Europe’s New “Indispensable Nations”

Joschka Fischer

NATO secretary general Stoltenberg at NATO Foreign Affairs meeting

 

BERLIN – After the shock of the United Kingdom’s Brexit referendum and Donald Trump’s election as President of the United States in 2016, this will be a decisive year for Europe.

Upcoming parliamentary elections in France, Germany, the Netherlands, and possibly Italy will decide whether the European Union will hold together, or whether it will disintegrate under the neo-nationalist wave sweeping the West.
 
Meanwhile, the Brexit negotiations will begin in earnest, providing a glimpse of the future of the EU-UK relationship. And Trump’s inauguration on January 20 may someday be remembered as a watershed moment for Europe.
 
Judging by Trump’s past statements about Europe and its relationship with the US, the EU should be preparing for some profound shocks. The incoming US president, an exponent of the new nationalism, does not believe in European integration.
 
Here he has an ally in Russian President Vladimir Putin, who has long tried to destabilize the EU by supporting nationalist forces and movements in its member states. If the Trump administration supports or turns a blind eye to those efforts, the EU – sandwiched between Russian trolls and Breitbart News – will have to brace itself for challenging times indeed.
 
The consequences for the EU will be even more serious if, in addition to setting the US relationship with Russia on a new foundation, Trump continues to call into question America’s security guarantee for Europe. Such a move would be at the expense of NATO, which has institutionalized the US security umbrella for more than six decades. Europeans would suddenly find themselves standing alone against a Russia that has increasingly employed military means to challenge borders, such as in Ukraine, and to reassert its influence – or even hegemony – over Eastern Europe.
 
We will soon know what comes next for NATO, but much harm has already been done.

Security guarantees are not just a matter of military hardware. The guarantor also must project a credible message that it is willing to defend its allies whenever necessary. Thus, such arrangements depend largely on psychology, and on a country’s trustworthiness vis-à-vis friends and foes alike. When that credibility is damaged, there is a growing risk of provocation – and, with it, the threat of escalation into larger crises, or even armed conflict.
 
Given this risk, the EU should now shore up what it has left with respect to NATO and focus on salvaging its own institutional, economic, and legal integration. But it should also look to its member states to provide a second security option.
 
The EU itself is based on soft power: it was not designed to guarantee European security, and it is not positioned in its current form to confront a hard-power challenge. This means that it will fall to its two largest and economically strongest countries, France and Germany, to bolster Europe’s defense. Other countries such as Italy, Belgium, the Netherlands, Luxembourg, Spain, and Poland will also have a role to play, but France and Germany are indispensable.
 
Of course, living in continental Europe means having Russia as a neighbor, and neighborly relations, generally speaking, should be based on peace, cooperation, and mutual respect (especially when one’s neighbor is a nuclear power). But Europeans cannot harbor any illusions about Russia’s intent. The Kremlin approaches foreign policy as a zero-sum game, which means that it will always prioritize military strength and geopolitical power over cooperative security arrangements.
 
Russia does not view weakness or the lack of a threat from its neighbors as a basis for peace, but rather as an invitation to extend its own sphere of influence. So, power asymmetry in Eastern Europe will lead only to instability. If Europe wants a stable, enduring peace, it first must ensure that it is taken seriously, which is clearly not the case today. Europe can credibly strengthen its security only if France and Germany work together toward the same goal, which they will have an opportunity to do after their elections this year.
 
EU diplomats used to murmur off the record that Germany and France would never see eye to eye on military and financial issues, owing to their different histories and cultures. But if security conditions take a turn for the worse, that may no longer be the case. Indeed, reaching a compromise on both sides of the Rhine should not be so difficult: France undoubtedly has the experience to lead on defense; and the same goes for Germany on financial matters.
 
If pursuing this European security option prompts the US to renew its own security guarantee, so much the better. Meanwhile, the EU should also forge a post-Brexit cooperative strategic arrangement with the UK, whose geopolitical position and security interests will remain unchanged.
 
The old EU developed into an economic power because it was protected beneath the US security umbrella. But without this guarantee, it can address its current geopolitical realities only by developing its own capacity to project political and military power. Six decades after the Treaty of Rome established the European Economic Community, history and current developments are pushing France and Germany to shape Europe’s future once again.
 
 


Buttonwood

2016 may have been an economic as well as political turning-point

Investors may be too optimistic about the direction in which the world is changing


THANKS to Brexit and the election of Donald Trump, 2016 is widely viewed as a political turning-point. But it may also come to be seen as an economic turning-point, marking the third big change of direction since the second world war.

The post-war period from 1945 to 1973 was the era of the Bretton Woods system of fixed exchange rates and capital controls. It was a time of rapid economic growth in the rich world as countries rebuilt themselves after the war and as the technological innovations of the first half of the 20th century—cars, televisions, and so on—came into widespread use. High taxes reduced inequality; fiscal policy was used to control the economic cycle. It all came crashing down in the early 1970s as the fixed-currency system collapsed, and an oil embargo imposed by Arab producers ushered in stagflation (ie, high unemployment combined with inflation).

By the early 1980s, a new system had emerged. Currencies floated, capital controls were abolished, the financial sector was liberalised, industry was privatised and tax rates on higher incomes were cut.

In this system inequality widened again (although economists still debate how to parcel out the blame between technological change and globalisation, as China and other countries took a full part in trade). Growth was slower than in the Bretton Woods era but inflation was reined in. Monetary measures replaced fiscal ones as the main policy tool. This era suffered its defining crisis in 2007-08 and has come to an end.

The final years of both periods were marked by a degree of monetary experimentation. In the late 1970s many policymakers were converted to the doctrine of monetarism—the idea that by setting a target for the growth of the money supply governments could control inflation (and that controlling inflation should be the main aim of their policies). But monetarism proved harder to implement than its proponents thought; the monetary targets behaved unpredictably.

By the mid-1980s, monetarism had been quietly dropped.

Since the 2008 crisis, monetary policy has had to be rethought again, with central banks grappling with the “zero bound” for interest rates. Their first move was to adopt quantitative easing, the purchase of assets to drive down longer-term borrowing costs. Some have since followed this up with negative rates on bank reserves.

Financial-market trends have played out against the backdrop of these two policy eras. Equities did very well for 20 years under the Bretton Woods regime, but started to falter in the mid-1960s, well before the system’s collapse. Perhaps investors already took fright at signs of inflation; bond yields had been trending upwards since the end of the second world war.

In the era of globalisation a great equity bull market began in 1982 but declined in 2000-02 with the bursting of the dotcom bubble. That was a portent of the bigger crisis of 2007-08. Both showed how investors could be prey to “irrational exuberance” and push asset prices to absurd levels. Just as rising bond yields in the 1960s presaged the inflationary battles of the 1970s, so falling bond yields in the 1990s and 2000s foreshadowed today’s struggles with deflation and slow growth.

Financial markets seem to expect that political turmoil will indeed lead to another change of economic regime. Since the American election the MSCI World equity index has rallied and the Dow Jones Industrial Average has hit record highs. Valuations reflect this optimism. In the early 1980s price-earnings ratios were in single digits. In contrast, the S&P 500 now trades on an historic price-earnings ratio of 25. Another contrast with the 1980s is that, back then, short-term interest rates were at double-digit levels and equity valuations were able to climb as rates fell. That cannot happen now.

So what kind of economic regime are investors expecting? They seem to be cherry-picking the best bits from the previous two regimes—the tax cuts and deregulation of the 1980s with an expectation that (as under Bretton Woods) fiscal, rather than monetary, policy will be used to smooth the ups and downs of the cycle.

But the populist revolt is, in large part, a reaction against the free movement of capital and labour that has made so many financiers rich. A much bleaker outcome is possible, whereby rising nationalism leads to trade wars and an ageing workforce makes it impossible for the rich world to regain the growth rates of past decades. Change is coming. But rather than resembling the 1980s, the new regime could look more like the 1930s.


The CIA Keeps Putin’s Secrets

Western governments stayed silent on the U.K. polonium murder of a Putin critic.

By Holman W. Jenkins, Jr.

    The Russian president in Saint Petersburg, Russia, Dec. 26. Photo: Getty Images


Here’s one more way U.S. intelligence on Russia may not be up to snuff. Many would like President Obama to repay Russian hacking by releasing secret details of Vladimir Putin’s stolen wealth, estimated at up to $160 billion. They may be disappointed to learn the data don’t exist.

The idea of weakening Mr. Putin by laying out his secrets is a good one. We proposed it here three years ago. But even then, when the U.S. Treasury announced sanctions on Mr. Putin’s “personal bank” after his Crimea grab, it was quoting the 10-year-old allegation of one of Mr. Putin’s domestic opponents. Treasury revealed nothing you couldn’t find from Google.

A second problem may be that Mr. Putin actually owns title to nothing. At least in the latter stages of Russia’s kleptocracy, he merely points to things and people give them to him. Recall Patriots owner Robert Kraft at first acquiescing in the politely diplomatic storyline that he gave his 2005 Super Bowl ring to Mr. Putin as a gift. Later, Mr. Kraft came clean: Mr. Putin asked to try the ring on, then “put it in his pocket, and three KGB guys got around him and walked out.”

The extreme murkiness of who owns what, and for how long, under Putin sufferance is illustrated by the financial coup with which he ended 2016.

To relieve a strained Russian budget and show the country’s appeal to Western investors, his underlings arranged a partial privatization of state-owned oil giant Rosneft. Yet the Italian bank supposedly financing the purchase admitted it was still mulling whether to participate.

The key Western participant, Anglo-Swiss mining giant Glencore, was revealed in the Russian press to be off the hook for most of the cash for its $5 billion stake: “Russian banks provided it an exemption from this obligation.”

So where the money came from and who might end up owning many of the shares is about as clear as mud.

Still, critics are not wrong to suspect Mr. Putin is sensitive to corruption allegations. Nobody predicted the Arab Spring, the Ukrainian revolution, the fall of Gadhafi, etc. Mr. Putin cannot be certain when a public eruption might sweep him from his throne.

Igor Sechin, the Rosneft chief and Mr. Putin’s No. 1 ally, has been flinging lawsuits in all directions to suppress Russian media reports about his mansions and yachts. A billion-dollar palace on the Black Sea, allegedly built for Mr. Putin with diverted hospital funds, has been shrouded in murky transactions. Reportedly the property is now owned by a friendly businessman who paid many times its market value.

At least the CIA ought to have complete files on Mr. Putin’s early days when Russia’s media culture was wide open and free-wheeling. His alleged involvement in the disappearance of $93 million in food money as deputy mayor of St. Petersburg was documented by a special committee of the city’s elected legislature.

Ditto the 1999 apartment block bombings that killed 293 Russians and helped cinch his election as president. Even before the attacks, reputable European and Russian newspapers in Moscow reported that such outrages were being planned by Russia’s secret police. Several subsequent scholarly and journalistic studies have endorsed the view that these “terrorist” acts were actually engineered by Mr. Putin’s supporters.

U.S. intelligence agencies surely have definitive estimates on both of these episodes. The CIA may also be able to tell us more than we already know about many convenient murders and suspicious deaths that greased Mr. Putin’s rise and protected him from inopportune disclosures.

OK, let us stop kidding ourselves. Let Rep. Adam Schiff, a top Democrat calling for exposure of Putin secrets, stop kidding himself. Western governments have kept silent even on the polonium murder in London of dissident Alexander Litvinenko, an act of international nuclear terrorism.

Why? Because they are unwilling to press hard on the Putin regime, fearing either blowback or his replacement by the devil they don’t know.

Mr. Obama’s sanctions have been precisely calibrated with these fears in mind, and Donald Trump brings only so much room for change. Rest your mind: Nothing in “The Art of the Deal” suggests Mr. Trump would voluntarily surrender the leverage Mr. Obama’s existing sanctions give him in future dealings with Mr. Putin. At the same time, he will stop accommodating Mr. Putin by supplying loud but weak rhetoric that Mr. Putin can play back to the Russian people as evidence the U.S. represents a geostrategic threat that Mr. Putin is manfully and victoriously outwitting.

The best and likeliest outcome if Mr. Trump is successful is that Mr. Putin will stop being an international problem in the run-up to his own re-election in 2018 and a year or so thereafter. Mr. Trump will be freer to concentrate on domestic reform and reacting to whatever emergencies the European Union inevitably throws up in the new year.

This holiday will be temporary. Mr. Putin, who has no realistic hope for a peaceful retirement, and whose society and economy are rotting out from under him, is almost certain to be a bane for the world and Russia in the coming decade.


The Market Warnings Out of Harvard

Former Treasury Secretary Larry Summers and another academic discuss risks ahead for stock and bond markets.

By John Kimelman

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Harvard University's main campus Getty Images
 
 
As a former Treasury secretary under Bill Clinton and an ex-Harvard University president, economist Lawrence Summers is one of the best known academics at Harvard.
 
The same can’t be said for Paul Schmelzing, a Ph.D. candidate at the university.
 
But both men have made headlines in the past days for their warnings about the investment marketplace.
 
During an interview with Bloomberg television Wednesday, Summers argued that investors, by pushing on stocks over the past two months, have been too optimistic about the risks associated with Donald Trump’s pending presidency.
 
The Harvard professor, a Democrat, cited the possibility of protectionist measures by the U.S. as well as changes to foreign policy and domestic social policy as issues that are creating extraordinary uncertainty. 
 
Meanwhile, Schmelzing, a Ph.D. candidate in economics who is currently a visiting scholar at the Bank of England, writes that if the latest bond market bubble bursts, it will be worse than in 1994 when global government bonds suffered the biggest annual loss on record.
 
In an article posted on Bank Underground, which is a blog run by Bank of England staff, Schmelzing writes that history suggests a big selloff in bonds will be driven by inflation fundamentals, and leave investors worse off than the 1994 ”bond massacre.”
 
As for Summers’ comments, it’s easy to discount them as the “sour grapes” utterances of a man who wound up on the losing side of the contentious political debate. Summers is after all among the more partisan members of the economist fraternity.
 
But to be fair to Summers, he seems on firm ground in much of what he says, especially when he talks about Trump’s most controversial protectionist policy prescriptions.
 
He also has a legitimate claim in questioning whether Trump’s plan to alter the tax law to encourage U.S. companies to bring foreign profits back to the U.S. will end up achieving the goal of helping the U.S. economy and creating jobs in the process. It must be added that Hillary Clinton backed a similar approach as a candidate so one would hope that he would have voiced these concerns if she had won.
 
“The vast majority of the companies who have large overseas cash also have substantial amounts of domestic cash,” says Summers. “The reality is that cash that is brought home will be used to pay dividends, to buy back shares, to engage in mergers and acquisitions, to rearrange the financial chessboard, not to invest in large amounts of new capital. It is a chimera to suppose that there will be large increases in capital investment as a consequence of that repatriation.”
 
Schmelzing, by contrast, focuses his comments on the bond market.
 
In his paper, he divides modern-day bond bear markets into three major types: inflation reversal of 1967-1971, the sharp reversal of 1994, and the value at risk shock in Japan in 2003.
 
According to Bloomberg, the Bank of America Merrill Lynch Global Government Index of bonds fell 3.1% in its worst-ever annual loss in 1994 as then-Federal Reserve Chairman Alan Greenspan surprised investors by almost doubling the benchmark short-term rate. Treasury 10-year yields surged from 5.6% in January 1994 to 8% in November.
 
Schmelzing writes that the current bond market is facing the “perfect storm” of potential steepening of the bond yield curve, monetary policy tightening, and a multiyear period of sustained losses due to a “structural” return of inflation resembling that of 1967.
 
Global inflation expectations, as measured by the yield difference between nominal and index-linked bonds, have risen to the highest since May 2015 after falling to a record low in February last year.
 
“By historical standards, this implies sustained double-digit losses on bond holdings, subpar growth in developed markets, and balance sheet risks for banking systems with a large home bias,” Schmelzing says.
 
But there are a few things worth considering before getting too worried. Rumors of the bond market’s demise have been rampant for several years and yet the sector has stubbornly held up.
 
Also, if Summers is right in his contention that Trump won’t be able to deliver on the promises implied in current stock markets, bonds may be a refuge, making a liar out of his junior Harvard colleague.