Back to Mr. Orr

With Tuesday's ruling by Federal District Court Judge Stephen Rhodes that Detroit is eligible for Chapter 9 bankruptcy, the initiative now shifts back to emergency manager Kevin Orr.

The 140-page ruling, in which Judge Rhodes noted that the insolvency of Detroit was easily proven by the numbers, that the use of federal mechanisms for resolving municipal debts does not violate the tenth amendment, and that, under federal bankruptcy law, state-protected pensions are "no different than other contracts or debt", allows Mr. Orr to proceed with a comprehensive re-structuring plan that will certainly include pension cuts as it more broadly addresses the City's $18 billion debt, and the positions of all of the City's over 100,000 creditors. These bondholders, union members and others had tried to argue that, prior to filing for bankruptcy, Mr. Orr had not provided the time or resources to bargain in good faith, a requirement for bankruptcy approval. Interestingly, Judge Rhodes agreed. But he went on to say that the sheer number of creditors, many of whom were unwilling or unauthorized to negotiate on the behalf of others, rendered good-faith bargaining on the part of Mr. Orr's office impracticable; he wrote, "it is impracticable to negotiate with a stone wall". He added that the city should have filed for bankruptcy years ago.

Appeals to the ruling are, of course, underway. Minutes after the ruling, in an interview on the street outside the Detroit federal court building, the lawyer for the 1.6-million-member American Federation of State, County and Municipal Employees ((AFSCME) disagreed with virtually all Judge Rhodes' substantive points, indicating the union would appeal immediately. That same day, the union's President, Lee Saunders, characterized pension cuts for Detroit retirees as "just nuts" and "morally corrupt", and pledged a robust fight against Michigan Governor Snyder when he runs for reelection. Watching from Washington D.C., Ms. Randi Weingarten, president of the American Federation of Teachers, weighed in, calling the ruling "a dark day for the people of Detroit....who are now at risk of losing everything".

Mr. Saunders' and Ms. Weingarten's language notwithstanding, the morally corrupt, dark days in Detroit existed long before Judge Rhodes' ruling or Kevin Orr's appointment by Governor Snyder. And notwithstanding nor underestimating creditors' pain from Detroit's impending financial restructuring, and notwithstanding the challenge to board members of the City's Detroit Institute of Arts in determining a way to monetize their extraordinary collection rather than selling it, the ruling, and the competence of Mr. Orr's office, combine in a way that will not only finally stop Detroit's rot, but also present the city and its new mayor, Mike Duggan, with the chance to re-invent, and grow again. 

Policy Regression?

In Berlin, it's been a demanding, frustrating two months of coalition negotiations since the parliamentary elections. But it appears that Germany's three principal political parties have figured it out - they announced yesterday an agreement to form a new "grand coalition" government. It will be led, for a third time, by Chancellor Angela Merkel and her Christian Democratic Union (CDU), who won 41.5% of the votes in the fall election, compared with 25.7% for the next biggest party, the Social Democrats (SPD).

So the European Union's most important economy will once again have a government, though only assuming ratification of the coalition contract by the 470,000 members of the SPD on December 14 (an uncertainty, given that much of the SPD's blue-collar base is uncomfortable with the business-centric wing of Ms. Merkel's party). But just how grand is the new contract? The 185-page document bears the clear stamp of the SPD: it establishes a minimum wage, to begin in 2015, for the first time in Germany, a move opposed by not only employer groups, but even the unions, and especially by the country's central bank, concerned with its negative impact on employment, especially in eastern Germany where labor productivity remains anemic. It also actually lowers the eligible pension age for those who have worked for 45 years (when long-term German demographic trends are hardly favorable to growth, and when most other governments in developed countries are, for the same demographic reasons, looking to raise it), and directs temporary surpluses in the pension trust fund to more social spending rather than being used to reduce contributions. Ms. Merkel's CDU did prevail in one area - there will be no tax increases, and no new debt after 2015.

But the larger question remains: will these policy compromises coming out of the coalition agreement so substantially dilute the successful reforms in Germany, particularly those of the labor market begun more than a decade ago, that the country's globally competitive position will be undermined? This will be the delicate balance Chancellor Merkel will need to strike as the new coalition government begins its work - to, on the one hand, ensure that the overall impact of any new government economic policy is the enhancement of now weakening German productivity, while, on the other hand, to placate her coalition partners on the left so as to prevent a collapse of the government and the political instability, in Germany and the EU as a whole, that would ensue.

Italian Prime Minister Enrico Letta, no stranger himself to walking the fine line of coalition government, and perhaps feeling a bit less threatened following yesterday's vote in the Italian Senate to expel Silvio Berlusconi, was quick to express his relief and pleasure that a new German government is being formed. He is well aware that the German government will remain at the center of the euro zone's strategy in tackling debt and banking issues - a sort of euro-underwriter - and, in 2014, Mr. Letta may well need such a service. Ms. Merkel's balancing act, then, could become even more complicated.

Blunt Force

Economic sanctions - the iron fist part of international diplomacy - have proven to be at best a blunt instrument, typically dismally ineffective in undermining regimes by attempting to starve them of resources normally obtained through trade and capital flows. Thus, for example, over nearly a half century, Americans have been prohibited from trading with, investing in, or traveling to Cuba. And while there is little doubt this embargo has contributed to the poor and dysfunctional Cuban economy (though the damage done by the government's central planning is far worse), the Castro brothers and their tiny ruling elite are, after all these decades, still in place. Indeed, the big, bad Americans and their sanctions have provided, if anything, just the excuse needed by the Castros for the glaring failures of their socialism.

Much the same can be said for economic sanctions against other dictatorships, such as Burma, North Korea and Iran - there have always been other governments, firms and individuals - notably Chinese - willing to fill the void left by an American embargo. But, in the case of Iran, the news this week is that sanctions may finally have begun to work, precisely because America has not been alone in applying them. American trade restrictions, initiated at the time of the Iranian Revolution in 1979, and progressively broadened since 2006 to include, among others, international financial firms doing business with Tehran, became all the more effective when the United Nations, concerned that Iran refused to halt uranium enrichment and co-operate with the IAEA,  joined in with their own progression of four Resolutions in the period 2006-10. Then, in 2010, the European Union began a series of Iranian asset freezes, and travel and oil import bans. Many individual countries initiated similar restrictions; even China and India agreed to at least reduce their imports of Iranian oil, or pay for it in their local currencies instead of US dollars.

Such a broad application of sanctions over many years has exacted considerable harm on the Iranian economy. Its domestic politics changed as well - Hassan Rouhani won (more accurately, was allowed to win) Iran's presidential election last June in part because he promised to work for an easing of sanctions. The Iranian economy is a mess. Iranian oil export revenues (which have accounted for as much as half of total government expenditure) have dropped precipitously in recent years. Gross Domestic Product is falling and unemployment is soaring. And isolation from the international banking system has caused the rial, Iran's currency, to drop by two-thirds against the US dollar. Perhaps most worrying for the Ayatollah's theocracy, general price inflation is 40%, and even higher for fuel and foodstuffs, rates which threaten the nation's social fabric if not the onset of ruinous hyper-inflation.

Seen in this context, the Iranians eager participation in the round of talks in Geneva regarding their nuclear program, with the emergence last Sunday of an initial Agreement that eases some sanctions and temporarily halts their further uranium enrichment, is hardly surprising. And the American Congress - wary of Iran's sincerity - is making it very clear that if compliance is not complete, and if further progress to a final Agreement over the next few months is not evident, the relaxation of certain sanctions will be reversed and then further strengthened.

Seems, at least concerning Iran, the blunt tool of foreign policy is not so blunt, or ineffective, after all.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

A Forced Awakening in 1963

Andrew Young - a pastor, an author, a Congressman in the mid-1970s from Georgia's 5th district, a former Ambassador to the United Nations, a former Mayor of Atlanta, a leading member of the Southern Christian Leadership Conference during the 1960s Civil Rights Movement, and a personal friend of Martin Luther King Jr. - noted this past week, in remembering the life of John F. Kennedy, that for the first part of his Presidency, Kennedy knew little, and cared even less, about African-American civil rights. He wished it would all just go away, and barely even spoke or otherwise engaged with the leaders of the Movement, according to Young.

By late-1962, however, events and politics were combining in a way that would completely change Kennedy's focus, and much else. Democrats had done relatively well in the mid-term Senate election in November of that year, making a net gain of three seats from the Republicans and thus increasing their control of the Senate to two-thirds. So Kennedy's near-obsession with not alienating Southern Democrats - who were White, and who, given their still-complete political control of the South, would be critical to his re-election in 1964 - became somewhat less immediate. But, more importantly, the Civil Rights Movement's policy of non-violent civil resistance was continuing to do exactly as intended - produce crisis situations between activists and local southern government authorities. In particular, Movement leaders had initiated the Birmingham Campaign in early 1963, with a carefully-defined goal of de-segregating the merchants of downtown Birmingham, Alabama. In a march to that city's county buildings, black protesters came up against the infamous Eugene "Bull" Connor, the Birmingham Commissioner of Public Safety. The mass arrests that followed included that of Martin Luther King Jr., an event which, given Reverend King's emerging national prominence at that point, led to Attorney General Robert Kennedy's intervention to obtain King's release from jail after five days. Subsequent events in Birmingham, including Mr. Connor's brutal response (police dogs and fire hoses) to the Children's Crusade in May of 1963, and the attempt by Alabama's Governor George Wallace in June to block the integration of the University of Alabama, led to widespread public disgust in America, and to the Kennedy administration's far more forceful intervention. US Deputy Attorney General Nicholas Katzenbach, and the Second Infantry Division, were sent on June 11, 1963 to physically remove Governor Wallace from the steps of the University's Foster Auditorium, thereby allowing the enrollment of Vivian Malone Jones and James Hood. That same evening, President Kennedy addressed the nation with his landmark civil rights speech, and on June 19 introduced his Civil Rights bill to Congress.

While the bill began its inevitably difficult passage through the House and Senate that summer, civil rights leaders were making final plans for what would become in August the massive March on Washington for Jobs and Freedom. Kennedy, who initially feared the march would damage his bill's prospects for passage, changed course and decided that it was important to work to ensure the success of the march, mobilizing support from more church leaders and even the UAW. Success indeed ensued - an estimated 300,000 demonstrators, black and some white, showed up in front of the Lincoln Memorial on August 28, 1963, witnessed Reverend King's famous "I Have a Dream" speech, then disbursed peacefully.

By November of 1963, with passage of the Civil Rights bill proceeding (though facing considerable opposition in the House Rules Committee from its chairman, Howard W. Smith, a known segregationist) , Kennedy decided on a trip south, to Dallas, in part to appease the southern white Democratic power structure in time for the upcoming presidential campaign in 1964. Ensuing events in that city on November 22 would, of course, change politics, and much else, in America forever. 

Kennedy's assassination left the bill in danger of languishing in Mr. Smith's Rules Committee, until the new President, Lyndon Johnson, stepped forward on November 27, addressing a joint session of Congress and imploring them to pass the bill. He said: "No memorial oration or eulogy could more eloquently honor President Kennedy's memory than the earliest possible passage of the civil rights bill for which he fought so long". In the face of Johnson's unrelenting persuasion by any and all means, the bill moved to the Senate, where despite 54 days of filibuster against it by the "Southern Bloc" of 18 Democratic senators, was passed (somewhat modified) by both houses of Congress, and signed into law by President Johnson on July 2, 1964. Racial, religious and sexual discrimination, and southern politics, would never be the same again.

Consider for a moment what could be accomplished legislatively if America's current President were willing and able to utilize the bully pulpit in a manner even approaching that of Presidents Kennedy or Johnson. Instead, we have a President who prefers aloofness, and whose very credibility has sunk so low that even matters of a fiscal nature cannot be resolved, not to speak of a long list of opportunities missed regarding health, immigration and foreign policy. It seems Mr. Obama's legacy will be more like that of President Carter than of President Kennedy.

Missing Ingredient

Regarding the American corporate sector today, here's the question: why is there so much balance sheet inefficiency, that is, why are corporate cash balances large and growing?

Being liquid (that is, having cash that is available immediately) facilitates executing a particular investment or retiring maturing debt, and is thus often a corporate objective. Corporations generate cash through profitable operations, and/or they borrow it through, for example, the issuance of bonds. They have been doing both in recent years; corporate profits as a percent of GDP are at an historic high, and bond issuance has been robust, given that the cost of such capital is at the lowest level in more than half a century - as shown in the chart below, bond yields are just above 5 per cent, a rate not seen since the mid-1960's.

But US corporate cash balances have in recent years been well beyond the levels needed to implement a timely investment strategy, be it of a physical nature (buying equipment and building factories and hiring workers) , a share re-purchase or dividend program, or an acquisition or merger. Corporations have been buying back their own shares and in many cases increasing dividends. But for the most part, they have been hoarding, especially in accounts abroad. Cash on the balance sheets of US non-financial companies now stands at $1.48 trillion, up 10 per cent from a year earlier and some 81 per cent from 2006. The opposite side of this same coin is that the current private sector investment cycle is one of the weakest in decades. Non-defense capital goods orders (excluding aircraft) have increased by a mere 0.3 per cent per month, less than half the rate of business investment between 1993 and 1998, a difference that is even more dramatic when one considers that corporate bond yields averaged about 8 per cent in the 1990's.

So why this dearth of investment when cash is so abundant and cheap? Weak aggregate demand is partly to blame - unemployment, though falling slowly, remains high (particularly when underemployed and discouraged workers are added to the registered unemployed). But this is a chicken and egg argument, because unemployment is high in part because of weak investment. More importantly, corporate America has zero clarity regarding U.S. fiscal policy, particularly tax rates, and has come to believe that political brinkmanship and deadlock will persist in Congress, especially given that effective Congressional compromise, and Presidential leadership, have all but disappeared. A new study from the Peterson Institute finds that some 900,000 jobs have gone missing since 2009 because of "crisis-driven fiscal policy".  Seems the quantitative impact of Washington ineptitude, through its effect on business investment, is bigger than anyone thought. And it's not helpful that America's President clearly misunderstands - even disdains - business.

The fiscal drama is to continue, with new budget and debt-ceiling deadlines set for January and February next year. Corporations will remain flush with cash, but will likely still restrain their investment activities given that a necessary ingredient - confidence - has not yet returned.