The US must avoid igniting a currency war

Arbitrary calculations should not be used as a basis for imposing tariffs

The editorial board


© Bloomberg


Donald Trump’s obsession with currency manipulation has reached a new high. The president’s latest tweet on the subject last week suggested the US should “match” what he called a “big currency manipulation game” played by Europe and China. Worryingly, his outburst followed recent moves by US institutions to focus more on currency manipulation. These come on top of Mr Trump’s frequent attacks on the Federal Reserve for keeping interest rates too high, and his nomination of a prominent Fed critic, Judy Shelton, to its board. Using the dollar as a weapon to boost trade will lead to further unwelcome politicisation of trade policy and risk rising retaliation.

Mr Trump’s latest accusations come just a few weeks after he took aim at European Central Bank president Mario Draghi. He tweeted that Mr Draghi was “unfairly” manipulating the euro, adding that “they have been getting away with this for years, along with China and others”.

His tweets are not, however, in isolation. In May the US commerce department issued a proposal that would see sanctions imposed on countries deemed to be manipulating their currencies. This would be done as part of countervailing duties — a process used to combat unfair subsidies by trading partners — and would involve the US Treasury providing an estimate of fair value for individual currencies.

The US Treasury’s latest report on currency manipulation also cast its net wider. The scope of surveillance was extended, switching from assessing the country’s 12 largest trading partners to those with a bilateral trade surplus with the US of $40bn or more, adding an additional nine countries to the list.

Two of the three thresholds for being deemed a currency manipulator were also lowered, making it more likely that countries meet the conditions. Despite these changes no country met all three criteria, but China remained on the US monitoring list as did Japan, South Korea and Germany. Italy and Ireland joined the latter on the list, as well as three other countries that also use the euro.

Floating currencies such as the euro and the yen cannot meet one of the Treasury’s three criteria for manipulation: persistent, one-sided exchange rate intervention. The proposed addition of currency valuations — where no single agreed methodology exists and estimates can vary widely depending on what data are used — would be a way around this issue for Mr Trump.

Currency provisions are also creeping into trade deals under Mr Trump. The US-Mexico-Canada Agreement includes the first legally enforceable commitment on exchange rate flexibility and disclosure of future intervention. But it does not contain any penalties for perceived currency manipulation, nor does it have any practical implications given that the three currencies float freely. The US-Korea Free Trade Agreement also includes some currency provisions, but these are not legally binding.

Tying currency manipulation to trade policy has some rationale — currency weakness improves competitiveness and can quickly offset any tariffs. But it ignores the role of internal, and often structural, savings and investment decisions. This is not to mention the role of interest rates on capital flows, especially the influence of US monetary policy on financial conditions around the world. It also appears oblivious to the role of US fiscal policy in the widening trade deficit.

Currency manipulations can undoubtedly distort trade and growth. But imposing tariffs on the basis of arbitrary calculations of currency valuations is not the way to go.

domingo, agosto 11, 2019

CYCLES MATTER / SEEKING ALPHA


Cycles Matter

by: Eric Basmajian


Summary
 
- The most important factor regarding your asset allocation is the economic cycle.

- The best way to improve your portfolio is to position according to the direction of the economic cycle.

- Sectors and assets perform vastly different depending on the direction of the economic cycle.

- When the economy is cycling down, defensive sectors greatly outperform cyclical sectors.

- The economy is currently cycling lower which is why defensive sectors continue to outperform.
 

Cycles Matter
 
The most important determining factor for the return profile of various assets and equity sectors is the direction of the economic cycle. Is the economic cycle trending higher or trending lower?
 
When the global economic cycle is trending higher, high beta sectors dramatically outperform, long-duration fixed income suffers and equity volatility is generally lower than average. This is a great time to be long of cyclical equity sectors.
 
Conversely and unsurprisingly, when the global economic cycle is trending lower, a "down cycle," cyclical equity sectors suffer large declines, defensive equity sectors greatly outperform, long-duration fixed income generally rises and equity volatility or "market events" are an active risk.
 
Since the start of 2018, the global economic cycle has been in a "down cycle" which explains the dispersion in sector performance, the decline in interest rates and the constant volatility in equities including the "market event" in December 2018 which is highly consistent with down cycles throughout history.
 
Below I will outline the research to support these claims in a study I collaborated on with Teddy Vallee of Pervalle Global. You can find Teddy on Twitter at (@TeddyVallee)

Identifying Growth Cycles

The first part of this analysis is defining up cycles and down cycles. We use a signaling process including the length of the decline/rise, the magnitude and the breadth of the move to define the peaks and troughs.
 
In the chart of the Global PMI below, we identified seven up cycles and eight down cycles, the eight which is currently still underway.

Down cycles are defined by moves in the chart below from A to B while up cycles are defined as moves from B to A.
 
 
Global PMI:
Source: Bloomberg, EPB Macro Research
 
 
Once the growth cycles were defined, we tested the average and median performance of various equity sectors, fixed income positions, currencies, commodities and more.
 
In roughly 22 years, there were only 15 major portfolio pivots that you needed to make to achieve the best returns, minimize drawdowns by positioning in the correct sectors and beat the averages.
 
Historically, major portfolio pivots only occured every 1.5 years with some pivots lasting well over two years, far from a short-term strategy and quite reasonable even for long-term 401k investors, long-only investors or tactical long/short asset managers.
 
I will present some of the data below.
 
Performance Dispersion - The Cycle Is Critical
 
The tables presented below highlight the start date of each up cycle and down cycle as well as the duration, the return per week, return per month and full-cycle return. The average and median for each category is also presented.
 
For the S&P 500 (SPY), the cycle is absolutely critical when it comes to the return profile. During up cycles, which lasted an average of 1.3 years, the average return is over 25%. Conversely, the down cycle, which lasts an average of 1.62 years carries an average performance of -6.44%.
 
 
Cycle Performance: S&P 500:
Source: Bloomberg, EPB Macro Research, Pervalle Global
 
 
Currently, the global economy remains in a down cycle, which based on various leading economic indicators used to forecast the direction in the domestic and global economy, is set to continue through year-end. It is highly possible to have a positive S&P 500 return in a down cycle, something we are currently witnessing although this current regime has not concluded.
 
The analysis gets more interesting when we dig into the sector-level performance.
 
Utilities have been the best-performing equity sector since January 2018 despite overwhelming criticism about valuation and commentary regarding a general "crowded" trade, but the historical analysis shows that Utilities (XLU) are in fact nearly always a top-performing sector during a down cycle.
 
Utilities dramatically underperform the broader market during up cycles, carrying an average return of just 4.34% while boasting a positive return north of 7% during down cycles while the broader market typically falters.
 
Cycle Performance: Utilities:
Source: Bloomberg, EPB Macro Research, Pervalle Global
 
 
One portfolio allocation decision you can make during down cycles, if you prefer to hold equities, is to shift towards an overweight balance in Utilities and other defensive equity sectors that tend to outperform.
 
The second key to investing through a down cycle is to underweight, avoid, or short cyclical sectors.
 
Financials (XLF), on average, outperform the broad market during up cycles but nearly double the average losses during down cycles.
 
As I will outline in a section at the end of this note, financials have been a major laggard since the start of 2018 (or the start of the current down cycle) which is again, perfectly consistent with history.

Avoiding financials during down cycles, which we are likely to remain in through the balance of 2019 based on long and short leading economic indicators remains a prudent decision.
 
Cycle Performance: Financials:
Source: Bloomberg, EPB Macro Research, Pervalle Global
 
 
One of the most cyclical sectors, industrials, as you might expect, outperforms during up cycles and falters during down cycles.
 
 
Cycle Performance: Industrials:
 
 

Source: Bloomberg, EPB Macro Research, Pervalle Global
 
 
We have tested nearly every equity sector, various currencies, fixed income, commodities and more through various up cycles and down cycles and use this information in making portfolio allocation decisions.
 
The data above, which is only a slice of the total results, reinforce why it has been a good decision to stay long of defensive equity sectors, high quality fixed income such as US Treasuries (TLT) and relatively high yielding cash while avoiding or staying short of financials, industrials, and cyclical sectors more broadly.
 
Current Market Performance - Does It Make Sense?
 
Identifying a decelerating rate of economic growth does not translate to a bearish view on the broader equity market. I personally have not shorted the S&P 500 and actually, hold a long yet underweight allocation in SPY.
 
The analysis of equity sector performance, however, nearly perfectly aligns with the historical analysis during down cycles.
Current Market Performance Since January 2018:
Source: Bloomberg, EPB Macro Research
 
 
The massive decline in interest rates, radical outperformance of Utilities, the negative return in Financials and Regional Banks (KRE) are all historically consistent with a second derivative slowdown in economic growth.
 
"Market events" such as December 2018 are also highly common and an ongoing active risk during down cycles.
 
With the current down cycle still underway, a "market event" or large correction remains an active risk.
 
Drawdowns are significantly diminished during up cycles.
 
Adding An Inflation Kicker?
 
An analysis that I worked on individually added an inflation component to the equation and the results were highly similar. The order of sector performance during up cycles and down cycles remained consistent with the analysis above although the magnitude was amplified when combined with rising or falling inflation.
 
The analysis below shows the average monthly excess return over the S&P 500 for each sector during a down cycle (growth decelerating) and also when inflation expectations were trending lower, as they currently are today.
 
 
Average Monthly Excess Performance When Growth Is Falling & Inflation Is Falling:
Source: Bloomberg, EPB Macro Research
 
 
Utilities remain a top performer as does long-duration fixed income. Banks, energy and transportation stocks lag.
 
With economic growth still currently in an empirically observable down cycle and inflation expectations trending lower in Europe and the United States defined by breakeven rates, sector dispersion is likely to remain large.
 
How You Can Spot These Trends Using Leading Indicators
 
Having the analysis of which sectors to overweight and underweight during each regime of growth and inflation is only one, yet a critical, step.
 
Equally or if not more important is having a leading indicator process to forecast the direction of the global and domestic economic cycle.
 
Using a series of long leading indicators, confirmed by moves in short leading indicators, we have early warning signs of when the cycle is going to inflect positively or negatively.
 
These economic inflection points are where most investors get caught offsides in the wrong sectors or asset classes and therefore suffer the largest drawdowns or periods of relative underperformance.
 
If you are a macro-based investor, having a leading indicator approach coupled with the analysis of relative performance during up cycles and down cycles will allow you to significantly increase your chances of being positioned in the best sectors while avoiding the laggards.
 
401k investors will be alerted when to shift assets or reduce exposure to stock funds in favor of bond funds.
 
Even if you are an individual stock picker, your hit rate, or probability of success will be increased dramatically by identifying the correct sectors from a macro standpoint, based on the trending cycle, and narrowing your basket of stocks to select from.
 
Cycles matter.
 
Having a process that involves long leading, short leading and coincident economic data, coupled with the historical sectoral analysis during each cycle of growth and inflation will help to dramatically improve your investing results.

How to Make the Monetary System Safer

By Matthew C. Klein


Illustration by Joel Arbaje

 
Investors spent the past week obsessed with Federal Reserve Chairman Jerome Powell’s testimony to Congress. But they may have been focused on the wrong thing.

The markets were looking for a sign that the Fed would keep the rally going. But that shortsightedness overlooks the central bank’s most important task: monetary stability. When money holds its value, consumers want to spend, and companies want to invest. Monetary instability can damage the economy, and in extreme circumstances, even lead to depressions.

The U.S. Constitution gives Congress the power to “regulate the value” of money to prevent these problems. Most money, however, is produced by the private sector: More than 90% of America’s money supply takes the form of short-term debt issued by banks and other financial firms, rather than physical currency printed by the Treasury. That private debt is largely backed by risky assets, such as long-term loans to businesses and consumers.

The result is “a monetary system in which the private part is vital, but inherently unstable,” as Paul Tucker, the former deputy governor of the Bank of England and the current chairman of the Systemic Risk Council—a nonpartisan body formed by the CFA Institute and the Pew Charitable Trusts—wrote in a recent essay.

Governments are tasked with stabilizing this inherently unstable system. Unfortunately, Tucker argues, officials are hampered in their efforts by their incompatible assumptions about how the economy works. The danger is that they will “adopt policies that err on the side of softness” at the expense of “resilience”—meaning that devastating crises would become more likely, thanks to looser regulations.

Inflation and bank failures are the two traditional threats to the integrity of the monetary system. Because they seem distinct, central banks generally handle them separately: Sound monetary policy is supposed to prevent inflation, while prudent financial regulation is supposed to keep banks safe. The tasks are often handled by different people in different departments with different ways of thinking about the world. In Tucker’s view, this compartmentalized approach undermines both price stability and financial stability.

For example, monetary policy makers now believe that the economy’s underlying growth rate is much slower than it used to be and that interest rates have to be much lower than in the past to generate enough spending to keep the economy running at full capacity. Since the Fed began publishing long-term forecasts at the beginning of 2012, officials’ estimates of the “normal” level of short-term interest rates have dropped by roughly two percentage points. Central banks, therefore, have less room to fight recessions by lowering borrowing costs.

Combined, these developments have significant implications for the valuation and riskiness of banks’ assets.

First, as Tucker puts it, “loans originated prior to the realization that growth is low will be riskier than originally believed, [and] expected losses will be higher.” Businesses borrowing in anticipation of rapid sales growth will be disappointed, while consumers hoping to repay their debts out of higher incomes may be forced to default.

Worse, the slower pace of trend growth and the limited scope for monetary stimulus caused by lower rates means “there would be little or no scope for borrowers in general to grow out of debt overhang problems.” Banks cannot wait for bad loans to fix themselves if downturns are deeper and recoveries are weaker.

Banks, therefore, have less scope to absorb losses than they think, which means they are borrowing too much. There is not enough equity to protect depositors and other short-term creditors. Unfortunately, the banking regulations written in 2010-11 were calibrated using old data and have not been updated to reflect the new economic outlook. Whatever levels of bank equity people thought were appropriate for a world of structurally faster growth and higher interest rates are therefore too low for today’s environment.

In theory, regular stress tests could help remedy these deficiencies. That is not what is happening. A recent Fed study found that the tests are becoming decreasingly challenging, despite increasingly dire macro scenarios. The “severely adverse” macro scenario in the 2019 test, for example, assumed U.S. gross domestic product would drop twice as much as in the Great Recession, but that pretax net income would fall less than 1%, relative to total assets.

Over the three years of the forecast period, the 18 major banks tested would supposedly experience about $296 billion in total loan losses—far less than the $430 billion written off by the biggest banks during the financial crisis’s three worst years.

Monetary policy makers would also benefit from learning more about the financial system when setting interest rates. The old assumption was that rate cuts reliably boosted the economy by encouraging households to borrow and spend. This damps short-term swings in the business cycle. But, over longer periods, it increases debt and makes crises more likely. Eventually, the process becomes self-defeating: Rate cuts lose much of their potency once consumers are over-indebted and credit-constrained.

Despite enjoying dramatically higher home values, Americans scarred by the crisis are still cashing out less home equity than they were in the 1990s. That has suppressed consumption and made it harder for the Fed to hit its inflation target.

Stabilizing the monetary system is a challenging job. It is even harder when the people doing it are working at cross-purposes, with contradictory models of the economy and financial sector.

Far-Right AfD

Germany's Populist Party Embraces Its Extremist Wing

By Melanie Amann and Ann-Katrin Müller

AfD Bundesparteitag in HannoverFoto: Bjoern Hoecke und Alice WeidelHonnover Kongresszentrum, 03.12.2017Fotograf; Hans-Christrian Plambeck
AfD Bundesparteitag in HannoverFoto: Bjoern Hoecke und Alice WeidelHonnover Kongresszentrum, 03.12.2017Fotograf; Hans-Christrian Plambeck


The far-right fringe of Germany's populist Alternative for Germany party is gaining ground. Politicians in the party who once opposed the wing and its leader, Björn Höcke, have abandoned their resistance and are taking steps to embrace the extremists.

It was the video that proved decisive. Four minutes of images of Björn Höcke, the leader of the far-right nationalist wing of the right-wing populist AfD party, the so-called "Flügel." It showed him jogging through the golden autumn leaves of his village, shaking the hands of workers and women, feeding sheep and then firing people up in a speech. "When you celebrate me, I feel the passion," Höcke says in the video. "I bow my head in humility for your efforts."

A few days after Höcke's image video was presented at the Flügel's annual "Kyffhäusertreffen," a yearly meeting of the far-right wing in the eastern German state of Thuringia, he combined the video with a combative speech against the arbitration tribunals and the federal executive committee of his party and the more than 100 AfD members who wrote an open letter appealing for the rejection of Höcke. In the letter, more moderate members of the party lambasted his "excessive cult of personality" and rejected his "divisive criticism" of internal party opponents. The letter also made clear that, "The AfD is not and will not become a Björn Höcke Party!"

Was the aim of the letter to spark a revolt within the party? Would the signatories of the appeal, who were conservative, but more mainstream, finally take a stand against the racist völkisch tirades made by Höcke, the party's boss in the state of Thuringia, who is known for peppering his speeches with the language of the National Socialists, and other radical forces within the party?

Such an offensive is already overdue, because even though the party is currently being threatened with official observation by Germany's domestic intelligence agency, the Office for the Protection of the Constitution, the far-right wing of the party has been allowed to go on with its work recently largely unhindered by the rest of the party.

Non-Aggression Pact

It's also hard to imagine that the latest appeal against Höcke will do much to change the situation given that top AfD officials, who are supposedly mainstream, like Alice Weidel, who heads the the parliamentary group in the parliament, the Bundestag, have long since come to terms with the far-right wing and with Höcke. Behind the scenes, Weidel has even forged a non-aggression pact with Höcke, a man she wanted to throw out of the party only a few years ago. For the first time, leading representatives of Höcke's wing of the party and friends of the politician, like the far-right intellectual Götz Kubitschek, are talking about how they can turn Weidel into an ally -- and what they can expect from it.

By doing so, party group leader Weidel is embarking on a dangerous path toward political extremism -- one that AfD party leaders Jörg Meuthen and Alexander Gauland have already taken. Indeed, the Flügel is anything but marginalized in the AfD -- it has been established within the party's mainstream for some time now.

That's even obvious in the open letter. Among more than 100 signatories -- according to the party's own statements, it has a total of 36,000 registered members -- there are almost exclusively representatives of the middle functionary level of western Germany. There are no prominent politicians among the signatories, and only 11 of them hold one of AfD's 91 seats in the Bundestag. That's not what a broad alliance looks like.

Overtures to the Right-Wing Extremists

Weidel began making overtures to the far-right wing about a year ago. Earlier, she been a declared opponent of Höcke, and had even tried to initiate proceedings to have him excluded from the party. But now she took the initiative and sought contact with Höcke through intermediaries. Since then, there have been several meetings, mostly in Berlin -- at times just with Höcke and his friend and mentor, the New Right publisher Kubitschek. And at times there have been slightly bigger meetings with people like Kubitschek's wife Ellen Kositza and AfD party head Gauland.

The fact that Kubitschek has been mediating is indicative about how serious the far-right wing is about gaining footing within the party mainstream. Höcke and Andreas Kalbitz, the 46-year-old from the eastern state of Brandenburg who is pulling the strings within the far-right wing, are closely associated with the publisher and follow his advice when coming up with their policies. Previously, he had tried to make it seem as though he had a slight distance from the party, but it is now clear that he both has and indeed wants to have influence on the party.

"Several meetings took place in a very positive, open atmosphere," Kubitschek said of his meetups with Weidel. He said the meetings hadn't been about individual issues, but about "behavioral teachings and attempts at mediation," very fundamental questions of strategy. Things like: "Where does the AfD stand in the political arena? How can they work together to preserve party unity? How can external pressure be fended off? How can the party base be encouraged and how can the process of finding consensus be institutionalized?"

Kubitshek's conclusion is that "all participants agree that pacifying the party is one of the most important tasks of all." He said he experienced Weidel as a smart, open-minded and well-read woman. "I think she understands what Höcke means and wants," he said.

A mail from Weidel in 2013, before she joined the AfD, made public by the Welt am Sonntag newspaper, indicates that Weidel and right-wing radical Höcke hold similar views. In it, Weidel's tone sounds a lot like Höcke's. At the time, she was already railing against "culturally alien peoples such as Arabs and Sinti and Roma" and against politicians she described as being "puppets" of the powers that won World War II. In parliament, she would later agitate against "headscarf girls, knife-wielding men on welfare and other good-for-nothings."

A Strategic Shift

Since Weidel's strategic shift in the AfD, she has enjoyed the support of the far-right wing. When her party donations scandal came to light at the end of 2018, few activists on the far-right spoke negatively about Weidel and almost no one called for her resignation. If her former opponents hadn't maintained their silence, she probably would have lost her position.

Conversely, Weidel remains silent when there is criticism of the far-right wing. The recent appeal against Höcke obviously didn't include her signature. The best you can get out of her when she comments on Höcke's video is that she finds the staging "irritating" and parts of his speech "dispensable," while also arguing that mudslinging "needs to be prevented."

Representatives of the Flügel wing prefer to speak of a "learning curve" rather than any kind of pact. "She has long known that the party can't shake off Björn Höcke and his network without incurring damage," said Kubitschek. "And that Höcke play a necessary instrument in the AfD concert." For her part, Weidel is always ready to overcome prejudices she has, said a source close to Höcke. The message is clear: The far-right wing of the party can no longer be defeated.

In the past, Kubitschek likely would have rejected Weidel as being too willing to adapt. But now, she's even allowed to give a lecture at his next "Summer Academy" in Schnellroda, a village in the eastern state of Saxony-Anhalt. "Her lecture ought to be perceived as a gesture within the party: That they have more common than what separates them," Kubitschek said. Weidel has voluntarily entered into this hostile embrace and it is unlikely she will ever be able to untangle herself from it. When she makes her appearance in Schnellroda -- an event whose organizer, Kubitschek, tries to give an intellectual spin to right-wing extremist messages -- Weidel's entry into the Flügel world will be sealed.

Weidel's spokesman confirmed that she has held three meetings with Höcke since the last parliamentary election. But he said that the claim his boss had entered into a pact with Höcke was nothing "but an insinuation." And Weidel herself said, "As parliamentary group leader, I am rightly being asked to respect a certain principle of neutrality." She added that she has attempted to be an "integrating force" in her parliamentary group, with success. And that just talking to someone doesn't mean that one is adopting their opinion.

But it does clearly show that nothing is being done to hinder the other camp, no matter its beliefs.

Government Monitoring Increasingly Likely

The Office for the Protection of the Constitution has been monitoring the Flügel since the beginning of the year. The government is focusing on Höcke and the cult of personality surrounding him, and the intelligence agency also kept an eye on this year's Kyffhäusertreffen meeting. A decision issued by the agency this week can be interpreted as a warning shot. The domestic intelligence service says it considers it proven fact that the Identitarian Movement violates the principles of the German constitution. Several activists with the movement, which is fashioned as more modern version of right-wing extremism, are associated with the AfD, especially within the Flügel, despite the fact that the party has formally distanced itself from the Identitarians.

If Höcke and his followers gain the upper hand, it's hard to envision a scenario in which the Office for the Protection of the Constitution wouldn't place the entire party under formal monitoring for extremist, anti-constitutional activity. That's what makes it so astounding to see the Flügel moving toward the center of the party -- or the rest of the party moving toward the far-right extremist wing.

It has helped the far-right wing that every previous attempt to hold it down has failed spectacularly. The crash of former AfD party heads Bernd Lucke and Frauke Petry as well as the unsuccessful proceedings to kick Höcke out of the party have had a deterrent effect.

Highly Professional, Tightly Organized

But the success of the far-right wing is also attributable to the fact that it has become highly professionalized, tightly organized and has shifted its strategic direction. Members of the Flügel no longer aspire to join the top ranks of the AfD and instead prefer to operate in the background, avoiding public conflicts. That gives critics fewer opportunities to attack. More moderate members of the party even seemed to have developed a certain nonchalance about the possibility of being officially monitored. At the beginning of his speeches, party leader Meuthen is even fond of mockingly addressing the "dear informants who are present," after all, "I have a very big heart."

In 2016, Meuthen became one of the first people from the more moderate AfD camp to open up to Höcke and to attend meetings held by the far-right Flügel. Internally, he has always been considered a weak party leader, and later, he struggled as a result of a campaign donation scandal. The fact that Meuthen was able to become the party's leading candidate in recent elections for the European Parliament is also in part due to the fact that he has withheld from criticizing the far-right in his party. In return, Flügel operative Kalbitz personally made phone calls and sent out text messages in support of Meuthen's candidacy.

Of course, Meuthen views the situation differently. "There has never been such a pact," he said. He claims that Kalbitz only promoted him because he thought he was the right candidate. "Just as I have promoted Kalbitz in the election to the state parliament." He then added, "If the Flügel is reasonable and clearly demarcates itself from extreme positions, I see no reason to take action against it." He said there had been "positive changes" in that wing of the party.

There are also other prominent opponents of Höcke and his wing who have recently grown conspicuously quiet. One example is Beatrix von Storch. One senior member of the Flügel mockingly says she just has "fine instincts" and that she's surely thinking about elections for the national executive committee at the end of November. Storch did not want to comment for this story.

'Compromises on all Sides'

Kubitschek, who is in constant contact with Höcke and Kalbitz, is the main person behind the party's strategic reorientation. The publisher views the Flügel as an "indispensable and trend-setting current" in the party. But the wing does not embody the entire AfD, so it "is necessary that it work together with other camps in the party," Kubitschek said. "This can only be done with compromises on all sides." Fortunately, he said, Weidel has recognized this.

According to Kubitschek, there is only one way forward for the future of the party in its entirety. "In the long run, it must be possible to bring the AfD into a form in which it can conduct negotiations and make policy." For that to happen, he said, the party must be pacified internally.

In the long run, he said the "Flügel as a political platform within the AfD will be too small, anyway." Kubitschek believes it cannot replace the new alliances between "reconciliatory professionals" in the party that are needed. He said that Höcke's role in the party also needs to change -- that he needs to become "one leadership figure among others, one who operates without a cult of personality and works together in ways that mobilize" people.

A Normal Part of the AfD?

With that, the goal has been set: Höcke and his backers are to become a normal part of the AfD. Now, it's up to Thuringian state chapter leader Höcke to assume that more modest role. Although he has been more reserved recently, making few appearances on the national stage, time and time again, he acts out during major appearances, as he did recently at the Kyffhäusertreffen meeting.

This time the anger in the party over his ego trip was so great that Höcke apparently tried to do damage control behind the scenes. He texted Meuthen, for instance. At the same time, his people spread the word that there was no chance of Höcke entering into the ring and running to become the party's leader.

Andreas Kalbitz, who has been said to have aspirations for the party chairmanship, issued a similar commitment. "I won't be running for the position of party head at the national party conference at the end of the year," he said. He then offered his reasoning. "I believe the current situation within the party requires a candidate who is perceived as being more neutral and balancing than I seem to be for some at the moment." He said his utmost concern is party cohesion and unity for common success.

The men inside the Flügel also have a better candidate lined up. If everything goes well between now and the party conference at the end of November, Tino Chrupalla will become party leader. The politician, from the eastern state of Saxony, landed a seat in the federal parliament by direct vote and is considered Gauland's favorite to succeed him. The 44-year-old has the ability to connect with all the different camps within the party. He's not a member of the right-wing extremist Flügel, but he did travel to their meeting at Kyffhäusertreffen. "I just wanted to take a look," Chrupalla said, emphasizing that he remained seated during the ovations for Höcke. "That's not my style," he said. But even he doesn't go any further than criticizing Höcke's actions. To the contrary. "I don't have a problem with the Flügel, I don't see any differences in content between myself or Andreas Kalbitz -- I just sometimes express myself somewhat differently.

This is exactly how the "conciliatory professionals" -- the ones Kubitschek says will make up the AfD in future - sound. It's no coincidence. Chrupalla is familiar with Kubitschek's strategic ideas. "We've talked a lot these past few days," said Chrupalla. And: "He's very good at judging things."