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23 July 2021

The incidental central bank

Our main story is about the ECB's new forward guidance. We explain why this is a fair-weather strategy; we also have stories on the rise in semiconductor prices and supply bottlenecks; on French centre-right candidates for the presidency; on the French and Austrian climate change plans; and, below, on one of main political consequences of the Nord Stream 2 project.

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Today's free story

Poland looks to China

One unintended consequence of the US climbdown on Nord Stream 2 could be to push some of the EU’s eastern periphery closer to China.

We noted an interesting article by China Observers highlighting Poland’s perceived rapprochement with China. Bronislaw Komorowski, the former Polish president, visited China in 2011 to sign a document establishing a strategic partnership, and Poland was one of the first countries to sign a memorandum of understanding with China to join the belt and road initiative in 2015. It was an enthusiastic member at first, but as has been the case with many BRI signatories, imports from China swelled in the following years while promised Chinese investment failed to materialise. By the end of 2017, Chinese foreign direct investment in Poland was estimated at just €1bn, most of which had been channelled into Chinese acquisitions of Polish companies rather than new infrastructure projects.

The Poland Asia Research Centre writes that enthusiasm turned to scepticism by 2017 when Antoni Macierewicz, the former Polish defence minister, blocked the sale of a parcel of land for a logistics hub that was meant to be part of BRI. By 2018, Poland was the second-largest importer of Chinese goods in Europe after Germany, with imports reaching $31bn, against just $2.5bn of exports. Poland began taking a tougher stance on China, adopting 5G security rules that effectively banned Huawei from its networks, and arresting a former security officer and Chinese Huawei employee in Warsaw on spying charges. This was viewed as a strategy to improve its military relationship with the US to hedge against Russia.

Under Donald Trump, Poland’s relationship with the US thrived, but circumstances have changed since Biden took office, and so has Poland’s strategy. When the Biden administration began signalling it would drop its opposition to Nord Stream 2 last winter, Polish authorities were outraged. Zbigniew Rau, the Polish foreign minister said he learned about the decision from the media and that the country had not been consulted, and Poland was reportedly left dissatisfied with the results of the Biden-Putin summit in Geneva.

This has translated into a new strategy designed to get Washington and Brussels' attention. In January this year, Rau discussed closer bilateral cooperation with Wang Yi, his Chinese counterpart, and Andrzej Duda joined a virtual summit for the 17+1 cooperation format, a pre-cursor to the Belt and Road, the following month.

Duda spoke with Chinese leader Xi Jinping in March to discuss purchasing Chinese Covid-19 vaccines, and Rau later visited China to express support for the EU-China comprehensive agreement on investment (CAI), despite Poland’s earlier protests against the deal, which was largely spearheaded by Germany and France.

Having witnessed its relations with Europe deteriorate over the previous year, China has been quick to trumpet its closer ties with Poland, but as China Observers writes, tangible outcomes will be more important for Warsaw. The same could be said for its relations with the EU.  

Eastern European countries like Poland are in a better position to push back against China because they gain nothing from CAI and export very little to China compared to Germany and France. The US and larger EU member states continue to ignore these countries’ investment needs and security concerns at their peril. Members of the eastern flank are just as susceptible to economic coercion as Germany and France have been, and Poland is in a uniquely vulnerable situation because it is one of the EU’s most carbon-intensive economies - the upcoming green transition will be more expensive for Poland than most other member states. The EU does not have much to offer in terms of securing Poland’s borders, but green investment is a viable alternative.

And yet, the two are locked in an increasingly tense dispute over human rights and rule of law: just this week, the EU threatened financial sanctions if Poland refuses to suspend a controversial disciplinary chamber for judges. Poland-China rapprochement may be diplomatic showboating right now, but Poland is becoming increasingly alienated from its most important western allies. This is a risky situation.

22 July 2021

Orbán escalates battle with Brussels

Viktor Orbán made another cynical play yesterday with a plan to hold a referendum on Hungary’s recent anti-LGBTQ legislation.

The law bans promoting or portraying homosexuality or sex reassignment to minors, including in schools. The European Commission already said this legislation is in violation of a host of EU laws when it launched three proceedings against Hungary and Poland over violations of fundamental human rights last week.

After accusing Brussels of withholding approval of its national recovery plan in response to the law, Orbán has now upped the ante. Brussels claims delays in recovery plan approval are stemming from a lack of anti-graft measures in place in Hungary. As we argued last week, it could also be that a large group of member states will not receive any funds until at least September because it will take that long to raise the funds. 

No specific date has been set for Orbán's referendum, though the results might to be a foregone conclusion given the questions citizens will be asked, which include:

Do you support the presentation of sexual media content to minors that could affect their development without restrictions?”

On making the announcement, Orbán recalled a similar referendum initiated in 2016 in response to the EU’s migrant relocation plans. He asked citizens to say no now, just as they did five years ago. It’s a clever move because a no vote would give the law a veneer of democratic legitimacy, allowing Orbán to argue that it reflects the will of the people, no matter who it hurts.

We recall that Daniel Kral, a European economist, recently flagged the EU funding set to flow in Orbán’s direction – it’s not just €7.2bn of recovery fund spending, but more than €20bn of structural funds. Orbán has a lot to lose, particularly given that he will be running against a united opposition party in next year’s elections. If there was ever a time for the EU to turn the screws, now would be it.

21 July 2021

How not to stop bitcoin

You can always tell hypocrisy when somebody predicts that a certain event won't happen, and then calls for rule changes to make sure it won't happen. For example, you forecast that inflation won't be a problem, and then you call for an overshooting inflation target.

The same goes for the crypto-debate in Europe: if you think that bitcoin is a bubble that will eventually burst, why worry? Hardly a day goes by without a central banker hyperventilating their views that bitcoin is not money. Yesterday the EU proposed to regulate it. Remember the words of Herb Stein, President Nixon's economic adviser. If something is unsustainable, it will end. You don't have to end it. Or put it the other way around: if you think you need to regulate it, then surely you think it is a problem.

We take no views on whether current or past market valuations of bitcoin are sustainable or not. So far, the technology behind bitcoin has proved remarkably stable. The anonymous Satoshi Nakamoto created bitcoin as a means of payment that bypasses the control of governments and central banks. It works even in regimes like Russia that have made it illegal to use bitcoin, and that have criminalised all bitcoin-related activity. Alexei Navalny's campaign has been funded by bitcoin transactions, for example. But even Russia's highly skilled hackers couldn't break blockchain. Yesterday the European Commission proposed that Europe should follow the lead of Vladimir Putin and regulate crypto - as part of its new anti money-laundering rules.

What this is telling us is that they are worried. What we are certain of is that they can't conceivably succeed. Technically, as Reuters reports, the EU proposes the so-called travel rule, which applies to ordinary wire transfers, to crypto transactions. If a bank handles crypto-assets, they must include the customer's name, address, date of birth and bank account number, along with information about the person receiving the money. It will also become illegal to own anonymous crypto-asset wallets. The idea is to stop the use of crypto assets for the purposes of money laundering.

Europe is a very bank-centric place, and officials may well harbour the illusion that German Sparkassen or French mutual banks are the go-to places for secret crypto-transactions. The internet does not exactly start in Helsinki and stop in Athens. All that will happen is that people use off-shore wallets not subject to EU regulations. The EU cannot stop anonymous internet transactions - just as the Russians can't.

The Commission is, however, aware that there is a great danger of driving the market underground. It said that in order to balance the risks, the new rules would be limited only to transactions for €1000 and over, with a number of stated exemptions in both directions. 

The crypto regulation reminds us of a debate in the German Bundestag in the early 1990s, when MPs thought they could curtail email in order to save what they thought was a well functioning telegraph network. We wish the European Commission good luck.

20 July 2021

Lords warn about QE

The House of Lords is known for producing high quality reports. This one on quantitative easing piqued our interest in particular.

QE started off as an unconventional policy, and is nowadays the mainstay of monetary policy globally. The Lords' report refers only to the Bank of England, but many of the points it raises have direct relevance for the ECB as well.

We highlight only two points here: the long-term impact on government financing and an explicit climate change mandate as a secondary goal.

Regarding the first, the Lords are particularly worried about a scenario where a persistent rise in inflation combined with stalling economic growth would impact government finances. The Lords take a much more sceptical view of the inflationary outlook because of the combined impact of QE, strong government spending, large savings, and supply bottlenecks in the global economy. In the scenario of persistent inflation, government finances would be in danger. Britain's office for budget responsibility calculated that a 1pp increases in short- and long-term interest rates would increase debt interest spending by 0.8% of GDP by 2025-26.

If the Bank of England were to raise base rates, it would have to buy government bonds at a correspondingly higher rate too. In the UK, the Bank of England purchases government bonds at the base rate, which is now 0.1%. The Lords say they are concerned that the Bank of England will come under political pressure not to raise base rates in order to guarantee the flow of asset purchases on which the UK government depends.

In the hearing preceding the report, the Lords were told that the Bank of England and the Treasury could reduce the impact of potential interest rate rises by not paying interest on commercial bank reserves. This would effectively constitute a tax on the banking system. The Lords noted that the response of the treasury on this important point was ambiguous - which is telling us that this idea is clearly under consideration as a rainy-day defence.

The Lords argue that the Bank of England's credibility rests on its operational independence. Once this is lost, it would be difficult to regain. They noted dryly that the central bank's enthusiasm for QE did not correspond to its understanding of the economic effects. They also noted that central bank research tends to show QE in a more positive light than the academic literature. We see exactly the same happening at the ECB. Central economic research is used increasingly as an ex-post vindication of policy. You don't get much self-criticism from the economic research departments.

The other point we would like to draw attention to is the addition of climate change to the Bank of England's secondary mandate. The UK government has left it to the Bank of England to implement the policies. That's pretty much what happened at the EU level, where the ECB has now made it its job to control the carbon footprint of banks - which we think is plainly ridiculous. The Lords are asking the government to set out a clear policy of what the government expects the Bank of England to do. We think that would be useful in the EU as well.

19 July 2021

Vaccination and the quest for safety

It is not hard to see how vaccination is becoming the new dividing line in our societies, prone to radicalisation on both sides. As the delta variant sweeps over the continent, not getting vaccinated seems like a personal choice, to the detriment of the community that wishes nothing more than to get the pandemic behind it. Vaccination though is not a full insurance against new variants. Much of what we know about the virus and its effects is based on past variants. Inferences of what it means for the next wave will be prone to error. 

Yet, politicians are pressured to create facts that help society to move on. France and Greece are the first EU countries to make vaccinations mandatory, not only for health staff. Vaccination or recovery will be required for visits to restaurants and bars or other entertainment. If the situation worsens, vaccination may become mandatory for other groups as well. France already announced a vaccine pass for teenagers as from autumn on. Given the little we know about those vaccines and how long it normally takes to approve vaccines for children, it is quite a fast track.

This public discourse is pitching personal liberty against social responsibility. The desire to control risks jumps hoops and equates vaccination with liberation from the virus. How far will it go against personal freedoms? The two countries will impose sanctions for health workers if they refuse to get vaccinated. They will have the choice to get vaccinated or quit their job. That is a personal choice to take for a public service worker.

What we find extraordinary is the way politicians and commentators frame it. This is where it gets murky. Gabriel Attal pitches the vaccinated as the ones ready to work against a capricious minority that prefers to protest against it. Last Saturday about 110,000 protested throughout France against the new sanitary rules. A mix of people against vaccination, or the way it was imposed as a mandatory rule? Maybe this will become the new gilets jaunes movement, as some suggest. Will they get the backing from a vaccinated population? We have our doubts. This is the new dividing line, defining majority over minority. There is a responsibility for a fair discourse here too.  

Social pressure to get vaccinated is likely to increase. Those not wishing to get vaccinated in the healthcare or social care sector will have to prepare to change jobs, and those who enjoyed socialising will have to change life-styles. Vaccination could redefine normative values of our societies. How effective the vaccination is to deliver safety and a secure return to normality is almost irrelevant, as those studies takes time while the meaning of vaccination is decided in the immediacy of the situation. And what normality is there to return to? If life with the virus has taught us anything, it is that the future is more uncertain than ever, and we may chose how much more we accept this or not. The floods in Germany, Belgium and the Netherlands are a stark reminder that we need to prepare for radical uncertainty.

16 July 2021

An important ruling about Russian gas

The fight against Europe’s gas dependency on Russia is fought on several fronts. Joe Biden is outwardly keen to mend relations with Angela Merkel, who is in Washington right now on what is likely to be her last trip to the US. But on substance, the US position on NordStream 2 has not changed. It looks likely that the pipeline will be completed this summer, but it is far from clear whether or when the gas will flow. Just as the US can impose sanctions on those who build the pipeline, it can impose sanctions on those who use it.

Another battle is being fought in the courts. Yesterday the Court of Justice ruled in favour of Poland and against Germany in a case involving Nord Stream 1, and Opal, the pipeline that connects from Nord Stream 1 at the Baltic Sea in Germany and runs through to the Czech Republic.

The case is superficially about whether it was acceptable for Gazprom to raise the throughput. But more important is the establishment of a legal principle. Poland had argued that the increase in flow volumes constituted a violation of the principle of energy solidarity in the EU. Germany argued that energy solidarity constituted a purely political concept. The Court of Justice rejected Germany’s position, and ruled that the European Commission was under a legal obligation to take into account the security of gas supplies to EU markets, as Reuters reports.

The Commission had previously given the green light to the increase in throughput, but Poland challenged the decisions in a tribunal. Germany then took this case to the Court of Justice, and lost again. As with successive cases involving economic policy, the Court is filling vast legal grey zones with concrete decisions.

What this specific decision will do is to raise the hurdle for profitability of Russian gas projects - fight them with bureaucracy. Even if Nord Stream 2 becomes operational, it is far from clear that it will become profitable. If the Commission is formally required to take into account the energy security of Poland and the Baltic States, it is quite likely that NordStream 2 will also be subject to throughput caps. Gazprom criticised what it considers the creation of artificial barriers to investment in the European gas system. That is exactly what this is. But the official legal view now considers these barriers to be a feature, not a bug.

15 July 2021

Le Pen's divorce letter to the Germans

Marine Le Pen pledged to divorce from Germany if she comes to power in 2022 to focus on more strategic alliances with the UK and the US. In l'Opinion she paints the image of a great nation betrayed by Germany time and again. She is clearly fishing for votes from the military and those with nostalgia for la grande nation, where France, with its nuclear and military might, accuses Germany of not following suit despite signing on to the idea of a common defence union. This may have traction, and as such should not be easily dismissed.

Whoever wrote this for her did a good job tapping into the emotional quagmire of French identity and linking it to some hard facts, ignoring the other 93% of policy cooperation. Le Pen accuses Germany of pulling a diplomatic stunt on France by participating first, then taking over to finally lead the project. Faced with this, Paris gives in driven by emotions, altruism and cowardice. This is not limited to the military. The narrative resonates with some hard feelings from France's fallouts with Germany over the monetary union. Le Pen does not even have to mention it. And as always, the good and the bad are clearly defined in this story. France hoped that Germany would change, but no. Nor has France since Charles de Gaulle in this story. The only way for change to happen is to change the story. 

The article made some points too. German identity narrative is in itself full of obstacles: anti-nuclear, neutral and pacifist. Its doctrine in international engagements is to engage in everything and exclude nothing. France and Germany are apart on objectives about military platforms and the diplomatic means to pursue them. Le Pen accuses Germany of blackmailing and withdrawing without any consideration for Paris. The Schwerin space project was brought up as an example where the Germans ditched the project with France to pursue their own satellite in competition with the French. Another difference is that German's perspective makes it look more to the East. And as for the industrial dimension, Germany looks more at technology than at military capacity building while France has the order reversed.

The article says the UK is a much more natural partner, sharing diplomatic status and nuclear capacities. Le Pen also advocates negotiating an alliance with the US to face the challenges in the Indo-Pacific and in space. And with allies around the world she aims to unite in the fight against Islamic terrorism. 

This article comes clearly from a military historic perspective. The UK a better partner? Forget trade or the standoff over vaccines France and the UK recently went through. Using the la grande nation narrative to define French identity can still get Le Pen votes, but it will not define the future.

14 July 2021

Weaponising humans

Yet another country is weaponising asylum seekers in an effort to push back against the EU, and this time the story is almost unbelievable.

Frontex announced yesterday that it plans to launch a rapid border intervention to the Lithuania-Belarus border to assist with growing migration pressure, after more than 800 illegal border crossings were reported in the first week of July alone, out of a total of 1700 this year.

Frontex reported that while most migrants recorded during the first half of the year came from Iraq, Iran and Syria, authorities had noted a change in the composition of migratory flows. Today, most arrivals come from the Republic of Congo, Gambia, Guinea, Mali and Senegal. This could be indicative of an extraordinary new strategy.

Gabrielus Landsbergis, the Lithuanian foreign minister, has accused Belarus of flying in migrants from abroad and sending them over the border to EU countries, telling Reuters that asylum seekers are being used as a political weapon. Lithuanian MEP Rasa Jukneviciene, meanwhile, said Belarus and Russia are organising human smuggling networks, with the assistance of Iran, to fly people to the Lithuanian border. A 550-km razor wire barrier is now being built, and Fabrice Leggeri, the executive director of Frontex, has said the agency will fly migrants right back out of Lithuania using commercial and charter flights if they are not granted refugee status.

If Lithuania's accusations are true, it could have profound implications for EU asylum policy. Until now, asylum seekers had simply been allowed to cross borders unchallenged in disputes between the EU and its neighbours. To actively seek out and assist asylum seekers in reaching EU borders underscores just how valuable such a strategy can be for disgruntled governments and sanctioned countries. The EU’s immigration and asylum policies remain weak and fragmented. Whatever the outcome for the migrants themselves, the political costs will be high. Unable to hit the EU with any effective economic sanctions, and unconcerned about the collateral damage to desperate and innocent people, Belarus might have found a much more effective way to hurt the union.

13 July 2021

Opposition to 2035 CO2 phase-out

FAZ writes this morning that there is opposition within the European Commission to the phasing-out of the fuel-driven motor car by 2035. Valdis Dombrovkis, Commission vice president, and Thierry Breton and Adina Valean, commissioners for the internal market and transport, favour a postponement to 2040. This debate reminds of us of the postponement of the exit from coal in Germany, which has been put back to 2038. What is happening right now all over Europe is that governments and the Commission are buckling under pressure from industry, and are choosing the soft option of delaying most of the adjustment to the next decade.

Among governments, France is leading to those who favour 2040 as an exit, but there are others, including Sweden, who argue that such a long transition phase is likely to take the pressure off. That’s also our own view on this matter. In our experience there are two types of transitions - those that encourage and accelerate innovation, and those that postpone it. A 14-year transition phase is beyond the life span of current management boards of car companies. It’s the next guy’s problem.

The other area of disagreement concerns interim targets. The original Commission proposal foresaw a 65% reduction until 2030. Realistically, that would only be achievable if manufacturers already start making and selling electric cars in large quantities by then. It will be interesting to see whether this number, too, will be watered down. If you pick 2040 as your zero target, it would be logically consistent to pick a lower reduction target for 2030 as well - in the order of 50%. That would mean that the whole timeline gets pushed back.

Another important number is the prescribed minimal distance of electric charging points on motorways, which the Commission wants to set at 60km.

It is also important to remember that this is just the proposal itself. We would not be surprised if the EU Council waters it down even further.

12 July 2021

Fourth wave, no lockdown?

Yesterday France joined the UK and Greece in rejecting the notion of new lockdowns to contain Covid-19, with Clement Beaune, European affairs minister, telling media the country must learn to live with the virus instead.

Although he didn’t rule out reintroducing limits on the number of people allowed in bars and restaurants, and to extend the use of a Covid health pass, Beaune said positions aren’t as hard as they used to be because vaccines are available.

He was echoing Kyriakos Mitsotakis, who announced last week that while he can’t make vaccinations mandatory, Greece will not close again to protect a few unvaccinated people at the expense of the vast majority of the Greek population. The Greek prime minister also cited the availability of vaccines as the primary factor in his decision, arguing that there are some people who consciously choose not to protect themselves and their loved ones, and whose behaviours always carry the risk of a new wave. In the UK, Sajid Javid said the same late last month, stating that data on vaccinations was heading in the right direction and that the UK must learn to live with Covid.

This no doubt came as a relief to many, but as some countries are learning, opening too fast too soon carries its own risks. We previously noted that Catalonia’s fourth wave was rising after the government allowed nightclubs to reopen until 3.30am, with new positive cases among the 15-29 year old demographic in Barcelona rising eightfold in just 15 days, and hospitalisations rising by 33% in the 10 days to 7 July.

A similar situation is playing out in the Netherlands, where the number of new cases rose to 10,283 on Saturday, an eightfold increase compared to one week ago, with the under-30s again accounting for the bulk of new infections.

On Saturday Mark Rutte announced cafes and bars will close at midnight, and nightclubs will have to close entirely, stating that it is not a question of blaming an age group or sector, but of protecting the vulnerable. At the same time, the Dutch prime minister said there was no indication masks should be brought back in shops, and that testing for entry will continue at theatres and sports stadiums, which will remain open.

A new trend is clearly emerging, in which young people free to socialise but not fully vaccinated are the most-affected by the fast-spreading Delta variant. Mortality is not surging as it has in previous waves, which is likely the deciding factor for many governments in rejecting new lockdowns, but rising hospitalisations among young people could soon overwhelm health systems in hotspots. Any hopes that this summer will be like the last are quickly fading. We also note that the most vulnerable segments of the population would have received their second doses around six months ago by now. Booster shots will likely be on many country’s pandemic agendas by the end of the summer.