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The uprisings in the Arab world and the U.S.-European military intervention in Libya are currently driving transatlantic policy discussions. However, the ongoing Eurozone crisis and the fate of debt-laden countries remain issues of concern for both Europeans and Americans. Other critical challenges are also consuming Europe’s attention: reversing the economic slowdown and regaining competitiveness; dealing with rising populism and public opinion backlash against the influx of North African refugees; and forging a common foreign policy that can both respond to changing political and economic developments and enhance the European Union’s role in a new multipolar world.

On May 26, the Center on the United States and Europe at Brookings (CUSE) and the Heinrich Böll Foundation hosted experts and top officials from both sides of the Atlantic for the 2011 CUSE annual conference. Panelists explored critical issues shaping the future of transatlantic relations, from the euro crisis to how the United States and Europe can craft a common response to the wave of democratic uprisings in the Arab world.

After each panel, participants took audience questions.

Audio

• Europe's Future in a Turbulent World
• Europe's Future in a Turbulent World
• Europe's Future in a Turbulent World

Transcript

• Full Transcript (.pdf)
• Panel 1 Transcript (.pdf)
• Panel 2 Transcript (.pdf)
• Panel 3 Transcript (.pdf)

Event Materials

• 20110526_europe_future
• 20110526_europe_future_panel_one
• 20110526_europe_future_panel_two
• 20110526_europe_future_panel_three

       

       

       

       

       

In the last two months China has executed a decisive change in its policy for managing its currency, the renminbi. Ending an eight-year period of slow but relentless appreciation against the U.S. dollar, the People’s Bank of China (PBOC) engineered a swift devaluation of about 3 percent, and doubled the size of the currency’s daily trading band. These moves took financial markets by surprise and sowed confusion. Was Beijing simply trying to re-ignite export growth by making its currency cheaper? Or was it making a more fundamental shift?

The answer is straightforward. China has taken a huge step towards making its exchange rate more flexible and market determined. In doing so, the authorities have clearly signaled their intention to switch from a monetary policy that mainly targets the exchange rate, to one that mainly targets domestic interest rates. The change in renminbi policy is thus part of a broad and ambitious financial reform strategy, reflecting the agenda laid out last November in the “Decision” published following the Third Plenum of the 18th Party Congress. It is all about improving China’s macroeconomic management, and has little or nothing to do with boosting exports.

Four Phases of China’s Exchange Rate Management

To understand the significance of the new renminbi policy, some background is helpful. The history of China’s exchange rate management can be divided into four phases. In the first, from 1979 to 1994, there was a steady depreciation in order to wean the country off the artificially overvalued exchange rate inherited from the previous period of Communist autarky. During this period Beijing maintained a dual exchange rate system. This consisted of an official rate, still overvalued, but gradually converging toward reality, which essentially applied to the capital account; and a more market based “swap rate” which was available to exporters. The purpose of this arrangement was to enable a competitive (though rudimentary) export economy to develop while still keeping the local price of imported capital goods relatively low, and avoiding the collapse in living standards that a full-on depreciation would have caused.

The second phase was a brief transition period in 1994-1995 when the two exchange rates were combined and the currency was allowed to float more or less freely in order for fair value to be established. In late 1995 the value of the renminbi was fixed at a rate of 8.3 against the U.S. dollar, initiating the third phase—a hard peg against the U.S. dollar—which lasted until July 2005.

It’s important to recall that the first test of this regime was the refusal to devalue in 1998 in the wake of the Asian financial crisis, when the currencies of the countries with whom China was then competing for export orders all fell dramatically. Rather than devaluing to help out exporters, Beijing hardened its peg. This was costly: China’s exports flatlined in 1998, and arguably the relatively strong currency played a role in the deflation that China suffered for the next four years. One reason the government hardened the peg, rather than devaluing, was to establish that China was a dependable player in the world system and that its currency could be relied on as a store of value. The short-term hit to exports was more than offset by the strategic gain in China’s reputation as “responsible stakeholder” and a safe place for foreign direct investment.

The hard peg against a declining U.S. dollar led eventually to a depreciation of the trade-weighted, inflation-adjusted exchange rate (known as the real effective exchange rate, or REER) that contributed to the exploding exports and ballooning trade surpluses of the early 2000s. This in turn prompted the fourth phase of Chinese currency policy: a crawling peg against the U.S. dollar, starting in July 2005. Each day, the PBOC fixed a reference rate for the renminbi against the dollar, and permitted the currency’s value to fluctuate within a narrow band around the reference. The daily trading band was initially set at 0.3 percent (in either direction), and subsequently widened to 0.5 percent in 2007 and 1 percent in April 2012. Over eight years, the crawling-peg system delivered a 35 percent appreciation against the U.S. dollar and a 40 percent appreciation of the REER.

In light of the vociferous criticism China endured for its undervalued exchange rate, it is striking in retrospect how swift Beijing was to change its currency regime once a serious external imbalance appeared. As late as 2004, China’s merchandise trade balance was around 2.5 percent of GDP, just slightly above the 15-year average. In 2005 it jumped to 5.5 percent, and the decision to let the currency rise was immediate. At first the rise was too timid, and the trade and current account balances continued to expand. But by mid-2007 the appreciation pace picked up to 5 percent a year. The ultimate result of the crawling-peg regime was a reduction in the current account surplus from its peak of 10 percent of GDP in 2007 to the measly 0.8 percent recorded in the first quarter of 2014.

As the above account makes clear, mercantilist motives historically played a secondary role in China’s exchange rate policies—and after 2007 China pursued an anti-mercantilist policy of deliberately shrinking its trade surplus. Beijing’s bigger concerns were the exchange rate’s role in facilitating a broad shift from administered to market prices (1978-1995), as an anchor for monetary policy (1995-2013) and as instrument for correcting an external imbalance and promoting a shift in favor of domestic demand (2007-2013). Lying in the background was the idea that a relatively stable exchange rate was strategically beneficial. After the Asian crisis, foreign investors were reassured that China was a safe place for direct investment; and after the 2008 global crisis the case for the renminbi as an international trade-settlement and portfolio investment currency was strengthened.

Given this history, we can safely rule out the theory that this year’s devaluation is a tactic to boost exports at a time of flagging domestic demand. An explanation that better fits both the recent facts and the historical context is that, in line with the Third Plenum Decision, Beijing wanted to make the exchange rate more flexible and market-determined. But it faced a problem: for almost 18 months from September 2012, the daily market rate of the renminbi was at or near the top of the 1 percent trading band, because investors assumed (rightly) that the Chinese currency would always go up: it was a “one-way bet.” The one-way bet caused large-scale capital inflows that were routinely much larger than the monthly trade surplus. Under these conditions, if the central bank had simply widened the daily trading band, traders would quickly have pushed the value of the currency to the top of the new band, and even more capital would have flowed in. To prevent this outcome, the PBOC in late February starting pushing down its daily fixing, and ordered Chinese state-owned banks to sell renminbi and buy dollars. In mid-March, when the “one-way bet” psychology had been chased out of the market, PBOC doubled the daily trading band to 2 percent.

Welcome to the Managed Float

It is clear that China has entered a new phase of currency management, and the rulebook that has worked well since 2005 must be heavily revised. Two observations inform this judgment. First, the main aims of the strong renminbi policy have been achieved. The current account surplus has been virtually eliminated, and at least one serious technical study of the currency (by Martin Kessler and Arvind Subramaniam of the Peterson Institute for International Economics), the structural undervaluation of the renminbi has been eliminated.

Second, the adoption of a 2 percent daily trading band means that, on a day-to-day basis, the renminbi rate can now be determined mainly by the market most of the time (since only at times of extreme stress do currencies move more than 2 percent in a day). This newfound capacity seems consistent with the broad aim articulated in the Communist Party’s reform agenda last November, of having market forces play a “decisive role” in resource allocation. A willingness to let the currency float more freely is also consistent with the apparent agenda to liberalize deposit interest rates within in the next two years, which implies shifting from a monetary policy that mainly targets the exchange rate to one that mainly targets a domestic money-market interest rate.

It is also clear, however, that the renminbi will not simply be left to its own devices: the float will be a heavily managed one. Mechanically, it will likely operate much like the Singapore dollar “basket, band and crawl,” or BBC system, with an undisclosed trade-weighted index target, a 2 percent daily trading band puts a limit on extreme movements and a periodic readjustment of the slope of the policy band to prevent a major misalignment of the currency emerging (as it did at the end of China’s hard-peg era).

Strategically, the two most important aims of Beijing’s exchange rate regime will be maintaining stability of both the current and capital accounts, and providing support for the emergence of the renminbi as a serious international currency. (For an analysis of the renminbi-internationalization drive, see China’s Global Currency: Lever For Financial Reform.)

The first factor basically means that when capital flows (in or out) threaten to become destabilizing, the PBOC will use the exchange rate to reverse those flows; the same applies to extreme movements in the current account. In effect, Beijing will try to keep both parts of the balance of payments in roughly neutral position, while it undertakes deep reforms of the domestic economy.

The second aim means that sustained depreciation is unlikely to be tolerated, since as the new kid on the block the renminbi still must convince global investors that it is a reliable store of value over the medium to long term. Yet intolerance for sustained depreciation is perfectly compatible with significant short-term depreciations lasting several months or more, to correct current or capital account imbalances. The days of the one-way bet are over.

The bottom line is that Beijing has made a decisive commitment to a much more flexible and far more market-driven exchange rate—exactly what the U.S. Treasury Department and the International Monetary Fund have been suggesting for years. This commitment means that the exchange rate will cease to be a major point of friction between China and its trading partners. The interesting question now is how quickly China will follow up with the even bigger task of liberalizing its domestic financial system.

       

Financial advisors offer their clients many advantages, such as setting reasonable savings goals, avoiding fraudulent investments and mistakes like buying high and selling low, and determining the right level of risk for a particular household. However, these same advisors are often incentivized to choose funds that increase their own financial rewards, and the nature and amount of the fees received by advisors may not be transparent to their clients, and small-scale savers may not be able to access affordable advice at all.  What is in the best interest of an individual may not be in the best interest of his or her financial advisor.

To combat this problem, the Department of Labor (DoL) recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code.  The proposed conflict of interest rule is an important step in the right direction to increasing consumer protections.  It addresses evidence from a February 2015 report by the Council of Economic Advisers suggesting that consumers often receive poor recommendations from their financial advisors and that as a result their investment returns on IRAs are about 1 percentage point lower each year.   Naturally, the proposal is not without its controversies and it has already attracted at least 775 public comments, including one from us .

For us, the DoL’s proposed rule is a significant step in the right direction towards increased consumer protection and retirement security.  It is important to make sure that retirement advisors face the right incentives and place customer interests first.  It is also important make sure savers can access good advice so they can make sound decisions and avoid costly mistakes.  However, some thoughtful revisions are needed to ensure the rule offers a net benefit. 

If the rule causes advisors’ compliance costs to rise, they may abandon clients with small-scale savings, since these clients will no longer be profitable for them.  If these small-scale savers are crowded out of the financial advice market, we might see the retirement savings gap widen.  Therefore we encourage the DoL to consider ways to minimize or manage these costs, perhaps by incentivizing advisors to continue guiding these types of clients.  We also worry that the proposed rule does not adequately clarify the difference between education and advice, and encourage the DoL to close any potential loopholes by standardizing the general educational information that advisors can share without triggering fiduciary responsibility (which DoL is trying to do).  Finally, the proposed rule could encourage some advisors to become excessively risk averse in an overzealous attempt to avoid litigation or other negative consequences.  Extreme risk aversion could decrease market returns for investors and the ‘value-add’ of professional advisors, so we suggest the DoL think carefully about discouraging conflicted advice without also discouraging healthy risk.

The proposed rule addresses an important problem, but in its current form it may open the door to some undesirable or problematic outcomes.  We explore these issues in further detail in our recent paper.

      

Introduction

I would like to thank the Department for giving me the opportunity to testify on this important issue. The document I submitted to you is more general than most of the comments you have received, talking about the issues facing retirement savers and policymakers, rather than engaging in a point-by-point discussion of the detailed DOL proposal¹.

Issues around Retirement Saving

1. Most workers in the bottom third of the income distribution will rely on Social Security to support them in retirement and will save little. Hence it is vital that we support Social Security in roughly its present form and make sure it remains funded, either by raising revenues or by scaling back benefits for higher income retirees, or both.

2. Those in the middle and upper middle income levels must now rely on 401k and IRA funds to provide income support in retirement. Many and perhaps most households lack a good understanding of the amount they need to save and how to allocate their savings. This is true even of many savers with high levels of education and capabilities.

3. The most important mistakes made are: not saving enough; withdrawing savings prior to retirement; taking Social Security benefits too early² ; not managing tax liabilities effectively; and failing to adequately manage risk in investment choices. This last category includes those who are too risk averse and choose low-return investments as well as those that overestimate their own ability to pick stocks and time market movements. These points are discussed in the paper I submitted to DoL in July. They indicate that retirement savers can benefit substantially from good advice.

4. The market for investment advice is one where there is asymmetric information and such markets are prone to inefficiency. It is very hard to get incentives correctly aligned. Professional standards are often used as a way of dealing with such markets but these are only partially successful. Advisers may be compensated through fees paid by the investment funds they recommend, either a load fee or a wrap fee. This arrangement can create an incentive for advisers to recommend high fee plans.

5. At the same time, advisers who encourage increased saving, help savers select products with good returns and adequate diversification, and follow a strategy of holding assets until retirement provide benefits to their clients.

Implications for the DoL’s proposed conflicted interest rule

1. Disclosure. There should be a standardized and simple disclosure form provided to all households receiving investment advice, detailing the fees they will be paying based on the choices they make. Different investment choices offered to clients should be accompanied by a statement describing how the fees received by the adviser would be impacted by the alternative recommendations made to the client.

2. Implications for small-scale savers. The proposed rule will bring with it increased compliance costs. These costs, combined with a reluctance to assume more risk and a fear of litigation, may make some advisers less likely to offer retirement advice to households with modest savings. These households are the ones most in need of direction and education, but because their accounts will not turn profits for advisors, they may be abandoned. According to the Employee Benefits Security Administration (EBSA), the proposed rule will save families with IRAs more than $40 billion over the next decade. However, this benefit must be weighed against the attendant costs of implementing the rule. It is possible that the rule will leave low- and medium-income households without professional guidance, further widening the retirement savings gap. The DoL should consider ways to minimize or manage these costs. Options include incentivizing advisors to continue guiding small-scale savers, perhaps through the tax code, and promoting increased financial literacy training for households with modest savings. Streamlining and simplifying the rules would also help.

3. Need for Research on Online Solutions. The Administration has argued that online advice may be the solution for these savers, and for some fraction of this group that may be a good alternative. Relying on online sites to solve the problem seems a stretch, however. Maybe at some time in the future that will be a viable option but at present there are many people, especially in the older generation, who lack sufficient knowledge and experience to rely on web solutions. The web offers dangers as well as solutions, with the potential for sub-optimal or fraudulent advice. I urge the DoL to commission independent research to determine how well a typical saver does when looking for investment advice online. Do they receive good advice? Do they act on that advice? What classes of savers do well or badly with online advice? Can web advice be made safer? To what extent do persons receiving online advice avoid the mistakes described earlier?

4. Pitfalls of MyRA. Another suggestion by the Administration is that small savers use MyRA as a guide to their decisions and this option is low cost and safe, but the returns are very low and will not provide much of a cushion in retirement unless households set aside a much larger share of their income than has been the case historically.

5. Clarifications about education versus advice. The proposed rule distinguished education from advisement. An advisor can share general information on best practices in retirement planning, including making age-appropriate asset allocations and determining the ideal age at which to retire, without triggering fiduciary responsibility. This is certainly a useful distinction. However, some advisors could frame this general information in a way that encourages clients to make decisions that are not in their own best interest. The DoL ought to think carefully about the line between education and advice, and how to discourage advisors from sharing information in a way that leads to future conflicts of interest. One option may be standardizing the general information that may be provided without triggering fiduciary responsibility.

6. Implications for risk management. Under the proposed rule advisors may be reluctant to assume additional risk and worry about litigation. In addition to pushing small-scale savers out of the market, the rule may encourage excessive risk aversion in some advisors. General wisdom suggests that young savers should have relatively high-risk portfolios, de-risking as they age, and ending with a relatively low-risk portfolio at the end of the accumulation period. The proposed rule could cause advisors to discourage clients from taking on risk, even when the risk is generally appropriate and the investor has healthy expectations. Extreme risk aversion could decrease both market returns for investors and the “value-add” of professional advisors. The DoL should think carefully about how it can discourage conflicted advice without encouraging overzealous risk reductions.

The proposed rule is an important effort to increase consumer protection and retirement security. However, in its current form, it may open the door to some undesirable or problematic outcomes. With some thoughtful revisions, I believe the rule can provide a net benefit to the country.

^{1. Baily’s work has been assisted by Sarah E. Holmes. He is a Senior Fellow at the Brookings Institution and a Director of The Phoenix Companies, but the views expressed are his alone.}

^{2. As you know, postponing Social Security benefits yields an 8 percent real rate of return, far higher than most people earn on their investments. For most of those that can manage to do so, postponing the receipt of benefits is the best decision.}

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Hillary Clinton was not ready on day one.

The autopsies of her defeat for the Democratic nomination contest all point to a series of early blunders by her campaign. Her campaign plan was simple: leverage her name recognition, early money lead, and organization to win the Super-Tuesday contests, thereby wrapping up the Democratic nomination in early February. As the inevitable winner, she could be the centrist candidate on the Iraq war and tout her experience as a problem solver.

But her over-confident and over-priced campaign consultants failed to recognize that in a “change” election, caucus attenders were not excited by an Iraq war centrist who also happened to be a Washington insider. Clinton’s lack of a plan to effectively contest the caucuses allowed Barack Obama to win what would be the all important delegate race, and more importantly, give him the mantle of momentum while she appeared mired in the mud at a crucial mid-February stage of the campaign.

But she was ready on day two.

She hit her stride late in the game by impressively winning a series of primary contests. All the more remarkable: she did so on a shoestring election-to-election budget while the media wrote her off as a spoiler. With a newfound voice that emphasized she was a populist who would fight for the people, her new message resonated particularly well as the economy continued to falter.

Unfortunately, by the time she retooled her message and got rid of the people who had driven her campaign into the ditch— campaign manager Patti Solis Doyle and chief strategist Mark Penn—it was already too late. Obama had built a nearly insurmountable lead in the delegate count.

It is here that the rules matter.

If states had not moved up or “frontloaded” the date of their primaries and caucuses, under the misimpression that doing so would give them a greater voice in the 2008 nomination, Clinton might be the Democratic nominee.

She would have received more delegates from Florida and Michigan, two states that she would have likely won if all Democratic candidates had vigorously campaigned, but was denied a full slate because these states violated party rules by holding their elections too early. Counting these contests was important for her delegate count and to her argument that she had won more popular votes than Obama.

If states had not frontloaded their primaries and caucuses, she would have recovered from her early stumbles before it was too late. She would have minimized damage from her disastrous February, when Obama racked up an impressive string of victories even in Virginia, where she might have done better given her later strength.

The irony is that Clinton was expected to benefit from frontloading. Only a candidate with name recognition, money, and organization could compete. Lesser candidates like Joe Biden, Chris Dodd, Mike Gravel, Dennis Kucinich, Bill Richardson and even John Edwards would be quickly weeded out of the field, leaving her with only one real opponent to dispense with.

The lesson is that frontloading does not well serve the nomination process. Running for president is an unrehearsed drill. Mistakes will be made. Candidates become better as they learn how to campaign and to craft messages that work. Democratic Party leaders will undoubtedly look hard over the next four years at what steps can be taken to even out the flow of the nomination contests.

While these lessons may resound loudly for Democrats, they apply equally well to Republicans. Democrats permitted the process to play out over a longer time by awarding delegates proportionately; Republicans brought their nomination to a faster close by awarding delegates by winner-take-all. John McCain became the inevitable winner of his party’s nomination without even winning a state’s vote majority before his opponents dropped like flies.

While Republicans have delighted in the continued fight among the Democrats, McCain has been in a holding pattern since winning his nomination. Unable to use his time effectively to make headway with the American public, he has incurred problems in his own party. As evidence, 30 percent of South Dakota and Montana Republican primary voters registered a protest vote by voting for someone else.

Perhaps McCain won his party’s nomination too soon. He lost to George Bush in 2000 and has yet to demonstrate that he can run an effective general election campaign. He would have benefited from being more strongly tested, making more mistakes, and learning from them in the primary season. Now, he and his campaign will have to learn on the job in the general election, while they face, in Obama, an opponent who has been tempered in his party’s nomination fire stoked by Clinton.

Plenty of time remains for McCain to make his mistakes and for Obama to make more—and for both to recover before November. Campaigns often become so knee-jerk reactive to criticisms of any mistake that they fail to recognize the value in the lessons that may be learned. The primary election season is thus a valuable period for candidates to plumb their strengths and shore up their weaknesses, and we need to find a way to restore it as such.

      

       

Seven months have passed since Israel officially apologized to Turkey for the Mavi Marmara incident of May 2010, in which nine Turks were killed by Israeli fire. What seemed, at the time, to be a diplomatic breakthrough, capable of setting into motion a reconciliation process between America’s two greatest allies in the region, has been frustrated by a series of spiteful interactions.

The Turkish-Israeli alliance of the 1990s and first decade of the 2000s was viewed by senior U.S. officials as an anchor of stability in a changing region. The relationship between Ankara and Jerusalem served vital U.S. interests in the Eastern Mediterranean and the Middle East, and so it was therefore a U.S. priority to restore dialogue between the two former allies-turned-rivals. The Obama administration, throughout both terms, has made a continuous effort to rebuild the relationship and was ultimately successful in setting the stage for the Israeli apology and the Turkish acceptance of that apology. The U.S. was not the only party that stood to gain from reconciliation; both Turkey and Israel have many incentives for normalizing relations. For Turkey, the reestablishment of a dialogue with Israel has four main potential benefits: It would allow for greater involvement in the Israeli-Palestinian peace negotiations, it would provide greater opportunity for information sharing on the developments of the Syrian civil war allowing Turkey to have a more comprehensive perspective, it would also provide more economic opportunities for Turkey especially with regard to cooperation in the field of natural gas (following Israel's High Court of Justice recent ruling that paves the way toward exports of natural gas), and finally it would remove an irritant from Turkey's relations with the United States. In turn, Israel would benefit from the reestablishment of dialogue in three major ways: the rebuilding of relations between senior Turkish and Israeli officials would facilitate intelligence sharing and help to gain a more complete picture of the Syrian crisis, Israel would have the opportunity to contain delegitimization efforts in the Muslim and Arab worlds, and Israel may be able to rejoin NATO related activities and maneuvers.

Despite these enticements, in recent weeks a series of news stories and revelations have put the Turkish-Israeli relationship, yet again, in the international spotlight, raising doubts whether reconciliation between the two countries is at all possible at this time. As the Obama administration struggles to deal with the fallout of allegations that the NSA has tapped the office and cellular phones of Western European leaders and as it focuses on more pressing issues in the Middle East, namely the P5+1 negotiations with Iran, the Syrian crisis, Egypt and negotiations between Israel and the Palestinians, it finds itself with little time to chaperone the Turkish-Israeli reconciliation process. Nevertheless, despite tensions, direct talks are reportedly being held between senior Turkish and Israeli officials in an effort to reach a compensation agreement in the near future.

The Israeli apology and Turkish acceptance, orchestrated by Barack Obama during his trip to the region in March 2013, was an essential first step in a long process of reconciliation, aimed at normalizing relations between the two countries after a four year hiatus in their relationship. The next step was an agreement between the two sides in which Israel was to pay compensation to the families of the victims of the Mavi Marmara. Several rounds of talks between senior Turkish and Israeli representatives were reportedly held during the spring of 2013 in Ankara, Jerusalem and Washington, but to no avail. Disagreements over the amount of compensation to be paid by Israel were reported, but later, in July, Turkish Deputy Prime Minister Arinc clarified that money was not the issue. He stated that the problem lay in Israel’s refusal to acknowledge that the payment was a result of its “wrongful act.” Arinc added that another point of contention was Turkey's demand that Israel cooperate in improving the living conditions of the Palestinians in the Occupied Territories. Arinc emphasized that only when these two conditions were met could the countries move forward to discuss the specific amount of compensation.

The shadow cast over negotiations by Arinc’s comments was darkened by a string of comments made by Turkish Prime Minister Erdogan against Israel. First, he blamed the “interests lobby” – perhaps a reference to the so-called “Israel Lobby” -- for the large protests that took place against him and his government in Istanbul’s Taksim square and across Turkey in June. Then, in August, Erdogan accused Israel of backing the military coup in Egypt, citing comments made in 2011 by the French Jewish philosopher Bernard Henri-Levy, as proof of a long standing Israeli-Jewish plot to deny the Muslim Brotherhood power in Egypt. This drew sharp Israeli criticism, notably from former Israeli Foreign Minister, Avigdor Lieberman, who compared Erdogan to the Nazi Minister of Propaganda, Joseph Goebbels.

Despite these setbacks, bilateral trade between Turkey and Israel has expanded since the official apology and the number of Israeli tourists returning to visit Turkey has risen dramatically. Yet it is clear that with such harsh rhetoric it will be difficult to effectively advance a reconciliation process. Among American, Turkish and Israeli experts, the prevailing view is that Erdogan and the AKP government, mainly due to domestic political considerations, are not interested in normalizing relations with Israel, and that the only reason Erdogan accepted Israeli Prime Minister Netanyahu’s apology was to gain favor with U.S. President Obama.

At the end of August, as the plan for a U.S. military strike in Syria gained momentum, relative calm prevailed in the relations between Ankara and Jerusalem, both focusing on preparations and plans to address the fallout of such an attack. Yet, just when it seemed that tensions were reducing, and Turkish President Gul stated that negotiations "are getting on track," in a September interview with the Washington Post, a series of news stories and revelations injected a poisonous dimension to the already-strained ties.

In early October another round of Turkish-Israeli verbal attacks and counter-attacks was sparked by a Wall Street Journal profile of the Turkish Head of Intelligence, Hakan Fidan, which included a quote from an anonymous Israeli official stating, "It is clear he (Fidan) is not an enemy of Iran." Shortly after came the revelation by David Ignatius in the Washington Post that quoted reliable sources that pointed to Fidan as allegedly passing the names of 10 Iranians working for the Israeli Mossad on to the Iranian intelligence in early 2012. These ten people were later arrested by the Iranian authorities. Senior Turkish officials blamed Israel for leaking the story to Ignatius and the Turkish daily, Hurriyet, reported that Fidan was considering severing ties between Turkish and Israeli intelligence agencies. Reactions in Turkey and Israel to the Ignatius story were harsh and emotional. Turkish officials denied the report while Israeli officials refrained from any public comments. The Friday edition of Yediot's front page headline read, “Turkish Betrayal,” and former Foreign Minister Lieberman voiced his opposition to the apology made in March; he expressed his opinion that it weakened Israel’s stance and image in the region, and he attacked Erdogan for not being interested in a rapprochement.

In recent days Prime Minister Erdogan struck a more conciliatory tone, saying that if Israel is denying involvement in the leak then Turkey must accept it. Israeli media outlets reported over the weekend that Israeli and Turkish negotiators are again trying to reach a compensation agreement. Israeli experts, quoted in these reports, view November 6 as a possible target date to end negotiations over this agreement. The logic behind this being that former Israeli Foreign Minister Lieberman’s verdict is expected that day. If acquitted of corruption charges Mr. Lieberman will return to the Foreign Minister’s job and will likely try and block any attempt to reach an agreement. Turkish experts however assess that Turkey is simply not ready to move forward at this time due to domestic political constraints, as Prime Minister Erdogan and the AKP are bracing for Presidential and local elections in 2014.

Notwithstanding, the next few weeks will be crucial in determining whether Turkey and Israel can move forward and finally put the Marmara incident behind them. Turkey and Israel both have separate disagreements with the U.S. - Turkey over Syria, Egypt and the Turkish decision to build a missile defense system with a Chinese firm under U.S. sanctions; Israel over the Iran nuclear issue. However, the lingering Syrian crisis and reported progress on the Israeli-Palestinian track, in addition to economic considerations such as trade, tourism and above all potential cooperation on natural gas may entice both sides to proceed. Undoubtedly, a final deal will require strong U.S. support.