Markets

# The Tendency of Commodity Prices to Fall Over the Long Run

The Prebisch-Singer hypothesis states that real commodity prices have a tendency to fall over the long run. Harvey et al. have shown that the historical evidence from four centuries of commodity price data is consistent with the hypothesis. The most convincing explanation of the phenomena is that, with important exceptions, the income elasticity of primary commodities is less than 1. This means that incomes grow faster than demand for primary commodities, so that prices must fall to clear markets. This mechanism is subject to ecological constraints since if the ecological constraint bites, prices must rise to clear markets. So far, fundamental ecological limits have not trumped the tendency of commodity prices to fall over the long run. The tendency introduces a dynamic, systematic bias in favor of the core and against the periphery of the world economy since, by construction, nations or regions specializing in primary goods belong to the latter. In what follows, I’ll illustrate the tendency for a large number of commodity classes since 1850. All data is from David S. Jacks’s website.

Overall, the picture is that non-fuel commodity prices have fallen. Figure 1 shows the unweighted average of 37 non-fuel commodities. While there is a medium term cycle, the trend is clearly negative.

Figure 1. Non-fuel real commodity prices (1850-2010).

The main exception is energy prices, which have shown a tendency to rise over the long run. See Figure 2.

Figure 2. Real energy prices (1850-2010).

We should not expect the real price of gold (or other precious metals) to fall over the long run because it was, and still approximately is, the numeraire. Indeed, there is no long term trend in precious metal prices. See Figure 3.

Figure 3. Precious metal prices (1850-2010).

Figure 4 shows the price of beef and other animal products. We see that even though pork and hide prices have fallen over the long run, the price of beef (and lamb) have increased significantly. This is because the income elasticity of beef is greater than 1 since it is not yet a necessity for the bulk of global households. Indeed, as mass affluence spreads around the world, we should expect the demand for beef to grow faster than global income.

Figure 4. Animal product prices (1850-2010).

Let’s move to proper commodities starting with grains. Growing wheat, rice and corn is the mainstay of the world’s farmers. The real price of their product has been falling systematically over the past 150 years. See Figure 5.

Figure 5. Grain prices (1850-2010).

I know what you are thinking: These farmers ought to plant cash crops such as cotton. Not so fast. The prices of cash crops have also fallen just as much if not more than grains. Figure 6 shows non-food soft commodities.

Figure 6. Non-food soft commodity prices (1850-2010).

Figure 7 shows the systematic decline in the price of “drug foods” that played such an important role in the early modern world economy.

Figure 7. Drug food prices (1850-2010).

What about metals and minerals? Are commodities that are dug out lucky as a class? The evidence does not support that conclusion. Figure 8 shows metal prices. The data is noisier but the common trend component is clear.

Figure 8. Metal prices (1850-2010).

Figure 9 shows the prices of minerals such as iron ore and sulphur. Here the trend is even more manifest.

Figure 9. Mineral prices (1850-2010).

I hope to have convinced you of the tendency of commodity prices to fall over the long run. The finding raises the stakes for the politics of global inequality and the international division of labor. But trend analysis is merely the first step. For a full analysis of the role of commodities in the global condition, we have to look at how both the terms of trade between the town and the countryside (defined in terms of price levels) and the volatility of commodity prices affects commodity producers and informs their politics.

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# Yellen Let the Cat Out of the Bag

The Fed has failed to deliver on its inflation target consistently.

So in the Q & A after her speech, Yellen spelled out why the FOMC expects inflation to “return” to target. It was a remarkably honest admission at the FOMC Press Conference, June 14, 2017.

[The neutral rate] is hard to pin down; especially given the fact that the so-called Phillips curve appears to be quite flat—that means that inflation doesn’t respond very much or very quickly to movements in unemployment. Nevertheless, that relationship, I believe, remains at work.

Yellen is wrong. As I have argued previously, the ‘second unbundling’ has transformed the inflation process in the core of the world economy such that global slack drives inflation; not domestic slack. More recently, Auer, Borio and Filardo (2017) have shown that the intensity of participation in global value chains explains the time-variation and the international cross-sectional variation in the strength of that relationship. They have thus tied the mutation of the inflation process directly to Baldwin’s ‘second unbundling’. How long do we have to wait before the FOMC catches up with the BIS?

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# How the affluent get $500 billion in tax giveaways each year After I finished writing this post, I found these very useful tables here. They help triangulate the class structure and are more helpful at the beginning of my piece than at the end. BIG GAINS IN THE NEOLIBERAL ERA have largely been cornered by the wealthy. We may even have been underestimating the true wealth of the ultrarich by a factor of 2 because the truly wealthy hide nearly half their wealth in offshore secrecy jurisdictions. I have hitherto emphasized paying attention to the very top of the distribution—the 0.1 percent—because the concentration of material resources in the hands of oligarchs is a significant threat to democracy. Indeed, ultraconservative billionaires are behind the insurgency that used to be called the GOP. But that is not the end of the story. The main driver of regional polarization is the two-tier polarization of the US economy into a high-productivity tradable sector that accounts for just 2 percent of new jobs but a third of new value added and a low-productivity non-tradable sector. Affluent, college-educated workers have managed to corner all the wage gains over the past generation due to their near-monopoly on jobs in the former. The rest have seen their incomes stagnate and their share of the national pie shrink. Figure 1 displays the share of pretax income of the top 1 percent of income earners. We see that vertical income polarization has returned to levels last achieved in the roaring twenties. But affluence in America goes deeper. Not everyone in the 99 percent has lost ground in the neoliberal era. Those in the top 20 percent—roughly speaking, families earning six-figure incomes—have done relatively well. Figure 2 shows the share of the next 19 percent of income earners. We see that their share of the national pie has increased slowly but steadily over the past two generations. Rational public finance would see the government lean against the inequity of the market. Through progressive taxation, tax credits, subsidies, and spending targeted at less fortunate families and regions, fiscal policy ought to be used to ensure a more equitable distribution of the national economic pie. Congress can’t stop talking about making life easier for hard-working Americans. In reality, as we shall see, tax giveaways largely benefit the affluent. Figure 3. US non-discretionary federal budget breakdown. Figure 3 presents a top-level breakdown of the non-discretionary federal budget. Medicare, social security, and the military consume two-thirds of the US budget. But the largest component by far, accounting for a third of the budget, is “tax expenditures”—technical jargon for tax credits, subsidies, and other giveaways that is fiscal spending in all but name. In the current fiscal year, tax expenditures account for nearly$1.5 trillion. The biggest of these giveaways is exclusion of employer contributions for medical insurance premiums and medical care, which will cost the public purse $2.7 trillion over 2016-25, according to the US Treasury. Preferential treatment of unearned capital gains (which are taxed at 15 percent instead of the 35 percent charged on earned income) will cost a cool$1 trillion over the same period. Exclusion of imputed rental income will cost $1.2 trillion, and the mortgage interest deduction will cost$950 billion. (All these numbers are from here.)

Who benefits from these giveaways? Figure 4 shows the distribution of the beneficiaries. The affluent, the top 20 percent of income earners, get 51 percent of all tax expenditures. The rest is split regressively among the lower classes.

Figure 4. Shares of tax expenditures by income quintile.

If we drill down further, we find that some of these giveaways are much less regressive than others. For instance, one-half of the $66 billion earned income tax credit goes to the lowest quintile and 95 percent of the$59 billion child tax credit goes to the bottom 80 percent. The employer-sponsored health insurance exclusion is somewhere in the middle. Two-thirds of this supermassive $258 billion giveaway goes to the bottom 80 percent. Pension contribution, capital gains, local taxes and the mortgage interest deduction are much more regressive. Some 94 percent of the$83 billion capital gains giveaway ends up in the top quintile, as does two-thirds of the $140 billion pension contribution exclusion. Figure 5. Distribution of selected tax breaks. Figures 5 and 6 drills down into the most regressive giveaways. We have not included the$17 billion carried interest giveaway to ultrarich hedge fund managers and other such long-running scandals. But the picture that emerges is not pretty. The top quintile gets the vast bulk of the giveaways for capital gains, state and local taxes, mortgage interest, charitable contributions and capital gains exemption at death. All in all, the top quintile cornered $446 billion of the$873 billion given away in 2013, according to the Congressional Budget Office.

Figure 6. Percentage shares of quintiles for selected tax giveaways.

Beyond the regressive distributional impact, these giveaways distort incentives and harm the economy in various ways. For instance, Weicher notes that the mortgage interest deduction (MID),

…encourages taxpayers to pay for homes with debt rather than with cash or financial assets, causes wasteful and unproductive misallocation of physical and financial capital, and distributes benefits disproportionately to upper income households. Furthermore, the MID results in less economic productivity, reduced labor mobility and greater unemployment, depressed real wages, and a lower standard of living. The MID is so damaging to the economy that nearly every economist believes that “the most sure-fire way to improve the competitiveness of the American economy is to repeal the mortgage interest deduction.”

A truly progressive politics will have to take on not just the rich but the affluent as well.

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World Affairs

# Trump is Pushing Iran into Russian Arms

The most important consequence of the Bush demolition of the Iraqi state has been the reemergence of Iran as the most influential power in southwest Asia. The core of southwest Asia is now a vast zone of Iranian influence that General Suleimani ominously calls the “Greater Persian Gulf region.” Iran is now the dominant foreign power in Lebanon, Syria and Iraq, and has significant influence in Yemen and Afghanistan as well. With thousands of Iranian troops fighting in the Levant, Iran is projecting its power further west and more deeply than at any time since the peak of Safavid power in the seventeenth century.

Part of the reason is simply that Iran is arguably the most powerful state in the region. Figure 1 shows the distribution of war potential in the Middle East. All data is represented as national shares of selected power resources of the regional powers. Iran has a population of 80 million, a close second to Egypt’s 85 million. Its economy is comparable in size to Turkey’s and Saudi Arabia’s (although the latter is mostly income from oil sales on the global market and is not reflective of national capabilities). Iran has proven oil reserves of 160 billion barrels, second only to Saudi Arabia’s 269 billion. Its endowment of arable land is second only to Turkey’s. Most astonishingly, some 269,000 Iranians graduate with degrees in engineering or the sciences every year compared to just 212,000 in the rest of the regional powers combined.

Figure 1. Distribution of war potential in southwest Asia. Source: CIA, World Economic Forum.

Israel is barely visible in the spider chart of war potential—a major flaw of these metrics. Israel punches dramatically above its weight for a number of reasons. First, Israel is a settler colony of the crème de la crème of Europe. Perhaps as a result of sustained selection on cognitive ability in medieval Europe or the survival effect of the liquidation of the bulk of European Jewry (smarter Jews presumably escaped at higher rates than dumber Jews from the Nazis), Ashkenazi Jews have the highest IQs of any ethnic group ever recorded. Not coincidently, Jewish people are massively overrepresented among Nobel Laureates. Combined with the traditional Jewish emphasis on education (with universal literacy probably as early as the second century CE), the per capita skill-set and knowhow of the Jewish state has no counterpart anywhere else in the world. Second, Israelis are far more willing to fight for the flag—a very important factor in warfighting capabilities since the rise of nationalism at the end of the eighteenth century—than any other nation for obvious historical reasons. Third, like Prussia in the classical European balance of power, Israel’s geostrategic position has led to the development of a highly effective operational art of war that has made it into a modern day Sparta. Surrounded by hostile states and with neither the resources nor the manpower to win long, drawn-out wars of attrition, the militaries of both states cultivated an art of war that sought to front-load conflicts and seek the decisive victory. Fourth, Israel has successfully cultivated a close security relationship with the unipole—in no small part due to the influence of American Jewry. This has given Israel greater access to advanced weapons and military knowhow than any other regional power including Turkey (even though Turkey, unlike Israel, is a member of Nato).

Still, modulo the special case of Israel, Figure 1 provides a good approximation of the war potential of regional powers in southwest Asia. It shows that Iran has the most balanced portfolio of intrinsic power resources in the region. Saudi Arabia, by contrast, is a pure petrostate. Iran’s population is 2.7 times as large as Saudi Arabia’s. It has 5 times as much arable land, 4 times as many graduates, and produces 6.7 times as many engineers and scientists every year as Saudi Arabia. The Kingdom has been able to access and sell—with foreign expertise and knowhow—a much greater portion of its oil deposits and has, as a result, accumulated considerably greater financial resources than Iran.

Saudi Arabia has tried to convert its financial firepower into military might by spending gargantuan sums of money on weaponry. Figure 2 displays the real military spending of the regional powers as well as the real price of crude. (We start the clock in 1971 when the British left and the gulf RSC emerged.) The salafi oil monarchy is by far the biggest military spender in the region. Since 2003, Saudi military spending has grown rapidly along with the price of crude to reach levels dramatically higher than other regional powers.

Figure 2. Military spending by regional powers in southwest Asia. Source: SIPRI.

But it is extremely difficult, if not outright impossible if other ingredients of national power are lacking, to convert financial resources into warfighting capabilities simply by spending giant sums of money. The most important determinants of national warfighting capability are after all the size and skill-set of the populace and its willingness to fight for the flag of the nation-state. The Saudi populace is much smaller, much less skilled, and not nearly as motivated to fight for the flag as that of Iran. This is why a war between Iran and Saudi Arabia will be pretty much a one-sided affair. However, since Saudi Arabia is a US protectorate it is not at risk of being conquered by its stronger neighbor. Due to the presence of the US pacifier, security competition in the bipolar gulf region has instead been projected onto regional playing fields.

The dominant story of the region since 2003 has been the expansion of the zone of weakness. Three hitherto strong states of the region, Iraq, Syria, and Libya, have joined Lebanon, Palestine, Yemen and Afghanistan (the last is on the border of southwest and south Asia) as the playing fields of the regional powers. The regional players are Iran, Saudi Arabia, Egypt, Turkey, and to a lesser extent Israel. Although each regional power has their own particular security interests, the object of the regional game is to secure the orientation of weak states, or if there is no central authority, to secure influence in the polity or security zone by bankrolling and arming local security actors. Even more important than the push factors of regional security competition are the pull factors of sub-state actors seeking patrons. These features are manifest in the Syrian war but are no less true of other parts of the zone of weakness.

Some players are more in demand than others. No one except the Phalangists wants to be caught hobnobbing with the Israelis. Even the Kurds are tight lipped about their security cooperation with the Jewish state. More generally, transnational identities allow states in the region to mobilize opinion across borders. Sunni Arab groups, including many salafi jihadists, look to Saudi Arabia and the other Sunni Arab oil monarchies for support. Shiite actors seek Iranian support. Due to the rise in sectarian temperature—most dramatically as a result of the Syrian war—regional Sunni Arab actors, like the Palestinian resistance groups Hamas and Islamic Jihad, that used to be Iranian clients have pulled back. On the other hand, actors that were barely Shiite, such as the Alawi regime in Syria and the Houthis in Yemen, have become Shitte, and pushed further into Iranian arms. So the rise in sectarian temperature cuts both ways.

Figure 3. The regional game.

When the Syrian uprising began, Saudi Arabia saw a major opening to wrestle away Syria—a state that is central to the Sunni Arab imaginary—from the Iranian orbit. Weapons, money and fighters poured into the warzone through the Turkish rat line. Much of the flow originated in the oil monarchies and went to salafi jihadist groups such as ISIS, JN and Arhar al Sham. But the Iranian-Hezbollah intervention prevented the fall of Assad. Once the Russians intervened on the regime’s side, the great Saudi dream of rolling back Iranian influence in the Levant became tenuous. With the fall of Aleppo to the regime’s forces, all such hopes were dashed.

Meanwhile, the US-Saudi puppet in Yemen had been displaced by the Houthis with the support of the former Yemeni president (a Sunni). Saudi Arabia’s aggressive young leader Mohammed bin Salman al Saud (MBS), responded by launching an air war with the logistic and diplomatic help of the Obama administration.  There was a lot of brouhaha about Iranian influence in Yemen; Saudi Arabia’s backyard. But Iranian influence was always more imagined than real. The Houthi political movement, in fact, enjoyed broad-based, cross-ethnic support and was neither simply a Shiite group nor an Iranian proxy. The main consequence of the Saudi terror campaign in Yemen was to give a boost to Al Qaeda in the Arabian Peninsula (AQAP), one of the most dangerous and capable salafi jihadist groups in the region. (Yemen was not the only place where the main result of Saudi meddling was to strengthen salafi jihadism.)

Lost in the regional narrative was a potential gamechanger. This was an alliance between Russia and Iran—something that has never obtained ever before in history. Even though both were simply fighting together to save the Assad regime and there were no plans for a broader alliance, there was always the potential for one. The Obama administration was smart enough to know that it would not be in the US interest if Iran acquired a rival great power patron. (Obama went so far as to say that the Saudis and the Iranians would have to “share the region.”) As long as the United States could keep the door ajar just a little bit, Iran had more to lose from defying the Western alliance than gaining a great power patron.

In this trip, Trump has slammed the door in Iran’s face. It may further the interests of the oligarchs connected to the Trump White House. But it makes no sense in terms of US interests in the region. We should not be surprised if Iran gets closer to Russia and the Ruskies extend their influence in the Middle East as a result. I am not suggesting that this is a certainty. Russia has so far pursued defensive and limited aims—basically shoring up the Assad regime. But that is no guarantee that the Kremlin will not exploit this opening.

There was something deeply shameful about Trump declaring Iran to be a sponsor of terror whilst standing in the heart of terror finance; entirely bogus claims based on Iranian patronage of Hezbollah and Hamas, which for all their Islamic rhetoric are nationalist resistance groups; not Islamic terrorists. Islamic terrorists, like the one who murdered young kids in Manchester this week, are without a single exception salafi jihadists who are bankrolled by financiers in the permissive jurisdictions of the gulf oil monarchies that Trump just declared his eternal love for. In fact, Iran is the one Muslim power that is guaranteed to be an ally against salafi jihadism. If the United States was serious about tackling salafi jihadism, the place to start is to put the oil monarchies is a financial straightjacket—all financial flows out of the gulf ought to monitored by a terror finance task force set up by Western intelligence agencies.

It’s too easy to blame the Trump administration for following policies that are so manifestly against the US and Western interest. The truth is that the blame lies on a broad swath of the foreign policy community—including Democrats. Somehow the debacles of the Bush administration have failed to kill the rogue states doctrine that is at the root of America’s failed foreign policy.

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# Why did the United States invade Iraq?

Bush’s decision to depose Saddam has always perplexed the Policy Tensor. I have previously argued that US policy with respect to Iraq after 1990 was inconsistent with foreign policy realism; that, during the 1990s, US foreign policy was guided by the rogue states doctrine that served as the justification for the forward-deployment of US forces around the globe (and defense spending high enough to allow for garrisoning the planet after the threat from the Soviet Union vanished into thin air) by inflating the threat posed by confrontation states; that Saddam became a poster child of the rogues’ gallery that the foreign policy elite in Washington said they were determined to contain; and that the US policy consensus on the threat posed by the person of Saddam Hussein meant that Saddam was most at risk from a revisionist policy innovation in Washington.

So when George Bush went about “searching for monsters to destroy,” Saddam was the most tempting target. The consensus in policy circles against Saddam explains why the US invaded Iraq and not Cuba, North Korea, Iran or Libya; or any other confrontation state that could, more or less convincingly, be framed as a “rogue state”, “outlaw state”, “backlash state”, or “Weapon State” (as Krauthammer put it in Foreign Affairs). In short, Bush was following the path of least resistance when he chose to overthrow President Hussein.

But why did Bush want to depose Saddam in the first place? The US veto on potential rivals’ access to gulf energy was already secured by the United States’ impregnable maritime power in the region. That is, with or without a friendly regime in Baghdad, the US could deny any challenger access to gulf energy simply using its overwhelming maritime power.

Moreover, almost any conceivable US national interest could’ve been more easily secured by bringing Saddam in from the cold. If Bush wanted his friends in the oil industry to benefit from access to Iraqi oil, Saddam could easily have been brought in from the cold on that very condition. If Bush wanted to ramp up Iraqi oil production to lower oil prices (and perhaps undermine Saudi Arabia’s position as the swing producer and its hold on OPEC), the easiest way to do that would’ve been to allow Western oil firms to invest in Iraqi production capacity. If Bush wanted an Iraqi regime that was a geopolitical ally of the United States and Israel, even that was within the realm of possibility with Saddam at the helm in Baghdad.

Suppose that for whatever reason it was impossible for the United States to work with Saddam. Then, any conceivable US interest would’ve been better served by replacing the regime led by Saddam Hussein with a more compliant military junta. For a democratic regime in Baghdad was ethno-demographically guaranteed to fall within the orbit of Iran.

In fact, what I found after combing through the archives of the 1990s was that US-Iraq relations had been personalized to an extraordinary degree and that there was an overwhelming consensus in the foreign policy establishment that the ideal scenario would be a military coup by a more accommodative general. The idea was that if Saddam were deposed by a more accommodative general, we would get the best of both worlds. An iron-fisted junta would provide stability in the sense that Iraq would serve as a bulwark against Iran and keep a lid on both ethnic nationalism (Shia, Sunni and Kurdish) and salafi jihadism. And a more accommodative leadership in Iraq would remove Iraq from the ranks of the confrontation states and thereby enhance the security, power and influence of the United States and its regional allies.

These considerations explain why, after kicking Saddam’s army out of Kuwait, Bush’s dad left Saddam in power and watched from the sidelines as Saddam crushed the Iraqi intifada. Bush Senior later explained the decision in his book that he coauthored with Scowcroft:

While we hoped that a popular revolt or coup would topple Saddam, neither the United States nor the countries of the region wished to see the breakup of the Iraqi state. We were concerned about the long-term balance of power at the head of the Gulf. Breaking up the Iraqi state would pose its own destabilizing problems.

The core of the Bush revolution in foreign policy was the decision to break with this policy consensus. Specifically, Bush Jr’s policy innovation was to overthrow Saddam Hussein without replacing him with a more accommodative military junta. What possible US interest could be served by that policy? What did principals in the Bush administration hope to accomplish? What was their grand-strategy? I think I finally have an answer.

My interpretation builds on the findings and arguments of a large number of scholars. For the sake of conciseness, I’ll focus exclusively on the excellent anthology edited by Jane Cramer and Trevor ThrallWhy Did the United States Invade Iraq? In what follows, I’ll summarize their findings before presenting my interpretation. All quotes that follow are from this book unless otherwise specified.

Cramer and Thrall argue that the core foreign policy principals in the Bush administration were President Bush, Vice President Dick Cheney and Defence Secretary Donald Rumsfeld. It’s plausible to imagine that they came under the sway of neocons and to the neocons’ well-known strategy of regime change in Iraq in the heightened threat environment after 9/11. But that story is inconsistent with the facts.

The record indicates they did not even make a decision after 9/ 11; they apparently had already made up their minds so they did not need to deliberate or debate. Instead they discussed war preparations and strategies for convincing the public and Congress, with no planning for how to make democracy take shape in Iraq.

Cheney played an extraordinary role in the administration. In particular, he handpicked almost all the neocon hawks who led the drumbeat to war:

Cheney helped appoint thirteen of the eighteen members of the Project for the New American Century.… Cheney lobbied strongly for one open advocate of regime change—Donald Rumsfeld—who was appointed to be Secretary of Defense. And then, Cheney and Rumsfeld together appointed perhaps the most famous advocate for overthrowing Saddam Hussein in order to create a democracy in Iraq, Paul Wolfowitz, as Undersecretary of Defense. Cheney created a powerful dual position for Scooter Libby …John Bolton as special assistant Undersecretary of State for Arms Control and International Security; David Wurmser as Bolton’s chief assistant; Robert Zoellick as US Trade Representative; and Zalmay Khalilzad as head of the Pentagon transition team…. [Cheney appointed] Elliot Abrams, Douglas Feith, Richard Perle and Abram Schulsky.

But, Cramer and Thrall argue, quite convincingly in my opinion, that “the neoconservatives and the Israel lobby were “used” to publicly sell the invasion, while the plans and priorities of the neoconservatives were sidelined during the war by the top Bush leaders.”

The State Department and the oil industry were becoming increasingly alarmed about the neoconservatives’ oil plan and Chalabi’s open advocacy for it. In the eyes of the mainstream oil industry, an aggressive oil grab by the United States might lead to a destabilization of the oil market and a delegitimizing of the Iraq invasion. This was argued in an independent report put out on January 23, 2003 by the Council on Foreign Relations and the Baker Institute entitled Guiding Principles for U.S. Post-Conflict Policy in Iraq. The report cautioned against taking direct control of Iraqi oil, saying, “A heavy American hand will only convince them (the Iraqis), and the rest of the world, that the operation in Iraq was carried out for imperialist rather than disarmament reasons. It is in American interests to discourage surch misperceptions….

The State Department plan triumphed over the neoconservatives’ plan, and this helps demonstrate that Cheney, Rumsfeld and Bush did not allow the neoconservatives and the Israel lobby to dominate US foreign policy even from the inception of the invasion. In fact, Bush appointed Phillip Carroll, the former chief of Shell Oil, to oversee the Iraqi oil business. Carroll executed much of the oil industries’ preferred plans for Iraqi oil. Revealingly, when L. Paul Bremer, the head of the Coalition Provisional Authority, ordered the de-Ba’athification of all government ministries in Iraq, Carroll refused to comply with Bremer’s order because removing the Ba’athist oil technocrats would have hindered the Iraqi oil business. In the end, the Baker plan (aligned with US oil industry interests) was implemented in its entirety. The US official policy was to use Production Sharing Agreements (PSAs) that legally left the ownership of the oil in Iraqi government hands while attempting to ensure new long-term multinational oil corporation profits.

On de-Ba’athification, on Chalabi, on Iraqi participation in OPEC, on the privatization of Iraqi oil, on bombing Iran and Syria, on threatening Saudi Arabia or giving the Saudis access to advanced weaponry, the administration went counter to the neoconservatives’ proposals and policy desiderata. In fact, the “neoconservatives realized that they had been used to sell the war publicly but were marginalized when it came to the creation of Middle East policy. In 2006 prominent neoconservatives broke with the administration and resoundingly attacked Bush’s policies.”

So, if the neoconservative vision of an expanding zone of democratic peace was not the motivation for the invasion, what was? “Cheney, Rumsfeld and Bush,” Cramer and Thrall argue, “were US primacists and not realists.”

Cheney authorized Paul Wolfowitz to manage a group project to write up a new Defense Planning Guidance (DPG) drafted by various authors throughout the Pentagon in full consultation with the Chairman of the Joint Chiefs of Staff, Colin Powell (Burr 2008). The DPG was leaked to the New York Times on March 7, 1992 (Tyler 1992). The radical plan caused a political firestorm as it called for US military primacy over every strategic region on the planet.

The draft DPG leaked in 1992 was widely perceived as a radical neoconservative document that was not endorsed by the high officials in the George H. W. Bush administration. Dick Cheney sought to distance himself from the document publicly while heartily endorsing it privately. Pentagon spokesman Pete Williams claimed that Cheney and Wolfowitz had not read it. Numerous other Pentagon officials stepped forward to say that the report represented the views of one man: Paul Wolfowitz. The campaign to scapegoat Wolfowitz for the unpopular plan was successful and the press dubbed the DPG as the “Wolfowitz Doctrine.” However, recently released classified documents show that the document was based on Powell’s “base force” plan and was drafted with the full consultation of Cheney and many other high Pentagon officials (Burr 2008). In the days after the leak, Wolfowitz and others worried that the plan would be dropped altogether. But in spite of the controversy, Cheney was very happy with the document, telling Zalmay Khalilzad, one of the main authors, “You have discovered a new rationale for our role in the world.”

Cramer and Thrall conclude:

The Policy Tensor agrees with the characterization of principals in the Bush administration as primacists. The problem is that invading Iraq does not follow from the grand-strategy of primacy. The primacists’ argument is straightforward and indeed compelling. The idea is that it was in the US interest to prolong unipolarity as long as possible and that required an active policy to prevent the reemergence of a peer competitor. As the authors of the Defence Planning Guidance put it in 1992,

Our first objective is to prevent the re-emergence of a new rival, either on the territory of the former Soviet Union or elsewhere, that poses a threat on the order of that posed formerly by the Soviet Union. This is a dominant consideration underlying the new regional defense strategy and requires that we endeavor to prevent any hostile power from dominating a region whose resources would, under consolidated control, be sufficient to generate global power. These regions include Western Europe, East Asia, the territory of the former Soviet Union, and Southwest Asia.

Separately, in combination, or even in an alliance with a near-peer, the so-called rogue states were never (and never would be) in a position to pose “a threat on the order of that posed formerly by the Soviet Union.” The combined GDP of the “rogue states”—Iraq, Iran, Libya, North Korea, and Cuba—never exceeded that of California, Texas, or New York. Even if Saddam conquered the Arabian peninsula and consolidated control over its oil resources, he would be in no position to “generate global power.” In any case, the unipole could quite easily deter an Iraqi invasion of the Arabian peninsula.

Even a nuclear-armed Iraq would be in no position to impose its will on US protectorates in the region, much less on the United States itself. Those who argue that a nuclear-armed Iraq or Iran cannot be deterred simply don’t understand the logic of nuclear deterrence. If Saddam has successfully acquired a nuclear deterrent, the United States would not have been able to invade and occupy Iraq. But the Iraqi deterrent would have been useless for the purposes of aggression, conquest, or regional domination. Had he retaken Kuwait, the United States would still have been able to kick him out simply because he would’ve been in no position to threaten the use of nuclear weapons against US forces for then he would be making the incredible threat of suicide to hold on to his conquests. Put more formally, extended deterrence is hard enough for the unipole; it is well-nigh impossible for a regional power like Iraq under Saddam.

If the United States under Bush had acted in accordance with the grand-strategy of primacy, she would have cared little about minor confrontation states and much more about actual potential rivals. In particular, the United States would have tried hard to thwart the emergence of a peer in the two extremities of eurasia. A more aggressive strategy to maintain primacy would see the United States not only preventing the consolidation of either of these two regions under a single power, but also undermining the growth rate of the only power that has the potential to become a peer of the United States without conquering a strategically important region. That is, if the Bush administration had followed the grand-strategy of primacy, it would’ve blocked China’s admission into the WTO, and more generally, prevented China’s emergence as the workshop of the world. That would’ve prolonged US primacy with much more certainty than the destruction of the entire rogues’ gallery.

So what was the grand-strategy that made the decision to invade intelligible?

Jonathan Cook has argued for a much more radical proposal in Israel and the Clash of Civilizations. He argues that it was in the Israeli interest to have its regional rivals disappear from the ranks of the confrontation states and be broken up into statelets that would not pose any significant threats to Israel’s regional primacy; and that the Israelis managed to convince principals in the Bush administration of the merits of their revisionist agenda for the region:

I propose a different model for understanding the [Bush] Administration’s wilful pursuit of catastrophic goals in the Middle East, one that incorporates many of the assumptions of both the Chomsky and Walt-Mearsheimer positions. I argue that Israel persuaded the US neocons that their respective goals (Israeli regional dominance and US control of oil) were related and compatible ends. As we shall see, Israel’s military establishment started developing an ambitious vision of Israel as a small empire in the Middle East more than two decades ago. It then sought a sponsor in Washington to help it realise its vision, and found one in the neocons. (p. 91.)

Yinon’s argument that Israel should encourage discord and feuding within states – destabilising them and encouraging them to break up into smaller units – was more compelling [than Sharon’s status-quo, state-centric vision of Israeli regional primacy]. Tribal and sectarian groups could be turned once again into rivals, competing for limited resources and too busy fighting each other to mount effective challenges to Israeli or US power. Also, Israeli alliances with non-Arab and non-Muslim groups such as Christians, Kurds and the Druze could be cultivated without the limitations imposed on joint activity by existing state structures. In this scenario, the US and Israel could manipulate groups by awarding favours – arms, training, oil remittances – to those who were prepared to cooperate while conversely weakening those who resisted. (p. 118.)

Israel and the neocons knew from the outset that invading Iraq and overthrowing its dictator would unleash sectarian violence on an unprecedented scale – and that they wanted this outcome. In a policy paper in late 1996, shortly after the publication of A Clean Break, the key neocon architects of the occupation of Iraq – David Wurmser, Richard Perle and Douglas Feith – predicted the chaos that would follow an invasion. ‘The residual unity of the [Iraqi] nation is an illusion projected by the extreme repression of the state’, they advised. After Saddam Hussein’s fall, Iraq would ‘be ripped apart by the politics of warlords, tribes, clans, sects, and key families.’ (p.133.)

I think Cook is mistaken about the importance of Israeli influence but he is onto something. Even if Israel managed to persuade principals in the Bush administration, there is no evidence to suggest that the Israel lobby, or even the neocons more generally (the lines between the two are blurred), had decisive influence over the Bush administration’s Middle East policy. (My position here is congruent with Cramer and Thrall’s). But what is clear is the frame of reference in which smashing Israel’s rivals would be in the US interest.

More precisely, I think principals in the Bush administration figured that Israel was nearly guaranteed to be a strong ally of the United States is a difficult region. After the reorientation of Egypt (mid-1970s) and the Islamic revolution (1979), three regional poles prevented total US-Israeli domination of the Middle East: Iran, Iraq and Syria. Smashing these confrontation states would guarantee Israel’s regional primacy and therefore, I think principals in the Bush administration reckoned, further the US interest in more easily dominating the region in a permanent alliance with its junior geopolitical ally. In other words, the grand-strategy of the Bush administration was to remove, by threats or by the use of force, Israel’s regional rivals in the Middle East.

They hoped to overthrow or cow into submission, the regimes of Iraq, Iran and Syria; and thereby establish unchallenged US-Israeli supremacy in the Middle East. What I am saying is that the United States’ grand-strategy was based on an ill-informed regional variant of offensive realism—one whose logic was conditional on a permanent alliance with a regional power—as opposed to the global and unconditional variant of offensive realism assumed by the grand-strategy of primacy (as put forward, say, by Mearsheimer).

It is clear that regional primacy was in the Israeli interest. It’s a bit of stretch to argue that it was it was also in the US interest. The problem is that, military primacy or not, Israel simply does not have that much influence in the region. Because it is a pariah in the Middle East, few actors try to seek its patronage (the Kurds are the main exception); most look to Iran, Saudi Arabia, or global powers. It is nearly impossible for Israel to play the role formerly played by Iran under the Shan or Egypt under Nasser. The United States has no choice but to work with other regional powers (Egypt, Turkey, Syria, Saudi Arabia and Iran) to work out regional problems. Moreover, from the perspective of a global power trying to minimize the costs of ensuring stability in a multipolar region of strategic significance, a balance of power is considerably more attractive than the precarious primacy of a pariah; perhaps even one guaranteed to be a permanent ally.

But the fundamental flaw of the grand-strategy pursued by the Bush administration was not the conflation of US and Israeli interest. (It can be argued, after all, that since Israel was basically guaranteed to be a permanent ally, Israeli regional primacy was squarely in the US interest.) No, the fundamental flaw of the revisionist strategy was the outright dismissal of the costs of the ensuing instability. No matter how far the prewar consensus was from foreign policy realism, at least the unbounded costs of regional instability were understood. When Bush broke with the consensus and smashed the Iraqi state, he clearly did not appreciate just how bad things could get.

Breaking up confrontation states into ethnic statelets and zones of weakness may sound like a splendid idea to half-baked geopolitical analysts. But instability and weakness are a source of insecurity, not power; as both the United States and Israel have since discovered.

To wrap up: The grand-strategy pursued by the United States when it invaded Iraq was to smash the regional poles that acted as confrontation states in the Middle East, whose removal from the equation promised unchallenged US-Israeli supremacy in this strategically-relevant region. Principals in the Bush administration simply did not appreciate the unbounded costs of the regional instability that would ensue.

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Thinking

# Balance Sheet Capacity and the Price of Crude

I’ve written before about the macrofinancial importance of broker-dealers (a.k.a. Wall Street banks). I emphasized the key role played by dealers in the so-called shadow banking system and have shown that fluctuations in balance sheet capacity explain the cross-section of stock excess returns. I have also argued for a monetary-financial explanation of the commodities rout. In this post, I will show that fluctuations in dealer balance sheet capacity also explain fluctuations in the price of crude.

The evidence can be read off Figure 1. Recessions are shown as dark bands. The top-left plot shows the real price of crude for reference. The spikes in the 1970s correspond to the oil price shocks in 1973 and 1979. Note the price collapse in 1986 and the price shock that attended the Iraqi occupation of Kuwait (the spike in the 1990 recession). Note also the extraordinary run-up in the price of crude during the 2000s boom and the return of China-driven triple digit prices after the great recession. Finally, note the dramatic oil price collapse in 2014 due to the US fracking revolution. We know that much of the fluctuation in the oil price was a result of geopolitical, supply-side and exogenous demand-side factors. My claim is that much of the rest is driven by the excess elasticity of the financial intermediary sector.

Figure 1. Source: Haver Analytics, author’s calculations.

Specifically, I show that fluctuations in the balance sheet capacity of US securities broker-dealers predict fluctuations in the oil price. We define balance sheet capacity as the log of the ratio of aggregate financial assets of broker-dealers to the aggregate financial assets of US households. We stochastically detrend the quarterly series by subtracting the trailing 4-quarter moving average from the original series. The plot on the top-right displays the stochastically detrended balance sheet capacity. We will show that it predicts 1-quarter ahead excess returns on crude.

We run 30-quarter rolling regressions of the form,

${R^{crude}_{t+1}=\alpha+\beta\times capacity_{t}+\varepsilon_{t+1}}, \qquad (1)$

where ${R^{crude}_{t+1}}$ is the return on Brent in quarter ${t+1}$ in excess of the risk-free rate and ${capacity_{t}}$ is the shock to balance sheet capacity in quarter ${t}$. We must take care to interpret rolling regressions because instead of two parameters suggested by equation (1), we are in effect running 183 regressions with different parameters.

The plot on the bottom right displays the percentage of variation explained in each predictive regression. We see that balance sheet capacity became a significant predictor of the price of crude in the mid-1980s. It’s predictive capability diminished in the mid-1990s, before gaining new heights in the 2000s. The period 1999-2007 was the heydey of financially-driven fluctuations in the price of crude. That relationship collapsed in the second quarter of 2007. During the financial crisis and the period of postcrisis financial repression, the relationship disappeared entirely. It only recovers at the very end of our sample in 2016.

The bottom-left plot in Figure 1 displays a signed measure of the influence of balance sheet capacity on the price of crude. We display the product of the slope coefficient in equation (1) with one minus its p-value. This measure kills three birds with one stone. We can (a) keep track of the sign of the slope coefficients (to see whether or not it reverses direction too much), (b) get an additional handle on the time-variation of the strength of the predictive relationship, and (c) control the noise by attenuating the slope coefficients in inverse proportion to their statistical significance. Note that we have reversed the direction of the Y axis in the plot on the bottom-left.

The slope and significance metric tells a story that is very similar to the one told by the percentage of variation explained. Moreover, we can see that the relationship is economically large and negative. The interpretation is that positive shocks to balance sheet capacity compress the risk premium embedded in the price of crude. When balance sheet capacity is plentiful, risk arbitrageurs (speculators who make risky bets) bid away expected excess returns. Conversely, when balance sheet capacity is scarce, risk arbitrageurs are constrained in the amount of leverage they can obtain from their dealers and are therefore compelled to leave expected excess returns on the table.

The main result above—that dealer balance sheet growth predicts returns on crude oil—was originally obtained by Erkko Etula for his doctoral dissertation at Harvard.

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Geopolitics

# The Near-Unipolar World Reconsidered

Figure 1. Countries rescaled by the number of people earning more than \$200 dollars a day in 2002. Source: WorldMapper.Org.

This is an ongoing conversation with Ted Fertik.

Thanks for the link man. Tooze (2014) was an amazing read! I want to talk about two things. First, I am going to shamelessly insist that I was right about the role of near-unipolarity in Tooze’s schema. Second, I want to talk about how near-unipolarity relates to the history of the twentieth century. All quotes are from Tooze (2014) unless otherwise specified.

“In the wake of World War I think the stakes were higher.” Why were they higher? “What was at stake was a new global order under the sign of what has been variously referred to as ultraimperialism, American hegemony, or Empire”; that Churchill described as “the pyramids of peace” (quoted in The Deluge). [Emphasis mine.]

The “central challenge facing the German political elite” was the “sheer scale of twentieth-century Anglo-American economic predominance.” Tooze shows that the interwar order was one of unabashed Anglo-American cohegemony. The “main question” of the international politics of the interwar era is “how to understand the insurgency against the order.” More pertinently, the question facing the Germans was should they “conform and assimilate themselves to its power” or “mount an insurgency against it”?

“We must view that struggle as more asymmetric, and thus as an expression of the combined and uneven development of the international system…” [Emphasis mine.]

“Neither the international relations of the interwar period, nor World War II itself are well-described by models…derived from the more truly multipolar world of the late nineteenth century.

I contended that the world from the close of the nineteenth century to the rise of China in the 2000s was secretly near-unipolar. I presented GDP numbers and argued that GDP was a good enough measure to detect near-unipolarity. But I also have strong historical reasons to think carefully about near-unipolarity—as the quotes from Tooze above suggest.

When I say near-unipolar, I mean that there is a especially strong state in the system such that no state could hope to prevail against it in a war or an extended rivalry; that there is no doubt about the identity of the strongest state in the system; and that when statesmen evaluate great power war and great power military alliances they had to care a great deal about the unipole’s position—computations on the outcome of great power war and confrontation premised on the unipole’s disinterest have to be thrown out of the window if the unipole weighs in the balance.

Note again that this is a weak definition. It just means that there is a football in a pile of tennis balls. The unipole may not even have a standing army. It may or may not exercise influence abroad. A lesser great power may run the maritime world and lesser great powers may worry much more about each other (especially their strong neighbours) than the unipole. In fact, if the unipole is insular and isolationist, it may not cause the other great powers any headaches at all. Indeed, they may even make fun of its extant weakness.

However, in a near-unipolar world, such disdain is contingent on the foreign policy of the unipole. Were the unipole to mobilize its war potential and be willing to use force on the world stage, the lesser great powers would have to eat their insulting words. Moreover, lesser great powers threatened by each other can be expected to try to secure the protection of the unipole. An alliance with the unipole is, after all, very useful given the rule of force in world affairs. The unipole may therefore get pulled into other people’s fights despite itself. Even insularity and isolationism thus do not completely thwart the gravitational pull exerted by the unipole.

One could write a convincing history of the twentieth century in this frame of reference. The philosophy of history that such a work requires is almost insultingly straightforward. The basic fact of near-polarity serves as the single explanatory variable. That is, the twentieth century as the story of the clarification of the real balance of forces. Or history catching up with the secret topology of the world.

In this frame of reference, the outcomes of the main great power confrontations of the twentieth century—World War I, World War II, and the Cold War—were more or less known in advance. The game had, in fact, been rigged from the get go.

What explains the British surrender of naval preponderance in the Western Hemisphere in 1900? What explains the results of 1918? What explains the Washington Naval Conference of 1922? The stability of the interwar European order in the 1920s? The breakdown of that order and the turn to radicalism in 1931? The startling fact that not the winner but the power that basically sat out the Second World War dictated the postwar order? The outright capitulation of the second ranked power in the so-called bipolar world in 1989? All these questions have a single answer: The fact of the asymmetric size of the football.

Is it possible to construct a tighter, more parsimonious narrative frame? Is it not, then, a quite compelling frame of reference?

References

Tooze, Adam. “The Sense of a Vacuum.” Historical Materialism 22.3-4 (2014): 351-370.

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