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23 September 2022

Were we wrong about Putin?

In our main story we ask whether we misjudged Russia’s domestic politics and its role on Vladimir Putin’s decision-making process; we also have stories about how the west could respond to Putin’s nuclear provocations; on Viktor Orbán’s latest broadside against EU sanctions on Russia; on the slow death of the German debt brake; on a brighter outlook for a new UK-EU deal on Northern Ireland; and, below, on why the Giorgia Meloni-led right-wing coalition is in such an advantageous position ahead of this Sunday’s elections in Italy.

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Understanding the Italian election

Italy’s election is almost upon us. This will be our last briefing before polls close on Sunday night. Although there’s been a polling blackout for a couple of weeks, it would be a real surprise if the right-wing coalition of Fratelli d’Italia, Lega, and Forza Italia didn’t win. FdI are likely to come out much stronger than any other party in the coalition, and Giorgia Meloni is the best bet as Italy’s new prime minister.

The right-wingers are in a strong position thanks to their ability to make the most of Italy’s complicated electoral system. There are a few quirks of how the Italian legislature, and the country’s elections, work that make it unique within Europe. The first is a parliamentary model that political scientists refer to as perfect bicameralism. This means that both houses of parliament, the Chamber of Deputies and the Senate, have an equal amount of power constitutionally.

In order to form a government, a party, or coalition of parties, must be able to command a majority in both the Chamber of Deputies and Senate. Because proportionally elected seats are allocated nationwide in the Chamber of Deputies but regionally in the Senate, the composition of the two houses is usually slightly different. This makes coalition-building even more necessary than it is in other European countries.

But the most significant quirk for this election is Italy’s electoral system. Because the Italian constitution does not set out a specific voting method for conducting elections, this has changed frequently in recent history. The latest system, which has been in place since 2017, is known in Italian as the rosatellum, after the lawmaker who came up with it. Under it, a third of all seats in both the Chamber of Deputies and Senate are elected via first-past-the-post constituencies, like they would be in the US House of Representatives or British parliament.

What this means in practice is that alliances between parties that can jointly decide to avoid fielding candidates in the same constituencies have a considerable advantage. That’s the secret to the right-wing coalition’s success. They are facing a centre-left that is divided into three camps: an alliance between the PD and some smaller left-wing parties, Five Star, and a tie-up between two prominent centrist politicians. Facing off with an opposition that will be running against each other, success is all-but-guaranteed.

If there are any spoilers, they are likely to come in the Senate elections. A constitutional amendment in 2020 significantly cut the number of parliamentary seats to 400 in the Chamber of Deputies and just 200 in the Senate. This makes the difference between victory and defeat much slimmer. The Senate’s regional basis also helps the centre-left parties, since their support bases are more strongly concentrated in specific parts of the country. The PD are still strongest in the left’s traditional heartlands of Tuscany and Emilio-Romagna. Five Star are the most popular party in southern Italy.

While we still expect a right-wing victory overall, observers should watch out for Five Star. One of the big stories of the campaign has been their comeback in the south, off the back of a cost-of-living focused campaign. They could over-perform, at the expense of Lega.

22 September 2022

I shall be austere tomorrow

No one expects an austerity package from EU member states in times like these, the least from France. The whatever-it-takes during the pandemic may be over, as Bruno Le Maire keeps on insisting, but faced with the energy crisis, the pendulum won’t swing to the other side either. Also, since Emmanuel Macron lost his outright majority in parliament, there are concessions to be made to the opposition in parliament to ensure the passage of the 2023 budget. This is likely to come with a price tag.

We already see the cursor moving in this direction. The latest copy of the 2023 budget increased public expenditure by €7.5bn compared to the draft in August. The biggest chunk of this, €4.7bn, is dedicated to the environment ministry, mainly to compensate for the rise in prices for gas and electricity. The government is clearly preparing for more payouts. The total cost of the support measures from petrol to energy cheques is estimated at €47bn, according to Les Echos. The other big chunk of this increase, €2bn, goes towards health. 

This may not be the last budget draft to register an increase in expenditure. Elisabeth Borne is currently making the rounds, talking to the main opposition parties to sound out their positions. Apart from the budget there is the pension reform on the table where the opposition has each their own take. Austerity can wait for another year or two. Politics reigns supreme.

21 September 2022


Remember Olaf Scholz's speech in Prague, hailed as his answer to Emmanuel Macron Sorbonne speech? Scholz proposed an end to majority voting on foreign policy, a reiteration of a long-standing German demand. In the German world view, the big problem with EU is not that Germany has dirty deals going with Russia and China, but the fact that small countries can veto EU foreign policy decisions.

The delusion of an end to majority voting over foreign policy ended in the European Council yesterday after the Czech council presidency made some discrete enquires, and was told by several countries that they are not willing to give up their veto. They need it to protect themselves against Germany. Hungary’s no was predictable. But Ireland also said no, on the grounds that this is silly deflection of the more urgent tasks that are needed right now. Austria is not keen on it either. Most countries were circumspect. Only five countries fully supported Scholz's foray: France, Italy, the Netherlands, Denmark and Sweden.

We are not surprised to hear this. The fundamental problem with Europe’s foreign policy is that in the past it has been driven mostly by German commercial policy. What Scholz should have done instead of making demands on others, is to start by announcing a shift in German foreign policy itself, away from the Neo-Mercantilist model. And then seek allies for the new approach. It is not about what the EU can do for Germany, but what Germany can do for the EU.

This did not happen because of the way Germans are framing the debate. In that debate, the problem with the Nord Stream 2 is not the pipeline itself, or the dependency it created. It’s all Vladimir Putin’s fault. Who could have predicted that he would invade another country?

Another debate that never happened in Germany is the foreign policy impact of a large and persistent current account surplus. You can’t be a Neo-Mercantlist and a human rights advocate at the same time. The persistence of such surpluses requires dirty deals with dictators in foreign lands. The discussion Germany, and the EU, need beyond the urgent issue of the current crises is what constitutes a European foreign policy interest. Is our guiding principle respect for democracy and human rights? Is it to prevent geopolitical imbalances? Or do we continue to equate our interests with those of BASF and VW? There is no consensus in Europe on this matter. Don’t start with QMV.

20 September 2022

Cyprus - the US gun against Turkey

By lifting the three decade long arms embargo on Cyprus the US is recalibrating the power dynamics in the Eastern Mediterranean: it is offering Cyprus a way out of Russian military purchases and is sending a warning to Turkey to know its place when it comes to its land and sea claims against Cyprus’s territory. There's no doubt that American arms could shift the power balance in the region. It is a warning to Turkey not to escalate further, and an opening bid for Nato negotiations with Turkey.

It is not a complete lift of the embargo though. The US will remove blocks for one year on the sale or transfer of non-lethal defence articles and defence services. The US imposed the arms embargo in 1987, in the hope that it could encourage the reunification of the island, about one third of which has been controlled by Turkey since an invasion in 1974. But the move was counterproductive, pushing the Cypriot government to create alliances with other countries without leading to progress on reunification.

The timing for lifting the arms embargo announcement was no accident. Photos of Recep Tayyip Erdogan circulated showing him arm in arm with Vladimir Putin, as part of a trio with China’s president. The US will use Cyprus like a gun at the negotiation table, a reminder that the US can make life difficult for Erdogan in so many different ways as the world is shaping itself into spheres of influence according to the logic of whoever is not with us is against us, writes the editorial of the Greek newspaper To Vima.

The lifting of the arms embargo is a tactical move as part of a new Cold War that is about to emerge as the new world order. We can see the short term rationale, but what are the long term consequences for the region? Is their calculation that Erdogan can be reasoned with once he receives a reminder of who is in charge? What will they put on the table to convince him to return to his Nato allies? Erdogan is a cunning negotiator, as the EU has previously found out. These negotiations will drag on for a while. In the meantime, Cyprus will become a new market for the US arms industry. It is also perhaps worth pointing out that Cyprus is one of the few remaining EU members that is not in Nato. This is another way of welcoming Cyprus into the alliance.

19 September 2022

Who is investing in China?

Trade is no longer what it used to be. European companies pulled out of Russia in protest against the invasion of Ukraine. EU institutions are looking into new ways of monitoring human rights adherence and the application of environmental values in supply chains. Suddenly there is a lot more to consider when investing in new ventures abroad.

This also applies to China. A new report by Rhodium, a private China research institute, suggests that there is already a structural shift visible in European foreign direct investment into China that cannot only be explained by China’s zero-Covid policy.

They registered the concentration of European FDI around a few players, and the absence of new investors. The top 10 European investors in China account for 80% of all investment over the past four years concentrating on five sectors, with the car industry standing out in particular. German companies lead the list, with VW, BMW, Daimler and BASF alone contributing 34% of FDI between 2018-2021. BASF just inaugurated a huge industrial site in Guangdang, that will in 2030 be one of BASF’s three major production sites in the world, investing €100bn into the development. They are there for the long haul, to make profits locally.

Another observation is that virtually no new investors have entered China over the past four years. This is partly due to China’s zero-Covid strategy, which has complicated flows and repelled investors. But according to Rhodium’s conversations with stakeholders, there are also long term risks that come into play. We expect Xi Jinping’s wish to take over Taiwan whilst still in power, and the possible US retaliations, to be perceived as a potential threat. Then there are human rights worries that feature more prominently in European debates, a sensitivity accelerated by Russia’s atrocities in Ukraine.

We see Germany also quietly retreating on its support for Chinese investments. Robert Habeck remarked recently that a fourth terminal of the Chinese shipping company Cosco in Hamburg may not be authorised. Olaf Scholz announced a diversification strategy from 2023. The government also started to revoke government guarantees for companies, currently at €11.3bn for China over a total of €19bn worldwide. The first guarantees pulled were for companies operating in Xinjiang over human rights concerns.

What is yet to come? Investors will continue to come to China. It is a huge market, after all. Past investments oblige future ones. A rollback of China’s zero-Covid restrictions is also likely to prompt investors to return. But amid the diversification strategy that governments and companies in Europe are currently undertaking, it may well be that investment in China will be mostly for the fully committed, writes Rhodium. This also may affect the internal logic of companies, decoupling their China operations from the rest. A strategy that suits China’s authorities well.

16 September 2022

Inside the Mercantilists' mind

We noted a lot of glee on Twitter about Vladimir Putin’s failure to secure any meaningful concessions from Presisent Xi Jinping of China. Michael McFaul, a former US ambassador to Russia, noted that Xi did not promise Putin any weapons, ammo and chips: only words of solidarity, and a willingness to buy discounted energy from Russia. We are not sure that this is exactly what happened yesterday.

Putin’s war is not in China’s interest. China is not openly supporting Russia. But beware of inverse logic.

China’s biggest geostrategic goal is to reduce its dependency on the west. China cannot risk a confrontation with the US - over Taiwan - for as long as its national wealth is invested in US treasuries. This transition will take time, and there are powerful interests inside China that work against it. What we do know about the interaction between geopolitics and economics is that you cannot be both a Mercantilist and a superpower. This is why the EU is what it is, and why the US is what it is. The US derives an increasingly important part of its power from its willingness to absorb the Mercantilists' savings surpluses.

China is not in a position to absorb Russia’s sanctioned surpluses. And it is dependent on exports to the US or to third countries where payment flows go through the US. China is therefore not able to flout sanctions openly, but it is supporting Putin in subtle ways, the most important of which is the export of dual-use goods. Chinese exports to Russia are a category to watch out for in the next few months.

We also keep wondering whether Olaf Scholz might be playing a similar game. He is rhetorically supporting Ukraine. But we also know that Scholz played a double-game in the past. He held a 90 minute phone call with Putin this week. The Germany media reported only that Scholz called on Putin to withdraw his troops - the ultimate dog-bites-man story. We suspect that the restatement of known positions was not the main part of a 90-minute long conversation. We are asking ourselves whether Scholz might have offered concessions to Putin on sanctions in exchange for a resumption of gas supplies. The most positive spin is that he might have offered Putin concessions for a peace settlement, but that’s not really in Scholz's power.

What we do know is that the Mercantalists think alike, new and old. We remember a story about Ludwig Erhard, a former German economics minister who later became chancellor: after East Germany built the wall, he pondered aloud how much he would have to pay Nikita Khrushchev to buy East Germany off him. He was surprised to learn that the country was not for sale. Putin is perhaps the biggest Mercantilist of all. The western sanctions are an example of why current account surpluses and waging war do not go together.

But the world is becoming less dependent on the west. Right now, we see the emergence of a new trading bloc, centred on China, with India, Russia, and parts of Africa. This is a formidable constellation. China will be the senior partner in that block. And Russia will need to find a new business model, with or without Putin. This is the big shift we are seeing - and from a western perspective there is nothing to be gleeful about.

15 September 2022

Remember Aukus?

The Indo-Pacific is another corner of the world of geopolitical importance. A worsening China-US rivalry and a looming crisis in the Taiwan Strait will be playing out there. The French have their role there, pursuing a balancing act between the different powers and their presence with a modest contingent of forces in La Réunion, French Polynesia, and New Caledonia.

Australia is preparing for worse to come. Last year, they cancelled a submarine deal with the French Naval company in favour of a nuclear-powered submarine deal with the US and the UK, named Aukus. The French took this as a diplomatic affront, because of the fact that they were not being told and included in talks before, and its implied doubts about the French capacity and reliability as a military partner in the Indo-Pacific. One year later, diplomatic ties have been stitched together again between the various partners and the French submarine company was compensated financially.

To crown the irony of the Aukus deal, it now seems that the US cannot deliver the submarines to Australia in the envisaged timetable after all. The order books are full, so delivery to Australia could take them well beyond the horizon. China might have made a move by then. The new Australian government, which backed the deal when in opposition, is now looking into alternatives, also keenly aware of its ageing submarine fleet. Instead of nuclear-powered ones, the search is on for non-nuclear submarines or even submarine drones, produced at home or bought from other suppliers. French producers are in the bidding game again, insisting though this time that the production would take place in France, not Australia.

In terms of its geopolitical strategy, France would still have to up the game. The ad-hoc nature of its current engagements with its thinly stretched military capacities is not fit for an event of high-intensity conflict, warn Jérémy Bachelier and Céline Pajon from the French Institute for International Relations. It takes more than a new submarine deal to signal to the region that France is a power to rely on.

14 September 2022

The Merge and the Fork - a modern tale

Something absolutely monumental is happening in the crypto industry today: the Ethereum Merge. Most readers won’t have a clue what this means. Ethereum is the other big crypto-blockchain. We, and others, believe that Ethereum is the real deal, in the long run more important than Bitcoin, because it has the potential to provide real financial innovation. Bitcoin is only focused on money itself. When we talk about financial innovation, we mean not just another way of repackaging credit and reducing transparency, but innovation that can reduce friction in the market. As the late Paul Volcker noted, there has been no real innovation in finance since the arrival of ATMs, despite claims to the contrary.

What is happening this week is that Ethereum will switch to a new technology that does not exclusively rely on mining, and thus on the massive energy consumption on which crypto mining relies. They are switching from what is known a proof-of-work protocol (POW) to a proof-of-stake (POS). What these protocols do is essentially verify the blocks of transactions in the blockchain. POS is a new, and by definition untested, technology that allows verification to happen - essentially through a democratic process of voting.

The changeover is called the Ethereum Merge, touted as the biggest upgrade in the history of the network. The word Merge refers to the merger of the main Ethereum network with the Beacon Chain POS system.

The Big Merge could be followed by the Big Fork. A fork is when a network splits into two, usually because of disagreement amongst stakeholders in the system. A lot of people have invested money into large racks of computers and graphics cards need for crypto mining, and they are not happy about this Merge. Ethereum forked before. There is nothing quite like a disagreement between computer scientists.

If the Big Merge is followed by the Big Fork, a lot of problems could ensue, as this article explains. This is not going to help the volatility in the crypto markets in the short-term, but it might provide a new perspective in the long-run. There are also legal issues. Many crypto ecosystems built on top of Ethereum could be in trouble, like the non-fungible tokens, which were the big hype last year. Blockchains, including Ethereum, have forked before. There is a fork called Ethereum Classic, but it is much smaller than the main network.

In a hard fork, the entire network is duplicated, and every transaction of the past is the same in both blockchains. Think of a fork as a biological cell duplication.

13 September 2022

Is ÖVP crisis over asylum seekers serious?

Austria’s ÖVP is spinning into a crisis after Laura Sachslehner, the secretary-general of the party, resigned last weekend. What is the cause? Some of the conservatives wanted to change a bill adopted in the summer to exclude asylum seekers from being eligible to receive climate bonuses, a position the coalition partner, the Greens, is vehemently opposed to. In her resignation speech, Sachslehner said that it would betray their values if the ÖVP were to accept that asylum seekers get the same as Austrians who get up every day, go to work and pay their taxes. Could this crisis threaten the coalition government with the Greens?

There are some in the ÖVP that support her stance, like its regional arm in Tyrol. But the momentum seems to go the other way. Chancellor Kurt Nehammer stands by the coalition with the Greens and he has more support inside the party than it seems, party sources told Der Standard. Sachslehner is seen as the last vestige of the Sebastian Kurz era, which Nehammer’s supporters are keen to leave behind. They want to keep the waves low. This may work or just reach another level with Kurz’s biography, expected this autumn. There is still some glorification of Kurz amongst party members, once heralded as the Wunderkind in politics. His demise was helped by the Greens, something Kurz fans won’t forget.

No one really knows how many asylum seekers would even benefit from this climate bonus. It is not even clear how to receive this data and it may not even be constitutional. The annual bonus, adopted in June, will benefit all people living in Austria and will be funded by the additional revenue generated by the CO2 price. From September, everyone who has resided in the country for over six months in 2022 will receive the payment of €500 per adult or €250 per minor automatically.

12 September 2022

United in mourning

We Europeans are no different from Americans in the way we mourn, but we are different in the way we are mourning the death of Queen Elizabeth II. Perhaps this is because she was the only living person who connected us Europeans to a past that precedes most of us. No other foreign leader paid such an emotional tribute to the Queen as Emmanuel Macron, who noted that she had touched French hearts. This from the leader of a republic. If a German head of state had died in office, which has never happened since the start of the republic, that person would not have received the same accolades and his death would not have given rise to a similarly sustained media interest.

If you compare this to the reaction in the US, the contrast could not be starker. Hillary Clinton thought this was a great moment to compare her friend, Nancy Pelosi, the Speaker of the House of Representatives, to the Queen. We don’t think that any European would have associate an ordinary politician with the Queen, not even someone as saintly as Pelosi. This is not because of deference, but because it is simply absurd.

Nothing quite compares to the reaction by one Dr Uju Anya, a professor at Carnegie Mellon in a subject called critical discourse studies. Dr Anya called her the monarch of a thieving genocidal empire and wished her excruciating pain. The tweet was later removed, but she doubled down in a subsequent statement. Although our own discourse is often critical, we are no experts in critical discourse studies. Then again, there are not many Europeans who are either, and who would have come up with a thing like this. 

It is the way we mourn that says a lot about us. One of the things Brexit did was to make people all over Europe, including and especially the UK, reflect on what constitutes European-ness. In the beginning, the campaign to remain in the EU started off as defence of economic interests, and it ended with a sense of loss of a European identity. As we can see in the reaction to her death, the Queen herself, who was reportedly in favour of Brexit, constituted part of this sense of European-ness. She was the most European of monarchs, and this not only because of the many inter-linkages of her family to European aristocracy.

We are not arriving at any big conclusions from this. But it is something to reflect on as the UK is now forging its own future outside the EU.