Why Germans' Ideas on Inflation Are Delusional

Germans are inflation hawks. This is with good reason: The hyperinflation of the Weimar period is widely seen as contributing to the rise of Hitler, who promised to bring stability to Germany again. After WWII, the German Bundesbank was famous for its inflation fighting. Germans were rightly proud of their post-war currency, the Deutsche Mark, and were resistant to giving it up. Germany enjoyed low and stable inflation. This stability allowed the German government to borrow money at low interest rates (it also helped that the German government tended not to borrow much money in the first place, though).

Germany no longer controls its own interest rates, however. Interest rates are set for the entire euro area by the European Central Bank (ECB), headquartered, at Germany's behest, in Frankfurt am Main, Germany. The ECB has done an "impeccable" job at maintaining stable inflation, its former head Trichet said. It's true: eurozone inflation has been stable since the euro was introduced. And yet Germans continue to warn of high inflation. The problem is, Germans don't seem to understand that inflation in Germany is only one part of the eurozone inflation picture.

Countries like Greece, Spain, Italy, and Ireland all have to accept swingeing cuts to government spending and are suffering a credit crunch. This is likely to lead to low or even negative inflation rates in those countries (Ireland experienced deflation of 7% near the end of 2009!). The correct response from the ECB in that case, if this low inflation meant the average weighted inflation throughout the eurozone was under 2%, would be to cut interest rates and try to keep inflation from falling any lower. Because Germany is not suffering austerity or a credit crunch, it's economy is growing. Inflation there will be higher as a result. If Germany is the fastest-growing economy in the eurozone (as it currently is), it is not unreasonable to expect it to have one of the highest inflation rates (or the highest). If everyone else's inflation rate is 1%, Germany's would need to be significantly over 2% (maybe 3, 4, or even 5%) in order for eurozone inflation on the whole to average 2%.

This terrifies Germans, but it shouldn't. This is not the Weimar Republic. The ECB has not abandoned all orthodoxy (in fact, compared with the Fed, the Bank of England, and the Bank of Japan, it's still quite conservative). A decision to cut rates when inflation has fallen due to reduced domestic demand is not madness, it's sensible policy. Higher inflation in Germany is also sensible. The euro crisis occurred due to imbalances within the single currency. Wages and prices (inflation) rose too quickly in the crisis-hit countries. They lost competitiveness, importing and paying for it by borrowing (a bit like the US, but more extreme). Much of the money borrowed came from Germany and France, by the way. In any case, prices and wages in Greece, Spain, and Italy (Ireland's have fallen again a lot already) need to fall relative to those in Germany to restore competitiveness and ease the imbalances in the zone. For this to happen, inflation would have to be low or negative in those countries for quite some time, or higher in Germany, Austria, the Netherlands, and Finland for quite some time. Or a little of both. If the ECB targets average inflation of 2% and Germany does not instate its own policies to try to cap inflation, that's what will happen.

Prices and wages need to rise faster in Germany and other "creditor" countries in the eurozone than in the debtor countries. That's just math. Allowing this to happen is not dangerous, it's sensible. Inflation is ugly, but deflation is even uglier. Germans need to accept this and let the ECB continue its "impeccable" management of the European economy. The euro crisis is the result of structural problems within the euro, which the ECB could not correct all by itself. It did not warn (or not enough) of the dangers of the bubbles in Spain and Greece (but neither did most other experts), so it's management has not been perfect, but as far as inflation is concerned, it has a good record. Germans have no reason to fear eurozone hyperinflation and should accept somewhat higher inflation in Germany. Germany has profited from the euro, too, though many seem to be unaware of this. I'll get to that in another post.

A Solution for Jerusalem

Blogs are great because you can do crazy things on them; like suggesting a solution for how Palestinians (from an as-yet non-existent Palestinian (or West Bank) state) and Israelis could share Jerusalem, allowing it serve as the capital for both countries. I like to focus on structure. The UN wished for Jerusalem to be an international zone administered by the UN itself (see General Assembly resolution 181). Funny, right? At the other extreme is just dividing the city in half. Considering the holy sites that are scattered around the city and are important to both sides and to other communities, that seems a terrible compromise. How about an essentially autonomous city-state partially influenced by the governments of Israel and Palestine, but designed to cater above all to the interests of Jerusalem itself?

It sounds crazy, I know. But it seems to me that the only way the two sides could co-exist in the Holy City is if those who live there are responsible for running it themselves. The only way the two sides would allow that, though, is if they had assurances that demographic changes, for example, wouldn't trample their interests there.

Here's how my little idea would look: Those who have had their main residence in Jerusalem for at least one year and are citizens of either Israel or Palestine would be eligible to vote in Jerusalem elections. Israelis would also be able to vote as usual in their own governments' elections, as would Palestinians. Jerusalem would have a mayor-governor elected by popular vote (using a run-off if necessary). This would hopefully make the mayor-governor a centrist character.

The legislature would need to be bicameral: A lower house would be elected using proportional representation of political parties. Any party getting at least 5% of the vote would be eligible for one of the 20 seats in this house. Eight candidates for the upper house would be appointed 50/50 by the governments of Israel and Palestine. The electorate would then select their favorite four of these to become the actual members of the upper house. This would allow those governments to rest assured that no laws would be passed in Jerusalem that would scare them (like changing voting laws or the constitution to one side's advantage). It also means that Palestinians would have the ability to vote on which Israeli-nominated candidates they liked and vice versa, somewhat reducing the likelihood of later gridlock and encouraging moderate candidates (much like the idea behind an open primary election as is being tried in Oregon and California).

Sound like a recipe for gridlock? Well, it might very well be, but the only way forward would be for the sides to find compromises. The way the system is designed, it should help to encourage moderates and discourage extremes while giving the two governments an emergency stop button if necessary. I don't see any way any of these facets could be changed.

Now on to the details: Jerusalem would be a semi-sovereign city-state. It would have no citizens, however, only residents. Furthermore, only its residents who were citizens of either Israel or Palestine would have the right to vote. There would be no checkpoints within the city, only on either side when leaving (though the Jerusalem police could put up entry checkpoints on either side, too, if it felt that necessary). If arriving by plane, for example, a visitor would have to have a valid visa for either Israel or Palestine. The statelet would have its own constitution, courts, and administration. People within Jerusalem would be subject to Jerusalem's laws, not those of either Israel or Palestine (though the two "parent" countries would obviously have some influence on laws passed there).

On to money: It's important to avoid coercion through government grants, so Jerusalem would have to have its own system of taxation. Residents would be exempt from income taxes in Israel and Palestine and subject to Jerusalem taxes instead. The only areas where Jerusalem would not be sovereign would be in foreign policy, trade policy, military, and on the grounds of the quarters of the two governments, who would both call Jerusalem their home.

Anything going into or out of Jerusalem via Israel would be subject to Israeli law, anything via Palestine to Palestinian law. This would likely make Jerusalem a competitive place alive with commerce, as customers and businesses could choose the best laws from the two countries as far as trade was concerned. Jerusalem could not make laws governing trade, as this would be the job of Israel and Palestine. It would likely have to share the Israeli and Palestinian currencies. People would have to get used to dealing with both. One might win out, however, as the government could decide freely which currency it would like to tax and spend in, giving one a competitive advantage. All these sorts of things could simply be left to fall into place.

This city would likely be a vibrant place, but also a wild one. Despite laws forbidding it, I can only imagine it would be teeming with intelligence agents from both sides and likely abroad as well (think Cold-War West Berlin). Years (or centuries, depending on how you count) of sectarian tensions would be unlikely to disappear over night. It would thus be important that the police and courts were appointed by the mayor-governor and approved by the upper chamber, ensuring that police actions were balanced between Israelis and Palestinians.

If sharing is possible (and that's an admittedly big "if"), it is only within a framework that promotes compromise while safeguarding core concerns. This is my attempt to suggest one.

When Privatization Makes Sense--and When It Doesn't

Governments are often bad at running businesses, but when there's no actual market, they may still be a better choice.

I was just reading about Bolivia's privatization of Transportadora de Electricidad (TDE), it's national power transmission grid. There's been a trend (again) towards nationalization of industries in South America. Argentina recently nationalized an oil company there owned by a Spanish company. Bolivia is paying the Spanish firm for the nationalization, however, whereas Argentina just expropriated the parent company's property.

The moral questions about confiscating property aside, however, there's a more important issue: Is private ownership always better? If not, when is it better for a government to own something? As hinted in the subtitle, it has to do with whether there's a market or not.

There are certain areas, like transportation networks, utilities, and infrastructure, where natural monopolies tend to arise. Monopolies are bad news because people are forced to buy from them, giving them too much power to jack up prices to whatever they want and make a ton of money. That obviously hurts everyone else. Think about city streets. Imagine if private companies ran them and had toll booths for their use. Not only would it be really irritating, but you would be forced to use certain streets. There wouldn't really be competition between "providers." You have to use the street you live on or cross that bridge into town. This is why it makes sense for governments to build and maintain roads. Some highways are privatized, but you can often use other roads and the pricing is generally controlled by a government authority.

Ports (including airports), suppliers of water, electricity, and telecommunications, public transportation, and rail networks (i.e. the tracks the trains use if not the train operators) are other good examples. It doesn't make sense to have five different companies running subway lines competing with each other, each with their own tracks. It would be wasteful and the price would be higher. It makes sense in such a case to have the government running it. Government provision of water and sewage treatment is also sensible. (Notice that waste collection is good in private hands, as the companies drive to consumers and can compete fiercely with each other.) Electricity grids, if not the providers, can also be sensibly placed in government hands. If they're not, the alternative is that the government sets rules on the prices the companies may charge to transmit competitors' electricity. The point is: there has to be a functioning, competitive market, regulation, or government ownership.

Bolivia's privatization of its power grid, therefore, is not necessarily unreasonable. If it is capable of doing a decent job expanding and maintaining it, and doesn't give special prices to favored power generators, then it may be an improvement. It would probably have been easier to solve any problems with targeted regulation instead, however.

Argentina's nationalization of an oil company, by contrast, makes no sense from the start (if the point is to improve things for consumers, that is). Oil producers compete heavily with each other. There are loads of them. If the government felt too much money from oil extraction in its territory was going abroad, it could have raised the taxes on oil companies (much as Australia has raised taxes on mining companies). Nationalizing an oil company serves no purpose except that the government can get its hands on a bunch of cash and assets without paying for them. In other contexts we call that what it is: theft. There are also other dangers: if the Argentinian government fails to invest in production, the oil company will return less and less money (Mexico and Venezuela are cases in point). This would reduce world oil supplies and rob Argentina of a viable industry, killing jobs along the way.

So privatization is no panacea. It makes sense in most cases as long as there is a real market (Britain's privatization of its water supply was probably a mistake, for example). If there's a competitive market, private companies will almost certainly do a better job than the government at providing goods and services efficiently. Where there's no market, however, there can be good arguments in favor of public provision. US Republicans would do well to remember that toll booths on sidewalks are silly and that some government money is needed to make sure bridges don't collapse. Privatizing all of them instead is, at best, a second-rate solution.