The dangers of war by remote control

Johann Hari has written a valuable piece on the dangers of drone warfare in Afgha-Pakistan called Obama's Escalating Robot War in Pakistan Is Making a Terror Attack More Likely.

Imagine if, an hour from now, a robot plane swooped over your house and blasted it to pieces. The plane has no pilot. It is controlled with a joystick from 7,000 miles away, sent by the Pakistani military to kill you. It blows up all the houses on your street, and so barbecues your family and your neighbors until there is nothing left to bury but a few charred slops. Why? They refuse to comment. They don't even admit the robot planes belong to them. But they tell the Pakistani newspapers back home it is because one of you was planning to attack Pakistan. How do they know? Somebody told them. Who? You don't know, and there are no appeals against the robot.

Now imagine it doesn't end there: These attacks are happening every week somewhere in your country. They blow up funerals and family dinners and children. The number of robot planes in the sky is increasing every week. You discover they are named "Predators," or "Reapers" -- after the Grim Reaper. No matter how much you plead, no matter how much you make it clear you are a peaceful civilian getting on with your life, it won't stop. What do you do? If there were a group arguing that Pakistan was an evil nation that deserved to be violently attacked, would you now start to listen?

This sounds like a sketch for the next James Cameron movie -- but it is in fact an accurate description of life in much of Pakistan today, with the sides flipped. The Predators and Reapers are being sent by Barack Obama's CIA, with the support of other Western governments, and they killed more than 700 civilians in 2009 alone -- fourteen times more than the 7/7 attacks in London. Last month there was the largest number of robot plane bombings ever: 21. Over the next decade, spending on drones is set to increase by 700 percent.

This supposedly 'safe' (for the Americans) warfare is likely to breed greater antagonism to the US than has existed beforehand.

I have long thought that the argument that the US is making the world safe from terrorism by fighting the Taliban was a furphy. The reasons why the US are there are complex, but Al Qaida is a franchise and can simply shift to somewhere else disillusioned with the US in the Islamic world (e.g. Yemen).

Like Lyndon Johnson before him, Obama has some great ideas for American society, but he continues to be a war President, prosecuting outrageous acts against civilians.  

Consumer Price Index

The latest figures from the Australian Bureau of Statisitcs show that inflationary pressures as measured by the CPI are relatively sedate. (The CPI is one measure of inflation - there is also the Producer Price Index)

Some pundits argue that this means that the RBA may be willing to hold off on a Melbourne Cup Day interest rate rise. The CPI figures came in at 0.7 per cent for the quarter and 2.8 per cent for the year

The RBA operates with an inflation target of between 2 and 3 per cent, but it gives greater credence to what is called underlying inflation. According to Michael Janda from ABC:

The Reserve Bank's preferred trimmed mean and weighted median measures of inflation came in at 0.6 and 0.5 per cent for the three months to September, virtually unchanged from the 0.5 per cent result for both last quarter.

That leaves underlying inflation running between 2.3 and 2.5 per cent for the year to September, depending which measure you look at.

What is interesting though is that key expenses for all of us have gone up - health, education and housing. Also not a great time to be a smoker or drinker, although food prices rises have been subdued.

House Prices

The never-ending debate about house prices continue, with The Economist providing some ammunition for those arguing that Australia's house prices are ripe for a fall. In Queensland the property sector is far from buoyant but there's also a chance that we could be in for a period of settled prices. To be honest I haven't a clue, although I know the cases for both sides (see earlier posts for the debate).

A house price fall would be negative for many people in Australia partly because rising house prices make people feel wealthier. I think it's unlikely that there'll be a rapid price fall anytime soon, which means that I'll be forever locked out of the housing market!

But anyway here's The Economist's table:

From 1997 to 2010 house prices increased by 220%. I knew there was something I should have been doing with my cash in the 1990s instead of going out for expensive breakfasts all the time. Looks like I missed the boat, but maybe we'll be thinking in 2023, "sheesh I wish I'd bought a house in 2010". Who knows?

What we do know is that right now it's much better to be living in Australia than in other countries where they speak English.

More on the Dollar

Two articles today provide different slants on the rise of the dollar the first provides an international focus and is by Peter Hartcher. He argues in "We may have landed booby prize in the currency wars" for the importance of US Dollar weakness in the Aussie rising story:

Countries everywhere are trying to cheapen their currencies to win a competitive edge over each other in world export markets. It's classic "beggar they neighbour" stuff.

By doing this, a country seeks advantage at the expense of others, trying to push its economic misery onto its competitors. When a number of big countries do this at once, you have a "competitive devaluation", a race to the bottom.

A rising dollar according to Hartcher is a "perverse victory, an apparent win for national pride that qualifies us for economic punishment ... overwhelmingly, the Aussie is strong now because the US dollar is weak."

While the Aussie has gained 10 per cent over the US currency over the past 12 months, almost all other currencies have risen against the US unit, too - India's by 2 per cent, Canada's by 3, Sweden's by 5, South Africa's by 7 and Japan's by 10.

A number of governments are desperately trying to resist this tide, fearing that their exports will lose a competitive edge as their currencies rise - South Korea, Taiwan and Japan have all intervened in the market to try to cheapen their money.

The main story, however, is China which is not trying to devalue its currency but prevent it from rising too rapidly.

The Chinese currency is already undervalued by every measure, yet it cannot rise because it is fixed by Beijing's decree. Other capitals, especially Washington, are livid. The US Congress is afire with threats of trade sanctions against China for "stealing American jobs" by "artificially manipulating its currency".

The US Treasury secretary, Timothy Geithner, cannot accuse China of joining the competitive devaluation, but he has accused it, as one commentator put it, of setting off a cycle of ''competitive non-appreciation". The meeting of world finance ministers and central bankers two weekends ago for the IMF annual meeting was supposed to deal with this problem. It failed.

The US, despite popular perceptions has powerful options of its own to deal with the problem, as Hartcher points out:

Last Friday Ben Bernanke, the chief of the US central bank, the Federal Reserve, signalled that he was preparing to send a new flood of free money into the country's economy, under the innocuous technocratic name of quantitative easing of money, or QE.

This is an admission of economic desperation from Washington. The Fed has already pushed interest rates to near zero. It has already sent out one flood of free money, called QE1, where it bought up $US1.7 trillion worth of mortgage and other debt, in effect pushing money into the hands of the sellers in the hope they will invest or spend it to simulate the economy.

Now Bernanke was announcing QE2. By hugely increasing the number of US dollars in circulation, this will push the greenback's value down further. It was this speech of Bernanke that sent the US dollar so low as to match the Aussie on Friday. 

Dr Ken Courtis, an international economist and former vice-chairman of Asia for Goldman Sachs, said: "The US is doing a lot of screaming about currency manipulation, but it's the one doing the manipulating, and no one has called them on it."

QE2 is just another way for the US to devalue its dollar to pursue export advantage over others. Courtis says: "The US public and private debt is running at 400 per cent of GDP. It's naive to expect that amount of debt to be repaid."

By devaluing its currency and by increasing its inflation rate, the US is trying to "melt away some of its debt at the margin", Courtis says. "This crisis is really the breakdown of the post-Bretton Woods international monetary system" as the US dollar's reserve status comes into question.

With the price of gold rising and private banks reopening gold vaults to accept investors' gold for the first time in two decades, "gold is the precursor", Courtis says. Increasingly, investors will store wealth in hard assets, including resources, real estate and agricultural land. Australia may have won the booby prize in the global currency war.

But, Courtis says, it will be well placed in this new world, because it has plentiful supplies of the most desirable hard assets.

QE2, Courtis jokes darkly, should be renamed Titanic 2.

A more sanguine take on a rising currency comes from Peter Martin, one of Australia's best economic commentators. In "Sit back and enjoy the wealth a higher dollar brings", Martin compares a rising dollar to a pay rise for all Australians. Although he doesn't note that like all pay outcomes in Australia some do much better than others.

NEVER let anyone tell you the high dollar is a bad thing. Unless you're the kind of person who wouldn't want a pay rise. The sharp increase in the dollar is boosting the buying power of every dollar we have.

If this is making you feel uneasy because the wealth seems unearned, lighten up. When our dollar bought less than half of what it does now (US47.75c in 2001) we accepted the impoverishment with grace.

As Martin points out the rise in the dollar - or increased international buying power has been earned through massive price increases in coal and iron ore prices (coking coal up 60%, iron ore up 100%)

Our miners are shifting more of the stuff as well, meaning the buyers (often in China) need to swap a lot more of their currency into our currency to complete the transaction, pushing up the price of our dollar and making even those of us who don't mine better off.

A higher dollar helps to distribute mining generated wealth throughout the economy, as do increased royalties and taxes, dividends and share prices, and industries that service the mining industry. Martin likens this (tongue in cheek) to "automatic socialism - spreading the gains (just as a lower dollar helps spread the losses when our export earnings fall)."

But there are losers, even if Martin gives mainly short shrift to their arguments saying that concerns have diminished over time.

The losers are traditionally said to be Australia's manufacturers, who compete with imports or try to sell their products overseas.

In a direct sense manufacturers also benefit from the higher dollar. Every dollar a manufacturer earns, every dollar a manufacturer has already saved, buys more. But in the same way as having a higher wage might put a job seeker at a disadvantage when it comes to getting or keeping a job, suddenly charging a higher price when expressed in foreign dollars will make it harder to sell your product. At home you will be competing against suddenly more affordable imports.

This is partly true but really a higher dollar is mainly negative for the tradeable manufacturing sector. Martin's argument that it matters less now because there are fewer manufacturers than there once was is also slightly comical.

It's less of a concern now, in part because there's less manufacturing than there was. Most of the Australian textile and clothing firms that used to compete with overseas suppliers have shut up shop. Mitsubishi has stopped making Australian cars.

And the manufacturers that are still here are increasingly importers as well as exporters. Holden imports parts for the cars it sells here and exports. Many firms are now so integrated across borders that it is hard to tell whether they export, import or just produce.

In Parliament yesterday Treasurer Wayne Swan rattled off the usual list of supposed victims of the higher dollar, ''trade-exposed industries such as tourism, manufacturing, agriculture and education finding it tougher to compete in global markets''.

He then points out the agriculture has also benefitted from higher prices for many products and the end of the drought might have come at the right time for many farmers. Indeed agriculture is a factor in a rising dollar

Official forecasts have the global wheat price up 20 per cent this year. The volume of wheat leaving the country will be up 33 per cent. The global beef price will climb 5 per cent, the global wool price 2 per cent. Agriculture is likely to join mining as one of the causes of the higher dollar in the year ahead rather than languish as one of its victims.

Sadly he is correct in pointing out that the education sector (Australia's third largest export) will be badly affected.

Education will do very badly. But it was set to do badly anyway. Bad providers of education have damaged the brand. The higher dollar will make the poor service the industry provides to overseas customers all the more apparent.

One wonders whether Asian students will still come to Australia if the dollar is worth $1.20 US. While the  education sector has made some mistakes, other parts of the economy will be badly affected through no fault of their .

Broadly, anyone who sells a service without a significant import component will find their product less attractive.

Tourism providers are a good example. (Although not the international airlines. We left the country an extraordinary 600,000 times in August, up 13 per cent on the year before.) Artisans and computer programmers are other examples.

Australians making musical instruments or software, for example, will find themselves undercut - unless they cut their prices. I am not being flippant. No one likes to cut their prices (except smart firms such as Coles and Aldi who have discovered there's money in it.)

But quoting a constant US dollar price on a website is one way to do it with dignity. Another way is to do it knowing that although you are charging fewer Australian dollars each is worth more.

Trying to stop the dollar climbing - trying to stop Australians becoming more wealthy in a mining boom - is next to impossible.

But if you want to try, Norway points the way. It imposes a petroleum super profits tax of 50 per cent and stores the loot offshore where it can't push up the currency.
It has succeeded in not giving itself a pay rise.

Now I know that Martin has in the past supported the Norwegian model so either he has had a change of heart or this whole exercise has been slightly tongue in cheek. We should be thinking about the future and putting off some of our so-called pay rise to benefit current and future Australians. We need to occasionally think that we are producers as well as consumers and while the consumer in us always wants lower prices, we need to produce to be able to consume. This doesn't mean closing ourselves off, rather it means simply thinking of innovative ways to increase our productivity and economic diversity.

The Rise and Rise of the Aussie Dollar

Now that the Aussie dollar has hit parity with the USD (if only briefly) currency issues are in the news. Over time, even with freely floating currencies it's possible for exchange rates to become skewed. One way to consider whether exchange rates are in line is through the concept of purchasing power parity (PPP).

A popular representation of PPP values is the Economist magazine’s tongue-in-cheek Big Mac Index, which compares the price of Big Macs around the world. According to PPP theory, the cost of Big Macs should be the same across countries once local currencies are converted to US dollars. A Big Mac in Switzerland ($6.78) will cost you a lot more than a Big Mac in China ($2.18) suggesting that the Swiss Franc is overvalued and the Yuan undervalued against the USD.

Right now the AUD is at 99.05 US cents. Now a Big Mac is $A4.35 meaning that it's worth $US4.31, which suggests that the Aussie is overvalued.

Big Macs are not really a good marker of PPP because they are generally considerably more expensive than local-food items in developing countries! There is also now an iPod Index, which does the same thing, but with a high technology, tradeable item rather than a basic food item This is significant because products that can be easily traded should, through the process of arbitrage, end up with the same price (allowing for exchange rates).

According to news reports Australia is one of the dearest places to buy an iPod Nano, suggesting also that the AUD is overvalued. In the real world, however, other factors play a big role, like the competitiveness of the US market and the costs of buying one in the US and sending it to Australia.

Unemployment and the Global Recession: Australian Exceptionalism

Australia's employment/unemployment outcomes during the global crisis has been truly outstanding. This is made incredibly clear from some excellent graphs in Treasurer Wayne Swan's regular Economic Note.

Wayne Swan's Economic Note surprisingly provides (seeing as he is a politician!) a good summary of key economic developments. Obviously Swan is biased towards selling his own book, but I often get some useful information from it (suitably filtered for bias). This week's note is no exception.

Swan shows two graphs explaining why "the worst economic downturn since the Great Depression" has had not been felt strongly in Australia and why talking about concepts of economic vulnerability are so difficult!

Now the debate really is over why this occurred and what the major factor in this amazing outcome actually was: luck, good policy or China. While the right of the political spectrum argues that China is most important and that the GFC ands the global recession were really a North Atlantic phenomenon, the Left argues that government played the major role.

To downplay the real dangers to the Australian economy in 2007-08 is silly. Government in Australia played a major role not just in spending initiatives but by providing government guarantees to the financial sector. Equally it would be silly to argue that China hasn't play a major role since 2009.

What is definitely true is that a lot of things have gone right for Australia over the past 18-20 years, just as a lot of things went poorly for the previous 18-20 years . Government policy since 1983 has been important, especially in making the Australian economy more adaptable to external shocks. But it now needs to play a bigger role in distributing Australia's luck across society and extending it into the future.

An Alternative View on Japan's Stagnation

There can be lots of easy comparisons between the economic crisis faced by Japan twenty years ago and the crisis now facing the United States. Both had severe real estate and financial busts which badly affected the real economy.

The literature on financial crises points out that financial crisis induced recessions go for longer than boom-bust business cycle recessions and this appears to be happening currently in the United States where consumers are restricting their spending to deal with the build-up of debt.

The general contention is that Japan failed to deal with its crisis and as a consequence has suffered twenty years of stagnation. Some worry that the United States is facing a long period period of sub-par growth.

Paul Krugman seems to delight in iconoclasm - or what we might call contrariness.

A decade ago, Japan was a byword for failed economic policies: years after its real estate bubble burst, it was still suffering from chronic deflation and slow growth. Then America had its own bubble, bust and crisis. And these days, Japan’s record doesn’t look that bad to an American eye.

Why not? For all its flaws, Japanese policy limited and contained the damage from a financial bust. And the question in America now is whether we’ll do the same — or whether we will take a hard right turn into economic disaster.

In the 1990s, Japan conducted a dress rehearsal for the crisis that struck much of the world in 2008. Runaway banks fueled a bubble in land prices; when the bubble burst, these banks were severely weakened, as were the balance sheets of everyone who had borrowed in the belief that land prices would stay high. The result was protracted economic weakness.

And the policy response was too little, too late. The Bank of Japan cut interest rates and took other steps to pump up spending, but it was always behind the curve and persistent deflation took hold. The government propped up employment with public works programs, but its efforts were never focused enough to start a self-sustaining recovery. Banks were kept afloat, but were slow to face up to bad debts and resume lending. The result of inadequate policy was an economy that remains depressed to this day.

But Krugman argues the black and while view of Japan's 'failure' is too simplistic and although its economy has been depressed it has avoided depression. Unemployment remained at relatively low levels compared to the current US situation partly because of government spending. The verdict is that Japan has avoided disaster. For the US the jury is still out and Krugman worries that the Republicans are stopping any comprehensive solution for a weak economy. 

Like their Japanese counterparts, American policy makers initially responded to a burst bubble and a financial crisis with half-measures. I’ve lamented that fact, but at this point it’s water under the bridge. The question is: What happens now?

Republican obstruction means that the best we can hope for in the near future are palliative measures — modest additional spending like the infrastructure program President Obama proposed this week, aid to state and local governments to help them avoid severe further cutbacks, aid to the unemployed to reduce hardship and maintain spending power.

Even with such measures, we’ll be lucky to do as well as Japan did at limiting the human and economic cost of the economy’s financial woes. But it’s by no means certain that we’ll do even that much. If the Republicans go beyond obstruction to actually setting policy — which they might if they win big in November — we’ll be on our way to economic performance that makes Japan look like the promised land.

It’s hard to overstate how destructive the economic ideas offered earlier this week by John Boehner, the House minority leader, would be if put into practice. Basically, he proposes two things: large tax cuts for the wealthy that would increase the budget deficit while doing little to support the economy, and sharp spending cuts that would depress the economy while doing little to improve budget prospects. Fewer jobs and bigger deficits — the perfect combination.

More broadly, if Republicans regain power, they will surely do what they did during the Bush years: they won’t seriously try to address the economy’s troubles; they’ll just use those troubles as an excuse to push the usual agenda, including Social Security privatization. They’ll also surely try to repeal health reform, which would be another twofer, reducing economic security even as it increases long-term deficits.

So I find myself almost envying the Japanese. Yes, their performance has been disappointing. But things could have been worse. And the case Democrats now need to make — the case the president finally began to make in Cleveland this week — is that if Republicans regain power, things will indeed be worse. Americans, understandably, are disappointed over, frustrated with and angry about the state of the economy; but disappointment is better than disaster.

One can only imagine how strong the United States economy would be if it abandoned its antipathy to certain regulations and supports for society such as education and health reforms.

Remember that the US right and big business is not opposed to regulation - just think about patents, copyrights, licences and the like and the health industry in general - just regulations that help to distribute wealth downwards. Bill Gates has no problems when it comes to government regulation of copyright and attempts to enforce it world wide. Regulations that distribute wealth upwards are fine. Big pharmaceutical companies have no problems with regulations that enable them to make billions on protected medicines whose marginal costs of production are negligible. (for an excellent exposition of these arguments see Dean Baker Taking Economics Seriously.

For those wanting a more traditional take on Japan's stagnation see the excellent series of articles on Japan in the New York Times, called "The Great Deflation"

Projections of Australia in 2050

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Projections of the future are of course fraught. There is always the possibility that black swan or game-changing events will make projections based on current knowledge irrelevant. Think the Internet. It has changed all our lives in recent times in a way unimaginable in the 1980s. While a few futurists might have imagined such a system, its impact on our social and work lives has been truly transformational. Think also about the impact on public finances of retired workers living longer as health outcomes improved over the post-war period. In earlier times many retirees died much sooner in their retirement thus placing much less of a burden on public provision?

Issues of population ageing and health expenses are major concerns for all developed countries with extensive public pension and health systems. In Australia the shift to compulsory super and the development of the future fund will help future fiscal burdens but many policy-makers and commentators continue to worry about the costs of ageing.
For those of you wanting a snapshot of Australian policy thinking on the subject then the various Intergenerational Reports (IGRs) are important reading.

Recently Treasury Secretary Ken Henry gave a speech discussing the latest IGR from January 2010.

As Henry puts it:
Some important stats are worth considering:

[T]he IGR is an analytical tool, based on assumptions and projections. It does not forecast where we think we will be, or should be, in 40 years time. Rather, it takes current economic and demographic trends, and current government policies and policy settings, and projects forward the implications of a continuation of those trends, policies and settings. While many people focus on the ‘point’ projections contained in the report, and how they compare with previous IGR ‘point’ projections, it would be safer to focus on the broad path of the pressures outlined in the report.

We currently have a population of around 22 million people with about 13½ per cent of those (less than 3 million) aged 65 and older.

By 2050, the population is projected to grow to nearly 36 million people with nearly 23 per cent of the population (more than 8 million) aged 65 plus.

[T]here will be only 2.7 people of working age to support each Australian aged 65 years or over by 2050, compared with 5 working age people per aged person today, and 7.5 in 1970.

But …

this is just one way to think about dependency. For example, unpublished projections indicate that for every adult without employment — excluding fully self-funded retirees — there will be only 1.8 people in employment in 2049-50, a fall from 2 currently.

This is a modest deterioration when compared against the ratios presented in the IGR. However, regardless of how dependency is measured, an ageing population is expected to lead to a deterioration in dependency ratios, with adverse implications for economic growth.

Over the long term what matters for economic growth is as the IGR makes clear, the Three Ps population, participation and productivity.

As Henry points out the proportion of working age people (those aged 15 or more), average hours worked by people of working age, and average output per hour worked determines real GDP growth per capita.  

Henry talks about the transitions in "prime working age", but this may change over time. It's likely that people will work til later than 65 in the future - some like me who will do so because they will want to and others who will have to to maintain their lifestyles.

Overall, however, the IGR and Henry argue that the main driver of growth will be productivity.

The proportion of the population of working age has risen steadily over the past 40 years — from 71 per cent to 81 per cent — and is projected to rise even further over the next 40 years — to 83 per cent. But among those of working age, the proportion in the age bracket with the highest rates of labour force participation — that is, aged 15 to 64 — is set to fall substantially — from 83 per cent today to about 73 per cent in 2050.

As this proportion falls, average rates of labour force participation will also fall. Ignoring productivity growth rates for the moment, that fall in labour force participation drives a projection of slowing rates of growth in GDP per capita.

Even with strong population growth, GDP growth will also slow. Thus, we project average annual GDP growth of 2.7 per cent over the next 40 years compared with 3.3 per cent over the previous 40 years.

Real GDP per capita is projected to average 1.5 per cent growth over the next 40 years compared with 1.9 per cent over the past 40 years.

In aggregate, the impacts of population and participation will be largely offsetting, leaving productivity as the major driver of future growth in real GDP per person over the next 40 years.

Henry then considers the implications for government spending:

We are projecting that nominal government spending per capita will grow at a faster rate than nominal GDP per capita, so that over the next 40 years government spending will exceed revenue by about 2¾ per cent of GDP — excluding interest payable on additional public debt.

In other words action needs to be taken now according to this framework:

Fiscal sustainability is a key theme of IGRs. Near-term, budget settings can have a substantial influence on the projected path of public finances over even a long period of time. Thus, the 2010 IGR demonstrates that by returning the budget to surplus in 2012-13 and committing to maintain a 2 per cent annual cap on real spending growth for some years, the medium-term fiscal strategy will make a significant contribution to addressing longer-term fiscal challenges.

This is not to say that, in light of the medium-term fiscal strategy, an ageing population no longer presents a threat to fiscal sustainability. Rather, what it demonstrates is that adjustments made now can reduce the need for larger adjustments later.

Spending on health is likely to increase substantially from 4 per cent to 7.1 per cent in 2050. Pensions and aged care will also increase.

The IGR projects total spending to increase to 27.1 per cent of GDP in 2049-50, around 4¾ percentage points higher than its projected low point in 2015-16. In today’s terms, that’s the equivalent of adding around $60 billion a year to government spending. Around two-thirds of the projected increase in spending over the next 40 years is related to health; reflecting pressures from ageing, increasing community expectations and the funding of new technologies. Growth in spending on age-related pensions (Chart 2) and aged care is also significant, both as a proportion of GDP and in real spending per person.

Just to show how fraught projections are note the differences between the 2007 IGR and the 2010 version.

Growing and ageing populations will have a big impact on Australia and it is likely that increases in immigration will be necessary as will increased infrastructure spending and city planning. But let's not kid ourselves that we really have any idea what the future will hold. Remaining a flexible, dynamic and equitable country that avoids historical vulnerabilities of resource and debt dependence will help Australia to deal with any black swan events in the future.