Traveling Through Multiple Europes

By Adriano Bosoni

Tuesday, November 4, 2014 - 03:00

Europe is overcrowded with people and with nations. Six decades ago, the need to suppress the dangerous forces of nationalism led to the unprecedented political, economic and social experiment now known as the European Union. The hundreds of thousands of EU citizens working across the Continent and the lack of border controls between member states show that the experiment has been successful in many ways. However, rising nationalism, pervasively high unemployment and a growing sense of frustration with governing elites also highlight the serious limitations of the European project. Over the past 12 months, I have traveled extensively throughout Europe, observing firsthand how the global economic crisis is reawakening dormant trends along the Continent's traditional fault lines.

The crisis is having an uneven effect on EU member states because the eurozone locks countries with different levels of economic development into the same currency union. Europe's geography helps explain these differences: Countries in the south have traditionally dealt with high capital costs and low capital-generation capacity, while countries in the north have seen the opposite.

In December, I drove from Barcelona to Madrid. The endless succession of mountains along the route encapsulates Spain's traditional struggle against geography: Merely moving people and goods from point to point on the Iberian Peninsula has always posed formidable challenges for governments and traders. This rugged geography also led to the development of small pockets of populations with strong national identities, creating tension between Madrid and the Basque Country as well as Catalonia. Spain has traditionally been a resource-poor country that has had to look to the Atlantic to find wealth while frequently resorting to violence to secure unity.

In contrast, most of Germany is flat. In May, I drove north along the Rhine, one of the country's major economic arteries. The river and its tributaries have blessed all of the people living near them, bringing incalculable wealth to trading cities such as Frankfurt and Cologne. The same holds true for the two other major German waterways, the Elbe and the Danube. But wealth does not necessarily mean peace. Both sides of the Rhine host multiple castles and fortifications, a reminder of the state of fragmentation that defined the Germanic world for centuries. The lack of any real physical borders to the east and west also helps explain Germany's historical conflict with its neighbors.

Highways in Spain and Germany highlight a more significant difference. During my journey between Barcelona and Madrid, I barely saw any cars, let alone trucks. At times, it was hard to believe I was traveling between the two major cities in the eurozone's fourth-largest economy. By contrast, Germany's autobahns are crowded with vehicles going from one point to another. The same geography that made Germany a place of conflict also explains its economic power: Germany is the center of Europe from almost every possible point of view.

The farther one moves from Germany, the more evident the crisis becomes. Traveling by train from Thessaloniki to Athens lets one see Greece's complex geography firsthand. Greece is a rugged country with narrow coastal plains that swiftly give way to mountains. Complicating matters, the country has some 6,000 islands and islets, only a handful of which are inhabited. Greece's extremely fragmented geography and its strategic position on the eastern Mediterranean helps explain why it has struggled throughout history to get anything done. Developing an integrated economy and collecting taxes has proven difficult, especially while repelling a never-ending series of invasions.

Walking down the streets of Athens reveals that this is where the crisis struck first and has had the deepest impact. The city's downtown is full of closed shops with broken windows, graffiti and other signs of long-term neglect. In Athens, I saw far more police than in any other major European city. But at no time did I feel unsafe. Police are not out in force because of crime but because of social unrest. Though Greece is relatively tranquil these days, the social situation is still a ticking time bomb.

At the other end of the Continent, Portugal looks similar. I arrived in early October, excited by recent figures showing a drop in unemployment and an improvement in the economic outlook. What I found, however, was a place where only tourism seemed to be working while everything else remained static. Lisbon and Oporto are bittersweet places where magnificent monuments and spectacular views coexist with poverty and economic depression. Though Lisbon ended its rescue program with the European Union and International Monetary Fund early this year, for many Portuguese, life remains hard.

Talking Politics Across the Continent

Whenever I'm in a foreign country, I make an effort to visit bookstores because the books people read and write offer insights into the social mood. Bookstores in Southern Europe are a reminder that the Continent's economic problems have become political ones too. The gap between voters and traditional elites keeps widening as people are becoming increasingly tired of the policies designed by Brussels and backed by domestic politicians.

Perusing the shelves, I saw numerous books with significant anti-austerity and anti-establishment themes, which in some cases took an anti-German flavor. In an Oporto bookstore, among the bestsellers was a book called We Are Not Germans, while a Rome bookstore had a book called It's Not Worth a Lira, a plea to leave the euro and return to Italy's old currency, that appeared to be quite popular.

Southern Europeans fear and admire Germany at the same time. On one hand, Germany is seen as a country where everything works and governments are efficient. On the other hand, it is also seen as a hegemon that doesn't understand or care about the situation in the nations it is trying to lead.

Europe's economic crisis is particularly puzzling for the center-left. Social Democrats have traditionally embraced the process of European integration because it offers economic prosperity based on big welfare states and strong labor legislation. But this model is in crisis in many countries, and even center-left governments are applying spending cuts under pressure from the European Union.

In Italy, I had dinner with a former union leader as the center-left's Matteo Renzi -- who had just been appointed prime minister -- was proposing reforms in several areas, including labor. "I don't like the direction Renzi is going," the former union leader told me, "but I will vote for the Democratic Party again because it's either them or the (anti-system) Five Star Movement." While conservative forces are moving to the right and nationalist forces are gaining strength, the center-left is going through an identity crisis that is generating frictions within the parties and confusing their traditional voters -- something French President Francois Hollande is learning the hard way.

In Athens, a journalist told me she did not share the views of the neo-Nazi Golden Dawn party, but at least it had never been involved in a corruption scandal like those that have traditionally surrounded the country's mainstream parties. Along with the concept of democracy, Ancient Greece also developed the concept of kleptocracy. Whenever you talk with Greeks about politics, a word comes to their mouths almost immediately: "kleptes," which literally means "thieves." Most Southern Europeans have similar views of their governments. And while there is a big gap between what people say in conversations and the way they vote, these anti-establishment sentiments are not going away anytime soon -- and will keep threatening the survival of the European Unión.

A Continent of Expatriates

While the economic and political impact of the crisis is evident in Southern Europe, its demographic consequences will take longer to be noticed but will probably be deeper. Before the current downturn, these countries had some of the lowest fertility rates in Europe, which, combined with rising life expectancy, led to an aging and shrinking population. The crisis made things worse because it generated high waves of emigration.

In the short run, emigration helps reduce the pain of the crisis because there are fewer people competing for jobs and more people sending remittances home. In the long run, however, it creates fiscal and economic challenges for the countries that see a decline in their labor forces. The economic crisis is returning Southern European countries to their traditional roles as places of emigration, where the young leave and the old are left behind.

But emigration is also problematic for the receiving countries. The rising number of refugees coming from Northern Africa and the Middle East is generating concerns in countries including Spain and Italy as well as Austria and Sweden. At the same time, immigrants from Eastern Europe are pushing Germany and the United Kingdom to find bureaucratic means to discourage them. In early January, an old lady in Frankfurt asked me where I was from. When I told her I was Argentinian-Italian, she smiled at me. She thought about her words and, after a while, said, "Italians are fine. It's Romanians and Bulgarians I'm worried about."

The irony is that the same process that is creating political and social tensions in Europe's core is helping to mitigate the negative effects of a demographic change. In Germany, I met many expatriates from across Europe, most of whom work at English-speaking companies with large Pan-European staffs. European enterprises can pick their employees from a pool of highly skilled workers from across the Continent without having to file significant amounts of paperwork. While the pressure to limit immigration is gaining momentum in Europe, I also expect businessmen to fight it.

The View From Outside the Eurozone

The economic crisis is not only leading to friction within the eurozone, it's also fragmenting the wider European Union. With Europe's main powers focused on the problems within the currency union, many of the newest EU members are feeling isolated. The re-emergence of a more aggressive Russia is complicating matters for these new members.

Of all the places I visited this year, Poland is probably the most interesting for the simple reason that its concerns are different from those of Western Europe. I visited Warsaw in May to attend a conference marking the 25th anniversary of the end of communism and the 10th anniversary of Polish EU membership. The timing was also interesting because the crisis in Ukraine was heating up, making the Poles increasingly nervous about Russian moves in Central Europe.

I found that Poland was a country confident about its economic strength but worried about its future. History has given the Poles a deep understanding of geopolitics and too many reasons to be worried about the events beyond their borders. I visited Warsaw a few days before the arrival of U.S. President Barack Obama. The excitement caused by his visit was a confirmation of Poland's strategy of developing closer ties with the United States to help it cope with a politically fragmented European Union and a hesitant NATO. The Poles are proud of being members of the European Union, but they are not completely confident that Brussels will come to their rescue should the crisis with Russia escalate.

One Europe, Too Many Europes

Strasbourg is an excellent place to reflect on Europe because it is a synthesis of everything that is great and tragic about the Continent. The city looks German but feels French -- because it's both. Crossing the Rhine from Baden-Baden to Strasbourg and seeing that there are no border controls, and nothing to indicate that you've moved from Germany to France but a small sign that reads "French republic," is normal for anyone who was born in the past 30 years. But from a French king's order to his men to "burn the Palatinate" in the late 1680s to a German leader's invasion of France in the early 1940s, having peace between the countries east and west of the Rhine is an anomaly rather than the norm.

Six decades after the creation of the European Union, this is still the key relationship to watch. The crisis has now reached a point where its two main players are under extreme pressure. Germany joined the eurozone under the assumption that no bailouts would be given to nations in distress and no monetization of debt would take place. France joined the eurozone under the assumption that it would remain the political leader of Europe. The crisis has put all the promises and agreements that supported the Franco-German unity in doubt.

Europeanists believe that things would be much better if the European Union became a true federation. They are probably right. The question is how to accomplish this. As Germany learned during its unification in the 1870s and confirmed during its reunification in the 1990s, building a large united political unity out of smaller entities requires the redistribution of money and power. But what should come first, money or reforms? The European Union is currently seeing the worst of both worlds: A monetary union without a fiscal union. In other words, it has sovereign states that don't control their currencies and supranational institutions that don't control fiscal policy.

We tend to think of Europe as a cohesive unit because there is an entity called the European Union that has headquarters in Brussels and is represented across the Continent. To a certain extent, this perception is correct. But if anything, the crisis serves as a reminder of Europe's perennial state of fragmentation, which is the consequence of history and geography. These divisions led to the current crisis and will hamper any attempts to solve it.

Editor's Note: Writing in George Friedman's stead this week is Europe Analyst Adriano Bosoni.

November 5, 2014 5:28 am

Dollar rally puts focus on Beijing

China’s currency has long been hitched to someone else’s wagon – that being the US dollar. But as central banks across the developed world plot diverging courses, Beijing is fast finding that the renminbi is prone to travel sickness.

Some analysts warn that the current slide in the yen and the euro is raising pressure on China to boost competitiveness by weakening the renminbi, something that would send shockwaves across the global economy.

China’s currency is anchored to the US dollar, against which it can rise or fall by a maximum of 2 per cent a day from a fixed rate set by the People’s Bank of China. This mechanism gives the central bank effective control of the exchange rate against the dollar, but not against the currencies of its other major trading partners.

While the renminbi has fallen this year by around 1 per cent against the dollar, it has risen recently to a record high against the Japanese currency, and is at its strongest against the euro for more than a decade.

On a trade-weighted basis, the renminbi has risen more than 15 per cent since the start of 2013, according to an index compiled by JPMorgan. Excluding Hong Kong, the eurozone is China’s largest trading partner while Japan is number three.

Though not a widely held view, Lombard Street Research estimates that the renminbi is now 15-25 per cent overvalued, and will depreciate as China looks to shift its economic model away from fixed-asset investment.
Beijing’s stated goal is use higher consumption to offset lower investment, although this rebalancing is expected to take many years of painful reform.

In the meantime, increasing exports to boost growth is the “only palliative” for the country’s economic malaise, Lombard’s Charles Dumas wrote in a recent report.

China’s currency management system has left it vulnerable to fluctuations caused by recent changes to central bank policy in the US, Europe and Japan.

Last week the Bank of Japan announced a major ramping-up of its asset buying scheme, less than two days after the US Federal Reserve ended its own quantitative easing programme. The result has been a steep drop in the yen, which hit a seven-year low of Y114 against the dollar earlier this week.
Similarly, the euro has been falling since the European Central Bank introduced a range of unorthodox policy measures to help stave off deflation. The single currency is now at its weakest against the dollar since the summer of 2012.

The yen and the euro have appeared locked in a race to the bottom, with each dropping 10 per cent against the dollar in the past six months. Against the renminbi, those declines are even greater, with each losing 12 per cent.

Meanwhile, the Chinese economy has continued to slow, recording its lowest growth since the financial crisis in the most recent quarter. Though exports picked up in September, wrinkles in the data suggest the numbers have been inflated by fake invoicing – an old ruse used to sidestep China’s capital controls.
“If the dollar continues to strengthen, the pressure on the PBoC to engineer another short and sharp mini-devaluation and once again shock expectations will rapidly escalate,” writes BNP Paribas economist Richard Iley in a report.

There is also the possibility of lower interest rates in China to help boost domestic demand. Barclays economist Jian Chang forecasts two rate cuts – one by the end this year, and another in the first quarter of 2015.

However, many analysts believe the most likely course is for the renminbi to be held steady against the dollar, rather than for a significant devaluation. Sacha Tihanyi, FX strategist at Scotia Bank, says stability is more important than the exchange rate in achieving China’s goal of economic transition.

“The last thing you want to do is disrupt financial markets and prompt capital outflows, which is what a policy of devaluation would do,” says Mr Tihanyi. “It wouldn’t be consistent with China’s policy preference.”


Heard on the Street

Bank Investors: Beware Senators Bearing Gifts

Reopening Regulatory Debate Carries Hazards for Banks

By John Carney And David Reilly  

Nov. 5, 2014 12:47 p.m. ET 

The ascension of Republicans to leadership in the U.S. Senate raises prospects for a change to financial regulation that has broad and bipartisan support and seemingly could be a boon to some medium-size banks. Unfortunately for investors, the potential costs of shaking the financial-reform tree may be too high.

Many bankers would like to see a change to rules for designating banks as systemically important. The Dodd-Frank Act drew a legislative line under banks with $50 billion or more in assets, subjecting them to greater scrutiny by the Federal Reserve and other regulators.

Voices across the political spectrum have talked about this demarcation being arbitrary or too low. In a speech this spring, even Fed Governor Daniel Tarullo , the central bank’s point person on financial regulation, said the line might better be drawn at $100 billion.

Around two dozen lenders with assets between $40 billion and $100 billion could seem to benefit from such a move, among them Zions Bancorp , Huntington Bancshares , M&T and CIT Group. This would relieve large cost burdens incurred to comply with enhanced regulation, including the need to submit to stress tests and resolution planning.

Proponents of the change also say it would allow regulators to better focus on those financial institutions that pose the widest-reaching threats to the financial system.

That rare consensus could put change within reach, giving Republican and Democratic lawmakers a rare chance to show they can work together. The danger: Any attempt to change one aspect of Dodd-Frank will be seen as a breach through which supporters of a far broader set of changes will charge.

Investors might be tempted to think reopening the debate over financial regulation could prove a bonanza for banks. Restrictions on trading, requirements to hold more capital, and stricter oversight have combined to weigh down returns, particularly at the biggest banks.

But reviving the debate over financial reform could also resurrect the question of what to do about too-big-to-fail banks and renew calls for them to be broken up. Some powerful lawmakers also have voiced support for raising capital levels even higher. That could put the likes of J.P. Morgan Chase , Bank of America and Citigroup back on the hot seat.

This is one of the problems that has plagued bipartisan efforts to amend the so-called Collins Amendment, which regulators say requires them to impose bank-capital requirements on insurance companies tagged as systemically important. No one thinks that is the right approach. But efforts to fix it have stalled, in part thanks to attempts to tack on other changes to financial regulations.

An added wrinkle: While banks have struggled with the onslaught of new regulations, they are getting a handle on them. Loan growth and returns on equity are starting to rise, as predicted by a Bank of England working paper published earlier this year. It found it takes about three years for banks to adjust to new rules. Upending them now could restart that clock, dragging returns down again.

Change has a sweet sound. But in this case it could leave a sour taste in the mouths of bank investors.

Op-Ed Contributor

The Midterms Were Not a Republican Revolution


NOV. 5, 2014                                       

    ON election night 1994, as Republicans recaptured the House for the first time in 40 years, I stood in the audience and watched my client Newt Gingrich, who would soon become speaker of the House, declare the beginning of the “Republican revolution.”
    I knew immediately that the smartest man I had ever worked for was making the worst rhetorical blunder of his career. Nobody voted Republican to start a revolution. They did so because they were fed up with a Democratic president overreaching on health care and a government seemingly incapable of doing even the smallest thing effectively. We all know what happened when Mr. Gingrich tried to turn his rhetoric into action.
    Sound familiar? No one is quite saying “revolution” this week, but Republicans across the country, in their glee over Tuesday’s elections, are coming dangerously close to making the same mistake.
    But that anti-Democrat wave was not the same as a pro-Republican endorsement. In many races that went from blue to red, Republican success was hardly because of what the G.O.P. has achieved on Capitol Hill. In fact, if Americans could speak with one collective voice — all 310 million of them — this is what they said Tuesday night: “Washington doesn’t listen, Washington doesn’t lead and Washington doesn’t deliver.” Purple states tossed out their Democratic senators for being too close to Washington and too far from the people who put them there.
    The current narrative, that this election was a rejection of President Obama, misses the mark. So does the idea that it was a mandate for an extreme conservative agenda. According to a survey my firm fielded on election night for the political-advocacy organization Each American Dream, it was more important that a candidate “shake up and change the way Washington operates.”
    I didn’t need a poll to tell me that. This year I traveled the country listening to voters, from Miami to Anchorage, 30 states and counting. And from the reddest rural towns to the bluest big cities, the sentiment is the same. People say Washington is broken and on the decline, that government no longer works for them — only for the rich and powerful.
    They voted out those who promised to do more in favor of those who said they would do less, but do it better. That’s why the Democratic candidates for governor who condemned their opponents for spending too little on education, transportation and programs for the poor and unemployed still lost.
    The results were less about the size of government than about making government efficient, effective and accountable. Our election night survey showed that 42 percent chose their Senate candidate because they hated the opponent more. One pre-election poll had over 70 percent willing to throw everyone out and start fresh.
    Winning on Election Day is not the end. The objective can’t be just to bide time for the next election; that’s a losing strategy. The mission has to be a restoration of confidence in the future. The question is: What can Republicans at all levels do to make this happen, and avoid repeating the mistakes of the past?
    First, hold Washington accountable. From the cover-ups of veterans dying while being denied care to using the I.R.S. to target conservative groups, recent scandals highlight the chasm between hard-working taxpayers and Washington. But this also means holding your colleagues accountable. No turning a blind eye to broken promises. If you’re truly different, act truly differently.
    Second, make the people’s priorities your priorities. In our survey, the top priorities were making the government more efficient and controlling spending. So tackle deficits and the national debt, and root out the waste and abuse of government programs. Reduce the crippling red tape and regulations that are strangling small businesses. As the House majority leader, Kevin McCarthy, said, show that a Republican Congress has both the wisdom to listen and the courage to lead.
    Third, stop blustering and fighting. Americans despair of the pointless posturing, empty promises and bad policies that result. Show that you are more concerned with people than politics. Don’t be afraid to work with your opponents if it means achieving real results. Democrats and Republicans disagree on a lot, but there are also opportunities of real national importance, like national security and passing the trans-Atlantic trade deal.
    Aside from a small activist constituency, Americans are not looking for another fight over same-sex marriage or abortion. This isn’t to say that voters want their leaders to co-opt their convictions. People are simply tired of identity politics that pit men against women, black against white, wealthy against poor. More than ever, they want leadership that brings us together.
    This isn’t about pride of ownership regarding American progress; this is about progress, period. Americans don’t care about Democratic solutions or Republican solutions. They just want common-sense solutions that make everyday life just a little bit easier. But they can’t get their houses in order until Washington gets its own house in order.