US Foreign Policy - US Interests versus Values

Periodically, most recently with regard to US foreign policy concerning the Arab awakening, the claim is made that US values frequently conflict with US interests. The interest for the US in the Mid-East is for a stable, generally secular, western friendly region which has historically been provided by local autocrats. The value generally claimed to be at conflict with US interests is democracy. Perhaps there is no conflict and the apparent conflict is just a matter of definition. Democracy is not an end in itself but a means to achieving goals. If a democracy leads to a fundamentalist Islamic government that persecutes people of other religions, limits education to religious studies for men only and recognizes few if any rights for women really in accordance with US values even if achieved via a free and fair election? Hussein in Iraq was an autocrat but he provided freedom of religion and gender equality which are key US values. If democracy leads to a civil war, are US values really served? If a country such as many of those in Africa doesn't have the institutions to support free and fair elections such as independent courts, media and election monitoring can a election really be expected to result in practices which are in accord with US values? If a country has an illiterate population with strong tribal loyalties arranged by geographic region it is likely that an election will result in an administration that is dominated by one culture or tribe which exploits the other tribes which usually results in a civil war.

I would argue that when comparing interests to values that an expansive definition of values is adopted with an assessment of what democracy will provide in light of a given nation's institutions and culture. I would also argue that stability is both a major interest and value of the US and is sometimes best served by an autocrat. The US has some ability to influence the policies of an autocrat through aid budgets and other means. Democracy as an alternative to an autocrat is no sure or quick thing. Democracy in some instances, will result in practices that are less in accord with US values than the previous autocratic government.

Western involvement in Libyan revolt

The major cause for the delay by the Western powers in determining their role in the Libyan revolt is the attempt to reconcile values with national interest and to reconcile short term tactics with long term strategy. In the short term, humanitarian imperatives caused by the Libyan regime’s willingness to use the military against civilians in rebel strongholds argues for immediate intervention. Once the regime’s military has entered the rebel cities there is nothing the West can do to prevent a slaughter short of a large military combat presence on the ground which is unacceptable. In the long term, the reluctance to support the rebels is based on not knowing whose interests the rebels represent or what tactics will lead to an end position that does not involve a bloody civil war or a divided country.

One option would be to proceed as follows;

1. The west would adopt a sanctuary zone concept with the zones surrounded by demilitarized zones say of 20 miles. Any regime forces entering the sanctuaries and/or attacking the sanctuaries would be destroyed by the Western powers. Any rebels leaving the sanctuary to go on the offensive would do so without any Western support.


2. A quarantine would be maintained that would prevent the current Libyan regime from importing any weapons or ordinance and Libyan assets would continue to be frozen. It would be helpful of the Algerian border and the southern borders could be monitored to prevent any imports to the Libyan regime of weapons and troops from these areas.


3. The rebel area would be provisionally recognized as a separate state entity apart from the current Libyan regime.


4. The Saudis would provide technical support to run the oil and gas industry and the Saudis would handle the sale of any oil and gas available for export. The Saudis alone would determine price and customer.


5. The French would provide administrative support, account for and dispense funds received from the sale of the oil to existing employees of state owned utilities and health and safety services.


6. The rebels would have a defined period of time, say 3 months, to adopt the core of a constitution, the framework for government and to elect representatives to the government. The Turks or Egyptians might take the lead in this effort.


7. All costs for infrastructure repairs, operation of services and cost for contractors assisting with the elections, formation of core government structure, etc. would be paid for by Libyan oil revenues.


8. If the Libyan government, government representatives and core constitution were acceptable to the western governments then the process to formally recognize the new government as the sole representative of Libya would be rushed to conclusion in the UN.


9. No military aid including weapons, ordinance or training would be provided until the new Libyan government was formally recognized.

Egypt - What Comes Next

I think it likely that Egypt will follow the road that Turkey followed in establishing a secular government. The West and the protesters want a democracy established in Egypt, Mubarak will not remain nor will his son be permitted to take the reins of government and a democratic election under the current rules would likely see the the Muslim Brotherhood gaining more influence than the Egyptian Army and large segments of the Egyptian population not to mention the West would tolerate.

Consequently, in the next 10 days I expect that Mubarak will leave Egypt, the military will take command in a caretaker role and will insist on a new secular constitution being developed after which elections will be held. Much like Turkey, the military will be given a position in government with the explicit objective of ensuring that a secular state is maintained.

Earmark Ban

The Senate today voted against a ban on earmarks claiming in part that earmarks are not expensive costing only $16b in fiscal 2010. However, there are some bills where earmarks are used to get enough votes to pass the bill which would otherwise fail and in these cases I think that you should count the total cost of the bill and not just the cost of the earmark in determining how much would be saved by banning earmarks.

Recall that when it appeared that healthcare reform did not have enough votes in the Senate to pass that an earmark was included in the bill which would pay 100% of Nebraska's additional Medicaid expense with the other states only receiving a 50% federal reimbursement of the increased Medicaid costs. Assuming that Nebraska's Senator Bill Nelson's vote made the difference between the healthcare reform bill passing, should you count the cost of this earmark as the $90 million in additional Medicaid reimbursement over 10 years or the $1 trillion of the new healthcare reform over 10 years?

The argument that earmarks are not a significant cost item is misleading.

Diane Rehm - Please Retire

I am a long time NPR listener and routinely tune in to the Diane Rehm show primarily due to the quality of the quests she is able to attract. Over the last year, a significant number of her guests were invited to discuss financial and economic issues. Ms. Rehm's questions are frequently circutious and she explored popular prespectives almost exclusively. In my opinion, she is not comfortable with basic economic theories, the financial products (MBS, CDO, CDS, etc.) and industry practices that contributed significantly to the financial crisis. She missed numerous opportunities to ask probing questions which could have helped educate even the average listener on government policy and options for legislation.

However, what prompts me to write this entry is that I have listened to Ms. Rehm in two recent shows push her personal view that non-lawyers should be adppointed to the Supreme Court. The two shows were her interview with Justice Breyer and her discussion with panelists of cases on the 2010 Supreme Court docket. Her argument in support of appointing non-lawyers is that the Supreme Court should "represent a great variety of thinking, not just lawyers". I consider her point to be simplistic, insipid and not well thought out. The only thinking that is appropriate for a Supreme Court Justice is legal thinking. Justices need to have a detailed understanding of the Constitution, resources which illuminate the intent of the Constitution such as the Federalist Papers and detailed knowledge of case law decided by the court. The court needs to objectively make decisions based on the Constitution and case law and nothing else. If non-judicial thinking and personal experience were the basis of Supreme Court decisions, the court would become partisian and the decisions would not form a basis for a continuation of legal thought. If people without the requisite legal background, regardless of how much they know about other subjects, were justices, the opinions of the court would come to be seen as arbitrary and capricious and precedents would be routinely overturned such that no person or firm could rely on the legal opinion of their attorney in making decisions. I feel sorry for the mother who has lost her son to gun violence but this experience has no place in determining a 2nd amendment issue and I say this from a personal perspective of believing that easy access to guns is a problem and don't want a gun in my house. The Supreme Court should not be basing their decisions on their assessment of the impact or benefit to society at large as this is the job of the legislators. Do we really want Joe the Plumber voting on the court? It may sound fine to argue that common sense is a valid basis for a legal opinion but consider that one person's common sense is another person's folly. The Court should make legal interpretations and that requires someone well versed in the law. No, I am not a lawyer and generally agree with Shakespeare on the value of lawyers.

The host of a talk show must have some understanding of the topics being addressed in order for the show to be informative and Ms. Rehm is seriously lacking on the more serious topics which she is increasingly addressing. Perhaps she should stick with book interviews and other lighter topics.

Increase Interest Rates to Stimulate US Economy

The typical recession is the result of demand exceeding supply which leads to price inflation and is addressed by raising interest rates to reduce demand. However, in the case of a deflating bubble resulting in a financial bust, the resulting situation is too little demand yet the same remedy of lowering interest rates is prescribed. Is it possible that this is the incorrect policy to correct the weak economy resulting from a burst bubble and that the correct policy might be the counter-intuitive policy of raising interest rates? Is it possible that reduced interest rates to stimulate demand might be appropriate for an economy with a large manufacturing sector with a low savings rate but might not be appropriate for a mature service based economy with a significant savings rate such as the US or Japan?

A significant reduction in interest rates by the FOMC might in fact cause demand and GDP to contract while increased interest rates might cause demand and GDP to expand. Although this may seem counter-intuitive, consider the following;

- In 2008, $223.3 billion of interest income was reported to the IRS. As a result of FOMC rate cuts, interest rates paid to savers have declined by at least 80% which, in general terms, has lowered interest income by about $179b and, assuming a 25% federal and state marginal tax rate, has lowered tax receipts by about $44b. The result is that the savers spend less which reduces demand and the state and local governments tax more, cancel projects and/or reduce staff which reduces demand further.
- Insurance companies make a significant amount of money on their float (investing premiums collected until a loss payout is required). When their investment income declines for a given projected actuarial loss, the appropriate response is to increase premiums which reduces the demand of policyholders for other goods and services. Deutsche Bank alone which is the 3rd largest 3rd party insurance asset manager has $150b in US insurance company assets under management.
- US university income comes from tuition and fees and investment income from their endowment funds. In 2008, 4-year not-for-profit colleges and universities collectively held more than $400 billion in endowments with Harvard University alone having an endowment fund of $37b in 6/2008. Typically, a university uses 5-6% of the endowment fund each year to pay for expenses. When earnings from endowment funds decline, the university will either increase tuition, claim additional state tax dollars and/or reduce staff.
- US employers who offer pensions use pension funds to pay for the pensions. Generally, the pension fund calculates how much they need to pay their future obligations, subtract expected investment income and collect the remainder from the employer. Given that the total value of US pension funds at the end of 2007 was $17.3 trillion, a 1% decline in investment income would require that employers contribute an additional $173b which would reduce money available to firms and government for projects and staffing. It should be noted that pension funds are already assuming a much higher rate of return on investments than they can reasonably expect.
- Higher interest rates typically lead to higher prices (inflation) although in a post-financial bubble it isn’t clear that this generalization would hold in the short term. There are certain sources of income such as social security retirement and disability benefits that are indexed to the Consumer Price Index (CPI). Given that social security retirement payments in 2009 totaled $564b and disability payments in 2009 totaled $121b, a 1% increase in the CPI would increase annual benefit payments by about $6.9 billion. Keep in mind that although there are other income sources contractually tied to the CPI such as union contracts, many employers base annual wage increase on the CPI. Given that total 2008 wages and salaries reported to the IRS was $5.95 trillion, even if just 25% of this income was increased by 1% due to a higher CPI this would lead to an annual increase of $14.9b.
- A higher interest rate would typically lead to a higher exchange rate. The net impact of a higher exchange rate on the balance of trade (net imports/exports) is difficult to estimate. However, some imports such as oil are priced in US dollars and as the dollar weakens the US oil cost increases while the cost of oil imports to other countries such as the EU declines. Higher US energy costs reduces consumer demand while lower energy costs to international competitors such as Germany reduces their costs which could reduce US exports.

Note that the above is a general analysis and that there are offsets to increased interest rates. For instance, increased interest rates might increase credit card interest which would reduce demand but can credit card companies really increase above the current 30%?

Of course, when faced with lower investment returns from safe investments, the investor could chase higher returns by investing in riskier assets such as mortgage backed securities but this might just result in a new crisis. Keep in mind that Greenspan intentionally kept interest rates low following the busting of the tech bubble due to anemic job growth but this made the financial bubble possible if not inevitable.

Public Advocacy, Grassroots Organizations and Snake Oil

The Internet and email have made it very easy for small groups of people to organize large numbers of voters to influence legislative policy priorities. Unfortunately, what are essentially special interests are able to portray themselves as general interests. The effort usually starts with a small group or industry who will benefit, a narrative that distorts the special interest portraying it as a general interest and the commissioning of studies by reputable organizations which develop creditable but biased data to support the narrative.

A case in point is the supposedly grassroots organization Defend My Dividend which is flooding the bandwidth with commercials requesting voters to contact their representatives to demand that federal tax rates on qualified dividends (dividends on stock owned for one year or more) not be increased. Starting with the 2003 tax cut legislation, the tax rate on qualified dividends was reduced to 15% (0% tax for people in the 15% tax bracket or lower). If no change is made, the tax rate on qualified dividends will revert to the rate that existed prior to the 2003 tax law change which taxed dividends at the same rate as ordinary income (wages, salaries, savings account interest, etc.). The Obama administration is proposing that the reduced rates only be retained for married tax payers with less than $250,000 in annual income ($200,000 for single tax payers) starting in 2011.

The Defend My Dividend organization was organized by several major utilities. On their web site, a major justification for not raising the rate is that it is a myth that the lower rate only benefits wealthy tax payers. The organization, citing a study by Ernst & Young which was paid for by the Edison Electric Institute and the American Gas Association, claims that 27 million Americans benefit from the lower tax rates and that 65% of the people who benefit have an annual income of less than $100,000. These claims are technically true but are very misleading. The study focuses solely on the number of returns by income bracket which report qualified dividend income and not the dollar amount of the qualified dividends by income bracket. As such, the study considers the person with a 2007 taxable income of less than $5,000 with an average qualified dividend income of $42.37 the same as the people with a reported income of more than $10 million who in 2007 had an average annual qualified dividend income of $1.5 million. No points for guessing who benefits more from the reduced tax rate.

Using the same 2007 IRS data used by Ernst & Young, I find the following;

- 80.9% of all qualified dividend income was reported by people with annual incomes of $100,000 or more.
- 65.1% of all qualified dividend income was reported by people with annual incomes of $200,000 or more.
- The preferred tax rate on qualified dividends reduced IRS tax receipts in 2007 by about $23.6 billion.
- Approximately 86% of the $23.6 billion in tax savings went to people with income above $100,000 and 76% to people with incomes above $200,000 and 46% to people with income above $1 million.

Just like the snake oil salesmen of the 19th century, they are claiming that reduced tax rates for qualified dividends are good for everyone when in fact most people will not benefit and end up paying higher taxes someplace else to make up for the revenue lost due to the lower tax rate on qualified dividends.