Russia Is Still a Hungry Empire

By MATTHEW KAMINSKI

The sight of Russian tanks rolling through Georgia was shocking yet familiar. Images flash back of Chechnya in 1994 and '99, Vilnius '91, Afghanistan '79, Prague '68, Hungary '56. Before that the Soviet invasions, courtesy of the Ribbentrop-Molotov pact, of Poland and the Baltics in '39 and '40. Kazaks, Azeris, Tajiks, Ukrainians remember -- from family stories and national lore -- their own subjugation to Russian rule.

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Other empires such as Britain and France adjusted, not without difficulty, to the fall of their distant domains. Far more of Russia's essence is tied up in the Imperium, and it barely tried to find a new identity after the Soviet Union fell. The war in Georgia marks an easy return to territorial expansion (here Moscow has taken chunks of Georgia for itself) and attempted regional dominance.

Russia is a relatively young nation, dating from after the turn of the previous millennium. Drive the highway from Gori to Tbilisi and you'll find signs of Christianity that predate Russia by some five centuries. Georgians will tell you, with a mixture of pride and scorn, that their culture and history goes back a lot deeper than Russia's.

Starting out as an isolated village, Muscovy grew by conquest, swallowing up lands and people at a dizzying rate, especially from the 18th century on. Though Russian nationalists claim otherwise, as a nation the Russians are a mix of Slavic, Asian and other European ethnicities. This national hodgepodge was wrenched together by an authoritarian czar who claimed his right to rule from the heavens.

The Soviets were even better empire builders. Vladimir Putin, whose formative years were spent in Dresden spying on the East German colonials, comes from this tradition.

Never in the history of empire was the periphery generally so much more advanced than the center. With each move into Europe, from the partitions of Poland to Stalin's great triumph at Yalta, Russia acquired what it didn't have -- an industrialized economic base, better infrastructure and above all contact with Western civilization. Aside from St. Petersburg and a few other towns, Russia itself stayed a largely rural, Eastern Orthodox backwater. It knew it too.

In the Soviet days, Russian culture, language and history were pressed on its captive nations. But these nations in and outside the U.S.S.R. never gave up their dreams of freedom. Starting in the Baltics, and then spreading to the Caucasus and Ukraine, their resurgence was, as much if not more than Mikhail Gorbachev, the internal force that brought about the Soviet Union's collapse. They easily imagined life without Mother Russia. Russia could not reciprocate. To dominate is to be.

Boris Yeltsin tried to give Russians an alternative narrative. For his own political survival he had to stoke a Russian reawakening against the Soviet behemoth. After leading the charge against the 1991 putsch, Yeltsin put forward democracy as a unifying and legitimizing idea for the new Russian state. But that went up in smoke with the shelling of the Russian parliament in 1993, the first Chechen war and the rise of the oligarchs.

Yeltsinism was fully discredited by the time Vladimir Putin took over. He doesn't give the impression he ever believed in its main precepts of partnership with the West and freedom at home. For a while, Mr. Putin pushed some economic modernization, including cleaning up the tax code. His instinct, however, led him toward the past. The so-called humiliations of the Yeltsin era, which to most Westerners who lived there then looks like a golden era of relative normalcy, called for vengeance. The young democracies around Russia that chose a future in the West were to be forced back into Moscow's sphere of influence.

It is curious to hear Russia invoke the Kosovo precedent to justify its invasion of Georgia. There is an unintended parallel. Two former communist apparatchiks (Mr. Putin and Slobodan Milosevic) took over weakened, demoralized countries and thought expansionist nationalism would lead them to glory.

The second Chechen war consolidated the Putin hold on power in 1999 -- as stirring up the Serbs in Kosovo did for Milosevic in the late 1980s. The Serbs were then like the Russians are today. A European nation, though somewhat set apart by Orthodox Christianity, that opts out of the Western mainstream. This choice, alas, requires victims like Kosovo Albanians or Georgians -- small nations whose fate the outside world might ignore.

The images from Georgia brought me back to a late May evening 12 years ago in Murmansk, the seat of Russia's Northern Fleet. There ahead of elections, I'd met a smart and amiable teacher in the Russian Arctic city who, true to his nation's reputation for hospitality, invited me home for vodka and some dinner.

Hours into our meeting I'd mentioned that perhaps Russia, then looking for its place, might aspire to become something like prosperous Norway just across the border from Murmansk -- a country able to provide its people a good life. It stopped him cold. In this grim setting, my new friend spat in disgust and said, "Russia is no Norway. It is a great power. It is destined to be great." Mr. Putin would doubtless agree.

For Obama,
Taxes Are About Fairness

On Saturday night at the Saddleback Church in Southern California, Rick Warren showed Jim, Gwen, Tom, Bob and Co. what a presidential moderator can accomplish when he makes the debate about the candidates and not himself.

Over the course of a two-hour, televised forum, the best-selling evangelical author and pastor took a novel approach to our presidential debates. He asked Barack Obama and John McCain the same simple questions -- and then gave them time to answer.

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Barack Obama and John McCain with Pastor Rick Warren, Aug. 16.

For example, here is how Mr. Warren asked the candidates to talk about their flip-flops: "Give me a good example of something, 10 years ago, you said that's the way I feel about [it] and now, 10 years later, I changed my position."

Likewise on abortion: "I know this is a very complex issue. Forty million abortions, at what point does a baby get human rights, in your view?" And again on the Supreme Court: "Which existing Supreme Court Justice would you not have nominated?"

These are not your standard-issue Beltway questions, and their directness made them hard to evade. Nowhere was this more evident than in Mr. Warren's attempt to get the candidates -- both of whom are trying to persuade the American people they are tax cutters -- to draw some fundamental distinctions between their approaches. In simple but arresting language, he cut to the chase.

Here's how he put it: "OK. Taxes. Define rich. I mean give me a number. Is it $50,000, $100,000, $200,000? Everybody keeps talking about who we're going to tax. How can you define that?"

Plainly this is a man who understands that it is easier to get a camel through the eye of a needle than to get a direct answer from a politician running for election. And indeed, while Mr. McCain was at first shy about giving a specific number, in the end he did allow that someone who had an income of, say, $5 million could pretty definitely be said to be rich.

Yesterday's Politico hooted that with this response Mr. McCain handed his opponent the perfect fodder for a TV commercial. That, of course, overlooks those who might actually find attractive Mr. McCain's fuller explanation. "I don't want to take any money from the rich," he said, "I want everybody to get rich."

Mr. Obama, by contrast, started out much more directly, suggesting that if you make $150,000 or less you may be poor or middle class. A family with an income above $250,000, he went on to say, is "doing well." And if you find yourself in that category, he's going to target you for a tax hike -- all in the name of creating "a sense of balance, and fairness in our tax code."

In fact, the idea of fairness is at the heart of his whole economic argument. And he goes back to it in almost every public appearance.

He talks about it as a general theme: "It is time for folks like me who make more than $250,000 to pay our fair share."

He invokes it as a solution for Social Security: "[W]e will save Social Security for future generations by asking the wealthiest Americans to pay their fair share."

He points to how it guides his energy policy: "The first part of my plan is to tax the windfall profits of oil companies and use some of that money to help you pay the rising price of gas."

And he stuck to it on capital gains, even after ABC's Charlie Gibson noted that the record shows increased taxes on capital gains -- which would affect 100 million Americans -- would likely lead to a decrease in government revenues: "Well, Charlie, what I've said is that I would look at raising the capital gains tax for purposes of fairness."

Translated into ordinary English, what that means is that it doesn't really matter whether a tax increase actually brings in more revenue. It's not about robbing from the rich to give to the poor. Robbing from the rich will do, especially if it's done in the name of fairness.

Now there are good reasons Mr. Obama is not likely to pursue the revenue side of the fairness question. As this newspaper noted in a recent editorial, the latest data from the Internal Revenue Service does not show to Mr. Obama's advantage. As we come to the end of the Bush administration, the top 1% of American taxpayers already pay 40% of all income taxes -- the highest level in 40 years. The top 10% of income earners pay 71% of the taxes.

Mr. Warren, a man of the cloth, has done us a great service by asking the candidates to answer a pretty secular question: What kind of income makes an American "rich"? Maybe in the more secular setting of an upcoming debate, one of our nonpastor moderators could ask the candidates the moral question: What specific rate of individual taxation would it take for the rich to be paying their fair share?

Inflation Is a Clear and Present Danger

By BRIAN WESBURY

The most painful and frustrating economic policy blunder of the past 50 years was the Great Inflation of the 1970s. Painful, because it was the catalyst for three damaging recessions (1973-75, 1980, 1981-82), all the while eroding living standards and seriously undermining confidence in America.

It was also deeply frustrating. Despite the teaching of Milton Friedman -- which clearly explained that inflation was caused by too much money chasing too few goods -- a combination of bad economic models, denial and political expediency allowed it to happen.

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President Reagan meets with Paul Volcker, chairman of the Federal Reserve Board, 1981.

One would think that the odds of a repeat were low, and for 20 years, after Ronald Reagan and his Fed Chairman Paul Volcker had the courage to get inflation under control with tight money and tax cuts, this was true. Unfortunately, the lessons seem to be fading. Today, the U.S. (and through it the world) faces its greatest threat from inflation in 30 years. And as in the past, this threat is being met with denial and political expediency.

Today's problems began seven years ago in 2001, when the Federal Reserve overreacted to the deflationary mistake it made in the late 1990s. The Fed vigorously pumped money into the economy in order to drive interest rates down rapidly.

As is so often the case, after the Fed has acted, but before the typical lag in monetary policy has fully played out, conventional wisdom argues that the Fed has become impotent. Back in 2002 and 2003, the logic was that the Fed was powerless over globalization, and low-cost labor would continue to feed deflation. In addition, because long-term rates were rising as the Fed cut short-term rates, many thought that markets were undermining Fed intentions.

But, as always, when the Fed injects excess liquidity into the system, inflation begins to rise. As early as 2002, soaring commodity prices and a falling dollar became the canaries in the coal mine of excessively loose monetary policy.

In their wake, almost every measure of inflation in the U.S. has moved significantly higher. In the past year, producer prices have increased 9.2%, while consumer prices are up 5.6%. Yet, because there are so many measures of inflation it is possible to focus on some, for instance consumer prices excluding food and energy (aka, "core" CPI), which remain benign. This allows many to say there is no inflation.

But oil and food are absorbing a large part of excess Fed liquidity. When consumers spend more on energy, they have less to spend in other arenas. This reduces demand for other goods, keeping prices lower than they would be otherwise. This helps explain the divergence between overall and core measures of inflation.

This divergence is now coming to an end. If the recent decline in energy and food prices continues, that money will be released and other prices will start to rise more quickly. The July jump of 0.3% in "core" CPI inflation is likely one of the first signs.

Some argue that the recent drop in commodity prices indicates lessening inflationary pressures. But nothing could be further from the truth. Commodity prices had reached levels that were not justified by current monetary policy. As a result, their pullback is just a correction, not the beginning of a new trend. If this pullback had occurred as the Fed was lifting the federal-funds rate, like back in 1999, it would be a different story. Excluding food and energy from the CPI is sometimes justified because their price movements are often volatile and short-lived. But the five-year average annual growth rate of the CPI, which should smooth out any short run issues, is now 3.6% -- its highest level since 1994. Moreover, the Cleveland Fed's trimmed mean CPI, which excludes the 8% of prices growing the fastest and the 8% growing the slowest, is also up 3.6% in the past year -- its fastest growth since 1991.

When investors hear comparisons of today with the 1970s, they immediately think double-digit inflation. But, it's not that bad -- yet. It took 20 years of accommodative monetary policy in the 1960s and '70s to create the Great Inflation. A more accurate comparison on the inflation front would be the late 1960s, when consumer price inflation accelerated to 6% from about 1%. This period was the precursor of the 1970s. Except for catch-up after the wage and price controls of 1971, the actual move into double-digit inflation did not occur until the late '70s.

With the real (or inflation-adjusted) federal-funds rate now negative, the signals are clear. The Fed is still adding more money to the system than is demanded, and this suggests that the general increase in inflationary pressures will continue. The only question is whether policy makers will get the courage to fight inflation before it gets out of control.

And this is the rub. Much like the 1970s, there is a widespread denial that inflation is a problem today. Some argue that Fed policy is not easy, either because the money supply is not growing, or that banks are deleveraging, which counteracts any attempt by the Fed to inject money.

The first argument hits at the root of Friedman's monetary theory. If money is not growing, then how can inflation be a problem? But money is growing. No measure of money is declining, despite bank deleveraging, and Reserve Bank Credit (the Fed's balance sheet) has expanded at a 14.4% annual rate in the past three months.

Another sign of easy money is that every country that pegs to the dollar, including China and the United Arab Emirates, is experiencing a rapid acceleration in its inflation rates as it imports inflationary U.S. monetary policy.

The second argument is belied by history. Between 1983 and 1994, exactly 2,747 U.S. banks and S&L's failed, representing total assets of $894 billion. During that period of deleveraging, real GDP in the U.S. expanded at an annual average of 3.5%. The Great Depression is the only period of sharp economic contraction in the U.S. correlated with bank failures. But that was clearly related to a deflationary mistake in Fed policy. Real interest rates were outrageously high in the late 1920s, and much of the '30s, which is not true today.

One of the reasons that monetary policy is so loose today is that our economy is addicted once again to easy money and low interest rates. We hear over and over that the Fed cannot tighten because the housing market and the economy are vulnerable. This was the same argument made in the pre-Volcker 1970s, when the U.S. bounced from one economic crisis to the next.

But a look back at the past 40 years clearly shows that the economy was much healthier in the 1980s and '90s, when real interest rates were high, rather than low as they were in the 1960s and '70s.

The Fed's "dual mandate" -- to keep the economy strong and prices stable -- serves to support this mistake. In contrast, the European Central Bank has a single mandate: price stability. No wonder the dollar has been so weak relative to the euro. Imagine two football teams. One with a single mandate: win. The other with a dual mandate: win and keep your uniforms clean. It's clear that the one with the single mandate will have more success in achieving its goals over time.

It is this combination of denial of actual inflation, bad economic models and the political expediency of keeping interest rates low that makes a repeat of past policy mistakes likely. In the end, inflation can be controlled -- the Volcker-Reagan strategy of tight monetary policy and tax cuts still holds the key -- but only if policy makers find the courage.

Mr. Wesbury is chief economist at First Trust Advisors, L.P.