Market Advisory Features
Business and the War
The Great Divide
Investment Banking: But Which Way is Up?
Spectacle or Substance?
America's Economy: The Challenge of Uncertainty
The American Dollar: How Far Can it Fall?
Shape of War: Preparing for the Worst
Countdown to War
An Engineered Crisis
THE INTERNET SOCIETY: Digital dilemmas
What Oil Can Do To Tiny States
Iraq's Neighbors: Angry, Worried and Impotent
Investigating Wall Street: It Just Gets Worse
A temporary setback?
FOR once, the forecasters got it right. Many of the pundits who study America’s economic numbers guessed that the economy expanded at an annual rate of 0.7% in the fourth quarter of last year. It did. The first official estimates, released on January 30th, confirm that the last three months of 2002 were the slowest of the year, with almost no growth from the third quarter. A dismal performance, clearly demonstrating that the economic recovery is not yet well established—and enough to renew concerns that the economy could yet slide back into recession.
Perhaps most worrying are the sources of weakness at the end of last year. Throughout America’s recession in 2001, consumers carried on shopping and helped to ensure that the contraction was one of the mildest on record. As 2002 drew to a close, though, the lure of the shopping malls faded, and consumer spending grew by only 1% at an annual rate in the fourth quarter—the slowest pace since 1993. Business investment and inventories continued to grow, but at a much slower pace than in the more buoyant third quarter.
It is always a mistake to attach too much importance to one set of figures, especially the advance GDP data which relate to the period to December—and which will be revised twice over the coming weeks. But the latest figures do appear to confirm the impression provided by more recent data and by anecdotal surveys, such as that recently published by the Federal Reserve: that America’s economy is faltering. Unemployment has been rising, consumer confidence is weakening and economic uncertainty is widespread.
That’s perhaps not surprising, with war in Iraq looming and continuing anxiety about the terrorist threat. The Fed explicitly recognised this in a statement released on January 29th at the end of a two-day meeting to review interest-rate policy. The Fed decided not to cut rates, and did not even think that future economic risks are weighted towards further weakness. It took the view that once the current geopolitical uncertainties are over, everything will be in place for a solid recovery.
That might strike some as a sanguine view of the current outlook, though it does tie in with the suggestion in some quarters that a short, successful intervention in Iraq would boost the American economy by ending uncertainty sooner rather than later. By the same token, however, a long delay followed by war, or a prolonged military engagement, could mean the postponement of any economic upswing.
In the short term, the government seems to be taking over from the consumer in providing an economic prop—defence spending rose by 11% in the fourth quarter. George Bush has presided over a sharp rise in such expenditure since the events of September 11th, 2001. He is also overseeing a spectacular rise in the government’s budget deficit, partly as a result of the tax cuts he has already pushed through. The deficit this year could reach a record $300 billion, according to the latest estimates. The additional tax cuts for which he is now seeking approval will make reining back the deficit almost impossible for the foreseeable future.
In spite of all the effort Mr Bush is investing in what will be his second fiscal stimulus package, few economists—or, indeed, ordinary Americans—seem persuaded that it will help strengthen recovery. For that, the Fed still seems to be betting on the full impact of its monetary loosening working through the economy. The most recent interest-rate cut came only two months ago—too late to have much, if any, impact on GDP growth in the final quarter of 2002. The optimists reckon it should get better from here on in. The pessimists still fear it could get worse.
But that is coming to an end, Mrs Arroyo declares, fixing the portrait of her father that hangs opposite her desk with a steady gaze. Whereas he ran for a second term and lost (to Ferdinand Marcos, the country's future strongman), she recently announced that she would not stand in next year's presidential election. Freed from the pressures of electoral politics, she argues, she will make a clean break with the past in her final 17 months in office.
Will she? Mrs Arroyo does not seem much of a revolutionary. She is, after all, very obviously a political dynast herself, and styles herself “Gloria Macapagal Arroyo” to ram the message home. Some say that she was reduced to announcing a grand new strategy only because her previous approach was getting her nowhere.
What is more, her plans do not seem much of a revolution. She has proposed over a dozen new laws, including such underwhelming steps as a pay rise for judges, an increase in taxes on alcohol and cigarettes, and a measure to allow banks to securitise loans. The most exciting items on the list are the extension of voting rights to Filipinos living overseas, and the computerisation of the balloting process.
Other politicians are pushing far more ambitious schemes to heal the country's ills. Jose de Venecia, the speaker of the House of Representatives, wants to switch from the current presidential system of government to a parliamentary one. The newspapers speculate daily about a “con-con” (constitutional convention) or some other form of “cha-cha” (charter change, meaning constitutional amendments). But the president's advisers point out that any grandiose projects will raise unhappy memories of Marcos's self-serving manipulation of the constitution, and thus distract attention from Mrs Arroyo's own, more limited plans.
They are probably right: even her modest agenda faces a fierce fight in Congress. Its members, after all, are still running for re-election, even if Mrs Arroyo is not. But should her act of self-sacrifice prove popular with the Filipino in the street, some congressmen might throw their lot in with her in search of reflected glory. One opposition senator, Edgardo Angara, has already announced that he applauds the president's patriotism and will help her to turn her ideas into law. But most lawmakers will think twice before voting to raise taxes in the run-up to an election.
Mrs Arroyo could try to coerce representatives by refusing to disburse funds earmarked for their constituencies. Senators, however, are not susceptible to that sort of manipulation, since they are elected from a single, nationwide district. At least one is running for president on a law-and-order ticket, and so stands to gain from a chaotic close to the Arroyo administration. Anyway, the favours Mrs Arroyo can offer over the next 17 months pale by comparison with what her successor can provide over the following six years.
Moreover, as Alex Magno, a presidential speechwriter, points out, most congressmen have connections to wealthy landowning or industrialist families. Others are sports stars or matinee idols. They are hardly the ones to vote in tougher tax-collection measures, another item on the president's wish-list. Nor are they keen on rolling back the Philippines' banking-secrecy laws, which anger rich countries worried about money-laundering.
Mrs Arroyo has always had a weak mandate. As vice-president, she came to power when street protests overthrew her predecessor, Joseph Estrada. His populist promises to help the poor and rattle the middle classes got him elected, but also turned the country's businessmen and bureaucrats against him. Mrs Arroyo's cautious and technocratic style has the support of the upper crust, but leaves the bulk of the electorate cold. This rift will continue to paralyse Philippine politics, whoever stands at the next election.
It has also reduced Mrs Arroyo to reform by stealth. On close inspection, her legislative proposals, modest as they are, do at least concentrate on two key issues. The first is government revenue.
Over the past five years, even as the economy has grown (in 2002 by an impressive 4.6%) the tax take has fallen from 17% of GDP to barely 12%. Mrs Arroyo herself has presided over the most precipitous decline, despite having pledged to put an end to tax-dodging and to restore the government's finances. The ensuing cash crunch, in turn, left her with little scope to do anything much, apart from scrambling to cut expenditure and rein in a galloping deficit. But her many incremental economic proposals—to put government procurement online, privatise the electricity grid, raise “sin” taxes, abolish tax breaks for certain types of car, overhaul the tax-collection agency, and so on—would add up to a windfall for the government if they all became law.
Mrs Arroyo's second main target is electoral reform. At the moment, Filipinos must write the names of their preferred candidates on to the ballot papers by hand. That means that only candidates with unforgettable names—celebrities and bluebloods—stand much chance. What is more, the 7m expatriate Filipinos cannot vote. Switching to ballots that can be read by computers, and mailed from abroad, could revolutionise the Philippines' politics—if politicians elected under the current system accept the change.
The shape of war
“WHEN”, asks Henry V after the battle of Agincourt, “was ever known so great and little loss/On one part and on the other?” In Shakespeare's play, the French lose 10,000 men and the English only a couple of dozen. In the Gulf war of 1991, America's military supremacy produced a similarly astonishing ratio of casualties. Optimistic American military analysts are now expecting a repeat performance. Iraq, they argue, was easily defeated in 1991; since then it has become weaker while America has become even stronger; therefore a war with Iraq this year will (in one fashionable formulation) be a “cakewalk”. Will it?
Maybe. America's military hardware—in particular, its surveillance equipment, munitions and means of delivering them—has evolved dramatically in the decade since the Gulf war. Its military superiority is now greater than any power's for many centuries. Meanwhile, the strength of Iraq's army, measured in tanks, artillery and troops, has declined by more than half. Its air force—almost irrelevant in 1991—is now even punier. Its navy is virtually non-existent. Sanctions have deprived the country of spare parts, and British and American aircraft patrolling the “no-fly” zones over northern and southern Iraq have (with special vigour recently) battered its air defences. In 1991, many regular Iraqi troops surrendered after firing a few token shots at their better equipped and trained adversaries. The memory of what happened to those who did not will encourage a similar response this time.
On the other hand, the Gulf war taught Saddam Hussein important lessons. The devastating results of trying to fight America and its allies as if they were Iran or Kuwait—in open terrain, where Iraqi forces were crushed by air power and artillery—will encourage Mr Hussein to try to lure the invaders into Iraq's cities. And America's conventional strength will encourage him to use other, unconventional methods. In 1991, Iraq did not use chemical or biological weapons. This time, the fact that the war will be explicitly directed towards removing his regime could also remove any inhibitions Mr Hussein has about using them. Before the Gulf war, he also refrained from pre-emptively attacking allied troops or other countries, which might have made the war much messier. This time, he may not.
Taking these unconventional and so-called “asymmetric” factors into account, says Michael O'Hanlon of the Brookings Institution, there are (for America) “more negatives than positives” in a comparison of the 1991 war with a possible one in 2003. Moreover, the putative conflict would take place in the new atmosphere of the war on terrorism and swelling anti-Americanism in parts of the Arab world, fortified by images of Iraqi casualties broadcast by the al-Jazeera TV network. In that sense, America risks becoming its own worst enemy. With this broader perspective, deposing Mr Hussein begins to look a much more hazardous enterprise.
One of the factors widely assumed to restrict American options is the climate. But like the winter that doomsayers predicted would wreck the campaign in Afghanistan, the Iraqi summer is not quite the showstopper it is reputed to be. After all, in the second world war Montgomery's “Desert Rats” and Rommel's Afrika Korps fought through the north African summer. American forces, under General Tommy Franks, could do the same in Iraq if necessary. Much of the fighting could be done at night, when America would have an even greater technological advantage. American troops would be wearing suits to protect them from chemical and biological weapons, which would add to their discomfort; but they would not have to wear them all the time. Fighting in the summer would be at least as difficult for the Iraqis.
All the same, the optimum time for George Bush to order an attack would be sooner rather than later. American public opinion remains favourable, but only narrowly. Americans do not want Mr Bush to act alone; but the goodwill of other countries, which helped to secure a unanimous United Nations Security Council resolution in November, could fragment even further. Keeping the American forces that are being assembled in the Gulf on station will be enormously expensive. And Mr Bush is unlikely to want an Iraqi war to interfere with his re-election campaign. All this argues for a start to hostilities—always assuming a casus belli has materialised—fairly soon. The end of February or beginning of March, after the climax of the Hajj pilgrimage, is the best guess.
If there is a war, the exact battle plan, and how long it will take to assemble the forces American military planners deem necessary, will partly depend on the co-operation of other countries in the region—in particular, what privileges Saudi Arabia and Turkey grant America in terms of both air space and bases. America could defeat Iraq without their help. But without the use of Saudi bases, bombing missions will be less economical. And getting troops on the ground in northern Iraq, and thus opening another front, will be much harder without Turkey's hospitality. (A second UN resolution, authorising war, would ease anxiety in both countries.)
Likewise, General Franks could easily do without active military help from other countries; but it would be better, for political cover, if they joined in. Britain despatched paratroopers and the descendants of the Desert Rats last week, and Australia has made a smaller commitment. Other countries may also weigh in.
These uncertainties are one reason to treat with scepticism the war plans that have purportedly been leaking out of the Pentagon over the last few months. These might be designed to intimidate and confuse the Iraqi leaders. Still, for what they are worth, the leaks suggest a debate among American military men and the Bush administration about how large a force ought to be amassed before an attack begins.
An Iraqi war would certainly involve a heavier American ground presence than the Afghan campaign, in which America largely relied on air power, special forces and local allies to defeat the Taliban and al-Qaeda. (In Iraq, because of the risk that the country might fracture and become ungovernable, the Pentagon may be reluctant to see Kurdish or Shia forces make dramatic gains.) America is likely to have up to 250,000 troops in the region eventually; but hostilities may start before some of them arrive, partly to avoid creating a huge concentration of forces that might become an easy target. Ken Pollack, also of the Brookings Institution, thinks such a “rolling start” would be perilous. Better, he thinks, to amass an imposing force, which will increase the chances that Iraq capitulates without a fight, and allow General Franks to respond to any contingencies or counter-attacks.
Amid all the propaganda and conjecture, some probable elements of an American campaign can be identified. It will begin with an intense aerial bombardment. In the Gulf war, fewer than 10% of the munitions dropped were precision-guided; this time, partly because of the development of a new type of satellite-guided smart bomb, the so-called JDAM that can be used in all weathers, a large majority of them will be. More American aircraft can now carry smart bombs, and more targets can be struck on each sortie. (Other new weapons, such as a bomb designed to short-circuit computer systems, may also see action.)
America's surveillance capabilities have dramatically improved, too. For instance, unmanned aerial vehicles (UAVs), such as the Predator, can now feed instantaneous surveillance data to commanders and pilots. Special-forces “spotters”, used on the ground in Afghanistan to pass on the co-ordinates of targets to pilots, will be deployed again.
Among the first targets will be Iraq's residual air defences, plus command-and-control and communications facilities. Sites in western Iraq that might be used for storing or launching any Scud missiles Iraq may still possess (as well as any weaponised drones it may have developed), will also be a priority. Dan Goure—now a military analyst at the Lexington Institute, but in 1991 a Pentagon official involved in the hapless effort to find Iraq's Scuds—expects much greater success on this front in 2003.
James Roche, secretary of the American air force, says that this phase of a war is likely to be much shorter than the long air campaign of 1991. Limited ground operations—such as the use of airborne troops in northern Iraq to protect the Kurds and to prevent friction between Kurdish forces and Turkey—could begin almost simultaneously. Other sites that could be seized speedily include Iraqi air bases and oilfields. Amphibious landings by marines in southern Iraq could follow. American armoured divisions in Kuwait will then drive north towards Baghdad. This advance is likely to be much more direct than Norman Schwarzkopf's disguised “left hook” in the Gulf war. Close air support could ensure that American forces encounter few serious obstacles, apart from the Euphrates river, on their way to the capital.
At the time, the 1991 Gulf war seemed to announce a new species of warfare. In retrospect, it can be seen to have followed a traditional pattern: a massive ground force was assembled, then sent into action after a prolonged bombardment. By contrast, a new war with Iraq is likely to be truly original in its speed and tactics. One of its original elements is likely to be the restraint with which America chooses its targets.
A massive show of force will help to precipitate a quick Iraqi surrender, and demonstrate America's power to other potential adversaries. But Mr Bush will be anxious not to create new ones, or provide al-Qaeda with new recruits. In his state-of-the-union message he vowed to spare “in every way we can the innocent”, and talked of “liberation”. Both he and Mr Hussein know the propaganda value of mishaps such as the bombing, in 1991, of a Baghdad air-raid shelter that was crammed with women and children. The need to govern Iraq after a war (multilaterally or otherwise) will make America especially keen not to alienate its people, or to destroy parts of the infrastructure upon which civilians rely. Mr Roche agrees with Kenneth Roth, of Human Rights Watch, that the increasing accuracy of America's weapons carries an increased expectation that it will avoid collateral damage. In Iraq, the duty to do so is likely to be scrupulously observed.
This sensitivity may even embrace regular Iraqi troops. Clausewitz maintained that the main aim of war was to destroy the enemy's forces; in this case, American strategy is likely to be closer to that of Sun Tzu, an ancient Chinese theorist who argued that “those skilled in war subdue the enemy's army without battle. They capture his cities without assaulting them and overthrow his state without protracted operations.” The shock caused by pictures of mangled Iraqi vehicles retreating from Kuwait was one of the reasons the Gulf war ended. This time, American invaders may bypass regular Iraqi soldiers on their way to Baghdad, saving their firepower for Mr Hussein's most loyal forces.
Mr Hussein will doubtless argue that, since America “started” the war, it ought to be held responsible for all resulting casualties, by whomsoever they are inflicted. He could choose to create large refugee flows to slow down an American advance, and place high-value military targets or weapons of mass destruction in civilian areas or close to schools, hospitals and mosques. He may once again use chemical weapons against his own population. “Would he do it and say the Americans did it?” asks Andrew Krepinevich of the Centre for Strategic and Budgetary Assessments. “And whom would al-Jazeera believe?”
American troops will need to prevent intensified repression of the Kurdish and Shia populations under cover of war, the sort of thing that happened during the Kosovo conflict. Conversely, Mr Bush will not want the world to witness bloody reprisals against Mr Hussein's allies. Large numbers of Iraqis, many of whom rely on state food rations, will need to be fed, watered, sheltered and protected from disease. All of this may complicate the central task of dislodging Mr Hussein himself.
What happens when American forces reach Baghdad? Optimists expect a coup (if one has not occurred already). Psychological operations (“psy-ops”) have already begun to encourage one. Mr Hussein's top brass are not as loyal to him as were, say, Hitler's, which is why he has developed elaborate counter-coup precautions. If he decides to put his survival above his reputation as an anti-American martyr, there might even be a negotiated settlement, with the Iraqi dictator perhaps retiring to a third country—if any could be found that would take him.
Yet American soldiers may have to fight in and through Baghdad and possibly in Tikrit, Mr Hussein's hometown and stronghold, about 100 miles (160km) north of Baghdad on the Tigris. As Mr Pollack says, most besieged cities fall bloodlessly; but, when they do not, terrible fighting tends to ensue. The Iraqi Republican Guard fought hard, if ineffectively, in 1991; and if some of its divisions are withdrawn to Baghdad, they, the “special” Republican Guard and other reliable troops (numbering around 100,000 in all) could offer stiff resistance.
According to Michael Eisenstadt, a military analyst at the Washington Institute for Near East Policy, withdrawing his forces into Baghdad would also carry risks for Mr Hussein. It would increase the chances of a coup and make desertions easier. Baghdad has a large and potentially seditious Shia population. Many of Mr Hussein's most loyal troops, who come from the Tikrit area, will be unfamiliar with the city's byways. Randy Gangle, an expert on urban warfare at the Centre for Emerging Threats and Opportunities, a Marine Corps think-tank, says that training can compensate for the lack of direct experience American troops will have of urban warfare. They would not, says Mr Gangle, behave with the callousness of Russian conscripts in Grozny. They would try to secure key places within the cities and provide escape routes for civilians.
But Mr Gangle also acknowledges that the “rules of engagement” in urban fighting tend to get less restrictive as your own casualties mount, as they did during the battle for Hue, in Vietnam, in 1968. And most of America's technological advantages will be nullified inside a city. Helicopters, essential for swiftly airlifting casualties, remain vulnerable there, as they proved to be in Mogadishu, in Somalia, in 1993. During a long siege, the imperative to fight tactfully could come into conflict with a political need to end the war swiftly.
If the conflict is protracted, instability in other Arab and Muslim countries, including Pakistan, is another big risk. Then there are Iraq's (alleged) biological and chemical weapons. Some analysts envisage their use during a climactic assault on Baghdad. But Mr Hussein might consider it more sensible to use them early, in the misguided hope of persuading Mr Bush to call off the invasion, or with the intent of doing his worst before he loses control of Iraq's airspace and communications. Iraqi officers may ignore orders to launch such a strike, which in any case would probably slow the American advance only a bit; but the effect on Iraqi civilians could be much worse. Mr Roche says the Pentagon is also worried about the inadvertent release of such agents by American bombing.
It is even possible that, before the first laser-guided bomb is dropped, Mr Hussein could make another break with past form, and pre-emptively attack American troops in Kuwait. Or he may strike at Saudi Arabia. Or—if he has the missile capability—he may hit out at Israel, in the hope of igniting a broader conflict. Israel is much better placed to defend itself against Scud attacks than it was in 1991, when the performance of the Patriot missile batteries entrusted with that job was unimpressive (though so too was that of the Scuds). Once a war begins, the presence of American forces in and over Iraq would make it much more difficult for Israel to retaliate; so, if that is what Mr Hussein intends, he might choose to provoke the Israelis in advance. A successful strike against Tel Aviv with chemical or biological agents could have catastrophic consequences.
That is improbable. So is the fear that Iraqi terrorists or their sympathisers may strike directly at America or its friends. But these are still possibilities. A war to oust Mr Hussein will be novel and almost certainly victorious, and in all likelihood swift and triumphant. But America and its allies need to be prepared for anything.
Assessing the exact impact of the prospective war is a tricky task. There are so many other factors affecting business confidence and economic performance—what statisticians would call “noise”. The shenanigans at Enron and WorldCom and the collapse of Andersen, for instance, have severely dented faith in big business. Together with the exposure of widespread conflicts of interest on Wall Street, the scandals have contributed to a loss of faith in stockmarkets, particularly in America: last year was the first in over a decade in which the mutual-fund industry saw a net outflow of funds. Moreover, businesses invested far more than was sustainable in the heady 1990s, and the bust that followed that boom is far from over. So, even if no war were looming, the figures for corporate spending would make depressing reading.
Even so, there are numerous business costs that are clearly attributable, at least in part, to the impending war. The most obvious of these is the price of oil, which has hovered above $30 a barrel for the past month. True, matters have not been helped by a general strike in Venezuela, the world’s fifth-biggest oil exporter, which has slowed shipments to a trickle. But experts calculate that there is a $5-a-barrel “war premium” in the oil price. This may be a boon for oil exporters, but a high oil price acts like a tax on economic activity for countries that import the stuff—the United States and most of Europe and Asia. It is not uncommon for a high oil price to clip a quarter or even half a percentage point off economic growth in the biggest oil-importing countries. That is particularly worrying at a time when growth is so lacklustre. Ironically, continental Europe, which has been reluctant to support war, seems to be losing out more than America from the oil-price surge, thanks to a higher import rate than either America or Britain, which pump their own oil.
The turmoil in stockmarkets has also restricted businesses’ freedom of action. Few companies are brave enough to seek to raise capital from frightened investors: Cazenove, a British corporate broker, announced on January 28th that it was shelving plans for a stockmarket flotation. Those companies that do risk a trip to the market for capital-raising—for example, some of Britain’s troubled life assurers—tend to do so only as a last resort and at a discount. Mergers and acquisitions have almost dried up, thanks to the difficulty of raising capital. The current bid battle for Safeway, a British supermarket chain is a rarity. Investor malaise has afflicted the markets for some three years now, but the recent sell-off seems to be driven more by fears of war than economic factors.
Just as businesses have put off the big, headline-grabbing deals, they are also stalling on smaller, in-house projects. Pittsburgh-based Nova Chemicals, for example, is postponing plans to expand its Texas facility until after the summer because it is worried that a long war could send the prices of its energy inputs rocketing and cut demand for its products. In a recent survey, the Federal Reserve, America’s central bank, found bankers, insurers, high-tech companies and airlines reporting that war worries were slowing their businesses. Overall, Economy.com, a forecasting website, reckons that war concerns will shave some $50 billion off total business investment in America this year.
At the World Economic Forum in Davos last week, business executives explained how the impending war was affecting their plans. Nissan, a carmarker, now reckons that, because of the war, it will sell some half a million fewer cars this year than planned. Others reckon that they are being hurt by a boycott of American products in the Middle East, or by Middle Eastern expatriates. Procter & Gamble, a consumer-goods giant, has suffered a 10% sales decline in the region thanks to a boycott. Sales of its Ariel washing powder were hit by a pro-Palestinian boycott: protesters disliked being reminded of the name of Israel’s hawkish prime minister.
Iconic American companies are most vulnerable of all. Martin Broughton, chairman of British American Tobacco, said that brands identified as typically American have suffered a loss of market share, with those that are almost synonymous with America, such as Coca-Cola, McDonald's and Marlboro cigarettes most vulnerable of all. Coca-Cola has admitted that it lost sales of some $40m-50m of soft drinks in the Gulf region over the last year. In France, sales of a Coke rival called Mecca Cola, which pledges to devote a fifth of profits to charity, especially in Palestine, have been rising.
Another concern is that the big increase in trade and just-in-time manufacturing in recent years has left companies vulnerable to supply disruptions. After September 11th, for example, all American flights were grounded and its borders closed for days. Companies responded in different ways. General Motors had to suspend production, but Dell was able to keep going after it chartered its own aircraft. Bain & Company, a management consultancy, reckons that businesses have not done enough to ensure that supplies continue to flow in during a war.
Part of the problem is that businesses find it hard to know which contingencies to plan for. Setting up alternative distribution centres or supply chains costs money, and extra costs are particularly unwelcome at a time when they are finding it tough to grow sales and sustain profit margins. The easiest strategy is to do as little as possible: no hiring, no expansion, no deals. That is why business organisations such as Britain’s Institute of Directors have argued that the best outcome now would be a war rather than a long period of diplomacy and uncertainty, but a war that ends quickly in American victory. Then, at least, the oil price might fall by $5-10 a barrel as fears of a prolonged conflict subside.
Countdown to war
MILITARY strategists contend there always has to be some flexibility built into the timetable. And so there is. But for Saddam Hussein, the countdown to war has begun. President George Bush has bluntly indicated that the Iraqi dictator now has only “a matter of weeks” to start actively co-operating with arms inspectors to prove that his country no longer has any programmes connected to nuclear, chemical or biological weapons. Failure to do that would mean America leading an invasion force to topple him, with or without a new United Nations resolution.
The strategy will be mapped out when Mr Bush plays host to America’s staunchest ally, Britain’s prime minister, Tony Blair, at his Camp David retreat on Friday January 31st. They will discuss which countries are prepared to send troops, which might make their military and other facilities available, and which are likely to sit on the sidelines. On that front, America and Britain now seem less isolated. Mr Blair called in on Spain’s prime minister, Jose Maria Aznar, on his way to Washington, DC, where Mr Bush was entertaining Silvio Berlusconi, Italy’s leader. Spain and Italy have joined Britain, Portugal, Hungary, Poland, Denmark, the Czech Republic and Slovakia in openly pledging their support for the United States. France and Germany, in contrast, insist on a second UN resolution before war. Russia supports that view, but may yet line up behind America. Countries in other parts of the world are as divided as Europe, although some, like Australia, have already sent troops to join the 150,000 soldiers massing in the Gulf region.
The next significant event will take place on February 5th, when Colin Powell, America’s secretary of state, presents to the UN Security Council details from intelligence reports. These reports, say members of Mr Bush’s administration, will not only show that Saddam is concealing weapons of mass destruction but that Iraq also has links to al-Qaeda, the terrorist organisation blamed for the September 11th attacks on America.
That evidence is thought to include spy pictures which show Iraqi forces moving weapons material from sites before UN inspectors arrive. As for the links with al-Qaeda, one official has said there are indications that the assassination last October of an American diplomat in Jordan was orchestrated by a Baghdad-based al-Qaeda operative. Once Mr Powell has made his presentation, those countries that have demanded to see a higher standard of proof than America has provided so far will be given only a short time to consider whether or not the new evidence amounts to that.
Meanwhile, the inspections will continue in Iraq as the pressure on Saddam intensifies. Iraq has asked Hans Blix, the chief UN inspector, and Mohamed ElBaradei, the head of the International Atomic Energy Agency, to come to Baghdad for talks ahead of the inspectors’ next report to the Security Council, on February 14th. On Friday, Mr ElBaradei said they were willing to go, but only if Iraq made some concessions. These included allowing interviews to be held with Iraqi scientists in the absence of government minders, and letting American spy planes carry out surveillance flights. “We need to make sure before we go that they are ready to move forward on these issues,” said Mr ElBaradei.
In the inspectors' report to the Security Council on January 27th, Mr Blix said Iraq did not appear to have reached a “genuine acceptance” of the disarmament process that was demanded of it. While the inspectors had not found any strong evidence of banned arms activities, plenty of questions remain unanswered. These include the whereabouts of nerve gas, material for biological weapons, more than 500 artillery shells filled with mustard gas and 6,500 chemical bombs. Mr ElBaradei said his team had found no evidence that Iraq had resumed the nuclear programme it discontinued in the early 1990s. He asked for several months to complete the inspection work.
That is unlikely to be granted unless Baghdad shows a change of heart. Whatever progress has been made will be reported back to the Security Council at the February 14th meeting. If Iraq is then still deemed to be prevaricating, that could be the point at which Mr Bush decides whether or not to seek a second resolution from the Security Council.
While members of Mr Bush’s regime say a new UN resolution backing military action against Iraq would be “desirable”, the president has made it clear he is prepared to go to war without one. Such a campaign could be launched swiftly, although it is likely that Saddam will be given one last chance. That might involve his agreeing to go into exile. This idea has been floated by a number of Arab diplomats; Iraq's neighbours are desperate to avoid warfare in the region.
American officials, however, think it highly unlikely that Saddam and members of his regime would ever agree to relinquish power and leave Iraq voluntarily. Some of Saddam’s officials have stated publicly that they will fight to the last. In a few weeks, they may have to.
The aim, according to the Pentagon sources quoted, is to cause such "shock and awe" that Iraqi troops will lose their will to fight at the outset. Just in case they do not get the message immediately, the US plans do the same again on day two, CBS said.
Whether this is the actual plan or merely a strategically timed bit of disinformation intended to terrify Baghdad in advance, I have no idea, but anyone who has watched television over the last few days can be in little doubt as to the awesome array of weaponry that is now being assembled for the attack. To a world that remains mostly unconvinced of the need for it, there is something surreal and not quite believable about this. How has it come about? And why now?
In 1990 at least, the issue was clear: Iraq had invaded a sovereign state (Kuwait) and could not be allowed to get away with it. Everyone, including those who favoured a solution by diplomatic means, could understand the principle at stake.
Since then, Iraq has done little to cause offence, though there are many things that it might have done to redeem itself. It could have made more effort to comply fully with UN resolutions, for instance, but it is not alone in that and other countries are regularly let off with a verbal slap over the wrist. Taken individually, none of Iraq's transgressions over the last few years provides a case for war. And taken collectively, they only tell us what we knew already: that Saddam Hussein is not the sort of man you would trust to look after your grandmother.
Overall, whatever military threat Iraq presents, it is no greater now than it was when UN weapons inspectors first started their work in the early 1990s and is almost certainly a great deal less. Essentially, the weapons at the centre of the current furore are the relatively small number of items that were still unaccounted for when the inspectors pulled out under pressure from Iraq in 1998. On the nuclear front, the best that the White House website can come up with is a one-line statement that Iraq's declaration to the UN last month "ignores efforts to procure uranium from abroad".
Until quite recently the prevailing view in Washington was that any danger from Iraq could be effectively contained - as, indeed, it has been for the last decade or so. This general lack of alarm about Iraq's military capacity was reflected in security council resolution 1284, approved in 1999, which sought to get the Iraqi issue out of the way by resuming weapons inspections in a less aggressive manner than previously, and then suspending sanctions if nothing untoward was found.
Iraq raised a number of objections (which it probably now regrets), but resolution 1284 remained the security council's preferred way forward until last November, when the goalposts were dramatically moved by the toughly worded resolution 1441 which, in one interpretation or another, looks set to give the US its pretext for military action.
What this amounts to is an engineered crisis that is driven from Washington rather than Baghdad. It began with the election of George Bush and a noticeably harder line on Iraq almost from the moment he took office. Since then it has hardened further as the neo-conservative hawks have gained predominance - helped in no small measure by Osama bin Laden.
Those who say that oil lies at the root of it are right up to a point, but it is not simply a matter of grabbing Iraqi oil. The neo-conservatives see Iraqi oil as a political weapon which can be used to undermine Saudi Arabia's influence and thus promote their grand design for reshaping the entire Middle East. Whether they will succeed in achieving their broader plans, even after an invasion of Iraq, is doubtful. But there is no doubting the damage that will be done to the US in the meantime.
Last week the US-based Middle East Institute published a report by Edward Walker, a former assistant secretary of state for the Middle East, who has also served as US ambassador in Israel, Egypt and the United Arab Emirates. Following a visit to Egypt and Saudi Arabia, he found that popular opinion in the region was "more antagonistic toward the United States than at any time in recent memory".
"The perception is that we are driven by the six Cs - cowboys; colonialism; conspiracy; Coca-Cola; cowardice; and clientitis," he wrote.
"The 'client' is Israel. The 'cowardice' is the perception that we are the schoolyard bully. Coca-Cola is the symbol of an alien consumer society; 'conspiracy' is based on unrealistic expectations of US capabilities; 'colonialism' is premised on a US drive to control oil; and 'cowboys' is drawn from a Hollywood style perception that the administration shoots from the hip.
"The reality is that when Arabs think of the United States they think of Israel - and when Americans think of the Arabs they think terrorism. According to the leadership in both Saudi Arabia and Egypt, these perceptions will be magnified tenfold if the United States invades Iraq."
It may be far too late to halt the rush towards war, but at least there are Americans who question what is happening. Last Thursday, Paul Wolfowitz, the deputy defence secretary, gave a talk at the council for foreign relations in New York. It was the usual sort of stuff, with a large dose of September 11 thrown in for good measure.
"Iraq's weapons of mass terror and the terror networks to which the Iraqi regime are linked are not two separate themes - not two separate threats. They are part of the same threat," Mr Wolfowitz said.
In the question-and-answer session that followed, he was challenged by a reporter from the New York Times - hardly one of the country's most dovish newspapers - who asked: "Given that we're talking about matters of war and peace, does the administration plan to make a further report and provide intelligence information to ... buttress its claims that Iraq has resumed the production of weapons of mass destruction? And if not, is this because of targeting concerns, sources and methods, or do you simply not have reliable information that would stand up in a public forum?"
Mr Wolfowitz replied: "I think the short answer ... is there is a lot of evidence; as the evidence accumulates, our ability to talk about it undoubtedly will grow. But we don't have a lot of time; time is running out."
So we may get the evidence in due course, but not necessarily before the war starts. The Iraqi affair has gone on for 12 years but now time is running out.
Why is it running out? Because Mr Wolfowitz says it is.
Another member of the audience summarised Mr Wolfowitz's position as "We can't tell you what we have of information, but trust us. It's there."
The questioner continued: "Isn't the fundamental principle of a democratic free nation precisely not to trust government? Why should Americans trust their government? We've heard that before in Vietnam, we've heard it many times: 'Trust us,' and it turned out to be untrustworthy.
"I don't see how this administration thinks it can build a policy for war, preventive war, that would be accepted by our allies and by American citizens on the basis of 'We've got the info; we can't tell you how we got it or where we got it; we've got it, trust us.' And isn't that a foolish and ultimately self-destructive way for this administration to proceed?"
Mr Wolfowitz answered: "I must say I sort of find it astonishing that the issue is whether you can trust the US government. The real issue is, can you trust Saddam Hussein?"
Certainly no one in their right mind would trust the Iraqi leader. But that does not mean they have to trust Mr Wolfowitz and the US government either.
The great divide
After a $1.6 trillion (£1 trillion) tax cut in the first year of his administration which focused its benefits overwhelmingly on the richest 1% of the country, he has now gone even further, proposing the elimination on share dividends.
It is another masterpiece of inequity. More than 70% of the $364bn in benefits will go to the wealthiest 5% of taxpayers. And there is no guarantee it will actually help the economy emerge from the doldrums.
Economic stimulus measures are supposed to boost consumption, through tax-cuts or government spending, in times of depression. They are temporary and tend to be targeted on the poor, who traditionally spend more of any windfall income than the rich. The Bush measure is permanent and targeted on America's plutocrats.
Most of the impact of the new $674bn fiscal package will not come on stream until 2004. So why is the Bush team, which is staking so much on a probable war with Iraq, also gambling on a tax give-away of dubious efficiency?
One reason is that Bush, his deputy Dick Cheney and the White House economic team are not Keynesians, but committed supply-siders. They believe in removing the financial shackles from those economic decision makers with the most clout - rich people.
They also believe in the "wealth effect" by which the cut in dividend tax will make shares more popular as an investment, thus boosting the stock market. The consequent feelgood factor among investors encourages them to go out and spend.
The fact that the effects might not be felt into 2004 does not bother the president. That is, after all, the year he stands for re-election.
No matter what the unemployment rate then, if voters feel that they are on the upswing once more, the Bush camp's thinking goes, that sense of optimism may be enough to carry the incumbent over the finish line once more. After all about two thirds of the electorate own stocks.
More striking for a foreign observer, the Bush camp appears to have no fear of being seen as pandering to a relatively small coterie of country-club types. Any European politician proposing such a elitist fiscal policy would be destroyed in the press and the polls.
It points to a fundamental cultural difference between America and Europe. While it is plainly ridiculous to call the US a classless society, class-consciousness is a very different phenomenon in American society.
Just go to see some Hollywood movies. The wealthy are generally portrayed as sympathetic. Only those who put on airs are cut down to size. Americans have little time for affectation, but they have more admiration than envy for the rich.
That explains why George Bush was able to pose as a "regular guy" in his presidential campaign despite his privileged background. Voters liked his folksy manner and did not resent his good fortune.
As the conservative commentator, David Brooks, put it: "If Americans see the tax debate as being waged between the economic elite, led by President Bush, and the cultural elite, led by Barbra Streisand, they are going to side with Mr Bush, who could come to any suburban barbershop and fit right in."
While Europeans overwhelmingly identify with the social class they sprang from, far more Americans expect to be rich themselves one day. In material terms they are an extraordinarily optimistic people.
A poll at the time of the 2000 elections found that 19% of those asked believed they were in the top 1% income bracket. Another 20% expected to be there soon.
Little wonder, then that Democratic complaints that the 2001 Bush tax cut was aimed at the top 1% had little resonance. Nearly 40% of the population saw that as a plus, and viewed Democratic attacks on the plan as socially divisive. Americans vote their aspirations, not their class interests.
Brooks argues that Americans do not see themselves as living in a society of rigid layers. Instead, he uses the metaphor of a school cafeteria where people tend to gravitate towards the table where they feel most comfortable, and where most people feel they are on the best, most convivial table.
So middle class Americans in the midwest may be aware that there are people elsewhere on much higher incomes but they are convinced that cannot feel as fulfilled and cannot live in such a neighbourly town as their own.
However, this sunny social optimism is not necessarily indestructible. The country has just emerged from a decade of rapid growth in which rags-to-riches stories abounded. The dot.com economy made everything seem possible to the middle classes with a little money to invest.
Class-based politics begins to sound more resonant once people feel they have been stuck in the same rut for more than a generation. That is why the most radical and resentful political notes are sounded in the black inner cities.
To most Americans, the downturn still seems a temporary hitch, such is the faith in the dynamism and resourcefulness of American enterprise, and small investors are biding their time waiting for the next boom.
That is what the newly-refurbished Bush economic team is waiting for. Fear of deficits has become a Democratic phobia. The current White House, like its inspiration, the Reagan administration is not bothered that its tax-cut policies have plunged the country back into deficit and added hundreds of billions in interest payments to the fiscal burden of future years.
It is convinced that wealth-effect-driven growth will ultimately flood the treasury with revenues and wipe out the debt, just as it did in the Clinton era. They are also counting on cheap oil after the next Gulf War. Those are two very big wagers.
IF IT came to a vote, America would lose. Amid the hurling of insults across the Atlantic, an increasing number of countries have spoken out to urge that the United Nations inspectors in Iraq should be given more time to search for evidence of weapons of mass destruction. While the administration of President George Bush has attempted to shrug off international protests, a crunch time approaches. The inspectors will present a progress report to the Security Council on Monday January 27th. The council agreed unanimously last November on the resolution that ordered Iraq to let the inspectors return, but now America cannot even command a majority among the five veto-wielding permanent members.
Of those five, only Britain seems certain to back Mr Bush if America tries to seek a new UN mandate authorising an invasion. France has repeatedly said it does not believe there is any justification for a war. China says its position is “extremely close” to France’s. Russia also veers towards the French line, although with large oil interests in Iraq its position could shift. France is also co-ordinating its opposition with Germany, which takes up the rotating seat as president of the full 15-member Security Council soon after it convenes on January 29th to consider its response to the inspectors’ report.
The report will be a mixed bag. Hans Blix, the chief inspector, told the Security Council earlier this month that he had found no “smoking gun”, such as a massive weapons cache. Iraq has provided passive co-operation while continuing to insist that it no longer has any programmes to produce nuclear, chemical or biological weapons. Its 12,000-page arms declaration to the UN contained omissions, but this is not considered by many countries to be a reason for war.
Some American officials have said it is not the job of the inspectors to find a smoking gun, but for Iraq to prove that is coming clean. That, according to some in Mr Bush’s administration, is not possible under the brutal regime of Saddam Hussein. As an example, they say the reason why Iraqi scientists will not agree to be interviewed outside of the country and away from their Iraqi minders is that they fear that their extended families will be killed if they appear to give anything away.
But some form of hard evidence of Iraq’s duplicity is demanded by France’s president, Jacques Chirac, and Germany’s chancellor, Gerhard Schröder, even though America has suggested the two countries are isolated in their efforts to avoid the use of force to remove Saddam. “Old Europe” is how Donald Rumsfeld, America’s defence secretary, described them. Germany’s foreign minister, Joschka Fischer, responded bluntly by telling Mr Rumsfeld to “cool down”.
America continues to maintain that as far as it is concerned, Saddam remains in breach of numerous UN resolutions made since the 1991 Gulf war. “I don’t think we’ll have to worry about going it alone,” Colin Powell, America’s usually doveish secretary of state, has said. Britain has already dispatched a large task-force to join the 150,000 troops gathering in the region. Australia has also sent a troop ship. Italy, Spain and a number of East European countries might also participate in an invasion or an occupation force. Russian officials have said they have information that the attack will begin in mid-February.
Mr Bush says he has not yet made up his mind about invading Iraq, even though his patience with Saddam is wearing thin. More harsh words against the Iraqi leader are expected when the American president delivers his state-of-the-union address on Tuesday January 28th. He could echo the view of some American officials—that if other nations want to remain “on the sideline”, that is their prerogative. By mid-week, it will become clearer whether or not America will try to get UN backing for a strike against Iraq. At the end of the week, Mr Bush will meet his closest ally, Britain’s prime minister, Tony Blair, at his Camp David retreat. It looks increasingly as if that meeting will be a council of war.
On January 24th, the newspaper owned by Saddam’s son, Uday, gave warning that “the events of September 11th will be a picnic compared with what would happen to America if it commits aggression against Iraq.” America can live with angry words from some of its European allies, even though such a falling-out may yet alter the balance of future alliances. But provocation like that from Iraq is only likely to hasten Saddam’s demise
AS AN exercise in pomp and protocol, the declaration of renewed Franco-German friendship will be hard to beat. On January 22nd, President Jacques Chirac and Chancellor Gerhard Schröder met at the Elysée Palace to pledge their nations' faith in a shared future. Some 603 German MPs had been invited to join 577 French counterparts in a special congress in the palace of Versailles. The next day the theme was the same but the location had changed: Mr Chirac was in Berlin, making two speeches of suitable gravity and opening a new French embassy—“our best, most beautiful and most expensive,” he joked before the event.
Yet, 40 years after Charles de Gaulle and Konrad Adenauer signed the Elysée treaty, do the protestations of mutual affection in this week's “Elysée Declaration” add up to genuine love? It is easy to argue that France, with its Gaullist tradition, will never be ready to subordinate its own interests for a notional common good.
For example, in Brussels, on the eve of the declaration, France's finance minister was blithely threatening to defy the constraints of the European Union's pact on stability and growth, a package of economic disciplines put in place in 1997 at Germany's insistence. The day before, at the United Nations in New York, France's foreign minister, implying a willingness to use his veto in the Security Council, was laying down a diplomatic gauntlet: if the United States took “the military short-cut” against Iraq without a new council resolution, France would “assume its responsibilities right to the end”.
Though Mr Schröder in last autumn's re-election campaign said that Germany would take no part in any war against Iraq, such independence of thought and word is a German exception, whereas for France it is almost a rule. Indeed, the German foreign minister, Joschka Fischer, conceding that “it would be entirely wrong to place us in the same rank with France and Britain on foreign and security policy,” commented this week that the Germans “are still discussing who we are—a question that appears absurd to any French person.”
In that case, does this week's declaration amount to anything more than an empty wish-list, to be ignored when the going gets tough? Helmut Schmidt, who as Germany's chancellor in the 1970s and early 1980s enjoyed a Europe-minded friendship with France's President Valéry Giscard d'Estaing, is one public doubter. In an interview with Le Monde this week, he declared that the “Franco-German motor of Europe no longer exists...What we need is a new treaty for a larger Europe, not a new one for France and Germany.”
Possibly so. But as a pundit for Arte, a publicly-funded Franco-German television channel founded in 1991, comments, the wish-list “creates obligations”. Some, for sure, will be more easily met than others. By all means declare January 22nd “Franco-German day”. Similarly, do put more cash into the Franco-German University (a network linking students in both countries), or insist that two foreign languages are taught at school. Such measures may or may not reduce the dominance of English (fewer than 1m French secondary-school pupils now learn German and only 5% of Germany's schoolchildren are still studying French in their final year), but their virtue is that they are hard to quarrel with. More tantalising, perhaps, is a proposal that French and German citizens may, if they wish, take dual nationality.
The harder obligations are those that go to the heart of government policy. Messrs Chirac and Schröder have bravely committed themselves not just to maintaining, and even accelerating, their rhythm of special meetings every six weeks. They have also decided to appoint in each other's country “a secretary-general for Franco-German co-operation”: a suitable Frenchman “of high level” will be attached to the chancellery in Berlin and a German counterpart will be posted to the office of France's prime minister, currently Jean-Pierre Raffarin, in Paris. Each, it seems, “will co-ordinate the preparation, implementation and follow-up” of the two nations' common European policies.
Nor does co-operation end there. When one country's cabinet discusses a subject of concern to the other, it will be joined by the relevant minister from that country, and “common Franco-German legislation” will be proposed to respective parliaments that will share both ideas and personnel and exchange regular visits by their European-affairs committees.
Dream just a little and the idea of a Franco-German Union, advocated this week by Pascal Lamy and Günter Verheugen, respectively French and German members of the European Commission, does not seem entirely outrageous. After all, this week's declaration already talks of the two countries taking co-ordinated or common positions when the EU talks of foreign policy, defence or the economy.
In the meantime, will reality spoil the dream? At this week's joint press conference at the Elysée, it was Mr Chirac who dominated, especially on Iraq. But that reflects reality. France, after all, is a nuclear power with its permanent seat in the Security Council, while Germany is militarily puny and diplomatically still nervous.
Given the strains of domestic politics and the poor empathy between president and chancellor, there will be plenty of sceptics to agree with Mr Schmidt. But there is a more generous interpretation: that France and Germany, like an old married couple, have many interests in common and can agree to disagree on the others. In the words of Hubert Védrine, France's foreign minister until the left lost last year's general election, “the Franco-German motor is still necessary but no longer sufficient” for reshaping Europe.
What oil can do to tiny states
“People are not ready [for oil]. It could be dangerous,” says Guilherme Posser da Costa, a former prime minister. A look at two of São Tomé's neighbours, who are both small and oil-rich, suggests he is right to fret. In Equatorial Guinea, a former Spanish cocoa colony, and Gabon, a French-dominated oil emirate, oil has done little to ease poverty or lengthen life, and much to corrupt politics.
Equatorial Guinea now pumps more oil per person than Saudi Arabia. Its economy, once negligible, has grown at an incredible 40% annually since 1996, when the boom began. A few years ago, the streets of the capital, Malabo, were as quiet as São Tomé's are today. Now, Malabo's pretty Spanish colonial architecture bristles with satellite dishes, and the streets, bathed at night in an orange glow from gas flared at a nearby methanol plant, are gaudy with sports cars, tropical palaces and prostitutes who flutter in from nearby countries such as Cameroon. And the tiny country's agriculture is blighted: cocoa and snail farmers have rushed to the towns to grab a slice of the oil bonanza.
Equatorial Guinea was never well-governed: Obiang Nguema, the president, seized power by executing his uncle in 1979. But oil has made his regime increasingly paranoid. Several members of the ruling family are thought to want a bigger slurp at the oil barrel. Mr Obiang sees plots everywhere, and arranges periodic crackdowns. Several opposition leaders were jailed last year after a mass trial, to which many defendants turned up with broken arms and legs. Mr Obiang scoffs at western notions of transparency, insisting that how much money his government earns from oil is nobody else's business. “Oil has turned him crazy,” says Celestino Bacale, a brave opposition politician.
In next-door Gabon, Omar Bongo has been in power since 1967. He is more subtle than Mr Obiang. He does not torture his enemies but buys them off. Decades of oil revenues have corrupted Gabonese society and eroded the work ethic. Citizens aspire to soft billets in the civil service, and turn their noses up at menial jobs like taxi driving or shopkeeping, which they leave to immigrants from poorer places such as Togo and Mali. Agriculture in Gabon, as in Equatorial Guinea, is all but dead.
The elite in Libreville, Gabon's capital, buy French bottled water, French milk and rognons de volaille gourmet catfood. Mr Bongo helps French companies keep competitors out, and France thanks him by stationing 600 soldiers next to one of his palaces, and neglecting to criticise him when he wins rigged elections.
Sadly for Gabon's petrocrats, however, the oil is running out. As output falls, the civil service may no longer be able to pay all its thumb-twiddlers, the migrant workers may go back home, and the Gabonese may have to relearn how to grow cocoa and drive taxis. And Mr Bongo may no longer have the funds to buy off his opponents. Recently, he has been stuffing the army with people from his home region.
Will oil bring similar troubles to São Tomé? Perhaps not. Independent-minded voters booted out the incumbents in two of the last three presidential elections. Mr de Menezes, a cocoa farmer who was elected in 2001, is trying to wriggle out of the oil-exploration contracts that his predecessor signed with Nigerian, American and Norwegian companies, and which the IMF agrees were bad deals.
This is holding up exploration along the maritime border with Nigeria, which the two countries plan to develop together. The president says that “oil interests” are trying to destabilise him. He also fears Nigeria, which has 800 times the population and a big army. So he has been making friends with America, breakfasting with George Bush in New York last year, and playing host to American military advisers. If oil is found, it will not flow for several years. But when it does, it could shake up São Tomé like a firehose aimed at a handful of sand.
ON A quiet Tuesday afternoon, Wall Street's bankers, brokers and bosses tuned in to watch Citigroup announce its results for 2002. Mainly, they wanted to see how a company battered by New York state's attorney-general, lousy capital markets, rising loan losses and imploding foreign operations could still earn $15.3 billion. Surely, they reasoned, if Citigroup could survive the past year, there was hope for everyone else.
Indeed, optimists can find hope amid the ruins. Citigroup's earnings, although bolstered by the bank's unique breadth of activities, was not out of line with the rest of the industry—if you exclude CSFB, a long-troubled, Swiss-owned investment bank, which lost SFr3.4 billion ($2.2 billion) last year. Returns on equity at Wall Street's biggest firms remain in the high single or low double digits. That may be the best response to hard times in the financial industry's history, says Diane Glossman, an analyst at UBS Warburg.
Better still, the investigation by New York's attorney-general, Eliot Spitzer, began with a bang but ended last month with a whimper. Citigroup contributed most to the settlement, $400m, but this was a mere sliver of the bank's revenues from telecom deals, which were at the heart of Mr Spitzer's inquiry. Historically minded optimists might even muse that the bear market is already a bit old.
Yet the mood in investment banks is far from celebratory. Mainly, this is because the Street's resilience has come at bankers' expense. Pay soaked up half of investment banks' revenues during the bull market. As revenues tumbled, so did compensation. Depending on the firm and the line of business, bonuses, which make up most of bankers' pay, fell by 40-60% in 2001 and then by another 10-50% last year, Ms Glossman estimates.
Although a few businesses have puttered along, notably bond issuance and trading, those with the highest margins, mergers and initial public offerings, have been somnolent. For the first time since 1988, more money was withdrawn from equity mutual funds than was deposited. Because of low interest rates, even money markets saw demand fall. Few investment banks have found fresh sources of revenue other than investing their own money (a risky business) or lending it at interest (a business so unattractive that every commercial bank is trying to get out of it).
In an attempt to squeeze fees out of slow demand, many investment firms are rewrapping their products, slapping on higher fees, and hoping that clients do not notice. Customers who once bought stocks and bonds, thus paying only a single commission per trade, are being encouraged to switch to packaged products with high, ongoing fees, such as in-house bond funds, and perhaps a second layer of charges for managing a portfolio of funds.
Investment firms are also eagerly selling high-cost hedge funds with stratospheric fees to investors of modest means. Previously, such investors would not have been allowed anywhere near such funds. They would do far better with a plain old mutual fund. All the investment firms' marketing efforts may do little more than refresh investors' suspicions that the industry is trying to fleece them.
Those suspicions may lead to expensive lawsuits in any case. As expected, Citigroup's results included a $1.3 billion charge for litigation, more than two-thirds of it for private suits. Robert Morgenthau, Manhattan's district attorney, continues to examine the bank's involvement with Enron. Within the next week or two, Mr Spitzer will release memos, e-mails and documents related to last month's settlement. If there was anything to his investigation, the disclosures should provide fresh embarrassment for Wall Street and possible fodder for civil suits.
There may still be worse to come. More litigation, so far only a twinkle in the eyes of the Securities and Exchange Commission and Mr Spitzer, may be on the way. True to past form, there have been no charges and such scant information as there is has leaked out through the press. A broad investigation into short-selling by hedge funds—a practice that is hated by the shorted companies but arguably keeps the market oiled—is said to be under way. More specifically, a hedge fund is under scrutiny for publishing potentially misleading research reports on the internet. A third investigation involves a Lehman Brothers analyst alleged to have passed the firm's research to her husband, who used it in his trading job at another hedge fund.
Even if the allegations are true, has any crime been committed? Hedge funds have no obvious duty to someone reading a free report on the internet. Lehman may have reason to be aggrieved about its opinions being lifted, but does the use of its research add up to insider trading? The closest precedent may be the prosecution in the 1980s of a Wall Street Journal reporter who leaked share tips prior to their publication in the paper's “Heard on the Street” column. The Journal had strict rules about the release of information and took a hard line. Lehman says the investigation does not involve the firm. The analyst is rumoured to have been suspended.
No one knows how far and for how long Mr Spitzer, not to mention civil litigants, will pursue the financial industry. Whatever the outcome, damage has been done. So nervous are investment banks about what regulators might one day see, or think they see, that they are giving their employees classes in e-mail etiquette (lesson one: write nothing). Internal comments are being faxed rather than e-mailed, thus leaving no trail. One fund manager says analysts call him on mobile phones, even to discuss public information, if they dare call him at all.
In the longer term, there is reason to question what investment banks will be able to offer clients if the way they disseminate information remains so constrained. Research departments, the focus of last month's settlement, are already under siege and conditions are likely to deteriorate in the months ahead. Hitherto, analysts have been paid out of three pots: retail broking, institutional sales and investment banking, which contributed perhaps half. This allowed some analysts to earn well over $1m a year, and maybe $20m. Now many will be fired; those that are not will earn at most $500,000. The best will probably join asset-management firms or hedge funds. Their job is, after all, to follow the most promising opportunities. If they are good at their jobs, they should be the first to know when Wall Street has lost its allure.
“GOVERNMENTS of the industrial world, you weary giants of flesh and steel, I come from cyberspace, the new home of mind. On behalf of the future, I ask you of the past to leave us alone. You are not welcome among us. You have no sovereignty where we gather.”
Ah, it all seems so long ago. In 1996 John Perry Barlow, a former cattle rancher, lyricist for a rock band, the Grateful Dead, and commentator on technology, posted these words in an online discussion group. His “Declaration of the Independence of Cyberspace” was an 800-word credo which claimed that users of the internet inhabited a new world of creativity, equality and justice which would forever remain beyond the reach of existing governments. “We will create a civilisation of the mind in cyberspace. May it be more humane and fair than the world your governments have made before,” he concluded with a flourish.
It is hard to believe today, but Mr Barlow's musings struck a chord at the time, spreading rapidly through the internet. The declaration encapsulated the exhilaration and wonder of millions of people as they logged on to the world wide web for the first time. It really did seem possible that the internet had launched a spontaneous revolution that might lead to a brave new borderless world.
Seven years later, Mr Barlow's claims sound absurd: just another example of the 1990s hype that produced the dotcom boom and bust. The internet, it seems, has turned out to be simply another appliance, a useful new medium like radio or television, not something likely to usher in a “civilisation of the mind”. Cyber gurus like Mr Barlow have also lost heart, and now issue equally exaggerated warnings about the internet's strangulation by government and corporate interests. With the help of governments, big entertainment companies are trying to “control everything that we know”, Mr Barlow says. “The fight about this will, in my view, determine the future of humanity.” Lawrence Lessig, a Stanford professor who is also a leading commentator on the internet, is almost equally apocalyptic: “The existing dinosaurs are succeeding in stifling the creativity inherent in this new medium.”
The taste for hyperbole of Mr Barlow, Mr Lessig and their sort may be easy to mock, but they are right in their fundamental claim: the internet and its related technologies are capable of transforming society. Far from being over, the computer and telecoms revolution that created the internet has barely begun. These technologies will change almost every aspect of our lives—private, social, cultural, economic and political. In some areas, the changes may be marginal, but in most they will be profound, and unprecedented.
This is because new electronic technologies deal with the very essence of human society: communication between people. Earlier technologies, from printing to the telegraph, have done likewise, and have wrought big changes over time. But the social changes over the coming decades are likely to be much more extensive, and to happen much faster, than any in the past, because the technologies driving them are continuing to develop at a breakneck pace. More importantly, they look as if together they will be as pervasive and ubiquitous as electricity. Whether this will be for good or ill is impossible to predict, because how they are applied will be a matter of social and political choice. Many of these choices will be difficult and divisive.
Billions of dollars have been lost betting on the idea that the internet would quickly change everything from retailing to entertainment. Internet usage has continued to grow, but most dotcoms have failed, and the telecommunications industry, which raced to build the infrastructure for cyberspace, is staggering under $1 trillion of debt. Yet it would be wrong to conclude that this is the end of the internet revolution. Boom and bust often follow the introduction of radically new technologies. In the 1870s America's railroad industry boomed in much the same way as the world's telecoms industry in the late 1990s, only to collapse in a similar heap of bankruptcies, accounting scandals, stockmarket losses and enormous debts. America's economy fell into recession.
A few years later, a reviving economy together with advances in railway engineering triggered a new wave of investment. Railroads quickly revived, changing American business forever. The same sort of thing happened when the internal combustion engine came along. In the first few years of the 20th century there were thousands of people tinkering with carmaking, most of whom went bust. A decade later only a handful survived, but the car was about to become the icon of progress.
The reason to think that the internet revolution will not only resume but accelerate is that advances in its underlying technologies show no signs of slowing down. The power of computer chips continues to race ahead. Moore's law—according to which the power of a computer chip will double about every 18 months (see chart 1)—has proved to be true since 1965, when it was first propounded by Gordon Moore, a co-founder of Intel, a chip maker. Intel is confident that it will be able to maintain this pace of improvement in silicon for another 15 years. Recent breakthroughs by researchers at IBM and Hewlett Packard in molecular electronics lead many experts to believe that Moore's law will continue to apply for perhaps another 50 years. Similarly dramatic advances in storage and transmission technologies are also in prospect.
Meanwhile, existing or impending technology is being applied ever more widely. Victor Zue, director of MIT's Laboratory for Computer Science, expects high-speed access to the internet to be virtually free in rich countries within five years. His laboratory's Project Oxygen is building an office on MIT's campus in Cambridge, Massachusetts, that will be wired to demonstrate the kind of “pervasive, human-centred computing”, driven by voice and involving a range of devices, that he believes will become possible in the near future. Many of its components are already being tested at MIT's laboratory and by its corporate partners.
On another front, Mr Zue's colleague, Tim Berners-Lee, famous as a founder of the world wide web, is trying to win agreement from a coalition of companies to establish the standards for what he calls the “semantic web”, a more intelligent version of today's internet that will take the drudgery out of searching for information by evaluating its context.
Even the sense of physical touch might some day become possible in cyberspace. Late last year, scientists at University College in London and MIT in Boston demonstrated a system that allows users at each end of a high-speed connection to manipulate objects, either alone or together. Microsoft researchers are now working on ways for consumers to store and catalogue every photograph, e-mail, document or telephone conversation they have had during their entire lifetime (though it is not clear why anyone not writing an autobiography would want to do this).
On a more mundane level, third-generation mobile telephones, despite all the delays and the billions squandered on 3G licences by telecoms firms, are still expected to offer consumers high-speed, always-on mobile internet access, complete with video, in the next few years. Rapidly proliferating “wi-fi” networks already offer wireless access on a local basis. Tiny tracking chips called radio-frequency identification devices are being used as pet passports. Soon they will be small, powerful and cheap enough to be implanted into everything from humans to milk cartons, recording and transmitting real-time medical data or serving as a form of inventory control. Sensors of every kind, including video cameras, should also become much smaller and cheaper. Forrester Research, a technology consultancy, predicts that 14 billion such devices will be connected to the internet by 2010.
How rapidly such new technology is introduced will depend on a number of factors—the state of the economy, the supply of investment capital and the appetite of consumers for new products or services. Fortunes will be made and lost many times over. But whatever happens, the power of computing and communications looks set to continue to grow, and its price to fall, at a steady rate for the next few decades. That will make it possible, at least in rich countries, to record most human interactions, wherever and whenever they take place, and to store and analyse this ocean of data at low cost.
For the sake of argument, this survey will assume that we are heading towards a networked society of ubiquitous, mobile communications capable of constant monitoring. Whether this arrives in 20, 30 or 40 years does not really matter. The point is that the destination seems not merely possible, but probable, so it is not too soon to ask: what do we want this technology to do?
The internet has already thrown up a host of legal and political conundrums, but these are only a small foretaste of the dilemmas—about privacy, security, intellectual property and the nature of government itself—that will have to be faced over the coming decades. The debate has already begun. This survey will outline some of main issues, and speculate on the way they are likely to go.
Angry, worried and impotent
WITH war in Iraq looming, the country’s Muslim neighbours are engaged in a frantic round of diplomacy aimed at avoiding a conflict which, they fear, would damage their economies, destabilise their politics and lead to a rise in extremism. Envoys have been criss-crossing the Middle East in recent days, hoping to persuade Saddam Hussein to comply with the demands of a United Nations resolution calling on him to disarm, or step down. There were even rumours, reported by Time magazine, of a Saudi-backed plan to topple Saddam using the Iraqi military, contingent on an amnesty being granted to most senior Iraqi officials. Optimists hope the talking will make a difference, but most people think Iraq’s neighbours, for all their understandable fretting, will be unable to dislodge Saddam and will have little leverage over President George Bush if he decides that war is the only option.
The region’s Muslim governments face a tough balancing act. Pulling in one direction is America, on which a number of them depend for their economic survival and political stability. Pulling in the other is Muslim public opinion, overwhelmingly hostile to war. Nine out of ten Turks, for instance, are against.
Even before the latest stand-off with Saddam, Muslims were angry about America’s support for Israel in its conflict with the Palestinians. Now, many believe America has manufactured the Iraqi crisis in order to get its hands on the country’s oil and redraw the political map of the Middle East. That they cannot take to the streets to vent their anger has only increased their frustration—Arab governments have clamped down on any sign of disaffection. They worry that if anti-American protests are not held in check, they could trigger a popular backlash—especially in countries such as Egypt and Saudi Arabia, where Islamist sentiment is on the rise.
Even so, this time around Muslim leaders are being less co-operative with America than they were during the 1991 Gulf war, when all Arab states lined up behind the forces that drove Iraq out of Kuwait. Only a handful are providing bases for American troops. Saddam is hardly popular in other Arab countries, but his relations with the leaders of some, such as Syria, have improved since the Gulf war.
As America intensifies its preparations for possible war with Iraq, two of its most useful allies in the region, Turkey and Saudi Arabia, have been stubbornly refusing to fall into line. Saudi Arabia has so far refused to allow America to use its territory as a launch pad for military strikes. Turkey’s support was crucial in the Gulf war, and the United States is said to want to base up to 80,000 troops in the country. But Turkey has said that it will not allow America to use its military bases without UN backing, and that it could make only a “limited” contribution to any American-led war. This has left America having to try bribery: it has offered to spend tens of millions of dollars upgrading Turkish bases if they are opened up to American warplanes.
The spin coming out of Washington is that Turkey’s powerful and pro-western generals are ready to side with the Americans, but are being held back by the Justice and Development Party, a mildly Islamist grouping that catapulted to power in the November 3rd election. This should be taken with a pinch of salt. The word in Ankara is that Turkey’s soldiers are just as worried about war as its civilians. The army’s chief concern is that Iraq’s Kurds would exploit the turmoil that could follow an Iraqi defeat by setting up their own independent state in the chunk of northern Iraq that has remained under their control since the end of the Gulf war. Moreover, the presence of American forces in Iraqi Kurdistan would make it that much more difficult for Turkey to carry out its threats to intervene militarily should the Iraqi Kurds seek to break away from Baghdad.
The other worry is the economy. Another war could unravel the modest progress that Turkey has made over the past few months in dragging its economy out of severe recession. The Turks claim to have lost tens of billions of dollars in trade revenues because of economic sanctions slapped on Iraq after the Gulf war. Turkey has been negotiating with America over a multi-billion-dollar package of aid and loans to cushion the economic impact of war.
Other countries are also worried about the economic impact of fighting. Jordanian industry, for instance, is highly dependent on Iraq, Jordan’s biggest trading partner and its only supplier of oil. In return for food, medicines and clothes, Jordan receives Iraqi oil at very favourable prices. The Jordanian government, like Turkey’s, has been discussing with the United States compensation for any economic damage.
Iraq’s neighbours are also worried about the prospect of refugees spilling over their borders once war starts. Jordan has made it clear it will shut its border with Iraq as soon as conflict breaks out, though it has said it will help the UN to care for refugees on the Iraqi side of the border. Syria is reported to be working to set up field hospitals and relief facilities near its border with Iraq, though it denies this. By one estimate, Jordan, Iran, Syria and Turkey can expect to have to deal with more than 1m refugees in the event of a war. An estimated 2m Iraqis fled the country during the Gulf war.
Given all these concerns, it is hardly surprising that Iraq’s neighbours have been playing for time, voicing opposition to an invasion of Iraq and holding back from offering America military support. But few observers think their current awkwardness towards America and diplomacy towards Iraq will have much of an impact on the final outcome. Once war seems inevitable, and given enough financial carrots, they are likely to buckle under American pressure.
The challenge of uncertainty
“SOFT”, “subdued”, “anaemic”. Apt descriptions for many European economies, perhaps a tad over-optimistic for Japan. Yet these are all descriptions of economic performance across America contained in the regular assessment released on January 15th by the Federal Reserve, America’s central bank, in its so-called “beige book”. To round off a dismal week for economic statistics, the Fed announced on January 17th that industrial production fell by 0.2% in December compared with the previous month. That came as a disappointment to economists who had been expecting a small rise. The trade deficit for November, released on the same day, came as a shock, though: a new record of $40.1 billion, way above the pundits’ predictions.
Monthly data are always unreliable, of course; there is always a plausible explanation for unexpectedly bad (or good) news. The November trade gap, for instance, reflected a big surge in imports following President George Bush’s action to halt the dockers’ strike on the country’s west coast. But nearly all recent economic statistics point to the same conclusion—that America’s recovery remains sluggish and erratic. This gloomy diagnosis is, ironically, likely to help Mr Bush garner political support for his latest stimulus package, unveiled on January 7th. It could also put pressure on the Fed to consider cutting interest rates again when its policymaking committee meets at the end of the month.
The biggest obstacle to healthier economic performance, though, is political. As the Fed’s chairman, Alan Greenspan, acknowledged in the closing months of 2002, uncertainty about the future is holding both investors and consumers back. The shadowy threat of international terrorism and the much more explicit prospect of a war with Iraq has made many Americans nervous about the future. For businesses still reeling from the speed at which the late-1990s boom turned to bust, the political climate is one more reason to put off investing in new plant and equipment or hiring new staff. For consumers, for so long the mainstay of the American economy, the thrill of the shopping mall seems, finally, to be on the wane. On January 17th, the respected University of Michigan survey of consumer sentiment showed an unexpected drop because of gloomier expectations of future spending.
That’s certainly what some of the most recent figures imply. Eight out of 19 manufacturing industries showed a fall in production in December. Car production fell by 4.7%, possibly a sign that the boom in car sales—fed by discounts and interest-free promotions—has faded. Static or falling production is not a comfortable base from which to make decisions about upgrading factories.
Nor does it encourage companies to hire new workers or retain existing staff. Employment fell by 101,000 in December—a sign that upheavals in the labour market continued all the way through 2002. The fact that the unemployment rate stayed at 6% suggests some people have given up looking for work (and so are not counted in the jobless data). That might have contributed to the fall in initial unemployment claims too, although economists reckon that seasonal upheavals in working patterns make figures at this time of the year especially hard to assess.
It is hard to put a favourable interpretation on most of the data. But it is important to keep a sense of perspective. Some recent figures look disappointing partly because they fall short of over-optimistic forecasts—a persistent weakness of those paid to predict the economic future, no matter how often they are proved wrong. The Fed’s beige book confirms that the economy remains weak, but also reveals signs of pick-up in several regions, most notably the industrial north-east. And America is still among the fastest-growing of the big industrial economies.
The Fed will be watching carefully for further signs of weakness—or, conversely, for signs of a pick-up in activity—during the rest of the month. Mr Greenspan is an avid, even obsessive, consumer of economic data. He has made it clear that the Fed stands ready to reduce interest rates again if it judges it necessary—even after 12 cuts in the past two years. At its last meeting, though, when it kept rates on hold, the Fed signalled that it did not expect to need to reduce rates any further.
Monetary policy still offers the best short-term policy response to weak economic activity, and with inflation low (producer prices rose by only 1.2% in the year to December) the Fed still has scope for further relaxation. Mr Bush’s much-vaunted fiscal stimulus is unlikely to provide appropriate help, and certainly not in a timely way. Fiscal policy is notoriously crude in its effects, and implementing the tax changes Mr Bush wants will take time even with a strong political tailwind. Resolving some of the current geopolitical uncertainties would provide a much more effective economic boost—but that might be beyond even the American president.
It just gets worse
For a start, the details of the Spitzer settlement are far from settled. The broad outlines of the deal are clear: the firms (the biggest of which are Citigroup’s Salomon Smith Barney, CSFB, Goldman Sachs, Merrill Lynch and Morgan Stanley) are to pay almost $1.5 billion between them. This is split between a $900m fine, $450m to promote independent research, and $85m for investor education. Analysts’ ties with bankers are to be cut, and “spinning”—reserving shares in initial public offerings (IPOs) for the executives of client companies—is to be banned. However, just how this will work in practice is far from clear. The firms that would provide the independent research called for by the settlement have not been chosen; indeed, some independent providers have insisted that they want nothing to do with the deal.
Under the settlement, analysts are to be banned from attending pitches for investment-banking business and investor “road-shows”. But the details of further “structural reforms” are still being negotiated. These are expected to stipulate that research should be separate from banking, with its own legal and compliance staff. (Citigroup has already done something like this.) And only research departments are to be allowed to end coverage of a company—in the past, this was often done at the behest of bankers who preferred it to the relationship-damaging effects of downgrading a client’s shares. It is not yet clear how many banks will be affected by the settlement. As it stands, the deal covers just the dozen or so banks already involved, but it could be extended to the entire industry.
More worrying for the banks is the fact that the settlement does not protect them from investigation by the National Association of Securities Dealers (NASD), the industry’s own regulator, nor from individual investors. Specific civil charges against each of the participating banks are due to be made public as early as this month. Together with potentially incriminating e-mails fired off by analysts and bankers, a number of which have already been published, these should enable investors to pursue their own cases against Wall Street. Already, one former star analyst, Salomon Smith Barney’s Jack Grubman, has fallen on his sword. In a deal that has yet to be finalised, the former telecoms-watcher will accept a fine of $15m and a lifetime ban on working in the securities industry, though he has admitted no wrongdoing. This deal would protect Mr Grubman from further action by the NASD, but not necessarily from investor lawsuits.
Mr Grubman is unlikely to be the only fallen star to end up in court. The NASD has informed Henry Blodget, formerly a top internet analyst at Merrill Lynch, that he may face charges over his research picks. During Mr Spitzer’s investigation of Merrill last year, which resulted in a $100m fine, several embarrassing e-mails from Mr Blodget were discovered in which he dismissed companies that Merrill was publicly touting.
The NASD is also expected soon to take testimony against Mr Blodget’s supervisor, Andrew Melnick, who is now co-head of research at Goldman Sachs, and Deepak Raj, who reported to Mr Melnick, and who still works at Merrill. This is a striking new development, as managers at the big banks had hoped to restrict regulatory investigations to individual analysts. But the regulators have not bought the “rogue analyst” argument. Instead, they are looking to highlight flaws in the entire structure of research departments.
The energetic investigations led by Mr Spitzer, the NASD and others are likely to reveal a lot more unpalatable details about bankers’ behaviour during the heady late 1990s. And more fines are sure to be levied: the latest bank to be hit is the former Robertson Stephens unit of FleetBoston Financial, fined $28m on January 9th for taking kickbacks from clients in return for allocating them shares in hot public offerings. As more and more individual investors join the legal fray, Wall Street’s woes are certain to increase.
How far can it fall?
Yet the dollar—or, more accurately, the people who buy and sell currencies—remained impervious to economic forecasts. The world’s most important currency continued to be its most sought-after. The euro endured what to many Europeans was a humiliating decline in its international value almost from its inception. Neither the American recession in 2001 nor the huge and growing current-account deficit (about 5% of GDP) seemed to discourage people from holding dollars. And then, in the closing months of last year, the dollar finally started to weaken. By the end of the year, the dollar had lost 10% of its value as measured against a trade-weighted basket of currencies. The first few days of 2003 have seen it slip further against the euro and the yen.
Will the slide continue—and if it does, what will it mean for the global economy? Only a brave forecaster would try to predict with any confidence where the dollar will be in six months’ time. Of course, currency economists make such forecasts all the time—but that's their job and they are frequently mistaken. The factors which affect the value of one currency in relation to another are numerous and complex, and often confusingly contradictory. It is not simply a question of working out what foreign-exchange speculators think. Most currency trading is not speculative: it is the consequence of economic decisions taken by largely rational actors. Any shift in a currency’s value is driven by the cumulative impact of those millions of rational decisions.
The source of the great dollar surge in the late 1990s was easy to spot. The booming American economy offered enormously attractive rates of return on investment: as a consequence, large amounts of investment capital flooded into the country. Even when boom turned to bust, America still looked to be a better home for capital than many other, even more lacklustre economies. In 2001 and 2002, for instance, Europe’s economic performance was disappointingly sluggish, and the prospects for 2003 look little better. Emerging-market economies have lost their allure for most investors, especially after the collapse of the Argentine economy.
As the most important reserve currency, the dollar is also seen as a haven in times of global political uncertainty. Even after the terrorist attacks on New York and Washington—putting America, for the first time, at the heart of the security threat—it was to the dollar that nervous investors first fled. More recently, gold has recovered some of its attractiveness as a haven, reaching its highest level in six years this month. But the yellow metal is still worth only a fraction of its long-term historical value.
The prospect of war with Iraq, and the continuing threat from international terrorism, have made investors more nervous about the future. Yet the tide now seems to be turning against the dollar. This suggests that, for the time being at least, factors other than risk-aversion are more powerful in determining currency flows. One of the most important is the recognition that American investment returns are likely to be significantly worse than in the recent past for at least the next year or two. It doesn’t need investors to start shifting capital out of America to weaken the dollar—lower inflows would be enough.
Some of the dollar’s weakness is also likely to be self-fulfilling. As investors become convinced that the American currency will depreciate, they will seek an alternative home for their funds. That will, in turn, put further downward pressure on the dollar.
But is the decline such a bad thing, for the American economy or the rest of the world? Few American exporters will weep as the greenback sinks: the strong dollar has made it difficult for them to compete in world markets in recent years. Nor will tears be shed among manufacturers who have been desperately trying to fight off competition from cheap imports. Those countries whose currencies are linked, loosely or tightly, to the dollar will breathe a sigh of relief as well—Hong Kong and Brazil are among those economies that have suffered as the dollar has soared. Argentina’s currency peg was stretched to breaking point—and beyond—partly because of the American currency’s strength.
Those countries that compete for business in America, or with American exporters, though, will not relish the impact of the dollar’s decline. The rise in the value of the euro might boost morale at the European Central Bank in Frankfurt, but it will not bring much comfort to Germany’s export-driven corporate sector. East Asian economies such as Singapore, still reeling from the collapse of the high-tech boom, have no reason to welcome a devalued dollar.
Paul O’Neill, the treasury secretary fired by President George Bush at the beginning of December, was known for his belief in the benefits of a strong dollar. Such conviction is the refuge of old-fashioned politicians who associate national pride with a strong currency. Mr O’Neill was accused of trying to talk up the dollar, and consequently blamed for its persistent strength. His successor, John Snow, is, as yet, innocent of such uncomplicated views. In reality, of course, politicians have almost no power to influence currency movements except in the very short term. They are reduced to watching when currencies overshoot—as they almost always do—on the way up, and on the way down.