Author: Warren Coats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 1975 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My recent books are One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina; My Travels in the Former Soviet Union; My Travels to Afghanistan; My Travels to Jerusalem; and My Travels to Baghdad. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon. I live in National Landing Va 22202

Saving Greece: Austerity and/or growth

Econ 101: When discussing Greece’s economic problems public officials and the press regularly toss out the need for “austerity” and/or “growth” as if they were clearly defined and understood concepts. I suspect that they mean quite different things to different people. While it is convenient to summarize complicated policies with single words, it can also stand in the way of understanding what is really meant. So what are the policies needed for Greece’s recovery and what should we call them?

Stocks and flows: For starters we need to distinguish the stock of Greek debt (the existing outstanding amount of previous, unrepaid borrowing) from its annual deficit. Greece’s debt reflects the past history of its annual deficits. Its current and prospective deficits foreshadow the future stock of debt. A full default on Greek debt—wiping it all off—would reduce Greece’s annual interest payments on its debt but beyond that would do nothing to reduce its annual deficit and the build up of its future stock of debt, which eventually would again become unsustainable. So forgiving (defaulting on) all existing Greek debt, by itself, will not resolve Greece’s problems.

Sticking with broad simplifications, Greece has two major economic problems. First, its government spends more than it can pay for without borrowing (the deficit — the flow of new debt). Moreover, like the U.S. and many other governments, it has made commitments to spend in the future (e.g. unfunded pension commitments) that are not yet reflected in its stock of debt or its annual deficits. This must change because it is not sustainable. Lenders will lose confidence in the government’s ability to service its debt and will stop lending. This calls for “austerity”, i.e. eliminating the annual deficit, by some combination of reducing expenditures and increasing tax revenue. I will return later to the distinction between structural and cyclical deficits.

Greece’s second major problem is its low productivity and uncompetitive prices. By themselves these would simply imply a lower standard of living for Greeks. But the average Greek has been spending more than his income by borrowing, giving the temporary illusion of a higher standard of living. To the extent that Greek spending is for foreign produced goods and services and these imports are not fully paid for with Greek exports, they must be paid for by borrowing. This artificial standard of living is obviously not sustainable.

Greece shares the same currency, the Euro, with 22 other European countries (including non members such as Monaco, Kosovo, and the Vatican).  If Greeks borrow domestically to pay for imports, Euros will flow out of Greece, tightening liquidity. This should put downward pressure on wages and prices in Greece, which would help restore its competitiveness with the rest of the Euro zone. If Greeks borrow abroad, interest rates on such borrowing should eventually increase to cover the increased default risk. This will discourage Greek borrowing. Greece has reached this point.

Some argue that if Greece had its own currency it could reduce its real wages by devaluing its currency and thus restore external competitiveness. Cutting real wages in this way would be easier, they argue, than cutting nominal wages directly as Greece has just done for government employees. Experience in other countries suggest that devaluing its own currency, if it had one, would set off domestic price increases to offset the loss of real wages unless labor markets were made more competitive. A spiral of devaluations and inflation would likely ensue. Only when real wages can be reduced to competitive levels one way or another can Greece hope to grow out of its current problem.[1] Thus the Greek government is undertaking structural adjustments to liberalize labor and product markets in order to make them more efficient and to make wages and prices more responsive to market conditions.

Some argue that the emphases in Greece should be put on growth.  Given the debate in the U.S. between Keynesian and neo classical economist over whether growth requires “stimulus” to increase demand (the Keynesian view) or “structural adjustments” to make labor and product markets more efficient and to encourage investment (the neoclassical view), it is not completely obvious what the proponents of growth in Greece have in mind. Attempting to promote growth with government stimulus to demand is not in the cards, as that would require more government spending and/or lower taxes and thus even larger deficits that no one is willing to finance. The only way for Greece to enjoy a higher standard of living is to undertake structural reforms that will allow the economy to be more productive and its wages and prices to be more competitive with the rest of the world.

So Greece needs to eliminate its deficits (actually run surpluses to reduce its outstanding debt) and liberalize its labor and product markets to establish balance in its external trade. All serious students of the Greek situation agree with this. The policy debate is complicated, however, by the interaction between growth and deficits and the speed with which an economy adjusts to changes.

If the Greek economy grows more rapidly it helps its debt problem in several ways. First, a growing economy generates more tax revenue from the same tax system. This reduces the deficit. It also tends to reduce government expenditures linked to safety net expenditure (e.g. unemployment insurance). This also reduces the deficit. In addition, the capacity of an economy to sustain and service debt is linked to its size. Thus economists look at the ratio of debt to GDP. A more rapidly growing economy tends to reduce the debt/GDP ratio by increasing the denominator.

While Greece must eliminate its deficits, the initial impact of expenditure cuts and higher taxes is to temporarily reduce income and tax revenue. Greece is experiencing this now. Its expenditure cuts have not reduced its deficit as much as expected because the temporary slow down in economic activity as displaced government employees (for example) look for new jobs, has been larger than expected thus reducing tax revenue by more than expected. A reduction in income has the same but opposite effect on the deficit as does an increase in income. This phenomenon is called automatic stabilization. Both Keynesian and neoclassical economists favor allowing such cyclical swings in government deficits and surpluses. But in the long run the government’s structural deficit (its full employment deficit) should be zero or at least smaller than the economy’s long run average growth rate. In Greece’s case it should be in surplus for a number of years to reduce its existing stock of debt.

The positive impact on competitiveness and income of liberalizing labor, services and product markets will also take time to develop. Balancing Greece’s fiscal budget now, before structural reforms have had time to work, would require much larger fiscal corrections (spending cuts and tax increases) than would be needed for long run balance.

This background should help understand and evaluate Greece’s options. Without external financial help (as is now provided by the EU, IMF and ECB), Greece could not adjust its fiscal deficits enough in the short-term to avoid the need to continue borrowing temporarily. Under these circumstances market lenders are likely to charge such a high risk premium to buy Greek sovereign debt to cover the prospects of default that deficits would become worse rather than better. Greece would default (with or without leaving the Euro). If it had defaulted in December 2011, it would have saved 16.3 billion Euros in interest payments on outstanding debt out of total government expenditures of €76.8 billion, but would have had to cut expenditures instantly an additional €6.3 billion to keep it within its tax revenues of €54.2 billion, over a 10% cut in non-interest expenditures instantaneously. This is austerity on steroids. The Greek economy had already stopped growing in 2008 and shrank by 3.3%, 3.5% and 5.0% in 2009, 10, and 11 respectively. The shock of default would surely depress the real economy further than the 2.0% decline currently forecast for 2012, reducing tax revenue further and requiring even larger cuts in spending. This does not take account of the impact of a Greek default on its banks, which hold a significant amount of Greek sovereign debt, and which the government would no longer be in a position to support. Default is no panacea, and this has not taken into account the possible negative effects in Spain and Italy, to name but two other European countries.

The approach taken by the IMF and EU is to agree with Greece on targets for both deficit reduction (austerity) and structural reforms (growth) that aim to restore full balance by 2021 and to finance the declining deficits in the interim at modest interest rates so that Greece does not need to borrow from the market. The program requires the “voluntary” write down of private sector holdings of Greek sovereign debt by about 70%. Greece would reduce its deficit from almost 10% in 2011 to less than 5% in 2012 (a primary surplus – i.e. not including interest on its debt—of 0.2%, raising to a primary surplus of 2.4% in 2013 and 5.0% in 2014). This “austerity” is being supplemented by significant structural reforms. The program is a balance between the pace of austerity and growth. Slower implementation of austerity requires a longer period of IMF/EU financing but with potentially more rapid growth.

Government employment is being reduced by 22% between 2010 and 2015 (150,000 employees). Future pension commitments have been reduced. Inflation has fallen below the Euro area average. However, external competitiveness has improved as the result of wage reductions in Greece rather than improved productivity, i.e. living standards have fallen. In general, labor market and business sector reforms have lagged. Changes in labor laws to allow more flexible wage bargaining and to ease the cost of lay offs are showing positive results. A number of services and professions have been liberalized to subject them to greater competition (cruise ships, highway freight, tourist coaches, regulated professions). The cost of starting new businesses has been reduced (“The new law reduces the number of steps (from 11 to 1), days (from 38 to 1), and cost (by more than 50 percent) required to start a business.”). Nonetheless the slow pace of such reforms is the major weakness of the program. Public acceptance of its changed circumstances and how best to deal with them has not be easy or smooth either.

It is noteworthy that the Greeks work more hours on average than any other European county (2,017 hours per year compared to 1,408 hours a year for Germans). German’s enjoy a higher standard of living because they produce more each hour they work. Greece needs to liberalize its markets to become more productive. Lowering wages will make Greek output more competitive beyond its borders but will not raise the standard of living for Greek workers.

The euro group has stated in its communiqué, “We reiterate our commitment to provide adequate support to Greece during the life of the program and beyond until it has regained market access provided that Greece fully complies with the requirements and objectives of the adjustment program.” The proviso is standard but also reflects Greece’s poor record of honesty and implementation.

IMF financial support is parceled out in quarterly installments contingent on Greece meeting the conditions agreed to for each quarter. This combines the carrot of financial assistance with the stick of close monitoring of Greece’s compliance with the reforms needed for long run success. There are no good options for Greece, but the current agreement between Greece and the IMF/EU seems to hold out the best hope for potential success. It balances austerity and growth. It will not work without public acceptance. Government promises to its public are being and must be broken. The Government needs to convincingly explain that these promises cannot be kept and that a brighter future requires the reforms that have been promised to the IMF/EU/ECB and the increased productivity and growth they should make possible.

Iceland and Ireland are well on their way to recovery from their debt disasters. If Spain and Italy can get and stay ahead of the adjustment and reform curve, and they have new governments committed to doing so, Europe should pull through and be stronger for the experience. But the next few years will be difficult.

[1] Mario Blejer and Guillermo Ortiz, “Latin Lessons”, The Economist February 18, 2012, page 94.

Afghanistan: Koran burning

Updated February 26, 2012

Associated Press: “More than 30 people have been killed in clashes since it emerged Tuesday that copies of the Muslim holy book and other religious materials had been thrown into a fire pit used to burn garbage at Bagram Air Field, a large U.S. base north of Kabul.

The death toll from days of unrest includes four U.S. soldiers – two killed last week by an Afghan soldier, and two military advisers shot Saturday at the Interior Ministry.”

By AMIR SHAH, Associated Press, February 23, 2012

“The unrest started Tuesday, when Afghan workers at the sprawling American base noticed that Qurans and other Islamic texts were in the trash that coalition troops dumped into a pit where garbage is burned. Some Afghan workers burned their fingers as they tried to salvage some of the books. Afghan government officials said initial reports indicated four Qurans were burned.

“The materials had been taken from a library at Parwan Detention Facility, which adjoins the base, because they contained extremist messages or inscriptions. Writing inside a Quran is forbidden in the Islamic faith, although it was unclear whether the handwritten messages were found in the holy book or other reading materials.

“A military official said it appeared that detainees at the prison were exchanging messages by making notations in the texts.

“A delegation of Afghan religious leaders, lawmakers and government representatives visited Bagram as part of the investigation. They issued a statement late Thursday calling for an end to protests and accused insurgents of infiltrating the gatherings to foment violence. They said they expected those responsible for the Quran burning to be prosecuted through the U.S. military court system.”

In response to these events I addressed the following question to a group of young Afghan intellectuals in Kabul:

“I am very interested in your comments on the Koran burning event in Afghanistan.

“The U.S. military made a regrettable mistake in burning some Korans at Bagram airbase. It was the result of ignorance of Afghan and Muslim attitudes toward the destruction of their holly book.  It was not the results of malice. President Obama personally apologized for the act to President Karzai, an extremely rare thing for American Presidents.

“In the West, idolatry is not respected. What is holly in the Bible, Koran, or Torah are their words, not whatever pieces of paper they might be printed on. Thus the reaction of some Afghans to burning some Korans is incomprehensible to us. Over a dozen lives have been lost because of this reaction.

“The Washington Post reported the following yesterday: “Those behind the act should be asked about their deed and must be punished,” said an officer near a U.S. military base in Kabul. “If I find the opportunity, I would shoot them in the head.” For us it is truly barbaric to put the burning of a book on the same level as taking a human life. I assume such views do not represent modern Afghan thinking and seriously doubt that Islam teaches such things, but I would be grateful for your views on these questions.”

Here is the resulting exchange followed by some non-Afghan comments first:

Diba Hareer

Warren Coats, you are right. For us, the educated Afghans, it does not make any sense at all. The incidents and the killings, which happened, cannot be justified. How on earth you could say, “We are killing each other, destroying buildings because our holy book was burned”. It’s unfortunate that we have very few educated people in our country. Our elites are getting out of the country and living in the west, as they cannot tolerate the chaos in Afghanistan. Their security is also at risk at times. We have only 34% literate men and 13% literate women. In our schools students are not taught the right values. If we teach our kids love, respect and patience, we can prevent these incidents to a high extent. The illiterate isolated masses can easily be manipulated. The manipulators took advantage of this opportunity and further encouraged the public to get crazy. I still believe the educated youths even few can bring a change since its proved that you can make a difference with as few as two persons. I hope those of us who are studying right now, get together and find a way to get Afghanistan out of this situation.

Masoud Dost

Miss Diba,
With respect to those elites that realize value of our holy Books.
It seems you are in big misunderstanding that our elites are out of country, it might be your own perception.
Any how, I really condemn those who do not respect holy books whether it’s mistakenly or with full understanding.
I accept that the illiterate isolated masses can easily be manipulated. The manipulators took advantage of this opportunity and further encouraged the public to get crazy.
The questions arises who pave such illiteracy, low level or high level, educated or uneducated, elite or …?

Diba Hareer

Masoud, by elites who are out of country I was pointing to those whose knowledge can contribute to reconstruction of our country but they do not want to work with the corrupt government. The majority (if not all, while I think so) are working with the government only to serve their pockets by taking the advantage of the corrupt system. Azizullah Lodin the chairman of high office of oversight and anti- corruption was complaining from corruption at his own office. I and you know that many of the current and ex-ministers’ files are with the office of Attorney General who are accused of corruption.. I wish I was able to tell u who the elites are. I am sure neither you nor I want to argue over those figures. The point here is to confirm that, killing and injuring one another and destroying the buildings are not sensible ways of showing that you are angry over burning Quran. What can u achieve by killing your country folk? I doubt if even a few number of these protestors know what is written in Quran and what does that mean. Besides that, they are destroying the image of Islam. They once again represented us as barbaric to the world.

Shoaib Rahim

‎Warren Coats i’ll try and share an observation on why this reaction took place then. The Jihad against the soviets created a new identity for the majority of Afghan population; i believe this identity to be obsessively revolved around a very specific and rigid interpretation of Islam. We were occupied, slaughtered and kicked out of our country during the Soviet war for being Muslims..and on the flip side, we were funded, armed and supported by all for strengthening the same identity. After the soviets left, although we failed to form a nation and keep the peace, Islam was the only alleged uniter among our people and more or less still is since notions of nationalism are still in its infancy. Secondly, life is not valued in our society and a life lost in the path of ‘defending islam’ is a virtue…it was enshrined in our value system during the Jihad against the soviets and this value lives on strong. This essentially means that you can’t compare Afghan society with other non-war afflicted societies because the values differ greatly. Third is a very strong notion of victimization by the ‘imperialist west’ and its anti-islamic agenda. Neo-conservative policies during Bush, Guantanamo Bay, constant targetting of muslims by western media..all play its role in demonizing the masses with anything “western”…and the US forces have had many instances of killings and quran burnings which have made the image worse. so we have Rigid Religious Interpretations + Cheap value of life in our society/celebration of life lost for religious cause + anti-western sentiments. Add in foreign hands and opportunists and you get the reality behind Afghan riots. At least I would see it like this.

Alessandro Califano

Warren Coats, I’d like you to focus on a different setting on regard of your question. Let’s imagine a Western country (why not the US?) being occupied by armed forces of a different religion and culture. Let us now imagine someone among these “alien” forces throwing a New Testament copy in the garbage can, along with used kleenex tissues and potato peels – are you really sure that locals would say: “Oh, please, we are strongly against idolatry, keep going in your doing…”? In my humble opinion, malice or not, people have been mowing down reciprocally for much less in some un-barbaric Western countries… Ever heard anything about Northern Ireland, yourself?

Two non Afghan comments. The first comment, from a Saudi friend, sheds light on the seeming anomaly of the routine practice of the Saudi government burning Christian Bibles confiscated in the Kingdom with no public outcry from anyone.

Yousef (Riyadh, Saudi Arabia)

I think the main cause of outrage in Afghanistan is because of “who” did it. As of my knowledge, the only way to dispose Quran in Islam is to actually burn it. It is not to be thrown with other waste since it contains the words of god. Basically because it’s holy.

I think if they let Muslims do the burning and clarified the reasons behind it before actually doing it it wouldn’t have had the same public response.

Tom Lutton (Washington DC)

Warren, thank you for sending this; it is good to hear from you.  Your simple act of asking a question, listening to the response, and sharing the response with others is a welcomed start to bridging a cultural divide that has been so wide for so long.  The lack of education on both sides certainly does contribute to the deplorable violence.  Honest communication and consistent efforts to understand differences ironically seem to be the weapons of choice to eliminate the cycles of violence.

The British American Relationship

I saw The Madness of George III in London yesterday evening on my way to Kabul. The evening included a nice dinner and visit with old friends Tim and Jan Conway, first met in St. Andrews Scotland in 1976. The play, and David Haig’s portrayal of King George III, was spectacular. British theater is the best in the world century after century.

The play set me thinking again about why American’s are so fascinated with England and the English monarchy. My ancestors are mainly English so I may have a slanted perspective. But America’s basic values and institutions, which are respected by all American’s what ever their ancestry, were built upon those of the United Kingdom. We see it most clearly when contemplating the role and place of the British monarchy in British governance.

What fascinates us, I think, is the interaction between the King (or Queen) and his government. From the Magna Carta on Britain has evolved a system of governance based on the rule of law. The powers of the King are limited and checked the powers of Parliament and The Law. This interplay, these checks and balances, are on display in every movie or play about the British monarchy. This, I think, is the core of our fascination with the British monarchy. The King is all-powerful and unquestioned within his household but constrained by tradition and law in his broader exercise of authority.

Indeed, with all of it’s shortcoming, Britain benefits a great deal from the rule of law. The rule of law is much more than having good laws evolved from practical experience (the common law approach of Britain and America rather than the civil law tradition of Europe). The rule of law is an attitude of the members of society. It is the orderly, voluntary adherence to the norms society has agreed on. The result is a much more efficient and relaxed social and economic life.

The English famously queue (line up in an orderly way). It makes the experience of waiting to be served so much more relaxed. Waiting in “line” in Italy, on the other hand is a tension filled, guerrilla warfare effort to minimize being taken advantage of by shamelessly rude Italians, all of whom have relatives or friends ahead of you in line holding their place. On average Italians are more charming than the English. I have concluded that this is necessary to compensate for their disregard for the rule of law. Italians don’t pay their taxes, don’t cue, and in general circumvent at every opportunity the law.

A consequence of the rule of law in Britain and northern Europe more generally and its weaker hold on the behavior of Italians and southern Europeans more generally is that the United Kingdom functions more efficiently. Social interactions are smoother. And members of society enjoy more true liberty. The weaker hold of the rule of law in the south is like a tax on the functioning of the system. The explicit taxes that are not paid by Italians are replace by the tax of higher cost social interactions as they struggle to improve or at least defend their place in line. Italian’s are only fooling themselves to think that they have gotten away with not paying their taxes.

The Future of Money

I solicited 12 articles on very diverse aspects of the future of money for the current issue of the Cayman Financial Review (I am a member of the Editorial Board).  http://www.compasscayman.com/cfr/

I wrote two of the articles myself and I hope that you enjoy them:

http://www.compasscayman.com/cfr/2012/01/11/The-future-of-money—What-is-it-/

http://www.compasscayman.com/cfr/2012/01/11/The-Technology-of-Money/

Peeing on corpses

It is not difficult to imagine a bunch of scared 20-year-old urinating on the corpses of enemies they killed first. In today’s Washington Post Sebastian Junger thoughtfully explains the environment in which the disturbing video of American Marines urinating on dead Taliban solders was made : http://www.washingtonpost.com/opinions/were-all-guilty-of-dehumanizing-the-enemy/2012/01/13/gIQAtRduwP_story.html

Whether we can understand such behavior or not, it has harmed our goals in Afghanistan and increased the danger to other solders. Marine Capt. Timothy Kudo, explains this perspective well in today’s Post: http://www.washingtonpost.com/opinions/as-a-marine-and-afghan-war-vet-im-insulted-by-the-desecration-video/2012/01/12/gIQAswIrwP_story.html.

The event is sad but America has demonstrated to the world how a mature democracy openly discusses and deals with its mistakes. We may be proud of that.

The Invented Palestinians

Five years after a previous visit to Israel and the West Bank and Gaza (or the OPT—Occupied Palestinian Territory—as the UN and the Palestinians call it), I am once again residing in the charming American Colony Hotel. As on my two most recent previous visits (in 2005 and 2006) I am advising the Palestine Monetary Authority that I helped set up in the mid 1990s on strengthening its capacities as a central bank and preparing to issue its own currency should the political and economic situation ever justify doing so.

The American Colony Hotel, now decked out for Christmas (see pictures), has a long history here—over 150 years—and has hosted many interesting guests. There are the politically important visitors such as Winston Churchill, Mikhail Gorbachev, Senator George Mitchell, George Shultz, James Wolfensohn, Kofi Annan, and T. E. Lawrence. There are the artistically important visitors such as Graham Green, Leon Uris, Saul Bellow, John Steinbeck and Marc Chagall. There are some big names in the media business such as Ted Turner and Barbara Walters and in music such as Sting and Juan Baez (my personal favorite). The list of movie starts is long, including Sir Ben Kingsley, Lauren Becall, Peter Ustinov, Ingrid Bergman, Omar Sharif, Richard Gere, Uma Thurman and Vanessa Redgrave. But the one that tickles me the most is Peter O’Toole, who visited here many decades after the visit of T.E. Lawrence who he portrayed in Lawrence of Arabia.

The Hotel is in East Jerusalem, that part of the city that is in the West Bank, OPT, or Palestine as you wish, that was occupied by the Israelis in the Six Day War of 1967. Following that war, famous visitors were generally making a political statement in favor of peace. The American Colony was considered neutral territory. I have written a lot in the past about the Israeli-Palestinian situation and if you are interested I urge you to reread earlier blogs (posted here for the first time): “The View from the West Bank – a history of the conflict”, “Jerusalem in august 2006”, “Leaving Israel August 11 2006”.

While here this past week, American politicians demonstrated again a lack of balance and/or understanding in addressing the truly difficult situation here. In the case of Newt Gingrich, who brushed aside the desire of Palestinians (Arabs or whatever you want to call the people driven out of their homes by Zionists sixty years ago and the Israeli Defense Forces almost 45 years ago) to return home, it is surely blatant dishonestly and vote pandering, as he knows better. The Israeli Press is ablaze with debate about Newt’s comments (as it always is about something), and Israel’s political relationship with the U.S. more generally.  Secretary of State Hillary Clinton’s visit and comments about women are still reverberating.

Balancing America’s commitment to the military defense of Israel with promoting the peace in the region that we rightly see as essential to Israel’s well being, has grown particularly difficult of late. President Obama stated the obvious several times during his administration (Israeli settlements being build in the West Bank are illegal, and the border between Israel and a new Palestinian state should be based on the borders of Israel approved by the UN long ago) then rolled over dead in the face of Israeli President Netanyahu’s (who we know from French President Sarkozy is a liar) shouts of outrage.

I had not appreciated before that when some Israelis quote Hamas and some other Palestinians as refusing to recognize Israel’s right to exist (which sounds rather like the desire for another holocaust) they are referring to the Palestinian demand for their “right to return” to their homes, the other insoluble issue preventing a resolution of the Israeli Palestinian conflict. Two articles on the front page of Monday’s The Jerusalem Post illustrate the issue. The banner article was titled: “Cabinet approves plan to fight illegal infiltration; Netanyahu: We will close businesses, so that the enterprise known as the State of Israel does not close – PM to consider repatriating workers when he visits Africa.” What is this all about? Statements by Israel’s Justice Minister, Yaakov Neeman, in the article just below the one quoted above help clarify that question.

Reacting to criticisms from visiting American participants in the Jewish Council for Public Affairs (JCPA) leadership mission to Israel of pending legislation containing loyalty oaths, the Minister scolded the American’s with raised voice saying: “There is no discrimination in any of the legislation…. We will have a majority of non-Jews if not. This is a Jewish state. If you don’t like it, you can move to another country.” He followed this with: “All Jews need to come home to Israel. I want them here. A Jew who doesn’t live here in Israel is not doing the most important thing.”

The Minister and many Israeli’s want a democratic Jewish state. That required them to drive out those living here who were not Jewish and preventing them and other non-Jews from returning (about 20% of Israelis are Arab). The refusal of Hamas and some other Palestinian’s to accept the legitimacy of the Israeli state is not anti-Semitism, it is an expression of their demand for their “right to return” home. It is anti-Zionist.

Israeli Jews are divided on this issue. Palestinians are divided as well. Those in the West Bank and living in Jordan as Jordanian citizens lead relatively prosperous lives and are prepared to give up their past claims on their homes and move on. These Palestinians are generally well-educated and hard-working. For them some token return of a few hundred thousand of the almost 5 million Palestinians driven out of their homes would be enough. But those 1.4 million still living in refuge camps after all these years (largely in Gaza, Lebanon, and Syria) have little to gain from, nor interest in, moving on. This split in the Palestinian ranks largely reflects the Hamas – Fatah divide.

Why then hasn’t the U.S. and the Quartet (U.S., EU, UN, and Russia) focused more on better treatment and integration of refuges in their host countries, largely Lebanon, following the good example of Jordan? And why has Israel so often frustrated the economic development of the West Bank and especially Gaza where most of the refugees still living in camps can be found. There in lies a very complicated story of conflicting interests among Israeli Jews, and among Lebanese political groups. The Lebanese do not allow Palestinians to work or become citizens for fear they will upset the delicate, existing balance between Christian, Sunni Muslim and Shea Muslim political groups and interests. The political conflict in Israel between those wanting a greater Israel and turning a blind eye if not actually encouraging illegal settlements in the West Bank and the peaceniks who favor a “two state solution,” is complicated by monopolistic business interests who continually use their economic and political influence to stifle (if not crush) economic competition from often very adept Palestinian enterprises. Thus no proposal for peace with the West Bank and Gaza can gain wide-spread support in Israel or in Palestine.

The Governor of the Palestine Monetary Authority told me at dinner last night that he feared that the resent wave of so-called “price tag” attacks on Palestinians and mosques in the West Bank and on the IDF (Israeli Defense Force) by right-wing Ultra Orthodox Jewish settlers risked turning what is now a territorial dispute into a religious dispute (Muslims vs Jews). For decades Ultra conservative Jews would park their campers in target areas of the West Bank and stay. When they were harassed by Palestinians for being on Palestinian property, the about to become settlers would seek protection from the IDF, which has occupied the West Bank since the Six Day War. Some months later they would demand adequate water and waste disposal, and then electricity and a few years later they would demand permission to build homes their on the grounds that they had already been living there for some time.

Many Israelis have lost patience with these settlers and periodically the IDF remove them from their illegal settlements. The settlers have dubbed their current attacks on the IDF as the “price tag” for being evicted from their illegal settlements. But right-wing Israeli governments have tolerated the continued advances of these settlements for years. The mystery is that the U.S. seems to tolerate it too. Netanyahu’s sharp rebuke of President Obama’s criticism of the settlements last year and Obama’s quick back down is a case in point. For the moment, the Israeli government seems to be creaking down. According to the Jerusalem Post: “IDF feels that to tackle ‘price-tag’ phenomenon, the gov’t needs to toughen legislation, increase policing, send a clear message.”

The United States has already faded as a major influence on events here. Speaking the truth would be the best way to serve the best interests of our friends in Israel, Palestine, and region. It would help if Newt Gingrich and other politicians stopped pandering to the Jewish and religious right voters in America who ally with them with unprincipled and inaccurate characterizations of the situation here in Israel and the Occupied Palestinian Territory. “Look who is talking about ‘invented’ peoples”

Leaving Israel, August 11, 2006

This is the re-posting of an earlier note:

Hi from Home

Sorry for two notes so close together, but travel conditions today warrant an update after British authorities arrested 24 terrorists who planned to blow up 10 planes over the Atlantic yesterday. I left Israel this morning on Lufthansa with the Governor of the PMA heading for Washington DC. We assumed that we were on the same flights all the way. Thus in Frankfurt I followed him to his gate. After one hour of extra security procedures we arrived at the gate to discover that we were on different flights and I was in the wrong terminal. Thus I passed through another security check point in the correct area and boarded my flight. To my disappointment the plane lacked the sleeper seats I was expecting. I am afraid that I grumbled about it to the steward. Half an hour later my name was called along with 5 other first class passengers and informed that we were being moved to another flight using a 747 with proper seats. The steward whispered that it was because of my complaint. This, however, meant that we had to go through the original security check point yet again. This time they took away my toothpaste and other similar items from my PC bag. They were not impressed when I told them that all of these items had passed through there three hours earlier. Go figure. Anyway, I am home safe (except for the security warning about demonstrations in Washington against US support of Israel’s war against Lebanon).

I would like to share with you the experience last week of one of my fellow advisors at the Palestine Monetary Authority (PMA). He was leaving Gaza, where the PMA has a branch, to return to Ramallah where I was working when he and his driver come under fire from an Israeli tank. This occurred at the Palestinian side check point of the border crossing from Gaza into Israel (the only way to get to the other part of Palestine in the West Bank). The gun fire lasted three hours during which he spoke by phone from the floor of his car to the Governor of the PMA and the U.S. Embassy. He is a fellow American and was born and raised in Virginia. You will be shocked, as he and I were, at what the American Embassy said to him. The woman on the phone said that his name, Akram Baker, sounded Arabic and asked if he was of Palestinian decent. He said yes. She asked what he was doing in Gaza and informed him that the Israeli government does not want American’s of Palestinian decent in Gaza and that the U.S. government would not help him. Israel basically keeps Palestinians living in Gaza prisoners within Gaza and makes it very difficult for Palestinians to enter and leave Gaza. The PMA Governor contacted the Palestinian President Abbas who got the Israelis to call off their tank. We seem to have a new second class American citizen.

The day before this incident one of the PMA employees in Gaza and her daughter were killed by an overhead Israeli helicopter. Akram asked me how I would define terrorism and answered his own question by saying the UN defines it as terrorizing (intimidating, frightening, even murdering) civilians in order to promote some political or ideological goal. Doesn’t that describe, Akram asked, Israel’s continued use of collective guilt and pressure against Palestinians to pressure their government to control terrorists in their own midst. For example, placing dozens and dozens of check points throughout the West Bank to make it difficult for Palestinians to travel around their own homeland (I had to go through two permanent check points every morning and again every afternoon between East Jerusalem and Ramallah—all in the West Bank—plus the occasional impromptu ones). Or closing the border to Palestinian day workers in Israel whenever a suicide bomber blows himself up in Israel? Or by arresting Palestinians legally and fairly elected to the Palestine National Authority (PNA) Parliament for simply being members of the Hamas political party because some terrorists affiliated with some members of Hamas held an Israeli solder. Or by destroying vast parts of Lebanon’s infrastructure and killing over a thousand of its men, women, and children to punish them (Christians included) for not being tougher against Hezbollah fighters in their midst (before the current war, a majority of Lebanese opposed Hezbollah and now a majority support them). Or, killing the PMA employee and her daughter as they walked down the street because they “tolerated” Palestinian terrorists in their midst who held an Israeli solder hostage.

For Palestinians, Akram said, Israeli solders are terrorists. That is why Palestinian children sometimes throw stones at the Israeli solders as they drive through their neighborhoods. It is the only weapon they have. A few become suicide bombers.

But what is Israel to do to defend itself when so many of its neighbors do not accept its right to exist. Become a better neighbor perhaps? But what does it mean that many Arabs do not accept Israel’s “right to exist?” This is a sanitized reference to the desire of many Palestinians to drive Israelis back off the land they took from Palestinians in 1948 and 1967. Hamas, Islamic Jihad, and other Palestinian terrorists are the small minority that cannot get over that historical fact and move on. Most Palestinians—everyone I have ever met—have moved on and would just like the Israelis to withdraw from the territories the UN demands them return (West Bank and Gaza) so that they can get on with their lives. In fact, like almost all political movements anywhere, Hamas really simply wants to govern like any other political party and has separated itself from its militant wing (sounds like the IRA of old). It is in Israel’s interest to make normal political participation more rewarding for Hamas than terrorism—to let Hamas or any other elected government succeed or fail on their merits and to hold them accountable for their performance. Israel and the rest of us should do all possible to help the Palestinian government succeed. A successful Palestine would be a safer neighbor for Israel. Instead, Israel has stopped transferring the taxes it collects for the Palestine government on imports through Israel, proliferated walls and checkpoints throughout the West Bank and made proper administration by the Palestinian government impossible. Now the failure of the PNA will be blamed on the U.S. and Israel. When will they ever learn,… when will they ever learn.

Jerusalem in August 2006

This note was written in August 2006 following the earlier (October 2005) posting of a brief history of the Israeli Palestinian conflict: “The View from the West Bank – a history of the conflict”

Hi from Jerusalem (East Jerusalem for those of you in the know),

After leading the IMF technical assistance teams that helped establish the Palestine Monetary Authority in 1995 and 96, I returned a year ago to prepare a blue print for the steps needed for the PMA to introduce its own currency some time in the (ever more) distant future. People in the West Bank and Gaze largely use the Israeli shekel and to a lesser extent the Jordanian dinar for payments and contracts. Keeping the notes in good condition and clearing checks in shekel requires arrangements with Israeli banks. These banks recently notified the PMA that they intend to end these arrangements soon. I have returned to help the PMA figure out what to do.

The political situation in and around Israel has gone from bad to worse, to much worse. You may substitute Iraq for Israel in the previous sentence as well. When Palestinians democratically elected representatives of Hamas in enough numbers to take over the government of the West Bank and Gaze (the Palestine National Authority) from the ineffective and corrupt government of Al-Fatah (Arafat’s party), political life for Israel and the West became more complicated. The military wing of Hamas is on the U.S. list of terrorist organizations, as is Hezbollah, the Lebanese terrorist group sponsored by Iran and Syria. Hezbollah also has democratically elected representatives in the Lebanese Parliament.

Israel is now at war with Hezbollah and more or less with Hamas. At least one well-known American commentator argued that Israel has a moral right to defend its borders and thus to attack Lebanon (its bombs have fallen on far more than its Hezbollah enemy). This totally and tragically misses the point. Israel is again acting against its own interests, which in the case of Hezbollah is to help build a strong Lebanese government and army that can disarm Hezbollah (as demanded by the UN) and enforce a peaceful and secure border with Israel.

I shudder at those who argue that (if you are strong enough) you just need to smash your enemies. Be tough. They don’t seem to live in the same world I do. Can the Shi’a Muslim Iraqis who now dominate the Iraqi government really wipe out all Sunni Muslim terrorists in Iraq or can the Sunni and Christian Lebanese and the Jewish Israeli’s really wipe out the Shi’a Hezbollah terrorists in Lebanon? Walid Jumblatt, the leader of Lebanon’s Druze community and a harsh critic of Hezbollah stated Saturday that “We have to acknowledge that they [Hezbollah] have defeated the Israelis….” Being tough and launching war on Hezbollah/Lebanon has greatly weakened Israel (militarily, economically, and politically), just as the miscalculated U.S. attack on Iraq has weakened America (militarily, economically, and politically). These acts of war have weakened the security of both of our countries, not strengthened it.

Wars between tribes and religious factions can only be “won” diplomatically. The infamous Hatfields and McCoys ended their vicious cycle of feuding only when they mutually came to accept that they would never succeed in totally exterminating the other. There would always be a son, or a relative, or a friend of a son left somewhere to carry on the hatred and revenge. The famous feud ended only when a combination of carrots and sticks and harsh experience led both sides to accept a credible truce as the best that they could do. Read or watch again Shakespeare’s Romeo and Juliet and weep.

A few weeks ago I watched a TV reality show called “The Nanny” (please done ask me why). In the show the well-meaning and conscientious parents of three little monsters were sinking into despair as their spoiled and confused kids walked all over them. The parents were not dumb, but they were failing as parents. My first reaction was that the Third Geneva Convention (on the Treatment of Prisoners of War) should be suspended for these awful brats. Where is George W when we could really use him? The British Nanny brought in to save this family, was wise indeed. She found as many ways to pull out and encourage the cooperation of the children (carrots) as she did to establish clearer and more consistent rules and punishments for violating them (sticks). In short, she found the right balance of incentives that encouraged these children to redirect their considerable energies into positive and pleasant behavior that became a joy to be around. It was brilliant. It is what societies need as well—values and rules under which everyone can get along. I am sure that you have seen perfectly behaved but regimented and dull children and laud, rude and out of control ones and said to yourself, please don’t make me have to be around either.

My boss in Baghdad emailed me last week: “Please don’t go to Jerusalem.  I don’t think that you will be safe there.  Come back to Baghdad.” She has quit a sense of humor. The security situation in Iraq has finally degenerated beyond my comfort level and I have not returned to Baghdad since December despite many requests to do so. I have been highly critical of that war, when we should be fighting Al-Quaeda in Afghanistan and elsewhere (they didn’t exist in Iraq until we attacked it). And I have been even more critical of our ineffective follow-on efforts to establish a stable democracy there. However, there is one aspect of our conduct of that war I am proud of.

Every war has produced atrocities (torture, rape, murder, etc). It is a tragic and unavoidable part of war. We are again seeing examples of this ugly fact with the revelations of the killing of 24 Iraqis, mainly women and children, by American Marines in Haditha in the heat of war. The rape of an Iraqi girl and murder of her family by an American solder (Steven D. Green) in Mahmoudiya was purely criminal. Four of his U.S. Army buddies have also been arrested in connection with those crimes. Iraqis are not surprised that Americans have done these things (in very limited quantities). But they are surprised at the openness with which we expose and punish them. We can be very proud of that. It gives credence to our belief that we try to live by high principles.

Our principles of government revere openness and honesty—what more recently has come to be known as “transparency.” We can thank our free press for making that principle meaningful. While the most professional, well-trained, and well armed military in the history of mankind protects our freedom from attacks from abroad, the most professional and dedicated press in the world protects us from attacks on your freedom at home. Our practice of transparency is the ultimate check and balance on government (or corporate or labor) abuse. When combined with the high standards that guide our military leaders, transparency has helped contain the abuses of power that exist in every military, police force, and government. Three cheers for our free press.

I hope that all is well with you.

Warren

Buying time for Italy

Buying time can be useful if you get something useful with it, otherwise it is a waste of time and money. Italy needs to borrow less domestically to finance its government’s expenditures (reduce its fiscal deficit) and to borrow less abroad to finance its imports in excess of its exports (reduce its trade deficit). The lower interest cost of the IMF and/or EU lending money to the governments of Italy and Spain at German sovereign debt interest rates can buy them time to enact and implement government spending cuts, tax increases, and market reforms that improve productivity and reduce labor costs before they need to borrow in the market at potentially much higher interest rates. Why might the IMF and the EU’s European Financial Stability Facility (EFSF) be willing to lend money at German rates when market investors aren’t? That is a good question without a clear answer, though most commentators seem to assume it without much question.

The pay off from the measures Italy needs to implement will take time to materialize. Liberalizing markets takes years to actually improve productivity and exports. Some domestic wage and price deflation will probably be needed as well. Reforms to the tax system take time to produce revenue. Above all it will be difficult for the Italian economy to grow (the essential ingredient of financial sustainability) while the rest of Europe, if not the world, is stagnating. In the interim, Italy’s deficits will remain above the levels expected to result from current reforms in the future (say two to four years down the line). If they cannot be financed at “reasonable” interest rates, Italy will be forced to default on its fiscal debt of about 2 trillion U.S. dollars (of which about $500 billion falls due and needs to be refinanced in 2012). The impact on the banks, pension funds, and others that hold this debt would be devastating beyond our experience.

Thus IMF et al financing can be useful if a) Italy actually enacts and implements now the reforms needed to become viable in the future, and b) if the IMF is more confident that Italy will achieve the desired outcome than are market lenders. Without condition “a”, buying time is a waste of time because Italy would default anyway only somewhat later after running up even more debt. With regard to “b”, it may be that the IMF is better able to assess and enforce Italy’s reforms than the market (the IMF reviews progress every quarter against agreed performance criteria before authorizing the next quarterly tranche of its loan), but it is not obvious that this is so. Market lenders can see any reforms actually undertaken and the result almost as easily as the IMF can. If these measures are credible and convincing, market lenders will reduce their risk premiums for lending to Italy. If so, no funds from the IMF would be needed.

On the other hand, lenders may have become risk averse in the conditions now existing in Europe and the U.S. and world economy. If so, they will demand an interest rate to lend to Italy that is more than the premium needed to cover the expected loss from default. In these conditions IMF/EU financing could make the difference between success or failure. Undermining confidence in the ECB and the purchasing power of the Euro would be bad under all scenarios. While more rapid growth in the supply of Euros as the result of ECB purchases of Italian and Spanish debt might not be expected to be inflationary in today’s depressed economies, the effect on Euro interest rates will depend heavily on public confidence in the ECB’s anti-inflation commitment (i.e. inflationary expectation. See my earlier note on the role of the ECB: https://wcoats.wordpress.com/2011/11/17/saving-italy-and-the-euro/).

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Comments:

Here are some interesting comments from friends on my earlier note on the use of the ECB to buy Italian debt.

Thanks Warren, it is hard to be optimistic that the politicians and technocrats of Europe will stumble on the only thing that will work.

Thought experiments: why do we never see calls for “break up of the $ zone” such as when Puerto Rico got into fiscal troubles (see Stossel and Cal Thomas or recent reforms)?  Why don’t El Salvador, Ecuador and Caribbean Islands “leave the $ zone” so they can devalue to prosperity?  So far, we have a credible “no bailout policy” so even Harrisburg must go into bankruptcy.  In the US $ zone, counter-party risk is still important.

What if: instead of a “euro zone” we had seen 16 countries in the EU unilaterally adopt the DM?  The Frankfurt-managed currency would have appreciated sharply in recent years compared to the US $, much like the C$, Aus$, et. al.  The adopting countries would then have been in the position of Chile 1981.  When pegged to a weak US $ during the Carter years, Chile thought pegging was great.  Then, on the first Tuesday of November 1980 the US $ started to appreciate, and Chile found themselves holding the tail of a tiger until they rediscovered the virtues of floating.

If Italy and others are to stay on the “paper-gold standard” of Frankfurt, they will have to reduce real wages (& pensions etc.) the old fashioned way.  If that is too painful politically, and if Frankfurt refuses to abandon administration of “paper gold”, then Italy, et. al. must remain the Appalachia of the euro zone.

Why would Cameron want the ECB to monetize euro-zone debts?  Is it because more inflation in the euro zone as well as the US will take the pressure off the UK pound?

Jerry [Jordan, former President of the Federal Reserve Bank of Cleveland]

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Warren,

You make a very elegant and compelling case. But I’m not convinced that it will work. The likelihood of the ECB remaining politically independent is slight. And the only way Germany will be able to enforce the kind of austerity it’s promoting will be to invade and occupy these countries’ finance ministries (which has already begun, but without decisive popular support). Just as in the US, the people who need to bear the brunt of a recovery–the largest banks (in this case, the French banks which are the most exposed) and the bond markets–are the least likely to do it, and so hold a near monopoly on the recovery. At some point the people really bearing the brunt—the people least able to do it–may just give up: on the ECB, on the Euro, on the EU. Russia in the 1990s is a case in point. How many European Putins are there waiting in the wings? So long as the US and China and nearly every other power is dealing with this crisis publicly at the other end of a ten foot pole, I find your, and any other positive, outcome, very unlikely at the present moment. Sacred tenets of central banking aside, from where I sit this looks like little else besides beggar thy neighbor. On every level.

Ken [Weisbrode, in Boston]

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Hi Warren,

I don’t have the time these days to read your lengthy blog essays, alas, but I did want to make an admittedly superficial comment or two.  I really wish somebody would actually treat a sovereign borrower like an ordinary client some time.  These Greek demonstrations are disgusting. Your country doesn’t have money, and you’re insisting that it keep the generous welfare taps wide open.  Just where is the budget supposed to get the money to pay you to shut you up?  It would be wonderful if the Greek demonstrators were given what they want, the country would default in a few days, and then the banks would take over the bankrupt estate and liquidate it.  Not that banks are such wise and nice entities, but I just feel the Greek demonstrators deserve exactly this.  It’s the logical consequence of their irrational demands.

Next topic:  I’ve never understood the phrase (one that I have translated you saying many a time, I might add) that “of course, interest rates can’t go negative, so central banks are seriously constrained in their ability to loosen the money supply once the rates are down near zero already”.  Why can’t they go negative?  If the economy is so moribund that banks aren’t lending any more, only fuelling the moribundity further (not that you can fuel moribundity…), why can’t/shouldn’t the central bank loan money to the banks at negative interest in order to kick start lending and economic activity in general?  It’s Keynesian deficit spending by other means – monetary instead of fiscal.

Just having a rare moment of economic musing, sorry to bother you with my infantile thoughts.  Hope all is well with you, and that you have a good Thanksgiving.  Nailya and I will be passing through DC in the next month or so, but literally passing.  If plans change and we end up staying a little while, I’ll let you know and perhaps we can get together for a bit of socializing.  Nailya’s gotten quite interested in economic and political affairs (she never had been in Russia, because there’s no point in getting excited about something that gets arbitrarily decided by the corrupt suits in the Kremlin without regard for anybody else), so I know she’d make a lively conversationalist.

Steve [Lang, former personal Russian/English translator for Mikhail Khodorkovsky after being the same for me and the IMF]