Anatole Kaletsky

Where will jobs and growth come from? As we enter the fifth year of the Great Recession, people all over the world are asking this question, but their political leaders are not providing any convincing answers, as has been made obvious in the U.S. presidential debate and the European Union summit this week.

The second presidential debate started with Jeremy Epstein, a 20-year old college student, pointing out that he had “little chance to get employment” and asking the two candidates for some reassurance and an explanation of how this would change. Mitt Romney offered lots of reassurance but not much explanation:

“I want you to be able to get a job. I know what it takes to get this economy going. I know what it takes to create good jobs again. I know what it takes to make sure that you have the kind of opportunity you deserve. When you graduate … in 2014, I presume I’m going to be president. I’m going to make sure you get a job. Thanks, Jeremy. Yeah, you bet.”

President Obama was more specific but hardly more convincing:

“No. 1, I want to build manufacturing jobs in this country again. That means we change our tax code so we’re giving incentives to companies that are investing here in the United States. It also means we’re helping them and small businesses to export all around the world. No. 2, we’ve got to make sure that we have the best education system in the world. No. 3, we’ve got to control our own energy.  We’ve got to reduce our deficit, but we’ve got to do it in a balanced way. And let’s take the money that we’ve been spending on war … to rebuild roads, bridges, schools. We do those things, not only is your future going to be bright but America’s future is going to be bright as well.”

Tinkering with taxes and investing in education, energy and roads may be good ideas, but does anyone believe such measures would resolve the deepest and most intractable unemployment problem that the U.S. and the world have faced since the 1930s?

Actually, somebody does seem to share Obama’s optimism: the European Union. Here are the takeaways from the “Compact on Growth and Jobs” prepared for this week’s EU summit: Investing in Infrastructure; Deepening the Single Market; Connecting Europe; Promoting Research and Innovation; Enhancing Competitiveness; Creating the Right Regulatory Framework; Developing a Tax Policy for Growth; Boosting Social Inclusion; Harnessing the Potential for Trade.

These are all worthy aims, just as the goals in Obama’s laundry list are, but they are exactly the policies that Europe has been trying to implement for the past four years, while unemployment has relentlessly risen. Why should they suddenly answer the desperate need for new jobs?

This question actually has a clear answer. But it is an answer that seems difficult for policymakers to articulate, not because it is too complicated but because it cuts across ideological divisions.

The challenge of job creation demands a two-part answer — and unfortunately these two parts appeal to opposite ends of the political spectrum. Creating new jobs and economic activity depends on private enterprise, and it is unclear whether government policy can do anything much to inspire the next Google or Starbucks. But just as important as creating jobs is restoring the old jobs destroyed by recession – and this job recovery depends primarily on the actions of governments and central banks.

The tens of millions of jobs lost globally in construction, retailing, hospitality, autos, household goods and other traditional industries since 2008 were not destroyed by a sudden breakdown in entrepreneurial zeal. They disappeared mainly because of collapsing consumer incomes, asset prices, credit and other macroeconomic dislocations.

To overcome the global crisis of unemployment, new jobs in new industries have to be created, just as old ones must be restored. But because job creation is associated with conservative deregulation, while job recovery points to Keynesian demand stimulus, the policies required to achieve these two objectives often seem to be in contradiction. The starkest case is in Europe. Greece and Spain are promised development through structural growth policies that encourage competition and deregulate labor. At the same time they are forced to impose deflationary fiscal policies that guarantee permanent recession and ever-rising unemployment. The result is a disillusioned populace, as both structural and macroeconomic policies are seen to fail.

Yet if not for ideology, structural and macroeconomic employment policies could be viewed as mutually reinforcing. If macroeconomic stimulus pulls the economy out of recession and preserves jobs in existing industries, that helps strengthen new businesses – at least until the economy approaches full employment and further stimulus starts to push up inflation or interest rates. At that point, old industries start to compete with new ones for workers and government spending “crowds out” private enterprise. That is when reductions in public spending and budget deficits become important to allow the private sector enough leeway for growth. When the economy is still in recession, by contrast, cuts in government spending and efforts to narrow deficits do not liberate private enterprise; they merely starve new business of incomes and demand.

Many politicians seem to think such ambiguities are too complicated to explain to voters. Nobody seems to advocate job-creation plans that combine conservative policies to promote competition and enterprise with Keynesian fiscal stimulus to boost demand. But this combination is plain commonsense. Driving a car requires a gas pedal, a brake and steering wheel, and these must be used in different combinations at different times. Voters are surely capable of understanding this; the question is whether politicians can understand it, too.

PHOTO: U.S. Republican presidential nominee Mitt Romney (L) and U.S. President Barack Obama speak directly to each other during the second U.S. presidential debate in Hempstead, New York, October 16, 2012.  REUTERS/Mike Segar

John Maynard Keynes said back in 1936 that “practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” Keynes himself is now a seemingly defunct economist, but his influence connects the two most important events of the week and perhaps of the year: the sudden reversal of fortunes in the U.S. election and the powerful critique of overzealous fiscal austerity produced by the International Monetary Fund.

What connects these two events is an economic question that almost nobody dares to raise publicly, but that now seems destined to dominate the U.S. election and that hung over the IMF annual meeting in Tokyo this week: Do deficits really matter? Or, to restate the issue more precisely: Are government efforts to cut budget deficits counterproductive in conditions of zero interest rates when fiscal austerity suppresses economic growth?

This conclusion is strongly suggested by the IMF’s “World Economic Outlook” produced for the annual meeting. The WEO presented six detailed case studies, starting with Britain from 1918 to 1939, of economies that tried to reduce large public debt burdens with various policy mixes in the past 80 years. It concluded that two conditions were essential for success: very low interest rates and adequate rates of economic growth. If fiscal austerity produces high unemployment and economic stagnation, it is doomed to failure, causing the government’s debt burden to go up instead of down. After examining this historical evidence, the IMF report hinted strongly that at least two major economies were now caught in self-defeating debt spirals: Spain, where the debt trap is created by political pressures from the euro zone, and Britain, where the futile austerity is entirely self-imposed.

The British example is particularly striking. While the British government has implemented bigger tax increases and spending cuts than any other major economy apart from Spain (equivalent to 4.3 percent of GDP since 2009), it has suffered a double-dip recession, missed all its fiscal targets and seen its national debt nearly double from 46 percent to 84 percent of GDP since 2009. Meanwhile, the U.S., which started with a bigger deficit and debt than Britain in 2009 and has made very little effort to tighten fiscal policy since then, has seen its net national debt grow considerably more slowly, from 54 percent to 84 percent of GDP. The better U.S. fiscal performance, despite far less fiscal “effort,” has been due entirely to faster economic growth.

Which brings me to the presidential debate last week. Mitt Romney won the debate largely by denying that his plan for a 20 percent tax cut would increase the U.S. budget deficit. Pressed to explain where the money for his tax cut would come from, Romney spoke of eliminating “deductions and exemptions [so] we keep taking in the same money when you also account for growth.”

But in interviews since the debate, Romney has promised not to touch any of the loopholes big enough to compensate for a 20 percent reduction in tax rates – mortgage interest, charitable contributions and healthcare. That has led most analysts to conclude either that Romney is not serious about cutting taxes or (more probably) that he is not serious about fiscal arithmetic and will allow deficits to explode.

There is, however, a third possibility. Perhaps large tax cuts would boost the U.S. economy so strongly that the lost revenues would quickly be restored through rapid income growth? In the Denver debate, Romney focused on this growth theme: “The revenue I get is by more people working, getting higher pay, paying more taxes. That’s how we get growth and how we balance the budget.”

Many Democrats instinctively reject the possibility of self-financing tax cuts, accusing Romney of “magical thinking” and likening his approach to Reagan’s trickle-down economics. But let us not forget that Reaganomics proved remarkably successful, generating average growth of 4.7 percent annually for six years. And neither should Democrats forget that self-financing fiscal stimulus, whether through tax cuts or public spending, is the essence of Keynesian economics.

Was Reaganomics successful because of Keynesian demand stimulus or conservative supply-side economics? Nobody can say for certain, and most likely there were benefits from both incentive and demand effects. But either way, Reagan was hailed as a national savior. Romney would be equally lauded if his tax cuts delivered strong economic growth, regardless of whether budget deficits initially expand, as they certainly did under Reagan.

This statement may sound like “deficit denial” – and in a sense it is – but the IMF has now produced persuasive evidence to back it up. This week’s WEO reports a new study of fiscal changes in 28 countries since the Lehman crisis, which shows fiscal policy working in much the way that Keynes predicted, but with two to three times more impact on GDP than previously supposed. The very high fiscal multipliers identified by the IMF suggest that big tax cuts could indeed be largely self-financing, as Romney hopes.

That fiscal policy is now much more powerful than in the past is hardly surprising. The world is again stuck in a liquidity trap, in which monetary policy is ineffective, much as it was in the 1930s, when Keynes developed his ideas on fiscal stimulus. How ironic that it now takes a conservative such as Romney to stop panicking about deficits and propose a full-scale Keynesian policy for growth.

PHOTO: Stacks of U.S. hundred-dollar bills are displayed during a presentation to the media in Mexico City, November 22, 2011. REUTERS/Bernardo Montoya

Rupert Murdoch conceded defeat this week in his battle with Google and the Internet, an adversary even more powerful than the British government. Murdoch, uniquely among the world’s media magnates, decided two years ago to create a “paywall” for the London Times that could not be penetrated by Google and other “parasitic” search engines. In effect, the paper was cut off completely from the public Internet. As one of Murdoch’s newspaper managers later described this strategy: “Rupert didn’t just build a paywall; he circled it with barbed wire, dug a moat around it and put crocodiles in the moat.”

On Monday Murdoch relented. Times articles started reappearing in Google searches, although anyone wanting to read them still has to pay £1 for one day’s paper or £2 per week. Coincidentally, News Corp, Murdoch’s holding company, announced the departure of its chief digital officer, Jonathan Miller. And Murdoch himself stood down as chairman of Times Newspapers, the News Corp subsidiary that controls his upmarket British papers.

Murdoch’s U-turn sends two interesting signals. The first, already much discussed, is about the disappointing results of this paywall experiment – just 131,000 subscribers after two years. The second is about Murdoch’s global empire and the future ownership of the Times. Having spent 20 years at the Times before leaving it six months ago, these signals sound to me like an SOS.

Murdoch’s papers, and the Times especially, are now caught in a perfect storm. Like all papers the world over, they are buffeted by technological transformation and recession. But they also face a third threat unique to News Corporation– the fallout from the phone-hacking scandal that has led to the arrest of several of Murdoch’s top British executives.

The hacking scandal has been hugely embarrassing and expensive, with legal costs estimated at $224 million in News Corp’s latest accounts. But much more important for the Murdoch papers not implicated, including the Times and the Wall Street Journal, is the scandal’s impact on News Corp’s business strategy – and its rationale for owning newspapers at all.

Outside shareholders of News Corp have long dreamt of the company ridding itself of scarcely profitable newspaper businesses to become a pure TV and movie business. This move was considered impossible under Murdoch, because of his sentimental attachment to print. But that was almost certainly a misunderstanding. Murdoch did not build the world’s greatest media empire through sentimentality. The reason why he loved papers, even when they suffered big losses, was because they gave him political power. For News Corp shareholders, in turn, Murdoch’s power brought business benefits.

Murdoch’s political influence allowed News Corp to overcome regulatory and political obstacles that defeated other media companies. The obvious case was News Corp’s recent attempt to take full control of BSkyB, the British satellite broadcaster, but there were many other cases. In fact, Murdoch’s ability to overcome obstacles – whether erected by politicians, regulators, unions or business rivals – that thwarted other moguls has been the key to his success.

That success could largely be attributed to audacity and vision. I once heard Murdoch boast that after all his biggest deals, financial analysts mocked him for ”overpaying.” Yet the accusation that “Murdoch overpaid” usually gave way to an appreciation that he had seen the true value of a concept like satellite TV or sports broadcasting that nobody else had properly understood. But throughout Murdoch’s career, his bold personality and vision have been usefully supplemented by the political influence derived from newspaper ownership. This ingredient in the Murdoch formula has now been transformed.

Once the phone-hacking scandal sabotaged the BSkyB bid, the business calculation behind newspaper ownership completely reversed. The papers were suddenly transformed from an asset into an albatross – and the arguments for keeping a print business within News Corp vanished. In July, Murdoch duly conceded this, announcing that all his publishing businesses would be split off into a separate company. Most financial analysts assume, and outside shareholders hope, that this new company will receive a very small share of News Corp’s $10 billion cash surplus. If so, it will be unable to subsidize loss-making papers for long.

Which brings us back to this week’s events at the Times. Murdoch’s decision to stand down as chairman suggests that the Times may be among the first candidates for disposal. But who would take it on?

The usual answer is a billionaire seeking a trophy asset. But print is now an obviously declining industry, threatening cumulative losses that would daunt mere billionaires. Multibillionaires from Russia, the Middle East and China might still afford such trophy assets, but would probably be politically unacceptable. In any case, many of the multibillionaires from these countries seem to prefer British football clubs.

Luckily there is one group of multibillionaires that might still view the Times of London as a worthwhile trophy asset – and have no interest in football, preferring cricket. For an Indian magnate with strong connections to Britain, such as Lakshmi Mittal, owning the London Times might be sufficiently thrilling to justify years of losses. Even more intriguing would be an Indian media group. Imagine the satisfaction for members of the Jain family if they could make the Times of London (circulation 400,000) a subsidiary of their Times of India (circulation 3 million) or for the Birlas if they could make it a supplement to their Hindustan Times (circulation 1.4 million).

In Britain’s 19th century heyday, Abraham Lincoln flattered the Times’s Washington correspondent by declaring that “I know of no greater power in the world than the Times of London – except maybe the Mississippi.” Some smart investment banker could soon be making a similar comparison – this time with the Ganges.

CORRECTION: This piece originally misstated the size of News Corp’s cash surplus. It is $10 billion, not $36 billion.

PHOTO: News Corp Chief Executive and Chairman Rupert Murdoch holds a copy of the Times newspaper as he leaves his home in London July 20, 2011. REUTERS/Andrew Winning

Who’s afraid of the fiscal cliff? Even as protests in Spain and Greece revive jitters in the euro zone, global businesses and investors have discovered a new political horror, this time in the U.S. The fear now in world markets is not so much about November’s election, but about the automatic tax hikes and public spending cuts that Ben Bernanke has dubbed the “fiscal cliff.” These fiscal changes, which come into force on Dec. 31 unless Congress passes new legislation, will tighten fiscal policy by some 4 percent of GDP, comparable to the austerity programs in Spain, Italy and Britain.

Given what fiscal austerity has done to Europe, the worries are understandable, but everyone should calm down. A drastic fiscal tightening is almost inconceivable after the election, because politics, economics and markets interact in Europe and America in opposite ways.

Let’s start with economic policy. The warnings from the Federal Reserve to U.S. politicians as the fiscal deadline approaches are all against allowing the legislated tax increases and spending cuts to take effect. Thus the Fed is giving politicians advice that is opposite that of the European Central Bank and the Bank of England.

Moreover, the Fed is now putting its money where its mouth is. By warning the U.S. government not to tighten fiscal policy, and simultaneously promising to buy bonds and to keep short-term interest rates at zero until the economy returns to full employment, the Fed is effectively offering to finance whatever deficit the U.S. government chooses to run at almost no cost.

In terms of economic philosophy, the Fed is now a clearly Keynesian institution. Bernanke sees unacceptable levels of unemployment and attributes them to an excess of saving over investment by the private sector. He therefore wants the government to keep borrowing until the private sector returns to normal levels of investment and spending – and promises to finance this borrowing with printed money. This policy is anathema in Europe, especially in Germany – so much so that EU treaties explicitly make “monetary financing of government” illegal.

The opposing economic philosophies of the Fed and the ECB are reflected in financial market pressures. In Europe, bond markets attack countries that persistently overshoot their fiscal targets or get downgraded by rating agencies, knowing that the ECB will punish such “profligate” governments. But global investors continue buying U.S. Treasury bonds regardless of how much the Congress borrows, safe in the knowledge that the Fed will keep short-term interest rates at zero and will support bond prices.

Because of this newfound Fed support, the “bond market vigilantes” who used to terrify Jimmy Carter and even Bill Clinton have vanished. And rating agencies that threaten to downgrade the U.S. government’s credit have become a laughingstock. Indeed, when one of these agencies did remove the U.S. triple-A rating last year, the price of Treasury bonds, far from plunging, actually went up.

Which brings us to politics. With the Fed warning in the strongest possible terms against any immediate fiscal tightening and with bond markets applying no pressure on the government to reduce its borrowing, why shouldn’t the Congress and president simply postpone for another year all the tax increases and spending cuts due on Dec. 31? Having avoided the fiscal cliff, why don’t the politicians then sit down and work on a sensible long-term program of gradual fiscal consolidation starting in 2014, as recommended by Bernanke and almost every other sensible economist? The answer is, of course, political polarization – and uncompromising partisanship could surely push the U.S. economy over a fiscal cliff. But how likely is an all-out political confrontation between the election and Dec. 31?

If Mitt Romney wins, it is inconceivable that a defeated President Obama and lame-duck Congress would blatantly sabotage the economy, defying the Fed’s explicit warnings and a newly elected president’s appeal simply to delay decisions until the new government is in power. In the unlikely event that the Democrats did attempt this affront to democracy, it would have no impact since investors and businesses would know for sure that any tax hikes and excessive spending cuts would be reversed within days of the new president’s inauguration.

But what about the more likely scenario that President Obama is re-elected, while Republicans continue to dominate Congress? This might mean more paralysis, but that is not the same as economic suicide. If we extrapolate from the politicians’ previous behavior, we would get procrastination until midnight on Dec. 31 and then a vote to postpone any major decisions for 3, 6 or 12 months. Pushing the economy over the fiscal cliff would require much sharper polarization than ever existed before the election. That is extremely unlikely, because the cost-benefit analysis of simply “kicking the can down the road” for another six months or so will change abruptly after Nov. 6.

Before the election, the main cost of postponing decisions was the political embarrassment of failing to exercise leadership and the risk of triggering a rise in interest rates. The main benefit was avoiding immediate damage to the economy.

After the election this calculation completely changes. Members of Congress sitting in the lame-duck session before Dec. 31 will be acting democratically by passing responsibility for major fiscal decisions on to their duly elected successors. And the Fed has removed the threat of higher interest rates. The costs of postponement have thus vanished.

Meanwhile, the benefits of protecting economic recovery have hugely increased. Before the election Republicans could reassure themselves that any economic damage caused by obstruction would be negated by the benefits of unseating President Obama. But after the election, this motivation will disappear. Instead, both parties will face the inevitable prospect of living together for four more years and will be held responsible by voters and business funders. Neither side will want to start this long period of uncomfortable, but unavoidable, cohabitation, by pushing the economy over a fiscal cliff.

PHOTO: A competitor jumps into the water during a cliff-diving competition near the central Bohemian village of Hrimezdice, August 4, 2012. REUTERS/David W Cerny

When the economic history of the 21st century is written, September 2012 is likely to be recorded as a defining moment, almost as important as September 2008. This month’s historic events – Ben Bernanke’s promise to buy bonds without limit until the U.S. returns to something approaching full employment, Angela Merkel’s support for the European Central Bank bond purchase plans and the Bank of Japan’s decision to accelerate greatly its easing program – may not seem earth-shattering in the same way as the near-collapse of every major bank in the U. S. and Europe. Yet the upheavals now happening in central banking represent a tectonic shift that could transform the economic landscape as dramatically as the financial earthquake four years ago.

To see why, we must go back in history 40 years, to the early 1970s. Maintaining full employment was at that time regarded as the main objective of all economic policy, and this had been the case for roughly 40 years, since the Great Depression. But by the early 1970s, voters had enjoyed decades of more or less full employment and were starting to focus on inflation rather than depression as the main threat to their prosperity. Economists and politicians were responding to this shift. Milton Friedman led a monetarist “counterrevolution” against the Keynesian obsession with unemployment, designing new economic models to challenge the Keynesian view that market economies were naturally prone to long-term stagnation. By restoring the pre-Keynesian assumption that market economies were automatically self-stabilizing, the monetarist models produced two powerful policy prescriptions directly opposed to the Keynesian views.

First, the monetarists insisted that price stability, rather than full employment, was the only legitimate target for monetary policy and government macroeconomic management more generally. Second, they argued that central bankers should not accept any direct responsibility for unemployment, since sustainable job creation depended solely on private enterprise – full employment would be achieved automatically if inflation were conquered and market forces were allowed to operate freely, with the minimum of government interference or union constraints. A few years later, Margaret Thatcher and Ronald Reagan turned Friedman’s intellectual revolution into practical politics. On top of its economic impact, monetarism had huge ideological effects by absolving government macroeconomic management of any direct responsibility for jobs and instead attributing unemployment to regulations, unions, welfare policies and other market distortions.

The historic significance of this month’s central bank decisions should now be clear. The Fed has promised to keep printing money until full employment is restored – and it has committed itself to even bolder measures if those announced last week prove inadequate. The ECB has undertaken to “do whatever it takes” to preserve the euro and specifically to buy Spanish and Italian government bonds with newly created euros in unlimited amounts.

In making these announcements, the Fed and the ECB were not just demoting their previously inviolable inflation targets to near-irrelevance. They were breaking intellectual and political taboos that had dominated central banking for four decades. This iconoclasm has prompted an extreme reaction from the one remaining bastion of traditional monetarism in central banking, Germany’s Bundesbank. On Tuesday the Bundesbank’s president, Jens Weidmann, described the new central banking quite literally as the work of the devil; Mephistopheles, he recalled, had used just such policies to create chaos and hyperinflation in Goethe’s Faust.

And indeed, the attempts to use monetary policy to restore full employment will need to overcome the two main objections presented by monetarist theory and repeated his week by the Bundesbank. Will printing more money produce intolerable inflation? And what happens if businesses fail to respond to monetary expansion by creating more jobs – won’t that lead to ever more desperate and risky efforts to artificially stimulate employment?

Most of the admonitions against using monetary policies to achieve full employment focus on the risk of unleashing inflation. On this score, the Fed and the ECB have a very credible response, offered most recently from Ben Bernanke and Mario Draghi last week: As long as unemployment and industrial excess capacity remain anywhere near present levels, generalized inflation is very unlikely. Even if some commodities, such as oil or food, experience inflation, this will be offset by others goods and services whose prices fall.

The more insidious danger is that the Fed will simply fail in its efforts to stimulate job creation and accelerate economic growth. Disappointment was, after all, the outcome of the last two rounds of QE. So why should this one be any different, even if the Fed keeps increasing the amount of new money printed? This is the troubling question that Bernanke has so far failed to answer or even seriously confront.

It may turn out that just injecting money into banks and bond funds is not sufficient, regardless of the amounts. A genuine economic stimulus may require newly created money to be distributed directly to businesses or households as suggested here in the past. Imagine, for example, that the extra $40 billion the Fed will pump every month into the bond market were spent instead on a $130 monthly payment to every U.S. citizen, repeated until the economy returned to full employment. With the taboo against central banks accepting responsibility for unemployment now completely broken, such truly radical monetary policies may just be a matter of time.

PHOTO: U.S. Federal Reserve Chairman Ben Bernanke addresses U.S. monetary policy with reporters at the Federal Reserve in Washington, September 13, 2012. REUTERS/Jonathan Ernst

Does the German Constitutional Court ruling in favor of a European bailout fund, closely followed by the big win for pro-euro and pro-austerity parties in the Dutch general election, mark the beginning of the end of the euro crisis? Or were these events just a brief diversion on the road toward a euro breakup that began with the Greek government accounting scandals in 2009? Most likely, the answer is neither. This week’s political and legal developments have given European leaders just enough leeway to avoid an immediate collapse of the single currency, but not nearly enough to end the euro crisis.

In this respect, the German Constitutional Court has acted exactly in accord with the powerful speech delivered in Berlin this week by George Soros and published in the New York Review of Books. This accuses German policy of condemning Europe, albeit inadvertently and with the best of intentions, to “a prolonged depression and a permanent division into debtor and creditor countries so dismal that it cannot be tolerated.” Germany does this by always offering “the minimum necessary [support] to hold the euro together,” while blocking “every opportunity to resolve the crisis” once and for all.

From what he calls this tragic record of missed chances, Soros draws a conclusion similar to the one presented in my columns three months ago. Germany can continue as the economic leader of Europe only if it accepts the responsibilities of a “benign hegemon,” much as the U.S. did when it forgave Germany’s debts and launched the Marshall Plan after World War Two. If, on the other hand, Germany continues to identify debt with guilt (the German language, significantly, uses the same the word, schuld, for both concepts), it will continue blocking any resolution of the euro crisis that might involve the sharing of government debts across Europe. If, on top of this opposition to mutualizing debts, Germany retains its taboo against any monetary financing of government deficit, as practiced in the U.S. by the Federal Reserve, then Europe will be condemned to long-term depression and quite possibly a revival of national hatreds. In that case, it would be better for all concerned if Germany left the euro.

Whether Germany can, in practice, be persuaded either to leave the euro – or preferably, to abandon its opposition to mutualizing and monetizing debts – will depend, according to Soros, less on diplomacy and economics than on the pressure of public opposition to austerity in France, Italy and Spain. But unless and until such pressure prevails, the policy of minimalist and moralistic crisis management will continue to determine conditions in Europe – which brings us back to the decision of the German Constitutional Court.

Coming hard on the heels of the bond-buying plan announced by the European Central Bank, the court decision has created relief and even optimism in financial markets about a durable resolution of the euro crisis. But this optimism will probably prove as ephemeral as all the previous outbreaks of europhoria.

The latest effort to resolve the euro crisis is based on the assertion by Mario Draghi, the ECB president, that the euro is “irreversible” and his promise to “do whatever it takes” to prove this. But Draghi’s promise to spend unlimited resources to defend any country threatened by a euro breakup is logically undermined by the conditions that the ECB has attached to its support, largely to satisfy the German moralism about schuld. This has now been reinforced by the constitutional court’s insistence that the European bailout fund must inform the entire Bundestag – and therefore presumably the German public – of the detailed conditions imposed in every support program, as opposed to the present practice of only providing confidential information to a small group of parliamentarians.

Economic arguments can be made both for and against further structural reforms and more fiscal tightening in the debtor countries. But there can be no dispute that imposing politically difficult conditions for ECB support must, by definition, create serious doubt about whether this support will be available when a debtor country’s euro membership is most in peril. This happens precisely when a debtor country’s ability to meet its fiscal targets is called into question, as in the case of Greece today. Thus, far from providing an absolute and unconditional guarantee that the euro is irreversible, Draghi and the German Constitutional Court have done the opposite. They have inadvertently laid out a road map showing how the euro could be broken up by market and political pressure.

The upshot is that every debtor country in Europe is now a sitting duck for currency speculators. Italy, Spain and other debtor countries can expect no support from the ECB until their economies deteriorate to the point where they will submit to ESM (European Stability Mechanism) austerity programs. And once debtor countries do agree to such programs, they will face speculation about the loss of ECB support whenever they appear to be missing their fiscal or reform targets. That in turn will force them either to abandon the euro or to tighten the fiscal screws even further and suffer more deflation. In short, the ECB and the German Constitutional Court have created a doomsday machine that is likely to widen the gap between debtors and creditors in Europe in precisely the way described by Soros.

This grim process seems set to continue until one of two thing happens. Germany could soften its insistence on excessive deflation and instead lead Europe toward a more growth-oriented fiscal and monetary policy similar to the one in the U.S. This could happen after the German election next autumn, though even the German Social Democrats are adopting an increasingly moralistic attitude toward southern Europe’s schuld. The alternative is that the debtor countries will rebel against German economic domination and try to force Germany out of the euro. As Soros succinctly puts it: “Germany must lead or leave.”

PHOTO: President of the German Constitutional Court (Bundesverfassungsgericht) Andreas Vosskuhle (5th L) announces the ruling on the European Stability Mechanism and the fiscal pact at the court in Karlsruhe, September 12, 2012. REUTERS/Kai Pfaffenbach

The North Atlantic hurricane season runs from mid-August to October, with a strong peak in storm activity around the middle of September. A less familiar but even more destructive pattern of disturbances is the financial hurricane season, which coincides with the meteorological one almost to the day.

Most of the great financial crises of modern history have occurred in the two months from mid-August: the Wall Street crashes of Oct. 22, 1907, Oct. 24, 1929, and Oct. 19, 1987; Britain’s abandonment of the gold standard on Sept. 19, 1931; the postwar sterling devaluation on Sept. 19, 1949; the collapse of the Bretton Woods global monetary system on Aug. 15, 1971; the Mexican default that triggered the Third World debt crisis on Aug. 20, 1982; the breakup of the European exchange-rate mechanism on Sept. 16, 1992; the Russian default on Aug. 17, 1998, the bankruptcy of Lehman Brothers on Sept. 15. 2008 – and this list could go on.

The coincidence between financial and meteorological hurricanes may not be entirely fortuitous. The global economy, like the world’s atmosphere, is a finely balanced complex system. In such systems, small perturbations can accumulate to trigger big effects. And just as the meteorological tipping points tend to occur when autumn air circulation starts to disrupt the humid air accumulated in the summer doldrums, something similar seems to happen to financial markets when trading becalmed by the summer holidays returns to normal. The result can be sudden and violent reaction to events accumulated over the summer that markets had seemed to ignore. The world economy does not, of course, experience hurricanes with the same regularity as the Caribbean. But when big events happen over the summer, financial disturbances become quite probable in the fall. This is probably the reason why September has historically been the worst month of the year for stock market performance. In fact, September is the only month in which Wall Street prices have, on average, declined since the 1920s.

The question now is whether the world economy has already adjusted to the potentially disruptive and disappointing economic events of the summer, or whether the summer doldrums in financial trading were merely a calm before the storm.

The testing period begins this week with Thursday’s ECB meeting and Friday’s U.S. job figures. Further challenges to financial confidence are likely from the German constitutional court verdict on euro bailouts on Wednesday and the Federal Reserve decision on quantitative easing the following day.

But rather than focusing again on these familiar issues, it is worth considering some worrying developments recently in other parts of the world. In China, economic activity has failed to accelerate as expected, despite repeated attempts at monetary and fiscal stimulus. This could mean simply that the government and the central bank have not yet done enough. It is possible, however, that the Chinese economy has become too complex to be managed and fine-tuned as effectively as in the past. Or perhaps the disappointing results of Chinese stimulus thus far reflect a broader failure of monetary policy, which is becoming evident around the world.

Recent disappointments in Britain support the latter interpretation. The British economy has enjoyed no growth for two years now, since David Cameron’s government decided on a radical experiment in fiscal belt-tightening, hoping that monetary expansion would offset the deflationary effects. This week Cameron responded to the failure of this experiment by sacking many of his ministers and announcing a new “pro-growth” strategy. On closer inspection, however, this “new” policy was simply doubling down on the one that failed. The growth measures consist mainly of promises to build unpopular new airports and railways from 2015 onwards. Meanwhile, the government will continue to cut spending and raise taxes, hoping that further monetary handouts to banks and bond investors will revive growth. The experience of the past four years suggests this is unlikely.

But if Britain cannot revive its economy with monetary easing, why should better results be expected from the Fed? Ben Bernanke, in last week’s Jackson Hole speech, effectively promised to keep pumping money into the U.S. bond markets until he achieved a strong economic recovery. But given that QE has failed to deliver full employment in 2010-12, why should it work any better in 2013?

Pumping money into the banks was a very effective emergency measure to prevent the collapse of the U.S. and British financial systems – and it could be equally effective in preventing the breakup of the euro, if only the German government would permit it. But financial stability and economic growth are different problems, and they may require different solutions. Unfortunately policymakers do not seem to understand this distinction. In the U.S. and Britain they refuse to acknowledge that printing money can ever be counterproductive. In Germany, by contrast, they refuse to accept that printing money can ever work.

Which brings us finally to the most important source of instability that threatens a financial hurricane this autumn – the impending clash between the ECB, Germany and the rest of the euro zone. This conflict, to which I will return next week, is certain to intensify between now and the next European summit on Oct. 19 – a date still well within the financial hurricane season.

PHOTO: A road sign sticks out above floodwaters in the aftermath of Hurricane Isaac in Braithwaite, Louisiana, September 1, 2012. REUTERS/Lee Celano

As the presidential campaign finally takes off with the party conventions, there seems to be only one point Republicans and Democrats agree on. This election will be about job creation and the role of government. But having defined this battlefield so clearly, neither side seems to have any credible ideas for dealing either of these supposedly decisive issues.

Let’s start with government. The Republicans claim to want smaller and less intrusive government. Yet they vehemently demand tighter government controls over abortion, immigration, marital arrangements and sexual behavior. On other politically less salient issues such as drugs, prison reform, alcohol use by young adults and doctor-patient privacy, Republicans consistently support government intervention, sometimes to a bizarre degree. For example, a law signed in 2011 by Florida’s Republican governor (though struck down promptly by federal courts) made it a crime for pediatricians to tell parents that they could endanger their children by keeping a loaded gun in their home.

The Democrats’ vision of government is equally paradoxical, but in the opposite direction. The Democrats, like left-wing parties in Europe, laud the economic role of government, and especially its importance in supporting public goods and regulating business abuses. But they deny the right of government to regulate, or even try to influence, private behavior, even when it impinges on community life in such areas, for example, as marriage, child-rearing or trade union activity, especially in the public sector.

In short, the left’s faith in government suddenly evaporates when it comes to social and lifestyle issues, while the conservative passion for smaller and less intrusive government only applies when money and economics are at stake.

Which raises the second, even more important, electoral issue — jobs. Mitt Romney has promised “a singular focus on job creation” and has accused Barack Obama of wasting his presidency on healthcare instead of creating jobs. The paradox is that when they are not attacking Obama for failing to create employment, conservative politicians insist that government has no positive role whatsoever in creating jobs — whether by hiring public-sector workers, supporting failing banks or auto businesses, or expanding fiscal and monetary policies to stimulate demand. Such is the conservative aversion to any government involvement in job creation that Senator Bob Corker, a leading Republican economic thinker, has even proposed legislation to remove employment from the legal objectives of the Federal Reserve.

The only job-creating role that conservatives now regard as legitimate for government is reducing business regulations and taxes. But given that the deepest and longest recession in postwar history followed decades of radical deregulation, it is hard to see the logic whereby further deregulation would, on its own, restore the jobs that were lost in 2008-09.

But if conservative political positions on employment are riddled with contradictions, the same is true on the other side. If anything, the Democrats have been even less successful in arguing their economic case for active government or pinning the blame for the recession on the laissez-faire economic policies of the Bush decade. President Obama, for all his eloquence, has never presented a coherent narrative of what went wrong in 2008 or how his policies could put it right. He has never challenged the laissez-faire assumption that a market economy will automatically return itself to full employment without any government macroeconomic intervention. He has not tried to explain the Keynesian argument that depression becomes inevitable if households, businesses and government all try to reduce their debt at the same time. And he has never even mentioned the role of monetary policy in easing the long-term burden of government borrowing.

Because President Obama has failed to justify or even explain his economic policies, while the Republicans have no coherent alternative, it seems unlikely that either side will have anything interesting to say in the U.S. election about the supposedly defining issues of government and jobs. This is a shame, because a genuine debate about the new relationship of governments and markets was desperately needed after the 2008 crisis.

The crisis tested and destroyed the Thatcher-Reagan view that “the market is always right” and that government is not the solution but the problem. Running another experiment with an even purer version of the free-market model, as many conservatives now demand, seems politically implausible, to put it mildly. But returning to the faith in a benign and omniscient government that preceded the Reagan-Thatcher revolution is not an option either, because that New Deal-Keynesian model was comprehensively discredited in the great inflation of the 1970s.

What is needed instead is a reappraisal of politics and economics that recognizes that governments and markets can both make big mistakes, that macroeconomic management is needed but must not impede private enterprise, that complex new systems of checks and balances may be needed to protect and promote both public and private interests. Two years ago, I wrote a book on this subject, suggesting that a new model of capitalism was starting to evolve from the 2008 crisis, in the same way that Thatcherism and Reaganomics emerged from the 1970s crisis and New Deal Keynesianism emerged from the 1930s. I was right that new thinking was needed about the balance between governments and markets, but totally wrong about the timescale on which any new model might evolve. Four years after the trauma of 2008, a serious new consideration of government’s role in the economy has not even started. The U.S. election is making that very clear.

The words “core” and “periphery” have become standard terms to describe the winners and losers in the euro crisis. But how could anyone with the slightest sense of history, or knowledge of art and culture, call Italy or Spain peripheral to Europe, while placing Finland and Slovakia, or even Germany and Holland, at Europe’s core?

As a part-time resident of Italy, with a home 100 km from Rome, the center of two millennia of European civilization, I could not be satisfied with this trite answer. Speaking to friends and neighbors in Italy this summer and observing the behavior of Europe’s leaders, I have been struck by a more interesting, and disturbing, explanation of the core-periphery split. These terms do not refer to the past or the present, but to plans for the future. Core and periphery are not geographic or historical descriptions, but euphemisms designed to legitimize permanent economic and political inequalities among the nations of Europe.

With every step toward a resolution of the crisis, the peripheral countries have lost political autonomy, economic opportunity and national self-esteem, while the core countries, especially Germany, have been enriched and empowered. By creating conditions in which the interest rates paid in Italy, Spain and the other Mediterranean countries are much higher than they are in Germany and its northern allies, Europe has imposed a large and permanent economic handicap not only on the governments of southern Europe but also on their private businesses and households.

Even the most profitable Italian businesses and the most solvent Italian homeowners are forced to pay double or even triple the interest rates of their German or Dutch counterparts. When Italy had a separate currency from Germany, this interest inequality did not matter because the lira was periodically devalued, thereby reducing the real cost of debt. But while the euro survives, the widening disparity in financing costs provides continuous subsidies for German companies, while stunting the competitiveness of Italian and Spanish businesses with terrible implications for job creation and economic growth.

Until recently, there has been surprisingly little protest in the peripheral countries against this manifest injustice. People seemed to swallow whole the German and northern European, narrative that presents Mediterranean economic inferiority and political subservience as natural consequences of geography and national stereotypes. In Italy, however, a change of mood became noticeable after Mario Monti, the country’s unelected but universally respected prime minister, started pushing back against German reform demands at the EU summit on June 29. In the past few weeks, this resistance has been gaining strength.

Italian politicians have become increasingly vocal in demanding radical measures from the European Central Bank to reduce interest rate spreads that are devastating Italian industry. Significantly, these Italian demands for ECB action now go well beyond the bromides offered by Mario Draghi, the president of the ECB. Draghi has disappointed his compatriots by insisting that any ECB measures be contingent on ever more German-inspired austerity measures. Italian ministers all the way up to Monti, by contrast, are now demanding unconditional action from the ECB to reduce credit spreads, with no further German demands for austerity and reforms.

A few months ago, Italians almost universally dismissed such defiance of Germany and criticisms of the ECB as futile gestures unworthy of serious post-Berlusconi-era politicians. In the past few weeks, however, this perception has begun to change. After three years of deep recession, massive tax increases, huge spending cuts and some of the most ambitious structural reforms implemented in a major OECD economy, there is a sense that Italy has done enough.

People are starting to re-examine the standard German narrative that Italy has recklessly mismanaged its finances, that its industry is hopelessly uncompetitive and that loss of economic and political subservience to Berlin or Brussels is therefore a natural fact of life. Italians are reminding themselves that: Italy’s tax revenues are strong, it has run bigger primary surpluses than Germany for most of the past 15 years, health and pension liabilities are now among the lowest in Europe, employment costs are lower than in France or Germany, trade deficits are negligible, and personal savings are higher per head in Italy than in Germany, the U.S. or Japan.

In short, Italians are realizing that they are not just some insignificant pimple on the “periphery” of Europe, but a country similar in population, wealth and economic output to Britain and France. They are also recalling that their country did as well or better than Germany, in terms of economic growth, wealth per head and industrial production, from the early 1950s until 1999, when Italy made the fateful decision to join the euro. That decision is now seen as a mistake by a plurality of 44 percent, against 30 percent, of Italian voters, who are starting to suspect that EU reform demands, far from making their country more competitive, are designed to reduce it to a position of permanent vassalage to Germany.

All of which suggests a dramatic conclusion. Instead of accepting further austerity and reform, Italy could insist that Germany stop making these demands or leave the euro. France, Spain and the others would then face a choice – back Italy and challenge Germany to leave the euro, or vice versa. We would then discover which countries are truly in the core and which in the periphery of Europe.

Whatever happens in the election and the euro crisis, the autumn of 2012 may go down in history as a pivotal moment of the early 21st century – a political season that may even be more transformational than the financial upheavals that started with the bankruptcy of Lehman Brothers four years ago. Paul Ryan’s nomination to the Republican ticket means American voters will feel forced to make a radical choice between two very different visions of the government and the market, in fact of the whole structure of politics and economics in a modern capitalist state. The choice facing Europe in the next few months – starting on September 12 with the Dutch elections and the German court decision on European bailouts – is in some ways even more dramatic: It is not just about the role of government, but about the very existence of the nation-state.

But do these decisions really need to be so radical? It is fashionable to proclaim that the future is a matter of black and white: bigger government or freer markets, national independence or a European superstate. But these extreme dichotomies do not make sense. The clearest lesson from the 2008 crisis was that markets and governments can both make disastrous mistakes – and therefore that new mechanisms of checks and balances between politics and economics are required. The second obvious lesson of the crisis was that economic problems ignore national borders and therefore that ever more complex mechanisms for international cooperation are needed in a globalized economy.

Given the historic importance of the decisions that have to be made this autumn on both sides of the Atlantic, it will be tragic if complex issues such as the role of government or the future of Europe are reduced to oversimplified choices between polarized alternatives.

In the U.S., the Ryan nomination has already filled the airwaves with claims about the courage of acknowledging that government spending and deficits are unsustainable and demand drastic cuts. But these claims are at best half-truths. It is true that U.S. government spending is rising inexorably and that only one part of the budget really matters in driving this trend – the exponential growth of Medicare costs. It does not follow from this, however, that the U.S. is threatened with national bankruptcy. And even if bankruptcy were on the horizon, radical reductions in Medicare or other government entitlements would not be inevitably needed to bring government deficits and debts under control.

The truth is that the U.S. government can continue to finance deficits for the next few years at no cost to future generations because the economy remains so weak that the Federal Reserve Board can print money without fueling inflation – and once the economy starts growing strongly enough to create inflation, a large part of the deficits will automatically disappear. But what about the long term, when excessive government deficits will surely become a problem? At that point, the unsustainable growth of Medicare spending can be tackled in four different ways: by reducing eligibility for government healthcare and replacing it with private insurance; by raising taxes to pay for rising medical costs; by tightening price controls on hospitals, doctors and pharmaceutical companies; or by lowering the regulatory costs of drug development and of training doctors. Many different combinations of these four approaches are not just possible in theory, but are being applied in practice in all OECD countries.

Yet politicians are habitually praised for “honesty” and “courage” when they falsely claim that only one of these options – whether privatizing Medicare or sharply raising taxes ­- is the inevitable answer.

The same fad for oversimplification can be seen in Europe’s response to the euro crisis. European leaders now almost unanimously claim that to avoid a breakup of the euro, “there is no alternative” to abiding by much tighter fiscal rules modeled on recent reforms in the German constitution. European voters have therefore been offered a radical Hobson’s choice: either abandon European aspirations or accept long-term economic depression and a humiliating loss of national sovereignty.

Recently, however, European politics appear to be shifting. As they prepare for next month’s elections, politicians in Italy, France, Spain and Greece, and even some in the Netherlands, are recognizing that there are less radical – and more sensible – options than simply accepting or rejecting Germany’s austerity demands. Most EU leaders now insist that fiscal tightening will only work if counterbalanced by much more radical monetary easing by the European Central Bank. Even more important, leaders in France and Italy are starting to accept the principle of fiscal and political union, but adding a crucial condition that has so far been missing from the debate. Collective European control over national fiscal policies, as demanded by Germany, will be acceptable if – and only if – it is balanced by collective responsibility for national debt burdens, which Angela Merkel has thus far refused to discuss. This more complex and balanced approach to fiscal integration could allow the euro to survive without condemning Europe to a decade of depression.

Whether such a nuanced approach will be acceptable to German political and public opinion remains unclear, which is why a confrontation between Germany and the Mediterranean countries probably lies ahead in the autumn. In Berlin as in Washington, the fashion for oversimplified radicalism has taken hold in both economic and political thinking – a tragic irony when global problems are clearly more complex than ever before.