23 May 2022
There came a time, somewhere during the euro area’s sovereign debt crisis, when we started discounting everything the European Council and the European Commission said. We no longer gave them the benefit of the doubt as we had done previously. Instead, we assumed that they were either lying or misleading, or at best raising expectations they could not meet. Remember the Juncker investment plan? In truth, it may not have been quite so black and white. They may have delivered 10% of what they promised. Over the years, chunks of 10% add up, too. But whether they do or not is a judgement to be made long afterwards.
With Olaf Scholz, we are already at this point of fundamental mistrust now, less than six months after he was elected chancellor. The gap between what he says and what he does is mind-boggling. Scholz's office is still blocking weapons deliveries to Ukraine, this time not outright, but through administrative hurdles. This is despite his government’s officially stated position that they are ready to support Ukraine with heavy weapons.
It is possible, of course, that Vladimir Putin has some kompromat on Scholz. Scholz has been close to two German financial scandals during his previous political lives, a tax evasion fraud by a Hamburg bank, and the Wirecard financial scandal. The media have dug up a few stories, stuff with a lot of innuendo, but no bullet. Maybe Putin, who has excellent contacts in the SPD, has more.
It is also possible that Putin might have threatened Scholz with something he might do.
Scholz may also be playing a double-game of his own. In the absence of any hard information, this is what we would assume. As we think through the impact of economic sanctions on German industry, and in particular the SPD’s voter base, it is clear that Scholz has a vital interest in maintaining commercial relations with Russia in the long run. A dirty ceasefire would be in his, and the SPD's, interests, especially if it were to lead to a relaxation of western sanctions. If Germany delivered its high-tech weaponry to Ukraine, that scenario becomes less likely.
Unsurprisingly, the CDU is starting to make a play on Scholz's duplicity. Friedrich Merz tweeted that Scholz's words and action do not fit together. The language is still polite. Roderich Kiesewetter, a CDU MP, was more upfront when he aired the ultimate conspiracy theory: Scholz wants a ceasefire based on current battle-lines, with Russia annexing the bits it has occupied.
In the absence of firm knowledge, all we can do as outsiders is to ask cui bono? This often yields better results than reliance on unverifiable private information or rumours. What we know is that the SPD is still firmly embedded in 20th century industrial politics, and that there is no change in sight. As the recent state elections have shown, the party’s secular decline is continuing. SPD politicians continue to see economic sanctions as a fundamental threat to themselves and their ageing voters. There was a reason why mostly SPD politicians cut energy deals with Putin. If Scholz’s words and action don’t match, we should assume that he is acting in self-interest.
19 May 2022
The hounding of Gerd
The madness of crowds is the sword which populists live and die by. No politician we have ever met was a more skilled manipulator of crowds than Gerhard Schröder. Now the crowds have turned against him. In 2002 and in 2005 he managed to turn around what started off as hopeless political campaigns through sheer popular appeal, and his ability to portray his opponents as aloof and elitist. In 2002, he won a narrow victory against Edmund Stoiber, who started out as the clear favourite. In 2005, Angela Merkel’s CDU set off with a 25 point lead over Schröder’s SPD. They both ended up at around 35%, with the CDU/CSU narrowly ahead. It was the beginning of the Merkel years, but the SPD at least remained in government.
Schröder is now persona non grata because of his unwavering loyalty to Vladimir Putin, his best friend. Die Welt reports that the European Parliament will today vote on a resolution to call on Schröder and Karin Kneissl, a former Austrian foreign minister, to drop their lucrative jobs at Rosneft. Schröder is the supervisory board chairman. Kneissl is a member of the board. If they do not follow that call, the European Parliament wants the two to be put on the sanctions list. We are sure that Olaf Scholz will move heaven and earth to block this, as always in private behind closed doors. We are not holding our breath. But it’s the thought that counts.
Die Welt writes that the resolution will be adopted by a large majority, after the EPP and the S&D, Schröder’s old party friends, cut a deal.
This is the same Schröder who has been lauded for his structural reforms, though not by us, and for his opposition to the Iraq war. We saw the young Schröder as a politician with unfailing populist instincts. But in his later years, he developed into a corporate type: his supply side reforms were much of the kind that big industry demanded. They did not make Germany more flexible or open it up to 21st century technologies. Nor did they encourage a start-up boom of small business. The whole point was to help large companies reduce labour costs, and for the government to save on welfare payments. There was a certain logic to him taking an industrial job after he left office. He has more respect for business than for politics.
The rise and fall of Schröder mirrors that of Germany’s industrial model. We had foreseen the decline of the Soziale Marktwirtschaft a long time ago, but we underestimated the resistance to change, and the length to which successive German governments would go to defend it. Along with Schröder’s labour reforms, Nord Stream 1 and 2 were an existential component of that attempt. What Schröder’s political action and the industrial model he championed have in common is a sheer lack of sustainability. And that which is not sustainable ends at some point.
18 May 2022
When sanctions miss the target
There is awful lot of self-congratulatory nonsense around about the EU's cohesion after Vladimir Putin's attack. We are not part of that consensus. We think they have not thought this through.
The data we are getting about money flows to Russia suggest that the sanctions have proved a giant own goal. We have succeeded in making oil and gas much more expensive, but we failed to reduce consumption to offset the price effect. The result is that we have provided Putin with a massive windfall gain from energy sales. This is worse than if we had done nothing, or if we had imposed a complete energy embargo from day one. This is an example where the EU way of lazy middle-ground compromise gives rise to very worst potential outcome. During the sovereign debt crises, we noted similar phenomena.
We reported yesterday on Russia’s all time record current account surplus for the first four months. Robin Brooks from the Institute of International Finance calculated that the April figure alone constitute a seven-fold (!) increase compared to the average of the last 20 years. How is this possible, given that Russian oil should be essentially off market by now? Data on shipping movements suggest that Greek tankers are making this possible, according to Brooks.
Janis Kluge, from the SWP think-tank in Germany, makes another important point: Putin is getting so much money now that he may be able to afford to impose gas sanctions on us later in the year.
17 May 2022
Reflections on the FDP
The biggest source of instability in German politics right now, and probably for some time, is the FDP. Germany’s liberal-conservatives badly lost the state election in North-Rhine Westphalia, where they have been in a coalition with the CDU. The CDU was the big winner, along with the Greens, and the FDP got squeezed. So did the SPD. Theoretically, it would be possible for the losers to form a coalition with the Greens: another traffic light coalition. But the FDP ruled this out yesterday. And rightly so. Traffic is not a construction that works for them. But the reasons for that are quite unsettling.
It is true that they had a bit of bad luck. The portfolios they chose, finance, traffic, justice and education, sounded better at the time than they do now. The Greens hit the jackpot with economics and climate, and the foreign ministries. Annalena Baerbock and Robert Habeck are in the news all the time.
But this is not just the usual cyclical swing in politics. It is worth reflecting on the plight of the German liberals because it carries lessons for liberal-conservative politics in Europe. We should remember that this is the party of Hans-Dietrich Genscher. It was the party of German foreign policy, the part that did not coddle Russian and Chinese dictators. The FDP was not so much the party of transatlantic relations, but of European integration.
During the coalition talks, the party expressed no interest in any of the foreign and security related portfolios: foreign, defence and interior. The most memorable FDP demand was freedom on motorways, its categorical rejection of the imposition of a nationwide speed limit. On finance, the party is a fully paid-up subscriber to the so-called debt-brake, a rather silly fiscal rule introduced by the Merkel administration in 2009 to provide a rigid fiscal straitjacket. We ourselves cannot recall a single numerical fiscal rule that stood the test of time. Fiscal rules are conservative econ-populism. The FDP, along with the SPD and the CDU were enthusiastic devotees of a rule that is now irretrievably broken.
Having fought so hard for the finance ministry, it was left to Christian Lindner, FDP chairman, to find loopholes in the debt brake. The traffic light coalitions set aside €100bn to fund the restoration of the Bundeswehr. The debt brake was suspended during the pandemic, and the government is now using the suspension to set aside funds so that they can claim to fulfil the rule in the future.
Behind this fiscal trickery stands a much wider political failure, which is to reduce the complexity of economic policy to a few static rules. The Greens have a very distinct, future-oriented agenda. Even if you disagree with the agenda, you would probably concede that it has scientific foundations. There also exist intelligent liberal-conservative economic agendas, but the FDP is still rooted in the ordo-liberal, social market economy debates of the 1950s. The FDP also has no particular interest in subjects like EU capital markets union or banking union. Like SPD and CDU, the FDP, too, is a party that did not think through the deeper implications of a monetary union. The FDP never stemmed against the populist narrative in Germany that the EU is full of fiscally profligate foreigners.
To its credit, the party is championing the cause of small business and start-ups. Venture capital is slowly beginning to take root in Germany. But the big obstacle for venture capital is the lack of an efficient capital market. And that can only ever happen on a European level. So if the FDP were really serious about small company start-ups, why do they not turn the dismantling of Germany’s protectionist banking sector into their theme, along with a European capital markets union? The FDP is a party of ordo-liberal slogans, but not a party of 21st century economic liberalism.
The intellectual rot set in a long time ago, even while Genscher was still roaming around Europe. Back in the early 1980s, the FDP was the counterpoint to a then-Keynesian SPD. In a world of three-party politics, the FDP was always necessary for anyone to form a coalition. It did not matter so much for the FDP that its policies were coherent. They would end up in government one way or the other. The intellectual rot of the party got much worse under the leadership of the late Guido Westerwelle, who tried to transform the FDP into a lifestyle party for the wealthy.
Decades of intellectual neglect are coming home to roost. And now that the CDU is modernising under a new leadership, voters are wondering what the point of the FDP is.
13 May 2022
Sweden and Finland are on the cusp of formally applying for Nato membership. Just three short months after Russia began its invasion of Ukraine, it is already permanently changing the face of European security. Once the two states join Nato, only Ireland, Malta and Austria remain neutral states within the EU. We are wondering, once again, whether everybody involved in this decision thought this through.
The war clearly fuelled a sense of urgency. Finland and Sweden have undertaken a marathon diplomatic effort to prepare for the decision to abandon their historic understanding of neutrality. The latest assurance was given by the UK, with a signed agreement for military assistance if either Nordic country were attacked, a placeholder for Nato’s Art. 5.
All seems ready for the two countries to make this historic step. Finland's prime minister and president issued a joint declaration, saying that Finland must apply for Nato membership without delay. Sweden, having resisted for so long, is also about to declare a similar line on Sunday. Even Ireland is feeling the pressure to rethink its neutrality. No matter how unrealistic it seems that Russia would attack them any time soon, for Ireland it was enough to see Russian state TV show a simulation of an attack on Ireland, just as one or two Russian ships were sighted along the Irish coast to get the Irish on their toes.
Being neutral is not easy, especially in times of conflict. It means constantly evaluating and facing moral dilemmas, and working through a complex mishmash of strategies, values and identities in a local, regional, and global setting, as Jack Horgan-Jones from the Irish Times puts it.
Neutrality is a long-term strategy with benefits. It is values-based and aspirational. It can be adapted to circumstances. Allowing for joint exercises with Nato does not mean they are part of it. Finland and Sweden are now ready to trade this sovereignty in decision-making for the assurance of protection by, but also dependence on, the US under Nato. It will require a shift in thinking, from neutrality to multi-lateralism, with operational and strategic implications. It will mean some doors will shut, for example as peace mediators post-conflict. It will also affect the relation with Russia post-war. Will Europe's security co-operation continue to accommodate neutrality amongst its member states?
There are implications for the US too. The more states bordering Russia are joining the alliance, the more US may have to provide for their security. Joe Biden may get a short-term boost through arms delivery to Ukraine, and through Nato enlargement. But will the enthusiasm last? The conservative Cato institute just published a paper listing nine reasons why the US should close the door to Finland and Sweden, and instead prepare to turn European defence over to Europe. A future Republican president may pick up on their arguments. Then Finland and Sweden would have lost their neutrality for what exactly? This could create a vacuum the EU may struggle to fill.
12 May 2022
Ukrainian frank talk
Ukrainians don’t mince their words when it comes to the EU and what they think their help is worth. Sanctions are not enough, arms delivery could be better, and a political community as suggested would be nothing but a consolation prize for the real thing. Frank talk like this is unknown in Europe.
The EU has developed a communication style that often hides more than it reveals, a way to account for all the differences it has to embrace in this big and diverse community. Ukraine will not enter this house without re-arranging the furniture and its structure. The more the Europeans talk about the fact that Ukraine is in their hearts, the more Ukrainians conclude that their war is our war too and that we need to do our bit to help them. But Europe distinguishes between what is in their heart and what needs to be done. Actions are based on rational examination, which might disappoint the heart. This way of dealing with reality goes back to Enlightenment. But will Ukrainians accept such a doctrine?
The war in Ukraine already revealed where Europe is at its weakest. Volodymyr Zelensky calls on European leaders to be more courageous and united in supporting Ukraine in defending itself against Russia. Andriy Melnyk, his ambassador in Berlin, dismissed Emmanuel Macron’s proposal of a political community as a diversion from EU accession, and insisted that Ukraine is either in or out. Our understanding is that Macron’s political community was for European countries, including EU accession candidates. Maybe some clarification would help. But it also shows that Ukrainians read proposals like these not as a positive gestures, but as half-heartedness and hypocritical behaviour.
Melnyk is not the kind of diplomat we are used to, outspoken, and crass at times. He accuses Germany of caring more about Russian gas and warm living rooms in the winter than the lives lost in Ukraine, and more about inflation than the global famine. Melnyk tells France and Germany off for hesitating to help Ukraine win the war. Ukraine needs the perspective of being part of the European family, he says. So who would want to deny them that?
The reality of the European accession process is more tedious than all these moral claims. No doubt this long-haul process will bring up resentments on the way. The urgency Ukrainians may feel will not be matched by the EU’s bureaucracy. Frustrations are a feature, not a bug. Turkey has experienced this. Ukraine will go through the same ups and downs. Will they be ready to accept this?
This is where Macron’s political community comes in. It was intended to provide a political perspective above the technical requirements. From an EU point of view, this is quite a big step. But if we cannot agree on what it means, would this proposal end up doing more harm than good?
11 May 2022
A dangerous proposal
We don’t think this idea will fly, but if it did it would be very dangerous. Josep Borrell, the EU’s High Representative, has proposed to sequester Russia’s foreign exchange reserves for the reconstruction of Ukraine. The idea has a superficial attraction. Russia can’t get to the money anyway, possibly never. So we might as well put it to good purpose. And the US had done it before, in Afghanistan. Various eastern European politicians have been demanding the same. Borrell is picking up on an idea that is clearly being discussed.
We are talking about money Russia mostly got from the west for selling oil, gas and coal, and other commodities. The money was obtained legally. When we take the money away, we are not returning the oil. Russia will no doubt construe it as an act as a theft. It is perfect legitimate to think about future restoration payments. But unilateral sequestration turns a legitimate goal into an illegitimate act.
Or at the very least, it constitutes a procedure that lacks an obvious foundation in international law. Herein lies a difference to the freezing of assets. Anybody who holds their foreign reserves in the EU knows that they are subject to existing national, European and international laws.
In those various laws, there is no legal foundation for the sequestration. FAZ asked a couple of international lawyers, who said they did not know of any legal basis. The law of occupation, for example, explicitly foresees restoration payments. But these payments have to be subject of a contractual agreement: a peace treaty.
Another lawyer pointed out that central bank reserves enjoy what is known in international law as immunity protection as they form part of the sovereign toolkit of the Russian state.
The freezing of central bank assets is based on national law, and constitutes a different category. The Russian state is still the beneficial owner of those funds. We are stopping them from using those funds to finance the war.
What is legal is not necessarily wise. We believe that the freezing of central bank assets will, in the long run, damage the reputation of fiat money in general, and the dollar and the euro specifically, because it constitutes a default on money’s primary function: to act as a means of transaction. Western policymakers with their customary short-term mindset are right that it won’t have any effects in the short term. The dollar is the global reserve currency for a reason, which is the willingness to absorb excess global savings. But other countries, like China, are now starting to look at the underlying policies that have given rise to the imbalances in the first place.
When we now go outside the outer parameters of international law, that process will be mightily accelerated. There is nothing quitw likw the prospect of a counterparty's default to concentrate an investor’s mind.
10 May 2022
Orbán threatens veto
Hungary's foreign minister has formally notified the EU that his country would veto oil sanctions against Russia. While this is not the end of the debate, it constitutes a significant escalation.
Our own interpretation of what’s going on is that it’s only partly about the oil. Hungary is highly dependent on Russian oil supplies. As of 2020, Hungary received about 60% of its oil imports from Russia, and as a landlocked country it has limited alternatives for receiving seaborne oil. The Russian imports it receives come overland, through the Druzhba pipeline. There is some credence to the suggestion that they would need more time to reduce their dependency.
But we think that it’s also about other balls in the air, namely funding and the Commission’s rule-of-law conditionality mechanism procedures against Hungary. Consider the statement Péter Szijjártó, Hungary’s foreign minister, made after Ursula von der Leyen’s meeting with Viktor Orbán, in which he said, of the country’s energy security, that,
“As long as the European Commission does not offer a solution to these problems, Hungary will not be able to support the sanctions package, as in this form, without proposals for solutions, this package will amount to an atomic bomb dropped on the Hungarian economy.”
Talk of a longer extension is a fig-leaf: though Hungary is a small player in oil consumption, a five-year exemption would be a non-starter. What Viktor Orbán’s government is clearly looking for is extra money, a slow-walk on the conditionality mechanism, or both.
Whether Orbán would continue to be this difficult if the Commission hadn’t decided to formally launch a procedure against Hungary last month is a counterfactual that’s impossible to test. But it certainly can’t have helped. The Commission is now actively locked in a dispute with the Hungarian government that could see the latter lose access to EU funds. At the same time, it is trying to convince Orbán to back sanctions which he can hold up indefinitely, should he so wish.
The bigger-picture issue is the limits of European integration via the backdoor: what the EU can actually achieve institutionally without treaty change. This saga with Hungary is a case in point, as its government uses its powers within the treaties to frustrate the Commission using a mechanism outside of it to try and get to them.
It’s an especially big problem if a country is non-committal about EU membership. Orbán increasingly seems to be thinking this way. One small, but significant, political development we noted is János Volner, a member of Hungary’s parliament, changing the name of his personal political vehicle to the Huxit party.
Volner used to be the leader of right-wing opposition party Jobbik’s parliamentary faction. But after breaking away from both Jobbik and a far-right successor party, the Our Homeland movement, he has largely towed the government line. Given that Volner is basically a system opposition figure, coming out and starting a Huxit party looks like a trial balloon. Orbán can see whether he could muster political support for leaving the EU, without publicly associating himself with such a risky venture at an early stage.
9 May 2022
Gazprom tries a charm offensive
Have the Russians blinked first? At first glance, it might seem to be the case, but we are not buying it. While some buyers of Russian gas continue to wait for clarity from the European Commission on how to comply with sanctions, Gazprom has sought to reassure customers. They have said that even under the new decree buyers will be able to make payments within the scope of the sanctions.
To back this up, they point to a new modification that the Russian government has made to the original decree. This version, released last week, clarifies who in the payment process is responsible for converting payments into roubles: Russia’s national clearing centre, and not the Russian central bank. Elvira Nabiullina, the Russian central bank president, also said that the conversion process would have to be completed in a two-day timeframe.
The idea behind this seems to be giving the Commission, and buyers, a way out of the central point of the issue: that the Russian central bank could be involved. This has been the firm opinion of the Commission so far in their multiple statements that the dual account decree would lead to breaching sanctions.
It also addresses another possible reservation buyers could have outside of the sanctions: the opacity of the process. From a risk management perspective, having part of the payment process completely outside of the control of the buyer was also problematic. In theory, this should shed light on where the money is going and what happens with it.
But in practice, the problem is still this: the Russian government can basically decide to do whatever it wants with the payment process, and implement it overnight. Even if the central bank isn’t involved now, there’s little to stop Vladimir Putin from saying that it will now have to be involved through some other modification of the decree. And even if the European gas buyers don't formally breach the sanctions, they are still colluding in circumventing them.
We expect that noncommittal buyers and the Commission will jump at the chance. Since so many buyers have already either started paying in roubles, or have set up the means to do so, stopping them would have been like trying to close Pandora’s box.
What we don’t think, however, is that anyone should view this as an attempt at de-escalation from Putin. Instead, it’s merely the insertion of another rung on the escalatory ladder.
6 May 2022
Germany not delivering weapons after all
Unsurprisingly, the German public is divided over weapons deliveries to Ukraine, with a small majority in favour. Olaf Scholz' political error has been, and continues to be, his attempt to straddle the two camps, ending up alienating both. His strategy is to be seen as supporting Ukraine in public while frustrating help in the background. It is unsurprising therefore that the Germans are thinking of him as a weak leader.
The latest news is that the last week’s policy U-turn on weapons deliveries is actually not happening. A report in Die Welt, which reads like a Kafka story, suggests that the German government wasn’t able to find the ammunition for the Gepard tanks. When confronted with this information, the chancellery refused to comment. They never comment on weapons deliveries. It’s top secret for a reason.
There has been some progress on the diplomatic front after weeks of mutual recriminations between Germany and Ukraine. But the main actor is not the chancellor, but Friedrich Merz, the opposition leader. When Merz became the first senior German politician to visit Volodymyr Zelensky since the outbreak of this war, he persuaded him to talk to President Frank-Walter Steinmeier. Steinmeier had previously been told that he was not welcome. The two presidents spoke yesterday, and apparently aired their differences.
Steinmeier has been the principal architect of Germany’s Russia policy, but unlike Gerhard Schröder, the president rescinded his position, admitted that it was a mistake, and that Putin cannot be trusted. Scholz is still holding back with a personal visit, preferring to send Annalena Baerbock, the foreign minister instead. Steinmeier is now planning to visit Ukraine.
Because of the long tenures of Konrad Adenauer, Helmut Kohl and Angela Merkel, Germany had a very small number of chancellors. Scholz is number nine since 1949. As an orator he reminds us of Kurt-Georg Kiesinger, who governed from 1966-1969. Kiesinger, too, was a master of the backroom deal, but wooden in his delivery and without much personal appeal. Scholz' most surprising success so far has been to put together a coalition of unlikely partners to pursue the energy transition. Scholz enjoyed a brief honeymoon - but one that did not last even the customary 100 days. Robert Habeck, the economics minister, is now the most popular member of the government. If we had to place an early bet on the 2025 elections, we see this as a contest between Habeck and Merz. Habeck will be better prepared as a candidate than Annalena Baerbock was last time. And Merz is of a different political calibre than Laschet. The only scenario of a second term for Scholz would be one where the SPD was marginally ahead of the Greens, where the three current coalition partners would still enjoy an overall majority, and agreed to form a coalition with the SPD instead of the CDU.