Shadow Government

Pivoting and rebalancing: The good, the bad, and the ugly

First the good:

1) The Obama administration has stopped calling its efforts to focus on Asia the "pivot" which implies turning your back on other crucial parts of the world.

2) The Obama administration is building upon diplomatic and strategic efforts of its predecessors and has dropped the White House adolescent trash-talking of "we are back" in Asia.

3) These efforts include serious attempts to build the free trade area of the Pacific first envisioned by the George H.W. Bush administration; upgrading relations with Taiwan and Japan begun by the Clinton administration; and the breakthrough in relations with India, the creation of "mini-laterals" such as the U.S.-Japan-Australia, and the movement of more forces into the Pacific that was the work of the George W. Bush administration.

4) For its part the Obama administration has started a relationship with Burma, tightened relations in South East Asia, and increased the tempo of U.S. military presence in the region.

Now the bad:

1) There is a danger of overpromising. The new defense guidelines were released in January 2012 at same time as talk of a "pivot" began. Concurrently, details of a new operational concept called Air Sea Battle were released, that despite protestations to the contrary, is more or less about how to defeat China in a conflict. This coincidence of events has regional allies believing that the U.S. has carefully developed some new "secret sauce" to keep the peace in Asia. The reality so far is two Littoral Combat Ships in Singapore, some good speeches in Vietnam, and some marines in Australia.

2) The administration is making critical strategic choices that will affect its posture in Asia.  One choice is to slash the defense budget. It already did so in 2009 to the tune of about $400 billion. This year the Budget Control Act will kick in lopping off hundreds of billions more.  The president has every right to choose the salvaging of and creation of more social welfare programs over the defense that is needed in Asia, but it is dangerous to misalign your stated strategic goals and your resources -- this is the famous "Lippman Gap."

3) The defense cuts badly affect the forces we need in Asia. The stealthy F-35 program has taken a big hit. The navy has said it needs anywhere from 500 to 313 ships in its fleet. It will end up with around 285 total ships by the end of the next five year defense program. The much touted next generation long-range bomber is underfunded -- by 2017 it is unlikely that we will have more than an industrial competition to build it, which means years before it comes on line. The list goes on: missile defense takes a hit, as does most certainly the workhorse of any Asian contingency -- attack submarines.

4) India. There is simply no way to check China's power if Afghanistan descends into chaos and India has to respond. In the rough and tumble of international politics it is very difficult to get regions to conform with U.S. government flow charts. India can only fully integrate into East Asia if there is some semblance of security along its land borders.

5) It is also unrealistic to think we can spend less time on the Middle East in order to spend more time in Asia for two reasons. First, the Chinese are competing with us in that critical region to mostly bad effect. Second, our allies depend on the stability we provide in the Middle East for oil.

Now the ugly:

1) Things with China will get ugly. Our talk of rebalancing is a response to Chinese power and provocations. The competition is intensifying. We repeat the mantra that our efforts in Asia are not about China as if saying it makes it true. In reality, politics, like physics, has an action-reaction cycle. While we are doing the right thing, China certainly views our actions as hostile. We should expect China to up its game militarily.

2) Related to the above, we need presidential leadership to explain to a war-weary public the need to maintain the power advantage in our competition with China. The public will ask understandable questions like why die for Taipei, or Manila or even Seoul and Tokyo? (Remember the questions "why die for Danzig or Berlin?") The debate will arise and could get ugly. It would be better to start this public education campaign now. We seek no conflict or quarrel, rather the commitments we are making are to maintain our position in a critical part of the world.  

The best course is not to cut down commitments at this dangerous time, but rather to bring resources in line with those commitments. Any other course will not lead to a "peaceful retrenchment." Rather, if the U.S. stopped playing the role of benign hegemon in Asia chaos would ensue.   No one would lead efforts to further build upon a economically vital region, stem proliferation, or keep great power peace. Deterrence is expensive, chaos more so. The president should explain to the public what he means to do in Asia and why.


Shadow Government

All hail the banking union

Eurozone leaders emerged from their latest all-nighter with a plan that sent the markets into paroxyms of relief: The German and French stock markets were up more than 4 percent Friday. The key heralded result was a commitment to move toward a banking union. This was taken as a critical concession by German Chancellor Angela Merkel and a key move toward resolving the crisis.

As the good folks at Foreign Policy have helpfully documented, this is not the first time European summiteers have stepped out, bleary-eyed, and announced there would be economic peace in our time. It's roughly the 20th. I warned before about celebrating any European plan to have a plan, and that's what this is. But how good is the plan? Is it a significant step toward solving the euro crisis?

The most striking move was the promise of a banking union. The European Central Bank would be given new regulatory powers over eurozone banks and European bailout funds could be sent directly to ailing banks to support them, without adding to national indebtedness. It would be nice to be able to dissect the details of how this new scheme will operate, but there aren't any yet. The bailout funds cannot be tapped until the ECB is empowered, and that will take at least a few months.

In theory, a move to bolster Europe's ailing banks could help. As the 2008 financial crisis aptly demonstrated, the financial sector provides the lifeblood of an economy; cut it off and the economy turns distinctly blue. Europe's economies are notably more dependent on bank finance than the U.S. economy and the banks of the troubled economies on the periphery have had trouble raising funds and retaining deposits. A move to bolster them could potentially stop a direct drain on the funds of impoverished sovereigns and move toward restoring normal functioning and growth in those economies.

There has been a clamor for such moves, partly on the well-established theory that banking panics can be self-fulfilling. The normal operation of banks is risky. If everyone tries to get their money at once, even a healthy bank will succumb. This is the rationale behind deposit insurance. Let all those small savers know their money is secure, restore calm, and the insurance may never even need to pay out.

So that's the hope. If the eurozone banking troubles are just the result of unfounded panic, a new backstop could restore calm. If there are a limited number of banks troubled by past lending into now-burst real estate bubbles, a well-funded cleanup could set things aright.

But the potential problems are enormous. Here are five sets of questions facing the new European banking union plan:

1. Politics of operation. In the story above, banks are just going about their ordinary business when an unfounded panic attack strikes customers. But banks can make choices about how much risk to take on. Riskier projects can offer higher returns. This is why the bailout has been coupled with regulation; Chancellor Merkel does not want a situation in which "Heads Bankia wins, tails Brussels loses." Bank regulation is difficult in ordinary circumstances (banks are big and complicated and even they may not realize the risks they are running). The situation is even more complex when you have close relationships between banks and politicians and bank lending is used to further political or industrial policy ends. Will Germany or France tolerate that kind of interference from the ECB?

2. Back door fiscal union? One of the risky behaviors that European banks have recently engaged in has been lending to the governments of Greece, Spain, and Italy. If the banks are allowed to keep purchasing government bonds, then direct lending to the banks looks like a back-door fiscal union, only without controls on government spending, a point made by James Mackintosh of the Financial Times. That would also beg the question of where the money will come from, since the summit proposed no new resources and existing ones would not cover those countries' needs. If a new bank regulator cuts off the flow of funds from the banks to the governments, that raises the question of who will be left to lend to the governments. When bond buyers disappear, interest rates soar.

3. Politics of resolution. All of the political questions apply even more strongly when it appears a bailout has failed. Who decides to pull the plug? Will powerful governments let national champion banks be disassembled by eurozone technocrats? Who decides how the losses are allocated? There are already lawsuits from small Spanish shareholders who claim they were misled into funding Spanish banks. If such shareholders or bondholders are wiped out - normal in a bankruptcy - that can have an economic and psychological impact.

4. What about London? Britain is not in the eurozone, of course, but London is the financial center of Europe. The EU is supposed to have a single market in financial services. Omitting Britain entirely would be like saying that we would regulate finance in the United States, except in New York. But on what grounds could the ECB hold sway over behavior in London?

5. Which risk are you insuring against? In the standard deposit insurance story, some banks get unlucky with their loans and their depositors are rescued. Europe's problem is that there is another sort of risk lurking: euro departure. Imagine two Greek depositors, one of whom keeps his money in his Athens bank, the other who moves her money to Frankfurt. If Greece were to leave the euro, our two depositors would have drastically different experiences. He would be much worse off than she would be, since his savings would be in depreciated drachmas. Would deposit insurance compensate him? It is hard to believe it would, particularly when one hears Europeans talk about how a departure would be an unacceptable violation of European law. Even if Europe were tempted toward forgiveness and inclined to reimburse such losses, the cost would be enormous. This would be covering virtually all bank deposits in a departing country, not just an unlucky few. The latest summit did not propose any new funds, much less the trillions of euros this could cost. If you do not insure against this risk, then insuring against the lesser, idiosyncratic bank risk is completely futile. If you do insure against this risk, the promise has to be credible to do any good.

In sum: another European summit; a burst of euphoria; a plan to have a plan; and many questions left unanswered. Eurozone leaders have expressed their good intentions, but in mid-crisis it is the seemingly-obscure particulars of banking practice that will determine whether or not the markets' relief was merited.