Chasing quotes

I’ve been noticing a quote, attributed to Keynes, that neatly encapsulates an argument I’ve been putting for some years.

The market can remain irrational longer than you can remain solvent.

The point of this is that, even if you can see a market bubble (or irrational slump) developing, you should not bet that prices will return to normal, for example by selling stocks short. The most sensible course is simply to avoid holding assets that are overpriced (I’ll need to work through the details of this argument formally some time – I guess it’s done in the literature on rational bubbles). Anyway, although the quote is being widely reproduced, I haven’t been able to find an actual citation, and the informal use of “you” leads me to suspect that these are not Keynes’ actual words. If anyone can find the source, I’d be very grateful.

On the same front, I gratefully acknowledge reader Bernhard Walpen, who sent me the full text of the Hayek quote on Pinochet that I mentioned some time ago. Here it is (with emphasis added by me):

Hayek, Friedrich August von, 1981: “En el Momento Actual Nuestra Principal Tarea es Limitar el Poder del Gobierno” [Interview], in: El Mercurio, April 4, 1981, p. D8-D9.

D9: “Bueno, yo le dirla que, como una institución a largo plazo, estoy totalmente en contra de las dictaturas. Pero bien puede ser un sistema necesario en un periodo de transición. A veces es necesario que en un país haya, durante un tiempo, alguna forma de poder dictatorial. Como usted comprenderá, es posible que un dictador gobierne de manera liberal. Y también es posible que una democracia gobierne con una total falta de liberalismo. Y yo, personalmente, prefiero a un dictador liberal y no a un Gobierno democrático carente de liberalismo. Mi impresión particular es – y esto es válido para Sudamérica – que en Chile, por ejemplo, habrá una transición entre un Gobierno dictatorial y un Gobierno liberal. Y en esa transición puede ser necesario mantener algunos poderes dictatoriales, no como algo permanente, sino como un arreglo de transición.”

My Spanish isn’t great, but it’s clear on the one hand that Hayek is endorsing the Pinochet regime [Bernhard’s extensive research on Hayek revealed no statement critical of Pinochet], and on the other hand, that he viewed it as a transitional stage in a movement towards a nondictatorial liberal government.

The most natural reading of the phrase I’ve emphasised is that, even without the prospect of transition, Hayek thinks a liberal (that is, free-market) dictatorship is to be preferred to an illiberal democracy. But as with Marxists and the ‘dictatorship of the proletariat’, the tendency is to use the prospect of ultimate transition to an ideal state to avoid a clear commitment for or against a dictatorship of indefinite duration. And, since the Pinochet regime did ultimately give way to a democratic government, it’s probably not sensible to draw firm conclusions on the basis of Hayek’s attitudes in this case.

Update In the comments thread, reader Alan from Southerly Buster provides a good translation. And Brad de Long notes that he has been unable to find a source for the Keynes quote which looks ‘too good to be true’. I agree – it seems like a response to arguments that Keynes would never have encountered, regarding the potential for rational speculators to stabilise markets.

Lessons from Afghanistan

This NYT report on the mess in Afghanistan is worth reading when we are thinking about likely developments in Iraq. The situation in Afghanistan after the fall of the Taliban was, in important respects, considerably more promising than in Iraq. There was not too much trouble in producing a government with wide support, or at least acquiescence, and there was broad pro-American sentiment. All that was needed for a successful outcome was a reasonably comprehensive effort at peacekeeping and nationbuilding.

Instead, apparently to keep a clear field of fire in the hunt for Taliban/Al Qaeda, the Pentagon confined the international peacekeeping force to Kabul and allied itself with local warlords, inevitably becoming the enemy of its clients’ enemies. The result, two years later, is that Afghanistan is in much the same position as it was before the Taliban took over – warlords ruling the provinces and a government whose writ doesn’t run outside the capital, and not even within it at night. The time when US forces can pull out without inducing collapse looks further off now than it did when Kabul fell.

One consequence is that not even the relatively modest sums promised as aid have been delivered. As I recall, the US even forgot its budget allocation until the need to cover bases for the Iraq war focused the mind of the Administration.

This ought to have been comparatively easy, and it’s been comprehensively botched. Watching the mess that was made in Afghanistan was one of the factors that led me to oppose the war with Iraq. Nothing that has happened since the fall of Baghdad has led me to revise my assessment on this score.

Another PFI deal goes sour

From the British Public Finance (published by the Chartered Institute of Public Finance and Accountancy) reports on a British deal in which the private supplier of school services simply walked away, two years into a five-year contract. One would suppose that there was some sort of performance bond to guard against this, but it isn’t discussed.

Some more interesting stories report higher costs due to PFI causing cuts in services and problems with the London Underground PPP.

Even more interesting is the suggestion here that the vogue for the provision of public services by for-profit companies has passed its peak and that interest is now turning to “public interest companies” – a version of what used to be called quangos (I’ll add a link on the etymology of this interesting term when I get time).

Against dictatorship

Saddam may be gone, but there are still plenty of nasty dictators infesting the world, some of them members of the Axis of Evil and others prominent in the Coalition of the Willing.

Nathan Newman sends the following message:

Here is the first round of what I think needs to be a stronger, pro-active condemnation of authoritarianism of all kinds and nonviolent solidarity movement resisting that authoritarianism as an alternative to Bush’s corporate militarism. And no place better to start than with than Cuba, where a range of left activists are circulating the letter below.

See this post for more.

Dollar vs Euro

All wars generate conspiracy theories. The most interesting theory doing the rounds in relation to the war in/on Iraq is based on the struggle between the US dollar and the euro for pre-eminence as an international reserve currency, and, in particular, a basis for trade in oil. Until recently, this theory has been widely circulated among opponents of the war, but a version recently appeared in Newsweek with the implication that the shift to trade in dollars was justified as ‘spoils of war’.

Although the factual details and the supporting analysis vary from version to version, the common factual core is the fact that both Iraq and North Korea have recently switched their reserves from dollars to euros and that Iran is considering following suit. This, rather than weapons of mass destruction, is seen as the real cause of the war. In some accounts, this is tied to the attempt coup, generally welcomed in the US, against Venezuelan President Hugo Chavez who had also undertaken some diversification of foreign exchange holdings. One report, widely circulated on the Internet, includes an anonymous insider who is quoted as saying ‘Saddam sealed his fate when he decided to switch to the Euro in late 2000’.

The North Korean angle can be dismissed fairly quickly. North Korea’s annual trade is roughly comparable with Tasmania’s and its foreign exchange reserves are negligible. Then again, by many accounts, North Korean was something of an afterthought in the Axis of Evil, brought in to replace Syria when it was realised that an all-Muslim Axis would not play well with the world public.
More generally, the focus on Middle Eastern petrodollars is redolent of the 1970s thinking that still dominates much policy debate on both sides of the politicla divide. The characteristic feature of this thinking is an overemphasis on the economic importance of oil. The vast majority of US-dollar denominated assets are held in Europe and (East) Asia, and it is the sentiments of investors in these regions that will determine whether the US remains dominant as a reserve currency. In economic terms, a decision by OPEC to quote in euros rather than dollars would make very little difference.

Before going on to look at the implications of the war for the dollar, it is worth asking ‘does it matter if the dollar is the world’s reserve currency?’ After all, the pound sterling was an important reserve currency until the late 60s, and this did not seem to do much for the British economy.

The US directly benefits from the ‘reserve currency’ status of the dollar through international seignorage, that is, the fact that the US government can print dollar notes for which foreigners, notably in Eastern Europe, are willing to exchange real goods and services. A shift towards the euro would reduce or eliminate this benefit. However, as Lawrence H. Meyer of the US Federal Reserve Board of Governors, has observed, the total benefit of international seignorage is about $US15 billion per year – not much of a motive for a war that has already cost about $US50 billion and is likely to cost much more.

The real issues are subtler and relate to the complex relationship between military power, economic power and the ‘soft power’ of cultural and diplomatic influence. A successful outcome in Iraq may be seen as reinforcing US hegemony and therefore increasing the willingness of market participants, including central banks, to take actions that reduce their own returns but bolster the status of the dollar as a reserve currency.

Taken as a whole, I would argue the Iraqi war has done the opposite. The effect has been to make the US appear dangerous and unpredictable and to increase the desire of most people and governments to constrain its hegemonic power. Moreover, Bush’s willingness to spend vast amounts on war while making yet more dramatic cuts in taxes has strengthened the perception that US debts will sooner or later be repudiated either directly or through inflation.

However, this is not the view in Washington, where military and economic power are still seen as going hand in hand. It’s clear that, in the minds of those formulating US policy, military victories achieved in the face of European opposition will pave the way for continued US economic dominance.

Thus far, the foreign exchange markets don’t seem to agree. Although the $US is still well above its fundamental value, it has declined steadily during the Iraq war, with little regard for whether the war news is good or bad.

Update This piece from the UK Centre for Economic Policy Research considers a wider range of effects including benefits for ‘home’ financial institutions, relaxation of the ‘external constraint’ on macroeconomic policy, the role of the region in international institutions, effects on macroeconomic policy coordination, and the wider consequences of exercising ‘currency hegemony’. They conclude that the impact of the euro replacing the dollar for most international transactions would be

The consequence could be a welfare gain of 0.5% of GDP (annually) for Europe, with a similar loss for the US – as well as the other economic and geopolitical attributes of the ‘hegemonic’ world currency.

On this estimate the cost to the US would be around $50 billion per year, still well below the cost of maintaining military hegemony, which will certainly raise annual US defence expenditure by at least $100 billion per year, while having only a marginal impact on currency hegemony.

Beazley blowback

Ken Parish essentially sums up my views on the prospect of Kim Beazley being returned as Labor leader. I’ll just focus on one point. The argument that, “given the current focus on foreign policy issues we need someone with a strong background in these issues” is refuted by experience. The 2001 election was fought on foreign policy issues, and Labor was crushed. Another election on foreign policy would be a virtual rerun, especially as the subtext of the Beazley campaign is that he would ensure that “you couldn’t fit a cigarette paper” between Labor and the government on Iraq.

I also think the current assumption of an inevitable Liberal victory is not soundly based. The government may have a big lead, but public support is far from enthusiastic, and could be eroded rapidly by an economic downturn or (less severely, but still substantially) by a bad medium-term outcome in Iraq.

Update I should emphasise that any decline in the government’s popularity is unlikely to be sufficient to deliver Labor victory by default – the only strategy Beazley has. Crean did not make a good start on presenting an alternative, wasting his first year on meaningless internal party reforms. But he has shown more signs of trying to do something positive since then, and I think could produce something worthwhile in response to the next Budget (possibly his last chance, if a double dissolution is held).

The big test

Palestinian PM-designate Abu Mazin appears to have succeeded in facing down Arafat over his choice of Cabinet. It still has to be approved by the Palestinian Parliament. Once that happens, Bush is committed to publishing his ‘roadmap’ for peace, which Sharon has already effectively dismissed, proposing a wide range of amendments.

This is the big test for Bush’s Middle East policy. If he pushes ahead and demands that Sharon accept the roadmap without significant change, begins dismantling settlements and so on, there is a fair chance that the resulting shift in public sentiment throughout the Arab world will lead to a successful outcome in Iraq. If not, the hostility to the US that is already evident in Iraq will only intensify – there are a number of possible ways the situation could develop from there, none of them appealing.

But as I argued at the time, if Bush was planning to do something serious about the Israel-Palestine problem, it would have been far more sensible to do it first, then deal with Saddam.