March 12, 2012 7:21 pm

The US labour market is still a shambles


It is understandable, given the number of times green shoots have been seen since the downturn began in December 2007, that there might be some scepticism about claims the recovery is finally under way. To me the question is what does it imply for policy? Does it mean we can be more relaxed about the demands for budget cuts emanating from fiscal conservatives? Or that the US Federal Reserve should start paying more attention to inflation, and begin contemplating raising interest rates? Even if this is not one of the many green shoots that soon turn brown, the economy will almost certainly need more stimulus if it is to return to full employment any time soon.



This is the inevitable conclusion from looking at the state of the labour market today. It is a shambles. In Friday’s US employment report, the proportion of working-age American adults in a job moved up only 0.1 percentage points, to a miserable 58.6 per centnumbers not seen since the downturn of the early 1980s. There are still 23m Americans who would like a full-time job but who cannot get one.


The jobs deficit, the number of extra jobs that would have been required to keep up with new entrants to the labour market, is 15m. Employment has yet to return to its level of December 2008. Male employment is still below what it was in February 2007 – meanwhile, the working-age population has grown considerably.

 

Let’s assume that job creation continues at the rate of 225,000 jobs a month. That is only about 100,000 beyond the number required to provide jobs for the average monthly number of new entrants into the labour force. At that pace, it would take 150 months to reach full employment13 years, some time around 2025. The independent Congressional Budget Office is more optimistic, forecasting the return of full employment by 2018.



With labour-force growth normally about 1 per cent per year and productivity growth about 2-3 per cent, it takes sustained output growth in excess of 4 per cent to bring unemployment down. No one expects growth at that pace for long enough to return the US economy to full employment any time soon.


We might, once deleveraging is finished, return to “normalgrowth rates; but what is required to get unemployment down is an extended period of above normal growth. However, three elements of “missing demand” (missing, that is, compared with 2007) make that unlikely: then, the household savings rate was zero, a result of the top 20 per cent of Americans saving 15 per cent of their income and the bottom 80 per cent spending an abnormal 110 per cent of their income.


Even after deleveraging and after our financial system is fully repaired, saving should not return to anything like the level it was before. Neither should we expect the “return” of American consumers – indeed, we should worry at their reappearance, for what it says about both their rationality and a financial system that facilitates such profligacy.


Before the crisis, 40 per cent of all investment was in property. We had a housing bubble that left a legacy of excess capacity. Continuing weakness in the property sector is reflected in high foreclosure rates and low home prices.


Finally, US states and local governments are constrained, to a large extent, by having to balance their budgets. They depend heavily on property taxes, so both revenues and expenditures have plummeted. This is why there are a million fewer public employees than before the crisis. Government as a whole is being procyclical, not countercyclical.



The pre-crisis bubble masked fundamental problems with the US economy. Low-income households spend a higher fraction of their budgets on consumption than richer households. Therefore, the redistribution towards the top – with the top 1 per cent getting more than a fifth of the nation’s income – would have led to weak aggregate demand in the absence of the bubble.


Moreover, just as the Great Depression was part of the transition of the economy from agriculture to manufacturing, the Great Recession is part of the transition from manufacturing to a service-sector economy. Growth in productivity, plus changing comparative advantage, made a decline in manufacturing employment inevitable. Markets on their own do not manage such dramatic economic transformations well.


Unfortunately, little has been done about the underlying structural problems. Indeed, the downturn, during which wages have not kept pace with inflation, has in many ways made US inequality worse.



Today the American economy faces three big risks. First, a steeper European downturn, as a result of the excessive austerity and the euro crisis. Second, complacency that the economy will recover quickly without government support. Though every downturn comes to an end, that should not be of much comfort. Third, that we accept that an unemployment rate above 7 per cent is inevitable.

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If my Cassandra forecast turns out to be wrong, stimulus can be cut. But if it turns out to be right, and we do too little, we will live to regret it.


The writer is a recipient of the 2001 Nobel Prize in economics and professor at Columbia University



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Copyright The Financial Times Limited 2012


HEARD ON THE STREET
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Updated March 12, 2012, 6:52 p.m. ET
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Falling Off the Commodity Supercycle
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By LIAM DENNING



Discussion of the supposed commodity "supercycle" tends to focus more on the "super" and less on the "cycle." But all true cycles eventually head down. This one could turn in 2014.



The current commodity supercycle can be dated to 1999. The major commodity indexes all hit their lows for the last 20 years early that year or in late 1998. Since then, the S&P GSCI index has risen fivefold, albeit with some wild swings.


China used 71 million metric tons of steel for every percentage point of GDP growth last year, according to UBS. Above, laborers install steel bars on the foundation of a residential construction site.


Two things explain this. The first is the recurrent Malthusian fear that the world is exhausting its stock of raw materials—think "peak oil." Surging Chinese demand has been the major cause of such fear.
Between 2000 and 2010, China accounted for 40% of the increase in global oil consumption and 123% for copper.


Cheap money has added fuel to this fire. Very low or negative real interest rates in most major economies have made it attractive to own commodities in anticipation of realizing higher prices later on. That is as true of a hedge fund borrowing at low rates to keep copper in a warehouse as it is for Saudi Arabia keeping some oil in the ground rather than pumping it now, only to invest the proceeds in low-yielding U.S. Treasurys.


Both of these pillars are now under threat. China's latest trade-deficit numbers, released this weekend, show a marked slowdown in growth in processing trade imports—the raw materials for China's own exports. That suggests weakness in developed economies, particularly in Europe, is causing Chinese exporters to scale back.


So is Beijing, which just cut its annual gross-domestic-product growth target. Infrastructure investment in the latest five-year plan is down 25% in real terms from the preceding one, according to UBS. While investment in public housing continues, it is unlikely to offset the sharp fall in private housing starts as China's property bubble bursts. This suggests breakneck infrastructure investment in China is slowing.
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Despite the commodity bulls' mantra of China needing to catch up to Western levels of consumption, its raw-materials consumption is already staggeringly high. Last year, China used 71 million metric tons of steel for every percentage point of GDP growth, according to UBS. That is the equivalent of almost 1,400 Empire State Buildings—per point. Meanwhile, Chinese per capita consumption of copper in 2010 was already above the level for the North American Free Trade Agreement, according to consultancy Bloomsbury Minerals Economics, despite China's GDP per head being far lower.



The transition in China's economy is in its infancy, but the shift should become clear within a couple of years.


Just as this undermines expectations of continuing commodity-price increases, so should a shift in global monetary policy. The Federal Reserve expects that abnormally low interest rates should start rising in late 2014. But fed funds futures increasingly indicate rates will rise sooner than that, perhaps as early as the start of that year.


Chris Watling, who runs research firm Longview Economics, identifies three periods in the past 80 years where episodes of ultra-loose U.S. monetary policy have coincided with upswings in the commodity-price cycle. These encompass the 1930s through the 1940s, the late 1960s through the 1970s, and the current period since 1999.


Based on the historical record, Mr. Watling surmises commodity supercycles—which tend to coincide with equity bear marketslast between 15 and 25 years. By that reckoning, the commodity cycle could start turning in 2014, although his analysis clearly implies a wide range of timing.


Commodity futures, by their nature, look forward to the supply and demand dynamics (and financing costs) of tomorrow. Even before the full implications of changing policies in Beijing and Washington become clear, commodity prices will likely have shifted down in anticipation.

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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved



March 13, 2012 8:02 pm

A hard slog in the foothills of debt


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Deleveraging” is an ugly word for a nasty journey: that towards lowering excessive debt after a credit bubble. What makes the effort particularly difficult now is that it affects the US and other large economies. This is a global, not just a local, event.


In January, the McKinsey Global Institute published an updated version of its invaluable research on deleveraging.* It is a sobering document: it shows that deleveraging has a long way to go; happily, it also shows that the US economy is the most advanced in deleveraging.

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One cannot get out of debt by taking on more debt. How often have you read such remarks? It is a cliché. As the McKinsey Global Institute study points out, it is also false. Sweden and Finland, both hit by big crises in the early 1990s, are good examples of why this is so.


The benign story unfolds like this: a big increase in leverage ends in a huge financial crisis; the government promptly restructures the financial system; excessively indebted private borrowers reduce their obligations by slashing spending; central banks cut interest rates; the resulting collapse in activity and profits pushes the government into huge fiscal deficits, which also support the economy; finally, the economy recovers, helped by exports, and the government begins its fiscal retrenchment.



Thus the temporary rise in fiscal deficits helps protect the economy from the forced private retrenchment. The alternative would be a depression, in which mass bankruptcy, not repayment, lowers debt. Unfortunately, the smooth adjustment path takes time.



It also depends on the government’s creditworthiness, which has to be far better than that of the private sector. This has been true for the US and UK, but not Spain, which is being coerced into savage retrenchment.



The danger is that the private sector never recovers fully, as seems to have happened in Japan. The McKinsey report lays out what must happen if that danger is to be avoided. The list includes: stability in the banking system; credible plans for fiscal sustainability; structural reform; rising investment and exports; and stability in the housing market and rebounding construction.



The amount of leverage the economy can support depends on who has borrowed and lent, on the value of the collateral and, not least, on economic activity. The surest ways to inflict an unnecessarily destructive reduction in leverage is to allow the economy to collapse. That is why aggressive monetary policy and large temporary fiscal deficits matter. If the public sector does not sustain spending as the private sector cuts back, the latter will go too far, causing unnecessarily deep damage to the economy.



Where then is the deleveraging now? In the case of the US, leverage declined by 16 percentage points, relative to gross domestic product, between 2008 and the second quarter of 2011. Over the same period, leverage rose in the UK and Spain. This is partly because the US has been far more successful than the UK and Spain in sustaining output. The US has also seen successful deleveraging in the financial and non-financial corporate sectors. In the UK and Spain, however, the financial sector has not deleveraged. Above all, the US has cut household leverage more than in the UK and Spain. It has even seen an absolute fall in household debt, largely due to default. Household debt has even returned to its long-run trend, though households are only a third of the way towards matching the Swedish deleveraging of the 1990s. (See charts.)



In all, the post-crisis US looks to be in better shape than these other two economies. Aggregate leverage (at 279 per cent of GDP in the second quarter of 2011) is far lower than in the UK (507 per cent) and Spain (363 per cent).


The ability of the US government to borrow remains strong. The UK government’s borrowing costs also remain low. The enormous balance sheets of its financial sector, at 219 per cent of GDP, explain much of the high UK leverage. But the UK government is retrenching, while deleveraging in the private sector is very slow. The cost of government borrowing is far higher in Spain than the US and UK, while private sector deleveraging has remained very limited, until now.



All these economies confront risks on their journey towards exit from the crisis. The US, for example, lacks a plan for fiscal sustainability and is too big to expect more than a modest boost from exports.



Investment, including construction, must drive its recovery. In the absence of a jump in private investment that does not depend on rising leverage, it may prove difficult to eliminate the fiscal deficit. Again, surges in corporate investment and net exports are essential if the UK economy is to recover and the fiscal deficit is to be eliminated, as the government wants. The UK faces the additional threat of a meltdown in the eurozone, which could inflict serious damage on its financial sector. In the case of Spain, a rapid shift in net exports must play the dominant role in the recovery, not least because Spain’s non-financial corporate sector is already highly leveraged, with debt at 134 per cent of GDP in the second quarter of 2011, against 109 per cent in the UK and 72 per cent in the US.



In all, it is going to take quite a long time to escape the aftermath of the biggest financial crisis since the 1930s. The good news is that a depression was prevented. Further goods news is that private sector deleveraging is progressing, especially in the US. As asset prices stabilise and the economies adjust, it should be possible to withdraw the exceptional monetary and fiscal support. The bad news is that this is likely to take longer than many expect. Premature withdrawal of monetary and fiscal support could push afflicted economies back into recession, with devastating effects on confidence. In the long run, moreover, big shifts in the external accounts will be necessary if a new round of irresponsible private borrowing or a continuation of huge fiscal deficits is to be avoided.



The road to deleveraging will be long and hard. It is essential to map out the road, including towards post-crisis fiscal consolidation. It is as important to realise that the story is still at its beginning, even in the US.

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* Debt and deleveraging, www.mckinsey.com/Insights/MGI

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Copyright The Financial Times Limited 2012.


Can the Poor Save the World?
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Jean-Michel Severino and Olivier Ray
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2012-03-13





PARIS – Events in 2012 so far have confirmed a new global dissymmetry. Caught between unprecedented financial insecurity and a somber economic outlook, the rich OECD countries and their middle classes fear geopolitical weakening and downward social mobility. In much of Asia, Africa, and Latin America, however, optimism reigns.




.Among developed countries, this unexpected shift of fortune has incited protectionism, exemplified by French calls for de-globalization. Meanwhile, among emerging economies, pride has sometimes manifested itself as conceit, tinged, after decades of Western arrogance, with schadenfreude. But, because the world’s developed, emerging, and developing economies are now so closely linked, they will either dog-paddle out of this crisis together or enter into a danger zone unseen since the 1930’s.




.After World War II, a new global economy emerged, in which a growing number of developing countries adopted export-led growth models, thereby providing industrialized countries with raw materials and household goods. This new economy was an undeniable success: more people left poverty in the twentieth century than in the preceding two millennia. And it enriched OECD countries, as imports of cheap goods and services strengthened their purchasing power.




.But this model also weakened rich countries’ social structures, widening inequalities and excluding a growing proportion of their populations from the labor market. Moreover, it is responsible for the financial imbalances that besiege us today: in order to counter the effects of widening inequality and slowing growth, OECD countries have boosted consumption by rushing into debt – both public (leading to Europe’s public-debt crisis) and private (facilitating the American subprime crisis).




.This would have been impossible had the OECD countries’ main suppliers of energy and manufactured goods not, over time, become their creditors. In a remarkable reversal of history, the world’s poor now finance the world’s rich, owing to large foreign reserves. Indeed, the hypertrophy of today’s global financial sector largely reflects efforts to recycle emerging-market countries’ rising surpluses in order to plug the rich countries’ mounting deficits.




.Until recently, this dynamic was considered transitory. Emerging countries’ growth would necessarily lead to convergence of global wages and prices, thus halting the erosion of manufacturing in the OECD countries. The demographic transition in the world’s emerging countries would encourage the development of their domestic markets, a fall in their saving rates, and a rebalancing of global trade.




.That might be true in theory, but the length of this transition period, which is at the heart of the global financial crisis, has been badly underestimated. The “inversion of scarcities” – the new abundance of men and women actively participating in the global economy, combined with a once-abundant natural world’s increasingly visible limitsrisk prolonging the transition indefinitely, for two reasons.




.First, from a macroeconomic perspective, we can no longer count on declining prices for raw materials, one of the economic stabilizers in times of crisis. Given rising demand in emerging countries, the cost of natural resources is bound to be a growing constraint.




.Second, from a social perspective, after a doubling of the workforce in the global labor market during the twentieth century, another “industrial reserve army” has arisen in China, and among the three billion inhabitants of the world’s developing countries.




.A rapid rebalancing of global growth by reducing financial imbalances between OECD economies and their emerging-market creditors is risky, because it would cause a major recession for the former – and then for the latter. Moreover, it is unlikely, because it assumes that emerging countries will run trade deficits with OECD countries, and that their domestic markets will become drivers of global growth.




.If this analysis is correct, a new global rebalancing strategy will need to begin somewhere other than the wealthy OECD economies. The implementation of new growth models in the developing world – the parts of South Asia, Latin America, and Africa that have not adopted export-led strategies – can provide at least part of the missing demand that the world economy urgently needs.




.The success of this scenario depends on a combination of three dynamics. First, interstate trade between emerging-market and developing countries must accelerate, thereby building the same kind of consumer-provider relationship as that between emerging and advanced countries.


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Second, domestic markets in the world’s poorest countries must be developed in order to foster more home-grown growth. And, third, financial flows to developing countries – both official development assistance and foreign direct investment – must rise, and must come not only from industrialized economies, but also from emerging and oil-exporting countries.




.Recycling global surpluses through the world’s bottom billionspresupposes a complete overhaul of standard economic models, which essentially assume that the Asian economic miracle can be replicated. After all, even if the world achieves significant economic growth between now and 2050, two billion of the world’s nine billion people will still live on less than two dollars a day, and a further billion will have little more than that.




.For emerging and wealthy economies alike, the world’s poor should not be viewed as a burden. In the current global economic crisis, they are the best exit strategy we have.



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.Jean-Michel Severino is Director of Research at the Fondation pour les Études et Recherches sur le Développement International (FERDI), and Manager of Investisseur et Partenaire. Olivier Ray is a development economist at the French Ministry of Foreign Affairs. They are the co-authors of Africa’s Moment.


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Copyright: Project Syndicate, 2012.


The State of the World: Germany's Strategy

March 12, 2012 | 2217 GMT .

By George Friedman

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The idea of Germany having an independent national strategy runs counter to everything that Germany has wanted to be since World War II and everything the world has wanted from Germany. In a way, the entire structure of modern Europe was created to take advantage of Germany's economic dynamism while avoiding the threat of German domination. In writing about German strategy, I am raising the possibility that the basic structure of Western Europe since World War II and of Europe as a whole since 1991 is coming to a close.



If so, then the question is whether historical patterns of German strategy will emerge or something new is coming. It is, of course, always possible that the old post-war model can be preserved. Whichever it is, the future of German strategy is certainly the most important question in Europe and quite possibly in the world.



Origins of Germany's Strategy


Before 1871, when Germany was fragmented into a large number of small states, it did not pose a challenge to Europe. Rather, it served as a buffer between France on one side and Russia and Austria on the other. Napoleon and his campaign to dominate Europe first changed the status of Germany, both overcoming the barrier and provoking the rise of Prussia, a powerful German entity. Prussia became instrumental in creating a united Germany in 1871, and with that, the geopolitics of Europe changed.

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What had been a morass of states became not only a unified country but also the most economically dynamic country in Europe -- and the one with the most substantial ground forces. Germany was also inherently insecure. Lacking any real strategic depth, Germany could not survive a simultaneous attack by France and Russia.


Therefore, Germany's core strategy was to prevent the emergence of an alliance between France and Russia. However, in the event that there was no alliance between France and Russia, Germany was always tempted to solve the problem in a more controlled and secure way, by defeating France and ending the threat of an alliance. This is the strategy Germany has chosen for most of its existence.


The dynamism of Germany did not create the effect that Germany wanted. Rather than split France and Russia, the threat of a united Germany drew them together. It was clear to France and Russia that without an alliance, Germany would pick them off individually. In many ways, France and Russia benefited from an economically dynamic Germany. It not only stimulated their own economies but also provided an alternative to British goods and capital.

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Nevertheless, the economic benefits of relations with Germany did not eliminate the fear of Germany. The idea that economics rule the decisions of nations is insufficient for explaining their behavior.


Germany was confronted with a strategic problem. By the early 20th century the Triple Entente, signed in 1907, had allied Russia, France and the United Kingdom. If they attacked simultaneously at a time of their choosing, these countries could destroy Germany.

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Therefore, Germany's only defense was to launch a war at a time of its choosing, defeat one of these countries and deal with the others at its leisure. During both World War I and World War II, Germany first struck at France and then turned to deal with Russia while keeping the United Kingdom at bay.

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In both wars, the strategy failed. In World War I, Germany failed to defeat France and found itself in an extended war on two fronts. In World War II, it defeated France but failed to defeat Russia, allowing time for an Anglo-American counterattack in the west.


Binding Germany to Europe


Germany was divided after World War II. Whatever the first inclinations of the victors, it became clear that a rearmed West Germany was essential if the Soviet Union was going to be contained. If Germany was to be rearmed, its economy had to be encouraged to grow, and what followed was the German economic miracle. Germany again became the most dynamic part of Europe.



The issue was to prevent Germany from returning to the pursuit of an autonomous national strategy, both because it could not resist the Soviet forces to the east by itself and, more important, because the West could not tolerate the re-emergence of divisive and dangerous power politics in Europe. The key was binding Germany to the rest of Europe militarily and economically. Put another way, the key was to make certain that German and French interests coincided, since tension between France and Germany had been one of the triggers of prior wars since 1871. Obviously, this also included other Western European countries, but it was Germany's relationship with France that was most important.



Militarily, German and French interests were tied together under the NATO alliance even after France withdrew from the NATO Military Committee under Charles de Gaulle. Economically, Germany was bound with Europe through the emergence of more sophisticated multilateral economic organizations that ultimately evolved into the European Union.


After World War II, West Germany's strategy was threefold. First, it had to defend itself against the Soviet Union in concert with an alliance that would effectively command its military through NATO.
This would limit German sovereignty but eliminate the perception of Germany as a threat.

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Second, it would align its economy with that of the rest of Europe, pursuing prosperity without undermining the prosperity of other countries. Third, it would exercise internal political sovereignty, reclaiming its rights as a nation without posing a geopolitical threat to Western Europe. After the fall of the Soviet Union, this was extended to include Eastern European states.



The strategy worked well. There was no war with the Soviets. There was no fundamental conflict in Western Europe and certainly none that was military in nature. The European economy in general, and the German economy in particular, surged once East Germany had been reintegrated with West Germany.

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With reintegration, German internal sovereignty was insured. Most important, France remained linked to Germany via the European Union and NATO. Russia, or what was left after the collapse of the Soviet Union, was relatively secure so long as Germany remained part of European structures. The historical strategic problem Germany had faced appeared solved.



Europe's Economic Crisis



The situation became more complex after 2008. Germany's formal relationship with NATO remained intact, but without the common threat of the Soviet Union, the alliance was fracturing over the divergent national interests of its members. The European Union had become Germany's focus, and the bloc had come under intense pressure that made the prior alignment of all European countries more dubious. Germany needed the European Union. It needed it for the reasons that have existed since World War II: as a foundation of its relationship with France and as a means to ensure that national interest would not generate the kinds of conflicts that had existed in the past.


It needed the European Union for another reason as well. Germany is the second-largest exporter in the world. It exports to many countries, but Europe is a critical customer. The free-trade zone that was the foundation of the European Union was also one of the foundations of the German economy.


Protectionism in general, but certainly protectionism in Europe, threatened Germany, whose industrial plant substantially outstripped its domestic consumption. The pricing of the euro aided German exports, and regulations in Brussels gave Germany other advantages. The European Union, as it existed between 1991 and 2008, was critical to Germany.


However, the European Union no longer functions as it once did. The economic dynamics of Europe have placed many countries at a substantial disadvantage, and the economic crisis of 2008 triggered a sovereign debt crisis and banking crisis in Europe.


There were two possible solutions in the broadest sense. One was that the countries in crisis impose austerity in order to find the resources to solve their problem. The other was that the prosperous part of Europe underwrites the debts, sparing these countries the burden of austerity. The solution that has been chosen is obviously a combination of the two, but the precise makeup of that combination was and remains a complex matter for negotiation.


Germany needs the European Union to survive for both political and economic reasons. The problem is that it is not clear that a stable economic solution can emerge that will be supported by the political systems in Europe.


Germany is prepared to bail out other European countries if they impose austerity and then take steps to make sure that the austerity is actually implemented to the degree necessary and that the crisis is not repeated. From Germany's point of view, the roots of the crisis lie in the fiscal policies of the troubled countries. Therefore, the German price for underwriting part of the debt is that European bureaucrats, heavily oriented toward German policies, be effectively put in charge of the finances of countries receiving aid against default.


This would mean that these countries would not control either taxes or budgets through their political system. It would be an assault on democracy and national sovereignty. Obviously, there has been a great deal of opposition from potential recipients of aid, but it is also opposed by some countries that see it as something that would vastly increase the power of Germany. If you accept the German view, which is that the debt crisis was the result of reckless spending, then Germany's proposal is reasonable. If you accept the view of southern Europe, which is that the crisis was the result of the European Union's design, then what Germany is proposing is the imposition of German power via economics.


It is difficult to imagine a vast surrender of sovereignty to a German-dominated EU bureaucracy, whatever the economic cost. It is also difficult to imagine Germany underwriting the debt without some controls beyond promises; even if the European Union is vitally important to the Germans, German public opinion will not permit it.



Finally, it is difficult to see how, in the long term, the Europeans can reconcile their differences on this issue. The issue must come to a head, if not in this financial crisis then in the next -- and there is always a next crisis.


An Alternative Strategy


In the meantime, the basic framework of Europe has changed since 1991. Russia remains a shadow of the Soviet Union, but it has become a major exporter of natural gas. Germany depends on that natural gas even as it searches for alternatives. Russia is badly in need of technology, which Germany has in abundance.


Germany does not want to invite in any more immigrants out of fear of instability. However, with a declining population, Germany must do something.


Russia also has a declining population, but even so, it has a surplus of workers, both unemployed and underemployed. If the workers cannot be brought to the factories, the factories can be brought to the workers. In short, there is substantial synergy between the Russian and German economies. Add to this that the Germans feel under heavy pressure from the United States to engage in actions the Germans want to be left out of, while the Russians see the Americans as a threat to their interests, and there are politico-military interests that Germany and Russia have in common.



NATO is badly frayed. The European Union is under tremendous pressure and national interests are now dominating European interests.


Germany's ability to use the European Union for economic ends has not dissipated but can no longer be relied on over the long term. Therefore, it follows that Germany must be considering an alternative strategy. Its relationship with Russia is such a strategy.


Germany is not an aggressive power. The foundation of its current strategy is its relationship with France in the context of the European Union. The current French government under President Nicolas Sarkozy is certainly committed to this relationship, but the French political system, like those of other European countries, is under intense pressure. The coming elections in France are uncertain, and the ones after that are even less predictable. The willingness of France to engage with Germany, which has a massive trade imbalance with France, is an unknown.



However, Germany's strategic interest is not necessarily a relationship with France but a relationship with either France or Russia to avoid being surrounded by hostile powers. For Germany, a relationship with Russia does as well as one with France. An ideal situation for Germany would be a Franco-German-Russian entente.


Such an alliance has been tried in the past, but its weakness is that it would provide too much security to Germany, allowing it to be more assertive. Normally, France and Russia have opposed Germany, but in this case, it is certainly possible to have a continuation of the Franco-German alliance or a Russo-French alliance. Indeed, a three-way alliance might be possible as well.



Germany's current strategy is to preserve the European Union and its relationship with France while drawing Russia closer into Europe. The difficulty of this strategy is that Germany's trade policies are difficult for other European countries to manage, including France. If Germany faces an impossible situation with the European Union, the second strategic option would be a three-way alliance, with a modified European Union or perhaps outside of the EU structure. If France decides it has other interests, such as its idea of a Mediterranean Union, then a German-Russian relationship becomes a real possibility.


A German-Russian relationship would have the potential to tilt the balance of power in the world. The United States is currently the dominant power, but the combination of German technology and Russian resources -- an idea dreamt of by many in the past -- would become a challenge on a global basis. Of course, there are bad memories on both sides, and trust in the deepest sense would be hard to come by. But although alliances rely on trust, it does not necessarily have to be deep-seated trust.


Germany's strategy, therefore, is still locked in the EU paradigm. However, if the EU paradigm becomes unsupportable, then other strategies will have to be found.

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The Russo-German relationship already exists and is deepening. Germany thinks of it in the context of the European Union, but if the European Union weakens, Russia becomes Germany's natural alternative.