While Barack Obama was busy yesterday telling Wall Street to shape up, French President Nicolas Sarkozy spent this morning criticizing the entire economic status quo. The key issue in question: how the world tabulates economic growth, or GDP. We’ve always known that the metric was flawed; since GDP is simply a measure of all economic growth, things like natural disasters, traffic jams, and urban violence (all of which put people and money to work even as they wreak havoc) can actually raise a country’s overall GDP. But never has anyone seriously tried to come up with a better way to calculate growth. Until now: at the behest of Sarkozy, a team of superstar economists, headed by Nobel laureate Joseph Stiglitz, have just unveiled some new ways to tabulate a country’s economic health. See below the dispatch from NEWSWEEK’s Tracy McNicoll, who attended the unveiling of the Stiglitz Report in Paris this morning:

In the magnificent Grand Amphitheatre of the Sorbonne in Paris's ancient student quarter this morning, Sarkozy spoke to a group of modern economic luminaries and other guests, with backlit marble statues of great scientific philosophers like Descartes and Pascal peering down at him from their perches. He waxed lyrical about the band of experts he'd commissioned 19 months ago to redefine how economic well-being is measured. The result was a 300-page report that blends science and philosophy. Even its authors admit it is meant only to open the debate, not conclude it.

Sarkozy had initially called on the group in February 2008 to tackle the gap between people's perceptions of their own day-to-day economic well-being and what politicians and statisticians were telling them about the economy. The disconnection between the two has increasingly led to a lack of trust in government and politicians around the world. As Sarkozy put it today, “Nothing is more destructive for democracy.”

When the project began, virtually no one─with the notable exception, perhaps, of Stiglitz himself─would have guessed that there was a violent recession looming. But the crisis made the commission's work all the more relevant, as the world searches for a more sustainable way to grow in the future. “In an increasingly performance-oriented society, metrics matter. What we measure affects what we do,” Stiglitz said today. “If we have the wrong metrics, we will strive for the wrong things. In the quest to increase GDP, we may end up with a society in which citizens are worse off.”

The report recommends shifting economic emphasis from simply the production of goods to a broader measure of overall well-being, which would include the benefits of things like health, education, and security. It calls for greater focus on the effects on income inequality, as well as new ways to measure the economic impact of sustainability (climate change specialists like Nicolas Stern are members), and recommended ways to include the value of wealth to be passed on to the next generation into today's economic conversation. What it didn’t do is come up with a quick and easy new way to tabulate a new measure of wellbeing. Some of the necessary yardsticks already exist; others still need to be invented.

Still, Sarkozy said he plans to shop the report all over the world. “France will open the debate on this report's conclusions everywhere. It will put it on the agenda of every international conference, every meeting, every discussion where building a new economic, social, and ecological order is the objective,” he told the Sorbonne crowd. “France will fight for every international organization to modify their statistical systems by following the commission's recommendations. It will propose to its European partners that Europe set the example by putting them into action. [France] will adapt its own statistical machinery in consequence,” he promised. Even the commission's rapporteur admitted he wasn't expecting Sarkozy's strong reaction.  

Stiglitz himself has been championing the cause for some time. He recalled this morning how, as head of President Bill Clinton's Council of Economic Advisers, he had put forward some of the same ideas. But, says Stiglitz, “We met such political resistance that our initiatives were thwarted.” In Sarkozy, Stiglitz has found a better advocate─perhaps in no small part because France’s own economic health would look a lot better using the alternative metrics.

Here’s a rare bright spot as a result of the global financial crisis. The World Bank’s Doing Business Report, which tracks how easy or hard it is to start new businesses in various countries around the world, is just out today, and more countries than ever are slashing red tape around starting businesses. Even as governments are getting more heavy handed in regulating banks and financial institutions, they are lighting things up for entrepreneurs – government reforms aimed at making it easier to start a company are up 20 percent this year, the highest jump since the survey started in 2004.

What’s interesting is that poor countries have taken the lead  – Eastern Europe, Central Asia, and Africa are cutting the time and money involved in starting new businesses most quickly, in large part because they’ve been hit hardest by the financial crisis. “For developing countries, this is a jobs crisis that effects their real economy – their policy moves are all about trying to create new jobs,” notes Neil Gregory, one of the World Bank directors who worked on the project. Even the Middle East and North Africa, areas traditionally reluctant to liberalize, are encouraging more business-friendly reform thanks to the collapse in oil prices from their high in the summer of 2008.

Will the tide turn once the good times are back? Unlikely, say World Bank experts – once countries start down the path of red tape cutting, there’s usually little impetus for them to reverse laws, since the job growth tends to lead to new jobs and thus new tax revenue. Good news for bureaucrats everywhere.

When Morgan Stanley Asia chairman Stephen S. Roach talks, people listen -- his opinions on the global economy have been known to trigger policy shifts from Beijing to Washington. For years, as Morgan Stanley’s chief economist, he was one of the Cassandras of the global economy, warning boom-day investors to be wary of the imbalances that eventually led to the financial crisis. Now, as the bank’s top executive in Asia, he’s written a new book, “The Next Asia,” published September 29^th in the U.S. The warning this time -- while this may be Asia’s century, the coming power shift from West to East won’t be as easy as everyone thinks. Below, he sounds off to NEWSWEEK’s Rana Foroohar.

Foroohar: How did the financial crisis change your view on the future of Asia?

Roach: I think it was a real wake up call for the entire Asian export led growth model. It puts the underpinnings of this in perspective – if the US consumer is in the early stages of a long term pull back, as I suspect, then Asia has big problems.

In your book, you talk a lot about the four “uns” of the Chinese economy -- what are these and how did you identify them?

I was in Beijing at the end of the national people’s congress in March 2007. The premier was speaking in the great hall of the people, and I was sitting not too far from him with some very senior Chinese officials. During the course of the speech, he said that “on the surface, the Chinese economy looks terrific, but below the surface, it’s unbalanced, unstable, uncoordinated, and unsustainable.” Before the English translation came through, the most senior official near me gasped. So, I knew whatever he had said was going to be big. Following that speech, I thought a lot about what he had said, and how the four “uns” were going to influence the course of China’s future.

It’s been a turbulent year in China, with the Uigher unrest and deaths in Xinjiang province this year, but also the amazing 2nd quarter GDP figures (growth was up 17 percent), which have inspired trust in the government. What’s your sense of the level of political risk in China at the moment?

The key issue is always employment, which was hit very hard this year due to the export crash in Guangdong province. More than 20 million migrant workers lost their jobs there, and this is a huge factor in social stability. Of course, the government knows that growth is the antidote, and that’s why the fiscal stimulus plan pulled out all the stops, and bank lending soared. While I’m not one of the people who believe there is major political risk in China at the moment, there could be problems longer term if growth slows.

And what’s the risk of that?

I think China will keep its momentum through the first half of 2010, but after that, if the US continues to be weak, exports in China will continue to lag and then it’s very possible you’ll see more unemployment. The government will undoubtedly respond in the same way, launching a massive stimulus with big infrastructure projects and lots of lending. So, you’ll have more of the same -- and the economy will become even more unbalanced (already, government investment is up to 50 percent of GDP, which is unprecedented).

There’s a sense that the Chinese have managed the financial crisis as well or better than any country. Would you agree?

When they released the 2Q GDP figures, there were a lot of congratulations internally and externally. But then they started getting more critical feedback. I wrote a piece in the FT saying that they’d sacrificed quality for quantity in terms of growth. And, to their credit, the leadership responded, both in terms of slowing bank lending and sending signals that a cooling of the stock market would be fine. I’m encouraged by that.

What’s the biggest myth about Asia right now?

The perception that the baton of economic leadership is seamlessly being passed from West to East. There’s a romance about the BRICs, or Asia, or China itself picking up effortlessly from the tired and over-burdened American consumer. All of this is premature. The basic premise of “The Next Asia” is that there’s still a lot of work to be done.

You dedicate your book to the 1.8 billion Asians “who remain on the outside looking in,” meaning those living on $2 a day or less. What’s the single most important thing that could be done to help these people?

Microfinance. What do you want -- foreign aid from your rich uncle, or the opportunity to empower yourself? There’s a lot of evidence now that microfinance can play a huge role in economic development.

You’ve traveled widely in Asia. Who have you met there that you admire most?

I think the heads of the major Indian conglomerates are very impressive. Mukesh Ambani (of Reliance) in particular stands out. This is a company that started in energy, then moved into telecoms, agriculture, retail, and did it all within a poor and complex Indian business environment. We could learn a lot from these companies.

During a recent trip to Japan, New York University economist Edward Lincoln was surprised to find executives at Toyota wringing their hands─not about sales, which were down 27 percent since the beginning of the year thanks to the global recession, but about their new position as the No. 1 automaker in the world. They nabbed the top spot last year after GM imploded. But Lincoln says that the Japanese automaker has come to realize that being the top dog means that you have to set the agenda for the rest of the industry, and also fend off all the people trying to knock you off the podium─a tough spot to be in

[MORE AFTER THE JUMP]

If she felt so inclined, Hillary Clinton could probably take it easy in Africa this week. That's what the numbers seem to imply, anyway. U.S. leaders enjoy some of their highest job performance ratings there, up even further from their dizzying heights during the Bush administration, according to a Gallup poll released Monday.

In Kenya, for example, where she kicks of her seven-country tour of the continent on Wednesday, 93 percent of the population approves of U.S. leadership. That's up from 82 percent last year. Among the seven countries surveyed, the median approval rating sits happily at 87 percent, up from 80 percent last year.

Not surprisingly, a lot of that has to do with Clinton's boss. Africans are enormously excited about the Obama presidency. Obama earned himself even more goodwill with his recent stop in Ghana. And the fact that Clinton's trip this week is the longest she's taken since assuming her diplomatic post earns the administration even more brownie points.

But even with all that good cheer in the air, Clinton is in for a bumpy ride--and that's largely her own doing.

[MORE AFTER THE JUMP]

Political infighting in Iran heated up yesterday when some of President Mahmoud Ahmadinejad’s conservative supporters warned him that he might not get a second term in office if he doesn’t start towing the line. The warnings came off the back of a tiff over the last couple of weeks between Iran’s Supreme Leader Ali Khamenei and Ahmadinejad, in which the former warned the president to get rid of his right hand man, Esfandiar Rahim Mashaie, who was perceived as being a bit too friendly towards Israel. The president ultimately bagged his number two, but only after taking his own sweet time – a slight to Khamenei.

While the conflict is portrayed as a relatively recent event off the back of the election turmoil, the fact is that Ahmadinejad has been increasingly on the outs with conservatives in Iran for many months now, and not because of Israel but because of the economy, which he has notoriously mismanaged. His ill-thought out energy and monetary policies as well as runaway public subsidies have resulted in double digit inflation, rising unemployment, and blackouts. Under Ahmadinejad’s watch (and the highest oil prices in decades) the country has become a net gas importer, despite its vast natural resource wealth.

A faltering economy was a key issue in the June 12th elections, but the problems go back farther than that. In January, as the price of oil was falling, the Supreme Leader announced that Iran’s new five year development plan, set to come into effect next year, would funnel 20 percent of the country’s oil and gas revenues into a new development fund separate from the Oil Stabilization Fund, which, according to many analysts, Ahmadinejad has plundered wildly. “There should be tens of billions of dollars left in the fund, and it’s not at all clear that there are,” says Alireza Nader, an Iran analyst at the RAND Corporation. “What is clear is that Ahmadinejad gave a lot of the oil money earned in the boom days to friends in the Revolutionary Guard, and to companies started by former Guard officers, often in the form of loans and no-bid state contracts.” RAND estimates that such companies, while typically corrupt and inefficient, are now the biggest economic players in Iran, with far-reaching influence in key sectors like manufacturing, construction, and banking.

Analysts inside and outside of Iran say that the creation of the separate fund is proof that the Supreme Leader was beginning to sideline the President, or at least stop him from wreaking more economic havoc, months ago. Now, the political fault lines in Tehran are growing ever more apparent, and that will likely make the country even tougher to govern in the coming months. The implication for markets, according to Eurasia Group Director Cliff Kupchan is “an even further reduced chance that diplomacy with the U.S. will be successful.” That means investors will be less likely to want to put much needed investment into Iran, and that could further destabilize the economy, regional trade, and possibly even oil exports. If that happens, the effects would reach far beyond Tehran.

Hilary Clinton, Tim Geithner and their Chinese counterparts are busy in D.C. at the first ever China-US Economic and Strategic Dialogue, a high level pow-wow in which the world’s 800 pound gorillas will try and smooth over issues like China’s supposed currency manipulation, trade conflict, disagreements over climate change and worries about the future of the dollar. As president Obama put it yesterday when opening the session: “We can’t predict with certainty what the future will bring, but we can be certain about the issues that will define our times. And we also know this: The relationship between the United States and China will shape the 21st century, which makes it as important as any bilateral relationship in the world. That really must underpin our partnership. That is the responsibility that together we bear.”

The relationship between China and the US is often portrayed as an edgy powder keg of misaligned interests that will inevitably explode at some point when China tries to buy the next big energy company or the U.S. institutes some ill-thought out trade protectionism. I think this is wrong. I actually believe that China and the U.S. are going to become much closer in the years ahead, and that many of the supposed conflicts will never come to pass. Cases in point:

1. The Chinese won’t sell off T-bills. I get so annoyed when TV pundits posit this idea that China is going to someday suddenly dump the $1 trillion in T-bills that it is holding and crash the U.S. economy. Guys, listen up – if they ever did this, their own economy would be the first to tank. What’s more, even if they started moving out of T-bills and towards, say, euros (which they aren’t doing right now), it would take decades for the two currencies to reach parity, during which time all the economies in question would adjust to the new reality. The dollar is going to be less important as a global currency in the LONG run. But the Chinese are in a co-dependant economic relationship with us – if we go down, so do they.
2. The Chinese won’t start a major war over energy. Yes, their demand for natural resources like oil, minerals, water and farmland is increasing rapidly (which has been a very good thing for commodities prices). And yes, some of their recent attempts to buy Western commodities companies (like Rio Tinto, or Unocal a few years back) have been contentious. But let’s get real – the Chinese now have modern, multinational companies that are simply trying to do business by the rules that we set up – they want to acquire companies to meet their growth needs just like anyone else. It’s quite possible that Chinese energy demands will help fuel continuing civil war in places like Africa, where various factions fight for control of natural resources. But those would have happened anyway – commodities nations are simply more prone to conflict no matter who the buyers are. Ultimately, China, the US and other major resources consumers will realize it’s in their best interests to cut joint deals rather than go to war over resources.
3. There won’t be a trade war between the U.S. and China. We heard a lot about “Buy America” a few months ago, but then it sort of went away. Then, a month ago, the Chinese instituted a “Buy China” clause. At first, this ruffled a lot of feathers, but its impact will be negligible. The Chinese might be able to offer subsidies to consumers to buy their own cheap electronics and white goods, but they still need to import all the complex machinery and natural resources to run their factories, and the middle classes would much rather consume upscale retail products made in the US and Europe than buy no-name home brands (at least right now). What’s more, the Chinese know that they’ll suffer most in any trade war – the US and Europe are their biggest trade partners.

While I don’t expect any major economic news to come out of the summit – just more of the same noises we’ve been hearing (say no to protectionism, manage the fall of the dollar and the rise of the yuan, etc), I do think it will be interesting to see how the Chinese-US political relationship develops going forward. Historically, Japan has been the major ally in the Asia-Pacific region. The Obama administration has made it clear that they’d like China to play that role in the future. What kind of a best friend will they be? Watch this space.

I want to respond to a reader who commented on yesterday’s post about the possibility that the U.S. dollar might be replaced by a new type of currency known as an “SDR”:

Reader: "[You suggest in your post that] 'Americans won’t be able to live quite as large as they have in the past.’ This is a vague statement. What exactly does it mean?  Does it mean that the value of the dollar is going to drop?   Maybe the author is purposefully being vague, because she is uncertain about the implications of issuing more SDRs?"

Apologies for sounding vague, but in fact, I can be quite specific about what would happen if the dollar was no longer the world’s major reserve currency. For starters, yes, the value of the dollar would drop, thus dimishing the wealth of the average American. But that’s going to happen anyway. The value of any currency tends to be correlated with the underlying strength of its economy. It’s been clear for sometime that the American government and the American consumer are carrying too much debt. Ultimately, that’s not good for either the U.S., or all the many countries that hold dollars as their main reserve, because endless amounts of American debt will eventually result in inflation that will devalue dollar assets.

The idea behind the SDRs is to break the dysfunctional economic relationship between the U.S. and the big export nations like China. Americans are encouraged to keep spending themselves into oblivion because it’s so cheap for them to do so, since the dollar is artificially buoyed by the rest of the world, in particular Asian exporters like China which would do a lot better to spend their surpluses on improving the lives of their own people rather than buying lots of dollars and burying them in the ground.

Theoretically, using a basket of currencies as the world’s reserve would bring more stability to the global economy by breaking this cycle. That could, eventually, help the dollar rebound (though probably not to its record highs). But first, as I said in yesterday’s post, the SDRs would have to be widely traded – and that’s not going to happen overnight. Hope this clears things up.  

Mac Margolis wrote last week about how the reliable democracies of Latin America have stood idly by while their more volatile neighbors eroded democratic institutions like legislatures and constitutions. Here, Ecuador's man in Washington responds:

There once was a time in the United States when only land-owning white men were allowed to vote. At the time it was called a democracy, although most citizens were excluded. 

Your correspondent Mac Margolis seems to long for such a time. Clearly he fears majority rule in Central and South America and disapproves of leaders who "exacerbate the region's class and race pathologies" by encouraging poor and indigenous people to vote and participate in their government.

[MORE AFTER THE JUMP]

Generally speaking, the UN gets low points for shock value on the Arab Human Development report it released today, the gist of which can be reduced to war = insecurity = bad for business. But Chapter 5, the economy section, deserves a look for two big reasons.

Reason A: The GDP Rollercoaster Ride

UNDP Arab Human Development Report 2009

 

If there were ever any question as to the extent of the MENA region's volatility, this should pretty much clear it up. After all the intense ups and downs of the multi-decade roller coaster ride, the region's per capita economic growth has hardly changed at all since 1980.

[MORE AFTER THE JUMP]

Some interesting news today on the currency front. Remember all the hoopla a few months ago about how the dollar was going to be replaced by a wacky new IMF backed currency that went by the acronym “SDR” – or special drawing rights? China was calling for the new system, and U.S. Treasury Secretary Tim Geithner didn't rule it out. Well, the IMF is now on the verge of taking a big leap towards this new system, with a proposal to increase the supply of these SDRs (which are basically just a bundle of several currencies including the dollar, yen, sterling, and the euro) by eightfold. The IMF will vote on the measure on August 7^th and would start issuing the new currency by the end of the month.

If it passes, this would be the first time the IMF would have increased the number of SDRs since 1981 – a pretty substantial shift. It doesn’t mean the dollar is going away – it still makes up 44 percent of the composite of the SDRs. But it does mean that the world is taking a big step away from the dollar as the de-facto global reserve currency. “The decision could mark a watershed moment in the evolution of global monetary relations,” say the folks at Capital Economics in London, who put out a smart note on the topic this morning. But for that to happen, many more parties would have to hold and trade the SDRs. Right now, only central banks and big government institutions can trade them.

What does all this mean for you? Ultimately, it means Americans won’t be able to live quite as large as they have in the past, since the dollar will become less important. But it also means that other countries around the world (who could potentially exchange SDRs for their local currencies) could live larger. That could be good for purchasing power, but could also fuel inflation and create a lot of volatility in currency markets. Which, of course, also means investment opportunities. Stay tuned.

Readers will be forgiven for not feeling like the economy is in recovery─American trade is down, unemployment is nearing 10 percent (closer to 20 in some parts of the country, if you count people who’ve stopped looking for work), and housing foreclosures are higher this year than last. Yet the global economy recovery is upon us, according to the number crunchers. The IMF just raised their projections for global growth to 2.5 percent from 2 percent─the first upward tick since the crisis began.

What’s really interesting to me is that U.S. is actually leading the recovery, in part off the back of our corporate profits, which are at record highs, despite the financial crisis. Of course, this again might not feel great to most folks. Why should bankers at “Golden Sachs” be taking home loot again so soon after a bailout? Yet the fact that at least some of the big banks appear to be back on their feet is actually good news for the larger economy. And in many ways, it speaks to how much better American policymakers handled this crisis than their European counterparts, despite stumbles along the way. Europeans are still doing stimulus in dribs and drabs and hoping the whole problem will go away.

Unfortunately for them, things will likely get worse in Europe before they get better. I spoke today with Chris Willliamson, chief economist for Markit, a global financial market research firm, who told me that rates of economic decline in Germany, Italy, and Spain are still comparable to the post 9/11 period. Things are not stabilizing in these countries─Spain is in the midst of a real-estate crash, Italy is risking sovereign default, and German consumers have their wallets zipped up tight, thanks to the fact that their big export businesses are in major decline. The French are holding steady, but only just. The entire eurozone is flat, as the U.S. and U.K. move ahead.

This is just the opposite of what folks were predicting six months ago. So much for the triumph of the Continental model of capitalism.

For more on the shape of the recovery in the U.S. and the rest of the world, check out our packages in next week's print editions.

How can we predict the next bubble? That’s the $64,000 question, and while nobody has an answer, Goldman Sachs made some interesting observations in a research paper they put out this week entitled “The Twilight Zone.” This is what the bank is calling the most sensitive period in the economic cycle, the one that comes right between a boom and a bust.

Previously, economic cycles were basically thought to have just two parts─theoretical models that the rocket scientists in major banks use to try and forecast the future generally have a “boom” line and a “bust” line. But the Goldman paper posits another period─the Twilight Zone period─which generally lasts between a few months to a year. It’s during this tipping-point period that investors can find clues to the next bust.

But which of the many hundreds of commonly tracked economic figures should investors be looking at to predict the next crash? Probably whatever data point that was most important to supporting the boom in the first place. For example, the 1920s boom in America was supported by a credit expansion that led to a huge increase in consumer spending (sound familiar?). But several months before the stock market crash, factory outputs of things like cars had started to decline sharply─a sure sign that consumers had stopped spending, and black clouds were on the horizon.

The same thing goes for other crashes, like the Latin American debt crisis, in which capital flight began a year prior to the various sovereign defaults, and the Asian crisis, which investors might have foreseen had they been looking at the sharp fall in external reserves in Thailand (which had attracted some of the hot money fueling the region’s boom).

Of course, hindsight is 20/20. But this report serves as a reminder that where you see smoking hot assets, you may very well soon see fire.

Check out this very interesting article from GlobalPost about how the financial crisis has led to a spike in conflict and violence around the world this year. As the author, Thomas Mucha, notes, "economics matters." Don't we know it.

By the way, one other point on this topic that I would draw out: natural-resource prices have been as volatile as they've ever been over the last 12 months. Given that the majority of conflict happens in commodities-rich areas, that's probably a key catalyst for the growing violence as well.

Could the next bubbles already be brewing, this early in a recovery? That’s what a number of sources I speak with have been saying in the past few weeks. Economists are worried about the price of oil, minerals, and other commodities─even though they’ve taken a slight dip in the past few days, they are still at prices far higher than usual at this point in the economic cycle. Ditto U.S. and European stocks, and especially emerging-market equities, which are really booming as everyone continues to dream of the days of double-digit returns. Even real estate is spiking again in places like China, Hong Kong, and a handful of other big cities in developing countries.

What’s driving this? An excess of spare cash around the world. Despite the downturn, there are still plenty of people holding lots of money on the sidelines, and they are itching to find a place to put it. If I had to pick the most worrisome bubble of the moment, I’d probably look east to China. Since last December, Chinese banks have given close to a trillion dollars in loans to help companies expand (year-on-year lending was up an unbelievable 1,000 percent at the start of this year). When I was in China in May, even bankers at state- run institutions were starting to worry that not all of this money was making its way into the real economy, and that much of it was being recycled into the stock markets and housing, possibly setting the stage for the next big painful bubbles there.

Policymakers in China and elsewhere are going to be reluctant to take any action around brewing bubbles right now, because the recovery isn’t yet entrenched. This is worrisome, because it could set the stage for yet another boom-bust cycle (more on that in a future cover story from our Morgan Stanley columnist, Ruchir Sharma). I wonder when we might once again enter the period that Goldman Sachs chief economist Jim O’Neill calls “the Twilight Zone”─a delicate time between boom and bust. This is when “the economic fundamentals that support a boom begin to break apart, but a future bust also becomes more likely.” This period must be managed with care by politicians. Tomorrow, I’ll blog more on the Twilight Zone and how we might make our way out of it unscathed in the future.