Left Flank

John Robb hopes the global system isn't as efficient as we designed it to be. Speed and connectivity will make this financial crisis into an «...uncorrectable and self-reinforcing feedback loop.»

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I'm not surprised The Weekly Standard's John McCormack links to an article trashing FDR by asserting «The seeds of that global conflict [WW2], unimaginable in 1933 given the relative weakness of Germany and Japan, were planted in the first years of the Roosevelt administration as FDR focused on the American economy.» I'm surprised Frederick W. Kagan wrote it.

As the scale of the economic crisis becomes clear and comparisons to the Great Depression of the 1930s are tossed around, there is a very real danger that America could succumb to the feeling that we no longer have the luxury of worrying about distant lands, now that we are confronted with a «real» problem that actually affects the lives of all Americans. As we consider whether various bailout plans help Main Street as well as Wall Street, the subtext is that both are much more important to Americans than Haifa Street.

One problem with this emotion is that it ignores the sequel to the Great Depression -- the rise of militaristic Japan marked by the 1931 invasion of Manchuria, and Hitler's rise to power in Germany in 1933, both of which resulted in part from economic dislocations spreading outward from the U.S. The inward-focus of the U.S. and the leading Western powers (Great Britain and France) throughout the 1930s allowed these problems to metastasize, ultimately leading to World War II.

Is it possible that American inattention to the world in the coming years could lead to a similarly devastating result? You betcha.

I actually agree with this opening, and I expected Kagan to argue that economic issues are security issues. Instead, Kagan turns hack and attacks FDR. This is an astounding reversal of post-WW1 history, when Republicans, led by Henry Cabot Lodge, blocked ratification of the Treaty of Versailles, because of Article One enabling the League of Nations. The US officially ended its participation in WW1 with the Porter-Knox Resolution on July 2, 1921. Republican presidents, Warren G. Harding and Calvin Coolidge, were bystanders as private agents conducted American foreign policy and Congress increased tariffs. Coolidge's term witnessed the Kellogg-Briand Pact of 1928 outlawing war. Herbert Hoover's most significant foreign policy successes involved improving relations with Central and South American nations by replacing the Roosevelt Corollary with the Clark Memorandum. The most significant Republican foreign policy goals in the 1920s involved German reparations. FDR, in 1932, confronted Republican isolationists in Congress.

Partisan animus must cloud Kagan's perspective on the Roosevelt administration. Kagan ironically doesn't appreciate «...the patience with which FDR brought the country to understand the danger of fascism.» FDR, one of the very few presidents fluent in foreign languages, including German, recognized the danger of Hitler's 1933 election immediately, yet it took him until 1941 to navigate the shoals of depression and Republican isolationism to position the US as the arsenal of democracy. In the process, FDR battled Democratic segregationists who, though, supportive of military force, also confronted FDR's economic and social policies. Kagan wants to divide presidential responsibilities for economic, social, and foreign policies, as if any president could get congressional approval for one without considering logrolling attempts to combine the three made by election-minded politicians.

Kagan deserves a spot on Fox with Michael Goldfarb, not a foreign policy fellowship.

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Jerome Chen adds another reason, foreign human rights criticism, why Beijing is just waiting for the right moment to take care of itself.

Saving face is important for China. But while the government clearly finds foreign criticism humiliating, it doesn't want to put a blight on its future in the global economy, of which it aspires to be a heavyweight player. It's also possible that China is just tallying up its resentments for the right moment. If one day China is in a secure enough position to wield economic and political leverage over Europe, it may not be as conciliatory because of the slights it has received along the way.

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Martin Wolf lays out a global action plan. It's still only just prevention, not a cure.

So what should be done? Some would argue: nothing at all. The view is widely held, particularly in the US, that the world needs a big purge of past excesses. Recessions, on this line of argument, are good. People who hold this view also argue that governments caused all the mistakes. The market would, they insist, be incapable of the errors we have seen. To them, Alan Greenspan's confession last week that «I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders» was about as welcome as Brutus's knife was to Caesar.

Intriguingly, the Bank's Financial Stability Report provides some support for this view: back in 1900, US banks had four times as much capital, relative to assets, as they do today. Similarly, the liquidity of the assets held by UK banks has collapsed over the past half-century. Implicit and explicit guarantees from governments have indeed made the financial system more dangerous than before. The combination of such guarantees with deregulation has proved lethal. Moral hazard is far from meaningless.

Yet the idea that a quick recession would purge the world of past excesses is ludicrous. The danger is, instead, of a slump, as a mountain of private debt – in the US, equal to three times GDP – topples over into mass bankruptcy. The downward spiral would begin with further decay of financial systems and proceed via pervasive mistrust, the vanishing of credit, closure of vast numbers of businesses, soaring unemployment, tumbling commodity prices, cascading declines in asset prices and soaring repossessions. Globalisation would spread the catastrophe everywhere.

Many of the victims would be innocent of past excesses, while many of the most guilty would retain their ill-gotten gains. This would be a recipe not for a revival of 19th-century laisser faire, but for xenophobia, nationalism and revolution. As it is, such outcomes are conceivable. Choosing to risk such an outcome would be like deciding to let a city burn in order to punish someone who smoked in bed. Risking huge damage now in the hope of lowering moral hazard later is mad.

Everything possible must be done to prevent the inescapable recession from turning into something worse. Many of the needed actions were laid out in an article on the FT's Comment page this week by Columbia University's Jeffrey Sachs. I would stress five points.

First, as Oxford university's John Muellbauer argues, deflation is a real danger. Yet deflation is lethal for indebted economies. Today, short-term interest rates look far too high in the eurozone and the UK. Central banks need to look at their economies afresh and cut rates by at least 1, and ideally 2, percentage points.

Second, the only way to let the private sector deleverage, without mass bankruptcy and huge falls in spending, is by substituting the asset everybody wants: government debt. Contrary to Professor Sachs, I think tax cuts are indeed part of the solution.

Third, it is crucial that lending be sustained both inside and among economies. Having gone to such trouble to recapitalise banks, governments should insist that their money be used to sustain credit lines to those likely to remain solvent. If banks are unwilling to do this, central banks will have to replace them, as the Federal Reserve is now doing.

Fourth, it is in the vital self-interest of the affected high-income countries to keep hard-hit emerging economies afloat through the crisis.

Finally, it is equally evident that the world will not return to equilibrium if countries in strong financial positions do not expand domestic demand. The day of the housing bubbles and huge current account deficits in high-spending high-income countries is gone. Those who rely on current account surpluses to sustain demand must think again.

Decisions made over the next few months may well shape the world for a generation. At stake could be the legitimacy of the open market economy itself. Those who view liquidation of past excesses as the solution fail to understand the risks. The same is true of those dreaming of new global orders. Let us first get through the crisis. The danger remains huge and time is short.

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For once I agree with Philip Bowring about the global division of labor needed to survive a short recession without fear of a depression.

It is primarily up to the U.S. and Europe to mend their own financial systems and not to rely on Asians throwing more good money after bad.

But it is primarily up to the Asian powerhouses to stimulate economic activity in a developing world that mostly is neither overburdened with debt nor choked by aging population.

Again, though, Beijing has other ideas. And, Sino-Japanese cooperation, when blaming each other is so much more domestically fruitful? It might take a Greater depression to pull that off!

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Henry Farrell and Dan Drezner scrutinize the inscrutable and offer three theories about Chinese actions in the current economic troubles:

1. PRC is not as powerful as we think because of its exposure to the global system;
2. PRC has no notion of what to do internationally and is willing to play a subordinate role, possibly to allow western states to take the blame for the mess;
3. PRC is pursuing mercantilist policies.

I'm banking on #3. Case in point, how really effective does the IHT think its finger-pointing can be?

Over the summer the Chinese central bank put an end to its short-lived policy of allowing the yuan to gradually appreciate against the dollar, a policy aimed at reducing inflation that would also raise the price of Chinese exports. Last week, the Chinese government announced that it would increase its rebates on taxes charged to exporters - giving them a further boost.

But trying to capture a bigger share of shrinking markets in the United States, Europe and Japan, just as they tip into recession, won't provide China much of an economic lift. What it will do is contribute to the slowdown in the rest of the world by hogging demand.

China would get much more bang for the buck if it focused on stimulating its own domestic markets for goods and services.

Beijing is probably dancing on tables celebrating the demise of the Washington Consensus, and is no doubt relieved it will not have to listen to American cabinet officials lecture them about currency appreciation and stoking domestic demand. «Patience» is one aspect of Chinese policy, but seizing opportunities goes right along with a hunger, in Chinese attitudes, to avenge itself on a global system that has fed on Chinese markets for centuries. And, Beijing can still conform later, when western states devise a solution, with more or less enthusiasm and more or less skill. The point is, Beijing can rattle the cage, which doesn't require administrative competence, a little, to prepare for the time when it can take the global reins.

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The Nobel laureate talks both humorously and straightforwardly about his disagreements with Hank Paulson and Ben Bernanke (less bailout, more capitalization, don't let Lehman Brothers fail), and his wishlists for an Obama administration - nothing for John McCain.

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