Onto the Next Hurdle

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What happened?

Last Sunday Theresa May, British Prime Minister, reached an agreement with fellow EU leaders on the United Kingdom’s intended withdrawal from the European Union (EU).

This came hours after Spain and the UK reached a last-minute agreement on the future status of Gibraltar, a British overseas territory. While Theresa May may have overcome one major hurdle, the next one already awaits her: parliamentary approval.

Why does it matter?

May is confronted with the unpromising scenario that neither her own party, the Tories, (1), nor the opposition (2), nor the population (3) supports her withdrawal deal. In case May fails to master ‘the art of the deal’ – and, thus, cannot secure a parliamentary majority at home – the UK risks crashing out of the EU without a deal. This would lead to a so-called ‘hard Brexit’: leaving both the single market and the customs union.

 What’s next?

(1): While the EU and the UK could, in theory, renegotiate another deal until the 29th March, this seems unlikely. It already took months to reach consensus amongst the 27 EU member states. Last week’s stand-off with Spain showed the fragility of the negotiations.

(2): It’s difficult to make forecasts in this fast-moving environment. May has been written off numerous times. Yet in the end she has proven remarkable resilience. This is largely due to her divided opposition, which struggles to get the 48 required votes to topple her.

(3): The idea of a second referendum gets thrown around from time to time. Whether this would imply a second referendum on Brexit itself, or on the content of a Brexit deal itself remains unknown.

Yet it’s important from time to time to realise the different perceptions about the EU. The vast majority of the British population perceives the relationship with the EU to be mainly of economic nature, as opposed to the rather civic interpretation widespread on continental Europe.


 

© Photo: https://qz.com/1474080/reactions-to-brexit-deal-from-world-leaders/

On Shadow-Banking, the Infectious Belt, and the China Dream

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What happened?

Back in 2013, Riad Ajami argued that China found itself in the midst of the ‘Middle-Income Trap’.

To Ajam, the key challenges awaiting the People’s Republic were:

  1. A sustained slow-down in state-directed infrastructure investment
  2. Growing industrial over-capacities
  3. The cheap labour pool running out
  4. Systemic risks due to unhealthy debt levels (‘shadow banking’)

Fast forward five years, what happened?

  • The CCP largely diverted state-directed investment towards high-tech – especially A.I.

  • Xi’s grand ‘One Belt, One Road’ initiative can be comprehended as an endeavour for opening up new markets for the domestic industrial over-capacities – besides vying for geopolitical influence.

  • As China attempts to avoid the ‘Middle Income Trap’, being the world’s manufacturing hub would no longer be an option anyhow. Chinese factory wages increased by 70% since 2011. More so, (industrial) pollution is one of the few issues that could threaten the CCP’s legitimacy.

  • It is estimated that China’s shadow-banking system grew close to $10 Trillion over the past decade (coming close to 90% of China’s GDP). All outside of the realm of government regulation.

Why does it matter?

Last year, Xi said that debt was one of the greatest threats to financial stability. The CCP has had the issue on its radar for a while now. However, each intended government crackdown led to new innovative debt instruments.

The Chinese proverb that ‘heaven is high and the emperor far away’ continues to hold true for many local governments. Yet it complicates the central government’s efforts in tracking down debt.

More so, vested interests further blur the picture. Xi’s recent centralisation of power can also be interpreted in that light. He needs to centralise power in order to take on the challenge.

What’s next?

While Xi’s geopolitical vision, as part of the ‘One Belt, One Road’ initiative, has been much applauded, one big risk associated with the undertaking remains largely overseen. The Belt is highly infected with institutional grievances.

While China might benefit from the (often) corrupt and autocratic governments in the short-term, it should be wary of associated risks with these types of governments in the long-term.

Last but not least, China is unlikely to back down in the Sino-American trade dispute for two reasons:

  1. For China it’s about more than trade. Ever since Obama announced his ‘pivot to Asia’, China has been suspicious about US’ intentions. The Trump administration’s hostile stance towards China further confirmed this perception. For China, it’s about Thucydides’ troika of themes:

i. Honour

ii. Fear

iii. Interest

And even more so about realising the ‘China Dream’. Backing down against the US would cast doubts about the CCP’s ability to realise Xi’s visions.

  1. Xi doesn’t have to worry about re-election, stakeholder costs, and parliamentarian majorities – unlike Trump with the midterms coming up. Thus, Xi is relatively immune to short-term economic blows with a strong set of centralised state-tools at his disposal.


 

© Photo: https://www.ft.com/content/b5441a6a-b7d1-11e7-8c12-5661783e5589

 

 

A Crisis Waiting To Happen

static.politico.jpgWhat happened?

Standard & Poor’s, the credit-rating agency, downgraded Turkey’s sovereign credit rating into ‘junk territory’. It expects further currency volatilities and forecasts a recession for next year. Since the beginning of the year, Turkey’s Lira has dropped 40% in value against the US Dollar. This is the result of:

  1. Failed efforts by the central bank to curb inflation
  2. Turkey’s vulnerability to declines in global liquidity
  3. The country’s diplomatic dispute with the US

Why does it matter?

The time of cheap money is running up. Central banks across the world are gradually tightening the reins. Capital becomes scarcer and more expensive. This negatively affects countries, such as Turkey, that are highly dependent upon foreign capital. Erdogan financed his massive infrastructure projects (that drove the economy for a good time) with foreign capital.

Turkey’s currency reserves further dropped below its short-term foreign debt levels. More so, Turkey has had for years a trade deficit. Foreign debt and trade deficits are per se not toxic. Yet they need to be financed with steady capital inflows. Because of Erdogan’s policies and the globally decreasing liquidity, this influx has faltered.

What’s next?

The need for reforms is high in Turkey. Thailand could serve as an example. In the aftermath of the East Asian Financial Crisis of 1997, the country fundamentally reformed itself. Nowadays, it has a trade surplus of 10% of its GDP. The ratio of currency reserves to short-term debt stands at 3:1. The upside of these developments could be seen last week. While various emerging markets’ currencies suffered, the Thai Baht remained stable.

As of now, it doesn’t look like a contagion risk for emerging markets. We are rather dealing with price-adjustments for risk.

The Turkish government would be well advised to:

  1. Raise interest rates
  2. De-escalate tensions with the US
  3. Sign an external funding agreement with the IMF

Since these measures will come with explicit and implicit costs, it seems unlikely that Erdogan will push for any of these soon.


© Photo: https://www.politico.com/story/2017/11/24/trump-recep-tayyip-edogan-middle-east-259604

Caught in the Spiral of Sanctions

rtxnnjh.jpgWhat happened?

On Tuesday a new set of US sanctions was imposed on Iran. This comes three months after President Donald Trump announced the US’ withdrawal from the JCPOA (‘Joint Comprehensive Plan of Action’). The new sanctions limit Iran’s access to foreign currencies. More specifically, it bans Iran’s ability to purchase US Dollar banknotes. In addition, they target critical industries for Iran, such as carpets and pistachios. The country’s energy sector has been exempted for now, yet sanctions will become effective in November.

Why does it matter?

Unlike the other spats of the Trump administration, such as with the EU or North Korea, there is no plausible way out. With the US administration being keen on regime change, Trump won’t make any concessions to the Iranian regime. Instead he is more likely to double down with the US’ economic might. The US possess exorbitant sanctions power for two reasons:

  1. The US Dollar is the world’s reserve currency
  2. The US Dollar underpins international trade

What’s next?

Iran’s economic situation will deteriorate sharply within the next few weeks. By November (when the oil sanctions snatch), the Iranian regime will have little options but to get back to the negotiating table with the US. It will be interesting to see how other JCPOA signatories (especially China and Russia) respond.

While they have pledged their adherence to the nuclear deal and trade, it is doubtful that they will risk being hit by secondary sanctions. Several European companies, such as Daimler, have already abandoned their Iranian operations.


© Photo: https://markets.businessinsider.com/commodities/news/oil-prices-spike-ahead-of-iran-sanctions-2018-8-1027435088

A small step for Boris, but a giant leap for the future UK-EU relationship?

 

regierungskrise-in-london-britischer-aussenminister-boris-johnson-zurueckgetreten.jpgWhat happened?

Both Boris Johnson, Secretary of State, and David Davis, chief Brexit negotiator, resigned on Monday. This happened after Theresa May, UK’s Prime Minister, secured her cabinet’s support for a soft Brexit blueprint over the weekend. The Pound rose as a result and British business lobby chambers seemed pleased with the draft. In contrast, David and Johnson saw the proposal contradict with their convictions favouring a hard Brexit, forcing them to step down.

Why does it matter?

Disappointed members of May’s Conservative Party are expected to push for a vote of no confidence this week. It’s uncertain whether the vote will secure the required 159 votes. If it were to succeed, May would be toppled and the UK would slide into crisis. In case the vote fails, May will have successfully pushed through her soft Brexit proposal – for now. The next few days will be important not only for the UK but also for its future relationship with Europe.

What’s next?

Last weekend’s Brexit blueprint revolves around a new UK-EU free-trade zone with identical regulations for goods. Financial institutions in London were warned that they were likely to lose existing levels of access to the EU market. Officials in the EU welcomed the latest developments. They hope to move forwards with settling the precise divorce terms. More so, they intend to draft the basic structure of a future trade deal by the end of the year.


 

© Photo: https://www.rtl.de/cms/regierungskrise-in-london-premierministerin-may-sortiert-ihr-kabinett-um-4148423.html

Saudi Pledges and OPEC’s Obsolescence

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What happened?

On Saturday (30.06) President Donald Trump announced that Saudi Arabia agreed to raise its oil production. The rationale behind the increase is the reduced global supply due to Iranian sanctions and Venezuelan turmoil. It remains unclear by how much Saudi Arabia agreed to increase its output.

Why does it matter?

The announcement caught funds and investors expecting further upsides in oil prices off guard. The Saudi move is like many other of the Kingdom’s moves linked to Iran. In a sense, by giving in to Trump’s demands, the Saudis reassure Trump to remain hawkish on Iran without having to fear major shortages on global markets.

The move also underlines the continuing obsolescence of OPEC (Organisation of the Petroleum Exporting Countries). Major oil producers, such as Russia and Saudi Arabia, shape their oil policies according to their own geopolitical objectives.

Finally, with US gas prices already being high, Trump was keen on doing something vis-à-vis increasing oil prices – especially with the important mid-term elections coming up in November.

What’s next?

Goldman Sachs expects oil prices to plateau between $75-$80 per barrel between now and the end of the year. Three underlying reasons support higher prices:

  1. Strong global demand driven by macroeconomic developments
  2. Supply disruptions of key producers, such as Iran, Venezuela, Angola and Libya
  3. Pipeline capacity challenges for US shale producers

 


 

© Photo: https://www.tradefinanceglobal.com/posts/saudi-arabia-arrests-effect-on-oil-price/

 

An Armistice to Avoid a Repeat of 1976

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What happened?

German Chancellor Angela Merkel (CDU) and Horst Seehofer, Minister of the Interior, (CSU) reached an agreement after dramatic days in Germany. Seehofer clashed with the Chancellor over the country’s migration policy. He threatened to resign in case proposed alternatives by Merkel wouldn’t have ‘the same effect’. In the end, both agreed to set up transit centres on Germany’s southern border.

Why does it matter?

The political crisis in Germany had the potential for far-reaching consequences:

  1. A separation of the Union parties CDU and CSU that already occurred once briefly in 1976
  2. A breakdown of the four-month coalition of CDU, CSU and SPD
  3. New Elections
  4. Further Uncertainty for Europe

This would have come at a time at which Europe finds itself confronted by various challenges, such as increasing trade tensions with the U.S..

What’s next?

The agreement ought to be seen as an armistice. Details on transit zones are vague. Doubts remain on the future working relationship between Merkel and Seehofer. A difficult relationship got even more difficult. Things don’t look good for Germany. A weak coalition, and a battered leader confronted with numerous challenges.

To further complicate things, last week’s EU summit underlined the divide between its 28 members. Countries, such as Hungary, skipped last week’s summit, while Italy blocked the release of a joint statement until tougher measures on migration were reached.


 

© Photo: https://www.cicero.de/angela-merkel-horst-seehofer-macht-verzicht

 

 

 

All Eyes on Singapore

What happened?

Four more days until Kim Jong Un, North Korea’s leader, and Donald Trump, President of the US, are expected to meet in Singapore (12.06). Officials on both sides are working behind the scenes to lay the ground for the historic meeting. Meanwhile Japan’s PM Abe has flown to Washington to convey his country’s security interests, fearing they will be overlooked.

Why does it matter?

It seems unlikely that North Korea and the US will reach a decisive deal next week. Too big are the remaining differences. Both parties have different interpretations about what ‘denuclearisation’ means. The US’ interpretation is CVID: complete, verifiable, irreversible denuclearisation of North Korea. Meanwhile the North Koreans only seem willing to denuclearise under the condition that the US withdraws its troops from the Korean peninsula.

What’s next?

Most negotiations involve compromises. How far each side is willing to go will be seen. North Korea crossed a red-line last year when it tested ICBMs (Intercontinental Ballistic Missiles) capable of reaching the United States. A possible first step towards a more comprehensive denuclearisation might involve the abolishment of the ICBMs in return for gradual sanctions relief. The meeting should focus on creating a diplomatic framework for further negotiations. A meeting with no deal and no diplomatic roadmap in sight would signal that diplomacy has failed. A realisation that every party would want to avoid.

 


 

© Photo: https://www.n-tv.de/politik/Trump-zieht-es-zu-koreanischem-Grenzort-article20412393.html

A Second New Government in Europe Within Two Days

What happened?

Besides Italy, Spain also received a new government after former PM Mariano Rajoy lost a confidence vote. The vote was caused by corruption scandals within Rajoy’s conservative Partido Popular (PP). Pedro Sanchez of the Social Party (PSOE) replaces Rajoy.

Why does it matter?

Sanchez will lead a minority government in the Spanish lower-house, just as Rajoy did. The lack of concessions, in the form of cabinet positions, towards the parties that supported Sanchez’ motion is interesting. Sanchez will have to carefully calibrate his policies to appease other parties in order to pass legislation, as his party only holds 84 seats – with an absolute majority requiring 176 seats.

What’s next?

The two most pressing questions the latest developments in Spain pose relate to the European Union and Catalonia. With respect to both issues, no major disruptions to the status-quo ought to be expected. The new Spanish government (PSOE) is a center-left party that will place value on the modus operandi, ensuring Spain’s continued economic recovery. While Sanchez offered forums for dialogue with Catalonia, neither will Madrid under his rule be open for Catalan independence.

 


 

 

© Photo: http://elestimulo.com/blog/pedro-sanchez-asume-como-presidente-en-espana-tras-salida-de-rajoy/

Making Sense of Italy’s 65th Government in 73 Years

What happened?

A new Italian government, composed of the populist Five Star Movement and far-right Lega Nord, has been sworn in on Friday (01.06). Giuseppe Conte, a former law professor, will lead the coalition as prime minster after months of political deadlock.

Why does it matter?

While Italy’s political future seems sorted for now, the wider repercussions for the European Union (EU) will only start unfolding now. Both parties have announced their intention of introducing a 15% flat tax rate and basic income. The proposed policies can be expected to further worsen Italy’s public debt levels (132% of GDP), putting the country on collision course with the EU’s budget rules.

As a result of the mounting public debt, ratings agencies would likely further downgrade Italy’s credit-rating, making it more expensive for the government to service its debt. Because Italy, accounting for 15% of the Eurozone’s GDP, is far bigger than Greece (the epicentre of the last Eurozone’s crisis), fears about the Euro’s future emerged.

What’s next?

A more confrontational relationship between Italy and the EU over matters ranging from fiscal rules to refugees can be expected. Special attention will be given to Mario Draghi, President of the ECB, to see how he deals with the Eurozone’s latest headache. An unfortunate side-effect of the Italian drama will be a further postponement of much needed European reforms. EU officials will be busy firefighting while domestic politicians will have a hard time convincing their constituencies of the benefits of more European integration against the backdrop of the rhetoric abroad.

 


 

 

© Photo: https://www.investing.com/news/economy-news/weekly-comic-italy-fears-on-hold-for-now-but-uncertainty-remains-1469590