Belly of the Beast

Doug Nolan

We’re at an important juncture for the global Bubble. There are growing divergences and anomalies. Market signals are increasingly conflicting and confounding: European equities in melt-up and U.S. markets at record highs, while China falters. Bond yields rising and commodities sinking. Talk of derivative issues and leveraged player struggles. Often discordant economic data providing fodder for bulls and bears alike.

Let’s begin at home. While recovering somewhat from March’s huge disappointment, at 16.81 million annualized (SAAR) units, April vehicles sales were significantly below estimates (17.1 million). This supports the view of tightened lending standards in auto finance. Also supporting the bear case, the ISM Manufacturing Index dropped to a weaker-than-expected 54.8, down from March’s 57.2 and February’s 57.7. March Personal Spending was reported flat versus estimates of up 0.2%. Non-farm Productivity was reported at a stinkball down 0.6% (est. down 0.1%).

At the same time, those anticipating stronger Q2 growth were this week heartened by a slew of data points (market now sees 100% probability of June rate increase). Most notably, the ISM Non-Manufacturing Index bounced back strongly from March weakness. At 57.5, the index almost recovered back to February’s 56.7, the high going back to October 2015. The ISM Manufacturing Price Paid Index remained elevated at 68.5, and New Orders were a strong 57.5. Durable Goods Orders were stronger-than-expected. And an indicator I’m monitoring closely these days, mortgage purchase applications, increased last week to approach the strongest level since 2009. And, of course, at 194,000, non-farm payrolls bounced back briskly from March’s (revised) 79,000. As a reminder of how services these days so dominate U.S. economic structure, April saw only 6,000 manufacturing jobs added.

Examining the data, it’s not difficult to explain this week’s upward trajectory in equities and downward pressure on bond prices. Ten-year Treasury yields increased six bps this week to 2.35%. Meanwhile, the S&P500 and Nasdaq Composite ended the week at all-time highs. Spanish stocks jumped 3.9%, and Italian equities surged 4.2%.

More intriguing, yields and equities rose as commodities came under heavy selling pressure. Crude sank $3.11 this week, trading below $45 for the first time since November. WTI ended the week at $46.22, after trading as low as $43.76 overnight. There was more to the sell-off than OPEC and American shale production. The week saw nickel drop 2.1%, tin 1.3% and lead 1.1%. Shanghai Aluminum fell 1.9%. The Chinese iron ore collapse continued, while Shanghai steel sank 6%. Copper lost 3.0%, trading to a 2017 low. Silver sank 5.7% and Platinum fell 3.5%.

It’s not all that astounding that markets disregard troubling issues unfolding in Chinese finance. The bullish narrative is focused on Trump administration tax cuts, deregulation and infrastructure spending. Throw in a European recovery and hope for EM. Talk is clearly not of a historic global Bubble vulnerable to a massive and fragile Credit Bubble in China. That is an analytical perspective markets avoid like the plague.

Market apathy notwithstanding, there are important developments to monitor. Let’s start with China’s economy, where it appears the past year’s Credit-induced thrust in activity has begun to wane. China’s Caixin Manufacturing PMI dropped to a weaker-than-expected (and barely expanding) 50.3 in April, the low since last September’s 50.1. Perhaps more ominously, the month-on-month decline in the Caixin Services index was even steeper. It dropped to 51.5, the weakest reading in almost a year.

The Shanghai Composite dropped 1.6% this week, trading to the low since mid-January. China’s growth-oriented ChiNext index fell 1.8% (down 7.3% y-t-d) to near multi-year lows. Notably, Hong Kong’s Hang Seng Financial index sank 2.7%.

May 4 – Bloomberg: “Signs are emerging that the Chinese government’s renewed drive to curb financial leverage is starting to bite. The number of wealth-management products issued by Chinese banks slumped 39% in April from the previous month, while trust firms distributed 35% fewer products, according to data compilers PY Standard and Use Trust. Sales of negotiable certificates of deposit, a popular instrument of interbank lending known as NCDs, tumbled 38% from a record, figures compiled by Bloomberg show. The system-wide contraction is a result of a flurry of government measures over the past month that included ordering banks to bolster risk controls, stepping up scrutiny of shadow financing and cracking down on malfeasance among senior bureaucrats. While the moves have rocked China’s financial markets, the government is sending a clear signal of its determination to curb the estimated $28 trillion debt pile that poses a risk to economic stability.”
May 3 – Financial Times (Gabriel Wildau in Shanghai and Peter Wells): “A key Chinese money-market rate matched a two-year high on Wednesday after the central bank drained cash from the banking system, part of an ongoing effort to tame financial risks by squeezing liquidity. Authorities are facing the tricky task of increasing regulation of risky financial instruments without spooking investors or raising borrowing costs in the real economy. Short-term lending rates have climbed since President Xi Jinping told a politburo meeting last week that financial security was ‘strategically important’ for economic and social development. Investors interpreted his remarks as a sign that monetary policy will tighten. The benchmark seven-day repo rate hit a two-year high of 3.18%...”
May 1 – Reuters (Adam Jourdan): “China's level of leverage is rising at an ‘alarming pace’, particularly in the finance sector, a senior central bank official said in a commentary, amid growing concern by the country's senior leaders over financial security. The official Xinhua news agency… cited Xu Zhong, head of the People's Bank of China's (PBOC) research bureau, as saying the country needed to deleverage at a ‘proper pace’ to reduce financial sector debt and avoid systemic financial risk. ‘China's overall leverage level is reasonable but is rising at an alarming pace, especially in the financial sector,’ Xu said.”

Chinese policymakers appear determined to harness the expansion of its booming financial sector. The apparent plan is to apply constraints in a manner so to not unduly risk economic weakening or financial instability. Over recent years, officials have attempted various measures to rein in overheated real estate markets as well as speculative commodities, equities and bond markets. A couple times policymakers even came close to bursting Bubbles, before abruptly reversing course. In the end, the overall timid approach ensured the ongoing ballooning of China’s now mammoth financial sector and Credit Bubble more generally.

The problem confronting Beijing – and global policymakers more generally – relates to the old “Austrian” analysis that Bubbles are sustained only by ever-increasing quantities of Credit creation. Inflate a Credit Bubble – with resulting elevated price structures throughout the real economy, asset markets and the financial sphere – and these various inflated price levels become progressively vulnerable to any meaningful and sustained slowdown in Credit creation.

There remains this dangerous misperception that economies can simply grow/inflate their way out of debt problems. This is at odds with reality. Especially late in the cycle, liquidity is funneled into inflating asset markets rather than to the real economy (suffering from overcapacity and waning profit opportunities). It becomes easier to make returns in finance than in goods and services. Meanwhile, policy measures to sustain the unstable boom further incentivize leveraging and speculating.

To this point, Chinese officials have “succeeded” in ensuring ever-increasing amounts of Credit. The upshot has been only more outrageous real estate (largely apartment) Bubbles, rapid Credit deterioration and deeper structural maladjustment.

Beijing understands that it has a problem and appears to have a new approach: They’re going to the Belly of the Credit Beast – “shadow banking” and, more specifically, “wealth management products” (WMP). They’re cracking down on “insurance” companies.

I often refer to a Credit Bubble’s “Terminal Phase.” Systemic risk rises exponentially at the end of the cycle – rapidly escalating quantities of increasingly risky Credit. And contemporary finance is replete with products and vehicles to transform high-risk Credit into perceived safe and liquid (money-like) financial instruments. We saw this dynamic in the U.S. at the late-stage of the mortgage finance Bubble, with “AAA” ABS/MBS, derivatives and the like. In China, frightening amounts of high-risk Credit have been intermediated through a labyrinth of WMP and shadow banking.

This week saw some justified fear that Chinese measures may cripple shadow bank risk intermediation, slow system Credit growth, spur speculative deleveraging and spark illiquidity. The notoriously leveraged and speculative Chinese commodities sector proved the weak link. And a bout of intense deleveraging in this space raised fears that an unwind of leverage and resulting Credit instability could turn its sights on the mighty and mighty vulnerable apartment Bubble. How vulnerable is Chinese mortgage Credit these days to a tightening of Credit Availability and a self-reinforcing decline in home prices?

Of course, everyone knows that Beijing will not tolerate things getting out of hand. Much like the end to the ECB’s QE program, speculative markets are content to downplay China risks perceived to be at least a number of months into the distant future.

Chinese stocks retreated in Shanghai and Hong Kong as concerns mounted over Beijing’s efforts to reduce financial system leverage - along with worries that a selloff in commodities and spillover into equities could negatively impact economic confidence.

Friday from Bloomberg: “The Hang Seng China Enterprises Index led declines in Asia, sliding 1.6% at the close local time. Back on the mainland, the Shanghai Composite Index slipped 0.8%, taking its drop in the week to 1.6% and briefly breaking a key support level of 3,100 points. The gauge has fallen for four straight weeks… Northeast Securities Co. and Sinolink Securities Co. fell at least 5.8%. Brokers in Shenzhen received notice from regulators that they must stop combining funds raised from various wealth-management products into a single pool and investing them as one portfolio… Investors worry the regulation on asset-management pooling in Shenzhen might expand to brokers nationwide, said Capital Securities analyst Liao Chenkai.”

Beijing’s intentions notwithstanding, there’s high risk that things do spiral out of control. Shadow Banking has been the marginal source of risk intermediation during the recent Credit onslaught. This Credit avenue appears to be tightening rapidly, which creates a serious dilemma for various groups of risky borrowers. Moreover, heightened stress in the “repo”/money markets impinges the small and medium sized banks that have aggressively borrowed short-term finance for high-risk lending and financial speculation (at home and abroad). Meanwhile, Chinese authorities have begun to target the insurance industry, most certainly a bastion of all things ugly late-stage Credit Bubble.

This amounts to an unfolding serious tightening of Credit and financial conditions. Sure, Beijing can, once again, lean on the enormous state banks to pick up the slack. Here’s where things turn fascinating – if not comforting. China’s big banks stepping up at this point to support the scope of system Credit growth necessary to hold bust at bay (say, to the tune of $3.5 TN annually) places these mammoth financial institutions in direct harm’s way. Waning confidence in China’s big banks would have major global market ramifications.

Returning to the “important juncture for the global Bubble:” The bulls are feeling “break out,” with the S&P500 playing catch-up to Nasdaq (Comp up 13.3% y-t-d), technology (MHS up 18.8%) and biotech (up 18.7%). Are things at the brink of turning even crazier, or does a bout of risk aversion catch everyone unprepared?

I’ll be on the lookout next week for indications of waning “Risk On.” Perhaps China worries spur some contagion effects in Asia. Weakness in Asian financials would offer a clue. As the biggest beneficiary of Chinese reflation over recent months, EM would seem susceptible to contagion.

Further energy and commodity price weakness would reawaken concerns for commodity-related Credit. The yen declined 1.1% during this week’s generally “Risk On” backdrop. 

Fledgling “Risk Off” would be expected to provide a yen boost, likely at the expense of Japanese equities. With Emanuel Macron poised to win big in Sunday’s French election, I expect market attention to pivot back to Asia. That said, an abrupt reversal to “Risk Off” would catch global markets by surprise, certainly including the speculative Bubbles that have inflated throughout European securities markets. 


Divided Turkey

Erdogan Leads His Country into the Abyss

By Onur Burçak Belli and Maximilian Popp

 Photo Gallery: Turkey Referendum Triggers Opposition

 
Recep Tayyip Erdogan emerged victorious from last Sunday's referendum, but his slim margin of victory may actually have weakened his rule. Opposition to the Turkish president's power grab is forming and the EU can do little other than stand aside and watch.

Nothing can hold them back. Not the rain, not the wind and not the well-armed anti-terrorism police. On Tuesday evening, several thousand demonstrators marched through Istanbul, a diverse group including students, pensioners, women in headscarves and punks, and many of them held up signs as they walked: "No to the presidency!" They also chanted: "Thief! Murderer! Erdogan!" And: "This is just the beginning. Our fight goes on!"

The protests began on Sunday, just a few hours after President Recep Tayyip Erdogan claimed victory in the referendum that grants him significantly expanded powers and the demonstrations have become larger on each successive day since then, spreading to more than three dozen cities. People in Ankara and Izmir, in Adana and Mersin, in Edirne and Canakkale have taken to the streets in opposition to Erdogan, accusing him of having manipulated the vote on the constitutional referendum.

According to media reports, the country's electoral commission accepted up to 2.5 million ballots despite their not having been stamped in accordance with the rules. Election observers from the OSCE found significant shortcomings with the vote, outlined in a 14-page preliminary report that also noted the unfairness of the campaign leading up to the referendum. The vote itself, the organization found, also violated some aspects of Turkish law. The opposition has refused to recognize the results.

"Erdogan robbed us of victory," says Istanbul-based businessman Koray Türkay, who is one of the organizers of the protests in Istanbul.

For the time being, only a small portion of the Turkish population is rising up against the government, with a total of 20,000 people thought to have participated in the nationwide protests.

Türkay, though, is nevertheless drawing parallels to the Gezi Park protests in summer 2013, which were ultimately crushed by the pólice.

More Repressive Measures

Immediately after the vote, Erdogan denied that any manipulation had taken place and claimed that the referendum had been "the most democratic election … ever seen in any Western country." Prime Minister Binali Yildirim added that the protests were "unacceptable." On Wednesday, dozens of protesters were detained and the police presence at the protests was boosted.

Türkay believes that more repressive measures are coming. "But we are not afraid. We will continue protesting until the referendum is repeated," he says. Turkey, in other words, could be facing the kind of escalation that took place during the Gezi Park protests.

The vote last Sunday was the most far-reaching political decision made in Turkey's recent history.

The constitutional amendments approved in the referendum essentially sweep away what was left of democracy in Turkey, completing Turkey's transformation from the republic of Atatürk into the republic of Erdogan.

Once the constitutional reforms come into force following the next election in 2019, the president will be able to pass laws by decree and dissolve the parliament whenever he sees fit -- and the office of prime minister will also be eliminated. It will mark the end of the separation of powers in Turkey. The president alone will make decisions regarding war and peace and he will have almost complete control over the judiciary.

Some of the 18 new articles come into force immediately. The High Council of Judges and Prosecutors, for example, which supervises the judiciary, will be reduced from 22 to 13 members, four of whom can be directly appointed by Erdogan. But should he go on to win re-election, Erdogan will become practically omnipotent.

The country that he rules, though, is deeply divided and the referendum has only exacerbated those divisions, with one half of the population venerating Erdogan practically as a cult leader and the other half not even recognizing his legal right to hold the presidency.

'A Victory, But Not a Triumph'

Indeed, Erdogan emerges from the April 16 referendum as both the victor and as the loser, with the vote having laid bare his weaknesses. Europeans are turning away from him, the debate over putting a halt to Turkish-EU accession negotiations has flared up again and the Turkish president is more isolated than ever before. He received congratulations on his referendum victory from only two Western heads of government: Donald Trump and Hungarian Prime Minister Viktor Orbán.

Erdogan has presented the referendum result as a success, even if the margin of victory -- 51.4 percent to 48.6 percent -- was extremely thin. But even among his supporters, there is nothing approaching a feeling of euphoria. "Erdogan has achieved a victory, but not a triumph," writes the columnist Abdulkadier Selvi.

Indeed, given the extreme effort the government put into the referendum campaign, the result for Erdogan's Justice and Development Party (AKP) can almost be seen as a humiliation. Together, the AKP and the right-wing extremist MHP party received more than 60 percent of the vote in the last parliamentary elections and they joined forces ahead of this referendum, assuming they would receive an equal level of support. Now, though, Erdogan's advantage has shrunk to a paltry 2.8 percentage points.

And this despite the fact that Erdogan leaned heavily on the state authorities prior to the vote -- on the police, on the administration and on imams in the mosques. Most media outlets paid no attention whatsoever to opponents of the constitutional amendments, opposition protests were prohibited and "no"-camp activists were arrested.

Erdogan's edge is so thin that it isn't even clear that he will be re-elected in 2019 so that he can exercise the unlimited powers that the referendum was designed to give him. AKP politicians are thus expecting that Erdogan won't wait that long and will call snap elections much earlier.

But such a move also seems risky. Erdogan suddenly seems vulnerable.

The Turkish president is falling victim to the demographic shift that he himself promoted. In the last two decades, millions of Turks have moved from the countryside to the cities, they have profited from the country's now stalling economic boom and improved their lots in life. The number of universities in Turkey has doubled.

Reasserting Strength

Paradoxically, a young, urban middle class has developed under the leadership of the AKP, one that is religious, but which is also oriented towards Europe and isn't interested in living in an autocracy.

The result is that Erdogan lost in three of the country's largest cities. Even in Üsküdar, the conservative-leaning quarter of Istanbul where Erdogan lives, a slim majority voted against the constitutional referendum.

Erdogan is likely to follow up his narrow referendum victory with an attempt to reassert his strength. The constitutional reform includes a provision that releases the president from political neutrality requirements, which means Erdogan can once again become the head of his party -- and he will no doubt seek to use that position to unify the AKP, which has recently shown signs of division. Prime Minister Yildirim announced on Wednesday that the cabinet will soon be reshuffled and AKP officials are likely to soon find themselves being monitored even more closely by the presidential palace.

The move, though, isn't likely to solve the fundamental problem facing the AKP: The connection between party leaders and the grassroots has frayed in many places, with the conflict between Erdogan and the Islamist movement led by the cleric Fethullah Gülen having alienated a huge number of supporters. Erdogan's coalition partner, the MHP, has also emerged weakened from the referendum. According to one survey, two-thirds of MHP supporters voted "no," defying the recommendation of party leaders. Prominent dissidents like former Turkish Interior Minister Meral Aksener could even take the step of forming their own party, which would leave Erdogan facing a serious challenge from the center-right political camp for the first time.

The opposition, too, is hopeful despite its defeat. It was long divided between Kemalists, nationalist, Kurds and socialists, "but April 16 has shown us that we can beat Erdogan if we work together," says Sezgin Tanrikulu, a member of parliament with the secular Republican People's Party (CHP).
 
On the Wednesday following the referendum, Tanrikulu is sitting in the Istanbul tea garden from which leftist students launched the fight against the military dictatorship 40 years ago and which still serves as a meeting point for critics of the regime. It takes him fully 30 minutes to recite the irregularities that marred the referendum. In several polling stations, he says, police forced people to vote "yes," and the state-run news agency Ajansi announced the results before all the votes were counted. There are likewise videos in circulation showing election volunteers replacing significant numbers of "no" votes with "yes" ones.

A Simple Calculation

But Tanrikulu is particularly bothered by the electoral commission's decision to recognize unstamped ballots. In 2014, AKP ordered a regional election to be repeated for precisely this reason.

Members of the electoral commission are unable -- or unwilling -- to say where the ballots came from or how many of them there were, and they have neither confirmed nor denied the 2.5 million number that election observers have cited. Without additional investigation, it will likely never be possible to say for sure whether the questionable votes affected the outcome of the referendum.

Tanrikulu makes a simple calculation: The "yes"-camp won the referendum by around 1.2 million votes. Should it emerge that only half of the unofficial ballots were manipulated, the result would have been different. "You can't change the constitution on that basis," he says.

On Wednesday, the complaint lodged by CHP with the electoral commission was dismissed and the party has now announced it plans to go to the Constitutional Court, Turkey's highest legal body. It has also threatened to pull out of parliament. Tanrikulu, though, doesn't think that the effort will ultimately be successful. In Turkey, he says, the rule of law has long since been suspended.

Opposing Erdogan is risky, as the persecution of thousands of opposition activists as alleged terrorists in recent months has shown. And Tanrikulu isn't immune. Pro-government media outlets have called for his arrest, with the newspaper Yeni Akit writing: "Why is this man still free?"

The referendum has triggered yet more uneasiness in a country that has seemed recently to be on the verge of disintegration. The mass arrests that followed the July 15 failed coup attempt have paralyzed elements of the state administration and the Turkish military is involved in conflicts in both Iraq and Syria. Even worse, tourists are staying away and the economy is struggling, with the country's statistical office announcing one day after the referendum that unemployment has risen to a record high of 13 percent. The lira is weaker against the dollar than it has been since 1981.

'Nothing Left'

Frustration with the government could explode into violence at any time, particularly in southeastern Turkey, where people have been suffering under massive state repression for months. Thousands have lost their lives in battles between Turkish soldiers and PKK rebels while hundreds of thousands more have been forced to leave their hometowns.

Kazim Örmek, 63, clearly remembers celebrating on the streets of his hometown Diyarbakir in June 2015 after the Kurdish party HDP won seats in Turkish parliament. He hoped that lasting peace would be the result, but was quickly disappointed. Shortly after the election, Erdogan reversed course and returned to the bellicose policies of the 1990s. The military began bombarding Diyarbakir and Örmek's house was destroyed. He now lives with his family in a rental on the outskirts of the city.

 Through the window, one can hear the roaring of the warplanes as they take off from the Diyarbakir on their way to bomb PKK positions in northern Iraq. "We have nothing left," he says.

Desperation can be seen on every corner of Diyarbakir. The historic city center lies in ruins following months of fighting and the shops are empty. Furthermore, the military has set up myriad roadblocks, where cars are searched and papers are checked. Tanks frequently roll through the city streets.

In the months leading up to the referendum, the government essentially outlawed the HDP, arresting 13 parliamentarians, including the two heads of the party, along with 84 mayors and several thousand functionaries. Party rallies were also banned.

People in the Kurdish areas of the country essentially had little choice but to vote on the constitutional referendum in a state of siege. Soldiers patrolled in front of the polling stations and election observers were arrested. But despite the intimidation efforts, eight out of 10 eligible voters in Turkey's southwest cast their ballots last Sunday.

The government has pointed out that several HDP voters in Kurdish provinces defected to the "yes" camp and has interpreted that as a sign that its anti-terrorism policies are working. But accusations of electoral fraud were particularly numerous in the southwest, with one election observation organization reporting that in almost 1,000 Kurdish polling places, not a single "no" vote was recorded. In addition, tens of thousands of internally displaced people were not allowed to take part in the vote because they do not have a permanent place of residence.

Nevertheless, a particularly substantial number of people in Kurdish areas voted "no."

Into the Abyss

They now feel, similar to Örmek, that they have yet again been betrayed. Rumors of electoral manipulation have confirmed the suspicions of many Kurds that the Turkish government cannot be trusted. Young people in particular are now turning to the PKK or other militant groups.
The country needs a conciliator, a leader who can reduce the current tensions and reconcile antagonistic elements of society. It needs the opposite of Erdogan.

The Turkish president has based his entire career on polarization and on dividing his friends from his foes. He relies heavily on Islamist, nationalist rhetoric. Had he enjoyed a large margin of victory in the referendum, he may very well have made concessions to his opponents, but now he will attempt to consolidate his power by way of intimidation and violence.

On Monday evening, Erdogan gave a speech from the balcony of the presidential palace in Ankara, his voice hoarse and his eyes squinted. "The crusader mentality in the West and its servants at home have attacked us," he cried. "But we as a nation were unshaken." As he did during the campaign leading up to the referendum, Erdogan once again promised to hold a referendum on the reintroduction of the death penalty. "We aren't interested in what Georg, Hans or Helga think. We only care what Ayse, Fatma, Ahmet and Mehmet have to say."

The government has extended the state of emergency, which has been in place since last summer's failed coup, by three months. Erdogan no longer sees himself as the representative of all citizens of Turkey, he is only interested in being the patron of the 51.4 percent that voted "yes" last Sunday. He considers everyone else to be terrorists and coup supporters. Since the failed coup, more than 100,000 civil servants have been suspended and almost 50,000 people have been arrested. Now, the next wave of arrests is likely to be on the horizon.

It looks as though there is nobody left in the government who could mollify the president. Long-time Erdogan confidants, such as former president Abdullah Gül, have withdrawn from politics and internal party critics would likely only have risked sticking their necks out had a majority voted against the constitutional reform.

In this entire process, the European Union has been relegated to the sidelines, looking on with no input whatsoever. The EU failed to deepen ties with Turkey at time several years ago when the country was more open to the West. Now, it can do nothing but watch as the Turkish drama unfolds.

Erdogan may ultimately stumble over his own hubris. But for the time being, the president seems determined to pull the country into the abyss along with him.


North Korea

How to deal with the world’s most dangerous regime

Donald Trump grapples with his trickiest task
 
NORTH KOREA can be as confusing as it is alarming. It is a hereditary Marxist monarchy. It has the world’s youngest supreme leader and also its oldest. The reigning tyrant, Kim Jong Un, is in his 30s; and his grandfather, Kim Il Sung, is the “eternal president” despite having died in 1994. To celebrate grandpa Kim’s birthday on April 15th, his grandson ordered warplanes to fly past in a formation spelling out his age: 105. He also ordered a gigantic parade, with goose-stepping soldiers and missiles on trucks. A male-voice choir belted out “Peace is guaranteed by our arms”, even as the regime threatens to rain nuclear destruction on its enemies and is building a missile designed to reach the continental United States.

Dealing with the bellicose junior god-king will be one of Donald Trump’s trickiest tasks. It will also be the first big test of how he handles relations with China, which are shifting as the rising superpower challenges the Pax Americana in Asia. There are no good options, but arriving at the least-bad ones will require understanding both the regime and the Asian geopolitical jigsaw into which it fits. It will also require patience. Ominously, Mr Trump says he has little when it comes to North Korea, and his vice-president, Mike Pence, says that “all options” are on the table.
Wanting to do something quickly is emotionally appealing. North Korea is a vile, blood-drenched dictatorship where any hint of disloyalty is punishable by gulag or death. Mr Kim has children imprisoned for their parents’ thought-crimes and his own relatives murdered on a whim. The prospect of such a man threatening Los Angeles is harrowing. Yet a pre-emptive strike on North Korea would be reckless beyond belief. Its nuclear devices are hidden, possibly deep underground. Its missiles are dispersed on mobile launchers. Tokyo is just across the Sea of Japan. Seoul, the capital of peaceful, capitalist South Korea, is only a few miles from the border. Northern artillery and conventional missiles could devastate it; a conflict could rapidly turn nuclear and kill millions.

Mr Trump cannot possibly want to start a war. His military actions in Syria and Afghanistan suggest that he is more cautious than his bluster makes him sound. But even creating the impression that he might strike first is dangerous. If Mr Kim were to believe that an American attack is imminent, he might order his own pre-emptive nuclear attack, with disastrous consequences. So Mr Trump should cool his rhetoric immediately.

Dealmaker, meet deal-breaker
 
For all his eccentricities, Mr Kim is behaving rationally. He watched Muammar Qadaffi of Libya give up his nuclear programme in return for better relations with the West—and end up dead. He sees his nuclear arsenal as a guarantee that his regime, and he, will survive. (Though it would be suicidal for him to use it.) Mr Trump can do little to change his mind. Economic sanctions that harm his people will not spoil his lunch. Cyber-attacks, which may account for the failure of some recent missile launches, can slow but not stop him. America can solve the Korean conundrum only with China’s help.

China has leverage over Mr Kim. It accounts for 85% of North Korea’s foreign trade and could shut off its oil supply. But its interests are not the same as America’s. North Korea is its ally.

China’s leaders do not like the Kim regime, but they do not wish to see it collapse and North Korea reunite, German-style, with the democratic South. That, China fears, would mean the loss of a valuable buffer. There are 28,500 American troops stationed in the South; China does not want them on its border.

To contain North Korea—and to conduct a successful foreign policy more broadly—Mr Trump has to learn how to talk to China. His instinct is to do deals. Last week he tweeted that he told Xi Jinping, China’s president, that “a trade deal with the US will be far better for them if they solve the North Korean problem!” Later he explained that his decision not to label China a currency manipulator, as he had threatened, was a quid pro quo for China helping out over North Korea. Dropping the currency threat was the right policy, but Mr Trump’s transactional approach to diplomacy is exactly the wrong one.

China would love to carve up the world bilaterally into spheres of influence, with the great powers dominating their regions and trading favours elsewhere. America has long been the guardian of something different: a rules-based order that applies to every country, big or small, and which has underpinned the relative peace and remarkable growth of the world since 1945.

That Mr Trump appears to scorn this rules-based global order is worrying. The world would become a more dangerous place if America started letting China break the rules (for example, in the South China Sea) in exchange for help to resolve whichever issue happens to be in the news. A better response to China’s rise would be for America to strengthen the rules-based order and invite China to join it more actively. Alas, Mr Trump is unlikely to do this.

So the best hope is that he or his diplomats persuade China that it is in its own interest to curb North Korea. And the way to do this is to talk about North Korea itself, not the yuan or American steel jobs.
 
Three generations of Kims are enough
 
China does not gain if North Korea destabilises East Asia, or starts a regional arms race that leads Japan and South Korea to build their own nuclear weapons. Mr Trump should reassure his allies in Tokyo and Seoul that they remain under Uncle Sam’s protection. But he should also deal with China’s concerns. To that end, he could make it clear that freezing and then rolling back the North’s nuclear programme is his goal rather than regime change. He could also guarantee that, were the North to collapse into the arms of the South, America would keep its troops south of the current north-south boundary. China hates to admit that the Kim dynasty might not last, but it is rash not to plan for that possibility.

The crucial message for Mr Kim as for his predecessors is that, if the North were to use its nukes, the regime would be obliterated. In the long run, reunification is inevitable and desirable. Meanwhile, the junior god-king can be deterred.


The Abdication of Political Leadership

Political leaders are giving up their power to popular votes with predictable results.

By Jacob L. Shapiro


British Prime Minister Theresa May announced on Tuesday that she will call for snap general elections in the United Kingdom to be held on June 8, which will for all intents and purposes be another vote on whether Britain should leave the European Union. Last month, Scotland’s parliament voted in favor of holding a second referendum on independence. Turkey went to the polls over the weekend and voted in favor of increasing the powers of the president. Catalonia maintains it will hold an independence vote this year. Iraqi Kurds are making similar noises about an independence referendum in 2017 as well. France will have a new president by May 7, and if Marine Le Pen can pull off an upset, she will push for a referendum on whether France should remain in the European Unión.

This is not an exhaustive list. It’s a small sample of the proliferation of these types of votes. It also represents a shift in how democratic politics works. When Britain joined the European Economic Community in 1973, it only held a referendum in 1975, two years after becoming a member. The important details were worked out by the elected British government and not by public fiat. For most of the modern Turkish Republic’s history, military coups were just as important as votes when it came to shaping the government. Israel was not created by a referendum but by war with its neighbors. When U.S. President Woodrow Wilson wanted to join the League of Nations, he did not put it to a vote of the American people. Wilson was blocked, but that was because of the U.S. Senate, not because he left it up to a popular vote.
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A newspaper stand shows a copy of Tuesday's Evening Standard, with the front page story relating to British Prime Minister Theresa May's call for a snap general election on June 8, in central London on April 18, 2017. DANIEL SORABJI/AFP/Getty Images


The word “democratic” has come to be thought of as a synonym for “virtuous.” But they are not synonymous. A country that governs itself by pure democracy would exist in a state of anarchy, not in a state of freedom. Freedom in the context of representative democracy is not the idea that everyone gets to have a say and that, if an individual disagrees, something should not be done. The democratic structures that exist in nation-states are built on principles of representative government.

Representative government begins with the recognition that everyone is not created equal. The ability to cast a ballot becomes the great equalizer, and allows everyone to elect a representative who will make decisions in the common interest. The power and freedom of the people is in the ability to not vote for that person in the next election, not in the ability to dictate each decision.

What is happening today is that politicians are being led by their people rather than being leaders themselves. When a government puts the most important issues it faces to a popular vote rather than acting on the mandate it was given by being elected, the result is not a more just expression of the popular will. The result is that decisions about what a national government should do are left to an opinion poll of individual sentiments instead of to the judgment of someone who earned society’s trust. A political leader’s job is to act in the best interest of the country and not in the best interest of individuals. If that leader is constantly looking over his shoulder about every decision, it defeats the purpose. The result is mob rule, albeit of a most civilized kind.

Political leaders are often powerless to solve the problems that beset their populations. The way to prevent Brexit would have been for then-Prime Minister David Cameron to make sure that Syrian migrants were not seeking refuge in Europe. The way to undercut the rise of Le Pen and the National Front would have been for President François Hollande to cut unemployment in half and double GDP growth. The gulf between what individual political leaders can do and what they want to do is wide.

Their job is not to fix problems, because many problems are either unfixable or beyond the abilities of an individual or even a government. Rather, a political leader’s job is to give the people confidence that the situation is being managed competently and with the best interests of the people in mind.

When a political leader turns the decision over to the people, he is admitting he does not know what is best. Such moves are justified by the claim that they are consistent with democratic principles. But democratic principles are sufficiently honored by each leader’s election and require no further legitimization. The result is that the population perceives both weakness and indecision from the person elected to make the hard decisions in the first place. People then gravitate toward politicians who seem most confident that they have the solution to the problem. The unemployed French worker will consider voting for Le Pen because Le Pen talks a big game about unemployment and how to fix it. Le Pen probably lacks the power to take France out of the EU unilaterally and, even if France exits the union, the French worker probably won’t get his job back. But these things matter less than the worker feeling like someone is paying attention and has an idea of how to fix the problem.

This in turn leads to the election of leaders for whom democracy is not the most important concern. It is an ironic juxtaposition that in a world where many are concerned about “rising authoritarianism” and “illiberal democracy,” there has been a proliferation of votes about specific policies that governments should adopt. The media is obsessed with the rise of illiberal authoritarian leaders in countries like Turkey, Hungary and Poland. U.S. President Donald Trump is viewed as a proto-authoritarian who is assaulting the foundations of American democracy. Brexit is a part of this narrative as well, and the potential that an anti-EU candidate might rise to power in France is being talked about as if it represents a mortal danger to Western civilization. The problem with this argument is that the rise of these leaders is predicated on democratic choice. How is it possible to square the fact that there is simultaneously more democracy in the world than before and that democracy’s end is also nigh?

The issue is not rising authoritarianism. The issue is also not the reanimation of 1930s fascism, which seems to be the only lens through which some can view political disagreements. The issue is that political leaders have stopped making decisions and have lost the confidence that it was their job to make decisions in the first place. As a result, governments are putting the most serious questions to popular votes, and it should not be a surprise that the results tend to favor people with the clearest sense of what should be done. The issue is not whether the proposed policies are effective or ineffective, or even right or wrong. The issue for many individuals is the capacity to believe that they are placing their freedom in the hands of a leader who knows what the problem is and promises to address it. Freedom means nothing but misery for voters who lost their jobs and cannot provide for their families.

The great theorists of representative government understood that government’s most basic job is to protect the life, liberty and property of citizens. But Fyodor Dostoyevsky understood that “the secret of man’s being is not only to live but to have something to live for.” The positions of leaders like Trump, Le Pen and others suggest that one should live for the nation and that the most important job of a government is to protect the nation. The position of leaders who call referendums is that they have no earthly clue what the answer is and no longer wish to be held accountable, so they let the people decide. The individual’s right to voice a narrow view is given priority over solving the country’s problems. It should not be a surprise that given these choices, the people choose leaders who give them something to live for. They want freedom from their own freedom, and they will continue to vote for those who give it to them.


Taxes Are Worse Than You Thought

By Mark J. Perry

Originally published by the American Enterprise Institute, April 16, 2017

 
 
We are quickly approaching the deadline for filing (and paying) our federal and state income taxes (extended to April 18 this year because of Emancipation Day), and that means it’s time for my annual post at tax time to help put things in perspective.
 

1. Some Historical Perspective. “In the beginning” when the US federal income tax was first introduced in 1913, it used to be a lot, lot simpler and a lot easier to file taxes; so easy in fact that it was basically like filling out your federal tax return on a postcard.
 
 
 
For example, page 1 of the original IRS 1040 income tax form from 1913 appears above.
 
There were only four pages in the original 1040 form, including two pages of worksheets, the actual one-page 1040 form above, and only one page of instructions (view all four pages here). In contrast, just the current 1040 instructions for 2016, without any forms, runs 106 pages.
 

Individual federal income tax rates started at 1% in 1913, and the maximum marginal income tax rate was only 7% on incomes above $500,000 (more than $12 million in today’s dollars). The personal exemption in 1913 was $3,000 for individuals ($72,850 in today’s dollars) and $4,000 for married couples ($97,000 in today’s dollars), meaning that very few Americans had to pay federal income tax since the average income in 1913 was only about $750. The Tax Foundation has historical federal income tax rates for every year between 1913 and 2013 here for tax brackets expressed in both nominal dollars and inflation-adjusted dollars.
 
 
2. Tax Graphic of the Day (above). Some more historical perspective…
 

3. Opportunity Cost. In a 2012 report to Congress (most recent data available), the National Taxpayer Advocate estimated that American taxpayers and businesses spend 6.1 billion hours every year complying with the income tax code, based on IRS estimates of how much time taxpayers (both individual and businesses) spend collecting data for, and filling out their tax forms. In addition, Americans will spend an estimated $10 billion for the services of tax preparation firms and $2 billion on tax-preparation software programs like TurboTax that still require many hours of time.
 

The amount of time spent on income tax compliance – 6.1 billion hours – would be the equivalent of more than 3 million Americans working full-time, year-round (or 2.1% of total US payrolls of 145.9 million). By way of comparison, the federal government currently employs 2.8 million full-time workers, and Wal-Mart, the world’s largest private employer, currently employs 2.2 million workers worldwide and 1.3 million workers in the US (both full-time and part-time). At the current average hourly wage of $21.90 an hour, the dollar value of the opportunity cost associated with tax filing would be more than $131 billion, slightly more than the 2016 GDP of Washington, D.C. ($127 billion).
 

As T.R. Reid pointed out recently in a New York Times op-ed, it really doesn’t have to be that way. For example:
 

In Japan, you get a postcard in early spring from Kokuzeicho (Japan’s IRS) that says how much you earned last year, how much tax you owed, and how much was withheld. If you disagree, you go into the tax office to work it out. For nearly everybody, though, the numbers are correct, so you never have to file a return.
 
 
4. Tax Progressivity. And just how progressive is the US federal income tax system? Very, very progressive, see the chart above showing average effective tax rates by various income groups in 2014 (most recent year available). That pattern of income tax progressivity explains why almost all federal income taxes are paid by the top income groups (see next few items).
 
 
5. Tax Progressivity and Tax Burden. According to the most recent IRS data, the federal income tax shares by six different income groups are displayed in the chart above. Almost all federal income taxes (97.3%) are paid by the top 50%, more than 2/3 of income taxes are paid for by the top 10% and nearly 40% of taxes are paid by the top 1% of taxpayers. For all of the criticism and negative publicity the “Top 1%” get, I’d like to personally thank that group this year at tax time for shouldering such a disproportionate share of our collective tax burden. It’s a form of “disparate impact” on the 1% that we all benefit from! So, I say “Thank You Top 1%” from all of us in the bottom 99% for your valuable and significant contribution to our nation’s tax burden.
 
 
 
6. Tax Burden of the Top 1% vs. the Bottom 95%. The chart above gives us another perspective on the tax burden of the top 1% over time, and compares the tax share of that group to the tax burden of the bottom 95% in every year between 1980 and 2014 (most recent year available). In 2014, the top 1% earned 20.6% of the total income reported to the IRS and paid 39.4% of all federal income taxes collected ($543 billion). The bottom 95% of US taxpayers earned 64% of total income (almost three times as much as the top 1%) and paid only 40.5% of the total income taxes collected ($550 billion). So once again, to the 1.395 million taxpayers in the top 1%, I say “Thank You” for paying almost as much in federal income taxes in 2013 as the 132.6 million taxpayers in the bottom 95% by income.
 
7. Bowling vs. Taxes. Speaking of the progressivity of income taxes, here’s a thought about the way we tax income vs. the way we score bowling. Under the scoring rules of bowling, you get rewarded, not penalized, for being successful. If you get a spare, the scoring system rewards you by adding the pins from the next ball into the current frame, and if you get a strike you get rewarded by adding your next 2 balls into the current frame.
 

Under our progressive income tax system with seven tax rates in 2015 increasing from 10% to 39.6%, you get penalized, not rewarded, for being successful, productive and entrepreneurial, because the more you earn, the higher the tax rate you pay. The top marginal income tax rate has been as high as 91% in the 1950s and 1960s, and 70% in the 1970s. If we scored bowling the way we tax income, we would subtract, not add pins for a spare or strike, i.e., penalize successful bowling. If we taxed income the way we score bowling, we would have lower, not higher, tax rates on our most successful income-earners.
 

8. Coincidence? Why are Tax Day (April 15) and Voting Day (first Tuesday in November) so far apart? Couldn’t we move Tax Day to the first Monday in November, or Voting Day to the first Tuesday following April 15?
 

9. What’s in a Name? Why do we call the IRS a “service?” Couldn’t it have been named a department like Labor, a bureau like the BLS or the FBI, a commission like the FTC, an administration like FDA, an agency like EPA, etc.?
 
10. 20 Inspirational Quotes about Taxes from Forbes, here are a few good ones:
 

“The taxpayer: that’s someone who works for the federal government, but doesn’t have to take a civil service examination.”

– Ronald Reagan
 

“We have what it takes to take what you have.”

– Suggested IRS Motto 
 

“It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the tax rates.”

– John F. Kennedy
 

I am proud to be paying taxes in the United States. The only thing is I could be just as proud for half of the money.”

– Arthur Godfrey
 

“A liberal is someone who feels a great debt to his fellow man, which debt he proposes to pay off with your money.”

– G. Gordon Liddy
 
 

Happy Tax Day!