By Carsten Nickel
Since the onset of Europe's crisis, Angela Merkel's step-by-step approach to managing reform of the eurozone has attracted much criticism, and her government's resistance to a systemic solution to the crisis has clearly failed to calm markets. For now, no one with real political influence in Berlin is willing to consider any strategic "Plan B" that includes a Greek departure from the eurozone. But when it comes to Greece, Merkel's insistence on "looking no further ahead than the headlights allow us to see" might actually prove to be a blessing.
The risk is rising, but it's still premature to expect an imminent "Grexit" from the eurozone. Call it incrementalism or muddling through, but we might be set for many months of more of the same. It's simply too early to determine yet where Greece, Germany, and the eurozone are headed, in part because Merkel is more flexible and pragmatic than her government's seemingly relentless insistence on front-loaded austerity suggests.
If and when it becomes inevitable, the Germans will offer concessions to keep Greece in the club. As a measure of Merkel's flexibility, consider how many agenda items now under discussion appeared to have been ruled out months ago: Talk of a European growth agenda will launch at the Brussels summit in late May, and the Bundesbank has now hinted that it could accept a German inflation rate slightly higher than the eurozone average as part of a macroeconomic adjustment process. Once Greek elections are behind us, Germany might well offer concessions on the timing of the Greek bail-out program.
Berlin calculates that a combination of eleventh-hour German flexibility and rising Greek fear of the potentially catastrophic consequences of Euro exit will persuade Greek voters to back a government that will accept the central German demand: That European financial help will continue to depend on Greece's willingness to push forward with structural (and painful) reforms.
Think of it as a political trade-off in German politics: To win domestic support for further assistance to southern Europe, Merkel needs assurance from other governments that structural reforms will move forward, assuring German voters that future crises are much less likely. With that reassurance, there is room for Merkel to compromise, even on important details.
Making things easier, Merkel's support within Germany remains strong. Foreign press and the opposition have cast recent local election losses for Merkel's Christian Democrats as a protest against her management of the eurozone crisis. But a hugely popular regional prime minister and the rise of the Pirate Party had much more to do with these results than anything to do with the euro, and members of Merkel's party are still prepared to accept compromise as the outcome of European negotiations. She remains the most popular politician in Germany, and despite public outrage over Mediterranean profligacy, there is still no German majority calling for the Greeks to leave.
None of this can keep Greece in the eurozone forever. Greece's future will be decided by Greeks. But Germans don't believe that an imminent Greek exit is inevitable -- and neither should we.
Carsten Nickel is an analyst in Eurasia Group's Europe practice.
By Gemma Ferst
The lack of global leadership, what we at Eurasia Group call the G-Zero, has become a common refrain among international thinkers. But while others wring their hands, over in his Ak Orda (White Horde) palace in windswept Astana, Kazakhstan's President Nursultan Nazarbayev is planning to do something about it.
In February, he launched G-Global: a bid to hatch a new world order through the exchange of ideas. Styled as an "electronic Bretton Woods," G-Global will disseminate a plan for global reform in May. On hand to provide intellectual firepower is the Eurasian Economic Club, which, bringing together top economists from Tajikistan to Moldova, has already produced a draft.
The road to Utopia could be long, though. Although G-Global boasts 10,000 members from 28 countries, the vast majority (more than 40,000) of the posts on its forum emanate from a single doctoral candidate at Irkutsk State Technical University, formerly the Siberian Mining Institute. None of the 543 participants who signed up in the last month has so far weighed in, suggesting that global traction may still be a ways off.
Nazarbayev, a former metallurgist who has ruled his oil-rich country since Soviet times, has long been something of a blue-sky thinker. The absence of criticism from his citizenry, combined with plenty of petrodollars, has fed an apparently genuine belief that it is his destiny to solve more than just Kazakhstan's problems. Previous schemes include a new, as yet unrealized global currency dubbed the Akmetal and an annual Congress of World Religions in Astana. (Nazarbayev commissioned British architect Norman Foster to design the $58 million Palace of Peace and Reconciliation -- a pyramid housing an opera house in its basement -- just to host the event.) He also came up with the idea of a Eurasian Union, well before Putin took it up again last year.
Nazarbayev cares greatly about how outsiders perceive him. He spends huge sums on Western public relations campaigns and has taken on Tony Blair as an adviser. Indeed, at 71, he is hoping to establish his legacy as an international statesman, peace-builder, and possible Nobel Peace Prize winner.
What G-Global really shows us, though, is what happens when authoritarian states try to innovate. Billed as a platform for free-wheeling discussion, G-Global comes with a code of conduct that is both granular and draconian. Contributors are forbidden to "maliciously non-adhere to the rules of the Russian language," for example, and are instructed to exclude any "political content" from their posts -- a practice that would seem to put the kibosh on serious attempts at revamping global governance.
This same autocratic reflex will hamper Kazakhstan's bid to become one of the world's most competitive economies by 2015. Nazarbayev refers to innovation as a "gigantic leap of the Kazakhstani snow leopard into the future" and has ordered the country's state-owned firms to modernize. But these firms -- even the start-ups -- are ruled with a centralized iron fist. And the government's response to unrest, notably the deadly violence in Zhanaozen last December, is always to tighten the leash.
With G-Global, Nazarbayev wants to "radically widen the number of participants in seeking anti-crisis solutions for the world." But he won't countenance a similar widening of Kazakhstan's own political process (letting the opposition stand in elections would be a start), which is why this particular snow leopard won't be influencing global leaders any time soon.
Gemma Ferst is an analyst in Eurasia Group's Eurasia practice.
MIKHAIL METZEL/AFP/Getty Images
By Antonio Barroso
With the survival of "Merkozy" at stake, German Chancellor Angela Merkel has inserted herself into the French presidential election on behalf of her eurozone partner, President Nicolas Sarkozy. It's not just because a Francois Hollande victory would make finding a new pithy nickname for the German-French duopoly difficult (though it would be a challenge -- "Hollmerk?" "Merkande?") Or because it has become trendy for like-minded political figures to support each other in races across national boundaries within the EU.
Merkel views the preservation of her partnership with Sarkozy as an important element in the timely resolution of the eurozone crisis, despite their rocky start, numerous disagreements, and natural rivalry. The devil that Merkel now knows well, and has spent considerable capital cultivating, is preferable to the devil she doesn't know, and can only speculate about -- a socialist who, while pro-European, has bashed the financial sector, disparaged austerity, and promised to maintain social spending. There are too many uncertainties in a Hollande presidency for Merkel to sit idly by in Berlin as Sarkozy continues to trail significantly in the polls ahead of the April 22 first-round vote.
That's why Merkel has actively stumped for Sarkozy, tying German conservatism to its French counterpart. The alliance between the German and French leaders is not just a personal bond, forged through the crucible of the eurozone crisis. Merkel believes she now has a partner in Sarkozy who shares her beliefs about the currency bloc -- and will push those interests (which also happen to be Germany's interests) in Brussels. After all of the painstaking negotiations and one-on-one meetings, she's not about to start all over again.
Hollande's political party, his campaign statements, and the fragility of the eurozone have many observers worried that a Hollande presidency would put France -- and the eurozone -- into greater danger. Some view Merkel's visible and vocal support of Sarkozy as validation of this viewpoint. But there are a few reasons why a Merkel-Hollande partnership would not be the market-rattling, eurozone-damaging outcome that many predict.
As wary as Hollande might be about austerity, or about the German model, his ability to take the EU in his ideal policy direction is limited. Why? Because the markets are on Merkel's side. Hollande only has so much room to maneuver before the markets punish France with higher borrowing costs, which would in turn threaten the integrity of the eurozone's bailout fund and its continuing efforts to prevent contagion. The pro-European Hollande does not want to preside over a new ugly chapter in the eurozone crisis.
It's also important to distinguish between what is campaign fodder and how Hollande would govern. Yes, Hollande has criticized the fiscal pact that Sarkozy, along with 24 other European leaders, agreed to in order to harmonize budgetary policies in member nations. But when Sarkozy is making his ability to lead France during an economic crisis a central campaign issue, Hollande has to find a way to distinguish himself. Hollande also can't proclaim the virtues of austerity -- and what is inherently a conservative fiscal policy -- as the leader of France's socialist party. Under the pressure of governing one of the eurozone's two major players, Hollande's policies are unlikely to differ drastically from Sarkozy's.
So is Merkel expending too much energy to stump for her favored candidate? Not necessarily. Hollande's socialist leanings, his reluctance to alienate his core voters, and his lack of a personal relationship with Merkel all suggest that decision-making between the two powers, and the eurozone as a whole, would be slower with Hollande as president. These ingredients are also the makings of a difficult personal relationship between the two leaders. And if there is one thing that markets have taught the eurozone, it is that dawdling in decision-making can be nearly as painful as making the wrong decision. The importance of Merkel's ability to pick up the phone, call Paris, and hear a familiar voice on the other end of the line should not be discounted. She doesn't have the luxury of time to cultivate another ally in the Elysee Palace.
Antonio Barroso is an analyst in Eurasia Group's Europe practice.
Franck Prevel/Getty Images
On Friday night, I co-keynoted the annual NYSE dinner with my friend, Morgan Stanley economist and Yale lecturer Steve Roach. It was a convivial group of about 40 CEOs, big listed companies, mostly American and European. Even against backdrop of a failing merger with deutsche bourse, the event went very well. Steve arrived, a little late, and quite shaken. He had just participated in an Open Forum event, a program that runs parallel with the WEF at Davos. He knew there might be trouble when he saw all the police outside. There were about 150 anarchists demonstrating, organized around the high school auditorium (it seats 1,000), who immediately started chanting and yelling -- and rushed the stage towards the end of the event. Security hustled him out the back, downstairs, through the kitchen, and into the dark…where he sped off. You have to give Steve credit -- he rallied pretty well within his friendlier confines of the Hotel Belvedere. But this was a Davos first.
Later that night, I went to the Google party, where all eyes were on the dance floor. Google had installed a "green dance floor" that showed how many watts were being created by the thumping Davos troops. Two points on that. 1. It's not entirely clear to me that this was a group you want to be boogieing down in front of, and 2. That has to be the most farcical pseudo green display since Vice President Gore offset the emissions from his 20-room Nashville mansion. It was a fun party though.
The party also let me spend some time with Circle of Blue co-founder and director J. Carl Ganter, who leads an organization filled with some of the smartest folks on global water scarcity/impact that you'll find. I always try to link up with them for a few moments to pick their brain on a topic that stands to take on increasing importance in the years to come. That's the great thing about Davos: It's a reasonably good bet that pretty much anybody you bump into on an abstruse topic is one of the best in their field. There was a sizable Circle of Blue cohort in attendance, wearing little silver/blue pins on their blazers (the only ones I consistently noticed doing that other than the Japanese delegation), and they always seemed to be moving together in a coordinated clump. At the Google party, though, Ganter's shirt was completely soaked. Not exactly the display I expected from the water scarcity folk.
Saturday morning, I had a host of CEO meetings lined up back-to-back, with a table reserved at the "forum lounge" for the occasion. It was a week of productivity in 2 1/2 hours -- that's the single biggest draw that Davos consistently provides and the most important reason people come. The 30 minute meeting is the standard at Davos; an hour tends to be looked at with suspicion. But for the folks with too many handlers, that can mean 15+ meetings in a day, which seems pretty inhumane.
Saturday night was the big banquet. But my annual tradition is to grab a small group of friends that look at global politics…and head up the funicular to a cozy little restaurant overlooking the village. Rule #1: Casual dress. And rule #2: If you mention a book you've written or are writing, you do a shot. I love that rule. Many fell victim before we headed back down for the after party once the banquet was winding down. And in a strange twist of fate, getting stuck on the funicular had all the elements of a horror movie -- but without the grisly finish. It was a welcome opportunity to share a last quiet conversation before the bustle of the after party and a long trip home. Davos -- exhausting yet exhilarating as always.
By Ian Bremmer and David Gordon
2010 was a difficult year for Europe, and things won't get easier in 2011. The eurozone will remain intact, but there's a serious risk that the debt crisis will become increasingly unmanageable this year. As peripheral countries struggle to implement structural reforms, the politics of austerity will put additional public pressure on supporters of the EU project in core countries like Germany and France.
In recent weeks, the EU has done little to allay investors' fears about the solvency of both sovereigns and banking systems in a number of peripheral eurozone countries. Key questions on the nature and timing of future financial bailouts remain unanswered, and important potential remedies, like increasing the European Financial Stability Facility (EFSF) and introducing new eurozone bonds, have been taken off the table, at least for now.
At the moment, the core countries, led by Germany, are committed to the euro and the European integration project, even as they avoid efforts to find systemic solutions to the crisis. In Spain and Portugal, governments are moving to fast-track fiscal consolidation and structural reform in an effort to preempt market pressures. While markets remain skeptical, the hope in Brussels, Berlin, and Paris is that this is just the beginning of a sustained rebalancing that will help stabilize the eurozone. In this view, the European economic crisis is the catalyst needed to restore policy convergence within the eurozone and to enforce peripheral Europe's compliance with the "Lisbon agenda" of labor and product market reform. Yet the idea that the EU, the ECB, and national governments can rapidly remake fiscal patterns of peripheral Europe -- let alone their labor markets and regulatory regimes -- strains credulity. That's especially true given the weak economic forecast for these countries and their inability to undertake currency devaluations.
Ireland, Greece, Portugal, and Spain have all taken impressive first steps on the fiscal side, but policy sustainability remains an open question. Politicians in each of these governments will have a hard time enforcing cuts to wages and entitlements that erode their nations' standards of living. Structural reforms like privatization and trade union regulation will threaten well-organized groups, which will mobilize in opposition. The result will not be explicit rejection of these programs, let alone an exodus from the eurozone. Peripheral Europe is more likely to take a page from developing countries in how they manage relations with the International Monetary Fund and World Bank -- with a lot of fudging and passive opting out of important parts of their plans.
The political challenges facing reform in the periphery will make it more difficult for defenders of financial bailouts within core countries, and we're likely to see new political fissures on this issue, especially in Germany. This problem will heighten the sense of broader political conflict on the continent, increase policy coordination risk (especially between Berlin and Paris), and undermine market confidence in the EU's ability to sort out the crisis.
All of this leads to the real danger: that the eurozone countries big enough to matter in global finance -- namely, Spain and Italy -- will find it increasingly difficult to borrow at rates that are financially sustainable. If that happens, the chances of a systemic crisis will grow dramatically.
On Wednesday, we'll look at no. 3 on our list of Top Risks for 2011: the geopolitics of cybersecurity.
Ian Bremmer is president of Eurasia Group. David Gordon is the firm's head of research.
LUKE SHARRETT/AFP/Getty Images
By Ian Bremmer and David Gordon
For the first time since the end of World War II, no country or bloc of countries has the political and economic leverage to drive an international agenda. The United States will continue to be the only truly global power, but it increasingly lacks the resources and domestic political capital to act as primary provider of global public goods. There are no ready alternatives to U.S. leadership. Europe is preoccupied with a multi-year bid to save the eurozone. Japan has complex political and economic problems of its own, and rising powers like China and India -- are too focused on managing the next stage in their development to take on new international responsibilities. We're referring to this new era as G-Zero, because that phrase captures the lack of international leadership at the heart of so many emerging political and economic challenges.
For a moment following the financial crisis, the G-20 looked like a forum in which the most influential developed and developing states could coordinate effectively on credible solutions to transnational problems. With so many more players at the table, there appeared to be a broader agenda and less room for agreement than with the G7, but members shared an overriding interest in the stability of the international system, and G-20 leaders were willing to work in concert to stabilize the global economy.
Yet, G-20 cooperation in 2008 and 2009 proved a short-lived collective reaction to panic, safety in numbers in the face of imminent disaster. The first indication it wouldn't last came in Copenhagen a year ago, following a climate summit marked by such disunity that the outcome was worse than if no meeting had taken place. Climate proved a sufficiently low-grade priority in the middle of a hard-fought global economic recovery that the frictions were largely forgotten. That's less the case with last fall's IMF meeting in Washington and G-20 meeting in Seoul, which ended with warnings of a global currency war and of a return to the national economic barriers of the 1930s. During both summits, the economic strategies of the world's leading economies were set in opposition to one another.
Why the G-Zero and not the formation of blocs that allow countries to pool their influence to get things done? Because the default policy response to a breakdown in global economic governance is every man/nation for himself. As demonstrated even in a politically integrated Europe, without adherence to common rules, there's no such thing as collective economic security. In the G-Zero, domestic constituencies will become increasingly effective in pushing populist agendas on trade, currency, and fiscal policy.
As geopolitics takes on an increasingly geo-economic hue, all the G-20 pledges to "avoid the mistakes of the past" will not prevent the G-Zero from taking hold and sparking other forms of conflict.
Next week, we'll dive deeper into the eurozone crisis, which takes the no. 2 slot on our list of top risks for 2011.
Ian Bremmer is president of Eurasia Group. David Gordon is the firm's head of research.
PHILIPPE WOJAZER/AFP/Getty Images
By Preston Keat
There is a new optimism in the Eurozone, but it may be masking some serious risks.
In a moment of crisis this spring, representatives of the 16 Eurozone governments came together to take dramatic action. Greece faced imminent financial collapse. Spain, Portugal, and Italy looked to be next in line. The Eurozone committed substantial sums of money, markets stabilized, and disaster was averted. Yet, Europe can no longer ignore the reality that the days of slow but steady Eurozone "convergence" are finished -- possibly forever.
Gone are the days when traders could ignore big differences in Greek and German economic policies as they invest in the two countries' sovereign debt. Prospective Eurozone members from Eastern Europe were once treated with little differentiation, despite wide variation in the credibility and transparency of their policymaking. The rule was for lower costs of capital for current members and Eurozone hopefuls alike, regulatory and legal integration, and diminishing attention to differences in national-level economic policymaking.
In the new Europe, the consensus favors belt-tightening. Governments must spend less money, collect more revenue, and guard against inflation. If governments fall of the wagon, it is feared, Europe's single currency will again be in serious trouble.
THOMAS LOHNES/AFP/Getty Images
The 11 people arrested and accused of spying for Russia have titillated the tabloids and reminded Cold War veterans of the good old days. But they won't do much damage to U.S.-Russian relations. In fact, the two governments are getting along much better at the moment. There are three major reasons for this, and all of them have to do with the view from the Kremlin.
recently ailing economy is now feeling much better. The financial crisis
inflicted more damage on Russia
than on most other emerging markets, in part because of a steep drop in oil
prices. When Obama first proposed a "reset" in U.S.-Russian relations, Moscow was hemorrhaging
reserves, and Kremlin officials hadn't arrived at any clear idea on what to do
about it. Prime Minister Vladimir Putin was traveling the country assuring local workers
that complacent oligarchs, not state officials, were to blame for the
volatility, and that their government would ensure that all would again be
well. President Dmitry Medvedev and his more western-oriented advisors were
beginning to look like convenient scapegoats should the public become restive
and Putin run out of businessmen to punish.
Things have changed. The economy has picked up thanks to some skillful economic management and a rise in oil prices out of the danger zone.
is feeling much better about its neighborhood. The Orange Revolution is now a
distant memory. In 2004, a presidential election in Ukraine lifted the Putin-endorsed
Viktor Yanukovych over Viktor Yushchenko. But Ukrainian nationalists and
several Western governments charged fraud, and the race was re-run. Yushchenko
won the do-over, fueling suspicion and hostility in Moscow. But his leadership earned little
public confidence during his five-year tenure, and Ukraine's latest election elevated
Yanukovych, who has now taken his country's bid to join NATO off the table for the foreseeable future.
Alex Wong/Getty Images
By Dan Alamariu
Despite rising concerns over a Republican Senate filibuster, over the next month or so, the U.S. Congress will probably pass the most comprehensive financial regulatory reform overhaul since the aftermath of the Great Depression. Yet the proposed overhaul has drawn strong criticism-from the left and the right-for not doing enough to prevent the next crisis, whether in dealing with too-big-to-fail banks, oversight of "shadow banking" or by not providing solutions for dealing with Government Sponsored Entities like Fannie Mae and Freddie Mac. Market reaction to each step in the congressional process has only added to the skepticism. Bank stocks gained both when the reform bill cleared the Senate and when it was reported out of the House-Senate conference. That indicates that investors see reforms as "manageable" for the financial sector.
In the very short term, the markets and the bill's critics have a point: it could have been tougher. It won't be a replay of the Glass-Steagall Act that separated investment from commercial banking in 1933.
But these reactions miss a crucial point: The reforms currently debated in Congress represent only the opening salvo of a larger reform process that will take years to complete and whose outcome will be both unexpected and more stringent on financials than the currently debated legislation.
Despite its critics, the Dodd-Frank bill (assuming it clears the Senate) will limit some of the activities that helped trigger the crisis. Large systemically important banks will need to hold more capital. Consumer protections will go a long way toward addressing issues like mortgage lending. Derivatives rules will move a significant number of these products into clearinghouses, allowing for increased transparency. Add enhanced investor protections, reforms of credit rating agencies, and changes to corporate governance, and you have something more substantive than its critics appear to realize. These may not be the radical solutions that some prefer, but they will have a large long-term cumulative impact on the U.S. financial sector.
It's impossible to say, of course, whether these measures can head off the next meltdown. The new rules will also create new risks and new loopholes that will be exploited. That's always the case with regulatory reform. But the current package will nonetheless limit the scope of financial activities that banks undertake today, and there are just too many changes in the Dodd-Frank bill to conclude that the proposed reforms are a wash. Their impact will be staggered, as rules based on the legislation will come online over a two-year period, if not longer. But they will impose significant hurdles on large financial institutions, which may become less competitive relative to smaller institutions. It may not be the sudden change that critics prefer, but it could still lead to a welcome and gradual diminution of the too-big-to-fail risks over time.
Second, the current legislation is far from the last word. Congress will take up regulatory reform again next year, following the Financial Crisis Inquiry Commission (FCIC)'s report in December. Mandated by Congress last year, the FCIC is based on the Pecora Commission that investigated the causes of the Great Depression and provided the rationale for the landmark pieces of legislation of the Great Depression Era (the Glass Steagall Act, the Securities Act of 1933, and the Securities Exchange Act of 1934). The FCIC has kept a relatively low profile until now, but its findings will bring another round of legislation. It remains unclear what we can expect on the 2011 agenda; that will depend on the post-election balance of power within Congress, on the perceived impact of the current regulations, and, obviously, on the findings of the FCIC. But there will be another debate and more legislation.
Then there's the bigger picture. Regulatory reform following a crisis is often a matter of trial and error. New rules are written, and sometimes rewritten. More regulations are introduced as the economic picture changes and as new risks land on the policymakers' agenda. Congress was still passing new pieces of Depression-era reform as late as 1940.
Congress may no longer have an 11-year attention span, but the current round of reform marks the beginning of a process that will last several years. And Washington won't be the only source of change. The Basel capital accords, which set the thresholds for capital reserve requirements, liquidity, and leverage that financial institutions must hold, are also being negotiated. This complex multilateral process involving all the developed economies, will take years to implement, once the changes are agreed on, likely later this year or early next. Finally, the United States will need to harmonize its extensive regulatory reforms with other large jurisdictions, most notably the European Union, and further changes to the regulatory environment will be needed.
The complexity and time-span of this process guarantees that nobody can predict exactly how the United States and global architecture will look in three or four years. A surge of economic growth -- or another financial crisis -- might radically change the list of available options. One thing we can say for certain: The current debate is merely the "end of the beginning" for reform of the U.S. financial sector.
Dan Alamariu is an analyst in Eurasia Group's Comparative Analytics practice.
Win McNamee/Getty Images
By Nicholas Consonery
Over the weekend, while in Busan, Korea, U.S. Treasury Secretary Tim Geithner said Beijing should resume "reform of their exchange rate mechanism." This brief comment was just a hint at the deluge of pressure China will face from the U.S. over currency policy in coming months unless the Chinese leadership allows the RMB to start appreciating against the dollar. But these days, Beijing looks less and less willing to alter course.
The RMB has been fixed against the dollar since the beginning of the financial crisis in July 2008. A month ago, Beijing looked like it was on the cusp of revaluing the RMB and allowing more upward momentum against the dollar -- mostly to assuage tension over currency policy with the United States.
But the debt crisis in Europe is weakening support in the Chinese government for changes in currency policy because the value of the RMB has been anything but stagnant against the euro in recent weeks. As concerns about European fiscal solvency have stewed in the markets, the dollar has appreciated significantly against the euro and other major currencies - and dragged the RMB along with it. Since January of this year, the RMB has actually appreciated by 20 percent against the euro-upward momentum that has accelerated significantly since May when concerns about solvency in Greece and Portugal wreaked havoc on markets. On Friday, June 4, the RMB appreciated by 1.58 percent against the euro in just that one trading day.
This rapid upward movement in the RMB against the euro presents a major concern for the Chinese economy. Why? Because the euro zone is China's single biggest export market, accounting for 19.7 percent of Chinese exports in 2009. In recent weeks, top officials at China's commerce ministry have publicly called for continued support for export-focused industries (which would include the currency peg) as the crisis in Europe plays out. Believers in this argument are now pointing to May's decline in China's purchasing manufacturer's index, which measures industrial activity, as early proof that Europe's troubles are already bleeding over into Chinese growth. Meanwhile, Chinese exporters and the local governments that support them report weaker confidence in the prospects for euro value and for the broader European economy.
But other policymakers in Beijing seem more optimistic. Among those is Zhou Xiaochuan, the central bank governor, who argued alongside Secretary Geithner that the euro crisis' impact on the Chinese economy "should not be very great." This may be wishful thinking, predicated on the belief that European officials can use enough fiscal alchemy to convince forex traders that the euro isn't on a set course to parity with the dollar this year. At the same time, Zhou might be trying to signal his continued support for pressing forward with reform to the RMB exchange rate mechanism now, despite Europe's woes.
It will fall to the top leadership in the Chinese Communist Party structure -- probably President Hu and Premier Wen themselves -- to settle this debate and make the final decision about what to do with the RMB. But if history is any guide, Beijing is steadfastly opposed to any kind of "shock therapy" for the Chinese economy. And a 20 percent appreciation of the RMB against the euro in just five months seems shocking enough to delay any more upward movement in the value of the Chinese currency for now.
Count the books now on store shelves that "reconstruct the crimes" that triggered the global meltdown. Count the Goldman Sachs jokes on late night TV. Count the hours that C-Span will devote to congressional inquiries into what happened, why it happened, and who is ultimately to blame. Forensics is a necessary process if we're to learn from our mistakes.
But while many are focused on the rearview mirror, the road ahead is sure to be bumpy for free market capitalism. That's what my book is about. And though I wrote a bit about this trend in last week's back and forth with Tom Barnett, I want to make the case here for the conflict to come.
The global economic and financial turmoil of the past two years has shifted the world's balance of political and economic power like no event since the end of World War II. The financial crisis has hastened the transition from a G7 world, one in which key international decisions were taken almost entirely among leaders of the developed world, to a G20 model that makes room at the international bargaining table for representatives of developing countries that don't share Western assumptions about the proper role of government in an economy.
It's already been a tough year for the rich world. Greece has demonstrated that Europe's weakest links can push the euro zone to the brink. Japan's indebted and dysfunctional government is treading water. America's real unemployment rate, the number that includes part-time workers who can't get full-time work and those who have simply stopped looking, reached 17.1 percent in April.
As the West struggles to its feet, China is again off to the races with 11.9 percent first quarter growth. The world's second largest economy embraced capitalism a generation ago, but it has never accepted the centrality of a capitalism driven primarily by market forces. China's brand of capitalism is driven mainly by its government.
A few final words from me on Tom Barnett's thoughtful response to my book. Tom has argued that the state capitalist phenomenon is not as "unprecedented" as I think it is. He notes that "It's not like OPEC's national oil companies or China's state-owned/-dominated enterprises came out of nowhere -- they've been there all along." He's right about that, of course. OPEC was generating international headlines in the early 1970s. Sovereign wealth funds began appearing in the 1950s. China has had state-owned companies for decades.
In my opinion, the difference is not in the institutions but in their importance for international politics and the global economy. Until the end of the Cold War two decades ago, the isolation of the communist world imposed sharp limits on the global economy's production capacity, but economic trends within it had little negative impact west of the iron curtain. Today, we're wired together as never before.
The global economy will depend heavily on China for future growth for years to come. China's growth has been dependent on exports to its largest trading partners: the European Union, the United States, and Japan. Though China has rebounded strongly from the global slowdown, thanks mainly to a massive state-directed spending spree, the Western financial crisis threw millions of Chinese out of work for some time. Greece's vulnerability has threatened the cohesion of the entire eurozone.
And we now live in a world in which state-owned companies (which answer to political officials rather than shareholders) own more than three-quarters of the world's crude oil reserves. With strong economic growth among emerging markets, global demand for oil is on a sharp upward trajectory. That means that state capitalist oil and gas exporters have much more direct impact on our standards of living than at any time in the past. And multinational companies are competing with Chinese state-owned giants armed with political and material support from Beijing in parts of the world where Chinese companies have only recently begun to compete.
State capitalism isn't new, but it has never been so directly important for how the rest of us live. Throw in historic levels of market turbulence and long-term debt issues in America, Europe and Japan, and I think that we now find ourselves in an extraordinary transitional moment in the history of the global economy.
There are several fascinating elections due this year. Next month, we can look forward to Britain's most unpredictable outcome in 100 years. In Poland, former Prime Minister Jaroslaw Kaczynski has become a presidential candidate in hopes of succeeding his twin brother Lech, killed in a plane crash earlier this month. Japan's ruling DPJ faces a referendum on its first turbulent months in power with upper house elections this summer. In November, recession-weary Americans will go to the polls to elect a new congress.
With all that going on, you probably haven't thought much about next month's local elections in North Rhine-Westphalia, Germany's largest state. Eager to institutionalize a post-bailout era of greater fiscal discipline, the German government is preparing to push for a major revision of eurozone rules in the form of a new European Union treaty. The aim is to build momentum behind a drive for fiscal consolidation and greater powers to enforce rules across the currency union.
But it's hard to imagine that Chancellor Angela Merkel's government will get what it wants. Irreconcilable differences remain among key European states, and Germany doesn't have the political power it held a generation ago in the run-up to introduction of the euro. Today's union is much larger, and the perceived benefits of convergence are worth less. The contentious debate over a new treaty will unfold just as the battle is heating up to replace Jean-Claude Trichet as president of Europe's Central Bank.
The immediate concern is that Standard & Poor's lowered Greece's debt rating to junk on Tuesday and Portugal by two steps. The big longer-term worry for Europe is that politicians locked into tough deflationary programs (in Greece and beyond) will take the once-taboo step of pushing for debt restructuring. We're not talking about the break-up of the eurozone, no matter how much apocalyptic rhetoric we hear in days to come or how many pundits write articles this fall with titles like "Who killed Europe?" But the less dramatic risks for European fiscal policy are plenty serious.
That's where Germany's local elections come in. The balloting in North Rhine-Westphalia, home to more than 20 percent of Germany's citizens, will provide a real test of Angela Merkel's center-right government. A bad result would jeopardize Germany's shot at tax reform. More to the point, it would weaken the entire eurozone by undermining support for fiscal discipline at the heart of Europe.
A return of the German left, even a modest one, will generate much more expansionary policy than we saw during the grand coalition period between 2005 and 2009. That will create stronger institutional support for German labor demands, driving a rebalancing within the eurozone as German labor costs begin to rise. That will undermine European competitiveness at a delicate moment in the union's recovery from recession. Over the longer term, it's hard to imagine Europe's fiscal woes improving in that environment. That's why I believe strongly in the eurozone, but not in a strong eurozone.
Ian Bremmer is president of Eurasia Group and author of The End of the Free Market: Who Wins the War Between States and Corporations? (Portfolio, May 2010)
AXEL SCHMIDT/AFP/Getty Images
My conversation with colleague and friend Nouriel Roubini continues today on our political and economic expectations for key regions in the year ahead. Today, we talk about Europe.
Bremmer: We're seeing the return of political risk to the Eurozone in a big way, as the line between developed and developing states becomes a little less distinct. Member states' coordination on fiscal policy has been breaking down for awhile, but a sharp economic slowdown has made matters worse. Markets may be underestimating risks of default among the most vulnerable; EU support is something less than a sure thing. Even without a default, governments will respond to economic stagnation with spending meant to prop up vulnerable sectors. As in the United States and China, it's all about jobs, jobs, jobs, and jobs.
In fact, stubbornly high unemployment is an especially serious problem in Eastern Europe, where a host of elections in 2010 could heighten tension and stoke unrest. Upcoming elections in a number of key countries materially increase the likelihood of instability. Nervous policymakers and legislators will face the temptations of channeling the frustration and anger of the unemployed with protectionist, populist, even xenophobic policy plans. Ukraine, Hungary, and Latvia are especially vulnerable, but even Poland could hit some turbulence.
Another issue to worry about: If one of the big Western European banks active in Eastern Europe finds itself in trouble, rescue efforts could become a mess.
Roubini: The recovery of the Eurozone and the rest of the advanced economies in Europe will also be anemic and below trend for several reasons: Potential growth in the Eurozone (2 percent) is lower than in the United States (closer to 3 percent). Most Eurozone economies could not do much counter-cyclical fiscal stimulus as they started -- even before the crisis -- with large fiscal deficits, large stocks of public debt, and financial systems that are both too big to fail and too big to save, because the sovereign does not have the resources to bail them out in case of a systemic crisis. Indeed, sovereign risk is rising in the Eurozone -- currently in Greece and Ireland but soon enough in Spain and other periphery economies. The European Central Bank has followed a tighter monetary policy than the Fed and may exit from low rates and QE sooner, thus hampering the economic recovery. Financial institutions in Europe have not fully recognized the losses on their toxic assets and have large exposure to Central and Eastern Europe, where the economic and financial crisis are not yet over. Moreover, the strength of the euro is hampering the recovery of the Eurozone economies, and the Club Med economies have both a competitiveness and a public debt problem, as nominal wages rising faster than productivity have led to rising unit labor costs, real appreciation, and large external imbalances. Thus, even the viability of the European Monetary Union may be challenged over the next few years.
Ian Bremmer is president of Eurasia Group. Nouriel Roubini is a professor of economics at New York University's Stern School of Business and chairman of RGE Monitor.
DAMIEN MEYER/AFP/Getty Images
There's a lot of buzz about French President Sarkozy's speech last night, more than Obama's state of the union address. In part because we were sleeping, and in part because while Obama gives a better speech, Sarkozy is a more effective populist.
It's no particular trick to go after the bankers; it's almost sport this year, but folks don't really have their heart in it.
Not so the French president. He went after the bankers, the dollar, capitalism with righteous indignation. Obama goes through the motions, but he's still all about hope and the vision thing (after all, he may need to tack back in a few months). Sarkozy wants to channel all these angry people.
To be fair, Davos folks aren't all that angry. Something like two people applauded when Sarkozy said the world had to put morality back into capitalism. There were all sorts of reasons for that (lack of) reaction -- antipathy, profound skepticism, malaise, jetlag. But it wasn't a message that was going to rile the Davos folks. Having said that, unless you're Klaus Schwab (or, nowadays, Bill Clinton), most of these speeches are for the home team.
* * *
Just overhead the Davos quote of the hour. South African President Jacob Zuma: "We must respect the culture of others. Polygamy is my culture and i treat my wives completely equal." Call it a wives' tale. Incidentally, there's a very large South African delegation accompanying the South African president, but I've only seen men.
Ian Bremmer will be blogging from Davos this week sending reports and commentary from inside the World Economic Forum.
PIERRE VERDY/AFP/Getty Images
Decided against the Bill Clinton event last night -- primarily in the interests of sleep. Due apologies. He's scheduled at a Coca Cola reception tonight, so I'll probably catch him there.
I did spend some quality time with Andrew Ross Sorkin. We were typing away on dueling computers, both generally unaware of each other ... until I finished up and looked over to my left. Lovely fellow. Surprisingly unselfpossessed given the extraordinary success of his recent book, Too Big to Fail.
We don't know each other well, but I particularly wanted to discuss the book with him. In part because I'd been recommending it to friends who refuse to read anything on the financial crisis. But mostly because it's such a complicated story that he handles with remarkable balance and discipline.
Andrew said his view on writing the book was akin to Tarantino directing a movie -- he wants everyone coming away believing they've read a different story. Interesting, clever, probably not my take (I generally want everyone to "get me." Though I suspect my general urge to be liked is greater than Andrew's.)
From my perspective, the thing Andrew got truly on the money, as it were, was his sense of humanity around all the major bankers (I think the public sector folks got a bit of a rougher ride). In 30 years, presuming a conversion, I suspect I'd like Andrew to be my rabbi. Perhaps unsurprisingly, the subjects disagreed. I didn't discuss the book with Merrill Lynch's ex CEO, John Thain, but I know him well ... and thought quite well of the portrayal. Not John's view, says Andrew. Same on Lehman's Dick Fuld -- and his annoyance with the book I've already heard from Dick's old friends.
Maybe the better take on Too Big to Fail is that if everybody finds something to criticize, he's hit it just right. Nah, that's clearly not right either. Just read it.
By Ian Bremmer and David Gordon
Now for the red
herrings, the places and problems where
we think there is less risk than meets the eye.
In Iraq, elections in March will spark violence as foreign militants try to undermine the transition to Iraqi national sovereignty. A U.S. troop withdrawal beginning right after the elections will invite more violence. We could see a Sunni election boycott. But compared to what we've seen before, and what might have happened, the overall story is remarkably positive. For the markets, Iraq is suddenly an opportunity. The institutions are becoming legitimate (even with the unresolved Kurdish issue), the army is starting to work, and most importantly, political leaders from all communities are beginning to recognize the value of Iraq's tremendous natural resource base from which all can benefit if they make the compromises to maintain stability in the country. For all their basic governance problems, there's very little chance of Iraq actually becoming a failed state at this point -- a meaningful risk even a year ago. It's not a place we're ready to vacation in, but we're bullish on Iraq.
Iraq is also moving in a positive geopolitical direction. Ties with Turkey have grown particularly quickly -- not just in the Kurdish region in the north, but in Baghdad. That's one of the few positive stories for Ankara this year. Arab states in the region are still hesitant to build ties with Iraq as they wait for clarity on its next government. Maliki hasn't been a popular figure with neighboring gulf Arabs, but they recognize that Iraq's economic consolidation won't wait for another four years, and they'll start making political overtures to Baghdad if Maliki's mandate is extended. And if the Iraqi prime minister isn't returned (which is certainly plausible), we'll see a stream of head of state visits to place relations with a new leader on a more solid footing. So whatever the electoral outcome in March, we're likely to see Iraq on a faster path to integration with regional political and economic infrastructure next year. Meanwhile, Iran's role in Iraq has quietly receded. Iran's controversial presidential election and subsequent state violence did nothing to improve Tehran's influence among Iraq's Shia population, where Iraqi nationalism has been steadily growing.
The headlines for Iraq next year will undoubtedly be the timing/delays/pace of the US troop withdrawal. But the real story is going to be a moderate government, growing geopolitical influence, and the most exciting new investment opportunities the region has seen in a decade.
AHMAD AL-RUBAYE/AFP/Getty Images
By Ian Bremmer and David Gordon
On balance, 2010 is looking like a tougher year for President
Obama than 2009 proved to be. Going into the new year, he has succeeded in
and climate change down the road, but pulling off real policy success on
either still looks unlikely. Unemployment remains high as the country pulls
weakly out of recession and mid-term elections appear on the horizon. While
Obama's popularity may take a beating, the coming year will see considerably
less actual domestic policy risk in the United States than in 2009. But the
exception is in the process of financial regulatory reform. That's likely to be
a tougher issue than people expect.
The reform package that passed the House of Representatives is comprehensive, though it will be moderated in the Senate, where for the first time under Obama a serious bipartisan effort is being undertaken. Either way, substantial change is afoot -- more far-reaching than anything we've seen since the Great Depression. The result will be a structure put in place to monitor and address systemic risk, largely self-financed from the financial community, as well as changes on many other issues, ranging from derivatives regulation to the proper role of the Federal Reserve Bank.
Unlike cap and trade or immigration reform, there's a very high likelihood that comprehensive financial regulatory reform will pass. But with mid-term elections approaching, it's likely to turn populist and lose a considerable amount of its bipartisan flavor. Congress as a whole is likely to imitate what's already come to pass in the United Kingdom, where an unpopular Gordon Brown government is going after the financial sector to try to lift its poll numbers from the morass. Congress doesn't want to be tarred by Treasury Secretary Tim Geithner, bailouts, or billionaire bankers. The best way to avoid that fate is to include some visibly populist elements in the new legislation, especially on consumer protection and executive compensation. Members of Congress will look to score points by taking aim at the Fed, but actual policy change there is a step too far -- the administration will likely ensure that nothing in the ultimate bill will undermine the Fed's political independence.
But while Obama's economic team will be wary of populist measures, Democrats in Congress and the president's own political advisors will see such measures as a necessary piece of "mobilizing the base" before mid-term elections. Big banks are an easy target, especially in the context of high profits and a strong recovery for the financial markets, but a weak overall economic rebound. The legislation should pass by late spring.
Regulators will be given significant new discretionary powers, including some authority for breaking up institutions deemed a systemic risk. A key risk is that, depending on the political environment, the newly empowered regulators could use their capabilities to issue strict rulings that go well beyond what is specifically included in the legislation. Regulators will also likely issue proposals for revising capital requirements upward next year.
Another key risk to watch will be efforts to impose further fees
and taxes on the financial system. With the U.S. government running record
deficits in the wake of the financial crisis, trying to recoup these costs from
the financial services industry will be seen as a relatively low-cost political
option. Executive compensation is one likely possibility; taxes on carried
interest for hedge funds are another.
Both the Americans and Europeans are aware of the risk of driving the financial industry into the ground with too much (or too drastic) regulation or taxation. But as reform becomes an election-year domestic battleground, the need to serve political interests will be increasingly at odds with the need to create an efficient framework for regulatory reform.
Next up: Japan.
Ian Bremmer is president of Eurasia Group, and David Gordon is the firm's head of research.
JEWEL SAMAD/AFP/Getty Images
By Hani Sabra and Willis Sparks
For the past several years, it's been easy to tell these brothers apart. Within the United Arab Emirates, Abu Dhabi is the serious, sober, more responsible one. Dubai is the flashy, free-spending younger sibling, rolling its eyes at big brother's conservative ways. Until 2007, the Dubai brand was synonymous with opulence; it boasted the world's tallest skyscraper, its first seven-star hotel, ostentatious housing developments marketed to Hollywood stars. The word Dubai began turning up in rap songs.
But when Dubai World, the emirate's largest state-owned conglomerate, requested a "standstill" of subsidiary real estate company Nakheel's bondholders last week, perceptions of Dubai took a serious hit. The brand had already suffered this year after the global financial crisis rolled through, capsizing the local real estate market and halting the flow of credit. But media coverage of Dubai over the past week has been especially harsh, and the emirate hasn't taken the criticism well. London's Sunday Times was removed from UAE newsstands last weekend for an article (and accompanying graphic) entitled "How Dubai's dream sank in a sea of debt."
Since last Wednesday, the other media focus has been on Dubai's relations with Abu Dhabi. Despite the Western media's fascination with Dubai's showmanship, Abu Dhabi has always been the dominant emirate. It's the capital of the country, the largest of the emirates and controls nearly all the country's oil. Abu Dhabi's ruler, Sheik Zayed bin Sultan al Nahayan, is the UAE's founder. It has already provided billions in financial aid and will now probably step in with billions more.
The most pressing question for policymakers and investors is this: How much authority is Abu Dhabi buying with this next expected bailout? In the short term, its influence will be significant, but not overwhelming. Officially, each of the emirates will remain quasi-sovereign. But the UAE will now look more like a federation and less like a confederation, as Abu Dhabi centralizes more of the country's political and economic decision-making power. The al Nahayans have long had issue with Dubai's profligacy and its debt-fueled growth model. (Abu Dhabi has typically made longer-term, more conservative and sustainable investments.) And Dubai will now have to adopt a more conservative financial model. But socially, Dubai will remain the more liberal hub of the UAE. The country needs tourism and new investment. That means that Abu Dhabi needs Dubai to be Dubai -- not another Abu Dhabi.
Beyond the economic issues, Abu Dhabi sees an opportunity to limit rival Iran's influence within the Persian Gulf. Dubai helps Tehran evade international sanctions by offering Iran the banking services that others deny them. Iran invests billions of dollars there each year, and Iranian citizens and businesspeople escape tensions in Tehran by hopping a quick flight to Dubai. As Abu Dhabi establishes tighter control of UAE foreign policy as the price of its financial generosity, Iran will find it increasingly difficult to use Dubai as a trading hub.
Ultimately, the relationship between Dubai and Abu Dhabi is not nearly as simple as it's portrayed in international media. Once the immediate danger of default begins to ease, tensions between the two ruling families will rise. In months to come, there is sure to be a tug of war over who controls what. But tomorrow we're likely to see the two ruling families use the UAE National Day holiday to affirm their solidarity. Until the risk of default is officially a thing of the past, Dubai and its (now wealthier and more powerful) sibling will stand together for an uneasy family photo.
Hani Sabra and Willis Sparks are analysts at Eurasia Group.
KARIM SAHIB/AFP/Getty Images
By Ian Bremmer
Moisés Naím wisely warns us in his latest FP column that transnational problems are pressing just at a moment when multinational consensus on solutions has become nearly impossible to achieve. If 20 countries produce 85 percent of global GDP, 20 countries generate three-quarters of global greenhouse gasses, just 21 are directly concerned with nuclear non-proliferation, and 19 account for almost two-thirds of AIDS deaths, limiting negotiations over collective action to the smaller number of states needed for workable solutions makes good sense. But in today's geopolitical environment, 20 is still a very big number.
The ongoing economic meltdown has accelerated the inevitable transition from a G7 to a G20 world. Gone are the days when the United States, UK, France, Germany, Italy, Japan, and Canada could credibly claim global political and economic leadership. Today, no institution that excludes China, India, Russia, Brazil, and a few other emerging heavyweights can fully address the biggest international challenges.
But it's not simply that it's tougher to forge compromises with 20 negotiators at the table than with seven. It's that some of the new players have fundamental disagreements with the established powers on some very big questions -- like what role government should play in an economy. Agreements on managing transnational health crises, nuclear proliferation, regional security, or greenhouse gasses and global warming will involve complex policy solutions with direct impact on domestic economies.
Second, the new governments at the table are preoccupied with problems much closer to home-issues that can be addressed on a (relatively) more modest and manageable scale. China's political leadership, an increasingly indispensable player on several transnational problems, is far more concerned with domestic than with international challenges. Much of its foreign policy is intended to fuel the continuation of explosive domestic economic growth-and the millions of jobs it creates. Its rhetoric may be global, but its focus is more often regional. The governments of India, Russia, and Brazil are likewise intent on managing the impact of the global recession on their domestic economies and advancing their political interests within their immediate neighborhoods. That's why much of the forward movement on transnational issues will come from regional groupings like the European Union, the Gulf Cooperation Council (GCC), and the Association of Southeast Asian Nations (ASEAN).
Some respected observers of international politics have called for a G2, a meeting of US and Chinese minds for the ultimate in minilateralist institutions. There are many reasons why this won't happen anytime soon-if ever. The Chinese leadership may enjoy such talk, but its most seasoned policymakers know well that China cannot yet afford to shoulder such burdens. Nor are Washington and Beijing likely to agree on how to solve many of these problems. And to reduce international consensus to two countries is to ignore the growing importance of many others.
In other words, Moisés is correct that 20 is a much more manageable magic number than 200. But these 20 are unlikely to accomplish big things for the foreseeable future.
by Ian Bremmer
vulnerabilities of emerging markets to social upheaval and state failure as a
result of the financial crisis is probably the most significant risk the world
will face this year. That's why last week's G20 decision to
significantly expand funding for the International Monetary Fund was so
important -- and part of why the meeting itself was successful. This success is
especially obvious once we accept the limits of what this forum can really
accomplish. An urgent call for help was answered, but there was never any real
chance that leaders would use this meeting to remake the international
financial and economic order in a way that genuinely reflects the shift of
recent years in the global balance of political and economic power.
But the seeds have been planted for longer-term problems. Chinese President Hu Jintao said very little during the event but was given an enormous level of respect by the other G20 participants and the media. This reflects the reality that many are now ready to accept China as a superpower. For the near term, this change will prove useful, because China has the money to help fund existing international financial institutions shepherd vulnerable countries through their domestic economic problems. But longer-term, it may become a problem, because China isn't fully ready to play this role and because China's leaders have fundamental disagreements with the leaders of other powerful states on how the global economic system should be governed.
Looking ahead, the broader promise of a G20 remaking the international order for long-term sustainability remains unrealistic. Reimagining the architecture of any multinational effort -- not just of financial institutions but of the nuclear non-proliferation regime, the composition of the United Nations Security Council, efforts to stop the international flow of illegal drugs, agreement on a single definition of "terrorism," a successor to the Kyoto protocols that will have a meaningful impact on climate change, and other difficult issues. That's just not possible in today's geopolitical environment.
Jeff J Mitchell/Getty Images
The Call, from Ian Bremmer, uses cutting-edge political science to predict the political future -- and how it will shape the global economy.