Europe's Un-Fed

FROM TODAY'S WALL STREET JOURNAL EUROPE

The euro zone's report of better-than-expected first-quarter growth of 0.7% last week vindicated Jean-Claude Trichet's approach to monetary policy. His European Central Bank has kept interest rates steady at 4% since June despite pressure to follow the U. S. Federal Reserve's example and open the spigots. The ECB had better steel itself, though, for that pressure will intensify.

Exceptional factors, such as the mild winter, gave German construction and thus overall output an unusual boost. Still, the GDP figures are too robust to suggest that the Frankfurt-based bankers were wrong to focus on inflation instead of growth. Especially as their easy-dollar colleagues across the Atlantic have been driving up global commodity prices with easier money.

Critics in Paris, Rome and other euro-zone capitals want ECB President Trichet to adopt an American -- dare we say, cowboy -- approach to price stability. They'll soon get additional ammunition. The first-quarter growth numbers offer a rear-mirror view of the economy. The road ahead will be bumpier.

Despite all the talk of recession, U.S. growth in the first three months was 0.6%, and may yet be revised higher. But just as America has slowed down, so will Europe. Euro-zone business sentiment and declining new orders point to perhaps as little growth as 0.2% in the second half of the year.

And yet it's hard to see how the bank, whose mandate is to maintain price stability, will be able to justify cutting rates as long as inflation is so high. Despite last month's fall in the consumer price index to 3.3% from 3.6% in March -- the first drop in eight months -- the continued oil price surge will likely see inflation jump back to 3.6% this month. The consensus is that inflation will stay at that level until autumn, when it may start to decline again. But it will likely remain above the ECB's comfort zone of 2% well into next year.

In this environment, a monetary shot in the arm would not only fuel inflation but hurt economic growth as well. Higher consumer prices are eating up real disposable income, which might decline by as much as 0.5% this year -- the first such fall this decade. Consumer spending will suffer just as the euro zone's other two growth engines -- exports and housing -- slow down. Printing more euros would only drive up inflation and further erode disposable income.

Other dangers lurk ahead. Wage agreements struck this year will likely increase euro-zone nominal salaries by more than 3%. Given productivity gains of only 0.8%, the pay hikes will lead to higher labor costs, which companies may be tempted to pass on to consumers.

The economic outlook suggests the ECB should and -- given recent performance -- will keep interest rates on hold. Some governing council members, such as Bundesbank head Alex Weber, have even raised the possibility that the next move may be a rate hike.

But the departure of two hawks from the ECB governing council this summer may strengthen the dove camp -- just as slowing growth and sticky inflation heat up the debate over ECB policy in coming months. Nicholas Garganas from Greece retires next month and Austria's Klaus Liebscher at the end of August. Mr. Liebscher's replacement is the Social Democrat Ewald Nowotny who has in the past criticized the bank's overriding focus on fighting inflation. Mr. Garganas's successor has not been chosen.

For the time being at least, Mr. Trichet is making clear where his priorities lie. Repeating Friday that price stability is the ECB's primary goal, he said that "there is no place for complacency." Mr. Trichet suggested that other central banks agree that their focus must be on calming inflation. "Now we have a world-wide consensus, almost a total consensus in seeing that it's important to stabilize medium-term prices," he said.

We'll have to see whether Fed Chairman Ben Bernanke shares the Frenchman's "total consensus." Luckily for Europe in these economically trying times, Mr. Trichet's commitment to fighting inflation has been more reliable than his peer's at the Fed.

Bring On the Foreign Policy Debate

By JOHN R. BOLTON

President Bush's speech to Israel's Knesset, where he equated "negotiat[ing] with the terrorists and radicals" to "the false comfort of appeasement," drew harsh criticism from Barack Obama and other Democratic leaders. They apparently thought the president was talking about them, and perhaps he was.

Wittingly or not, the president may well have created a defining moment in the 2008 campaign. And Mr. Obama stepped right into the vortex by saying he was willing to debate John McCain on national security "any time, any place." Mr. McCain should accept that challenge today.

The Obama view of negotiations as the alpha and the omega of U.S. foreign policy highlights a fundamental conceptual divide between the major parties and their putative presidential nominees. This divide also opened in 2004, when John Kerry insisted that our foreign policy pass a "global test" to be considered legitimate.

At first glance, the idea of sitting down with adversaries seems hard to quarrel with. In our daily lives, we meet with competitors, opponents and unpleasant people all the time. Mr. Obama hopes to characterize the debate about international negotiations as one between his reasonableness and the hard-line attitude of a group of unilateralist GOP cowboys.

The real debate is radically different. On one side are those who believe that negotiations should be used to resolve international disputes 99% of the time. That is where I am, and where I think Mr. McCain is. On the other side are those like Mr. Obama, who apparently want to use negotiations 100% of the time. It is the 100%-ers who suffer from an obsession that is naïve and dangerous.

Negotiation is not a policy. It is a technique. Saying that one favors negotiation with, say, Iran, has no more intellectual content than saying one favors using a spoon. For what? Under what circumstances? With what objectives? On these specifics, Mr. Obama has been consistently sketchy.

Like all human activity, negotiation has costs and benefits. If only benefits were involved, then it would be hard to quarrel with the "what can we lose?" mantra one hears so often. In fact, the costs and potential downsides are real, and not to be ignored.

When the U.S. negotiates with "terrorists and radicals," it gives them legitimacy, a precious and tangible political asset. Thus, even Mr. Obama criticized former President Jimmy Carter for his recent meetings with Hamas leaders. Meeting with leaders of state sponsors of terrorism such as Mahmoud Ahmadinejad or Kim Jong Il is also a mistake. State sponsors use others as surrogates, but they are just as much terrorists as those who actually carry out the dastardly acts. Legitimacy and international acceptability are qualities terrorists crave, and should therefore not be conferred casually, if at all.

Moreover, negotiations – especially those "without precondition" as Mr. Obama has specifically advocated – consume time, another precious asset that terrorists and rogue leaders prize. Here, President Bush's reference to Hitler was particularly apt: While the diplomats of European democracies played with their umbrellas, the Nazis were rearming and expanding their industrial power.

In today's world of weapons of mass destruction, time is again a precious asset, one almost invariably on the side of the would-be proliferators. Time allows them to perfect the complex science and technology necessary to sustain nuclear weapons and missile programs, and provides far greater opportunity for concealing their activities from our ability to detect and, if necessary, destroy them.

Iran has conclusively proven how to use negotiations to this end. After five years of negotiations with the Europeans, with the Bush administration's approbation throughout, the only result is that Iran is five years closer to having nuclear weapons. North Korea has also used the Six-Party Talks to gain time, testing its first nuclear weapon in 2006, all the while cloning its Yongbyon reactor in the Syrian desert.

Finally, negotiations entail opportunity costs, consuming scarce presidential time and attention. Those resources cannot be applied everywhere, and engaging in true discussions, as opposed to political charades, does divert time and attention from other priorities. No better example can be found than the Bush administration's pursuit of the Annapolis Process between Arabs and Israelis, which has gone and will go nowhere. While Annapolis has been burning up U.S. time and effort, Lebanon has been burning, as Hezbollah strengthens its position there. This is an opportunity cost for the U.S., and a tragedy for the people of Lebanon.

President Bush is not running this November, no matter how hard Mr. Obama wishes it were so. Mr. McCain will have the chance to set out his own views on when and where diplomacy is appropriate, and where more fortitude is required. In any event, from the American voter's perspective, this debate on the role of negotiations in foreign policy will be critically, perhaps mortally, important. Bring it on.

It's Time to Bust the Telmex Monopoly

By MARY ANASTASIA O'GRADY

It is a decade overdue, but Mexico finally has a clear path to ending the near-monopoly status of Telmex – Carlos Slim's Telefonos de Mexico. Whether President Felipe Calderón seizes the day will signal just how serious he is about modernizing his country's economy.

The cost to the economy of Telmex's dominance cannot be overstated. Lack of competition is the reason Mexicans pay some of the highest telecom charges in the developed world, according to a report last year by the Organization of Economic Cooperation and Development. It's also the reason Mexicans' access to telephone services – landlines and mobile – is "one of the lowest in the OECD." As a result, while the world forges ahead in the information age, Mexico is being left in the Stone Age.

Mexico finally has a clear path to ending Telmex's near-monopoly. But will President Felipe Calderón seize the opportunity? Americas columnist Mary Anastasia O'Grady reports. (May 18)

Good news came last week when the government ordered Telmex to provide interconnection to a key competitor. It is the first time since 1997, when Telmex's monopoly privileges ran out, that the government has been willing to enforce the terms of the 1990 concession title. That is the agreement signed at the time of privatization.

Even so, the ruling does nothing to solve the main cause of Mexico's inefficient and costly telecom market. Until Telmex is forced to provide competitive pricing to non-Telmex carriers that have to use the network, and simple number portability to customers who want to switch to other carriers, competition will not evolve. Telmex should also have to cease its practice of cross-subsidizing its telephony businesses.

Until now, Mr. Slim has been an immoveable object. When his monopoly privileges expired in 1997, regulators tried to make him provide network access, at competitive rates, to the other carriers. But by then he had gotten used to the spoils of the monopoly. Whenever regulators have tried to force competitive practices, he has used the courts to block them.

Mexico's largest special interest is also known for using his influence in the halls of Congress and with the executive. During the presidency of Vicente Fox (2000-2006), a former Telmex employee was miraculously named the minister of communication and transport. Judging from how little was accomplished under Mr. Fox, that minister wasn't shy about looking after his former boss's interests.

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Until now, Mexicans have been wary of crossing the powerful Mr. Slim, who is said to control 40% of advertising in the country. But the problems caused by Telmex's uncompetitive practices can no longer be ignored. To that end the telecom regulator, known by the Spanish acronym Cofetel, has drafted a proposal aimed at creating an environment where competition can flourish. The initiative calls for interconnection for all competitors at cost-based rates. It would also introduce an institutional framework similar to that of most OECD countries, and bring Mexico into compliance with the World Trade Organization.

The trouble is that Mr. Slim has already shown that he can litigate to eternity anything coming from the regulator. So even if the new regulation is adopted, Telmex is likely to use the injunction process to block its effectiveness. That is, unless Mr. Calderón trades Mr. Slim something for his cooperation.

Economic giants have gigantic appetites, and Mr. Slim's needs to be fed again. Having consumed Mexican telephony, he now wants to begin eating into the television market by delivering video. But the terms of his 1990 purchase of Telmex strictly forbid such an expansion.

So all the Calderón government has to do to tame the Telmex beast is to enforce the terms of the existing title concession. This would mean that the company would have to adopt accounting practices that avoid cross-subsidization. It also would mean making it clear to Mr. Slim that the Telmex concession title prohibits the provision of television services.

If Telmex wants to change the terms of that original contract so it can compete in video, Mr. Calderón should exact a price. If the company otherwise complies with its original obligations, the Cofetel plan can be put on the table, along with a fee, as the cost of a television license.

Standing firm on this point is important to the future of both television and telephony in Mexico. Right now cable companies are trying to deliver telephone services, but Telmex's interconnection rates are making it difficult to compete. Mr. Slim will crush these midsized competitors if he is allowed to offer video without opening telephony.

The Slim dynasty cannot prosper if it cannot expand into television. If Mexican regulators get smart and begin to aggressively privatize the wireless spectrum, its odds are even slimmer. That's why this is the moment to drive a stake through the heart of the Telmex monopoly. If Mr. Calderón passes up the chance, he will seal his own fate as a reformer and practically guarantee that Mexico will fail to live up to its potential in the next decade.

DAILY ECONOMIC DATA

Yes, We Have No Bananas

Back in 1979, before GDP growth had turned negative, Alfred Kahn, President Carter’s Chief Economist made a professional faux pas. He uttered the “R” word within earshot of the national press. Higher-ups in the White House quickly put the hammer to Dr. Kahn, suggesting that he never use the “R” word again.

To his credit, Alfred Kahn did not back down. He announced that from then on he would refer to the recession as a “banana.” He then began to say things like, “I think we are in for a serious banana.” He was funny, and he was right.

Twenty-one years later, in December 2000, Vice President-Elect Richard Cheney, told Tim Russert on Meet the Press that the US was probably on the “front edge of a recession.”

At the time, GDP growth was still positive and most economists felt a recession was highly unlikely.

The Clinton Administration, many economists and some of the pundit class immediately flogged Mr. Cheney, suggesting that talk of a recession by such a prominent leader was irresponsible. While he was right about the recession, Mr. Cheney refrained from using the “R” word in future public appearances.

This idea, that the use of the word “recession” by political leaders could cause fear and lead to a pull back in consumer spending, is not new. It can best be described as a Keynesian concept, and is clearly based on the idea that consumer confidence and “animal spirits” are a driving force behind economic growth.

For those who think this is silly, we were recently told by a senior economist in the Federal Reserve system that Cheney’s use of the “R” word probably helped cause the recession of 2001.

Despite this – despite the belief that using the word is damaging to the economy – there are few politicians these days not saying “recession.” The three senators, Clinton, Obama and McCain have all used the word recession multiple times, but no one is suggesting this is irresponsible. In fact, the media atmosphere has changed so much that a politician who does not think the US is in recession is now under suspicion.

Last week, President Bush was taken to task, especially in the blogosphere, because he refused to use the word recession. Instead, Bush said the economy was experiencing a “slowdown.” For this, the President is being described as rosy and unrealistic by Democrats.

Wow. What a turnaround. How can this be? How can it be so wrong to use the word “recession” in 1979 and 2000, but also wrong not to use it 2008? The world has surely turned upside-down.

The good news is that politicians and the press, no matter how negative or positive they talk, can’t actually change the direction of the economy.

Recessions and recoveries are caused by good and bad policy, not press conferences.

Kahn and Cheney were right because in both cases (1979 and 2000) the Federal Reserve had become tight enough to cause a recession. But all the talk of a recession today will be proved wrong because the Fed is not tight. In fact, the past 7 years of monetary policy has been the most accommodative since the 1970s.

As a result, no matter how much all this negative talk undermines economic emotions, and drives down consumer confidence, a recession is highly unlikely. The Fed is accommodative, tax rates are still low and productivity remains strong. As a result, the economy will prove resilient once again.