Fiscal Policy | FX | Politics & Geopolitics
This is an edited transcript of our podcast episode with Wolfgang Münchau, co-founder and director of Eurointelligence. We discussed German politics, the mismanagement of COVID, the EU Recovery Fund and EU climate policy. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Wolfgang’s Background and Career Path
Bilal Hafeez (00:03:16):
So, welcome Wolfgang to our podcast, it’s great to have you on.
Wolfgang Münchau (00:03:50):
Hello Bilal, thank you for having me.
Bilal Hafeez (00:03:52):
Well, before we jump into the meat of conversation, I always like to ask our guests something about their background. Particularly, what did you study at university and why did you go into the field that you went into, and how did you end up where you are now?
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This is an edited transcript of our podcast episode with Wolfgang Münchau, co-founder and director of Eurointelligence. We discussed German politics, the mismanagement of COVID, the EU Recovery Fund and EU climate policy. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Wolfgang’s Background and Career Path
Bilal Hafeez (00:03:16):
So, welcome Wolfgang to our podcast, it’s great to have you on.
Wolfgang Münchau (00:03:50):
Hello Bilal, thank you for having me.
Bilal Hafeez (00:03:52):
Well, before we jump into the meat of conversation, I always like to ask our guests something about their background. Particularly, what did you study at university and why did you go into the field that you went into, and how did you end up where you are now?
Wolfgang Münchau (00:04:05):
What I started with had nothing to do with what I ended up doing. I studied mathematics and business studies at various times, but I did not become a mathematician. I decided to become a journalist, and started off at a local newspaper in Germany for a very short time.
Bilal Hafeez (00:04:21):
But that’s an unusual thing, isn’t it? To do maths and then go into journalism. What made you want to do that? That’s a bit of an interesting …
Wolfgang Münchau (00:04:27):
No, no. My classmates. Because I always wanted to become a journalist, but you don’t start studying it in a way. You just study something you like, and I liked those things. The business economics background gave me some serious applied knowledge, but my passion was always mathematics, still to this day. I’ve always kept up with this as an intellectual discipline, but journalism was something I did. It’s always a duality of my mind, I suspect. I was always attracted to journalism. I don’t think I was particularly talented at it, or I didn’t think I was, but I got into it, and I was in England. I went to England to go to journalism school, I got a job. I didn’t expect to get a job. I got a job and later ended up at The Times newspaper. I didn’t expect that to happen, and things went on from there. So basically, the journalism which was something I just wanted to do for a certain period of time, became what I did. That’s how often careers happen.
Bilal Hafeez (00:05:29):
And then you ended up at The Financial Times and that was your home for a long time.
Wolfgang Münchau (00:05:33):
Yes I did. I ended up there at ’95, and shortly afterwards, they asked me to participate in the launch of The FT Deutschland, a German paper of The FT at the time, and I was the editor of that paper at one point. Then I returned to the UK in 2003 to become a columnist at Financial Times, where I had a column I’d written for a very long time.
The Unpopularity of Germany’s Governing Party, the CDU and its New Leader Laschet
Bilal Hafeez (00:05:54):
Great. Okay. No, that’s good. And I’ve been reading your columns for a long, long time and you’re one of my go-to people for getting insights into Europe. And there’s a lot going on in Europe, both in headlines and beneath the headlines. I suppose, perhaps we can start with Germany. There’s a lot of news coming out of Germany. One big story has been the CDU leadership, confirmation of Laschet, and then also the rise of the Green Party. So, perhaps you can give us your high-level thoughts on the state of German leadership as we go into the elections later this year.
Wolfgang Münchau (00:06:25):
Yeah. At the moment, it’s the most unusual election campaign that I can remember, certainly since 1998. There are some parallels with the ’98 elections, when Kohl lost against Schröder. Some people draw comparisons to the 1969 election, when there was a genuine change of government. That was the end of a 20-year CDU regime. I don’t want to make predictions. Laschet has been an extraordinary weak candidate so far. He’s unpopular. The party is also quite unpopular at the time. There are a lot of CDU folks who think, “Well, Kohl was unpopular and it didn’t matter.” But the CDU was quite popular at the time. And others say, “The CDU wasn’t particularly popular under Merkel.” But she was popular. But Laschet is unpopular and his party’s unpopular, it’s a bad combination.
Laschet’s Support for the Coal Industry
Wolfgang Münchau (00:07:10):
I often call him the coal guy. At EuroIntelligence, what is my main activity right now, we have been looking at European energy policy consistently for a very long time, and we’ve talked about Laschet long before he became a chancellor candidate or a CDU chairman. I talked to him as the coal guy, and he was basically the politician most instrumental in prolonging Germany’s exit from the coal industry. There’s been a long debate, not just among politicians, but among civil society groups, companies, state governments etc. to get a mega coal compromise going and to manage the exit from this industry, and Laschet held against this because he has got a big coal mining area in his state, which is North Rhine-Westphalia. He’s often seen in steelworks and coal areas. His views of industrial policies are very much about machines and old industry.
So, for me, the main issue in this election is that we have a candidate in the CDU. If you just look at the CDU, you’ll see this yourself – you have Markus Söder, who is a very slick politician. He’s the prime minister of Bavaria and the chairman of the CSU, but he’s also, as a man who leads the government in Munich – that’s Germany’s most modern town; it’s the only high tech city of any significance that Germany has. His interest is in those industries: artificial intelligence, pharmaceutical research, some of the stuff that’s been going on. That’s is a very different perspective those two people had. Now, Laschet won this contest, this has been going on for a while.
Bilal Hafeez (00:08:59):
Why? Why has he done so well? He doesn’t seem very popular, he seems old fashioned. So, how did he get the nomination? The CDU had the problem with AKK before, so they’ve got some experience of picking the wrong horse, so why did this happen?
Wolfgang Münchau (00:09:15):
You would think they would pick the person most likely to win the election. That’s not how the CDU works. The CDU is all about jockeying. After 16 years of Merkel as chancellor and another four years of Merkel as CDU chairwoman, people are now jockeying for positions. It’s now a post-Merkel era. There are seats to be filled, and the state premiers, the regional chiefs, they all want to be heard. Laschet’s strength is he is a very efficient chairman, literally. He chairs meetings, he’s the guy who lets everybody in. Not being the youngest anymore, he’s least likely to be there for another 16 years. Any young person would rather have an old guy who retires in four years or five years or so rather than the young Söder who might just hang on for a long time.
The Popularity of Sister Party CSU’s Leader Söder and His New Economy Focus
Wolfgang Münchau (00:10:06):
The real opposition to Söder in the CDU is not because they think he can’t win elections; they are afraid of him precisely because they think he can. And if the CSU, which is the smaller partner, occupies the chancellery, there will be a power shift. And that’s how they think; they think in terms of power. Their argument about the elections is the usual political argument of, “Well, there’s another five months. Things will improve.” And in reality, they do. Things will change in five, four months. People are upset about the way Laschet managed this. This was pretty much a backroom stitch-up, the way he got the nomination, and many people got upset. But if his poll ratings were to recover, all that would be forgotten. But if they won’t, then there could be some interesting dynamics.
Wolfgang Münchau (00:10:53):
One of the things we’ve been writing in EuroIntelligence is been the prospect of a split between the CDU and the CSU. That’s not in the cards now – it’s not in the cards before the election. But there is a scenario in which Laschet does badly while Söder does relatively well in Bavaria, and that would be a scenario in which the CSU might be prompted to think it is better off as a national party, which it has never done before. There has been poll out there that suggested that the CSU under Söder would get more votes than the CDU under Laschet nationwide. Now, these are hypothetical polls. Once you do this, then you test the reality and the reality might be very different. I think the CSU would have taken that in as a piece of information rather than, “Oh yeah, let’s do this.” But they’ve taken an interesting step – they have started to open up its online membership to people outside Bavaria. That’s the first time that has happened. While nobody made a big fuss about it, they are testing the waters. That’s for sure.
The Possibility of a CDU and CSU Split
Bilal Hafeez (00:12:00):
And just on that, if they were, this is hypothetical of course, if they were to split, would that happen before the federal election, or would that happen afterwards as a reaction to a bad election outcome?
Wolfgang Münchau (00:12:10):
There are different scenarios. There is a state election in the state of Saxony-Anhalt in June. If the CDU completely destroys itself there, and there is a scenario where things might just come to head beforehand. June is about the last moment where it could happen. Then you have three months until the election campaign. There would be no legal impediments for the CSU because to become a separate party, you can do that any time. Because the CSU is already represented in the federal parliament, it doesn’t have to apply or do all the stuff that new parties have to do. So, that can be organized pretty quickly. It’s a very, very low probability scenario, so let’s not get ahead of ourselves here. Also, it’s not a thing that Söder, the Chairman, can decide by himself. There are lots of vested interests in the party and he needs to carry the party along. But if the sense in the party is that they would lose seats because of the poor performance of the candidate, then there may well be a groundswell of opinion in Bavaria that this is enough, and that if the CDU wants to run with a weak candidate, then it’s probably best to decouple from that. I expect that argument to be made.
Bilal Hafeez (00:13:36):
You mentioned that a poll, obviously just one poll that was conducted recently, showed more support for CSU over the current CDU. Why is the CSU more popular? Is it to do with Söder? Is it to do with Bavaria? What is it that makes the CSU more popular?
Wolfgang Münchau (00:13:53):
In German history, we’ve only had a CSU candidate two times and both of them lost the election. It’s hard to sell a Bavarian Catholic to the northern Protestant voters of Germany. But Söder is a Protestant and he is from northern Bavaria, which is a very different Bavaria than the southern part.
Bilal Hafeez (00:14:17):
Is this Protestant/Catholic divide important, these religious denominations?
Wolfgang Münchau (00:14:22):
It’s not so much the religion that is important, but rather the character. Söder isn’t your classic Bavarian, he doesn’t come across as your classic Bavarian character. He is obviously a man with a regional identity, but so is everybody else in Germany. Laschet has an identity, and Söder just has another one. But it’s not like there is this strange Bavarian. That isn’t the case with him. The reason he’s popular is because he’s very slick (I mean astonishing slick for a German politician) and because he represents a new era. He’s younger but he also speaks a different language. He’s much more direct in his language. He doesn’t use the classic political language of hedging your bets and saying nothing in a long speech. It’s very direct. People like the way he was steadfast during the coronavirus crisis. He supported Merkel throughout.
On the other hand, Laschet was all over the place. [He managed the COVID response of North Rhine-Westphalia as its Minister President]. He considered himself pragmatic. He closed down, then he opened up, and he’s basically been saying we have to run a pro-business course, and then he closed down again. Nobody really knew what he was. That’s part of his problem is that he hasn’t had a very consistent policy. You remember in the UK when in Year One Boris Johnson was pretty unpopular with his handling of the crisis because it wasn’t consistent. But it’s only until his policy became consistent, which really started at Christmas with the vaccination program, a lockdown plan that is medium-term, that is based on certain criteria with clear marks etc. We all know that May the 17th is when the next step is, and then something in June, and maybe in the summer.
So, there were clear markers that were laid out, which wasn’t the case in Germany, and certainly didn’t happen in North-Rhine-Westphalia. There was this faction around Merkel and Söder was part of that, who wanted a similarly strong, clearheaded approach, and Laschet was one of those who opposed it. So, that kind of explains his [un]popularity in part, but generally it is about character. He is a very different character. It’s what people like. I recently saw a discussion on German television where somebody said, “I don’t trust Söder because he’s not a guy I would like to go on holiday with. On the other hand, there’s nothing really nasty about Laschet. He’s a nice guy, but the [problem] is that people do not necessarily see him as a Chancellor, and he will have to persuade people that this is indeed the case.
At the moment, the polls, as we observed in our briefing this morning, are all over the place. They would show the CDU at 28% sometimes, 23% or 21% sometimes. We’re seeing massive fluctuations in some of the small parties, like the FTP or the SPD. The SPD is between 13 and 18%, and which is a super large fluctuation margin, which reflects a lot of the uncertainty at the moment. There’s a lot of voters shifting from one party to the other. Another point we wrote about this morning is the peculiarity of the German electoral system because people have two votes. They have a first vote in which people elect a constituency MP, and like in the UK, the person who comes first gets it. But the remainder are made up from lists, and the sum total of everything would reflect the proportional number of the votes.
So, the CSU is a party that pretty much gets all of its first candidates through and virtually all of its MPs are directly elected. But there are parties, smaller parties like the Greens for example, that have hardly any candidates directly elected, but all their MPs are from the lists. So, you could for example, find a situation where a voter votes CSU in the first vote, a Bavarian voter, and votes for the Greens in the second vote. That is basically a form of tactical voting. My reading of the polls is that this volatility and fluctuation is also across the polling organizations, which is more unusual. There’s always some fluctuation, but this is in a very different realm now, which reflects some of the tactical voting, and not only the extent of tactical voting, but also [underlying] shifts that are happening.
It’s all to play for. The Greens have come up with a very competent candidate. Annalena Baerbock was the co-leader. She had a terrific start to her campaign. She’s very focused on the issues, and the Greens appeal to urbanites. They are a modern party. Söder mischievously said that she is far more modern than Laschet, which is true, but it seems to me that Söder might vote for her too. So, you will find some odd coalitions coming up and not just the classic left/right, but it’s more like old/new. That’s much more important.
Why are Greens so Popular in Germany?
Bilal Hafeez (00:19:24):
And in terms of potential implications of the Greens being in government, what are some of important changes that could happen if they were to come into power?
Wolfgang Münchau (00:19:35):
That would depend on the format in which they would come into power. If they came in as a junior coalition partner to the CDU under a Laschet government, they would get junior partners, especially if they are almost as large as the other party. Say, if the CDU got in with 25% and they got in with 24% and that would just be enough for a government. In the situation like that, they would take the Finance Ministry. My guess is that they would take the Finance Ministry and their first priority would be to manage the fiscal budget differently. They can’t reform the German debt brake or fiscal stability rule, but they can manage it differently.
So, my reading of their policy is that they would favour a much more gradual exit from the fiscal deficit, the COVID-related deficit. So, we may see a whole decade of deficits. And the debt brake, while it assumes a zero-balance budget pretty much most of the time, there are ways around it as long as there is a majority in the Parliament. And most importantly, they would favour a reform of the EU Stability Pact. That’s a really big deal. I would think that if they also occupied the Foreign Ministry, there we would probably see a gradual but not a radical departure from the more mercantilist foreign policy. And German foreign policy is all about business. They never criticize China’s human rights violations, or whatever happens in Russia. Maybe there’s some background diplomacy. But the Nord Stream 2 gas pipeline, there’s a lot of vested business interest at stake here. And that’s what they do, whatever America and others might say.
The Greens have a very different set of priorities, and we would probably see not an immediate and radical shift, but a shift where human rights might take a somewhat marginally larger role than it does today. And in terms of the fiscal spending, that would be the result of the fiscal relaxation and that would go into investment programs, digital programs, environmental programs etc. But it’s interesting, the Greens are very big on digital investments. So, their appeal is not just “green”, that’s obviously part of it, they also appeal to a broader coalition of younger people who want to see investment. And Germany has hopelessly under-invested in digital.
Bilal Hafeez (00:22:03):
On the under investment side, I mean that’s common criticism of Germany. Is it true that there’s been structural under-investment and infrastructure’s going creaking in Germany in all domains?
Wolfgang Münchau (00:22:13):
I’ll give you an example. The various local health departments, when they communicate with each other they use the fax machine. The police are always complaining they don’t have computers. Yeah, the country is massive and when people visit Germany, they think their mobile phone has broken down, when in fact there are large areas of the country which has no coverage of mobile phones. The cities have, but many rural areas don’t.
Bilal Hafeez (00:22:41):
But how can the infrastructure be so poor when Germany has all these leading manufacturing companies? They’re world-class.
Wolfgang Münchau (00:22:46):
The manufacturing companies are connected of course. But if you’re making widgets in industrial regions, you don’t necessarily need a lot of computers to make them. Obviously you might need some specialist machines to do this, you might need robots. There is certainly some technology in there as well, but it is a hybrid between old and new. One shouldn’t imagine a German company being a hyper-digitalized concern. That is not the case. In companies you would find that people are using computers. If you go to shops, the use of phones for payment, of credit cards, of electronic means of payment, is not nearly as advanced there as it is in virtually every country in Europe. Germany has the worst mobile phone network in the whole of the EU and that includes countries that are significant poorer than Germany, because Germany has decided …
I do remember when they had these auctions, the 3G auctions in the early 2000s, when the government got a lot of money from the phone companies. It was a profit maximizing; the auctioneering was a profit maximizing project for the government. But they overlooked that because the companies got squeezed and they only invested in the most profitable parts of the network, so that they were willing to keep big parts of the country uncovered. And still today, there are government people who say, “We don’t need to have every farm connected.” The mentality where you wonder…
I would say the farms especially need to be connected. You really want everybody connected. You don’t want to start saying “only the big cities, only where it’s work.” When you talk about networks, you don’t want to think about value for money or efficiency. The whole idea of a network is that really everybody is connected. 5G should make that possible, make it easier because you get interconnectivity, so that would radically change the availability of networks, but they would still have to invest quite a bit.
So, the Greens would probably be the party of investment, that’s their main appeal. Even if you are not necessarily a person that voted Green last time – they got 10% or 11% last time and now they are polling at 24%, 25%. They didn’t double or triple their electorate, it’s not because people have become “greener”, but because the current generation of Greens appeals to a wider set of people, especially younger people, who would have probably voted for SPD or CDU last time.
The Fiscal Implications of Greens as Dominant Coalition Partner
Bilal Hafeez (00:25:27):
Yeah. And you mentioned this scenario where the Greens are junior partner, but let’s say they were to become the dominant partner. Then what’s the implication of that?
Wolfgang Münchau (00:25:37):
If they become the dominant partner in the CDU/CSU coalition, the main thing would be the Greens would then occupy the Chancellery, and then the CDU would then occupy the Finance Ministry. So, you might actually find a scenario where the Greens are the dominant partner, that they might actually do less, because while the Chancellery is obviously a very important part of the government, especially if a Chancellor is very skilful and knows how to use power. You will find that the CDU will probably be the fiscally conservative element of the government. The interesting constellation would be if the Greens and the SPD form a coalition, maybe either with the FDP or even the Left Party.
Now, take the example of a coalition of the Greens, the SPD and the Left Party. Now, the Greens would be the most conservative element. They are in favour of defence spending, they are in favour of America’s policy on Russia, they support America’s policy on China, which is obviously not something the Left Party would do. So, there would be plenty of conflict, but they all agree on investment, and they all agree on dismantling the Stability Pact and the debt brake.
So, you could see potentially a very significant fiscal expansion. There will still not be a majority for constitutional reform to get rid of the debt brake, but the German parliament can suspend it every single year. So, if you have the single majority and you declare some kind of a fiscal state of emergency, and you can do this. You could say the COVID crisis has been so fundamental that we need a much more gradual adjustment process. So, they could do this for four years and keep deficits of 3% or 4% going, while the CDU would ideally get rid of these deficits gradually within two or three years and just return to the zero or even a surplus. So, that would allow a significantly higher degree of fiscal expansion. This is not a scenario I expect to happen. This would be a party, a government of the very left, the three.
Wolfgang Münchau (00:27:39):
I would no longer classify the Greens as a party of the left. They’re kind of a cloud that spans various positions. They are conservative in some areas, or have positions that would be considered conservative, let’s put it this way. I don’t think German politics at the moment can actually be well-classified in terms of left and right. The SPD has moved very much to the centre, I fail to see the left in it. CDU with Angela Merkel has moved to the centre. That’s the reason it has lost a lot of its classic nationalist crowd, some of whom have now gone to the AfD, which is a party of the far right. Interestingly, they’re not doing well from all these troubles. They’re stuck at 9% to 10% in the polls. There’s not much momentum for them.
Why Far-right AfD has Performed Poorly Recently
Bilal Hafeez (00:28:21):
And why do you think that is?
Wolfgang Münchau (00:28:22):
They have been internally divided. One general rule is, (there are many general rules that apply all the time in politics) is that divided parties don’t do well in elections, and that is the case at the moment. They’re all far-right, and are trying to distinguish between far-right moderates and far-right extremists. It’s something I struggled with – they have a faction, they have people who have marched with neo-Nazis. They have people who are neo-Nazis in the party, and there is a big row in the leadership of whether these people should be expelled or not, and this row has overshadowed the entire debate they’ve had.
The Mismanagement of COVID and the Political Impact
Bilal Hafeez (00:29:01):
And on the lockdown side, Germany initially seemed to have managed COVID well, but as time has gone on it seems to have been mismanaged a bit further. One is why has there been mismanagement, and there seems to be a bit of a backlash, and there seems to be talk of corruption. Like contracts given to companies and things like that. What’s been the fallout from COVID on the political side?
Wolfgang Münchau (00:29:24):
It’s a challenge they massively underestimated. People always think of Germany as a very disciplined country and that’s probably true in areas that are well organized from the start, but the health system was not. The health system is very good. That’s a very good privately managed decentralized system, but it does not cope well with crisis. You not only have the corruption, but you even have people cheating on the vaccination. There were stories that some children had gotten vaccinated because they knew some doctors, and there were a lot of young people who got the vaccination because they found ways to manage the queue.
Some politicians said, “Oh, let’s be pragmatic.” All this stuff about pragmatism is about cheating, that’s another word. And obviously the more young people get vaccinated, the fewer old people get vaccinated. So, if you want to get herd immunity for the groups that are more vulnerable, then each young person that gets vaccinated is already a setback in your system. It’s the same as what happened in Italy, where they started off with the young people because they followed some other sort of ideal where the vaccination rate of old people was very low. They will take a very, very long time to get to the level of herd immunity the UK has achieved right now, because the UK has actually a lower rate of vaccinations for young people than both Italy and Germany.
In the UK, nobody under 40 at the moment is vaccinated, almost nobody except a few people who have been working for the NHS in that age group. But generally there is no way in the UK to get through the system. The system is so tightly managed and that is not the case here. And it has become very difficult for the central government to coordinate the work of the state governments. The federal government originally didn’t want to…they just introduced legislation to introduce some national controls. That has just happened and was just signed into law by the president, so they can order a lockdown when the infection rates exceed a certain threshold, which has been not done in many, many local areas. In that case, schools will have to close and people will have to stay at home over night, and various restrictions will apply.
Bilal Hafeez (00:31:24):
And who’s lost out politically from this, would you say? Has Merkel lost the popular … I guess she’s less significant now, I suppose, but have CDU lost out from this or?
Wolfgang Münchau (00:31:33):
Her personal popularity has not changed much. She’s still a very popular leader, but the CDU, yeah. Before the pandemic the CDU polled around 28%. Then, during the pandemic it got to 38%, 40%, because people found reassurance in a strong government and people trusted the CDU to deliver stability in a crisis. When people realized that that didn’t happen, their ratings actually fell back to now below 28%. So, the additional support the CDU received was very temporary. You can’t blame Laschet for the low poll ratings. The CDU was at that level before the crisis – it was on the secularly declining trend. I think whenever something happens, Germany has a very good first wave and everybody said, “What is it about Germany?” We have a good health system, but we don’t exactly know why some countries had a good first wave and some didn’t.
I know especially with economists, or economists-become-virologists, they draw these conclusions. You cannot know anything from this data. Even today, we can make very few big assumptions from the data about how the lockdown has worked. We know now, there is a now an accumulation of data now, after a year, that most of the infections occur in closed rooms rather than outdoors. Now, that seems to be a robust knowledge, but to say that the Swedish experiment either succeeded or failed, we don’t know. And people have strong views about it, because for reasons that have to do with their vanity, or their own position, or their belief whether people should trust experts or not. But the Swedish experiment is inconclusive, we have to say.
Bilal Hafeez (00:33:11):
And is there some political parties or individuals that have turned anti-lockdown on civil rights grounds, human rights grounds or something?
Wolfgang Münchau (00:33:20):
It’s basically on civil libertarian freedom grounds. It’s been a big campaign in Germany by libertarians who object to it in principle, or who make the case that it is not proportionate. So that where the lockdown has been devised, I think there is at the moment an attempt to prepare a case in front of the German constitutional court to test the law that has just been signed and implemented. And it’s quite possible that the constitutional court might either strike it down, or more likely might just limit the law. It might just say, “Okay, you can do that, but you need to demonstrate that the measures are effective.” And not all measures are effective. For example, the measure that the night curfew is the one identified as the campaigners as the most vulnerable item, so they think that they have a chance to overturn that one. I think they’re not doing themselves any favours. What I find amazing about the German debate, and it’s astonishing and it’s disturbing, is that the lockdown debate happens almost independently from the vaccination debate, and almost independently from the infections debate.
So, lockdown is almost like something that you decide, something whether it’s the right thing or the wrong thing, on ground of principle. You wouldn’t say, “Okay, we have to do it when the infections are rife, when people are in danger, and then we can relax the lockdown once we have reached certain immunity levels.” This is also the reason why there hasn’t been so much political pressure in the period from December to March when the vaccination levels were so low. Now they have picked up since, so I say the vaccination crisis is over. They’re now vaccinating at full speed. People are saying there may be some setbacks coming, but that’s hard to predict.
So, so far in April, things picked up strongly, after Easter, they picked up. So, there should be some degree of protection by the summer. Whether they can actually go on holiday – I mean they all think they will, they all think that holidays are…and there are also problems with the Indian virus, the Indian mutant of the virus is now becoming a problem. And it’s hard to say, in Germany, the infections are not as high as they are in France, and they are stagnating at a level of about 160, 170 infections per 100,000 of the population, compares to about 130 in the UK right now. But the UK had significantly higher numbers during its second wave. In the winter, when these numbers spiked to high levels, and the rate was much, much, much higher.
Bilal Hafeez (00:35:57):
But in Germany, are we seeing hospitals reaching capacity and ICU units full, and all those sorts of things?
Wolfgang Münchau (00:36:04):
We see a degree of local stress, but nothing like what you saw in the UK. The health system is on the whole coping, and there is no impact on non-COVID related things. So, the system works in full, it’s not like anyone gets their treatment postponed because of COVID. The German health system is a very, very well equipped and it’s a very good system. It’s a very expensive system, but it’s coping well under the stress. That’s not the problem. The problem is the actual management of the vaccination process. This is not something for which Germany is well equipped.
Does the EU Recovery Fund Signal a Common EU Fiscal Policy?
Bilal Hafeez (00:36:40):
Yeah. And now I just want to widen out the conversation to Europe, Europe’s response. This is something you’ve written lots about in your various reports at EuroIntelligence, but one thing is there was a lot of hype around the European Recovery Fund last year, and you’ve been emphasizing a lot about the difference between spending versus loan guarantees, number one. So, it would be good to get some of your thoughts around Recovery Fund. And then secondly, from my understanding there’s a potential German constitutional challenge on the Recovery Fund. So, if you could just address those two, and then we can go from there.
Wolfgang Münchau (00:37:12):
Yes, okay. The Recovery Fund was meant to be Europe’s big response. People, journalists in particular love big headlines, so they talked about this billion-euro fund. But you can’t add up loans and grants, they’re two different categories. In particular you can’t say it’s 5% or 6% of GDP. You can’t take a five-year program and then set it against a single year of GDP. That’s dishonest. If you actually look at the grants component, which is the fiscal component (grants is money that you get and you don’t have to repay) we come to a number of 0.3 to 0.4% of GDP per year for five years. There’s a loan component which is now the same amount, a bit more. So, if you included that, you would come to 0.7-0.8% of GDP for this period. But a loan is not a fiscal thing. I’m not saying it’s a useless thing, because it’s earmarked for investments. The austerity years during the Eurozone crisis has led to a drought in investment.
This is the reason why Germany, as we just talked about, invests little into digital infrastructure, because that’s how that surplus happened. The surplus didn’t happen because people were paying higher taxes, they stopped investing, and in countries like Italy, it’s pretty dramatic. So, they will get money to invest into digital infrastructure, into road infrastructure, into high-speed railway network, into hospitals, into schools – investments that were not done. That’s very useful, especially since these investments are accompanied by conditionality of structural reforms. Now, we have to see how that pans out, but in an ideal sense it could be a very useful structural reform.
But it’s not a fiscal stimulus, and I think one has to be very clear about that. A fiscal stimulus is what the US just did. $1.9 trillion in one year, it’s 10% or something like that of GDP. That’s a fiscal stimulus. Now, we didn’t do anything like in Europe. We don’t do fiscal stimulus in Europe, not much. We just did the least, we just give guarantees. And people always do that, they always mix up guarantees and actual spending.
Germany’s Constitutional Constraints on a EU Fiscal Policy
Bilal Hafeez (00:39:20):
What about the idea of Euro-denominated bonds, this will all somehow turbocharge a Euro-denominated bond market?
Wolfgang Münchau (00:39:27):
It would only turbocharge a European bonds market if this became perceptualized. So, if this recovery fund became the first of many. If the 2020 budget has the next recovery fund, just maybe under a different name. But the idea of a Euro-zone, or an EU-based lending and investment program funded by them – if this turned into a kernel of an EU fiscal year, it gets us to the German constitutional court, because the German constitutional court probably won’t block the recovery fund. They didn’t grant an injunction. They were asked to grant an injunction that they refused. The little they said about it is that certainly the parliaments have a right to do this. In principle if they want to help each other, then the court will not object to it, but the court will rule on this case. This case is in front of them, it will take a couple of years, and they will, as they always do, they don’t ever block things, but what they do is they lay down principles that bind the government.
The reason we don’t have a fiscal union in the EU – after 20 years of Eurozone crisis, we still don’t have a fiscal union – is not because the German constitutional court blocked anything, it never blocked anything. But it’s because the German constitutional court bound the hands of the German government in the negotiations. The German government can constitutionally legally not agree to a fiscal union. It is against the German constitution. The constitutional court has made it clear that this is not possible, and it will make it very clear in this next ruling – whatever legal grey zones we may have, it will turn them into black and white.
Bilal Hafeez (00:41:05):
What is it in the constitution specifically that prevents this?
Wolfgang Münchau (00:41:08):
The constitution has a strong definition of sovereignty, that sovereignty cannot be shared. This is not an exact definition. They have what is called the democracy principle, and it means that the sovereign right has to be lodged in a very clear place. So, a parliament cannot bind future parliaments. So, even though the parliament has total fiscal sovereignty and has been re-elected every four years, it cannot bind future parliaments – so it cannot accept lending, it cannot force another parliament to repay a loan that they have decided to erase. Say if a country were to default (say Italy were to default on a bond and Germany would in theory have to pay up for this), the idea that a fiscal decision is taken that has not been voted on by the German electorate. That’s basically one of the several things they object to.
The other thing which is objectionable is that the whole Recovery Fund is based on an article in the Lisbon treaty that guarantees, or that allows countries to help each other in an emergency – it was an emergency clause – now, if you look at the spending of the Recovery Fund, it’s green spending and digital spending and you’re asking, what has that got to do with the COVID emergency? So, basically this is a very normal spending program. It doesn’t look like an emergency program.
In fact, you could have argued a [conventional] fiscal stimulus. Now, that would have been an emergency program. That would have actually qualified, but this structural thing that they’re now doing, they could actually run into danger. They could run into legal trouble if the court believes or comes to the conclusion that an emergency program cannot be a five-year structural program, unless you make a very clear case that COVID destroyed these structures, which may be possible for the health sector. But the digital infrastructure was hardly destroyed by the virus, so the argument…
The EU’s been getting around, not being illegal. There were lawyers and they thought they were on very strong ground, certainly in European law, they’re on strong grounds. But they’ve always been exploiting grey zones. Even with Mario Draghi, it was an exploitation of grey zones. When he did whatever it took there wasn’t a legal ruling that said he could do that, it came later. The court later said that was a perfectly legal thing.
However, the European Court has also imposed conditions that weren’t there before. The Court was very clear about what was possible and what wasn’t possible. So, where we started with the monetary union 20 years ago, it was full of legal grey zones. There’s a lot more clarity now – what the central bank is allowed to do, what the governments are allowed to do etc. My reading of the situation is that the Recovery Fund is a perfectly legal type of instrument, provided you don’t extend it too far. But it cannot be turned into a fiscal union, and that will eventually create an existential conflict between German constitutional and EU political preferences. And I don’t think the German constitutional court will ever put itself into a position where it says no, but it will force the German government to take that position.
Bilal Hafeez (00:44:18):
So, all this talk of there’s a higher chance of a fiscal union now, you think that’s overstated?
Wolfgang Münchau (00:44:24):
I don’t see it. I don’t see it. That’s basically if you don’t understand the politics. Brussels thinks that, and from a Brussels perspective, they’ve found a way in this technical method they first used for this European Unemployment Fund, which they agreed a year earlier. No, it was actually also at the beginning of the crisis, but it preceded the recovery fund by a few months. And this was a reassurance fund for unemployment insurance systems. And they used this method of issuing joint bonds that are guaranteed by member states, but raised by the EU. And they thought, “Well, that method can now be extended to the Recovery Fund and can be extended to the next budget.” We can basically keep that rolling over. Now, they will certainly try; there will be a very significant attempt to do that, but I’m skeptical that it will become permanent.
The ECB’s Upcoming Roadmap
Bilal Hafeez (00:45:20):
And you mentioned the ECB. Just more for an open general question, but how do you think Lagarde’s doing, and also the ECB’s push towards green policies, is that viable or not? Or is that encroaching into territory that isn’t really Central Bank’s territory?
Wolfgang Münchau (00:45:35):
The Central Bank has to support the general policy of the government, or in this case, the European Commission. It’s part of what a central bank does. I’m a little bit surprised how often Lagarde talks about green policies in comparison with how little she talks about monetary policies. It’s not so much that I don’t think they should do this and there are issues in, for example, their bond purchase strategy, where one needs to look at the issues of market neutrality. There are serious issues that the ECB needs to address. But the main issue for the Central Bank for the next 10 years is really managing to get out of this crisis and managing to do this in a way that is both economically optimal and legally feasible.
Again, we will have legal issues about the PEP Program, the Pandemic Emergency Purchase Program, and the question is how fast will the ECB have to unwind its purchases. There are people on its Governing Council who will press for the purchase to be tapered, not only reduced in net accumulation but unwound and sold down to where it was before. That will be a big, big debate coming up, and the President [of the ECB] will have to play a leading role in that debate.
Now, we can’t judge her performance. When she became president, she mostly inherited a policy. Then came the crisis, then they did what they had to do, and there isn’t really a lot of stuff that happened in terms of creative stuff like had happened the previous time. Draghi had QE and LTRO and totally different monetary instruments were developed in that period. That hasn’t happened yet, other than the PEP Program, which is more of the same. The only original thing about it is that it didn’t have to observe all these various self-imposed rules because it was an emergency program. But in the long run, they will have to go back to those rules.
I don’t know what the strategy is going to be, so I see big conflicts ahead in the ECB and that will require, and I think the judgment will come in future years, that will require a very determined leadership, and it will require a Central Bank President who’s really got their eyes on the ball.
Will EU Climate Policy be Successful?
Bilal Hafeez (00:47:49):
And then more generally, when you look at the global picture, the EU seems to be at the vanguard of climate change policy. Is that fair, or is that more talk than action? How do you look at the climate policy of Europe?
Wolfgang Münchau (00:48:03):
The EU is very good at selling its policies, and it has a lot of people who will believe just about anything it says – a lot of gullible fan boys in its network. The EU, if you look at the climate change, they have this Green Deal, and they have a 30% investment spending target. But if you know about the taxonomy of this, there are three layers for classified investment projects. One category 0%, one is 40%, one is 100%. Now, that’s not only the EU, that’s a general internationally agreed rule.
But we’ll just take an example. If you have a coal mine that just invests in a veggie burger canteen or something, that investment would qualify for 40% because every investment you make gets rounded up to the next degree. So, a 1% green content gets rounded up to 40%, not 0%. That was also criticized by the European Court of Auditors – the technical term’s known as taxonomy, of how do you actually categorize these things properly? There is no way the EU was spending this 30% green. They make it green, but it’s not. They account for it green.
My other favourite example is the Junker Investment Fund, the 300 billion investment fund. If you actually look down at what happened, it’s hardly anything, because it was an exercise of reclassification. And the EU is very good at that, because very technically you can employ large numbers of people who can reclassify things pretty conveniently and you have a large PR department that can write fantastic press releases and media that report it verbatim. But in the end, the EU has technology of environmental science, but it’s still an open game. I still think that even the United States, which is behind the EU, could overtake the EU in terms of emissions cuts and of environmental technologies, simply because success in this business, as in other business, will ultimately depend on investment.
The EU is not doing well in high-tech and digital; it’s not doing well in artificial intelligence. So, a lot of the modern areas are weak. The EU is doing well in – it’s still in there with a chance on the environmental investment. And to this extent, the success of the Green party, which we talked about earlier, is perhaps quite important. If we revert to fiscal austerity and low investments, then we would fall behind in that area as well. It’s no accident that our fiscal rules coincided with the technological decline. I’m not saying that all investments should be state, but if the state basically thinks it needs to run a surplus, then that has a broader macroeconomic implication that’s generally not understood in the EU.
What the Biggest Risks to Europe Are
Bilal Hafeez (00:50:44):
Just to wrap up this conversation, I mean we could go on to other topics, but I want to conclude here somewhat. What’s some of the big risks that worry you about Germany, Europe?
Wolfgang Münchau (00:50:52):
What the Eurozone crisis has shown us is that the Eurozone is not sustainable. That doesn’t mean it will collapse, but it does mean that it is not a sustainable monetary union as constructed right now. If you’re taking what everybody says it should be, or wants it to be or does not want it to be – that can’t be. So, either the Germans and the Dutch and the Northerners will eventually accept the need of fiscal unions, for which they will need to change their domestic constitutions, or face down the constitution courts, or find some solution to the either real or self-imposed problems, or the South of Europe converges to the North in a way that I find hard to see, even with the Recovery Fund. That’s part of the Recovery Fund idea that you get conversions, and when you have conversions, all the imperfections that we have matter less.
So, you will need to create a fiscal union and I don’t see that happening and I don’t see it happening on the scale that’s needed. There’s always a press release that can tell you it’s a fiscal union, like there’s a press release that tells that the Recovery Fund is 750 billion. If you believe that, you’ll believe anything, but the reality is that it isn’t 750 billion. The reality is that the fiscal element of it is much less. It is, in fiscal terms, almost statistical noise, compared to the spending that you see in places like Japan, the United States, or China, or even the UK. So, the fiscal union is yet to happen, and without it I don’t think the Eurozone will be either successful or sustainable. I’m not saying it will end. Somebody will pull out. At the moment nobody has an incentive to pull out.
So, that is not necessarily the way this will go, but you may find that monetary unions may not have to collapse, they might just wither. At the time of the Eurozone Crisis, we talked a little about parallel currencies and now, you have cryptocurrencies. If in 30, 40 years, all of a sudden, a part of the economy goes onto a different transaction system and then the Eurozone might still exist, but it might not be what we think it is. And also, there are various scenarios in which it could not unravel necessarily, but become less important. So, that would be my main concern, and if we continue to fail investing and there’s a genuine decline, political instability, and growing rule of Russia and China, Europe democracy might be challenged in more countries than in Hungary. This is not just about the Eurozone, this has a much broader implication for the way of European life.
Wolfgang’s Productivity Hacks and Book Picks
Bilal Hafeez (00:53:15):
Okay, well on that somewhat morbid note, let’s move on to something a bit more lighter and more personal. A question I always ask my guests is how do you manage your information research flow? Because obviously you have to keep on top of things, there’s all sorts of sources from Twitter, to releases from governments, the EU commission, whatever. How do you keep on top of things? What’s your technique?
Wolfgang Münchau (00:53:36):
My team and I assemble a news briefing every morning, so we have to basically be on top of the news flow in Europe. And for that purpose, I obviously rely on Twitter as everybody else. I have a very focused Twitter feed, and that also changes all the time. It’s interesting, I’ve been fine tuning the sources and making sure that it becomes quite diverse. But it’s mostly continental European newspapers in various languages. We are monitoring papers from Germany, France, Italy, Spain, and even Finland and Austria in intervals. Twitter, hours is spent on filtering this information. There is an overflow for information. I’m a collector of stuff, so I’m putting things in my media, and in the end we’ll pick up something and then there are overflow things.
It’s like a completely disorganized database that you ultimately search through in some sort of way. But over the years you fine-tune a method and it becomes a workflow. I find that, in terms of information gathering, over the years we’ve been relying less and less on English language media over the years, especially for Europe. This may have something to do with Brexit, but it’s also about quality information. A lot of high-quality information, say from Italy, you don’t get in any of the English language publications. And also in Germany, most of the really important stuff you need to know, you often pick up from local newspapers. There’s not just one source, but there are a variety of sources. There’s a great strength in the variety of Europe, but there aren’t any European newspapers or European media, so we find an awful lot by picking and finding information from those areas. But it’s work, and quite a lot of people are on it, so it’s something that needs to be harbored and picked, information.
Bilal Hafeez (00:55:28):
And the last most personal question is, what book or books have influenced you the most, either personally or on the work front over the years?
Wolfgang Münchau (00:55:38):
Interestingly, given work, my focus has been in the Eurozone, one of would have thought that the books on economics or politics would have been probably [my pick]. That has not been the case. In fact, especially on economics, I’ve found there has been very little that has had an influence. What has influenced me far more is history books. I think the single book that influenced me most was Mommsen’s Magisterial History of the Weimar Republic, which I read as a young man, and which showed me how seemingly stable democracies can collapse, and it taught me to be skeptical about claims that we’re living in different times, that it can’t happen here. So, that was probably the most important thing, but there were many other books. The ones that I kept in my mind, like Margaret McDonald’s Europe 1919 book about the Versailles Treaty, that stuck in my mind. So, it was generally on the side of history and economic history that I found more interesting, and taught me more about what is happening right now than certainly on economics.
Bilal Hafeez (00:56:41):
Yeah. That makes sense. And then if listeners wanted to follow your work, what’s the best place they can follow your work, and read your work as well? How can they subscribe to it and so on?
Wolfgang Münchau (00:56:53):
Go to our website, it’s called www.eurointelligence. And there you can take a look at what we do. We also do a podcast once a week, you can listen in, where it’s a slightly different format from this one. I like this format here, but we do it more among ourselves, talk about free flow what we think just happened this week. My column is there for free, it’s not behind the paywall. The main offering is our daily news briefing, which is an in-depth analysis, where we don’t say what ought to happen, which is what I do in a column, but where we actually say what we think is going to happen. It’s not the same thing often. It’s a different flavor. It’s geared towards different interests – we have politicians, we have financial investors, and also academics. So, there are different models to different users.
Bilal Hafeez (00:57:47):
Yeah, so I’ll include a link on the show notes so people can easily access all of that, both with the newsletter, to your website, but also to the podcast as well. So, with that, just wanted to give you a big thank you. That was a very wide ranging discussion and it could have gone for much longer. And hopefully, I’ll have to have you back as well. Thank you very much.
Wolfgang Münchau (00:58:03):
You’re welcome. And it’s great, we didn’t even discuss Brexit.
Bilal Hafeez (00:58:05):
I know. Yeah, that’s great. I always enjoy not talking about Brexit.
Wolfgang Münchau (00:58:09):
I’ve not had that in a long time.
Bilal Hafeez (00:58:11):
Great. Thank you.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)