovation cells must be diverse in every possible way, including language and cultural skills. In addition, they must be netted, each a node in a DoD-wide web, ensuring seamless information flow and collaboration.

Over time, similar webs should be established in the Departments of State and Homeland Security, and across all agencies in the National Intelligence Directorate [Office of the Director of National Intelligence]. Let's call this approach "Deep Red" for now. It’s a new way to organize, to think, to analyze, and to collaborate in order to anticipate and counter Technology Surprise during its developing stage and, absolutely, before its deployment.

Press Briefing

Dec 14, 2010

Estimating a Structural Model of Herd Behavior in Financial Markets. By Marco Cipriani and Antonio Guarino. IMF Working Papers
http://www.imf.org/external/pubs/cat/longres.cfm?sk=24496.0

Readout of President Obama's Meeting with the UN Security Council Permanent Representatives http://goo.gl/fb/V4hw8

Europe Needs a Tea Party - The euro isn't what ails the continent
http://online.wsj.com/article/SB10001424052748703727804576017261419831724.html

Remarks by the President at Holiday Reception for the Diplomatic Corps
http://goo.gl/fb/RBKc4

Operational risk - consultative papers issued by the Basel Committee
http://www.bis.org/press/p101210.htm

Press Briefing by Press Secretary Robert Gibbs, 12/13/2010
http://goo.gl/fb/BEhp6

Are Obama's Lefty Foes Racist? - The question turns out to be more than a joke
http://online.wsj.com/article/SB10001424052748703727804576017380223128082.html

Why Investors Need China in Their Portfolios - China represents more than 10% of the world's GDP, adjusted for purchasing power, but few investors have anywhere near a 10% China allocation.
http://online.wsj.com/article/SB10001424052748704457604576011564281603104.html

How About a Moon Base? - NASA's great engineers can pull it off without vast amounts of money. They merely need to be given the mission
http://online.wsj.com/article/SB10001424052748703296604576005580106794122.html

Smarter Measures in Fight against Piracy
http://www.cfr.org/publication/23611/smarter_measures_in_fight_against_piracy.html

Federal Judge Henry Hudson on the constitutionality of ObamaCare's individual health-insurance mandate in Commonwealth of Virginia v. Sebelius
http://online.wsj.com/article/SB10001424052748703727804576017751107976090.html

Statement by the President on the Senate Vote on Middle-Class Tax Cuts
http://goo.gl/fb/VXF12

The Fed's Policy Is Working. By Jeremy Siegel
The rise of long-term Treasury interest rates is evidence that investors are bullish on growth
WSJ, Dec 14, 2010
http://online.wsj.com/article/SB10001424052748703766704576009621740764118.html

The recent surge in long-term Treasury yields has led many to say that the Fed's second round of quantitative easing is a failure. The critics predict that QE2 may end up hurting rather than helping the economic recovery, as higher rates nip in the bud any rebound in the housing market and dampen capital spending. But the rise in long-term Treasury rates does not signal that the Fed's policy has backfired. It is a sign that the Fed's policy is succeeding.

Long-term Treasury rates are influenced positively by economic growth—which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity—and by inflationary expectations. Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields.

The Fed's QE2 program has raised expectations of growth and inflation, sending long-term Treasury rates up. It has also lowered risk aversion, which implies rising long-term rates. The evidence for a decline in risk aversion among investors is the shrinkage in the spreads between Treasury and other fixed-income securities, the strong performance of the stock market, and the decline in VIX, the indicator of future stock-market volatility. This means that expectations of accelerating economic growth—and a reduction in the fear of a double-dip recession—are the driving forces behind the rise in rates.

Those who look only at interest rates to judge whether monetary policy is too loose or too tight are making a mistake that monetary economists have long warned against. As a colleague of Milton Friedman at the University of Chicago in the 1970s, I remember him stressing that the extremely low interest rates of the early 1930s were not indicative of an easy monetary policy. They were instead the result of the Fed's drastically tight policy, which did not provide enough reserves to failing banks and drove the economy into the Great Depression.

Similarly, the double-digit interest rates that we witnessed in the 1970s were not indicative of the Fed's brave stance against inflation but of a far-too-easy policy that inflated the money supply and heightened inflationary expectations.

I admit that expectations of economic growth recently have been boosted by President Obama's agreement with congressional Republicans to extend the Bush tax cuts. But long-term Treasury rates were rising even before Mr. Obama announced his policy switch. The combined impact of the tax cuts and the Fed's QE2 policy will continue to stimulate the economy and send long-term interest rates higher. For this reason, it is likely that the Fed will not complete all of its purchases by the middle of next year. It may instead begin the process of draining reserves and raising short-term rates much earlier than most forecasters now anticipate. But monetary tightening will only begin if the pace of the economic recovery accelerates significantly next year, which I believe is increasingly likely.

We should not look only at interest rates to judge whether monetary policy is working. Indeed, in the present situation, if long-term rates were not rising, it would be a sign that the economy is in serious trouble—a sign that investors are worried about deflation and a decline in economic activity.

Mr. Siegel is a professor of finance at the University of Pennsylvania's Wharton School.


Nominations Sent to the Senatehttp://goo.gl/fb/fSkIr

'Billionaires On the Warpath'? - The GOP needs to address the class-warfare argument in moral termshttp://online.wsj.com/article/SB10001424052748703727804576017851441620350.html

The President, First Lady on Child Nutrition Bill
http://goo.gl/fb/cgKOK

The DREAM Act and American Commerce
http://goo.gl/fb/GMCuf

ObamaCare Loses in Court - A victory for liberty and the Constitution in Virginia
http://online.wsj.com/article/SB10001424052748703727804576017672495623838.html

Press Briefing

Dec11, 2010

Liu Xiaobo: I Have No Enemies: My Final Statement
http://nobelprize.org/nobel_prizes/peace/laureates/2010/xiaobo-lecture_en.html

President Obama Strongly Urges Passage of the Framework Agreement on Middle Class Tax Cuts
http://www.whitehouse.gov/the-press-office/2010/12/11/weekly-address-president-obama-strongly-urges-passage-framework-agreemen

The Collapse of the Guantanamo Myth - This week a Democratic Congress ratified Bush-era policy by refusing to fund any effort to shut the detention facility
http://online.wsj.com/article/SB10001424052748704457604576011390769140846.html

Remarks by President Obama and Former President Clinton
http://goo.gl/fb/R4Kmq

Subsidy Trains to Nowhere
http://online.wsj.com/article/SB10001424052748703440004575548494055265092.html

Readout of Vice President Biden's Call to Iraqi Prime Minister Nouri al-Maliki
http://goo.gl/fb/7UlUb

No hay acuerdo sobre los impuestos [1]

Parece ser que el miércoles, el vicepresidente Joe Biden dijo a los demócratas de la Cámara de Representantes que el acuerdo sobre impuestos era del tipo “lo tomáis o lo dejáis”, que no podía ser enmendado. Pero la noche del jueves, después de muy fuerte oposición de su base izquierdista, el presidente federal Barack Obama tarareaba una canción diferente, diciéndole a National Public Radio: “Mi sentir es que va a haber debate entre los líderas de la Cámara y el Senado [federales] acerca de los elementos presentes finalmente en el paquede [de medidas legislativas]. Tenga en cuenta que en realidad no redactamos una propuesta de ley”.

Bueno, ahora el líder de la mayoría en el Senado, Harry Reid (D–NV), ha presentado un proyecto de ley que deja muy claro que las negociaciones están en buena medida abiertas... al menos para la izquierda. Politico informa de que para comprar los botos de las senadoras Maria Cantwell (D–WA) y Barbara Boxer (D–CA), Reid ha añadido subsidios para compañías de energías eólica y solar que eran originalmente parte del primer y fallido “estímulo” de Obama. Y el senador Tom Harkin (D–IA) también ha intercambiado su voto por más subsidios para el etanol. Otros “edulcorantes” añadidos paa comprar votos izquierdistas en el Senado federal incluyen subsidios para electrodomésticos eficientes energéticamente y descuentos en transporte público para empleados.

Y la propuesta sólo puede empeorar. El jueves los demócratas de la Cámara votaron oponerse al acuerdo de impuestos de Obama. La speaker Nancy Pelosi (D–CA) dijo a Politico: “En reunión del grupo parlamentario, los demócratas de la Cámara han apoyado una resolución para rechazar el plan republicano del Senado tal como está ahora. Continuaremos el debate con el presidente y nuestros colegas demócratas y republicanos en los días sucesivos para mejorar la propuesta antes de que llegue a la Cámara para votación”. Y por “mejorar la propuesta”, la Speaker Pelosi sólo puede querer decir más impuestos y más gasto.

El acuerdo al que originalmente llegaron los republicanos tenía algo de buena política económica, pero también muchas medidas dañinas. La naturaleza temporal, dos años, del acuerdo no provee de certidumbre de largo plazo que necesitan los negocios para planificar las inversiones de largo plazo que crean crecimiento económico significativo y empleos. Permitir que vuelva el impuesto sobre las herencias (“death tax”), aunque sea a menor tasa de la inicial, no dará a las pequeñas empresas el alivio que una derogación permanente les daría. Por último, el acuerdo original prevé una costosa prórroga de 57 000 millones de dólares para subsidios de desempleo que no se deducen de otras partidas. Todo este gasto extra debería haberse eliminado para que fuese una propuesta de ley limpia. En vez de eso, la izquierda está añadiendo más gasto y subsidios a la misma.

Este otoño, el presidente Obama hizo campaña por todo el país prometiendo subir los impuestos a los creadores de empleo de América. En contraste, los conservadores hicieron campaña con la promesa de no permitir a la izquierda subir los impuestos a nadie el próximo primero de enero. El pueblo americano eligió la posición conservadora en lo que el propio presidente Obama calificó de “paliza bien dada”. La propuesta de impuestos presentada por Reid no es por la que los conservadores prometieron luchar en campaña electoral. Y la ley sólo empeorará en la medida en que más y más votos progres sean comprados con más y más gasto que aumente el déficit. Los impuestos no deben aumentarse al pueblo americano. El Congreso y el Presidente harían bien en marginar todos los demás asuntos irrelevantes de este debate y fijarse primordialmente y por encima de todo en impedir subidas de impuestos.

References

[1] Morning Bell: There is No Tax Deal, by Conn Carroll. Heritage, Dec 10, 2010. http://blog.heritage.org/2010/12/10/morning-bell-there-is-no-tax-deal

This translation was published, edited, as: "Impuestos: No hay acuerdo," http://www.libertad.org/impuestos-no-hay-acuerdo/

Press Briefing

Dec 09, 2010

Health Reform Wins Another Round in Court
http://www.whitehouse.gov/blog/2010/12/08/health-reform-wins-another-round-court

White House: The Framework for a Tax Agreement Is a Good Deal for Working Families
http://www.whitehouse.gov/blog/2010/12/08/framework-a-tax-agreement-a-good-deal-working-families


Giving Credit Where It's Due. WSJ Editorial
Speculators didn't destroy Greece
Dec 09, 2010, The Wall Street Journal, page 13
http://online.wsj.com/article/SB10001424052748703493504576007050934987050.html

Well, what do you know? Credit-default swaps didn't cause Greece's fiscal collapse last spring after all.

That's the conclusion of a study by the European Commission. The paper was drafted in the run-up to the Greek bailout, but has belatedly come to light following a freedom of information request from the Dutch newspaper Het Financieele Dagblad [http://www.fd.nl/artikel/20852357/geen-enkel-bewijs-speculaties-tegen-eurolanden]. Last March, as Greek bonds tumbled and the price of credit-default swaps on the country's debt soared, Greek Prime Minister George Papandreou repeatedly blamed "speculators" whose "abuses" of the CDS market and the bond markets were, he claimed, to blame for Greece's predicament.

So the Angela Merkel of Germany and French President Nicolas Sarkozy joined Mr. Papandreou in calling on the European Commission to investigate whether over-the-counter credit-default swaps—which pay the buyer if a debtor can't or won't make his payments—were being used to manipulate the sovereign debt markets.

The Commission's report looked at the prices of CDS and the yields on government bonds and concluded that, if anything, credit default swaps seemed to be underpricing the risk of default. What's more, the paper says, in many ways the CDS market in Europe is more liquid and more transparent than the market in the underlying bonds. The paper also cautions that restricting or even banning "naked" CDS on government bonds, as some EU leaders proposed last spring, would raise the cost of borrowing in Europe by denying investors a way of hedging their exposure.

In other words, the Commission's inquest into sovereign credit-default swaps found a market, free from nefarious influences and largely unregulated, working more or less as you'd expect. No wonder Brussels buried the findings.




Statement by the President on Tax Cuts and Unemployment Benefits
http://www.whitehouse.gov/the-press-office/2010/12/06/statement-president-tax-cuts-and-unemployment-benefits

Excerpts:

Now, Republicans have a different view.  They believe that we should also make permanent the tax cuts for the wealthiest 2 percent of Americans.  I completely disagree with this.  A permanent extension of these tax cuts would cost us $700 billion at a time when we need to start focusing on bringing down our deficit.  And economists from all across the political spectrum agree that giving tax cuts to millionaires and billionaires does very little to actually grow our economy.

This is where the debate has stood for the last couple of weeks.  And what is abundantly clear to everyone in this town is that Republicans will block a permanent tax cut for the middle class unless they also get a permanent tax cut for the wealthiest Americans, regardless of the cost or impact on the deficit.

[...]

So, sympathetic as I am to those who prefer a fight over compromise, as much as the political wisdom may dictate fighting over solving problems, it would be the wrong thing to do.  The American people didn’t send us here to wage symbolic battles or win symbolic victories.  They would much rather have the comfort of knowing that when they open their first paycheck on January of 2011, it won’t be smaller than it was before, all because Washington decided they preferred to have a fight and failed to act.

Make no mistake:  Allowing taxes to go up on all Americans would have raised taxes by $3,000 for a typical American family. And that could cost our economy well over a million jobs.

At the same time, I’m not about to add $700 billion to our deficit by allowing a permanent extension of the tax cuts for the wealthiest Americans.  And I won’t allow any extension of these tax cuts for the wealthy, even a temporary one, without also extending unemployment insurance for Americans who’ve lost their jobs or additional tax cuts for working families and small businesses -- because if Republicans truly believe we shouldn’t raise taxes on anyone while our economy is still recovering from the recession, then surely we shouldn’t cut taxes for wealthy people while letting them rise on parents and students and small businesses.

[...]

In exchange for a temporary extension of the tax cuts for the wealthiest Americans, we will be able to protect key tax cuts for working families -- the Earned Income Tax Credit that helps families climb out of poverty; the Child Tax Credit that makes sure families don’t see their taxes jump up to $1,000 for every child; and the American Opportunity Tax Credit that ensures over 8 million students and their families don’t suddenly see the cost of college shooting up.

[...]

I have no doubt that everyone will find something in this compromise that they don’t like.  In fact, there are things in here that I don’t like -- namely the extension of the tax cuts for the wealthiest Americans and the wealthiest estates.  But these tax cuts will expire in two years.  And I’m confident that as we make tough choices about bringing our deficit down, as I engage in a conversation with the American people about the hard choices we’re going to have to make to secure our future and our children’s future and our grandchildren’s future, it will become apparent that we cannot afford to extend those tax cuts any longer.

1,000-man militia being trained in north Somalia

 1,000-man militia being trained in north Somalia
http://www.usatoday.com/news/world/2010-12-01-somalia_N.htm

Key political risks to watch in Angola and the Gulf of Guinea

Key political risks to watch in Angola
http://www.internationalpathfindersolutions.com/key-political-risks-to-watch-in-angola.html

Key political risks in the Gulf of Guinea
http://www.internationalpathfindersolutions.com/key-political-risks-in-the-gulf-of-guinea1.html

Ping Pong Robot Learns by Doing

Ping Pong Robot Learns by Doing

http://spectrum.ieee.org/automaton/robotics/artificial-intelligence/ping-pong-robot-learns-by-doing

New derivatives rules could punish firms that pose no systemic risk

Nov 29, 2010

The Hangover, Part II. WSJ Editorial
New derivatives rules could punish firms that pose no systemic risk.
WSJ, Nov 29, 2010
http://online.wsj.com/article/SB10001424052748704104104575622583155296368.html

Not even Mel Gibson would want a role in this political sequel. Readers will recall the true story of Congressman Barney Frank and Senator Chris Dodd, two pals who stayed up all night rewriting derivatives legislation.

The plot centered around the comedy premise that two Beltway buddies would quickly restructure multi-trillion-dollar markets to present their friend, President Barack Obama, with an apparent achievement before a G-8 meeting. As in the movies, the slapstick duo finished rewriting their bill just in time for the big meeting in Toronto last June.

But after the pair completed their mad-cap all-nighter, no hilarity ensued. That's because Main Street companies that had nothing to do with the financial crisis woke up to find billions of dollars in potential new costs. The threat was new authority for regulators to require higher margins on various financial contracts, even for small companies that nobody considers a systemic risk. The new rules could apply to companies that aren't speculating but are simply trying to protect against business risks, such as a sudden price hike in a critical raw material.

Businesses with good credit that have never had trouble off-loading such risks might have to put up additional cash at the whim of Washington bureaucrats, or simply hold on to the risks, making their businesses less competitive. Companies that make machine tools, for example, want to focus on making machine tools, not on the fluctuations of interest rates or the value of a foreign customer's local currency. So companies pay someone else to manage these risks. But Washington threatens to make that process much more costly.

Messrs. Frank and Dodd responded to the uproar first by suggesting that the problem could be fixed later in a "corrections" bill and then by denying the problem existed. Both proclaimed that their bill did not saddle commercial companies with new margin rules. But as we noted last summer, comments from the bill's authors cannot trump the language of the law.

Flash forward to today, and the Commodity Futures Trading Commission (CFTC) is drafting its new rules for swaps, the common derivatives contracts in which two parties exchange risks, such as trading fixed for floating interest rates. We're told that CFTC Chairman Gary Gensler has said privately that his agency now has the power to hit Main Street with new margin requirements, not just Wall Street.

Main Street companies that use these contracts are known as end-users. When we asked the CFTC if Mr. Gensler believes regulators can require swap dealers to demand margin from all end-users, a spokesman said, "It would be premature to say that a rule would include such a requirement or that the Chairman supports such a requirement."

It may only be premature until next month, when the CFTC is expected to issue its draft rules. While the commission doesn't have jurisdiction over the entire swaps market, other financial regulators are expected to follow its lead. Mr. Gensler, a Clinton Administration and Goldman Sachs alum, may not understand the impact of his actions outside of Washington and Wall Street.

In a sequel to the Dodd-Frank all-nighter, the law requires regulators to remake financial markets in a rush. CFTC Commissioner Michael Dunn said recently that to comply with Dodd-Frank, the commission may need to write 100 new regulations by next July.

"In my opinion it takes about three years to really promulgate a rule," he said, according to Bloomberg News. Congress instructed us to "forget what's physically possible," he added. The commission can't really use this impossible schedule as an excuse because Mr. Gensler had as much impact as anyone in crafting the derivatives provisions in Dodd-Frank. No surprise, the bill vastly expands his agency's regulatory turf.

And if anyone can pull off a complete overhaul of multi-trillion-dollar markets in a mere eight months, it must be the CFTC.

Just kidding. An internal CFTC report says that communication problems between the CFTC's enforcement and market oversight divisions "impede the overall effectiveness of the commission's efforts to not only detect and prevent, but in certain circumstances, to take enforcement action against market manipulation." The report adds that the commission's two primary surveillance programs use incompatible software. Speaking generally and not in response to the report, Mr. Gensler says that the agency is "trying to move more toward the use of 21st century computers," though he warns that "it's a multiyear process." No doubt.

The CFTC report also noted that "the staff has no standard protocol for documenting their work." If we were tasked with restructuring a complex trading market to conform to the vision of Chris Dodd and Barney Frank, we wouldn't want our fingerprints on it either.

The report was completed in 2009 but only became public this month thanks to a Freedom of Information Act request from our colleagues at Dow Jones Newswires. Would Messrs. Dodd and Frank have responded differently to Mr. Gensler's power grab if they had realized how much trouble the CFTC was having fulfilling its traditional mission? We doubt it, but it certainly would have made their reform a tougher sell, even to the Washington press corps.

Congress should scrutinize this process that is all but guaranteed to result in ill-considered, poorly crafted regulation. In January, legislators should start acting, not like buddies pulling all-nighters, but like adults who understand it's their job to make the tough calls, rather than kicking them over to the bureaucracy with an arbitrary deadline.

Press Briefing

Nov 27, 2010

Against Ridley, Bill Gates: Africa Needs Aid, Not Flawed Theories - http://on.wsj.com/eME4cP

Africa Needs Growth, Not Pity and Big Plans. By MATT RIDLEY

WSJ, Saturday, November 27, 2010

http://online.wsj.com/article/SB10001424052748704648604575621122887824544.html

Bill Gates likes my book "The Rational Optimist." Really, he does. Even though he dislikes my points about Africa and climate change, these take up, as he notes, just one chapter. The rest he summarizes fairly and intelligently, and I appreciate that. It's great for an author when anybody reviews a book "well" in both senses of the word.

It is worth explaining why I chose Africa and climate change as the "two great pessimisms of today." The answer is simple: Whenever I speak about optimism and someone in the audience protests, "But surely you cannot think that we can ever solve..." the subjects that most frequently cross their lips next are African poverty and global warming. Mr. Gates also mentions potential threats from super-intelligent computers and pandemics. Maybe he is right to worry about them, but I have yet to be persuaded that either is more than a small risk.

Mr. Gates dislikes my comments on climate change, which I think will be less damaging than official forecasts predict, while the policies designed to combat climate change will be more damaging than their supporters recognize. I argue that if we rush into low-carbon technologies too soon, because we think the problem is more urgent than it is, we risk doing real harm to ecosystems as well as human living standards—as the biofuel fiasco all too graphically illustrates. The rush to turn American corn into ethanol instead of food has contributed to spikes in world food prices and real hunger, while the rush to grow biodiesel for Europe has encouraged the destruction of orangutan habitat in Borneo.

I also argue, however, that it is highly unlikely, given the rate at which human technology changes, that we will fail to solve the problem of man-made climate change even if it does prove more severe than I expect. For example, the world is on a surprisingly steady trajectory toward decarbonization. The number of carbon atoms we burn per unit of energy we generate is falling as we gradually switch from carbon-rich fuels like wood and coal to hydrogen-rich fuels like oil and especially gas. At current rates, we would be burning almost no carbon by about 2070, though I suspect that point will never actually be reached.

The question that I pose in the book is whether optimism is likely to be right. In essence, neither Mr. Gates nor I think that the problem of man-made climate change is going to prove insoluble or fatal to civilization. We disagree only on how urgent it is to devote massive expenditures to dealing with it, which would put poverty reduction at risk. I think that direct spending to alleviate malaria, which now kills a million people a year and whose incidence is likely to increase as a result of global warming by less than 0.03% per year, is a far higher priority. So does Mr. Gates, judging by his foundation's spending.

It is on Africa that Mr. Gates throws his sharpest barbs. Yet, once again, I think that we agree on the most important point, namely, that Africa can have a good future. "Development in Africa is difficult to achieve," he writes, "but I am optimistic that it will accelerate."

Yes! I don't believe that "everything will be just fine in Africa," but I do think that Africa's real and profound problems can be overcome. My targets are the ubiquitous pessimists who say that, whatever we do, Africa is doomed to remain stuck "in deepest, darkest poverty," in the words of one environmentalist.

Yet, with exceptions such as Somalia and the Congo, economic growth is gaining momentum all over the continent, birth rates are dropping and poverty is falling, as the Spanish economist Xavier Sala-i-Martin has documented. Lots of people deserve credit for this, among them Bill Gates. His foundation, as far as I can tell, does exactly what I suggest in the book by concentrating on solving real medical and humanitarian problems.

----

AID TO AFRICA

* $44 billion

Official development aid given to Africa in 2008

* $3.3 billion

Official development aid given to Ethiopia, Africa's top recipient of aid, in 2008

* 41% Aid to Africa that went to social services, including education and health care, in 2008

* 19% Aid to Africa that went to economic development in 2008

* $7.2 billion

Amount of development aid given by the U.S. to Africa in 2008

* 58% Africans living on less than $1.25 a day in 1996

* 50% Africans living on less than $1.25 a day in 2009

* $510 Gross domestic product per capita in sub-Saharan Africa in 2000 (in 2000 dollars)

* $623 Gross domestic product per capita in sub-Saharan Africa in 2008 (in 2000 dollars)

Sources: Organization for Economic Cooperation and Development, World Bank

---

Far from saying that aid "doesn't work, hasn't worked and won't work," I actually say this in my book: "Some of the most urgent needs of Africa can surely be met by increased aid from the rich world. Aid can save lives, reduce hunger, deliver a medicine, a mosquito net, a meal or a metalled road."

I go on to say that "statistics, anecdotes and case histories all demonstrate that the one thing aid cannot reliably do is to start or accelerate economic growth." Now here I admit that Mr. Gates does have a point. Unintentionally, I have given him and perhaps other readers the impression that, in my view, combating malaria or AIDS does not pay economic dividends. It does.

What I do take issue with is economic aid designed to stimulate economic growth. For example, a 2006 study by Simeon Djankov of the World Bank (now deputy prime minister of Bulgaria) and his colleagues concluded that "foreign aid has a negative impact on the democratic stance of developing countries and on economic growth by reducing investment and increasing government consumption." Economic aid diverts resources into projects that fail, puts money into the pockets of corrupt government officials and crowds out the efforts of entrepreneurs. In one example, only 13% of educational aid to Uganda reached schools; the rest was siphoned off by rent-seeking officials.

I am disappointed that Mr. Gates is so defensive about "top-down" aid. Just as everything from software design to education can benefit from bottom-up crowd sourcing in which elites no longer determine what happens, so surely humanitarian aid can benefit too, however much vested interests in governments and in big agencies dislike this trend.

Likewise, Mr. Gates takes issue with my assertion that the economy of the future will be post-corporatist and post-capitalist. I know that these radical ideas are not to everybody's taste, and he is right that most innovation takes place within existing companies. But it is very striking that some of the most far-reaching innovations over the past several decades have come from driven, visionary outsiders like Mr. Gates, Mark Zuckerberg and Sergey Brin rather than from corporate research and development departments. What is more, these innovations have been achieved with much less capital investment up front than in the days of Andrew Carnegie and Henry Ford.

It is true that there is still a vast amount of work needed to bring ideas to market, and this requires cash and corporate organization. But increasingly, corporations are turning themselves into virtual entities, arranged around flexible networks of suppliers, retailers and researchers, rather than monolithic bodies sitting in fixed plants. That seems to me to make the word "capitalist" somewhat misleading.

Mr. Gates thinks I underplay the role of education, government, patents and science in the innovation that drives economic improvement. Maybe, but I make a carefully argued case that most of the existing commentary overplays the role of these institutions and that innovation is sometimes hindered by these institutions, too, especially by patents and government monopolies.

Am I saying that we should cease worrying about trends that might cause problems? Of course not. I am arguing that we should worry about real problems, including Africa's plight, but that we should do so in the knowledge that we have solved many such problems before and can do so again. I am certainly not saying, "Don't worry, be happy." Rather, I'm saying, "Don't despair, be ambitious"—though I admit it's not nearly as snappy a song lyric.

—Matt Ridley's many books include, most recently, "The Rational Optimist" and "Francis Crick." His website is rationaloptimist.com .

It Gets Better: Office of Personnel Management Director John Berry http://goo.gl/fb/BNSwk

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Capital Punishment and Human Fallibility - Then-Gov. George W. Bush would almost certainly have stayed Claude Jones's execution had he known that a DNA test had been requested  http://on.wsj.com/ew5pWJ

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A Geneticist's Cancer Crusade - The discoverer of the double-helix says the disease can be cured in his lifetime. He's 82. http://on.wsj.com/fOmOhW

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