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27 January 2023

A new currency for the Brics?

The Brics countries will discuss plans for a common currency at their summit meeting in August, announced Sergey Lavrov, Russia’s foreign minister, yesterday. This format could challenge the US dominance in finance and trade, but as the history of the euro shows, there is a limit to how far this can go.

The term Brics was created in the early 2000s, referring to the economies of Brazil, Russia, India, China, and South Africa. Initially this group reference was created to attract investors to the then still-developing countries. But it later developed a life of its own. Since 2011 the four countries have hold regular meetings on trade and mutual support. Together they represent 42% of the world population.

What unites them now is a desire to challenge American hegemony in finance and trade, and to circumvent sanctions. As tensions between the west and China increase and become irrevocably hostile with Russia with its economic sanctions and diplomatic cut-offs, the two want to find an alternative to the dollar.

A common currency, be it a reserve currency, would not only help circumvent the sanctions. There are also benefits for trade. Intra-Brics trade as a percentage of world trade was around 10% in 2017. Politically, this prospect has become more feasible under the newly elected Luiz Inácio Lula da Silva in Brazil, who has his own misgivings towards the US. India, too, has a new agenda. India doubled its GDP over the past decade and is looking to become a major geopolitical actor in its own right. The Brics group may become a platform to do this.

The Western compulsion to isolate countries when they do something wrong creates incentives for those countries to think of alternative structures. Maybe the Brics will succeed. They are the largest group amongst those mulling alternatives, and they are getting organised. Over the past years they have held talks with some Middle Eastern actors and developed a Brics Plus format for new members to join. Brics Plus offers countries alternatives when it comes to trade, energy, and now also finance. The institutionalisation is still weak, and India still opposes the push to give it an anti-Western face. But there is momentum happening. There are already 12 states lined up to join the group. Iran is one of them. Turkey, Saudi Arabia and UAE have expressed their interest in joining, according to the Middle East business media Albawaba.

A reserve currency would challenge Western dominance more directly. There are also plans to strengthen the role of the BRICS New Development Bank (NDB) as well as the China-led Asian Infrastructure Investment Bank (AIIB). This would constitute a move away from the IMF and the World Bank for most of the BRICS members, especially China. How far this could go depends mainly on China. Watch this space.

26 January 2023

Tsipras calls no-confidence vote

It is an election year in Greece and politicians are likely to exploit every opportunity to score with the voters. Alexis Tsipras made such a move yesterday by tabling a motion of no confidence against Kyriakos Mitsotakis and his government over the wiretapping scandal. Will the public care enough to shift away from New Democracy to Syriza?

The move came after the independent Hellenic Authority for Communication Security and Privacy (ADAE) shared its findings from its investigation into the wiretapping scandal. They found evidence that six public figures, one minister and five high-ranking military personnel, had been spied upon, according to Macropolis. If confirmed, it would throw into doubt the government’s claim that there is no evidence. The second line of defence from Mitsotakis' team is that this has been the work of a rogue element of the intelligence service, of which the prime minister did not know about even if he was the one with overall responsibility for the intelligence unit. This will be much harder to prove.

The government also went into counter-attack mode, trying to discredit the head of the independent watchdog, Christos Rammos. The government speaker yesterday described Rammos as overstepping his mark and sacrificing his independence. As long as there is a denial of responsibility on Mitsotakis’ part, this strategy could turn out to be a slippery slope in a culture where independent institutions get the blame when something in politics goes wrong. This was for example the case of Andreas Georgiou, who is still being pursued by the Greek judiciary for allegedly inflating Greece’s 2009 deficit that pushed the country into the bailout.

Will it matter for the elections this year? So far, Greeks have other things to worry about. Tsipras put a political bet out there by making the wiretapping scandal a theme for the campaign trail. It is irreversibly now linked with his chances in the elections. Will it allow him to catch up in the polls?

According to the first Pulse poll this year, New Democracy still has a lead over Syriza. With 10% of voters still undecided, ND has a 33.5% indicative vote share against 26% for Syriza. If the polls are correct and the two parties on the far-right and far-left fail to qualify, there will be only six parties in the race and the threshold for an outright majority would fall below 38%.

25 January 2023

Turkey's threat match

Turkey cancelled the tripartite meeting with Finland and Sweden over their Nato bid. We do not expect any serious efforts to resolve Ankara’s hold before Turkey’s elections in May.

The west has seemed to scramble over how to react to Turkey. Could Finland join alone without Sweden as Pekka Haavisto, Finland’s foreign minister, suggested on Monday? Haavisto backtracked on his comments since, saying it is still the aim for Finland and Sweden to join together. If Erdogan were to succeed in dividing the two Nordic countries, it would increase his sense of power within Nato.

Turkey clearly has high blackmail potential over the two Nordic countries' accession that has yet to find its match within Nato. Earlier reports that the US could grant Turkey the purchase of its F-16 fighter jets in return for their green light for Sweden and Finland joining Nato may well reflect the intention of Joe Biden’s administration. But this comes from a position of weakness, not strength and integrity. The sale to Turkey is unlikely to make it through Congress and the Senate. Bob Menendez, chairman of the International Relations Committee of the Senate, made it clear that as long as Turkey continues its politics of threats, there will be no F-16 fighters for Ankara. Menendez has also linked this to the aggressive stance Turkey takes towards Greece. It is Turkey, not Greece, that is violating its neighbour’s airspace, encroaching on its maritime boundaries and threatening its sovereignty and borders.

He also criticised the rhetoric of the State Department, which called on Greece and Turkey to resolve their differences through dialogue on the basis of international law. This should change since there is only one side who is the aggressor, according to Menendez. If Turkey is willing to de-escalate, there is room for talks again. A principled position, and the first credible move we have seen to face down Recep Tayyip Erdogan’s threats. Will Biden dare to override the refusal and stand up to Menendez, who is after all a Democrat too?

A scenario with no F-16 fighter jets for Turkey but F-35 jets for Greece creates a new dilemma, as the US would be shifting the region’s power balance. And this will come with its own dynamic.

It is still unlikely that Erdogan implements his threats. Yet accepting his rhetoric and blackmail is not a way forward either, neither for Sweden, nor for the US or Nato.

24 January 2023

More maths in the UK, less in Germany

Sometimes you get a truly surprising statistic, like this one. The number of German first-year student enrolments in technical and scientific subjects has fallen from a peak of over 40% in the last decade to 37%. We look at the equivalent UK statistics, and note that they were around 40% in 2021. For those who try to check this claim, we made some adjustment to the UK numbers, since the UK counts psychology to the group of mathematical, scientific and technical subjects, whereas the Germans don’t. We would not have thought that the UK would have overtaken German in this specific category.

The lack of interest in science and tech subjects matters for an economy like Germany’s whose industry requires a steady flow of skilled labour, which it currently does not get. What has happened is that the strong rise in the total number of students during the period of 2006 plateaued in the middle of the last decade, and has started to fall in the couple of years. Of those, the portion of STEM students is also falling.

FAZ writes this morning that one of the deep problems is that Germany is falling behind in educational standards in schools, especially in mathematics and science. This trend started in 2012, and is still continuing. German schools also do not teach computer science to the same extent that it is taught elsewhere.

One thing Germany and the UK have in common is an acute shortages of maths and science teachers. In Germany, an estimate from the state of North-Rhine Westphalia is that schools will only be able to fill one third of their vacancies in maths, sciences and computer studies until the year 2030. It is not hard to see a link between lack of teachers at school, and a falling number of tech students at universities.

It will be fiendishly difficult to reform the German school system, which has not changed much since the late 1970s, because education is a competency of federal states. In the German debate, this issue lingers, but politics right now has other priorities.

23 January 2023

Towards a South American currency?

Will South America create its own common currency? This idea, kicked off in the international arena by an interview in the FT, will now inspire economists to look more closely at this new possibility. It will create a media buzz during Luiz Inacio Lula da Silva’s first foreign trip to Argentina this week. Is this plan for real? Some work has already been done. The currency, which Brazil suggests calling the Sur, is to boost trade integration in the region. How far could this initiative go? What are the obstacles?

We are no experts in Latin Americans economics, but we do understand a thing or two about monetary unions and the pitfalls to avoid. Even if it makes economic sense on paper, a single currency needs political will and backing of their societies to make it happen. There thus needs to be not only an economic but also a political case for this. Do Brazil and Argentina have what it takes to get this project to the finishing line?

It took the EU 35 years to get to its common currency, the euro, replacing existing currencies with its own bank notes and coins and creating a common central bank that is responsible for monetary policy for the whole euro area. Jacques Delors started work firstly at a technical level with national central banks, not via press announcements from politicians. There is a lot of preparation that needs to go into this. To go all the way towards a common currency means not only creating new institutions and a currency but also to let go of vested national powers. Are Brazil and Argentina ready to concede theirs?

A South American currency, let’s call it the Sur for now, may not even go through all those stages the euro did. It could end up being just a digital currency for commercial and financial trade only, more like the Ecu, a basket of European currencies that was the precursor towards the euro. Back in the 1980s, the Ecu was perceived as an additional currency companies had to deal with in their accounting, rather than a single currency that facilitated their trade. But today, now that most transactions are digital, an accounting currency makes much more sense. How successful such a digital currency is depends on how it is set up: what it consists of and whether it is pegged to any of the international currencies or free-floating. According to the FT, Brazil’s finance minister, Fernando Haddad, had co-authored an article last year before he took his current job, proposing a South American digital common currency. Will political ambitions stop there?

Or is this a movement for a new political initiative to revive cooperation in South America under a new crop of leftist leaders? A common currency may inspire a new sense of independence from the US. The fact that these talks happen at all is the result of Lula coming back to power.

Argentina also clearly has more to gain from such an initiative. With 100% inflation rates, it is the weaker economy compared with the large Brazilian market with just about 8% inflation. Argentina is Brazil's biggest trading partner.

How much is geopolitics coming to play? Brazil is one of the Brics countries that has not signed up with the West for sanctions against Russia. Is this an initiative to cut cords with the US? Or is this predominantly a regional initiative? Lula will stay in Argentina also to attend the summit of the 33-nation Community of Latin American and Caribbean States (CELAC) with a new generation of left-wing leaders that came to power over the last several years. On the agenda are discussions to build better value chains in the region that could open up a new dimension for nations that are predominantly raw material exporters. A common currency would be a crucial plank if it were to take off. But there are numerous obstacles, including diverse economic conditions, the geopolitical context, and tricky political situations at home with coalition governments and not much appetite for regional integration amongst the people.

20 January 2023

Divesting from Russia - really?

Western companies have mostly not divested from Russia since the beginning of the war in Ukraine. This is in contrast to the image portrayed in the press, and in spite of the sanctions and reputational damage those companies risk encountering. A new study from the University of St Gallen has found that of the 1400 EU and G7 companies that had subsidiaries in Russia before the war only 120 have divested at least one subsidiary from Russia by November 2022.

This is not the story we keep hearing. The media reported earlier on the likes of Ford, Renault, McDonald's, Ikea and Shell completely pulling out of Russia, according to a list compiled by Yale University. But these are not representative. Unilever and Subway are still operating there, for example. And now the data suggest that those who pulled out are the exception rather than the rule.

If we look at the geographical breakup in this Swiss study, it shows that among the western companies with subsidiaries in Russia, fewer than 18% of US companies and 15% of Japanese ones have completely divested by November 2022. Only 8% of European companies did so. Of those G7 and EU companies who kept their Russian subsidiaries in place, 19.5% are German and 12.4% are US-owned. This imbalance does not surprise us.

So the narrative of a vast exodus of Western companies from Russia is clearly not matched by real data, according to the two authors of the study, Niccolo Pisani and Simon Evenett. It shows the resistance of companies to political pressure. If this is not working in Russia, why should it work in China over human rights concerns? The evidence we are seeing from Germany is that the corporate sector is resisting political pressure to reduce its engagement in China. This is possibly the next source of transatlantic conflict.

19 January 2023

Grain exports, too, are more resiliant

We have been following the energy effects of the war in Ukraine continuously. The sudden stop of gas delivery from Russia to Europe led to skyrocketing gas prices with knock-on effects on other energy markets. Europeans had to find new providers to replace their gas contracts. A mild winter helped to keep existing storage levels high. New import facilities for liquefied natural gas are being opened. So the crisis in the winter of 2022 has been averted and, prices have been tumbling since. But Europe's fate for the winter of 2023 has not been decided yet.

We observe a similar pattern for grain exports. Russia and Ukraine are both significant global exporters of wheat, with Russia representing 20% and Ukraine 10% of total exports. Both are also the main producers and exporters of oil and seeds. The sudden halt of exports sent prices through the roof for wheat and oils. With it came warnings of food insecurity and poverty, especially in Africa where some countries depended heavily on Russia or Ukraine, and for countries that could no longer afford to buy at such high prices.

Since their peak in the summer, prices have come down. New export routes have been found and other exporters like Argentina and Australia have stepped in and increased their exports. The UN and Turkey also brokered a deal between Ukraine and Russia to ensure safe passage of grain exports through the Black Sea. Most of those cargo ships were not destined for the poorest countries in Africa but for Europe, China and Turkey. Only 17% ended up in Africa.

Prices may have been falling but they are still higher than before the crisis. For 2022 the annual increase is recorded as being 14% compared to the year before.

But more needs to be done to prevent food insecurity this year. The grain deal for safe passage through the Black Sea is about to expire in mid-March. The exports have nearly recovered to pre-war levels, a sudden stop would put this supply route into jeopardy once again. Also, 2023 is not 2022. Last year benefited from crops that were sowed out before the war, so insecurity was mainly about how to get the harvest in and to its export destination. This year, the insecurity due to the war covers all seeding periods.

Export partners have changed, possibly for the long term. Egypt switched from Ukraine to importers such as Argentina, India, the US, and France. Kenya turned towards Uganda and Tanzania, its neighbouring countries. Still, food insecurity is a reality for far too many: 205m in 41 countries according to the latest UN estimate.

18 January 2023

Turkey's price for Sweden's Nato bid

Recep Tayyip Erdogan’s outrageous demand that 130 alleged terrorists are to be extradited by Sweden and Finland if they want their Nato bid approved in the Turkish parliament may have been an emotional outburst, which is better to be ignored for now. What is more serious are reports that the US government advocates selling F-16 fighter jets to Turkey, and has linked this to Turkey’s approval of the two Nordic countries’ bids. By selling F-16 fighters to Turkey and F-35 fighters to Greece, the US administration in Washington wants to keep the power balance intact between the two traditional rivals. The sale to Greece may be smooth but the one to Turkey will not go through Congress and the Senate so easily, as some have already voiced their opposition.

The Turkish foreign minister may appear side-by-side with the administration, but is it really so clear that the US administration will get the deal through in Congress? This ambiguity will also play into Erdogan’s re-election campaign. Erdogan can demonstrate his power by either keeping the lid on Sweden’s Nato bid or getting his F-16 jets from the US. If the US were to approve the F-35 for Greece but not the F-16 for Turkey, he could also use this as an excuse to turn away from Nato and focus on other potential allies instead. And Turkey would most likely claw back power over Cyprus. Erdogan is playing his cards with the aim of winning his elections. Time is one variable the west could use to delineate the real issues from electioneering.

17 January 2023

When it pours... defence policy edition

We would not normally write about the resignation of a German defence minister. Christine Lambrecht has given up after a year of scandals and mishaps. But we find the focus on her conduct massively out of proportion because it deflects from a much deeper crisis in the Bundeswehr, for which Olaf Scholz and his party carry direct responsibility. Germany has under-invested in its military in a way that is now becoming apparent. A Bundeswehr general has warned at the end of last year that the country is not in a position to fight a sustained war. The main reason for Germany’s reluctance to supply weapons to Ukraine is the decrepit state of the kit. German think-tankers have been gushing about Scholz's change of era speech a year ago. But it was Scholz as finance minister in the previous grand coalition who vetoed a rise in defence spending. And it was Ursula von der Leyen, as defence minister, who allowed this to happen. These are the people who are now in charge in Europe.

Years of neglect mean that Germany is not even in a position to fulfil its narrow Nato obligations, such as the supply of 8000 troops and modern gear for the Nato response force. This Friday, Nato’s Ukraine defence contract group will meet in Ramstein to discuss deliveries of Leopard 2 battle tanks among other topics. It is not that Germany arrives at this meeting with an informed and coherent position. Scholz will probably announce a successor today. The biggest quality of the job will be a willingness to speak truth to power, which is not a quality that is rewarded in German politics.

Defence is an area where weak departmental leadership and chronic underinvestment are coming together. But this does not necessarily count against the survival of the government. Remember that Angela Merkel survived for 16 years despite a dismal record. Defence plays a relatively small role in the German political debate even today.

We have previously charted scenarios in which Scholz could still re-emerge as chancellor after the next election despite this mess, even after accounting for a dramatic fall in his popularity. One of the factors is the continued representation of the Left Party. It is currently self-destructing. If they fail to meet the hurdle for parliamentary representation, the current coalition might just carry a narrow majority for a second time running. That would still be our baseline scenario. The CDU/CSU is some ten points ahead of the SPD, but most of its support comes at the expense of the FDP, the liberal party, which is part of the present coalition. The FDP, too, would prefer the CDU/CSU as coalition partner, but the sum-total of the two parties has not shifted by enough to outweigh the support for the SPD and the Greens. The latest three polls have the SPD and Greens together at 35-41%, CDU/CSU and FDP at 33-35%. Those polling data are close to the last election result.

16 January 2023

Rare earth and European autonomy

The rare earth finds by the Swedish LKAB company in Kiruna in northern Sweden hit the news cycle like a bomb shell. Are they a potential game-changer for Europe’s green technologies? On the eve of Sweden’s official takeover of the EU presidency, the Swedish energy minister’s announcement in front of a press corps from across Europe gave rise to aspirations of what the estimated 1m tons of rare earths found in Kiruna could mean. Rare earth elements are used in electronic cars, wind turbines and mobile phones, for example. It would be the first rare earth mine in Europe. So this could potentially be a big deal. But from the announcement to the actual mining, there is still a long way to go. How far would the EU go to encourage mining of rare materials in Europe? What are the environmental effects of those mines and can the production of rare earth be limited to green industries only? The closer one looks, the more complicated the picture.

Let’s first put how important those finds are into perspective. The current estimate of rare earth finds is 120m of which 40m are in China, according to the Institute for Rare Earth Elements and Strategic Metal. So 1m does not sound much, also if one takes into account that it will take about 10-15 years to develop the mine. This is not only due to the long permitting process but also because there is some heavy construction and engineering involved. Werner Mussler in the FAZ made another back-of-the-envelope calculation: if all the 80m cars currently produced worldwide per year were to become electric, with each car needing half a kilo of rare earth, this would add up to 40,000 tons per year. The Swedish 1m would not last long.

Then there is politics. If the EU wanted to end its dependencies from China and Russia on raw materials and to counter the US inflation reduction act, it will have to define a new regulatory framework that makes green technologies cheaper and more readily available. The European Commission is currently working on lowering the barriers to the mining and production of critical raw materials for the green transition. But this is only half the way to the finished product. Then there is the processing industry with its complex and hugely energy-intensive processes of isolating and refining rare earths. The energy for this industry will need to come from somewhere. How green does this energy have to be? And rare earth elements are not only used for green technologies. They also play a role in petroleum refining and are important for military-industrial applications. The EU has no policy in place to restrict the sale of raw materials like rare earth to green purposes only.

Strategic autonomy sounds good on paper. But what it means in concrete terms implies working out what is possible and how to solve the trade-offs with current practices or other EU objectives.