So the financial collapse is now more damaging than the 9/11 attacks,  at least in terms of retail sales.

We have discussed previously the possibility of terrorists launching attacks against financial systems, and when terrorists hear analysis like this from Treasury Secretary Ken Henry, they can only be encouraged:

The array of financial instruments deployed within the global financial system has become so complex that it defies understanding. It is not just that nobody understands the whole system; that's hardly surprising. What is worrying, though, is the very large number of senior finance sector executives who don't appear to understand the consequences of even their own decisions.

If we don't understand it, how on earth can we protect it?

Such has been the scale of the global financial crisis that it is increasingly assumed it will mark a watershed for the world economy. In particular, many observers seem to see it as heralding the decline of the West and the rise of the rest. That might well be turn out to be the case, but it seems to me far from a foregone conclusion.

At first sight, the argument that the financial crisis is accelerating the decline of US economic predominance and simultaneously stimulating the rise in relative power of the emerging world seems pretty straightforward. After all, the epicentre of the crisis has been the US, and much of the fallout has been concentrated around the Atlantic economies. Certainly, there can be little doubt that the blow to US prestige and credibility arising from the effective collapse of its financial system is substantial. Not to mention the looming cost in terms of foregone growth and increased government debt. 

Then there is the grinding of teeth occasioned in East Asia (and elsewhere) at the marked difference in the economic policies now being followed by Washington as opposed to those it propounded during the 1997-98 crisis. The decision to turn to the G-20 also reinforces the idea of a diffusion in global economic power. All of which seems a reasonable interpretation of events. And yet... More...

Kien Choong writes in response to my post and Fergus' post, both of which critiqued The Economist:

The Economist leader is right to say that the US government should not be subsidising renewables per se. However, this is not to say there is no room for government funding to correct 'market failure'. The examples cited by the Economist blog (eg. infrastructure investments, smart electrical grid, subsidies to basic research) are projects that may be subject to market failure. Thanks for raising the issue in your blog.  The public discourse around government subsidy of carbon reduction measures needs to be more sophisticated. 

This raises a small correction I wanted to make to Fergus' post. Fergus is, on the whole, correct to say that the US car industry has been resistant to innovation and fuel efficiency. But GM has made a bold move in this direction recently with the development of the battery-powered Chevrolet Volt. Read this Atlantic Monthly profile to see just how important this car is for the company and for a post-petroleum automobile industry.

This raises the question of whether there is more justification for bailing out GM because they are pursuing environmentally friendlier vehicles. I would still say 'no', for the reason Kiem cites. Perhaps GM's bankruptcy would put back the development of electric cars by a while, but there is lots of competition in this field, and perhaps GM's design was not the best one anyway. The US government is not in a good position to make such judgments; the market is.

Unfortunately, though, if GM does go under we would be denied a fairly attractive electric car...

Photo by Flickr user gmeurope, used under a Creative Commons license.

This weekend’s meeting of the G-20 leaders has been hailed as marking a new era for international governance. At long last, it seems, the time of the anachronistic G7 has passed, and the global architecture is being brought closer into line with the underlying realities of the world economy. 

Back in 2006, the year Australia hosted G-20 finance ministers in Melbourne, my colleague Malcolm Cook and I wrote a paper called Geeing up the G-20, which argued that the G-20 should replace the G7 as the steering committee for the world economy. So I view the elevation of the grouping as welcome news. Indeed, it has gone further than Malcolm and I hoped back then, when we thought the prospects for an L-20 (a G-20 leaders meeting) were poor. Which just goes to show the difference the worst international financial crisis since the 1930s can make...

What should we expect from this weekend’s gathering? After all the initial excitement about the possibility of forging a new Bretton Woods agreement, expectations seem to have receded somewhat in recent days. More...

I read The Economist's leader on the train last night, about whether the US should kill two birds with one stone by focusing its economic stimulus on green projects. I couldn't quite put my finger on it at the time, but I thought there was something a little off about this piece of reasoning:

There is a historical parallel to this synergy between two worthy aims. Just as military spending at the end of the 1930s defeated both fascism and the Depression, so spending on fighting climate change should both wean mankind off fossil fuels and avert what might otherwise turn into the most serious downturn since the 1930s. Isn’t that neat?

No. Mr Obama’s commitment to solving climate change is devoutly to be welcomed. There is also a case for giving the economy a boost through government spending. But combining the two by subsidising renewable energy is, like many easy answers, the wrong solution.

How nice to see that one of The Economist's very own blogs has chosen to disagree: More...

Just what is World Bank President Robert Zoellick up to? He attended the G20 meeting in Brazil over the weekend, only to argue that this is the wrong grouping and should be replaced by a more exclusive gathering. To say the least, this is an unhelpful intervention, not just for Australia (which would be excluded from the Zoellick group) but also for the urgent need to address the current world situation.

Zoellick's attitude ignores the time-consuming negotiations of a decade ago which gathered a consensus around the G20 membership. A cynic might say that it just looks like a spoiling strategy to leave the anachronistic status quo in place, with G7 plus a few ad hoc new recruits who are allowed to sit in on the old club.

The problem with the Zoellick proposal is that it starts with the G7. More...

Rod Brazier from the Asia Foundation comments on the motivating forces behind Indonesia's anti-corruption drive, a debate we revived recently on The Interpreter:

The Greg Sheridan essay that Sam blogged about earlier today contains this paragraph about the use of purchasing power parity (PPP) to measure China's wealth against other countries:

PPP is basically a con. It rests on the proposition that a man in Peru gets fed, so does a man in France: therefore a bowl of rice in Lima should be given the same economic value as a meal of lobster and filet mignon in Paris. The problem is the world doesn't work that way. Countries interact with each other on the basis of real dollars, not PPP.

No, PPP is not a con. Crudely put, PPP is a means of adjusting for differences in purchasing power across countries. To do this, it compares prices of the same good. In other words, it compares the price of a bowl of rice in Peru with the price of a bowl of rice in Paris. The most famous (and very simple) version is the Economist’s Big Mac index, which compares the price of Big Macs across countries. More...

Yesterday's Wednesday Lowy Lunch presentation was a tour de force from the Director of the Lowy Institute's International Economy Program, Mark Thirlwell. I've never seen anyone speak so engagingly and fluently for an hour without once consulting notes.

If you want a survey of what has gone wrong with the global economy this year, who is to blame, the big losers and winners, and the return of government to the economic scene, listen to Mark's full presentation here. I also sat down with Mark afterward for this short interview:

Aplologies to Pete Speer for neglecting to publish this earlier, his reply to my post about the geopolitical implications of consumer debt:

What we have seen is the culmination of the consumption gratification society, where the household sector was lured by government (the political sector) to shuck savings and go up to their scrota and past with debt. 

The spending masked overspending by the political sector, both directly and in setting high liabilities in direct debt and accrued obligations which the next generation would be expected  -- somehow -- to pay. We are talking in excess of $54 trillion, with current annual deficits which may exceed $1 trillion over each of the next several years. More...

One thing John McCain and Barack Obama seem to agree on is the need for 'energy independence'. In fact, the need to wean the US from dependence on Middle Eastern oil has been something of a staple of US politics since at least the 80s, and economists are fond of pointing out the sheer dopiness of it.

One recent example I found (via Will Wilkinson's excellent blog) by David Henderson from the Hoover Institution makes an admirably clear case for treating oil like any other commodity. No economically rational country wants to be self-sufficient in bananas or coffee if others can produce those goods more cheaply. Why should oil be any different? Cutting foreign supplies by raising the tarriff would massively raise the price of domestic oil to consumers. And government subsidies for oil substitutes aren't the answer either, since subsidies are just a hidden and costly tax.

All good stuff, but on the geopolitical issues, the argument is a little weaker. Energy independence advocates argue that American dependence on Middle Eastern oil puts it at the mercy of unfriendly regimes like Saudi Arabia. Henderson is right that this is a poor argument for independence, since Saudi Arabia has absolutely no interest in cutting off this supply and couldn't selectively target America through an oil boycott even if it wanted to.

But is this really what people like John McCain have in mind when they refer to buying oil from regimes that 'don't like us very much'? I would have thought that their fear is not about economic strangulation at the hands of Saudi Arabia, but about the fact that Saudi Arabia funds Islamist extremists who wish to do the US great harm. By buying Saudi oil, the argument goes, the US is indirectly funding such activity.

Not that this makes the case for energy independence any more plausible: cutting oil imports from Saudi Arabia would just free up the supply for somebody else. Saudi Arabia would still get its petro-dollars, and hence so would the extremists. The US would just be penalising itself for the sake of a useless feel-good gesture. So in neglecting the terrorism angle, Henderson's argument is incomplete, but the substance of his case still holds.

Where Henderson does fall short is in failing to acknowledge the massive levels of US government intervention in the present oil economy.More...

The Australian had quite the scoop on the weekend, with an account of a 10 October phone conversation between the Prime Minister and President Bush. In the course of their talk, Rudd apparently helped convince Bush that the international response to the financial crisis had to come via the G20, not the G7.

The story shows the PM in a very good light, but David Flint, writing on Crikey's daily newsletter (subscribers only), is surely right to say that the leaking of the call makes it harder for world leaders to trust that their conversations with Rudd will remain confidential.

The other main talking point from the article is a direct quote from President Bush, who apparently asked Rudd, 'What's the G20?' That reminded me of an anecdote about Bush that I recounted in September:

Somebody who knew President Bush well once remarked to me. "You'll notice he never asks questions."

"Why not?" I said.

"Because he doesn't know what it's okay for him not to know."

It's nice to see that the President has at least overcome his reticence.

Andrew Bacevich, in The Limits of Power, certainly thinks so:

...American habits of conspicuous consumption, encouraged by Reagan, drew the United States ever more deeply into the vortex of the Islamic world, saddling an increasingly debt-ridden and energy-dependent nation with commitments that it could neither shed nor sustain.

I'm still not convinced Bacevich's book actually makes a very good case for a direct connection between American consumerism and its military adventurism. But on the more limited question of whether higher consumer debt has hurt the US economy, Bacevich seems to have found an ally in Barack Obama. This from an interview with Joe Klein:

"The engine of economic growth for the past 20 years is not going to be there for the next 20. That was consumer spending. Basically, we turbocharged this economy based on cheap credit." But the days of easy credit are over, Obama said, "because there is too much deleveraging taking place, too much debt.

And now the case for the defence, by the Atlantic Monthly's Virginia Postrel:

The expansion of consumer credit is one of the great economic achievements of the past century. One institutional and technological innovation after another has made borrowing easier and cheaper for rich and poor alike. With each development have come fears—sometimes fueled by the unforeseen problems that inevitably accompany new practices—that this is the change that surely will lead to disaster. Yet a half century after Black’s warnings, doomsday has not arrived, the “consumer-credit explosion” continues, and most consumers are much better off.

Finally, here's a reply to Postrel.

So, now we have to add countries to the ever-expanding list of casualties from the financial crisis.  Iceland has been the most famous sovereign victim to date, but a wide range of economies are suffering collateral damage of varying degrees.

Eastern Europe and the Former Soviet Union have been particularly affected: Hungary is under significant pressure, Ukraine is waiting for an IMF bailout, and the Baltics are suffering too. Elsewhere, Argentina (again!) and Pakistan are reportedly facing imminent default. Meanwhile, emerging market banks have been suffering from an ‘Iceland Look-alike contest’, with victims ranging from Kazakhstan to South Korea, while falling oil prices are now denting growth prospects in the Middle East. And even an emerging market powerhouse like China is turning to fiscal pump-priming in order to prop up growth.

One consequence is that, having been largely written off as an irrelevance in recent years, the IMF is now back in the front line of global finance. The Fund is currently discussing packages with a number of countries, including Iceland, Hungary, Pakistan, Ukraine and Belarus.

Staying with the theme of silver-linings for ageing international economic institutions, another thoughtful angle on recent events is provided in this blog post by the CFR’s Brad Setser, explaining why, in the current financial crisis, it's turning out to be  a good thing to be a member of the G7.

Finally, for an interesting view on the likely consequences of the crisis for the balance of power, take a look at this piece by Bill Emmot, which canvasses some potential winners and losers and argues that the current conventional wisdom may be getting this quite wrong.

Photo by Flickr user TW Collins, used under a Creative Commons license.

John Hannoush writes in reponse to my post arguing that the post-meltdown critique of free markets has been vocal but not coherent:

There is a risk that we are attributing too much coherence to the responses. I think it is possible that everyone, private and public, is making educated guesses but without any certainty they know where things are going. 

One question: to what extent is this crisis about the state's role in governing the supply of money (a lot of the problems seem to be about the creation of credit)? 

And a comment on the infamous 'We're all Keynesians now', which Mark I am sure is quoting ironically: strictly speaking, weren't the real post-World War II Keynesians wedded to the idea that governments could smooth out the business cycle by clever use of fiscal levers? The use of public money to spark things in economic downturns goes back a long way, I thought.

John is right to say that observers may be tempted to attribute too much coherence to the policy actions to date. As I noted in my post, what we’ve been seeing is a bunch of technocratic responses (some of quite varying quality) to a series of market failures, rather than an overall plan.  That said, however, it’s also fair to note that there has been something of a process of convergence to what we might call the British (or Swedish) model. It’s also been interesting to see how the views of academic economists have influenced matters. More...

Anne Applebaum of the Washington Post thinks so:

If you wanted to destabilize a country, wouldn't this be an excellent time to do it? If Country X's stock market can crash after the publication of a single article in an obscure newspaper, think what might happen if someone conducted a systematic campaign against Country X. And if you can imagine this, so can others.

Actually, Applebaum names political opposition movements and foreign enemies among those who could use such tactics, but why not terrorists? It remains something of a mystery why terrorists continue to focus so much on causing death and physical destruction, and largely fail to use tactics that would undermine institutions. More...

Last Friday, Professor Xu from Griffith University, an expert in the Chinese electricity sector and the author of the Lowy-Griffith publication China’s Struggle for Power, emailed me questioning local news stories about a looming drop off in China’s demand for coal.

The China demand story for metals and for coal are not the same, and Xu argues that China’s demand for Australian coal is unlikely to drop much, if at all, for four reasons:

1. Over 80% of China’s growing electricity generation comes from coal-fired plants (and this share is growing);
2. China’s domestic coal production is stagnant;
3. While the spot price for coal has dropped in China in line with global prices, the price for coal supply contracts (the key for electricity generators) has gone up recently; and
4. Winter is coming in China.

For those of you who read Chinese, here is a good source from the Chinese media. For those of us who only read English, here is a similar, longer-term argument.

Yesterday, I gave a guest lecture at ANU's Crawford School on 'The Return of the State'. When we first planned the talk – almost a year ago – the subject was intended to be mildly provocative. Now, of course, its just the conventional wisdom. Still, delivering the lecture was fun, and in the extended Q&A session, we had an interesting discussion about the intellectual framework that might be used to support the current shift back to a greater economic role for government.

One interlocutor argued that while the move to a more market-based approach to running the world economy that took place in the 1980s and 1990s – the broadly successful battle by free-marketeers to seize the Commanding Heights of the world economy — had a coherent ideological program to draw on, in the form of the writings of Milton Friedman and others, in contrast there is nothing similar today supporting the swing back to government. 

But is this true? More...

That's a quote from Hugo Chavez, welcoming the Bush Administration’s decision to nationalise large chunks of the US financial system.

It looks like the world’s leading economies have finally settled on a solution to the financial crisis: massive injections of public money to recapitalise their banking systems. Or in other words, nationalisation. Even the US is having to bite the bullet.

So that’s pretty much a slam dunk for the return of government thesis, then. Want even more evidence? Take a closer look at some of the details of the UK package for which Gordon Brown has been receiving a lot of credit. Banks that benefit from the UK government’s financial support have to agree to limit executive pay, adopt controls on how 2008 bonuses will be paid out to executives, accept restrictions on dividend payments, welcome Treasury appointed directors, and promise to maintain lending to home buyers and small businesses. That’s a fair bit of government control.

The magnitude of these changes will have all sorts of implications for the working of the world economy in coming years. Here’s a small one: remember that big debate about Sovereign Wealth Funds and government-controlled foreign investment earlier this year? Perhaps it will now take on a slightly different complexion, since a large swathe of the rich world’s financial system looks like ending up in the hands of its own governments.

Do yourself a favour and watch this retrospective of Oliver Stone's Wall Street, by NY Times film critic AO Scott. As Scott explains, the film is full of memorable lines, and below is a clip with the most famous quote of all. In fact, it is now so ubiquitous as to have become a cliche, so try to ignore it and focus instead on Michael Douglas. What a performance:

Nobel Laureate Paul Krugman speaking about the financial crisis on The World Today:

In retrospect, how could we have been so blind?

That's a common lament in life generally. But although we should examine scupulously how we can easily miss signs of an impending crisis, it is equally sobering to look at how quickly we incorporate previously unthinkable events and ideas into our worldview as if they were obvious and trivial. The idea that major Western governments could, en masse, effectively nationalise their banks would have seemed impossible a month ago, yet now it is the conventional wisdom on how to at least stem the financial bleeding.

What seems impossible in prospect looks inevitable in retrospect, but that retrospective sense of inevitability is actually a barrier to clear analytic thinking, because it inhibits us from imagining future Black Swan events. Faced with an uncertain future, there is a tendency to assume that it will look much like the present. But to remain open to future strategic shocks, one must remain alive to the idea that there is nothing inevitable about how the past unfolded.

Paul Krugman has won the 2008 Nobel Prize in Economics for his work on trade and economic geography. And yes, for any pedants out there, I know technically it’s ‘The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2008’, not that the distinction really matters. 

For what it’s worth, I think the award is well-deserved.  Krugman has long been one of my favourite economists (at the moment I am enjoying re-reading his short book, The Return of Depression Economics.) Still, if this story in the Guardian is correct, I can’t help but feel a small pang of disappointment. Wouldn’t it have been just a little bit funny if the award had gone to Eugene Fama, father of the Efficient Markets Hypothesis, in the year of the world’s biggest financial disaster since the 1930s?  I somehow feel a golden opportunity has been missed...

The US Treasury’s former attack-dog, Ted Truman, has now got his jaws around another Inconvenient Truth: that the world’s current financial problems not only have their epicenter in the US but can be largely sheeted home to US deficiencies.

Truman wants to argue that the blame is widely spread. One might almost conclude from his piece that the US was an innocent bystander, swept along by events beyond its control. He cites Japan as having had similarly loose monetary policy as the US, blames China’s exchange rate and reserve accumulation, says that housing problems were 'essentially universal' and that prudential regulators everywhere were 'consenting adults' in their misjudgments of the situation: 'The finance ministers and central bank governors should not blame Washington, they should blame themselves'.

Truman, now at the Peterson Institute, has always been a forceful advocate, even when defending the indefensible. But the counter-argument is pretty compelling: More...

There had been much eager anticipation that the G7 would come up with some coordinated action to fix the financial melt-down. Noted US economist Paul Krugman said 'now is the time for major action'. On Friday G7 met, agreed that 'urgent and exceptional action' is required, and…well, actually, they decided to go on doing what they had been doing beforehand, only more so.

The crisis has certainly illustrated the connectedness of financial markets. Nowhere is this better demonstrated than in Australia: without the US financial collapse, it’s hard to see why the Australian stock market, with its strong banks and booming resources sector, would fall so dramatically, with all the confidence-sapping effects that follow.

But just about all the policy responses have been essentially domestic actions: supplying liquidity, guaranteeing depositors, recapitalizing banks, bailing out failing financial institutions and getting monetary and fiscal policy re-set for the subdued environment.

None of the rest of us can provide any real help to the US as it grapples with its problems. If the US succeeds in quickly restoring the health of its financial sector and avoids a recession (a big ask), our own collateral problems would be over. So where is the big role for international coordination? What is happening in Washington is largely a diversion: little more than an opportunity to swap war stories and show off battle scars. The real job awaits when they all get home again.

We are in the economic equivalent of a rolling national security crisis.

That's an interesting turn of phrase from the Prime Minister. Presumably this was Rudd's attempt to communicate the scale and urgency of the problem, though it's also a reminder that threats to national security aren't always physical. The government has committed itself to maintaining 3% growth in the defence budget to 2018, but there might be some nervous officers on Russell Hill today as they contemplate the future. The government wants to pump prime the economy with new infrastructure projects, and since most of our weapons are bought overseas, could the government consider cuts there in order to boost domestic spending?

UPDATE: A colleague notes that the fall of the Australian dollar will also hurt the Defence Department's buying power when it comes to US and European weapons.

Guest blogger: Peter McCawley is a Visiting Fellow at the Indonesia Project, ANU, and former Dean of the ADB Institute, Tokyo.

Three weeks ago I said (hoped, really) that the US authorities would probably be able to restore order to chaotic markets and that Australia should be able to weather the international economic storm. My proviso was that fast progress was needed from US authorities in tackling basic problems. So where have we got to?

The good news is that, so far, Australia still seems better placed than most major northern hemisphere OECD countries. It's true that some of our markets have taken big hits recently. Commodity prices have fallen sharply, the Australian dollar has plummeted, and not surprisingly, the virulent 'crisis of confidence' virus has caused remarkable falls in the Australian stock market. More...

Sometimes, mind-numbing prolixity can be a virtue. Prime Minister Rudd spent almost all of his 7:30 Report interview last night using his usual mix of cliche and long-windedness to hose down host Kerry O'Brien's barely concealed panic about the financial crisis. For every O'Brien reference to 'depressions', 'tidal waves' and 'huge onslaughts', the PM parried skillfully with 'objective facts', 'substantial measures' and 'the confidence equation'.

Then, right at the end, the iron fist in the terry toweling glove:

KERRY O'BRIEN: What is your biggest fear for Australia, right now, what is your nightmare for Australia?

KEVIN RUDD: Kerry, my responsibility to Australia is to speak objectively about the problems we face, and equally objectively, about the strengths we have. People running around throwing their hands in the air talking about nightmares is not leadership. That's commentary, and I am not in the business of commentary. The nation requires plain talking, straight talking, about the problems we face and the strengths we've got. And that's what I intend to keep doing. (My emphasis.)

Yesterday I linked to an article which argued that the key to good decision-making lies in thinking about thinking, or what the psychologist Philip Tetlock refers to as 'the art of self-overhearing'. The idea, I think, is that well-practised introspection can help us avoid common cognitive traps.

As it happens, I've stumbled on a number of useful blog posts this morning which discuss precisely that issue, and specifically how these various traps have landed us in the present financial mess. Here's a list, starting with the best piece, which should be your must-read of the day:

• Atlantic Monthly blogger and economist Megan McArdle lays out all the thinking mistakes that led to the financial crisis: confirmation bias, bandwagoning, overconfidence etc. No one is blameless, and it's remarkable how similar some of these errors are to ones made in other systemic failures: one that comes immediately to mind is the various pre-war intelligence assessments about Iraqi WMD.
• Kevin Drum argues that pundits are overstating the effect of the financial meltdown on the presidential race, and that longer-term factors offer a better explanation. This goes to the common cognitive tendency to give too much weight to recent events.
• Also on this theme, Michael Clemens from the Center for Global Development calls for some historical perspective: '...many of the most worrisome recent crises are small bumps on a very long road.'
• But contra Clemens, Matt Yglesias argues that because we're used to thinking about the Great Depression as the very worst case, we lack the imagination to think that it might get worse. I think what he's trying to say is that these mental boundaries might impede clear thinking about how we deal with the crisis.
• Finally, here's a lecture by Clay Shirky on information overload. Shirky's an expert on the social and economic implications of the internet, and although this lecture is perhaps slightly off the topic of this post, it is relevent to the claim that the modern financial system is uniquely (and perhaps dangerously) complex. Information overload is not the problem (that's a permanent condition), it is that our means of filtering information may not be working. (Also, here's Shirky's blog.)

World Bank President Bob Zoellick seems well outside his allocated territory in his speech on modernizing multilateral economic institutions. When Wayne Swan meets him at the Annual Meetings in Washington next week, he might ask him who he speaks for in writing off G20 as 'unwieldy'.

Its precursor group during the Asian Crisis did a far better job than the Bretton-Woods institutions (IMF and World Bank) and showed what can be done with a group this size, given preparation and good chairmanship. If G20 has done less than it could have since then, it is because G7 and the IMF, while unable to adapt themselves to the needs of the current world economy, have at least been able to prevent a rival group from succeeding. More...

I'll have a Friday Funny on the US elelction a little later, but first, to the big story of the week:

Is it unkind and unfair to observe that American regulators and political leaders are starting to resemble Corporal Jones?

Atlantic Monthly blogger Andrew Sullivan today quotes John Gray on how a combination of war and debt has, historically, sunk empires. Sullivan comments:

Until the US scales back its imperial ambitions across the Middle East and seriously cuts its entitlement state, the country's global hegemony will come to an abrupt and humiliating end.

Perhaps Sullivan, like me, is reading Andrew Bacevich's The Limits of Power, which I confess I have so far found underwhelming. Bacevich's basic argument is interesting: the US has an overly ambitious foreign policy, he says, and it should be doing much more to put its own house in order. But Americans, argues Bacevich, don't wish to be told that there are limits to their personal or national ambitions, and that some bills eventually have to be paid. Carter tried to tell them (in his famous 'malaise' speech), but he was punished for it and replaced by a president who argued the American future was boundless. No president since has dared upset this narrative. 

What sours the book is it's strident tone and some pretty sloppy economic theorising. More...

Imagine you went into a deep coma some time in the 1980s, and awoke today. The first thing you'd hear about would be the massive nationalisation of financial institutions in the US and other countries devoted to free market principles. Strange stuff.

Then you might stumble on an interview with the Chinese Premier Wen Jiabao. To your 1980s eyes, it is strange enough seeing a leader of a communist country giving an interview, but the weirdness doesn't even begin there, because about a third of the way through the interview, the dude starts quoting Adam Smith! Approvingly!!

Mad, I tell you. Quite mad.

In a globalised world, financial markets are a potent transmission channel from the US to the rest of us. Indeed, our stock market responds more to the US than to our domestic fundamentals.

At first sight, last week’s policy mimicry might also suggest that the problems are the same. Australia followed the US and UK in banning short-selling of equities, and Australia’s $4 billion mortgage fund might look like a whimpish counterpart to the $US700 billion mortgage rescue package currently with Congress.

In the case of the provision of mortgage funding, it’s easy to differentiate the two countries. The US package will be used to buy existing housing assets. Whether these assets are 'toxic' or just temporarily undervalued by the market, there seems to be an acceptance that the authorities will pay more-than-market value for them, thus assisting the current holders, some of whom may not deserve help. In Australia, the plan seems to be to fund new housing borrowers: innocent bystanders in the troubles. It may be superfluous and populist, but it’s not a sign that 'this sucker could go down'.

Kevin Rudd’s speech to the UN General Assembly set out some specifics for reforming the international financial system. It’s good to see him plugging the G20 as the centre-piece of this agenda.

He was diplomatic enough not to draw attention to the irrelevance of the UN’s own specialized institution – the International Monetary Fund – in the current troubles. The IMF’s 185-strong membership is too large and too diverse to have a sensible discussion on this topic. Its smaller governance groupings have been unable to reform their composition to reflect today’s realities rather than the power balance of fifty years ago.

Thus the G20 group would seem to be well suited to work out the Big Picture of what to do. More...

Guest blogger: James Symons is a Lowy Institute intern.

I recently returned from a stint as an AusAID volunteer in Hanoi, Vietnam, and I can tell you, there is nothing like being on the ground for a year and listening to expatriate street buzz to put a few dings in my perceptions.

All I heard about before heading off was that Vietnam’s economy had been growing at an astronomical rate; WTO entry meant more FDI and capital accumulation. Everywhere I looked, people were knocking down houses and putting up new ones, and on the Red River dyke road from Hanoi airport, visitors could hardly miss the gargantuan development that will include, upon completion, over 50 apartment blocks, dozens of restaurants and a golf course (not to mention an enormous statue-adorned edifice at one entry which gives the Brandenburg gate a run for its money – until one realizes that the horses are made of fiberglass). More...

Yesterday, Trade Minister Simon Crean released the report of the Review of Export Policies and Programs undertaken by David Mortimer and John Edwards. Billed as ‘the most comprehensive review of Australia's approach to trade and international investment in more than a decade’, the whole thing, including appendices, adds up to well over 200 pages. So it will take a fair bit of time to digest. 

One early item of interest is the Review’s attitude to so-called Free Trade Agreements (FTAs). A lot of trade economists have been distinctly hostile towards FTAs in the past, and the previous government received a fair amount of telling-off from purists for its decision to pursue bilateral agreements alongside the multilateral process. The Review, it seems, doesn’t buy the purists’ arguments. More...

Well,  that didn’t take long. The boost to confidence provided by the US Treasury Secretary Hank Paulson’s bailout plan for the US financial system has turned out to be short-lived, as investors worry about the speed of negotiations over implementation, and about whether it will actually work. 

The proposal continues to draw criticism. See, for example, Paul Krugman’s latest column, Cash for Trash. Also worth a look are this post and then this one by Yves Smith, both at the Naked Capitalism blog. Meanwhile, Ken Rogoff continues to argue that the financial sector needs to shrink. Over at VoxEU, however, and as a counterpart to the Zingales post I linked to yesterday, Charles Wyplosz has an interesting comment explaining why Paulson is (maybe) right after all.

Elsewhere, Jim O’Neil in the FT writes in support of the weak version of the decoupling thesis.