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12 July 2024

Macron's next coup?

In our lead story this morning, we write about another of Emmanuel Macron's ingenious plans – a constitutional reform; we also take a deep dive into the dilemma faced by the French left; we also have stories about the now likely chancellor-candidacy of Robert Habeck; on Germany’s next cruise missile debate; on the fiscal consequences of higher defence spending; and, below, on the end of a beautiful relationship.

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Today's free story

Tu, infelix Austria

Across Europe, the energy relationship with Russia looks like it is dead. But in Austria, it is as healthy now as it was before the war. Up to May of this year, almost all of the country’s gas has come from Russia via pipeline. Austria’s justification for this has been that it receives the gas, piped into the country via Ukraine, via so-called take-or-pay long-term contracts. These would force Austria to pay Gazprom even if it did not accept the gas it is allocated under the terms of those agreements.

This may not be the case forever, though. Earlier this week, Leonore Gewessler, the Austrian energy minister, set up a commission to look into a contract between Austrian energy firm OMV and Gazprom, which runs to 2040. One objective of the commission is to see if there is a legal exit route from the contract. Another is to investigate the circumstances under which it was signed in 2018. This was, incidentally, the 50th anniversary of the Austria-Russia energy relationship.

Some of this may be politicking. Austria will hold elections in 2024. Ahead of these, the coalition between the centre-right ÖVP and the Greens has started fragmenting. Gewessler, a Green, was also the one responsible for the nature restoration law stunt in the EU Council last month that saw her defying Karl Nehammer, the ÖVP chancellor. The ÖVP was in power, with Sebastian Kurz as chancellor, when the current OMV-Gazprom deal was signed.

But there are other reasons to think that the Austria-Russia energy relationship could eventually meet the same fate as, say, the German one. Last month, an arbitration tribunal ruled in favour of Uniper, formerly the biggest German buyer of Russian gas, in a dispute with Gazprom over the status of its own long-term contracts.

That ruling invalidated Uniper’s obligations, which is significant since it was the single largest holder of these contracts prior to 2022. The terms of Uniper’s contracts may not be the same as OMV’s, and if it went to arbitration another tribunal could always rule a different way. Circumstances are also different, since an explosion knocked out the Nord Stream pipeline in 2022. But if there is a way out for Uniper, there may eventually be one for OMV.

This is especially since the route Austria’s gas supplies from Russia relies on could soon not exist. Ukraine has said that it will not extend its transit agreement with Russia when it expires at the end of this year. Austria was the first country in western Europe to start receiving Russian gas via pipelines from the east. It may be one of the last to stop soon. 

The legal mess that has followed the 2022 energy crisis, and what could come after the end of this year, should tell us a bit about the likelihood of a return to the status quo ante bellum in our relationship with Russia after the war too. That year saw a relationship that survived some of the scariest moments of the Cold War break down completely. Building it back up again in the future would not be impossible. But we should not underestimate the difficulty of doing so. 

11 July 2024

Final curtains in DC

We don’t get the sense that the Democratic Party has a lot of people who have been thinking this through. The degradation of Joe Biden’s neurological health has been evident since before the start of the primaries. The issue is also not whether he can debate Trump or win the elections – but whether he is able to fulfil his duties as president. One would have thought that the prospect of another Donald Trump presidency would have focused minds. But it did not.

The Wall Street Journal reports that the current wave of pressure on Biden to step aside seems to be fading. The Democrats are now ending up with the worst of all worlds, an incapacitated candidate and internal divisions. We noted that Trump has chosen to stay out of this debate to let the Democrats tear each other apart.

It is probably easier to see this from the outside: with less than four months to go until the elections there are not many good options for the Democrats now. The polls cannot tell you how any hypothetical candidate would fare against Trump. Some of the Democratic governors have been preparing for 2028. They are not politically or financially prepared. Harris is the only candidate with access to Biden’s campaign funds. If you try to squeeze a candidate past Harris – a white guy – without the democratic legitimacy of a primary campaign, you are not only going to lose the elections, you risk destroying your party.

The intelligent way to have addressed this problem is not to get George Clooney on the stage but to prepare a coherent plan that gives Biden a dignified exit, that puts Harris in charge, surrounded by a united team of the top Democrats lawmakers and governors. If this is not possible, your second-best strategy is to leave things as they are. 

The message for us over here in Europe is that we should no longer merely consider Trump as a potential winner, but as the most likely winner, and start make preparations now. Would we still want Ursula von der Leyen as a Commission president in a post-Biden era? The Nato summit in Washington is the final curtain for the old trans-Atlantic relationship. As happened in another place, the ageing lead actor has fallen off the stage. The EU’s job is to start the long and painful route towards its strategic independence. This includes defence, but the most important aspect we think is technology. Trump will be better advised this time. A partial US disengagement from Europe is likely. Judging by the state of political discussions in Brussels, Paris, and Berlin, we don't think the EU is ready for this. Not even close.

10 July 2024

Not paying off

When looking at our economies, there is often a disconnect. Some metrics may be useful, but they do not tell us as much about how people are living their lives, or experiencing economic conditions. If you try to isolate those, what you will find right now is quite a different story. It explains a lot of the current political mood, in our opinion.

One recent example of this is the findings from the OECD’s most recent employment outlook. It sets out a striking contrast between relatively healthy employment figures, in the US but especially in the euro area, compared to pre-pandemic levels, and real wages. Total employment growth in the euro area has outpaced GDP growth.

But real wages tell another story. As of Q1 2024, they have fallen since Q4 2019 in a number of different European countries, including Germany, Italy, Spain, Belgium, and Sweden. In Italy, real wages have fallen by 6.9% since 2019. Real wage declines have often been even more dramatic since Q4 2021, when inflation took off and Europe’s energy crisis began in earnest.  In Poland and the Netherlands, real wages have both increased since 2019: slightly in the case of the Netherlands and significantly in Poland’s case. Both countries have, however, seen real wage falls since 2021.

This is, we think, one of the key figures to look at if you want to understand political outcomes. In the US too, it is important: real wages have dropped there, both since the pre-pandemic era and since 2021, a different picture to rosier economic statistics. This helps explain why many Americans feel less buoyant about the economy than GDP growth numbers show.

Whether this translates to governments keeping or losing power over one election cycle, or being plunged into chaos or not, is imperfect, of course. Other factors, like political polarisation, differences in political system, and tactical voting come into play. But if it is a sustained pattern, it is a difficult one to escape.

These real wage drops have also come despite a pre-pandemic trend towards shorter average working hours continuing, and even accelerating, across the OECD. This may tell us something about the broader societal factors at play. In some countries, it could also point to misaligned incentives, such as income tax or benefits cliffs that disincentivise working, and therefore earning, more.

9 July 2024


France’s RN and the Labour Party had approximately similar vote shares in the recent parliamentary elections around one third. The difference, of course, is that Labour won with a massive majority whereas the RN did not. The difference is not so much due to voting systems as such. Both are versions of winner-takes-all voting systems. The main difference is tactical voting. Never before have we seen tactical voting playing such a decisive role.

Even the normally reliable French polls got this wrong. The UK polls were hopeless. Labour’s share of the votes was really very low, outside of all polling error margins. The data are telling us that Labour was after all not assured of victory as people had anticipated. The Labour victory, and certainly its scale, is to a large extent due to the entry of Nigel Farage, which fatally split the votes of the right. Had Farage and the Conservatives instead formed a strategic alliance, with Farage’s Reform contesting the strong pro-Brexit constituencies, and the Conservatives the erst of the country, the outcome would have been very different. We have yet to see the numbers, but our best guess would be a hung parliament, with a Labour/LibDem coalition.

Tactical voting is always and everywhere an artefact of voting systems. Even in purely proportional systems people might vote tactically to support one coalition over another. In systems like France's or the UK's, tactical voting can produce violent swings. But this goes both ways. What goes up this time, can go down next time.

In the long run, tactical voting increases volatility, but not political outcomes. In France, the centre and the left cannot sustainably collude to keep the right from power. They will now have to govern together. If they fail, the ire of centrists and moderate conservatives, and possibly even moderate Socialists, would turn against the Left, just as the voters of the hard left might see the centre, not the right, as its main opponent.

If you take a sufficiently long-term view, these fluctuations even out. Electoral systems matter, but as we saw in the UK and the US, they don’t keep extremes away. In France or Germany, they don’t either.

8 July 2024

Iran's pretense of moderation

The other big elections that have just taken place are those in Iran. The reformist candidate, Masoud Pezeshkian, won the presidential election run-off on Saturday against the hardliner Saeed Jalili.

Western media showed relief and heralded the election of a moderate president as a diplomatic game changer. Pezeshkian promised to revive the nuclear deal, engage with the west and to soften the country's hijab rulings.

But Iranian experts warn not to expect too much. Pezeshkian may talk reforms, but he is still a loyalist to Supreme Leader Ayatollah Ali Khamenei, who is the final arbiter in all state affairs. Pezeshkian also still has to govern with hardliners in his government.

Then there is the question of democratic legitimacy. Even if the officially recorded 50% participation rate was true, it would be a historic low for the regime. Turnout may even have been less than officially reported. Many polling stations throughout the country remained empty according to many social media postings, while there was some moderate traffic in dozens of polling stations in Teheran.

Pezeshkian, a former heart surgeon and lawmaker from the multi-ethnic region of western Iran, was the only reformist candidate allowed to run in the presidential elections. His victory came with a blessing from Khamenei. The foreign policy calculation in Iran is that it might soften the impact of the US elections. The regime dreads the return of Donald Trump. Last time around, Trump exited the nuclear power deal and introduced the maximum sanctions that weakened Iran. A reformist candidate may lull western electorates into believing that Iran has opted for a reformist government, while it continues to pursue hardline politics in more subtle ways. Still, Pezeshkian could demonstrate his skills in negotiating compromise with hardliners. 

5 July 2024

A tariff-ying outcome?

The European Commission has pressed ahead with its tariffs on Chinese electric car manufacturers. After a 4 July deadline expired, it will implement a range of additional tariffs, differentiated by manufacturers, on top of the 10% already applied on auto imports. BYD, China’s largest carmaker, gets off comparatively lightly, with an additional 17.4%. Saic, the largest Chinese importer of electric cars into the EU, will face additional tariffs of 37.6%.

Now the question is what China decides to do. Possible consequences range from being bad news if you are a Beijing-based cognac fan to being bad news if you are a German carmaker. The German carmakers are afraid it will be the latter, with Volkswagen having been critical of the tariffs. Germany’s government is similarly unhappy with them.

But overturning the Commission’s decision would require a qualified majority of EU member states representing at least 65% of the union’s population. That is an extremely high hurdle to overcome. This looks so far like one the more protectionist EU countries will win.

We have seen various scare-stories from the Chinese media too about retaliation against large-engine car imports specifically. These would hit the German automakers where it hurts. It is difficult, however, to ascertain the extent to which they are serious, or negotiating tactics designed to frighten the Germans, and put pressure on the Commission.

From our perspective, we don’t see why China would need to take a particularly hard line. Geopolitically, it would not make so much sense. We are in the middle of China’s contest with the US. Coming down hard on the EU would risk pushing Europeans closer towards the US in the longer run, which we doubt it will want.

There’s also, from this longer-term perspective, not necessarily much need. Even with the tariffs, many Chinese automakers may still be competitive with their European counterparts. The Rhodium group estimated a 50% total tariff would be necessary to put the two on a par. None of these reaches that level, though the Saic ones come close.

The other tool China has at its disposal is near-shoring. BYD will open a site in Hungary, and is considering a second elsewhere in the EU. Chery, another Chinese electric car specialist, is opening a factory in Spain. Like BYD, it may opt for a second one. These companies can keep the supply chain for the most important value-added component, the batteries, under their control.

4 July 2024

Not in his lifetime

Already assured of victory at today's general election in the UK, Sir Keir Starmer has started to make manifesto pledges for beyond 2029. Yesterday he said that the UK would not rejoin the EU within his lifetime, nor would it try to become an associate member of the single market or the customs union. People at Sir Keir's age - he is 61 - should be careful about making pledges about their lifetime - but one can safely assume that the intended horizon extends to a second term and beyond.

We are not surprised, except that the issue came up so early. The reason to shut this down right now and as conclusively as he did is that keeping the door open for the future has policy consequences today.

To rejoin even in the medium-distant future would have required him to start closing the massive regulatory gap that has opened since Brexit almost immediately. Most of that gap was due to divergence by the EU itself. The UK did not mirror the 50 or so laws of the Green agenda. It adopted the data protection regulation - GDPR - in the last decade, and maintains its own version to this day. But the UK does not have the EU's digital markets act, or EU regulation on AI and cryptocurrencies. Nor does have regulation on what is euphemistically called corporate social responsibility - making companies liable for human rights violations in their supply chains. For the UK to rejoin the EU even during a second term would require such a high degree of regulatory convergence that it would dominate all other policy areas. Why impose such constraints on yourself when you got elected on a pledge that you focus public services? 

We suspect that the emergence of right-wing governments in the EU and right-wing policy agendas are making the EU less attractive for the UK left. Political cycles between the UK and the EU have forever been asynchronous, but never more so than now. 

We see another reason in the EU's Luddite tendency, its attachment to 20th century technologies and corporatism. We always felt that the undoubtedly large economic gains from goods trade integration need to be set against the opportunity cost of the EU's failure to partake in the 21st century digital economy. The single market, as it is constituted today, is very much a product of 20th century product-focused regulatory thinking.

The option to rejoin would have been more realistic if the Labour Party had not swung behind the second referendum campaign, spearheaded by Sir Kier himself.  

It is also possible that Sir Keir's motives were much more party-political. He has more to fear from the Conservative regrouping around their old favourite theme of Brexit than from Liberals or Greens capturing pro-European metropolitan voters from Labour. We are also not sure whether the mostly pro-EU polling gives a sufficiently reliable indication of the public mood. Rejoining the EU in 2030 or 2035 would be a very different proposition from not leaving it in 2016. The young generation of the 2030s will have a different agenda than those of the last decade. They might come to regard the idea of rejoining the EU as a leap back towards the digital stone age.

3 July 2024

When the law bites back

What the EU and the US have in common that the centrist reliance on rule-of-law proceedings against their opponents is backfiring. They did not see this coming. The EU thought it could force recalcitrant governments into line through budgetary sanctions, without sparing a moment of thought that Viktor Orbán’s vote is needed for virtually all that is politically important right now, like sanctions on Russia, or Ukraine’s accession. The rule-of-law procedure started off with the intention to fight corruption and breaches of European law. But it ended up as a sanction mechanism against the far-right. It is not a legal procedure, but a political one. It is appointed politicians, in the Commission and the EU Council, who vote for it. When Poland changed government last year, the Commission revealed its hypocrisy when it dropped the procedure immediately. The very worst aspect of it is that together with political firewalls ended up having the opposite effect. It strengthened the opponents of liberal democracy.

The legal pursuit of Donald Trump falls into a similar category. The US was on the verge of graduating to the select group of countries that incarcerate the leader of the opposition. We can’t count the number of comments from partisan journalists, academics and other commentators who confidently declared that the multiple charges against Trump would kill his campaign. European newspapers in particular could not hide their glee about Trump finally meeting his deserved fate – leaving their readers in a dangerous delusion about US politics.

This week’s Supreme Court rulings have thrown the multiple legal campaigns against Trump into doubt. Worse, they backfired politically. Even before, they did not work politically. They gave Democrats a false sense of security. It lulled them into supporting Joe Biden for another term, when his mental deterioration has been obvious for some time. It is July now. How on earth can you organise an orderly primary for Democratic candidates? Jimmy Carter, Bill Clinton and Barrack Obama did not start out as front-runners. They needed the snake-pit politics of the primaries to get their agenda across. Chances are that if they manage to ditch Biden, they end with a controversial stich-up at the Democratic conference, or with Kamala Harris as the candidate. And then what? The Democrat establishment has been transiting from complacency to panic in a short period of time, with sparing a moment on the massive political misjudgements that caused this mess. There are some obvious parallels to French politics right now – where the political establishment, too, is obsessed with tactical games.

Back in 2020, when the EU passed its rule-of-law procedure, it already had bigger problems on its plate: faltering economic dynamism, falling behind the US and China in high technology; overreliance on the US for defence, on Russia for gas, and China for critical nodes in our supply chains. The economic dynamic has since become worse. As Mario Draghi said at a recent speech ahead of the publication of his report, the EU lacks the ability to mobilise capital. We are one or two French elections away from a sovereign debt crisis. Five years of unfocused hyper-activity, with the potential of another five years to come, are going to pose an existential threat when your enemy is more focused than you are. Should that not be what EU leaders should be discussing over dinner before they talk about jobs?

2 July 2024

Va Banque!

The last seven days have been a reminder of the power of intruding events. Emmanuel Macron’s gamble has not worked. Donald Trump has taken two big steps forward in his road back to the US presidency – the debate with Joe Biden and yesterday’s Supreme Court ruling on presidential immunity. There are no good options for the Democrats right now. Replacing him would be the riskier choice, not in theory but in practice. It is not as though the Democrats have agreed on who that person should be, and how that person, when selected, would run a successful campaign from start to finish in three months.

The legal pursuit of Trump was a slow-moving political train-wreck. So was the EU’s rule-of-law pursuit of Viktor Orbán. He is stronger than ever, and just started the six-month Hungarian presidency of the EU with the slogan to make Europe great again.

What we described above is not than just a string of recurring political misjudgements. It is a source of geopolitical risk in its own right: it is the tendencies of embattled governments to double down with political misjudgements. Liz Truss and Emmanuel Macron have little in common, except that they both took uncalculated risks. Probability theorists describes this phenomenon as gamblers’ ruin. In politics, in life, and in investing, you should take risks. But you should not play Russian roulette.

One of the reasons of our incapacity to spot such risks is the tendency, especially here in Europe, for everybody to huddle together in government – the pro-European coalitions in Brussels, grand coalitions in Berlin, or the centrist counter-revolution in Paris. Everybody is screaming at each other, but nobody is speaking truth to power. Just look at Macron’s uncritical centrist supporters who fell over themselves to laud the brilliance of his dissolution of the parliament. The French language has a great expression for this type of risk taking: Va Banque!, named after a 19th card game called Pharo, in which the gambler tries to match the house – the bank – with his bets.

Va Banque! is a bigger risk than impossible to predict events because it goes to the heart of where the real risk lies. Like Macron, who gambled all on an election, the west is taking similar uncalculated risks in its geopolitical decisions: the promise of open-ended support for Ukraine in pursuit of a nebulous war goals; the imposition of sanctions without an understanding of how they can be evaded; unconditional support of Israel; the implicit threat to go to war with China over Taiwan. And yet, our societies are not ready for any of this.

The day after Russia invaded Ukraine, the West imposed pre-agreed sanctions on Russia that had no material effects beyond pure-virtue signalling. It was the commercial interests that prevailed. The West's ambitious geostrategic goals stand in sharp contrast to our collective unwillingness to make offsetting sacrifices. We saw this in Brussels last week where a consensus emerged in the European Council in favour of debt-financed defence spending. Olaf Scholz vetoed it, but it is also the consensus of his own party. The SPD’s latest red line is that there can be no trade-offs between social transfers and defence spending. Our welfare systems are not only economically unsustainable, but also politically. That’s a geopolitical risk. Our societies are much more fragile than China’s or Russia’s. We read in the German media yesterday that the failure to inherit money from your parents has become a recognised trauma.

So herein also lies a source of geopolitical conflict – when you are trying to pick a fight without being politically in a position to do so. This is why we keep on remarking that the EU should focus on its core functions and make them work better: the single market, the banking union, the capital markets union.

The EU is clearly not following this advice. A sovereign debt crisis is a very plausible scenario in a low-growth environment with legally protected social rights. It is not the only risk, and possibly also not the worst risk. 

1 July 2024

An accident waiting to happen

Last week we wrote about one avenue through which the EU could take damage as a direct result of the French elections: through the repatriation of policy areas and pressure to lower French contributions to the EU budget.

Christian Lindner just gave us another one. He is quoted as saying that the ECB may be prevented by the courts from buying French bonds during a sovereign debt crisis. The trigger of the ECB’s transmission protocol instrument to help prop up the French bond market would raise what he called economic and constitutional questions.

Our own reading is that the ECB is legally entitled to trigger TPI for as long as governments are formally inside an excessive deficit procedure and comply with the guidance they have been given by the EU. The only conceivable hypothetical situation where we would see this condition violated would be a victory of the far-left. The danger the far-right poses to French democracy is of a different nature. It is not primarily fiscal. 

The EU’s and the euro’s survival are strongly premised on certain accidents not happening. In several countries the far-right is either in the main government, or the main opposition party. In France, the RN will be the largest party represented in the parliament. Oppositions eventually win elections. The UK is about to remind us of this fact.

A conflating accident the EU must avoid is that a political crisis in one country is turning into a crisis of populism in another. Lindner is a bigger threat to French sovereign bonds than Le Pen. Debt crises fall into the category of things you can trigger by talking about them.

We too see a problem of fiscal sustainability in France, but this is not related to the far-right. Macron’s government has been the fiscally most profligate in decades. If your fiscal deficit is accompanied by strong GDP growth, as is the case in the US, it won’t lead to a crisis. But that did not happen in France.

Each political scenario in France would have different fiscal implications. What troubles us is that there is not one that is sustainable. This is what investors should worry about, not what the ECB can do in an emergency.