An Encounter with a Diplomat in New York

By Grant de Graf

It was a cool day in the Big Apple, as winter began its approach. Pedestrians had already taken the initiative to don their heavy overcoats, a time proven protection against the cold winds that fanned through the city, at this time of the year. It was mid-morning and traffic in Midtown was rampant. Business was firing on all cylinders and her troops were leading the charge from the trenches.

The middle-aged gentleman straightened his red tie as he entered the hallway. He clutched to his Blackberry, responding to the call that had beckoned his attention,  moving to a deserted room that would provide him with some privacy. A security guard who had noticed the middle-aged gentleman enter the side room without authority,  unleashed the cover of his revolver and unlocked its safety catch. He cat walked towards the door, reporting his sighting over his walkie talkie to his superior officer. "I have target in sight. Permission to apprehend, requested."

"Negative," came the response. "We have positive facial recognition on target. I repeat, target has been identified as friendly."

"A little trigger happy today, Bruno?" a shy voice sounded from the security counter. "Or just a show of exuberance?"

"Hi Ms. Valintino. Just doing my job," responded the security guard with a smile.

"True. After all, it was Nixon who said that just because a person is paranoid, doesn't mean to say that the whole world isn't running after you," the elegant lady quipped. Her humor brushed over the security guard's head. "Fortunately, for the new facial recognition software that was recently installed, we avoided what could have been a major shootout."

"Hey, maybe Walt could do a review on the facial recognition technology?" the security guard suggested.

"Trust me. Walt has enough assignments to keep him busy for a month of Sundays, without any further distractions."

"I bet my Siri could have done the job. She would have recognized the target in no time."

"Another app, Bruno? Impressive," Valintino acknowledged.

Meanwhile, back in the privacy of the small but deserted anteroom, the middle-aged gentleman with subtle strokes of graying hair and shiny black shoes, was involved in discussion. He was conversing with a senior member of Hamas.

"It's a matter of simple arithmetic, Aziz," the middle-aged gentleman continued. "The question is, will all Palestinian people be more prosperous five years from now, if they reject a proposal for a two-state solution, or will they be further disadvantaged. It's my contention that the upside for Hamas in participating in a two-state solution is compelling. I have made that very clear. Both politically and economically."

The man with graying hair and shiny black shoes listened patiently to the response. It was long and emotional. He pressed his Blackberry against his ear, in the hope  that the conversation would adopt a more even-keeled level of expression. "Somewhere there has to be a wider degree of common ground between you and Abbas. The stakes are awfully high. You both stand to loose significantly, if you can't make it happen. I'll be on the next plane over, if the situation warrants it. You know that don't you?" he said rhetorically.

When the gentleman exited the room, he pondered over his conversation. He knew that the subject of Palestinian-Israeli peace talks, was a tough nut to crack.

"Welcome to America. The name is Jennifer Valentino DeVries," she said, extending her hand. "How was your trip over, from the other side of the pond?"

"Water off a ducks back, by modern standards. But thank you for asking, Jennifer," he responded politely. His accent was distinctly British. Those who bear an appreciation for the ring of the spoken word, would have noticed a slight accent that was not native to England.

"You had half our security unit on high alert, after your little escapade into our security room. Strictly out of bounds to the public."

"I must apologize. I had no idea."

"No problem. Our facial recognition security system identified you immediately," she said with a smile, handing him his security clip with an updated head and shoulder photo of himself.

We really appreciate you making yourself available for the Big Interview. It's become a leading platform for the Journal, à mon avis," she remarked, with a perfect French finish.

"I take it that you speak fluent French?"

"En effet. It's not as good as my Spanish, but better than my Mandarin."

"I'm impressed. Very global. My children all have Irish passports. For an Englishman, that's called global. Currently, I'm trying to get up to speed with my Arabic."

"And how's that going?

"Sababa!" he exclaimed with a chuckle. "Wait is that Arabic?"

They entered the elevator in private, while Bruno, the security guard, held back others who might have been inclined to accompany the couple, on their ascent.

"My wife would love to entertain the presence of your company. You must pop over for tea, on your next visit to London."

"Tea, without milk," Valentino said in jest. "Actually, I have a forthcoming assignment in London next week. I'd love to stop by."

As they exited the elevator, the Wall Street Journal Editor-in-Chief was alerted to their presence. His name was Robert Thomson. He warmly greeted the diplomat and thanked him for accommodating their request for the interview.

"We've decided to conduct the shoot in a private room, over some coffee and fruit," said Thomson. "It's more cozy, and that way we'll have an opportunity to edit out any bloopers."

The cameraman conducted a few test shots and checked the lighting. He strolled over to the coffee table and switched on the table lamp.

"Rolling and action," he affirmed.

"Welcome to the Big Interview. I'm Robert Thomson, Editor-in-Chief for the Wall Street Journal. Our guest today is Tony Blair."

To see the interview click here.

Why Greece Needs to Vote Against Austerity to Survive

By Grant de Graf

This week, the ECB gave Greece an ultimatum. The country's parliament must approve tougher and more stringent austerity, if it wants further funding from the ECB. The instruction came at a time, when a series of violent riots in Athens served to reflect the sentiments of Greece's citizens, towards the existing austerity measures imposed by the government. Teargas and force were required by the military, to battle protesters.

Now the ECB is calling on Greece to impose further austerity, obviously a consequence of the Central Bank's view that the riots in Athens were little more than a local Sunday afternoon tea party.

Before Prime Minister George Papandreou stands before his bedfellows and pronounces, "Friends, leaders and countrymen, lend me your wallets," some consideration is necessary.

Austerity on its own, is not a solution. It hasn't worked in Europe and neither will it work in the U.K. Venture down the streets of London, and ask any baker, banker or candlestick-maker. "How's the Oxford scholar?"  And they will tell you. "Unemployment has rocketed, spending is tight as a vice, and investment optimism is about as inspiring as the weather." In Europe that is what many call, an optimistic report.

True, Adam Smith did famously proclaim that when governments disinvest from the economy, market forces are permitted to respond and adjust to inefficiencies, so that equilibrium and full employment is achieved. But Joe the plumber is still chalking his snooker cue, waiting for the invisible hand to appear, laden with treasures from a sunken Spanish Galleon. "In your dreams, mate," a far away voice echoes.

No seriously, economist Adam Smith tested the dynamics of his rationale in a hypothetically free and efficient market scenario. However, as long as monetary policy combined with regulation is being dictated by a European Central Government, the Euro zone is anything but free. Even Smith would declare that all bets are off.

As I have oft pronounced, Europe's biggest challenge is the incongruent fashion in which monetary policy is dictated, independent to the application of fiscal policy. (See "Portugal Victim of EU Poison Pill Policy.") That dilemma is precisely what Europe and Greece are struggling with now. The inability of central bankers to implement fiscal policy at a central level (where monetary policy is enacted), especially when it runs contrary to local electoral sentiments. While Central Bankers party in debate over the unfolding Greek tragedy, politicians in Athens struggle with souvlaki, taramosalata and empty bottles of ouzo. Gone are the sounds from bouzoukis and belly dancers that pierced the Greek nights. All that remain are a few remnants of shattered crockery on the floor, a reminder of what it was like to be in Greece, when things were on a roll.

But Greece's biggest handicap, is its attachment to the Euro. Without the Drachma, there is no adjustment mechanism to which Adam Smith referred, a free rate of exchange instrument that could provide Greece with the ability to facilitate an economic recovery that would be export driven, due to competitive pricing. (See Paul Krugman's "The Road to Economic Crisis Is Paved With Euros")

In order to resolve the Greek crisis, some bold measures are necessary. They are actions that will test the courage of men and remain imprinted on the flag of every Greek citizen's heart.

Firstly, the Government needs to vote against austerity. Secondly, it needs to formalize an exit from the Euro currency and revert to the Drachma, to facilitate an economic climate that will expedite a recovery. Thirdly, it needs a moratorium with all its creditors, freezing capital and interest rate payments for at least 3 years. Fourthly, it needs to decrease taxes and draft a blueprint that will provide the market with strong incentives to  facilitate job creation, unlike the United States stimulus initiative. It is a proposal that will be a strike against an economy in recession, a step towards a recovery that will lift a nation.

Should Greece take the unfortunate step of voting for austerity and accepting the ECB poison pill package, it will simply be the launch of a new marketing campaign, to sell the public tickets on the Titanic at discount prices, rather than a step that will provide the country with the means for economic recovery; regrettably so.

G-20 Fighting a Battle of Relevance

By Grant de Graf

I was always the flea in the chamber, when speakers called for a show of hands, for those in support of Gordon Brown's economic policies. I was always the one that chanted "Aye" amongst the crowd of heads shaking violently, from side to side. Frankly, I am beginning to tire of the Tories' mantra that Labor pushed the country into recession by supporting bankers who robbed innocent folk of their savings. Lest anyone should forget, the whole world went up in flames and anyone standing too close to the fire, was a casualty.

Ironically, I also supported Margaret Thatcher's policies. Britain had been crippled by the unions, and when she slew the serpent with nine heads, the economy breathed with a new sense of life. I admire Ed Miliband for his political conviction, but I think little of his economic perspectives and policies. He is a socialist that would bring Britain to her knees. Similarly, I cannot say that I support the Conservative's austerity. You don't suddenly turn off the Boeing 747's engine, when you are looking for an open field on which to crash land the kite [gently].

The WSJ reports that Gordon Brown's "biggest worry was the G-20′s failure to craft the “global growth pact” that would address the global imbalances of high debts and slow growth in Western economies and high savings rates, undervalued currencies and a lack of consumer demand in Asia and elsewhere."

Point taken, but I wonder what remedy Brown proposes. It's a bit like the rugby prop forward who kept complaining to the referee that his opponent was wedging his head into his chest. "He's boring, Mr. Ref. He's boring," the player protested.

"Well you're not too interesting yourself," quipped the referee. Much to complain about, but nothing much to say.

In defense of Brown, I have not read his latest book "Beyond the Crash" which may offer some gifted pickings or remedies for a troubled economy. Either way, I prefer to push the carrot [the solutions] rather than the stick.

Fool's Trap: Measuring Inflation

By Grant de Graf

Probably one of the most frightening economic phenomena is the restrictive way in which bankers and economists are measuring inflation. These indicators are being used to make game changing decisions that invariably could exacerbate weakness in fragile economies.

Take the Euro-Zone's latest reading for inflation which came in at 2.4% in February, 2011 from 2.3% in January, the highest level since October 2008 and unchanged from the preliminary, or flash, estimate published on March 1, by the European Unions' Eurostat agency.

Let's also look at the report for the rise in consumer prices in the U.K. which "grew at an annualized pace of 4.4% in February to mark the highest reading since October 2008, while the core rate of inflation increased 3.4% from the previous year amid forecasts for a 3.1% expansion."

Typically inflation is measured by changes in the consumer price index [CPI] which provides a very limited perspective on the inflation that central bankers need to address.

The accepted practice for dealing with inflation and an economy which is over-heating, is to spike interest rates. The only problem is that we don't really have an economy that is overheating and that advances in the CPI appear to be a consequence of the demand and supply curve, rather than changes in monetary supply or business activity.

For example, unrest in the Middle East has been the cause for a rise in crude prices, which has caused an increase in fuel prices at the pump and in transport costs. The multiplier impact that this has on an economy is obvious. Secondly, the hike in food prices internationally, partially as a result of shortages, has also effected the CPI.

The fallacy that governments can raise interest rates to reduce inflation, which is essentially a function of demand and supply is misplaced. Most certainly, if trading levels of the Sterling and the Euro are anything to go on, the market believes that central bankers will increase interest rates to combat the recent increases in CPI, which they are calling inflation. Such a move by policymakers, in this instance would be a mistake. Changes in prices within any market mechanism is a natural function that contributes to the equilibrium process and the efficient distribution of goods.

When money supply within an economy increases, or robust growth is the cause for higher prices, then there may be justification for a government to use interest rate policy to curb an overheated economy. That is not the case here.

A more accurate way to measure the harmful effects of inflation that governments seek to constrain, is to track increases in real wages and decreases in unemployment, to access the impact that inflation is having on an economy.

Case in point, WSJ reports:

"Eurostat said wage growth in the euro zone picked up in the final three months of last year [2010] from its record-low pace, although pay still rose less rapidly than prices.

"Employment edged up only modestly over the final three months of last year, so consumer spending appears unlikely to grow rapidly in the months ahead or make a major contribution to growth in the broader economy."

Clearly, the recently reported increases in CPI, both in the United Kingdom and the Euro Zone do not justify for an increase in those region's interest rates. The impact of increasing interest rates would further constrain growth in fragile economies, and would not have an impact on CPI, in the way that governments may desire.

Portugal Victim of EU Poison Pill Policy

By Grant de Graf

Portugal is the latest victim of the difficult standards and expectations that the European Union is imposing on its members, to meet high levels of austerity and government spending cuts. Very often the dogma that is being propagated at central government is one that may be good for the Union in general, but which is inappropriate at a local level.

As predicted, attempts to implement the stringent measures of austerity by central government are bound to impact the electorate. Politicians are being forced to resign or being compelled to become recipient to the wrath of their respective voters, who express dissatisfaction with the manner in which their economy is being managed. This has been true of Ireland where the ruling party was ousted and more recently in Portugal, when Prime Minister José Sócrates was forced to tender his resignation, after Parliament rejected a new austerity plan.

One may argue that Portugal's attempt to implement the austerity measures was voluntary and a course which was inspired to win investor confidence, for its slew of bond issues that it has had to facilitate. However ultimately, investors will be wooed through any action that has a positive long term goal, even if that plan amounts to stimulatory measures, for the economy.

Additionally, Portugal's ratio of GDP to debt remains low relative to Japan, Italy and France.

Austerity vs. Stimulus

By Grant de Graf 
[Sourced  and adapted from an article by Antonios Sangvinatsos, a professor of Finance at Stern School of Business, New York University]

Trying to Understand the Multiplier Effect

Austerity measures are usually combinations of government spending cuts and increased taxes. Stimulating practices, on the other hand, are consisted of combinations of the exact opposite actions, increasing government spending and/or reducing taxation. Therefore, it is clear that perhaps one has to choose one or the other, austerity or stimulation.

The above premise is based on the belief that one can create stimulation in the economy by increasing government spending or reducing taxes, and that one can save money by cutting spending or increasing taxes. But how much of it is true? Are the policies that help the country’s balance sheet hurt the economy’s growth? This article attempts to answer both questions.

It is always the case in economics, that an action generates more than one effect and often times these effects move in opposite directions. This is the case also here. Let us start with the alleged austerity measures and their effects.

Austerity Measures

Spending Cuts
Effect on Output: Output may decline.
Effect on Balance Sheet: Interest rates may decline.

Tax Hikes
Effect on Output: It may decline.
Effect on Revenues: Collected taxes may go up or down.
Spending Effect on Output

In what follows the consequences of spending cuts will be discussed, or increasing spending, on output. The current economic situation is described by anemic growth and high debts. Currently the discussion has focused on whether one, for example the U.S., should engage in tight fiscal policy, and more specifically, in cutting spending. This week FT hosts a debate on the same topic inviting articles from renowned economists.

Whether spending has an effect on output is summarized by the value of the spending multiplier. This is a number that stands for the number of dollars is generated in output by one dollar spent by the government. Advocates of spending policies justify their opinions on spending multiplier greater than 1.0. How much of it is true?

The answer is that, at best, the academic community has been inconclusive about the effectiveness of spending on stimulating output. This means that there is a lot of doubt, in the academic community, that spending works, i.e. that spending has a multiplier value greater than one.

For example, Barro and Redlick (paper link, WSJ article) find that defense spending has a multiplier of 0.6-0.7 at the median unemployment rate – while holding fixed average marginal income-tax rates – and there is some evidence that the spending multiplier rises with the extent of economic slack and reaches 1.0 when the unemployment rate is 12%. Estimating spending multipliers for non-defense spending is problematic as the nondefense government purchases are positively correlated with the business cycle and it is difficult to establish causality. Is it the spending that created growth or the growth that spurred government into spending? Barro and Redlick think the latter.

The same ideas are reiterated also in an FT article by Kenneth Rogoff. He believes that:

“At the same time, the stimulus benefits of massive fiscal deficits are not nearly so certain as proponents of a new surge of spending maintain. The academic evidence on Keynesian growth effects of fiscal deficits is thoroughly inconclusive. Ironically, a lot of the newfound conviction comes from the casual empiricism on the growth effects of the Bush tax cuts, evidence that few academics consider sufficient to outweigh the mass of previous results. Indeed, it will take researchers many years, perhaps decades, to sort out the effects of the massive fiscal stimulus that many countries undertook during the crisis. My guess is that scholars will ultimately decide that fiscal policy was far less important than monetary policy and measures to stabilize the banking system.”

In addition, a rough method I employ gives me a spending multiplier of 0.6, less than 1.0, rendering spending an ineffective policy. Finally, there are people who argue that the multiplier is negative, in which case, spending by the government decreases the output. This is also called crowding out.

There are however economists who argue that the multiplier is greater than one. Christina Romer, head of the President Obama’s Council of Economic Advisers, and Mark Zandi, from Moody’s, claim that the multiplier is 1.6. Note that, Keynes believed that the U.S. multiplier in the 1930s was 2.5.

Policy Implications

It is clear, now, that if the value of the multiplier is what the consensus has it in the academic community, around 0.6 or lower, cutting spending will have a small effect on output, as it is also the case that giving another stimulus package will generate little additional growth in the economy. Clearly, the opposite is true if the multiplier is 1.6 or higher, like some people advocate. However, the benefits of any policy have to be weighed with the benefits or costs of contingency scenarios. A policy creates repercussions that also need to be evaluated. For example, spending cuts may or may not decline the economy’s output, but it also has an effect on the country’s balance sheet, the expectations of both the bond investors and the consumers. A policy decision is an act of balancing the fears of all the groups that are involved in a given situation. (Prof. Antonios Sangvinatsos, elaborates in an article the big number of factors that affect the value of debt.)

One may conclude that the effectiveness of either austerity or stimulus will be largely determined by the economic sectors that are targeted by authorities to invoke their policies. Ultimately, some areas of government cuts or spending will have a greater impact than others.