A Few Thoughts on LTRO

The ECB is taking almost any quality asset a European bank offers up and putting it on its balance sheet, as part of its long-term refinancing operation (LTRO). Basically, this allows a bank to post an asset at the central bank and receive 1% money, which they can turn around and use to either improve their own balance sheet and liquidity or buy European sovereign debt at, say, 6%. If the bank then makes 5% on the loan and leverages it up, it can “get whole” in a short time.

This is the same principle (in theory) that Paul Volcker used in 1980 when he allowed US banks to carry the debt of defaulting Latin American countries at face value. Given enough time and interest-rate spread, a bank can work its way out of a problem. And it worked for Volcker. Eventually, US banks made enough money to be able to write off the bad debts.

While this is a band-aid, an attempt to cover up the real problem of banks that are basically bankrupt and sovereign countries that are either in default or at risk of default, it is so far proving to help. Germany has essentially thrown in the towel on keeping the ECB from printing money. While they still growl and bark, like any well-trained dog they stay in the yard. They are a big dog, and their barking makes you nervous as you walk past, but so far they are allowing the ECB to prop up banks throughout Europe. On that point at least, Sarkozy won.

As long as LTRO continues, it should postpone the problem of a true banking crisis – until Portugal has to default, and then all eyes turn to Italy and Spain. If the ECB is allowed to fund Italy and Spain, even through the back door, it will mean Germany has made its choice to keep the euro intact, no matter the cost.

Greek Exhaustion Syndrome

One of my very good friends had a small private dinner this week with the chairman of a major German bank, who remarked, with a sense of gallows humor, that he thought he could get his fellow German banks to chip in enough money to give to Greece to just make them go away. They really have Greek Exhaustion Syndrome.

He also thought Portugal would eventually would have to leave, and said he thought he would take a haircut on Irish debt. Italy and Spain will somehow make it. At least that is the view from the top of the German bank pyramid.

Portuguese interest rates are soaring. Without life support from Europe, they cannot keep up their borrowing at rates that will allow them to recover. While they are gamely trying to reduce their deficit, austerity is reducing their GDP and thus their tax revenues. They will have no choice but to default at some point.

The interesting case is Italy. They have room in their budget to cut, as I have outlined in prior letters. If the ECB subsidizes their debt (lowering the interest-rate cost) or an agreement is reached to lower the rate on their bonds, they theoretically could make it. But either path is default by another name. Maintaining the status quo is not possible. It will not be long before they are at 130% debt-to-GDP, if Europe falls into recession. The IMF has long maintained that 120% is the line in the sand.

It is just a matter of who pays and how the payment is made. But someone will pay.

And there’s this note for those who think austerity comes with few consequences. From the Centre for European Reform:

“Eurozone policy-makers – from President Sarkozy and Wolfgang Schäuble to the former President of the ECB, Jean-Claude Trichet – advocate that Italy and Spain should emulate the Baltic states and Ireland. These four countries, they argue, demonstrate that fiscal austerity, structural reforms and wage cuts can restore economies to growth and debt sustainability. Latvia, Estonia, Lithuania and Ireland prove that so-called “expansionary fiscal consolidation” works and that economies can regain external trade competitiveness (and close their trade deficits) without the help of currency devaluation. Such claims are highly misleading. Were Italy and Spain to take their advice, the implications for the European economy and the future of the euro would be devastating.

“What have the three Baltic economies and Ireland done to draw such acclaim? All four have experienced economic depressions. From peak to trough, the loss of output ranged from 13 per cent in Ireland to 20 per cent in Estonia, 24 per cent in Latvia and 17 per cent in Lithuania. Since the trough of the recession, the Estonian and Latvian economies have recovered about half of the lost output and the Lithuanian about one third. For its part, the Irish economy has barely recovered at all and now faces the prospect of renewed recession.

“Domestic demand in each of these four economies has fallen even further than GDP. In 2011 domestic demand in Lithuania was 20 per cent lower than in 2007. In Estonia the shortfall was 23 per cent, and in Latvia a scarcely believable 28 per cent. Over the same period, Irish domestic demand slumped by a quarter (and is still falling). In each case, the decline in GDP has been much shallower than the fall in domestic demand because of large shift in the balance of trade. The improvement in external balances does not reflect export miracles, but a steep fall in imports in the face of the collapse in domestic demand.”

Portugal and Greece are on that path, if they do not opt out of the eurozone. Italy and Spain cannot avoid the sad results of too much debt without major European support, which means the ECB, as no country will offer that amount of help, as none has the money to do so. But that means a lower-valued currency and purchasing power, higher energy and commodity costs, etc. As I keep saying, it is not a matter of pain or no pain, it is simply a choice of which pain and how much of it you want to have.

It is interesting to watch the game being played with Greek debt (merely interesting, because I have no Greek debt). Private bond holders are now looking at only getting about 30% on the euro. They are now asking that the ECB share some of their pain, and the IMF seemingly agrees that the ECB should. The ECB is aggressively resisting any such notion. An interesting principle is being set here. If you do it for Greece, then the line will get much longer. The euro is on its way to parity with the dollar, as I have said for a very long time.

Those predicting the death of the dollar (at least against major world currencies) and hyperinflation do not understand the rather vicious nature of deflation and debt deleveraging. But that is a topic for a later letter.

Ah, but what do we have here, at 3:36 AM (via my London partner, Niels Jensen), but an article by Nick Doms on Examiner.com, asserting that, yes indeed, Greece will default:

“Greece plans an orderly exit out of the Eurozone according to two sources close to Mr. Papademos, Greek Prime Minister, who spoke on condition of anonymity earlier today.

The sources confirmed that plans are ready to return to a legacy currency given the current circumstances and that such exit would be dealt with, quote ‘in as orderly a fashion as possible’ unquote….

“A Greek exit strategy will probably not be announced officially until early March when the EU finance ministers meet.”

Uncertainty about whether Greece will stay in the euro is crippling its prospects

THE banners at the entrance to the Bank of Greece museum in Athens promise a “fascinating journey through Greece’s modern economic and monetary history”. How could any passer-by resist? Inside the museum ranks of glass cases enclose an array of coins and old bank notes, as well as the paraphernalia used to make them. The bills range from 5 drachma up to 100m drachma, a reminder that Greece has had problems with inflation in the past. The end of history, at least for this exhibition, is 2001 when Greece adopted the euro. But the country’s present troubles suggest an important chapter to the story of Greek money is still to be written. Some reckon the drachma may roll off the presses again.

This is no longer just a fantasy of diehard sceptics about the euro in Britain and Germany. Even Greeks concede that the big problem afflicting the economy, now in its fifth year of recession, is the uncertainty about whether Greece can stay in the euro and get its act together. Savers are anxious that their cash might be forcibly converted to a new Greek currency. By November the Greek banking system had lost a quarter of the deposits it had two years earlier. To fill the gap, the banks have borrowed €43 billion ($56 billion) of emergency funds from the Greek central bank on top of €73 billion of secured loans from the European Central Bank (ECB). Credit remains in short supply because banks have had to cut loans and raise borrowing costs. Informal credit arrangements between firms are breaking down. Foreign suppliers now demand cash payment upfront, making liquidity even scarcer.

Few investors or businesses are brave enough to make long-term bets on the Greek economy in these conditions. The stockmarket has fallen steeply (see chart 1). “You can buy good companies for pocket money,” says one business chief. Assets are cheap but they would become cheaper still were Greece forced out of the euro. Capital spending is down by almost half from four years ago; house building has fallen by two-thirds. The one bright spot is tourism: visitors to Greece were up by 10% last year, in part because tourists steered clear of the unrest in north Africa.

There are hopes that the economy might recover next year if Greece’s place in the euro is confirmed. Agreement on a big new support package from the euro zone and the IMF would put some minds at rest. But a deal on new money cannot be thrashed out until the IMF in particular is sure that Greece’s public finances are on a sustainable path.

That depends, among other things, on private-sector creditors signing up to a bond-exchange deal that will see half of the face value of their Greek paper written off. A deal is proving elusive. Bondholders think Greece’s European rescuers should share in the pain. The ECB has purchased around €40 billion of Greek government bonds, at a discount to their face value, as part of its programme to stabilise bond markets. It stands to make a profit on them, which riles private bondholders. They also want a higher interest rate on the new bonds than officials are willing to sanction. Until a deal is done, Greece is stuck.
 From bad to worse

The ever-gloomier diagnoses of Greece’s economy and public finances further complicate negotiations. An IMF report published at the end of last year said that a 50% write-down on private-sector bonds, a target set at an EU summit in October, together with €130 billion of extra official financing at low interest rates would give Greece a decent chance of getting its public debts down to 120% of GDP by 2020.

But that assessment already looks too sanguine. The headwinds facing the economy are proving much stronger than had been forecast. Greece’s GDP probably fell by 6% last year, far more than expected. A weaker economy has made it harder for Greece to meet its fiscal targets. Softer growth in the rest of the euro-zone economy has not helped. But the depth of last year’s slump owes much to a shortage of liquidity, an influence which most economic models ignore, says Yannis Stournaras of IOBE, an Athens think-tank.

The Greek central bank’s figures show that bank credit to households and private firms fell by 2.4% in the year to November. Banks suffering a drain of deposits have had to husband their liquidity. Official lending figures do not reflect the drying up of other sorts of credit. An informal system by which firms used postdated cheques to pay for supplies has broken down, in part because banks are warier of taking them as collateral for short-term loans. Firms complain that the government is slow to pay value-added-tax (VAT) rebates, making the liquidity shortage worse. Few foreigners will supply Greek customers on the basis of a credit guarantee from a Greek bank. So Greek importers, however solid, usually have to pay cash upfront.

Some firms are finding ways round the stigma of being a Greek enterprise and the credit troubles that brings. The headquarters of Aquis, a firm that runs hotels and resorts in Greece, was recently moved to London by its founder, Ioannis Kent. It is now a UK holding company with a British bank account into which the firm’s revenues are paid. Other firms have delayed payments to suppliers and employees.

A necessary fiscal squeeze is adding to the downward spiral and risks becoming self-defeating. The sorts of public spending that are likeliest to induce other economic activity, such as roadbuilding, have been cut, says Mr Stournaras. Big tax increases are not a sure-fire way of raising revenue in a country where taxes are routinely avoided. The rate on restaurant meals was raised from 11% to 23%; such a sharp jump seems almost an invitation to cheat for cash-strapped small businesses. The IMF says a shortfall in VAT receipts suggests some firms are not complying. A hike in car taxes prompted many drivers to hand in their licence plates.

With so many uncertainties, the Greek economy cannot hope to attract the investment it needs to spur recovery. Until a deal on private-sector losses is finalised and implemented, investors cannot rely on a second bail-out package that will keep Greece in the euro. Even if a deal on losses is agreed in principle, a substantial number of holdout creditors could force the Greek government to implement a coercive restructuring. That might further unsettle bond markets and depositors. Banks will also have to be recapitalised after taking losses on their Greek bonds; no one is sure whether they will remain in private hands.

Goodwill hunted

Slow progress on freeing up the economy and cutting the deficit has cast doubt on the ability of Greece’s leaders to implement reforms. Last year the country moved up one place (to 100th) in the World Bank’s rankings of 183 countries for ease of doing business. Businessfolk call for something more radical to demonstrate the country’s commitment to reform.

One suggestion is immediately to shut down lossmaking or underutilised public entities. Another is to tackle the corruption and inefficiency of the tax system by outsourcing the job to foreign tax officials or to a private-sector tax consultancy. That would speed up much-needed use of centralised computer records and stop the face-to-face contact between tax collectors and taxpayers that begets bribery. A signal that banks would operate at arm’s length to the state would also reassure potential investors. So would a high-profile assault on a closed industry.

But Greece’s economic problems are too big to be fixed quickly. Despite a jobless rate that has risen to 18%, Greece still has a current-account deficit of 10% of GDP (see chart 2). For an economy to have so much slack and yet consume more than it produces is a sign of chronic uncompetitiveness. The IMF has said it will take more than a decade for Greece to become competitive. Some reckon it would be easier for Greece to regain its edge by going back to the drachma and devaluing than by keeping the euro and suffering grinding wage deflation. The short-term disruptions would be outweighed by long-term gains.

Most businesspeople see little merit in devaluation. “The empirical evidence is against it,” says Efthymios Vidalis of SEV, Greece’s main business federation. “Greece had two devaluations after joining the European Union and the benefits were short-lived before inflation eroded them. It didn’t work.”

There is another way. When the crisis struck, Apostolos Vakakis, the founder of Jumbo, a Greek retailer, faced a choice: cut costs by 20% or raise productivity by that amount. He chose to improve productivity. In return for a pledge not to cut jobs or wages, Jumbo’s employees agreed to work harder. Each store is now staffed with fewer workers, allowing the firm to open outlets at a faster rate.

Many stress the importance of greater competition in bringing business costs down. In contrast to devaluation, the benefits from opening up professions and industries to competition are permanent, says Mr Stournaras of IOBE. “It is the ‘doing business’ sort of competitiveness that matters,” he says. Greek executives point to the lack of competition in trucking, where no new licences have been issued since 1971, as an example of an industry that raises costs for other Greek firms.

Public opinion also still favours the euro: more than 70% of Greeks say they want to stay in the single currency. But if Greece is to have the breathing-space it needs to right its economy, it has to convince its rescuers that they are not throwing good money after bad. A deal on private-sector losses is only a first step; it seems likely that the euro zone will also have to stump up more money than expected to keep Greece going. It will be a while before the drachma printing plates on display in Athens can truly be confined to history.

Greece may need more money.

Greece is struggling to reach an agreement on debt relief with its private-sector creditors. But even if it ultimately does, the country may need vastly more funding than has been envisioned so far. German commentators on Friday say it’s time for a bit of honesty from Europe’s leaders.

Greece needs more money. That would seem to be the growing consensus in Europe as negotiations over debt relief between Athens and the private sector drag on. On Friday, Jean-Claude Juncker, who chairs meetings of euro-zone finance ministers, became the most recent European politician to sound the warning bell.

„If Greece’s ability to sustain debt is proven and there is an overall understanding with the private sector, the public sector will also have to ask itself whether it will not provide help,“ he told the Austrian daily Der Standard in an interview published Friday.  The talks between Greece and the Institute of International Finance, which is representing the country’s private creditors in the haircut negotiations, have proven difficult as the two sides have been attempting to come up with an interest rate on the new bonds that will be issued to current debt holders. European politicians have said that this rate should be as low as possible so as to give Greece a shot at meeting its goal of reducing its sovereign debt to 120 percent of its economic output by 2020. Institutional bond holders, however, are holding out for a higher rate and resisting any agreement that could push their losses beyond the 50 percent they had originally agreed to.

A successful conclusion to the negotiations is necessary before a final agreement can be reached on a second bailout package for Greece. With Greece facing €14.5 billion in bond redemptions in March, time is of the essence. The European Central Bank is also currently considering whether to accept losses on the Greek bonds it holds.

Last year, EU leaders agreed that the second bailout fund for Greece — coming on the heels of the €110 bailout package assembled in the spring of 2010 and now all but used up — would have to be worth €130 billion. But, with Greece’s financial situation having gotten worse since then, Juncker is not the only one who thinks this figure might have to be enlarged. European Economic and Monetary Affairs Commissioner Olli Rehn said on Thursday at the World Economic Forum in Davos that, even if Greece receives the envisioned €100 billion in debt relief from its private creditors, it still wouldn’t be enough. His spokesperson in Brussels added that experts were currently in the process of calculating Greece’s true needs.

Germany has consistently refused to consider throwing more money at Athens, but it may back down under increasing pressure.

The EU has also made the new bailout package dependent on Greek reform efforts. Several EU leaders have expressed frustration at how announced austerity measures have been implemented and insisted that there will be no aid without further belt-tightening.

The topics and tropes fall faster than snowflakes here in Davos, where several thousand of the world’s leading business people, politicians and policy makers gather once a year for an annual think-fest. And with literally hundreds of panels, debates, interviews, workshops and symposia taking place, it would be impossible to capture all of the ideas competing for attendees’ attention. But, still, as in any complex system, patterns start to emerge. With three of  the event’s four days almost over, here are some early bets on what may go down as the major themes of this year’s convocation.

Capitalism needs a fundamental overhaul. That capitalism is somehow broken has become one of Davos’ most persistent themes. Indeed, “Is 20th Century Capitalism Failing 21st Century Society,” was the topic of TIME’s own panel, which kicked off the proceedings here on Wednesday. Since then, no fewer than three other panels have been devoted to some variation of “fixing capitalism” or “remodeling capitalism.” No one here is arguing that capitalism should be scrapped wholesale, of course. Instead, the most rational arguments have pointed out that not only is capitalism the best system yet devised for enhancing the well being of the greatest number of people, but that it is also immensely supple and flexible. In 200 years, capitalism has already gone through several major iterations. But what, practically speaking, will a global capitalism retooled for the 21st century look like? More regulation? Or less? State Capitalism, like that practiced by China, Russia and many countries in the Middle East? Well, no one has quite figured that one out yet. But a surprising number of attendees (and these are the world’s most direct beneficiaries of the current system) seems to agree that something is wrong. And that in itself is remarkable.

The Arab Spring must end happily. Representatives from the revolutionary movements that recently toppled regimes in Tunisia, Egypt and Libya are among the stars of this panel. Many of them are wearing the hallowed holographic badges, which means that they have been invited to some of the very highest-level meetings usually reserved for heads of state, ministers of finance and their ilk. This indicates that the powers at the very core of the World Economic Forum are interested in the Arab Spring as a matter of paramount global importance. (That said, among the regular attendees, the Eurozone is of far more interest. At one panel discussion I attended on “The Future of North Africa,” the auditorium was about 10% full. For a “Future of the Eurozone” panel taking place immediately after, it was standing room only. This is worrying on several levels.)

The Eurozone crisis will continue to muddle along, but muddling may be enough. The European finance ministers in attendance are all staying on message: Eurobonds are not happening, austerity measures are the way forward now, greater fiscal union is the end goal, and Greece will not default or leave the Eurozone. Interestingly, for the first time in a long time, most of the policital/policy/media hive mind is cautiously optimistic that the Eurozone may actually be starting to heal itself. (Note that UK Prime Minister David Cameron, who sharply criticized the euro rescue plans yesterday, is a spectacular exception.) Much credit is being given to Mario Monti, the unelected technocrat Prime Minister of Italy, who has been widely praised as walking the fine line between implementing reforms that will bring results gently enough not to incite mass revolt by Italian society.

China is still the star. Brazil has come to Davos in a big way. As has Mexico, and India, and Azerbaijan. But the panels on China are packed, and everybody wants to talk about China, and while the cult of the Chinese technocrat has long been on the rise, we are now reaching the full flower of absolute reverence. American business people speak in hushed tones about the new generation of Chinese leaders as if they are supermen: They are well-educated, worldly, wise, and compared to the haplessness and paralysis that western governments have demonstrated over the past two years, they are paragons of good governance. They glide over a lot of complexities, of course, but they can’t help it. They are in love.

Americans and Europeans are pointing fingers at each other. Why is the global economy not in full recovery? The Europeans complain that none of this would have happened if the Americans had not taxed the global financial system when its housing bubble burst. To which, the Americans respond that that may be true, but they claim to have put their house in order and the only thing that’s holding America’s economy back now is European uncertainty. Then, arguments commence.

Germany is pushing for Greece to relinquish control over its budget policy to European institutions as part of discussions over a second rescue package, a European source told Reuters on Friday.

„There are internal discussions within the Euro group and proposals, one of which comes from Germany, on how to constructively treat country aid programs that are continuously off track, whether this can simply be ignored or whether we say that’s enough,“ the source said.

The source added that under the proposals European institutions already operating in Greece should be given „certain decision-making powers“ over fiscal policy.

„This could be carried out even more stringently through external expertise,“ the source said.

The Financial Times said it had obtained a copy of the proposal showing Germany wants a new euro zone „budget commissioner“ to have the power to veto budget decisions taken by the Greek government if they are not in line with targets set by international lenders.

Under the German plan, Athens would only be allowed to carry out normal state spending after servicing its debt, the FT said.

„If a future (bail-out) tranche is not disbursed, Greece cannot threaten its lenders with a default, but will instead have to accept further cuts in primary expenditures as the only possible consequence of any non-disbursement,“ the FT quoted the document as saying.

The German demands for greater control over Greek budget policy come amid intense talks to finalize a second 130 billion-euro rescue package for Greece, which has repeatedly failed to meet the fiscal targets set out for it by its international lenders.

CHAOTIC DEFAULT THREAT

Greece needs to strike a deal with creditors in the next couple of days to unlock its next aid package in order to avoid a chaotic default.

„No country has put forward such a proposal at the Eurogroup,“ a Greek finance ministry official said on condition of anonymity, adding that the government would not formally comment on reports based on unnamed sources.

The German demands are likely to prompt a strong reaction in Athens ahead of elections expected to take place in April.

„One of the ideas being discussed is to set up a clearly defined priorities on reducing deficits through legally binding guidelines,“ the European source said.

He added that in Greece the problem is that a lot of the budget-making process is done in a decentralized manner.

„Clearly defined, legally binding guidelines on that could lead to more coherence and make it easier to take decisions – and that would contribute to give a whole new dynamic to efforts to implement the program,“ the source said.

„It is clear that talks on how to help Greece get back on the right track are continuing,“ the source said. „We’re all striving to achieve a lasting stabilization of Greece,“ he said. „That’s the focus of what all of us in Europe are working on right now.“

Multinationals, responsible for creating millions of jobs, manage to pit governments against one another in terms of wages, work conditions and taxation. Political leaders flounder in countering multinationals’ claims about the need to reduce excessive regulations, fire workers at will or accrue huge profits for shareholders. The multinationals have more power, argues Daniel Bell for the Huffington Post: “the laws of the country must conform to the dictates of MNCs, rather than to the people’s will.” Company executives argue that their ability to select targets for charity is better than government programs relying on taxation, that a net increase of jobs anywhere in the globe has higher moral ground than protectionism. Bell concludes, “the clash may not be between good guys and bad guys, but rather between competing systems of morality.” In the clash between corporate-backed authoritarianism and democracy, nations must decide if some form of global governance could provide basic standards for all and tame the multinationals. – YaleGlobal

Governments are powerless in imposing popular controls on multinational corporations, which can simply jump borders and remove jobs

We are familiar with the truism that multinational corporations are too large and powerful and cannot adequately be controlled by democratically elected politicians. MNCs constantly complain about rigid labor regulations; they want the right to fire workers at will, because otherwise they won’t survive in a ruthlessly competitive market. Moreover, the pace of technological change has increased exponentially the last few years, and the need for labor flexibility has become ever more pressing. If rigid labor regulations hold up the need for innovation, the MNC will pack up its bags and move to a country that is more „welcoming“ to big business. From a democratic perspective, the problem is clear. The ultimately controlling power should lie in the hands of the people and their elected representatives. But here it seems the MNCs have more power; the laws of the country must conform to the dictates of MNCs, rather than to the people’s will. In his State of the Union address yesterday, President Obama tried to reassert the people’s authority: he said he would change the tax code to punish companies that move jobs overseas, and reward companies that return jobs to the United States.

But what makes sense from a democratic perspective may not make sense from a moral point of view. Or so it was suggested earlier today at the annual meeting of the World Economic Forum at Davos. In two sessions (open to the reporting press) with CEOs of major MNCs, it was surprising (to me) the extent to which the CEOs appealed to moral (rather than strictly economic) arguments to justify their ways.

To address the criticism that they had lost their moral compass, the CEOs tried to deflect responsibility for the suffering caused by the financial crisis and the subsequent „great recession,“ but these arguments were not very persuasive. Brian T. Moynihan, CEO of Bank of America, claimed that banks tended to reflect the excesses of the economy, but he did not add that some banks exacerbated those excesses by knowingly peddling dubious products to consumers. David M. Rubenstein, managing director of the Carlyle Group, said that wealthy financiers should not be condemned because they pay low tax rates if the law allows it, but he didn’t add that those low tax rates may be due to loopholes fought for by well-funded lobbies that effectively skew the political system in the interests of the rich and powerful. What’s legal may not be moral.

But the CEOs also put forward some arguments worth pondering. John T. Chambers, the CEO of Cisco, argued that the best performing companies also tend to engage in substantial corporate philanthropy. His own company gave away $299 million last year. He didn’t explain the connection between profit-making and philanthropy, but perhaps the point is that being known as a „good“ company increases the motivation of employees to be productive; and perhaps the regulatory authorities are more likely to be supportive of „good“ companies.

The issue of job creation seemed even more fundamental to the moral outlook of the CEOs. Several CEOs emphasized that they create jobs and they should be given the conditions to do so. But job creation also involves destruction, or, as they put it, disruption. Duncan Niederauer, CEO of NYSE Euronext, pointed out that restructuring of his company required 20,000 job cuts. But he added that such restructuring was done with a vision of more growth, particularly in emerging markets. Put in moral terms, the loss of some jobs is justified because it allows for the creation of more jobs. The problem, from a democratic perspective, is that the jobs are often created in other countries.

But what if the total number of jobs is greater than the number of jobs lost, isn’t that a good result? As Patricia A. Woertz, CEO of the agricultural conglemerate Archer Daniels Midland put it, economic growth that adds jobs wherever they happen is a positive. And governments that try to prevent that process — like President Obama in the name of protecting jobs at home — should presumably be condemned from a moral point of view (assuming that MNCs do in fact create more jobs than they destroy, globally speaking). That is, they should be condemned from the point of view of theories of universal moral reasoning that value human well-being regardless of national boundaries. Democrats who value nation-based collective self-determination may side with President Obama. But the clash may not be between good guys and bad guys, but rather between competing systems of morality.

Daniel A. Bell

Why China’s rise really is bad for America — and other dark forces at work.

I have spent my working life writing about international politics from the vantage points of the Economist and now the Financial Times. Surrounded by people who tracked markets and business, it has always felt natural for me to see international economics and international politics as deeply intertwined.

In my book Zero-Sum Future, written in 2009, I attempted to predict how the global economic crisis would change international politics. As the rather bleak title implied, I argued that relations between the major powers were likely to become increasingly tense and conflict-ridden. In a worsening economic climate, it would be harder for the big economies to see their relationships as mutually beneficial — as a win-win. Instead, they would increasingly judge their relationships in zero-sum terms. What was good for China would be seen as bad for America. What was good for Germany would be bad for Italy, Spain, and Greece.

Now, as the paperback edition of my book comes out, the prediction is being borne out — which is gratifying as an author, although slightly worrying as a member of the human race. The rise of zero-sum logic is the common thread, tying together seemingly disparate strands in international politics: the crisis inside the European Union, deteriorating U.S.-Chinese relations, and the deadlock in global governance.

This new, more troubled mood is reflected at this year’s World Economic Forum. In the 20 years before the financial crisis, Davos was almost a festival of globalization — as political leaders from all over the world bought into the same ideas about the mutual benefits of trade and investment and wooed the same investment bankers and multinational executives. At Davos, this year, the mood is more questioning — with numerous sessions on rethinking capitalism and on the crisis in the eurozone. The European Union is an organization built around a win-win economic logic. Europe’s founding fathers believed that the nations of Europe could put centuries of conflict behind them by concentrating on mutually beneficial economic cooperation. By building a common market and tearing down barriers to trade and investment, they would all become richer — and, eventually, would get used to working together. Good economics would make good politics. The nations of Europe would grow together.

For decades, this logic worked beautifully. But, faced with a grave economic crisis, this positive win-win logic has gone into reverse. Rather than building each other up, European nations fear that they are dragging each other down. The countries of southern Europe — Greece, Portugal, Italy, and Spain — increasingly feel that they are locked into a currency union with Germany that has made their economies disastrously uncompetitive. For them, European unity is no longer associated with rising prosperity. Instead, it has become a route to crippling debt and mass unemployment. As for the countries of northern Europe — Germany, Finland, and the Netherlands — they are increasingly resentful of having to lend billions of euros to bail out their struggling southern neighbors. They fear that they will never get the money back, and their own prosperous economies will be dragged down. Now that France has lost its AAA credit-rating, Germany is left as the only large AAA-rated country in the eurozone. Many Germans feel that they have worked hard and played by the rules — and are now being asked to save countries where people routinely cheat on their taxes and retire in their fifties.

From the beginning of the crisis, Europe’s politicians have argued that the solution to a severe crisis within the EU was „more Europe“ — deeper integration. Unfortunately, their interpretation of what this means is rather different and dictated by the singular nature of their national debates. For the southern Europeans, „more Europe“ means Eurobonds — common debt issuance by the whole European Union that would lower their interest rates and make it easier to fund their governments.. But the Germans regard this as a dangerous pledge simply to underwrite their neighbors’ debts, long into the future. For them, „more Europe“ means stricter enforcement of budgetary austerity from the center — German rules for everybody.

Over the next year, this inherent contradiction is likely to cause increasing discord and rivalry within the EU as the political argument plays out against a deteriorating economic climate. Britain’s refusal to go along with a new European treaty at the December 2011 Brussels summit led to screaming headlines about a continental divorce. But it is likely to be just a foretaste of things to come. The development to watch for in European politics will be the rise of political parties that are more nationalist in tone and that take a much more skeptical attitude to the European Union — not to mention the single currency. Marine Le Pen and the National Front will do well in the upcoming French presidential election. Other rising Euroskeptic parties include the Freedom Parties in the Netherlands and Austria, the Northern League in Italy, the True Finns in Finland, and a motley collection of far-right and far-left parties in Greece.

Ironically, this intensifying crisis in Europe comes just at the time that the United States has decided to readjust its foreign policy to concentrate much more on Asia and Pacific. Although the „pivot to Asia“ is being presented as a far-sighted reaction to long-term economic trends, it also represents an adjustment to a shift in the global balance-of-power in the aftermath of the global economic crisis.

Put bluntly, the United States is taking the rise of China much more seriously. American preeminence, long into the future, can no longer be taken for granted. Nor can it be assumed that a stronger, richer China is good news for America — as successive U.S. presidents argued all the way back to 1978. On the contrary, both as individuals and as a nation, Americans are getting the queasy feeling that a richer, more powerful China might just mean a relatively poorer, relatively weaker America. In other words, the rise of China is not a win-win for both nations. It is a zero-sum game. That belief is now feeding through into the presidential election — and is reflected both in the protectionist rhetoric of Mitt Romney and in the soft containment of China of the Obama administration.

Romney has promised to designate China a „currency manipulator“ and to slap tariffs on Chinese goods. These kinds of arguments have surfaced before, particularly during presidential elections — but they are not normally made by pro-business Republicans. However, with America beset by worries about high unemployment and a spiraling national debt, old nostrums about free trade are easier to jettison. Missed in all the excitement of a presidential election is the extent to which protectionism is being intellectually rehabilitated in the United States. Respected economists like Paul Krugman and Fred Bergsten have argued that imposing tariffs would be a legitimate U.S. response to Chinese currency policies.

A similar shift is underway in America’s military and strategic thinking. The Obama administration’s much-ballyhooed Asian turn is essentially a response to the rise of China. According to the Economist, China is likely to be the world’s largest economy (in real terms) by 2018. And Washington sees Beijing as already flexing its muscles, with increases in military spending and a harder-line in border disputes with a range of neighbors, including India, Japan, and Vietnam. As a result, the United States is seeking to make common cause with China’s nervous neighbors — bolstering alliances with its traditional Asian allies, while committing to strengthen its own military presence in the region. This move is all the more significant since it comes in the context of a plan to make deep cuts in overall U.S. military spending.

The Chinese are not wrong to see this policy as essentially one of „soft containment.“ They are unlikely to respond passively. A new Chinese leadership — under pressure from a nationalist public — might push back hard.

American-Chinese relations have long contained elements of rivalry and co-operation. But, increasingly, the rival elements are coming to the fore. This is not yet a new cold war. However, the state of relations between the United States and China — the sole superpower and its only plausible rival — are likely to set the tone for international politics in the coming decade.

In fact, the increasing rivalry between Washington and Beijing is an important contributor to the third major manifestation of the spread of zero-sum logic through the international system — the increasing deadlock in multilateral diplomacy, from the World Trade Organization (WTO) to climate-change negotiations to the G-20′s stalled efforts at global financial regulation.

In the heyday of globalization over the past three decades, big trade agreements were both a symbol and a driver of the strengthening of common interests between the world’s major powers. The creation of a European single market in 1992 and of a North American free-trade area in 1994, the setting-up of the WTO in 1995, and the admission of China to the WTO in 2001, were all landmarks in the creation of a truly globalized economy. But the days of heroic new trade accords are over. World leaders have stopped even calling for a completion of the Doha round of trade talks; the repeated empty exhortations have become embarrassing. There have been, however, some small victories: At the end of 2011, Congress finally passed a free-trade deal between the United States and South Korea, and Russia was admitted to the WTO around the same time. But the WTO is now largely playing defense, trying to prevent a major new outbreak of protectionism. Officials there dread the prospect of being asked to adjudicate a U.S.-Chinese dispute over currency — fearing that any such case would be so politically charged that it could blow apart the world trading system.

It is a similar picture in other areas where there were once high hopes for multilateral cooperation. The world climate talks were saved from complete disaster in Durban, South Africa, at the end of 2011 — but few believe that the vague and vestigial agreement reached there will have any real impact on the global problem. The G-20′s efforts to push forward with new forms of global financial regulation have also disappointed. The crisis within the European Union — which has so long seen itself as the champion of global governance — has damaged the whole cause of multilateralism.

A few months ago, I found myself sitting next to a senior EU official who turned out to have read my book. „My job is to prove your zero-sum thesis wrong,“ he told me. I replied that, as an author I hoped to be proved right — but as a European and a human being I was hoping to be proved wrong. My lunch companion laughed and said, „That is too dialectical for me.“

It is one of the nice things about the best EU officials that they are happy to talk to their critics, and comfortable using words like „dialectical.“ However, I fear that cultured technocrats will not do terribly well in the new era. A zero-sum world may summon up rather darker forces.

Obama wants America to get back to the business of making things. That means developing skilled workers at home while taking a global view

President Obama is right: America’s long-term success hinges on its ability to invent technology the world wants. It seems simple, but getting America back in the business of making things isn’t. It’s a global process. An idea born in Silicon Valley could be engineered in Switzerland, tested in China, and assembled in Taiwan. A stimulus to boost manufacturing may help the U.S. economy in the short term, but reinvigorating postwar-style production or space-race ingenuity is impossible without an increasingly capable workforce. Business demands it. And without it, long-term success will remain elusive.

These days manufacturing extends far beyond the assembly line. It’s about inventing and solving problems: researching, testing, and experimenting with ideas and technology. The development of new products more and more defies borders. It’s impossible to make electronic goods exclusively on U.S. or U.K. soil—the supplier base, infrastructure, and often the expertise needed to produce everything from electric cars to solar panels is dispersed.

Within that context, it’s easier to understand why highly skilled jobs are going the way of assembly and manufacture. New research by the National Science Foundation (NSF) reports that more companies are taking research and development—and 85 percent of the new jobs it creates—overseas. Still, this is by no means a one-way street. As Caterpillar shifts some R&D abroad, it’s considering moving parts of its manufacturing operations back to the U.S. Creating new products is no longer one size fits all.

But constructing an economy that’s built to last depends on a ready supply of talented individuals: people who invent, create, and develop the ideas that will drive exports and those who can assemble them. China gets it. To make its economy more knowledge and technology intensive, China is investing heavily in science and engineering education, infrastructure, and R&D support. Already wages are increasing, the middle class is growing, and the country is developing new technology rather than just assembling products. And while the U.S. continues to file more patents than any other country, the Far East’s investment in R&D, fueled by China, matched U.S. contributions in 2009, according to the National Science Board’s report, Science and Engineering Indicators 2012.

ENGINEERING: U.S. VS. ASIA
To compete, the U.S., like the U.K., needs more engineers and scientists. But of the world’s engineering graduates, less than 4 percent of degrees are earned in the U.S. vs. 56 percent in Asia, says a report from the NSF. It’s no wonder such companies as Airbus, 3M, and Caterpillar are looking East for R&D talent.

At my company, Dyson, we’re in the process of doubling the size of our U.K. R&D team to 750, but we don’t have enough qualified people to fill the specialized roles we need. While we carry out R&D of new technologies, we’re increasingly dependent on a combination of engineers at home and abroad to get our machines to market.

Greater job training and partnerships between academia and industry are a step in the right direction. Currently half of U.S. science and engineering degrees go to students from outside the country’s borders. Why train brilliant minds simply to send them home again? In his State of the Union address, President Obama acknowledged that it’s these individuals who will invent new products, start small businesses, and create new jobs.

WHILE THEY’RE YOUNG
But long-term success demands more. Government must invest in science and engineering education at an early age. And for homegrown talent, getting young people to be creative, test their ideas, and solve problems—rather than learning by rote—would help inspire and enthuse. More practical science experiments and innovative hands-on engineering classes, combined with more consistent STEM (science, technology, engineering, and mathematics) teacher development, would help reinvigorate interest in subjects children too often give up on.

Manufacturing isn’t about us and them anymore. To safeguard it while creating future jobs, the U.S. needs to invest in a highly educated workforce and allow inventive companies, new and old, to thrive. Countries such as Singapore, where we make high-speed digital motors for our appliances, gear their education systems to better suit the progressively high-tech nature of their economy.

Both the U.K. and the U.S. could offer greater financial incentives for promising students to study STEM subjects and help plug a growing gap. Better career advice—engineering is both highly rewarding and well paid—and more readily available industrial scholarships and experience would ensure that more of these students apply their knowledge to invention.

To make the most of this talent, innovative small businesses should be prioritized when it comes to higher tax relief and lending. These companies often come with bigger risks—R&D is expensive and time consuming—but greater potential rewards. And R&D tax credits are essential: They support creative businesses of all sizes without forcing the government to pick winners.

It’s not possible to follow the old method of making what worked in the past. New economies and customers are emerging, supplies and suppliers are shifting, and talent can’t be treated territorially. The U.S. should embrace the changing nature of manufacturing while investing in the bright minds that will deliver on its long-term potential.

James Dyson is founder and chief engineer of Dyson Ltd.

David Cameron has delivered a firm rebuke to Germany at the World Economic Forum, calling on Berlin to contribute significantly more resources and guarantees to help solve the eurozone crisis.

The British prime minister stressed on Thursday that although progress had been made, particularly with the European Central Bank’s funding of the European banking system, policymakers were still far from finding a solution to the underlying problems of the crisis. He criticised eurozone leaders for being distracted by other issues, such as the introduction of a financial transaction tax – an initiative he described as “quite simply madness”.

His speech in Davos reflected British officials’ long-standing and deep frustration with Germany’s leadership of the single currency area and called for a much stronger firewall to prevent contagion within the eurozone, common European sovereign debt and for powerful countries committing to reduce their trade surpluses as much as the struggling countries seek to minimise their deficits.

The sentiments chimed with many British and US delegates at the WEF who have criticised Germany for seeking to persuade other countries to “become more German” without the corollary that Germany must “become less German” by importing more and allowing its trade surpluses to shrink.

“Yes, tough fiscal discipline is essential. But this is a problem of trade deficits, not just budget deficits,” Mr Cameron said.

The prime minister’s speech followed an address by Angela Merkel, German chancellor, on Wednesday in which she rejected calls for a significantly greater financial commitment to underpin the euro. While she also accepted that austerity alone was not enough, she insisted troubled peripheral European economies must impose structural reforms to become more competitive.

Bankers in Davos and financial market investors have become significantly more optimistic this year that the European authorities are getting to grips with the eurozone crisis, but Mr Cameron begged to differ.

“We need to be honest about the overall situation”, he said. “The crisis is still weighing down on business confidence and investment?.?.?.?so we still need some urgent short-term measures.”

He sided with the International Monetary Fund’s call for bigger firewalls to protect countries struggling to finance their deficits, but which do not have longer-term concerns about solvency. For the longer term, he added that the eurozone needed a central bank that would always stand behind the currency, further economic integration and fiscal transfers and collective debt issuance.

“Currently it’s not that the eurozone doesn’t have all of these, it’s that it doesn’t really have any of these,” he said.

But the message that will annoy Berlin the most was that he called on Germany to allow its trade surplus to fall.

“As Mario Monti has suggested, the flip side of austerity in the deficit countries must be action to put the weight of the surplus countries behind the euro,” he said, referring to the Italian prime minister. “I’m not pretending any of this is easy. These are radical, difficult steps for any country to take.”

The call for Germany to accept eurobonds was an attempt to align Britain with Christine Lagarde, the IMF’s managing director, who travelled to Berlin this week with the same message.

So far, there is no sign that Germany is willing to change its mind.

DAVOS, Switzerland—After receiving nearly half a trillion euros in cheap loans from the European Central Bank last month, the Continent’s banks face a dilemma: to invest the money in lucrative but potentially risky government bonds or hoard the cash at a loss.

The choice reflects the uncertainty surrounding Europe’s financial system at a time when dark clouds continue to hover over the euro-zone economy and its common currency. Regardless of whether banks use the money to buy bonds or simply stash it at the central bank for safekeeping, consumers and businesses are unlikely to see much of the funds pumped back into the economy in the form of loans.

The ECB in December extended about €489 billion ($640.88 billion) in three-year loans to hundreds of banks that operate in the euro zone. The loan program was primarily designed to fend off a potential cash crunch. European banks face hundreds of billions of euros of debt coming due this year and, with funding markets shut to all but the strongest institutions, some banks faced the prospect of serious liquidity problems.

Bankers and government officials gathered in Davos, Switzerland, this week for the World Economic Forum are virtually unanimous that the ECB’s loans have eliminated such fears, at least for now. And the ECB is poised at the end of February to offer banks another chance to take out the loans. Bankers and analysts expect them to borrow hundreds of billions more.  The ECB loan program provides „a very significant degree of breathing space to banks,“ said Adair Turner, chairman of the U.K.’s Financial Services Authority, in an interview here.

But bank executives say lenders are taking radically different views on how to use the money.

Some are squirreling it away. In at least some cases, that means parking the funds back at the ECB in a facility that houses bank deposits overnight.

Thanks to the ECB loans, the banking industry is „awash with liquidity, although I have to admit that most of that liquidity goes back to the ECB overnight,“ said Francisco Gonzalez, chairman of Spanish lender Banco Bilbao Vizcaya Argentaria SA.

That sentiment, echoed privately by other senior European bank executives in Davos this week, also is apparent in the amounts housed in the ECB’s overnight deposit facility.

They have been climbing since the loan program was launched last month, peaking on Jan. 17 at €528 billion, the largest sum on record. (They fell slightly this week to about €485 billion.)

The downside is that leaving the money in the deposit facility is a money-losing proposition. The ECB pays a paltry 0.25% interest rate—less than the 1% that banks were charged to borrow from the ECB in the first place.

But it offers banks the comfort of knowing their funds are safe. Industry experts said this week that such safety is more valuable in the current environment, especially for lenders in troubled countries such as Italy, Spain and Portugal. „‘Survival first’ will have to be the mantra for most banks in peripheral European countries,“ analysts at RBC Capital Markets wrote.

„Those [banks] with liquidity are parking it with central banks. Those without liquidity are borrowing from central banks,“ said Peter Sands, chief executive of U.K. bank Standard Chartered PLC, which didn’t borrow funds from the ECB. „So instead of being the lender of last resort in times of crisis, central banks have become the central actor.“

Other bankers and investors said several lenders are using the funds to snap up large quantities of government bonds in stressed countries. The theory: The banks could pocket a tidy profit thanks to high interest rates on the government bonds.

That, in turn, could defuse governments’ financial problems and simultaneously help repair banks’ balance sheets by boosting their profits.

This so-called carry trade resembles the way U.S. banks rebuilt their capital and profitability levels after the financial crisis by using cheap funds from the Federal Reserve and capital from the U.S. government’s Troubled Asset Relief Program to buy higher-yielding assets including Treasurys.

But it exposes banks to the risk of drops in the price of the bonds, particularly if the European crisis takes a turn for the worse.

„We are really seeing clear signs that this money is not simply staying in the deposit facility, but is circulating in the economy,“ ECB President Mario Draghi said earlier this month, pointing to the declining yields of some European government bonds as a sign that banks are using the funds to buy the bonds. „By and large, the banks that have borrowed the money from the ECB are not the same as those that are depositing the money with the deposit facility of the ECB.“

Even if banks are using the funds to buy government debt, that won’t necessarily provide permanent relief to cash-strapped European governments. „Without greater demand from nonbank investors, the level of supply absorption may not be sustainable,“ said Guy Mandy, a European rates strategist at Nomura, on an investor call Thursday.

Some bank executives said they are loath to publicly confirm they are using ECB funds to buy government bonds for fear of public criticism that they are using central banks’ money for a quick buck rather than to help kick-start the European economy by lending the funds to customers.

Some bank executives said the ECB money will eventually trickle down into loans to businesses and individuals.

„The cost of funding is going down very rapidly. That will put more money in the margins of the banking system, which is good because in order to give credit you need strong banks,“ said BBVA’s Mr. Gonzalez. „We are in the process of filtering that money down to the real economy.“