Policy Tensor

Oh No, Not Again

In Arab Uprisings, Middle East on March 27, 2015 at 12:47 am


Tell me if you have seen this tape before. There is a civil war in a Middle Eastern state. The Saudis claim that the guilty party in the civil war is Iran’s lackey and immediately swear to support the opposition. The United States gives the go ahead for intervention by the gulf monarchies. The monarchies realize that they cannot deploy ground forces and decide to fight via proxies. Meanwhile, Iran decides to counter Saudi influence by ratcheting up its support for whosoever has now become Shi’a. And it all goes downhill from there.

The decision to delegate the arming of the rebellion in Syria to the gulf monarchies was the worst foreign policy mistake of the Obama administration. Even the groups that were not salafi pretended to be so in order to get their hands on the arms and money flowing from coffers in the gulf. No wonder that the moderate opposition evaporated. Iran answered by ratcheting up support for the Assad regime. Until the outbreak of the Syrian conflict, the Assad regime wasn’t considered Alawi’; and the Alawi’, in turn, were not really considered Shi’a. With the sectarian temperature regaining the highs of the eighties, the Assad government became Alawi’, and the Alawi’ ‘became Shi’a’.

The dangers of the ‘bait and bleed’ strategy that McDonough had persuaded Obama to follow against the advice of the State Department, the CIA, and the Pentagon, were foreseen by, among others, the Policy Tensor.

The United States has been fighting against Al Qaeda in the Arabian Peninsula (AQAP) in Yemen for a decade. Yemen has a weak state. As a result, Saudi Arabia, Egypt, Iran, the Soviet Union, Israel, the UK and the US have all bankrolled and armed actors in Yemen at one point or another since the second world war. When the wave of Arab uprisings hit Yemen in 2011, Saleh, a US client, was quick to lose control of the central government. The US repeated the trick it had already tried in Egypt—to replace the guy with his second-in-command. In Egypt, US efforts to install Omar Suleiman had failed. But in Yemen, they were successful. Hadi was elected as the only candidate on the ballot in February 2012.

The Houthis constitute 40 per cent of Yemen’s populace. This tribal community of ten million controls the hills and has historically escaped control from the coastal cities plugged into the maritime world. To cut a long story short: Hadi’s campaign to subjugate the Houthis failed. Instead, the Houthis took over the capital so that our man had to flee. The Houthis, Shi’a or not, have gained tremendous legitimacy in the eyes of the general khat-chewing populace. Indeed, the Houthi movement is the most formidable political force in Yemeni society. It is hard to see how they can be defeated from the air.

If the invaders provide sufficient ground forces, perhaps the Houthis can be pushed back to the hills. But are the monarchies in a position to send an army with the capability to pacify even the low-lying areas? And even if sufficient force is forthcoming for that limited aim, it will only prolong the civil war. There is not an iota of a chance that the Houthis can be defeated at home, in the hills. A legitimate central government that has authority over anything but a rump state in Yemen is impossible without political accommodation of the Houthis. On the other hand, if the monarchies bombing Yemen now fail to provide sufficient ground troops, they will be tempted to bankroll Salafist-Jihadist militias to secure their aims; just as they did in Syria.

A Saudi invasion of Yemen opens up a new front in the proxy war with Iran. Obama is in the process of finalizing a deal with Iran that would bring the latter largely back in the fold. He should reconsider his decision to support the Saudis’ action in Yemen. Political accommodation of the Houthis is quite attractive to the United States. A Houthi-led government will serve as a bulwark against AQAP. A lower sectarian temperature, due to the absence of a proxy war between Iran and Saudi Arabia in Yemen, will help in coordinating the effort to defeat ISIS. If the United States continues to support the Saudi-led invasion against the Houthis, Yemen will not see stability in the foreseeable future. Mark my words: Baiting Iran in Yemen will prove as beneficial to the United States as baiting it in Syria. By switching to accommodate the Houthis now, the United States will able to secure a not-bad outcome: a regime that can hope for stability and one that will be a natural ally in the fight against Salafist Jihadism, even if it never manages to rule the entire country.

Obama has demonstrated the ability to shift gears. He has shifted to a policy of rapprochement with Iran, as advocated by the Policy Tensor. Only yesterday, the United States started bombing Tikrit to help with the stalled campaign to oust ISIS from the town of Saddam’s birth. (It is quite difficult to retake urban territory from a skilled adversary with modern weapons.) Kerry has clearly signaled that Assad can stay in Syria. A nuclear deal is now the baseline scenario; thanks to Bibi’s antics. Perhaps the administration deserves better than a B. But in order to earn that A-, Obama has to show some spine and get the Saudis to accommodate the Houthis.

A Reformulation of the Transition Debate

In Capitalism on March 15, 2015 at 11:32 am


“Is there not in short, whatever the society and whatever the period, an insidious law giving power to the few? An irritating law, it must be said, since the reasons for it are not obvious. Yet, it is a stubborn fact; taunting us at every turn. You cannot argue with it. All evidence agrees.”

Fernand Braudel, Civilization and Capitalism, vol. 3: The Perspective of the World

Conceptual notions have to be judged by their usefulness. No matter how precisely we define any mental construct, it may be of little use if it does not allow us to tackle open questions and attempt to solve interesting problems. Mere precision may be worse than the alternative if it clouds our thinking instead of illuminating reality. But more often than not, what stands in the way of progress is our psychological and institutional attachment to established definitions and paradigms long after they have lost their usefulness.

The dominant conception of capitalism is the Marxist notion which puts wage labor—“capitalism is, by definition, based on the exploitation of wage labor”—at the center of the frame of reference. The defining relationship is that between the holder of capital on the one hand, and the holder of labor on the other. In the Marxist machinery, the struggle between these two protagonists, the class struggle, is nothing less than the very motor of history.

In the most advanced capitalist societies, said motor is now effectively defunct, on account of the fact that the presumably stronger protagonist has more or less capitulated. Trapped inside national boundaries and in the face of the changing geoeconomics of global production, labor unions have tried in vain to keep up the fight. (I know that sounds harsh. Indeed, I am a friend of the unions and a card-carrying tax-and-spend liberal. But you have to call a fight when it’s over.) Real wages have been stagnant for an entire generation while the vast bulk of the past thirty years’ gains in productivity have been captured by the protagonist who, according to Marxist eschatology, should have been laid to rest long ago. Perhaps it is time for a rethink.

Marxist historians have traditionally made their bones in the transition debate. The question to be answered has never changed: how did feudalism give way to capitalism? In this essay, I will argue that we need to reformulate the question. Before I can present my reformulation, let me reconceptualize both notions. I will endeavor to do so in as straightforward a manner as possible.

Every sedentary society has been dominated by a tiny elite. Instead of the focusing on the surplus and the method of its appropriation, we shall focus of the nature of the domination itself. A high feudal order is characterized by the fusion of politico-military-economic power in the person of the feudal lord. Even after the reemergence of state power, feudal societies were dominated by landed oligarchies. In particular, states could only reestablish a monopoly of violence by committing to defend the landed oligarchs’ property. A capitalist society on the other hand, is characterized by the dominance of a merchant-financial oligarchy. One way to reformulate the transition debate then is to ask: How did the merchant oligarchs muscle out the landed oligarchs?

This is a useful formulation. One can inquire into the strategies pursued by these two protagonists. In the aftermath of the Black Death, the lords were busy putting down the peasants’ rebellion. Meanwhile, Western European merchants were gathering the reins of a far-flung system that was invisible at ground level. (They had “the perspective of the world”.) One can argue, as I have, that the rise of the European world economy in the fifteenth century rigged the game in favor of the merchants and against the lords at the center even as it strengthened the hands of the lords in the periphery. It is this that explains reserfment east of the Elbe precisely when Western Europe began its long rise.

But even this formulation is not enough. It does not account for any variation in exits from feudalism. In the Italian city-states, the take-over by the merchants was early and direct. In Iberia, the confluence of state power, foreign capital and expertise, and virgin overseas possessions ensured that the exit led straight to retierdom. In the northwestern extremity of the continent, the Dutch experience lay between that of the Italian city-states and England. In the latter, the strength of the territorial state meant that the most important resource to be mined was state power itself; and this is precisely what the merchants set out to do. Meanwhile, the territorial states of the continent saw the rise of absolutism. Feudalism did not survive even east of the Elbe: Russia and Prussia forged even stronger states than the absolutist French monarchs, which usurped power from the lords.

This brings us to the second reformulation: What accounts for the differential exits from feudalism? I have come to realize that we are missing a key protagonist. This third protagonist is the bureaucrat. For what is happening in the early modern period is not a simple shift of power from lords to merchants. The most important long-term development, in fact, was the rise of the modern state. Different components of the politico-military-economic power of the lords on the eve of the Black Death were cannibalized by different actors in the course of the next few centuries. It is, so to speak, the geospatial variation in the balance of power between these three protagonists that explains the differential exits from feudalism.

At the center, merchants gathered the reins of the world economy and gained the upper hand. They played a decisive role in shaping the state into a highly effective instrument of national mercantile interest. This is especially true in England where the bureaucracy was a tool of the merchant-financiers. The lords, of course, remained extremely wealthy and powerful down to the early twentieth century. But they had morphed into rentiers and threw in their lot with the City and its portfolio managers who channeled their enormous wealth overseas.

A very different political equilibrium obtained in Prussia. Here, the Junkers threw in their lot with the bureaucrats who established their supremacy very early on. German merchant-financiers, a group of great antiquity, largely remained outside the jurisdiction of the Sparta of the North. And when the garrison state conquered the rest of Germany in the nineteenth century, the split remained. The leaders of the great capitalist combines of Germany in the early twentieth century were still waiting hat in hand outside the offices of the bureaucrats. It is this that explains Germany’s unique path whereby the constitutional authoritarian state left civil society largely unmolested, whilst excluding centers of private power from state policymaking.

The exit in Russia was similar to Prussia in that merchants were largely excluded from politics on account of their weakness. But instead of a constitutional state, Russia evolved a conspiratorial state. Politics was restricted to the Kremlin where the oligarchs watched each other warily and kept the Grand Prince under house arrest. In this curious system, the civil service accumulated an enormous degree of power. Capitalists were not simply waiting outside offices, they were kowtowing to bureaucrats.

In the rest of the continent, different configurations obtained depending principally on the strength of the state. As a general rule of thumb, the balance of power among the protagonists becomes more favorable to the merchants as one moves northwest and to the lords and bureaucrats as one moves east depending on the strength of the state: The weaker and more peripheral the state, the stronger the landed oligarchy.

I suspect that the rise of the military-bureaucratic state on the periphery was not simply a response to the rise of capitalism on the Atlantic seaboard. The feudal lords themselves relinquished power to the state; increasingly relying on it to maintain their position in the social order. But in as much as it was a response to the rise of the European world economy, it was indeed an effective one: It allowed the states that took this exit to compete in the balance of power despite being dealt a losing hand in the world economy.

The exit from feudalism thus looked very different in different parts of Europe. The differential exits from feudalism had very large scale effects on the history of Europe and the world. The variation is explained by the balance of power between the lords, the merchants, and the bureaucrats. It is time we recognize that the notion of the transition from feudalism to capitalism is misleading and obscures these large-scale realities.

Measuring The Financial Boom

In Markets on February 23, 2015 at 6:26 pm

This morning’s Economist espresso served up a warning on the current asset price boom. The US and UK’s stock markets are at record levels; Japan’s is at a 15-year-high; and the EU’s is at a 7-year-peak. The asset price boom is the result of central banks’ extraordinarily accommodative policies. The prospect of economic recovery in the US has added fuel to the fire. But just how overvalued are stocks? And what is the extent of the financial boom?

The Case-Shiller cyclically-adjusted price-earnings ratio (CAPE) is a good measure of the general level of stock price valuations. CAPE’s long-run average of 16.6 is sometimes taken as a benchmark. I have never found that satisfactory. The ratio uses the 10-year moving average of earnings as the denominator. Expected future earnings may easily be considerably larger or smaller depending on whether one is coming out of a long recession or a long war, et cetera. Still, at 28, the CAPE has already crossed the level prevailing before the crisis.     


There is another reason the policy tensor is dissatisfied with CAPE. It only looks at the stock market. But a financial boom may migrate from the stock market to other assets and back. The current financial boom extends far beyond the stock market. In particular, bonds seem to be overvalued as well. One can’t simply throw in corporate bonds and divide it by earnings. That is not a meaningful ratio since interest payments get deducted from earnings. In order to come up with a meaningful ratio, one must find a suitable denominator.

I have found just such a measure that I call the balance sheet ratio. For the numerator we choose the total liabilities of US nonfinancial firms, including equity and debt. For the denominator, I selected total capital stock of all US nonfinancial firms, available from the Bureau of Labor Statistics. This includes all productive assets of US nonfinancial firms. One can think of the firms using these assets to generate revenue from which they have to pay both their bondholders and their shareholders. The total liabilities of firms, equity plus credit, must be serviced by their future revenues. The idea is that if the price of assets get bid up excessively, it should show up in a higher balance sheet ratio.

Balance sheet ratio

Should we expect the balance sheet ratio to stay constant over time? The short answer is no. One should expect the ratio to rise over time if the return on deployed capital, firms’ physical and intellectual assets, is increasing over time. The chart below shows both the balance sheet ratio and the return on capital deployed. We can see that the return on deployed capital has been rising since 1990. And that this rise accelerated in the 2000s. 

Balance sheet ratio and capital income

I regressed the balance sheet ratio on the return on capital deployed. I performed two regressions. The first with the 1990-2012 data and the second with 2000-2012 data. The number of observations in the second regression is too low to give us much confidence. Moreover, due to the asset price boom of the 2000s, the predicted values are overestimates. Still, I provide charts of predicted vs. actual balance sheet ratios for both. 



Whether or not we trust the second regression, the implications of both are the same. As a sanity check we look at another ratio, balance sheet to GDP:

balance sheet to gdp

A fairly coherent picture emerges from these charts. The size of corporate balance sheets is unwarranted by fundamentals. The balance sheet ratio measures both the stock market boom and the credit boom. No matter how you slice and dice it, we are in the midst of a major financial boom. 


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