Why the financial crisis helps the dollar

Europe

Swaggering on

But Russia will find the going harder

A few minutes before midnight on December 31st 2008, President Dmitry Medvedev will stroll out of the Kremlin and stand before cameras in Red Square, steam coming from his mouth. In his first new-year address to the nation he will speak about Russia’s resurgence and its demand for respect; he may talk about his difficult decision to send troops to Georgia; he is likely to mention the turbulent economic climate and Russia’s ability to weather the storm. Then the clock on the Kremlin tower will strike 12 and millions of Russians will click glasses to the tune of the old Soviet anthem, restored by Vladimir Putin eight years ago.

Russia is heading into its first truly difficult years since Mr Putin took power

What will happen next and how much Mr Medvedev’s reassuring words will correspond with reality is harder to predict. But all the signs are that Russia is heading into its first truly difficult years since Mr Putin took power in 2000. Its small victorious war in Georgia was the culmination of Mr Putin’s era, which was marked by high oil prices and the sense of restored pride. In practical terms, however, this escapade did not win Russia anything that it did not have already while pushing its relationship with the West to a new low. Russia’s hurried recognition of South Ossetia and Abkhazia, which it controlled anyway, has created the prospect of a prolonged stand-off with the West.

When Mr Putin announced his choice of Mr Medvedev as his successor some for­eign pundits, bankers and home-bred liberals rejoiced: at last, after the belligerent Mr Putin, comes a mild-speaking young lawyer with no background in the secret services and few memories of the cold war. Only unrepentant pessimists, such as Andrei Illarionov, who had worked with Mr Medvedev at one stage, gloomily predicted that Mr Medvedev would try to overcompensate for his civilian background. So far the pessimists have the upper hand: Mr Medvedev has tried to prove himself not by diverging from Mr Putin, but by imitating Mr Putin’s bellicose style and sounding even tougher than his patron.

The West may not have much leverage over Russia, but the rift in the relationship is coming at a time when Russia can least afford it. One reason Mr Putin was able to ignore Western opinion on human rights or the worsening business climate was that Russia was swimming in money. The Kremlin never paid the price for destroying the Yukos oil company or revising the terms of produc­tion-sharing agreements with foreign firms. Rising oil prices and a steady flow of cheap credits from foreign banks made Mr Putin feel all but invincible and masked structural problems in the economy.

In 2009 Russia will face a much tougher economic reality. Credits from foreign banks have dried up. Oil prices have fallen sharply. Imports are rising faster than exports, so that Russia’s trade surplus, which had been growing strongly, will start to shrink. To make up for this, the government will spend more money from its oil-fuelled stabilisation fund, but some of this money will go into inefficient state corporations, increasing the state’s share in the economy and complicating efforts to bring down inflation, which is in double digits. Russians will see their real incomes grow more slowly.

No more mister tough guy?

In the past, the Kremlin had to worry only about a marginalised group of Russian liberals. Now it may face discontent from a wider public which cheered Mr Putin’s tough stance with the West while incomes rose.

Russia’s economic growth will become a lot more dependent on foreign investments. The optimistic scenario is that Russia’s economic needs will tame its hostility towards the West and that the political system created by Mr Putin and inherited by Mr Medvedev will become more flexible. The war in Georgia makes this scenario less likely than it would have been a year ago. Instead, the self-sustained logic of the Putin regime suggests that Russia will continue to search for enemies both outside the country and within. This may mean more hostile rhetoric and possibly actions in the former Soviet republics which Russia considers its own sphere of influence.

But it would also make Russia’s economic modernisation less likely. Several years of unchecked xenophobia have made Russians much more receptive to authoritarian and nationalistic rule than to liberal ideas. On the other hand, the more oppressive the Kremlin becomes, the more resistance it will face from its own ethnically Muslim republics, particularly in Ingushetia, where people are fed up with corrupt leadership and the constant abuse of human rights. In the short term, Russia’s war in Georgia has served as a reminder to places like Ingushetia and Chechnya that Moscow is ready to steamroll any opposition. But in the longer term, having undermined Georgia’s territorial integrity, Russia has inadvertently put its own at risk as well.

Why the financial crisis helps the dollar

Finance

Currency comeback

Why the financial crisis helps the dollar

Even in quiet times, predicting the paths of exchange rates is a fool’s errand. Economists can come up with the most reasonable of arguments for why this currency will rise and that will fall, only to have their forecasts overturned by small shifts in the financial weather. In 2008, working out where foreign-exchange markets might be in a week’s time, never mind a year’s, has been about as easy (and as sensible) as holding a finger to the wind in a tornado.

To make matters trickier still, past financial crises have been national or regional—meaning that analysts have had only a few currencies to focus on. This time the turmoil is much broader, and America and western Europe are in the thick of it. And whereas economies as a whole can suffer or stockmarkets around the globe can fall, in foreign-exchange markets it is relative prices that count: whether the world economy is doing badly or well, some currencies must go up and others down.

Even so, some trends are discernible. And those trends do not look at all bad for—of all currencies—the dollar, even though the financial crisis began in the United States and America’s economy is in hard times. Indeed, as the crisis intensified during 2008, the dollar’s six-year decline against the euro and some other leading currencies went into reverse. There are good reasons to think that the dollar will hold up in 2009.

Everything is relative

The demand for a currency depends on the return that investors expect from holding it. That in turn depends largely on the interest rates on offer and on underlying rates of economic growth. At first sight, little of this favours the dollar. American official short-term interest rates are far more likely to go down than up. The rates on Treasury notes have at times fallen to almost zero: at almost any price, the safety of government paper trumps risky-looking banks. And America’s growth prospects for 2009 are poor. Some economists have even argued that the financial crisis could spell the end of the dollar’s long reign as the world’s premier reserve currency—doing for the greenback what the Depression did for the gold standard.

Look around the world and there are, to be sure, better bets on offer than the dollar: the yen is one, even though Japan’s economy is faltering. For Japanese investors, prospects are no better abroad than at home; and the carry trade—borrowing cheap yen and buying assets denominated in high-yielding currencies—has become a much harder game to play. The Chinese yuan is not about to reverse its climb either, even if exports and the economy slow down. But European currencies are a different story.

In both Frankfurt and London, central banks have more room to cut rates than in America, and are likely to use it. That would narrow transatlantic differentials. The outlook for growth in Europe is no better—and is perhaps even worse—than in America. Housing markets in Britain, Ireland and Spain were every bit as bubbly as in America.

The backing of Uncle Sam still counts for something

Moreover, the backing of Uncle Sam still counts for something. That will help the dollar if a slowing world economy gives investors in emerging markets a lasting bout of the collywobbles. (It seems a fair bet that it will.) Treasury notes are still regarded as a safe haven—and they will continue to be trusted, even if America has to issue many more billions of dollars’ worth to finance the bail-out of its banks. Stephen Jen, an economist at Morgan Stanley, points out that in past years there have been huge flows out of dollars and yen into European and emerging-market currencies, which will have to return. He has a long list of currencies that could come under severe pressure, which includes the Indian rupee, the South Korean won and the Brazilian real, as well as “most” east European currencies.

A faltering world economy will also weigh down commodity producers’ currencies: the Australian and New Zealand dollars, which lost ground in 2008, may lose more in 2009. The most vulnerable currencies when financial storms break, however, belong to countries whose banks, companies and households owe large amounts of short-term debt denominated in foreign money. In the Asian crisis of 1997-98, that meant a collapse of the Thai baht, the Indonesian rupiah and others. This time the most conspicuous victim has been the Icelandic krona. Even if they are not in for such a rough ride, other countries may be exposed too.

All in all, if 2009 brings a currency crash, the dollar is unlikely to be the victim.

Madoff Hits Feeder Funds, Auditors: Jane Bryant Quinn

Madoff Hits Feeder Funds, Auditors: Jane Bryant Quinn (Correct)

Commentary by Jane Bryant Quinn

(Corrects name of Madoff firm in 2nd paragraph, location of professor in 9th paragraph, name of accounting group in 15th paragraph.)

Dec. 31 (Bloomberg) -- When you invest in a fund of hedge funds, or a partnership that promises to find top managers for your money, you get an annual Independent Auditor’s Report. But what does that report actually show? Not much, as investors in Ascot Partners, Gabriel Capital, Fairfield Sentry, Tremont Group Holdings and other Madoff feeder funds learned to their loss.

Major accounting firms such as BDO Seidman, KPMG, McGladrey & Pullen and PricewaterhouseCoopers audited the statements of the various funds that fed money to Bernard L. Madoff Investments. The firms told their investors that everything was A-OK.

Then Madoff was arrested for allegedly running a $50 billion Ponzi scheme, and investors got the devastating phone call: Oops, disregard previous statements. Sorry about that.

The question for investors is, are the auditors legally liable for their mistake?

As a general rule, auditors don’t dig deeply into partnerships that farm out money for others to invest. They look only at the top layer -- that is, the partnership itself. Madoff sent audited reports to Ascot and the other feeder funds, which incorporated them into the statements sent to investors. The funds’ own auditors checked that the numbers added up. Period. End of story.

To underline the limits of those responsibilities, BDO’s March 17, 2008, audit of Ascot said that it expresses no opinion on the “effectiveness of the partnership’s internal control over financial reporting.” I’ll say.

Auditor Sued

An enraged New York Law School, which allegedly lost $3 million, filed a class action lawsuit against BDO, as well as against Ascot Partners and its general partner, Ezra Merkin, chairman of GMAC LLC. The complaint charges that BDO ignored “red flags” that should have pointed to problems with the Madoff audit.

BDO responded aggressively, saying that the plaintiffs “seek to blame others for their own investment decisions.” It calls the charges “unfounded” and says that its audits followed “all professional standards.”

Accounting Professor Edward Ketz of Penn State University in State College, Pennsylvania, thinks that including BDO in the lawsuit is a stretch. “Accountants are entitled to rely on the audit reports of others,” he says. He likens it to being in a mutual fund that invests in Microsoft. The auditor checks the mutual fund’s reports but doesn’t investigate the accuracy of Microsoft’s books.

Question of Qualifications

All that’s true, says Lynn Turner, former chief accountant of the Securities and Exchange Commission, but with a proviso: “You have to assure yourself that the other auditor was qualified.”

That’s a tiny ray of light for the plaintiffs. Should BDO have asked questions about Friehling & Horowitz of New City, New York, the unknown firm that signed off on Madoff’s books? It was a one-accountant shop, with no other known audit clients, keeping track of what was supposedly a complex $17 billion dollar business.

“You have to ask, does the scale or expertise of the auditor call into question whether the audit can be relied on?” says Charles Mulford, accounting professor at the Georgia Institute of Technology in Atlanta. “That’s going to be a question for the courts.”

It’s a question for the accounting profession, too, which has probably been too complacent about third-party audits. Since Enron, federal standards have existed for firms that audit public companies but not for smaller firms. They fall under state jurisdiction.

Plugging the Gap

Until three weeks ago, New York was one of only six states that let auditors practice without undergoing peer review. After Bernie, New York hastily plugged that gap. Peer review is an independent check on an auditor’s quality controls.

Even if New York’s law had been in place, however, it wouldn’t have helped Madoff’s investors. The new law exempts firms with two or fewer accountants, such as Friehling & Horowitz. What’s more, for the past 15 years, David Friehling has claimed not to do audits, on an annual form he’s required to file by the American Institute of Certified Public Accountants.

Friehling hasn’t been heard from yet. His phones aren’t being answered and his office is reportedly for rent. As Madoff’s auditor, his job was to obtain objective information, through a clearing house or stock-transfer agent, to support the accuracy of the accounts. But Madoff was his own custodian and cleared his own trades, so all reports led back to Bernie’s now- infamous 17th floor.

Significant Case

For investors, the case against BDO -- as well as future cases against other big-name auditors -- is significant. It either didn’t occur to them to wonder about the Friehling firm or else they checked and Friehling passed. If the court concludes that that satisfied the law, then the law needs to be re-addressed.

After Enron and the failure of its accounting firm, Arthur Andersen LLP, the Public Company Accounting Oversight Board was born. The big firms grumble about the new rules, but they’ve forced a higher standard of care. Turner thinks that auditors for private firms should be brought under mandatory oversight, too.

There are two takeaways from this sad story:

First, when you put money under management, you should always write the check to a third-party, independent custodian, such as Schwab or TD Ameritrade, not to the manager’s own firm. An independent custodian lets the manager trade but prevents him or her from taking money out of the account. All withdrawals go to you.

Second, feeder funds are a racket. They collect the money, extract a large fee, and pass it on to another manager who does the work. By the time both levels of fees are paid, your principal probably will decline, even if the fund itself makes gains. The general partners in feeder funds have only one job: to be rich, mingle with the rich, and make the rich want to surrender their money, at any price. Not bad work, if you can get it.

(Jane Bryant Quinn, a leading personal finance writer and author of “Smart and Simple Financial Strategies for Busy People,” is a Bloomberg News columnist. She is a director of Bloomberg LP, parent of Bloomberg News. The opinions expressed are her own.)

U.S. Stocks Advance; General Motors, Citigroup Shares Climb

U.S. Stocks Advance; General Motors, Citigroup Shares Climb

Jan. 2 (Bloomberg) -- U.S. stocks advanced on the first day of trading in 2009, following the biggest annual drop for the Standard & Poor’s 500 Index in 71 years, on expectations government spending will curtail the recession.

General Motors Corp., the largest U.S. automaker, rallied 12 percent after receiving $4 billion in initial rescue loans from the Treasury to help it avoid collapse. Citigroup Inc. rose as much as 5.5 percent, while Alcoa Inc. climbed 8.9 percent and Home Depot Inc. added 2.8 percent. Starwood Hotels & Resorts Worldwide Inc. jumped as much as 18 percent on takeover speculation after agreeing to notify one of its largest investors of any offers.

“The worst has been seen,” Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said on Bloomberg Television. The firm manages $190 billion. “I’m not looking for a super year in 2009; I think we’ll do better” than in 2008.

The S&P 500 rose 1.7 percent to 918.92 at 11:36 a.m. in New York. The Dow Jones Industrial Average increased 148.87 points, 1.7 percent, to 8,925.26. The Russell 2000 Index of small U.S. companies advanced 0.8 percent.

Stocks in Europe and Asia rose today, trimming losses from last year’s record slump in the MSCI World Index, as investors speculated governments will step up efforts to revive the global economy and lower oil prices lifted retailers.

The S&P 500 decreased 38.5 percent in 2008, the most since the 38.6 percent plunge in 1937 and sank to an 11-year low on Nov. 20. Volatility increased, with the index rising or falling 5 percent in a single day 18 times.

Rebound from 11-Year Low

The benchmark index for U.S. equities has climbed more than 5 percent this week, extending its rebound from an 11-year low on Nov. 20 to almost 22 percent. Stocks rallied last month as the government rescued Citigroup, President-elect Barack Obama pledged to stimulate growth with spending on infrastructure projects and the Federal Reserve cut interest rates to as low as zero percent to combat the worst financial crisis in seven decades.

GM surged 38 cents to $3.58. The loans are part of $17.4 billion in financing that the Treasury has promised to GM and Chrysler LLC in a bid to avert a bankruptcy by either company. GM’s infusion will help the Detroit-based automaker pay suppliers as its cash dwindles.

Citigroup climbed 33 cents to $7.04. Chief Executive Officer Vikram Pandit and Chairman Win Bischoff will forgo 2008 bonuses after the bank lost three-quarters of its market value and got a $45 billion U.S. bailout, Pandit said on Dec. 31 in a memo to employees.

Hotels Gain

Starwood added $3.27 to $21.17 for the biggest gain in the S&P 500. The third-largest U.S. lodging company entered into a confidentiality agreement to give Equity Group Investments LLC the opportunity to top any third-party takeover bid, Starwood said in a regulatory filing.

Wyndham Worldwide Corp., the franchiser of Ramada and Super 8 hotels, advanced 13 percent to $7.39.

Stocks climbed even after a report showed manufacturing in the U.S. shrank in December at the fastest pace in almost three decades as the recession deepened and spread overseas. The Institute for Supply Management’s factory index fell to 32.2, less than forecast and the lowest level since 1980, from 36.2 the prior month, the Tempe, Arizona-based private group said today. Readings less than 50 signal contraction. The group’s price measure fell to the lowest level in almost six decades.

‘Priced In’

“A lot of the bad news is priced in,” said Matthew DiFilippo, director of research at Indiana, Pennsylvania-based Stewart Capital Advisors LLC, which manages $1 billion. “From an economic perspective we don’t expect good news for some time. In the long run the economy’s going to turn and earnings are going to improve.”

Oshkosh Corp. climbed 12 percent to $9.96. The Wisconsin- based maker of military trucks won a contract valued at as much as $1.12 billion to provide support services for heavy- and medium-duty trucks used by the U.S. government.

DryShips Inc. and Genco Shipping & Trading Ltd., whose vessels transport commodities, gained as rates to charter Capesize-class ships rose and China completed plans to support its steel and auto industries. Dryships rose 19 percent to $12.73. Genco added 16 percent to $17.16.

Europe’s Dow Jones Stoxx 600 Index climbed 3.6 percent today, while the MSCI Asia Pacific excluding Japan Index increased 1.1 percent. South Korea’s president pledged to counter the economic slowdown, while India’s central bank cut interest rates for the fourth time in less than three months, extending the steepest set of reductions since 2000.

Beer and Cigarettes

At its lowest closing level of 2008 on Nov. 20, the S&P 500 was down 49 percent for the year and 52 percent from its Oct. 9, 2007, record of 1,565.15. The plunge came as more than $1 trillion in credit-related losses at global financial companies triggered the first simultaneous recessions in the U.S., Europe and Japan since World War II.

Brewers and tobacco growers boosted by takeovers as well as discount retailers were about the only winners in 2008.

Anheuser-Busch Cos. jumped 31 percent after InBev NV agreed to acquire the owner of Budweiser beer to create the world’s biggest brewer. Wal-Mart Stores Inc., the biggest retailer, and restaurant operator McDonald’s Corp. were the only two companies in the 30-stock Dow average that rose last year.

Corporate profits have fallen seven straight quarters, according to the U.S. Bureau of Economic Analysis. Should earnings fall through the first half of 2009, as analysts surveyed by Bloomberg project, it would be the longest streak since the government began tracking quarterly data in 1947.

The Chicago Board Options Exchange Volatility Index, known as Wall Street’s fear gauge, posted a 78 percent gain to 40 in 2008. Its close of 80.86 on Nov. 20 was the highest in its 19- year history. The so-called VIX, a measure of how much investors are paying for insurance from stock declines in the options market, had never exceeded 50 before October. It slid 5.6 percent today.

Let's Be Worthy of Their Sacrifice

Let's Be Worthy of Their Sacrifice

'The wounds I received I got in a job I love.'

KARL ROVE

This holiday season, home in Texas and surrounded by close friends and family, I often found myself thinking about virtual strangers.

Corbis

A Navy Seal at work in Afghanistan.

I met them this fall when I spoke at the Naval Special Warfare Foundation (NSWF) dinner. The NSWF supports naval commandoes with scholarships and assistance for families of Navy Seals killed or wounded in combat or training.

During my White House years, I came to know of the heroic actions of the Seals and other special operators in the global war on terror. These men willingly follow evil into dark and perilous places. They volunteered to be on the front edge of the conflict whose outcome will shape this century.

The highlight of the NSWF dinner was a video of "snatch and grab" operations in Afghanistan. It showed helicopters lifting off to pounding music, night footage of Seals jumping onto roofs and rappelling into dusty fields, the breathtakingly destructive power of American missiles and machine guns, and compound doors blowing open and terrorist suspects being rounded up.

The Seals who prepared the video had carefully mined President Bush's speeches, using his voice and words as narration. I was touched by this and knew the president would be, too. So when I met the Seal who'd produced the video, we exchanged email addresses. Later, before he left for Afghanistan for his umpteenth deployment, I asked for a copy of the video to show the president.

About Karl Rove

Karl Rove served as Senior Advisor to President George W. Bush from 2000–2007 and Deputy Chief of Staff from 2004–2007. At the White House he oversaw the Offices of Strategic Initiatives, Political Affairs, Public Liaison, and Intergovernmental Affairs and was Deputy Chief of Staff for Policy, coordinating the White House policy making process.

Before Karl became known as "The Architect" of President Bush's 2000 and 2004 campaigns, he was president of Karl Rove + Company, an Austin-based public affairs firm that worked for Republican candidates, nonpartisan causes, and nonprofit groups. His clients included over 75 Republican U.S. Senate, Congressional and gubernatorial candidates in 24 states, as well as the Moderate Party of Sweden.

Karl writes a weekly op-ed for The Wall Street Journal, is a Newsweek columnist and is now writing a book to be published by Simon & Schuster. Email the author at Karl@Rove.com or visit him on the web at Rove.com.

He was happy to supply one but had a request in return. Could the wives and children of his unit's members see the White House Christmas decorations while their husbands and fathers were deployed?

The First Lady readily agreed and with NSWF's help, 75 Seal family members were greeted at the White House just before Christmas by the president and Laura Bush. It was one of the high points of Mr. Bush's last holiday in Washington.

On Christmas Eve, I received an email from Afghanistan, with thanks for helping to facilitate the tour. Attached was a picture of the videographer and his team, ready for that night's mission. Bearded and scruffy, covered with weapons and standing in a rude shelter, they were all wearing bright red Santa Claus hats. It was the best gift I received this Christmas.

I met another Seal at that NSWF dinner. He'd been shot eight times in Iraq and had undergone nearly two-dozen operations. One bullet had taken off part of his cheek and nose. He was destined for reconstructive surgery in a few days.

Yet he didn't feel sorry for himself. He was full of charisma, confidence, cockiness and joy. After all, he confided, when you're a wounded Seal, the world's best doctors want to operate on you so they can brag about it. Besides, he explained, he was just showing that a Seal really could catch bullets with his teeth.

He said that after a couple more procedures, he'd "be back in the game." I asked what he meant. He was amused and said he was going back into action. "My team needs me," he said before letting out a laugh. But you knew he meant it, and you knew his team did need him.

He went off to get a drink for his wife. I didn't want to pry, but I asked her how she felt about him going back into action. She said she was all for it because that's what he was made for. I had to fight back tears.

The next day, I got an email from the retired Navy Seal buddy who'd talked me into speaking at NSWF. He shared a picture of the sign the wounded Seal put on his Baghdad hospital door.

On it, the Seal had scrawled that visitors shouldn't "feel sorry" for him. "The wounds I received," he wrote, "I got in a job I love, doing it for people I love, supporting the freedom of a country I deeply love. I am incredibly tough." And on his sign he promised "a full recovery" and wrote that his hospital room was a place of "fun, optimism, and intense rapid regrowth. If you are not prepared for that, GO ELSEWHERE." He signed it "The Management."

I keep this picture with me so I think every day about those I met this fall. And I thought about them often during the holidays.

When I did, I felt awe that such men and women exist, and gratitude that they put themselves in harm's way for our nation. I hope America continues to be worthy of such staggering service and sacrifice.

May the New Year bring safety to all who wear our country's uniform, success in the missions they so passionately believe in, peace and comfort to their families, and reunion with all whom they love.

Mr. Rove is the former senior adviser and deputy chief of staff to President George W. Bush. NSWF can be found at nswfoundation.org.

Conservatives Can Unite Around the Constitution

Conservatives Can Unite Around the Constitution

The coalition that supported Reagan is as viable as ever.

PETER BERKOWITZ

After their dismal performance in November, conservatives are taking stock. As they debate the causes that have driven them into the political wilderness and as they contemplate paths out, they should also take heart. After all, election 2008 shows that our constitutional order is working as designed.

Ken Fallin

Frank Meyer

The Constitution presupposes a responsive electorate, and respond the electorate did to the vivid memory of a spendthrift and feckless Republican Congress; to a stalwart but frequently ineffectual Republican president; and to a Republican presidential candidate who -- for all his mastery of foreign affairs, extensive Washington experience, and honorable public service -- proved incapable of crafting a coherent and compelling message.

Indeed, while sorting out their errors and considering their options, conservatives of all stripes would be well advised to concentrate their attention on the constitutional order and the principles that undergird it, because maintaining them should be their paramount political priority.

A constitutional conservatism puts liberty first and teaches the indispensableness of moderation in securing, preserving and extending its blessings. The constitution it seeks to conserve carefully defines government's proper responsibilities while providing it with the incentives and tools to perform them effectively; draws legitimacy from democratic consent while protecting individual rights from invasion by popular majorities; assumes the primacy of self-interest but also the capacity on occasion to rise above it through the exercise of virtue; reflects, and at the same time refines, popular will through a complex scheme of representation; and disperses and blends power among three distinct branches of government as well as among federal and state governments the better to check and balance it. The Constitution and the nation that has prospered under it for 220 years demonstrate that conserving and enlarging freedom and democracy depends on weaving together rival interests and competing goods.

Unfortunately, contrary to the Constitution's lesson in moderation, the two biggest blocs in the conservative coalition are tempted to conclude that what is needed now is greater purity in conservative ranks. Down that path lies disaster.

Some social conservatives point to the ballot initiatives this year in Arizona, California and Florida that rejected same-sex marriage as evidence that the country is and remains socially conservative, and that any deviation from the social conservative agenda is politically suicidal. They overlook that whereas in California's 2000 ballot initiative 61% of voters rejected same-sex marriage, in 2008 only 52% of voters in the nation's most populous state opposed the proposition. Indeed, most trend lines suggest that the public is steadily growing more accepting of same-sex marriage, with national polls indicating that opposition to it, also among conservatives, is weakest among young voters.

Meanwhile, more than a few libertarian-leaning conservatives are disgusted by Republican profligacy. They remain uncomfortable with or downright opposed to the Bush administration's support in 2004 for a constitutional amendment banning same-sex marriage, and its continuation of the Clinton administration's moratorium on government funding of embryonic stem-cell research.

In addition, many are still angry about the Republican-led intervention by the federal government in the 2005 controversy over whether Terri Schiavo's husband could lawfully remove the feeding tubes that were keeping his comatose wife alive. These libertarian conservatives entertain dreams of a coalition that jettisons social conservatives and joins forces with moderates and independents of libertarian persuasion.

But the purists in both camps ignore simple electoral math. Slice and dice citizens' opinions and voting patterns in the 50 states as you like, neither social conservatives nor libertarian conservatives can get to 50% plus one without the aid of the other.

Yet they, and the national security hawks who are also crucial to conservative electoral hopes, do not merely form a coalition of convenience. Theirs can and should be a coalition of principle, and a constitutional conservatism provides the surest ones.

The principles are familiar: individual freedom and individual responsibility, limited but energetic government, economic opportunity and strong national defense. They are embedded in the Constitution and flow out of the political ideas from which it was fashioned. They were central to Frank Meyer's celebrated fusion of traditionalist and libertarian conservatism in the 1960s. And they inspired Ronald Reagan's consolidation of conservatism in the 1980s.

Short-term clashes over priorities and policies are bound to persist. But championing these principles is the best means over the long term for conserving the political conditions hospitable to traditional morality, religious faith, and the communities that nourish them. And it is also the best means over the long term for conserving the political conditions that promote free markets, and the economic growth and expanded opportunity free markets bring.

Moreover, a constitutional conservatism provides a framework for developing a distinctive agenda for today's challenges to which social conservatives and libertarian conservatives can both, in good conscience, subscribe. Leading that agenda should be:

- An economic program, health-care reform, energy policy and protection for the environment grounded in market-based solutions.

- A foreign policy that recognizes America's vital national security interest in advancing liberty abroad but realistically calibrates undertakings to the nation's limited knowledge and restricted resources.

- A commitment to homeland security that is as passionate about security as it is about law, and which is prepared to responsibly fashion the inevitable, painful trade-offs.

- A focus on reducing the number of abortions and increasing the number of adoptions.

- Efforts to keep the question of same-sex marriage out of the federal courts and subject to consideration by each state's democratic process.

- Measures to combat illegal immigration that are emphatically pro-border security and pro-immigrant.

- A case for school choice as an option that enhances individual freedom while giving low-income, inner-city parents opportunities to place their children in classrooms where they can obtain a decent education.

- A demand that public universities abolish speech codes and vigorously protect liberty of thought and discussion on campus.

- The appointment of judges who understand that their function is to interpret the Constitution and not make policy, and, therefore, where the Constitution is most vague, recognize the strongest obligation to defer to the results of the democratic process.

If they honor the imperatives of a constitutional conservatism, both social conservatives and libertarian conservatives will have to bite their fair share of bullets as they translate these goals into concrete policy. They will, though, have a big advantage: Moderation is not only a conservative virtue, but the governing virtue of a constitutional conservatism.

Mr. Berkowitz is a senior fellow at Stanford University's Hoover Institution. An expanded version of this article is forthcoming in Policy Review.

The Euro Decade and Its Lessons

The Euro Decade and Its Lessons

How to rebuild the global financial system.

The single European currency, born on New Year's Day in 1999, is a rare economic shining star of the past decade. The euro's record also offers timely lessons for the debate about how to rebuild the global financial system.

AP

Outside EU Council headquarters in Brussels.

At its birth, these columns called the euro "the most ambitious experiment since the launching of the Bretton Woods system at the end of World War II." Now Nicolas Sarkozy and others want a new Bretton Woods. In a speech to the European Parliament in October, the French President said that "the monetary system should be rethought [within] fixed exchange rates." For our money that's about the best economic insight Mr. Sarkozy has offered.

The euro's great achievement has been to provide a stable means of exchange for the world's largest single market. Currency risk was ended and transaction costs cut for anyone doing business in eurozone countries, which number 16 with Slovakia's entry yesterday. Such an outcome was far from assured. The idea had gestated for decades and met deep skepticism. In the November/December 1997 edition of Foreign Affairs, U.S. economist Martin Feldstein predicted the euro "could lead to conflicts in Europe and confrontations with the United States."

But it didn't take long for Europeans to forget their francs, Deutsch marks and pesetas once euro coins and notes came into circulation in 2001. Travel was made easier, as was trade and investment. Interest rates fell. Prices for labor and goods were suddenly transparent across the bloc, increasing competition. As important, the creation of a single European Central Bank (ECB) has better insulated monetary policy from political manipulation. Politicians could no longer attempt to inflate their way out of their employment or fiscal problems. National central banks could no longer finance fiscal deficits, removing a source of economic instability.

The single economic space anchored by the euro has also forced European policy makers to compete for people, goods and capital with improved policies. While we had hoped to see more reform by now, the pan-European reduction in corporate tax rates is one fiscal benefit of the euro. Even Germany has cut corporate taxes, after its efforts to harmonize rates across the European Union failed.

The current financial storm has also shown the benefits of a common currency. Some countries have been harder hit than others, and we hear again that a monetary policy conducted by a multinational ECB favors big states like France and Germany and will push the eurozone to the breaking point. Yet in the panic of the last year the Continent would have suffered more without the euro -- from currency devaluations and wildly diverging interest rates. This is the reason so many other EU countries want to join, and Italy for all of its economic problems stays in. Membership brings too many privileges.

The monetary trauma of the last 10 years hasn't come from the euro but instead from its volatility against the dollar. The nearby chart tracks this movement from the euro's birth at 1.18 euros per dollar to its close New Year's Eve at 1.39. Like most currencies, the euro declined during the strong-dollar era of the late-1990s, only to soar against the greenback as the U.S. Federal Reserve made its historic mistake of flooding the world with dollars earlier this decade. It declined mid-decade as the Fed belatedly tightened, only to soar again in late 2007 and early 2008 as the Bernanke Fed gunned the money supply once more. After an even briefer decline, the euro has climbed sharply again since Mr. Bernanke cut rates virtually to zero last month and signaled his new policy would be "quantitative easing" -- i.e., printing as much money as it takes to revive the U.S. economy.

While it is rarely discussed in the financial press, this volatility imposes huge costs on global commerce. The greenback's 18% decline against the euro in the last 10 years is effectively a 18% price increase on all goods to the U.S. from the eurozone. Sharp and unpredictable exchange-rate movements lead to the misallocation of capital and mistaken business judgments. The excessive depreciation of the dollar against the euro in late 2007 and early 2008, followed by its spectacular recovery in the third quarter of 2008, led to the overshooting in both directions of oil prices.

Robert Mundell, the Nobel laureate and intellectual father of the euro, has argued plausibly that a major catalyst for the escalation of the financial panic in September and October of 2008 was the sudden if temporary rise of the dollar against the euro after a year of rapid decline. The deflationary impact presented banks with larger losses on their dollar assets.

One irony of the current moment is that Europeans seem to understand the dangers of floating exchange rates better than Americans do. ECB President Jean-Claude Trichet said in 2008 that the responsibility of a central bank is "to avoid additional volatility in already highly volatile markets." As its strong record on fighting inflation shows, the ECB lives by this mantra. The Fed has not during this decade, with tragic results.

For Mr. Mundell -- and former Fed Chairman Paul Volcker -- the lessons point to the eventual need for a single global currency. That may be a political leap too far. But the world could still harness the benefits of exchange-rate stability if its political and economic leaders began to discuss how better to coordinate monetary policy. Mr. Mundell suggests, for starters, a mechanism for close coordination among the Fed, the ECB, and the Banks of England, China and Japan.

In the wake of the financial meltdown and with a new Administration in Washington, new progress may be possible. The Bush Administration has been clueless on monetary issues, with all three of its Treasury Secretaries repeating that the price of currencies should be set like the price of any other commodity. But the supply of corn, say, isn't set by a cartel of central banks and copper isn't a medium of global commerce. With Mr. Volcker's help, President-elect Obama has a unique chance to exercise global monetary leadership.

The decade of the euro has demonstrated that there is an alternative to the instability and volatility of the era of floating exchange rates that began with the collapse of Bretton Woods in 1971. It's time to build on that lesson for the good of free markets and global prosperity.

Thursday, January 1, 2009

Peter Schiff 12/31/08 - Wall Street Unspun [Part 6] New Years Ed

Bush and Obama Opt for Corporatism over Freewheeling Capitalist Economy

Bush and Obama Opt for Corporatism over Freewheeling Capitalist Economy

by David Boaz

David Boaz is executive vice president of the Cato Institute and author of The Politics of Freedom: Taking on the Left, the Right, and Threats to Our Liberties.

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Is Barack Obama a socialist? Not really. Is George W. Bush a free marketer? Not hardly. In fact, right now they both seem to be pursuing policies that are neither socialist nor laissez-faire but rather corporatist.

The Bush administration has spent close to a trillion dollars to keep the managers of big companies in the driver's seat. Instead of a free-market policy of letting the market determine winners and losers, the administration says Bear Stearns, AIG, Citigroup and other big Wall Street firms are "too big to fail." They can take dramatic risks and the taxpayers will cover them.

For the first time, the government is supporting mortgages and consumer borrowing — up to $800 billion worth. As critics complain that banks have lured consumers into mountains of unaffordable debt, the government is seeking to shore up credit cards, auto loans and other consumer debt.

Timothy Geithner, president of the New York Federal Reserve Bank, has been a key player in these bailouts. He is Obama's choice to be Treasury secretary. Obama himself wants to extend the government's new programs to support specific companies, including the major car manufacturers, bailing them out at a cost that would begin at $25 billion.

In all these cases the government is seeking to support existing businesses. That isn't laissez-faire. It isn't what free-market advocates support. But it is what Bush is doing and Obama wants to continue.

Corporatism has a history in American economic policy, but it has generally been advanced as a guiding philosophy only in other countries. Corporatism was seen as an alternative to both the egalitarianism of the French Revolution and the laissez-faire economics of Adam Smith, with the state working closely with the different elements of society, especially labor and business.

As the Nobel laureate Edmund Phelps wrote: "The fundamental corporatist idea was to retain the private income, private wealth and private ownership of firms that (were) so central to capitalism (and found in avant-garde examples of market socialism too) but to remove the brain of capitalism — to curtail and to modify the mechanism of experiments and discoveries undertaken by unorganized entrepreneurs and financiers on which capitalism relied. . . . Corporatism sought to interpose the interests of the whole society in a range of decisions affecting the directions taken in the business sector."

The real choice Americans face is whether we want a free market or a corporate state.

We've always had some elements of the corporate state in America — subsidies, tariffs, monopoly privileges, regulatory cartels — but we've prospered because of the freewheeling entrepreneurship and creative destruction that characterizes most of our economy.

In a few short months, the Bush administration has turned the focus of our economy to corporatism. Every day brings another story about businessmen seeking their profits in Washington, not the marketplace:

• Life insurance companies are seeking to buy savings and loan institutions in order to qualify for a piece of the $700 billion bailout fund.


• Realtors and homebuilders are asking for mortgage subsidies, tax credits and interest-rate "buydowns" to stimulate demand for their product.


• Recently "the health insurance industry said" — a pretty corporatist phrase right there — that it would support regulations requiring insurers to accept all customers, regardless of illness or disability, as long as Congress would require every American to buy insurance.


• After Congress turned down a bailout for the car companies, the firms are asking the Bush administration to fund them on its own authority.

Meanwhile, Obama advisers are saying that if the federal government invests billions of dollars in businesses, it should get some influence on company policies regarding foreclosures, lending, executive compensation, environmental effects and product lines.

So politicians would be making important corporate decisions, which means less attention to meeting consumer demands and more emphasis on satisfying outside interest groups.

Some bailout advocates want to go even further.

Jonathan Cohn of the New Republic suggests that the federal government use its new power over the auto companies to fire a General Motors vice chairman who has expressed skepticism about the catastrophic effects of global warming, and congressional Democrats wanted to forbid the firms from filing lawsuits against state environmental regulations.

That's corporatism for you: Big, established corporations get taxpayers' money as long as any dissenting scientific or political opinions are suppressed.

Socialism is dead even in Moscow and Beijing.

The real choice Americans face is whether we want a free market or a corporate state.