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9 September 2022

Oh no, minister

The death of a monarch does not usually end a monarchy. But we wonder whether the sacking of Sir Humphrey might constitute the beginning of the end for that other great British institution: the civil service.

The decision by Kwasi Kwarteng, the new UK chancellor, to fire Tom Scholar as permanent secretary to the Treasury, is hugely significant because it constitutes the necessary precondition for a shift in fiscal policy. John Maynard Keynes famously criticised what he called the Treasury View - the pinnacle of economic orthodoxy - that will always seek a restrictive fiscal policy. There is a modern version of the Treasury view, as exemplified by Scholar and other civil servants in his department, the view that got Rishi Sunak to raise national insurance and corporation tax. We see those tax rises as right up in the annals of bad economic policy decisions on par with the early Thatcher government’s excessive monetary and fiscal tightening as the country went into recession. Conservative chancellors in the past differ only in their relative effectiveness of lobbying their prime ministers in favour of the prevailing Treasury view. Kwarteng, the new guy, is going to be different.

We keep an open mind on the Truss experiment, the biggest fiscal policy expansion in modern UK history. The energy subsidies are huge. The UK is capping energy bills. We think, and hope, that this move could pay for itself - or technically that its fiscal multiplier will be greater than one - because it will take pressure off the Bank of England and because it will support consumers during the winter. Helping people meet bills and buy essentials is not what drives inflation. It’s the credit-financed car purchases or home improvements that does.

Judging by some of the horrified reactions in the media and the wider civil-service-fan-club, we wonder whether people misjudged the impact of Boris Johnson’s departure. They hated him for delivering Brexit, but Johnson governed in a conventional way. To make Brexit work requires a rebooting of many areas of British life, starting with the civil service. The problem is not that civil servants opposed Brexit, but that the whole system is hardwired to discourage change. The UK sits at the opposite end of the spectrum from the US, where incoming presidents bring thousands of high-level officials to run the administration. There is no such thing as a Sir Humphrey in the US.

The reason why Brexit requires civil service reform is that Brexit requires a re-write of the most important regulations the UK inherited from the EU. The form of Brexit chosen, the hardest version, can only function under a regime of regulatory competition. This is not the form of Brexit we would have chosen. Had the UK accepted Theresa May’s Brexit agreement, the country would been locked in the EU’s internal market for a fairly long time: time enough for a new generation of voters to rethink the decision. 

The Truss administration may not last beyond the next election, but two years is long enough to provide the underpinnings of a workable Brexit: a re-organisation of the civil service, or at least a change in the top tiers, followed by regulatory reforms. The Treasury is the key institution, and Kwarteng is a formidable operator who appears to know what he is doing. The strategy may still fail. But we know that at least it will be attempted.

And if the electorate were to reject this, we would have reason to believe that they would, one day, reject Brexit too. But if there is such a thing as a Brexit strategy, this lot is the one that will deliver it. Or nobody else will.

8 September 2022

Russia to use stablecoins

The western sanctions are clearly hurting Russia, just as the sudden drop in gas supplies is hurting Europe. We keep an open mind on who will fold first. Given the rumblings in German politics, we are not too confident that Europe is politically ready for a cold winter. But Russia’s problems are even more immediate. The embargo of dual-use electronic goods is causing serious supply shortages for Russia’s military. Vladimir Putin is in bad need to transact. This is why we think the news of the country developing crypto payment system is important. Crypto networks are clearly not mature enough at this point for Russia to circumvent the stricture of western financial sanctions.

But crypto networks can make a marginal difference. There is no way Russia can launder its euro surpluses back into the global economy through crypto markets, but it might be able to purchases critical assets it needs for the war. The country’s finance ministry announced yesterday that it was looking into stablecoins, according to Tass. It cites Russia’s deputy minister of finance as saying at a conference in Vladivostok that Russia was working with a large number of countries to create new two-side platforms without resorting to dollars and euros. He said stablecoins could be tied to a generally accepted instrument like gold.

Mikhail Mishstin, Russia’s prime minister, added more details. As Le Soir reports, he said digitals assets constituted a good opportunity to ensure uninterrupted payments. He called it a safe transactional alternative for all parties involved in the transaction that would guarantee the uninterrupted flow of goods into and out of Russia. Iran’s trade ministry has also approved the use of cryptocurrencies for imports, for exactly the same reason.

We know that there is currently a lot of scepticism about the future of crypto, after the recent and still ongoing decline in the dollar value of bitcoin. We think this decline is overdone, given the two killer-apps that crypto has the potential to deliver. One is transactional independence from the dollar and euro legal jurisdictions. The other is potentially large efficiency gains in international finance. But crypto cannot solve the fundamental problem of economic imbalances. As both Russia and Germany have discovered this year, there is a price to be paid for a Mercantilist economic strategy which makes you accumulate foreign assets, and raises your dependency on others. It is the single biggest fundamental error in the political narratives in both countries, one that equates economic success with the size of exports. Crypto won’t solve the problem of economic imbalances. But it might help get Putin some of the components he needs.

7 September 2022

Energy savings: the next wave

What is socially acceptable is about to shift once more. After Me Too changed gender interactions and the pandemic social distancing, here comes the energy crisis with its energy savings.

Amid skyrocketing energy costs some have no choice but to cut their consumption. Others come to see it as a matter of principle and as part of the climate change agenda. Whatever the motivation, energy savings are about to become much more mainstream. The French call it sobriety. But what is the appropriate state of sobriety in a time where energy is still not yet coming from renewables in larger volumes, and won’t do so for the foreseeable future? This is the new grey zone we are operating in, with lots of unknowns about how long and severe this energy crisis will be. It will depend also on how much will be buffered by government interventions. This, too, can become scrutinised for not setting the right incentives. Muddling through and making some tough choices will be how we are moving forward.

There are many roads towards how to save. Each EU country has its own version of it. The Italian government recommends turning off heating for at least 2 hours a day or reducing it by 2 degrees. The Spanish recommend switching off heating over night. Germany has stopped illuminating public buildings like the Bundestag in the night. And Emmanuel Macron recommends websites with energy savings tips, and will introduce a sobriety law for public administrations.

This period has a distinct flavour of the early days of the pandemic. Every country was doing their own thing and micro-managing. Social distancing was 1m in one country, 2m in another, while masks requirements and rules for social gatherings were all over the place, in Germany  they even changed from one region to another. Also, leading by example becomes political as Boris Johnson had to find out with his various parties during lockdown.

Social media already goes for a hunt on politicians. Who can be accused of what energy-consuming sin? Macron can say good-bye to jet-skiing for now, while Jean-Luc Mélenchon had to defend his 4×4 on the grounds that it is still better than using a van. Words and deeds will be checked under the watchful eyes of the sobriety squad.

We are, however, unlikely to see the beggar-my-neighbour spurts we have seen in 2020 when EU member states were hoarding masks or hospital equipment at the detriment of others. France already agreed to provide Germany with gas, and gets electricity from Germany in return. Mutual benefits it is. The other difference is that we have more time to prepare and it does not cost lives from day one. Let’s hope we have learned some more lessons from the pandemic that can help us to prevent repeating the same errors again and again.

6 September 2022

Erdogan's foreign policy game

Recep Tayyip Erdogan’s references to the 1922 war and his warning that Turkey may come down on Greece one night is freaking out many in Europe. Bild ran a title saying that Erdogan threatens Greece with war. Liberation describes is as triggering a trauma for the Greeks, transmitted from one generation to the next. There was a reaction at the diplomatic level too. The EU called for de-escalation. The Greek government wrote a letter to the UN and Nato. The French foreign minister raised the issue in a meeting with her Turkish counterpart yesterday, before going to Athens. Kyriakos Mitsotakis is expected to meet Emmanuel Macron in the coming days.

Turkey and Greece are historic rivals, disagreeing on a series of current issues ranging from overflights, the status of the Aegean islands, maritime borders, hydrocarbon resources in the Mediterranean, Cyprus, and refugees crossing their borders. Erdogan has been stepping up his rhetoric in recent weeks, referencing historic traumas like the 1922 war between the two nations. As history has taught us, this is part of a playbook ahead of every violent confrontation. Against the backdrop of Russia’s invasion in Ukraine and its hybrid war against the west, Turkey’s escalating rhetoric may seem even more threatening, even if it is unlikely to be backed up by any actions. Turkey has more to gain by threatening than by actually going into a physical confrontation with Greece.

Provocations against Greece are part of a wider picture. Turkey has become a major player in geopolitics both by coincidence, and thanks to its ability to seize an opportunity when it comes along. The war in Ukraine demonstrated to the world Turkey's mediator role as the only Nato country still in talks with Vladimir Putin. Erdogan managed to organise safe passage for Ukrainian grain ships through the Black Sea. Turkey is also offering to mediate in Libya, where new fights between rival groups have broken out. It is preparing a military operation in Syria to secure its interests. And it still holds the key over accepting Sweden and Finland into Nato.

Another important leg is Turkey’s defence industry, which is increasingly becoming a serious exporter. It all started in the 1980s when the US refused to sell them weapons after Turkey occupied Northern Cyprus. Keenly aware of their dependence on their ally, Turkey set out to become more self-sufficient militarily, developing its own missiles and other military equipment. Turkey is now a leading developer and producer of drones. Its Bayraktar TB2 model was used by the Ukrainians in the early days of combat with great success. The drones' success and high level of prominence during the Ukraine war created new demand. Currently 24 countries have already signed up for this model. Their other models may get a boost too.

In foreign policy terms, Erdogan seems to do well at calibrating Turkey’s interests between east and west. Putin and Erdogan know how to be on different sides in a conflict. They have done so in Syria and in Libya. It is part of their bargain. The provocations against Greece will continue. After all, Erdogan is preparing for elections and the centennial of the Turkish Republic next year. And, like Russia and Iran, Turkey pursues an irredentist vision under the current regime and wants to make the most of it. 

Looking at it from a wider angle, it is clear that Turkey has become a force to reckon with due to luck and double diplomacy. We may deplore Turkey’s violations of human rights and the poor state of its economy, but in terms of foreign policy, it looks like a dream came true for Erdogan.  

5 September 2022

Macron's east European warmongers

A speech by Emmanuel Macron in Paris last week should serve as a reminder of the foreign policy tensions that lie ahead in the EU. Macron told an ambassador’s conference in the Élysée that the EU should not allow east European warmongers determine EU foreign policy, or even allow eastern Europeans to act unilaterally in support of Kiev. We heard a commentator joking that Macron at least avoided Jacques Chirac’s infamous remark that Eastern Europeans had missed an opportunity to shut up.

Given the history of foreign policy unilateralism by France and especially Germany, it will be interesting to watch how this will go down in eastern Europe. What France and Germany are absolutely not doing is try to lay the foundations for a long-term foreign policy strategy for the EU. For the Germans, foreign policy is still mostly about selling cars abroad and other neo-Mercantlist goals. It is as though this is the most natural thing. What else is there?

We agree with Macron that many eastern Europeans are driven by a hatred of Russia that will persist even if Vladimir Putin were replaced by a democratic leader. But he offered no bridge. In his big European speech last week, Olaf Scholz made the same mistake. Instead of offering a shift in Germany’s foreign policy strategy, he just demanded the abolition of the foreign policy veto, the only instrument east Europeans have against German unilateralism. There is virtually no recognition in German and French foreign policy circles that their own policies have been part of the problem. Remember Nord Stream 2?

Once Ukraine and Russia reach a settlement, which will happen eventually, these issues will come to a head. Or maybe earlier. It is not clear whether the current policy consensus will survive a cold winter. We have no doubt that France and Germany will be among the first to seek normalisation with Russia. Other areas of disagreement will be the future role of Nato and relations with China. The best-case scenario for the avoidance of this moment of truth would be for the current US administration to remain in office indefinitely. If Donald Trump, or any Republican of Trumpian disposition, were to win the 2024 presidential elections, we would expect to see a major division of the EU into a pro-US and pro-autonomy camp.

It may be impossible to avoid this split. But those, like Macron, who seek foreign policy autonomy should be under no illusion that this could be a force for disintegration. We ourselves have been arguing that future European integration will have to be preceded by a period of disintegration. But we doubt that the Germans and the French have thought this through.

2 September 2022

What does it mean if Russia buys yuan?

Bloomberg has a story on a discussion deep inside the Russian government on the future foreign reserve strategy. It quotes freely from a presentation given at that meeting attended by Elvira Nabiullina, the central bank governor. The central message is that Russia will buy up to $70bn in Chinese currency. The idea is to build up a portfolio more resistant to western sanctions, and to counteract the fast appreciation of the rouble against what Russian officials call soft currencies, the dollar and the euro. The presentation was notably frank in stating the dire difficulties faced by Russian reserve managers. It says that the accumulation of liquid foreign exchange reserve for future crisis was extremely difficult and not expedient. We thought the following admission is remarkable:

The frozen $300 billion were of no help to Russia; on the contrary, they became a vulnerability and a symbol of missed opportunities.

If we had to make an educated guess, this quote comes from Nabiullina herself, or one of her officials, rather than from the government. The strategy advocated is the purchase of small volumes of currency of friendly countries, but overall volumes are strictly limited. The presentation also warned that larger purchase volumes would require formal agreements with China and other countries Russia deems friendly.

We wonder who has an interest in leaking the content of this discussion. The only rational explanation we can think of is to affect the rouble-dollar exchange rate. The news had a small but notable effect on markets.

Michael Pettis reminds us that there are only two ways in which China can absorb Russian currency purchases: do nothing, and accept a deteriorating trade position. Or offset the inflows by buying western currencies. This means Russia would shift the currency risk to China. China, too, is currently pondering a strategy to make itself less dependent on the dollar. As we keep writing, and as Pettis keeps pointing out, what we are seeing here is the difficult position of the mercantilist. If export surpluses are your business model, as in China and Russia, you are dependent on western currencies. Independence from the dollar and the euro requires a change in the business model. 

What this means in practice is that Russia has no unilateral levers at its disposal. It has to tread carefully, and needs strategic allies. This problem cannot be fixed through clever reserve management. 

1 September 2022

Why is digital strategy still a thing?

We recall the period when the digital economy started in earnest in the US, in the mid-1990s, and when the Europeans believed all the they needed to do is get lots of computers into schools. Computers-in-schools has been symbolic of Europe's failure to make a mark on the digital world. The problem is not only that all big tech companies are American, with a few exceptions. The deeper problem is that our economies are not reaping the benefits in the way we use the technology. It is still astonishing that in the year 2022, the concept of digitalisation is still a thing in Germany.

Digitalisation was one of the big agenda items for Germany's traffic light coalition, an issue of particular importance for the FDP. Yesterday, they presented their digital strategy. This news was crowded out almost entirely by the energy crisis. But we believe that success or failure of this strategy will in the long run be more important than how we get through this winter.

We cannot, of course, do justice to a report of over 50 pages. When we read it, what struck us the most is just how behind Germany is. One of the goals is to get 50% of companies and households covered by optical fibre connections. In the UK the goal is now 90%. Another goal is more computers-in-hospitals. Britain's National Health Service is fully computerised. The goal in Germany is to get the health insurance companies to adopt a single patient file system for 80% of all patients.

Why is Germany lagging behind so much? We think it's combination of the following factors: excessive decentralisation that keeps a lot of third-rate mangers secure from competition; too much priority on revenue generation when auctioning off infrastructure licences; and, of course, austerity. All kinds of investment went down during the calamitous austerity years.

We are not ready to call this strategy the right way forward. For our taste there are too many pilot projects and too much focus on rules, especially on data protection. What governments should do instead is create an economic environment in which high-tech start-ups can flourish, in which failure does not lead to personal bankruptcy, and in which the state focuses on things like basic infrastructure, legal frameworks, and regulation. If we had to write a 50-page essay on the future of the digital economy, we would probably spend less time on data protection, and more on how to harness social value from the data.

31 August 2022

Erdogan's vision

Turkey and Greece are at loggerheads once again, this time over Recep Tayyip Erdogan’s latest references to - and from the Greek perspective, distortions of - the 1922 war. Actual topics continue to loom big in the background: Turkey’s hydrocarbon explorations in the Aegean Sea, its occupation of Northern Cyprus, and violations in each other's air space. 

Both nations have a history of a competitive relationship for at least 200 years. Then there is an occasion, as Erdogan is preparing for the elections and the celebrations of the centennial of the Turkish Republic in 2023. Fights over historic events are as potent a conflict trigger as current events. The Ottoman Empire may have ceased nearly a hundred years ago, but its narratives live on in the Greco-Turkish relationship. In two wars the Greek naval forces exposed the vulnerability of Turkey’s long Anatolian coastline, and the advantage they held thanks to the many Greek islands just off of Turkey's coast. Hydrocarbon exploration can thus be seen as a way to claim back some of the lost territory, that is if they find some gas or oil.

For Erdgogan, the elections next spring are about his own survival. The steep economic crisis strengthened his determination to justify his way of ruling the country, including his peculiar, anti-western economic policy, the silencing of dissidents, the use of Islam in politics, and the way he enforces loyalties. The polls are not yet giving a complete picture. At least 20% of voters are still undecided. The opposition needs a strong leader to stand up to Erdogan, though they won’t oppose him on foreign policy. If Erdogan wins, he will use his vision for Turkey and turn the page written by the nation’s founder, Mustafa Kemal Atatürk. We could see the emergence of a more central-Asian type of republic, writes Ahwal. Relations with Greece could get a lot worse.

30 August 2022

Herr Scholz goes to Europe

When Europeans discuss the future of Europe, the problem is not so much that they disagree, but that they are talking about different things. Early on in his presidency, Emmanual Macron set out his visions for a united Europe in his Sorbonne speech, mostly focused on institutional reform. Olaf Scholz yesterday choose Prague as the venue for his speech. The ever-gullible German journalists were impressed by the venue, Karlova University, and the fact that it happened at all. Angela Merkel never did this.

We understand why European politicians, having gotten themselves into the mess they are in now, have a secret longing for geopolitical power. But you are not going to get there through majority voting on foreign policy, or through a new European air defence system. The veto is an old German demand, designed primarily to prevent Poles from blockading German neo-Mercantilist foreign policies like Nord Stream 2. The first step to geopolitical power is to choose the right sequence of priorities, and in particular to finish what you started. There can be no European army without a fiscal union. We would also put a capital markets union high on the priority list. You need it if you want to leverage the euro's role in foreign policy.

The biggest obstacle to a geopolitical Europe was Germany, because of its refusal to countenance a fiscal union, and its foreign policies designed to promote the well-being of German companies. Germany still wants to strike bilateral commercial deals with the likes of China. That's the stuff that will have to stop, and this is what Scholz is not offering.

Here are Scholz's concrete proposals: a joint air defence system between Germany, Poland, the Baltic Republics, the Netherlands, the Czech Republic, Slovakia and the Scandinavians. In other words, an inter-governmental project. He also proposed a relaxation of strict military export controls for Ukraine.

On the foreign policy veto, he proposes a gradual abolition, including on questions of economic sanctions. He also wants a stronger rule-of-law enforcement mechanism, and reforms to Art. 7, which would allow the EU to sanction a member state. This is not new either. It would obviously have to wait until after the current governments in Hungary and Poland have left. Some of these proposals require treaty change. But as FAZ noted, Scholz did not talk about an intergovernmental conference, which would be needed to do this.

The economic proposals were neither here nor there. He is in favour of lower debt - who isn't? - and said any strategy had to be politically communicable. The is a frequently used expression in Germany, and for us exemplary of the lack of strategic thinking in Berlin and Brussels. There is too much focus on communication, and not enough on content.

26 August 2022

Virtues and costs of cash money

Digital money has been on the rise for some time now. It got a big boost through the pandemic, when shops insisted on card tapping as a way to avoid the spread of the virus. The temporary phenomenon turned into a structural shift. Some cafés we have been to won’t take cash anymore. Many consumers rely solely on their smart phones for their shopping. No need to fiddle around and find the right number of notes anymore. For shops it reduces costs, administrative time and insurance premiums. Many call it progress.

But there is something about the physicality of cash that cannot be replaced by digital transactions. It requires a meeting between seller and buyer, both are to count to get the amount right. It is tangible, not just a number on the screen, but a real note or coin in your hand. It can be used without restraints from technology or electricity access. It is not subjects to attacks from hackers. It is anonymous and untraceable, an advantage not only for criminals but also for a society that loves its freedoms in the face of more and more compliance and transparency procedures. It is accepted by everyone in the society, young and old, rural or urban.

Banks though come to see this differently. For them, cash is an expensive service to provide. And there is the eternal pressure to cut costs. Bank branches and cash service points have shut down over the years in areas outside the city centre, forcing people to make longer journeys to get their money. A consumer report in the UK estimates that around 300 cash machines disappear per month at the moment. This itself accelerated the switch to digital money.

But was the whole point of a bank not to provide the public with cash? The Irish bank AIB announced that 70 of its 170 branches would be cashless. After a public outcry and a sharp political admonition by the Irish prime minister, AIB, which is still 65% state owned, rowed back on its decision. This anecdote suggests that governments will have to think about how they can ensure that cash will remain accessible to the public, possibly through regulation.

Also banks are about to explore new cost-saving methods to offer cash. BNP Paribas, Société Géneral and Crédit Mutuel are in discussion to pool their cash point services. Smart ATMs to allow businesses to deposit cash more easily and cashbacks in shops are also possibilities to ensure a more broader access to cash for people who don’t use digital money.