DON'T DRIVE, DONT' EAT, WELCOME THE HOT CLIMATE

Obama and the Jews

America's Jews account for a mere 2% of the U.S. population. But they have voted the Democratic ticket by margins averaging 78% over the past four election cycles, and their votes are potentially decisive in swing states like Florida and Pennsylvania. They also contribute an estimated half of all donations given to national Democratic candidates.

So whatever his actual convictions, it is a matter of ordinary political prudence that Barack Obama "get right with the Jews." Since Jews tend to be about as liberal as the Illinois senator on most domestic issues, what this really means is that he get right with Israel.

AP

And so he has.

Over his campaign's port side have gone pastor Jeremiah Wright ("Every time you say 'Israel' Negroes get awfully quiet on you because they [sic] scared: Don't be scared; don't be scared"); former National Security Adviser Zbigniew Brzezinski ("I think what the Israelis are doing today [2006] for example in Lebanon is in effect – maybe not in intent – the killing of hostages"); and former Clinton administration diplomat Robert Malley (an advocate and practitioner of talks with Hamas).

The campaign has also managed to clarify, or perhaps retool, Mr. Obama's much-quoted line that "nobody is suffering more than the Palestinian people." What the senator was actually saying, he now tells us, is that "nobody has suffered more than the Palestinian people from the failure of the Palestinian leadership to recognize Israel, to renounce violence, and to get serious about negotiating peace and security for the region."

Still more forthrightly, Mr. Obama recently told the Atlantic Monthly that "the idea of a secure Jewish state is a fundamentally just idea, and a necessary idea, given not only world history but the active existence of anti-Semitism, the potential vulnerability that the Jewish people could still experience."

I can think of no good reason to doubt the sincerity of Mr. Obama's comments. Nor, from the standpoint of American Jewry, is there anything to be gained from doing so: The fastest way to turn whatever dark suspicions Jews may have of Mr. Obama into a self-fulfilling prophecy is to spurn his attempts at outreach.

Yet the significant question isn't whether Mr. Obama is "pro-Israel," in the sense that his heart is in the right place and he isn't quite Jimmy Carter. What matters is whether his vision for U.S. foreign policy in the Middle East – and the broader world view that informs it – will have ancillary effects favorable to Israel's core interests.

Take Hamas and Hezbollah, which pose the nearest threats to Israel's security. Mr. Obama has insisted he opposes negotiating with Hamas "until they recognize Israel, renounce terrorism and abide by previous agreements." He also calls Hezbollah a "destabilizing organization."

But if Mr. Obama's litmus test for his choice of negotiating partners is their recognition of Israel and their renunciation of terrorism, then what is the sense in negotiating without preconditions with Iran and Syria?

Alternatively, if the problem with Hamas and Hezbollah is that neither holds the reins of government, what happens when they actually do? Hamas won the Palestinian parliamentary elections in January 2006; Hezbollah sits in the Lebanese cabinet. Would Mr. Obama be willing to parley if, in the course of his administration, either group should come to power?

Or take Iran, which Israelis universally see as their deadliest enemy. Yes, there are arguments to be made in favor of presidential-level negotiations between Washington and Tehran – perhaps as a last-ditch effort to avert military strikes on Iran's nuclear facilities. But does anyone seriously think Mr. Obama would authorize such strikes?

Instead, Mr. Obama says he favors "tough diplomacy," including tighter sanctions on Iran's Revolutionary Guards Corps. Last fall, however, he was one of only 22 senators to oppose a Senate resolution calling for the IRGC to be designated as a terrorist organization, a vote that made him a dove even within the Democratic Party. Mr. Obama argued at the time the amendment would give the administration a pretext to go to war with Iran. It was an odd claim for a nonbinding resolution.

Or take Iraq. Israelis are now of two minds as to the wisdom of the invasion of Iraq, mainly because they fear it has weakened America's hand vis-à-vis Iran. Maybe. But is it so clear that a U.S. withdrawal from Iraq wouldn't further strengthen Iran's hand, and consolidate the so-called Shiite crescent stretching from southern Iraq to the hills overlooking northern Israel?

Finally, there is Israel itself. In the Atlantic interview, Mr. Obama declared that "my job in being a friend to Israel is partly to hold up a mirror and tell the truth," particularly in respect to the settlements. Yes, there are mirrors that need to be held up to those settlements, as there are to those Palestinians whose terrorism makes their dismantlement so problematic. Perhaps there is also a mirror to be held up to an American foreign-policy neophyte whose amazing conceit is that he understands Israel's dilemmas better than Israelis themselves.

Khosla's Conspiracy

Spiking food prices, global shortages and Third World riots have managed to elicit repentance from some ethanol evangelists. Not Vinod Khosla. As the Silicon Valley billionaire explained last week in an interview with the San Francisco Chronicle, ethanol's contribution to the crisis is "very minor" and "overblown."

"Food prices have been going up," Mr. Khosla conceded. "But there are massive PR campaigns trying to ascribe most of the blame to biofuels." Apparently "lots of people" are behind the plot, though Mr. Khosla singled out one: "Clearly, the American Petroleum Institute has been very, very concerned about food prices, and you wonder why."

Gosh. API is a trade group for the oil and gas industry that is radioactive on Capitol Hill. But we didn't realize that API's tentacles were wrapped around the World Bank, the International Monetary Fund and the USDA, all of which blame ethanol for inflationary pressures on food prices. Nor did we appreciate how much authority API's views carried with the U.N.'s special rapporteur for the right to food, Jean Ziegler, who says Western biofuels programs are "a crime against humanity."

There are other factors at play (especially the Federal Reserve's easy monetary policy) but this conspiratorial vision is uniquely unfortunate. Mr. Khosla and his well-heeled peers are among those who persuaded Congress to create the subsidy bonanza that causes the U.S. to convert food to fuel. Now that the price shocks from corn and other crop scarcities are ricocheting world-wide, he blames a Washington policy outfit that can barely get its phone calls returned.

Like other green venture "capitalists," Mr. Khosla now claims that corn ethanol is merely a springboard for the cellulosic varieties, which don't draw on food stocks. Of course, his investments in such fuels also come with their own handsome subsidies. As long as he's on the federal dole, perhaps Mr. Khosla should take a vow of embarrassed silence.

Mexico

Inside this issue
• Mr Calderón’s success is the result of his decision to declare war on organised crime

• Government moves to crush cartels amid worries over country’s rise as a narcotics producer

• US objections put a road freight scheme in peril - -

Content

Richer, more confident, but still looking to the US

Calderón has reason to celebrate, albeit cautiously, writes Adam Thomson

Politics: Calderón faces a challenging year ahead

Energy reform is one among many pressing issues, reports Adam Thomson

Emigration: High US wages draw workers across the desert

Politicians are struggling to find solutions, reports Laura Dixon

Narcotics: Going head to head with the cartels

Adam Thomson on why there is an offensive against organised crime

Mortgage lending: Astonishing comeback from the tequila crisis

A government-led revolution has transformed the housing sector, reports Adam Thomson

Microfinance: Thriving industry is proof the poor can, and do, save

Adam Thomson says there are now about 40 banks providing products to lower-income families

Competition: Beer and oil monopolies head the list of targets

Ronald Buchanan asks how far the government will go in curbing the cartels

Transportation: No truck with border traffic

US objections put a road freight scheme in peril, says Laura Dixon

Mexico City: Metamorphosis of a metropolis

Laura Dixon says the capital is going green and is a thriving cultural melting pot

Central banks, cheap talk and costly signals

Central bankers talk about inflation more than a teenage boy thinks about sex. Perhaps they talk about it too much. In contrast to teenage boys, for whom less action would probably be a good thing, central banks would be well advised to talk less and act more. In the US, the Euro Area and the UK, the track record of inflation during the past few years has deteriorated to the point that a material loss of credibility may well be imminent for all three central banks involved - the Fed, the ECB and the Bank of England.

The chart below shows this track record. Note that the Euro Area was only created in 1999, so the pre-1999 data are for a synthetic Euro Area. The Bank of England did not achieve operational independence for monetary policy until June 1997. The Bank of England targets CPI inflation of 2 percent (until December 2003, it targeted a 2.5 percent inflation rate for the RPIX). The ECB targets CPI inflation below but close to 2 percent. No one knows what the Fed means by price stability. It may have ‘comfort zones’ for the inflation rate of the PCE deflator (core or headline) or of the CPI (core or headline), but the exact location of these comfort zones is even harder to determine than the location of comfort stations in an American city.

Monetary policy works mainly through expectations of future actions by the monetary authorities. To a lesser extent it works through the history of past actions. It works almost not at all through the current policy action, that is, through this month’s choice of the official policy rate. Expectations of future policy actions drive current asset prices (such as stock prices, bond prices, house prices, the exchange rate etc.) and rates of return, through intertemporal speculation and arbitrage. Expectations of future policy decisions also influence expectations of price and wage setters and of households and firms engaged in consumption and capital formation decisions.

If the current policy rate, unaugmented by the leverage of current actions, policy announcements and the private sector’s understanding of the policy rule, had to do all the work of controlling inflation and moving the output gap around, either monetary policy would not work at all or we would see humongous changes in the policy rate. This leverage depends on credibility - on the belief of market participants that the authorities will do what it takes, now and in the future, to meet their mandate - a price stability mandate in the Euro Area and in the UK, and a dual mandate (price stability and real economic activity) in the US.

Since the beginning of the decade, the Fed has been so unsuccessful in the pursuit of its price stability mandate, that its price stability credibility, if not shot, must be badly frayed at the edges. The variability of inflation has been signficantly higher in the US than in the Euro Area and in the UK, and the average rate of inflation in the US has also been higher.

Not surprisingly, mean inflation expectation one year ahead (according to the University of Michigan survey) now stand at 5.7 percent. Mean inflation expectations 5 to 10 years ahead are 3.5 percent. Loss of credibility in the Fed’s willingness and/or ability to maintain price stability is a fact - not surprising, given the institution’s willingness to cut rates massively and swiftly when the real economy turned down, despite continuing high inflation. The only question is how to regain credibility. Only actions, that is, rate increases, can do that now.
In the UK too, the anti-inflationary credibility of the Bank of England is slipping. In the Bank’s own survey, asked to give the current rate of inflation, respondents gave a median answer of 3.9%, a series high, compared with 3.2% in the November 2007 survey, the previous series high. Median expectations of the rate of inflation over the coming year were 3.3%, a series high, compared with 3.0% in November, the previous series high.

The ECB has been talking more toughly about the overriding importance of price stability than even the Bank of England. Yet the Euro Area inflation rate is and has been for quite a while, higher than the UK inflation rate, despite the ECB’s inflation-target-that-dare-not-speak-its-name being slightly south of the UK’s. Not raising rates when inflation is so clearly above target, and is expected to remain above target over horizons at which the ECB can influence it, is to undermine the ECB’s antiinflationary credibility. Unfortunately, good Euro-Area-wide survey-based inflation expectations data are hard to find. Asset market-based inflation expectations in the Euro Area as in the US and the UK (based on nominal and index-linked sovereign debt instruments or derived from inflation swaps) are flawed for a number of reasons, of which the existence of a (positive or negative) inflation risk premium may not be as important as a number of technical market distortions.

When the markets and wage and price setters in the wider economy are not sure about the objectives, independence, courage or judgement of the monetary policy makers, they want a signal from the central bank to convice them that the central bank means business. This signal must be expensive, otherwise it is cheap talk. The economic conjuncture today permits a costly signal that will separate the wheat from the chaff. Raising rates now will undoubtedly deepen the economic slowdown and may turn it into a recession. Inflation wimps will therefore not do so. Hairy-chested inflation foes will.

Financial stability concerns, which remain serious, should not stand in the way of policy rate increases. The risk-free short nominal interest rate has little if anything to do with the kind of liquidity crunch that has plagued the markets since August 9, 2007. Should the liquidity squeeze take a turn for the worse, then central banks can increase their activity as lenders of last resort and market makers of last resort; they can expand liquidity at whatever the level of the policy rate happens to be.

Possible liquidity-enhancing measures include the following: a wider range of eligible collateral at the discount window, in repos and at the range of special funds, schemes and facilities that have been created (punitively priced of course, to minimize moral hazard); a wider range of eligible counterparties (subject to proper regulatory requirements of course) at the discount window and in repos; longer maturities for collateralised loans; and if necessary the outright purchase of illiquid assets (at properly punitive prices).

Escapists, when they cannot meet a target have an easy solution: change the target. It is key to resist the siren songs calling for a change (read: increase) in the numerical value of the inflation target or a modification of the inflation index to core inflation or some other price index that happens to have produced lower inflation numbers in the recent past.

Changing the objective of the central bank in the UK or the Eurozone from being lexicographic or hierarchical - with price stability coming first and real economic activity only subject to or without prejudice to the price stability target being met - to involving a trade-off between deviations of inflation from its target and the output gap would be the ultimate cop-out. This would produce the ‘flexible inflation targeting’ framework that has backfired so badly for the US; it would legislate an inflation bias into the performance of the Bank of England and the ECB.

Raising the numerical value of the inflation target would in all likelihood shift the medium-term and long-term inflation anchor (wherever that is now) up by the same amount as the increase in the target, thus producing an equal increase in actual inflation without benefits for real activity.
Core inflation, the inflation rate of a bundle that excludes food and energy (sometimes other flexible-price commodities as well) is useful for monetary policy only if either people don’t eat, drink, drive cars, heat their homes and use air conditioning, or if core inflation is a superior predictor of future headline inflation over the horizons that the monetary authority can influence headline inflation – a better predictor not only than headline inflation itself, but than any readily available set of predictors. After all, the monetary authority should not restrict itself to univariate predictor sets.

Non-core prices tend to be set in auction-type markets for commodities. They are flexible. Core goods and services tend to have prices that are subject to short-run Keynesian nominal rigidities. They are sticky. The core price index and its rate of inflation tends to be less volatile than the index of non-core prices and its rate of inflation, and also than the headline price index and its rate of inflation.

However, the ratio of core to non-core prices or of the core price index to the headline price index is predictable, and so are the relative rates of inflation of the core and headline inflation indices. The phenomenon driving the increase in the ratio of headline to core prices in recent years is well-understood. Newly emerging market economies like China, India Vietnam have entered the global economy as demanders of non-core commodities and as suppliers of core goods and services. This phenomenon is systematic, persistent and ongoing.

When core goods and services are subject to nominal price rigidities but non-core goods prices are flexible, a relative demand or supply shock that causes a permanent increase (decrease) in the relative price of non-core to core goods will, for a given path of nominal policy rates, cause a temporary increase in the rate of headline inflation, as well as a temporary reduction in the rate of core inflation. So if you plot the difference between the headline inflation rate and the core inflation rate on the vertical axis against the rate of headline inflation, as I have done for the US in earlier blogs, you get a distinct positive association.

Therefore, when there is a continuing upward movement in the relative price of non-core goods to core goods, core inflation will be poor predictor of future headline inflation for two reasons. First, even if headline inflation were unchanged, core inflation would, for as long as the upward movement in the relative price of non-core goods continued, be systematically below both non-core inflation and headline inflation. Second, for a given path of nominal interest rates, the increase in the relative price of non-core goods will temporarily raise headline inflation above the level it would have been if there had been no increase in the relative price of non-core goods to core goods. When the increase in the relative price of non-core goods comes to a halt, headline inflation will not decline below the level it would have been at without the increase in the relative price of non-core goods. It would take a reversal of the increase in the relative price of non-core goods for headline inflation to fall below the path it would have been on in the absence of the increase in the relative price of non-core goods.

It’s time for central banks to put their money where their mouths have been for too long. In the words of that well-known monetary economist, E. Aaron Presley: “A little less conversation, a little more action please”. It’s time to fight headline inflation and squeeze that nasty genie back into the bottle.

DON'T DRIVE, DONT' EAT, WELCOME THE HOT CLIMATE

Bashers Beware

The Presidency: It takes little courage — or brains — to join the mob vilifying President Bush. But the Democrats (and Republicans, too) depicting him as villain will one day regret it.

---

---

In the eyes of members of both parties, George W. Bush seems to be the cause of everything from the recent GOP special election losses to a flagging economy to today's bad weather.

Barack Obama plans to reach the White House by claiming the presidency of Sen. John McCain would amount to a third Bush term. McCain, meanwhile, seems to think it a wise campaign strategy to highlight his differences with the president, such as outgreening the greens on global warming.

Rep. Tom Davis, former chairman of the National Republican Congressional Committee, reflected the panic engulfing many Republicans in Congress last week when he called President Bush "absolutely radioactive" and warned, "They've got to get some separation from the president" if they want to win this November.

How about a dose of reality?

On the economy, there are indications the sun is coming out after a fairly mild economic storm. More data are showing a recession will be avoided, and it looks like a new bull market in stocks began in March after a short and shallow bear.

The report earlier this month of 20,000 jobs lost in April was far better than had been expected, and unemployment remains low at 5%.

There is undeniably a lot of gloom and doom out there, with the Reuters/University of Michigan sentiment index at a 26-year low. But the National Association for Business Economics announced Monday that it expects the current downturn to be mild and brief.

NABE "anticipates a significant pickup in the second half" with real GDP for 2009 projected to be 2.9%. It may not even classify this downturn as a recession at all.

For the resilience of this economy, we can thank the president. He pushed substantial tax cuts on income and investment through Congress, which were followed by four years of growth, generating over 8 million jobs.

The president also can be thanked for appointing Ben Bernanke, chairman of his Council of Economic Advisers, to succeed Alan Greenspan as Federal Reserve chief. Bernanke has moved on several fronts to keep the economy afloat — including creatively making more credit available to combat the subprime mortgage crisis.

As for national security, Obama keeps saying the war in Iraq and the rest of the administration's foreign and defense policy have, as he put it last week in South Dakota, "prevented us from making this country safe." But the country is safer than anyone expected after 9/11.

There has not been a single terrorist attack on the homeland, and we have instead foiled multiple terrorist plots to kill innocent Americans. America has succeeded in foiling these plots because Bush gave the National Security Agency the authority to monitor any and all communications of suspected terrorists, by telephone, e-mail or other means.

The president also gave authorization for the CIA to employ tough interrogation methods on terrorists in custody, to the extent of transporting those detainees to secret locations abroad.

As we have prevented the terrorists from taking their jihad to the U.S., we have taken the global war on terror to the terrorists' home soil. We have given Muslims in the Middle East the opportunity for freedom in Iraq, proving that we are willing to spill our blood and expend our own resources to defend our interests as we promote their liberty.

When faced with the entire Washington establishment demanding an end to the war — including his own father's secretary of state, James Baker — President Bush stuck to his guns, placed a new general in charge and employed a surge strategy that is now winning the war in Iraq in resounding fashion.

This is the supposed albatross Republicans are so intent on distancing themselves from and which Democrats believe to be the key to victory in November. The facts of the last seven years tell a different story.