The Euro Is A Rearview Gauge Of Geopolitical Risk

By: Andrew_McKillop

What Goes Up Will Go Down
Five weeks into 2014 the Eurozone-18 and even the EU-28's stock exchanges are being treated as something of a safe haven bet by investors retreating from “risk assets” in emerging economies. They also see the euro money as safe, but this is very far from sure. The president of the European Central Bank, Mario Draghi has admitted either openly or by implication many times since the 2008 crisis began, that the euro is overvalued. Since 2008 and more so today, the euro still plays the role of a geopolitical barometer. The euro rises with global risk and the opposite, but this cart and horse combination is in no way timeless. It is under attack from the real world - and even by Germany.

Normal logic says the euro should now rise again as investors rush for the exit from emerging markets, from natural resources – and even from oil. To be sure, analysts can pretend the opposite, for example Kiran Kowshik, analyst at BNP Paribas, cited by the Wall Street Journal 4 February said the exact opposite claiming the euro should theoretically fall against the USD and JPY in times of stress. He said:  "Normally you would expect it to fall [in times of stress], but it does seem to be acting like the yen and the dollar and rising in bouts of nerves now".

The “bouts of nerves” at this time specially concern Europe's doorstep Ukraine, nearby Syria, and relations with Russia. Off the radar screen for most analysts, Europe's continuing and deepening domestic economic, social and political crises include rising anti-Europe and anti-euro sentiment even among German political parties, but in this case with a specific anti-euro focus. The newly formed Alternative for Germany – which did unexpectedly well in the recent election finishing just short of the 5% threshold needed to enter the Bundestag – insists that its anti-euro agenda is not the same thing as anti-Europe. AfD says it wants to end the common currency, because in its view the common currency is undermining the European ideal. 

Trade Surplus Political Deficit

The EU economic crisis is the real explanation of the Eurozone-18's spanking trade surplus, with imports continually dragged down by the continent's stagnant economy and massive unemployment. The overvalued euro, as much as overpriced labor in Europe however makes an export-led recovery for Europe a pipedream. Europe's mass unemployment can only drag along so far before it creates powerful anti-Europe and pro-nationalist political sentiment, and the euro will be among the losers.

So far as Ukraine, and the other 5 ex-Soviet eastern Europe and west Asian countries targeted by the EU's Eastern Partnership project is concerned, these are all very far from “windfall gain” potentials for Europe, exactly like Putin's rival Eurasian Union project. Inside Russia, Putin faces rising domestic turmoil as his third presidential term continues, aggravated by his Kremlin doggedly pursuing the goal of creating the Eurasian Union, a supra-national entity modeled on the European Union.

His Eurasian Union is directly opposed by the EU's Eastern partnership project, with key countries such as  Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine supposedly disputed by both the EU and Russia. On this EU hit list of “partnership states” for example, Ukraine, Armenia and Azerbaijan were at one stage or another thought by Kremlin strategists as “likely or certain” to join Putin's Eurasian Union designed to dissuade them from joining the EU. Taking only Ukraine, when or if this heavily destabilized country falls into the European sphere, it will firstly bring its massive debts and massive organized crime syndicates.

The EU makes a point of not holding referendums on “enlargement to the east”, but its experience with the most-recent enlargement, taking in countries including Romania, Bulgaria and the Baltic States, has been an economic and political burden – not gift. Going further with eastern enlargement may be attractive to the Commission's elite, but has little or no public support in Europe. In Russia, public opposition to Putin's Eurasian Union is already strong and vocal. 

The Syrian civil war is petering out – and Russia has become a risk asset itself, its economy slowing and its debt rising, a country that is increasingly isolationist and uninterested in Europe. Polls show that Russians rank the influx of “other ethnic and national groups” into Russia as the main threat to economic and national security, higher even than Islamic terrorism. To mollify public rage, the Kremlin is engaging high-profile mass deportations of over-stay guest workers – some 300 000 Moldovans are currently targeted, but opinion polls and petitions calling for zero immigration from Central Asia are now rife and repeated in Russia.

Putin's Eurasian Union experiment, for which Kazakhstan is about the only sure taker, like the EU Asian partnership project is unpopular at home and its economic bases are unrealistic. The likelihood of Putin's project seeing the light of day is close to zero – average Russians will be happy to see it fail.

The mood of Russians is isolationist and Putin knows this. Europe, conversely, sails along with its ego-boosting March Eastward. Later on, the bills will fall due, and the overvalued euro will be one of the victims. In the EU28, the average voter and taxpayer loses no sleep over winning or losing the struggle for Tadjikistan or Belarus with Putin, but attitudes towards Ukraine may be more sympathetic – until the economic side of the cards on the table is turned over and put on view. Some member states, especially Poland but less certainly Germany believe they “can do things with Ukraine”, but all realistic assessments on Ukraine's accession to full membership of the EU suggest this will be a cost process for Europe needing decades – possibly two of them.

Outdoing the Fed

Citigroup analysts cited by Wall St Journal note that the euro's “safe haven status” will in no way shield Europe from external shocks to market confidence in Europe-peripheral, and international markets. When or if the ECB had to also take on and bail out Ukraine's public finances and private banks, and finance the accession of other broken-back ex-Soviet countries, the potential for the ECB-mirror cracking to show the evil witch – not Snow White – would be high.

Only for as long as the euro remains “safe haven”, this enables money-printing by the ECB that rivals that of the US Fed - but the ECB makes a point of moving the goalposts and using its smoke generators to mask the exact amount and type of “monetary easing” it engages. The semi-federal but in no way united European banking and monetary system helps this obfuscation. Adding the derivatives, it is not possible to say how much state, banking and corporate debt is ECB-supported, but the number is vast and just as important, is growing.

Conversely hard data shows the ECB is neck and neck with the Fed operating the ultimate low-interest money policy. The ECB's low interest rates make loans in euros uber-attractive. Overseas borrowers can use them to fund risky, high-yielding investments outside Europe, and shift away from the two previous favorites for this, the USD and ultracheap borrowing in Japanese yen. Current reasoning suggests that scared investors quitting Emerging markets will need to buy euros to terminate and liquidate their risk assets – further raising the euro's value if only on a short-term basis.

The net result and consequence is Eurozone deciders feel they are in a “can't lose” sweet spot. This may presently have collateral effects - bolstering their “outdo and beat Putin” east European and west Asian initiative, which reads like a trial essay by Halford Mackinder – that he decided not to publish because it was so silly. Unremarked by most, time-out for this policy in fact dates from several years back in time.

Game-changers notably focus the changing German-Russian relationship, and Germany's total dominance of ECB policy and strategy. Both of these are not mellowing with time, but are cracking apart. Until about 2010, Germany could not afford to alienate Russia. For Berlin, Russia could reliably supply relatively cheap energy – although the key term “relatively” must be printed in block capitals - and was also a potential source of low-cost labor from ex-Soviet eastern Europe, and possible or potential market opportunities. Russia, fattened by petrodollars and gaseuros was a key target destination market for German exporters looking for alternatives to already-stagnating EU domestic markets but this policy and strategy set has not stood the test of time, nor resisted changing economic, energy, political and resource conditions and relationships.

Observers note that Germany is now itself likely the most important game-changer for European foreign and monetary policy. Apart from losing its former fears and foibles concerning the Russian Bear, its former rock-hard addiction to a rock-hard overvalued euro may also be game-changing.

Not the German Euro

Germany is showing its new No Fear approach to Russia, giving active support to opposition groups in Ukraine despite this in no way conferring any immediate gain or responding to any pressing strategic imperative for Germany. This action signals it has lost its former “Putin calculus”, for reasons including Putin's own domestic political opposition and clear loss of interest in extending Russian power in eastern Europe and Asia. At the same time, Germany has started distancing itself from other EU28 countries in several domains including the economy.

German economic policy deciders are now heavily divided on the former total-consensus hard euro policy, but are increasingly united on Russia. The consensus view is that Russia's export market potential was overestimated in the same way as its role as the biggest supplier of – overpriced – energy to Europe. To be sure, Russia will remain a key supplier of energy to Europe but major change is at work in world energy, starting with world natural gas. Russia is both totally dependent on energy trade and in the past, like OPEC played “price taker” for oil and gas, for decades at a time. Dependence on Russian energy exports is not only a two-edged sword, but something of a Paper Tiger, to many Germans today.

German isolationism has been underestimated outside Germany. At least as important as Russian isolationism and like US isolationism this has direct effects on “defending the money”. US isolationism  can be analyzed with reference to the commitment to “defending the dollar”, with at least as much implications as German isolationism may have for euro-money policy. Overall and on balance, German money strategists note that a weak US dollar has in de facto terms better served US foreign policy, and also the domestic economy for the past 30 years, than the reverse of a strong dollar.

In other words: Why defend the euro?

More significant for the euro, this is Nobody's Money. Defending nobody's money is a default process, currently operated by the ECB utilising ultra-Keynesian policy and strategies. These, in their Keynesian logic, can only lead to a weaker euro - but for an increasing number of German deciders this weaker euro will mean a stronger Europe. This is a revolutionary change in German thinking. It throws off the “shadow of Weimar Germany” and the Great Inflation of the early 1920s, which dictated strong money policy from the moment postwar Federal Germany was reconstituted in 1953.

We can now predict that “surprise change” in German monetary policy is coming, and statements reflecting that change are therefore likely. Recent months have seen extreme high euro rates against the USD and JPY, suggesting that “benign neglect” of an intrinsically overvalued euro, and a natural downward process for the euro, are now overdue. Behind the scenes, the equally-unrealistic EU Eastern project and Putin' Eurasian initiative are both likely to fade from the headlines due to massive domestic opposition to these outdated, unrealistic and uber-costly concepts.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

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