US-European Threat Perceptions Diverge

The trajectories of the monetary policy at the Federal Reserve and the European Central Bank are diverging.  It is the keystone of our anticipation of further euro weakness in the year ahead.  In addition to this monetary divergence, there is a geopolitical divergence that will be of growing significance. 

At the heart of the geopolitical divergence lies asymmetrical threat perceptions.  Simply, if crudely put, the US perceives a greater threat from Russia's actions than many in Europe.   It is not just Russia's activity in Ukraine, and Crimea, which it annexed, but also its ongoing harassment of its neighbors airspace and waters, and its occupation of parts of Georgia and Moldova.   The US also sees that China's state-directed economy gives it unfair competitive advantages that need to be checked. 

That Europe does not seem as threatened by Russia or China as the US is not new.  What is new is that both are going to come to a head of sorts in the first half of the new year.     The outcome will likely impact companies and industries.  

The sanctions on Russia, implemented into order to force it to fully implement the Minsk peace treaty with Ukraine were set to expire at the end of January.  European officials have agreed to extend them through July.  The unanimity of the decision should not be confused with the level of commitment.   

Indeed, some EU members want to re-engage the Russia.    Just like French President Hollande argued after the Paris attack that the security pact trumps the stability pact, so too does the reinvigorated war on ISIS overshadow Russia's activity on its borders.   

Recall that even after Russia's little war with Georgia in 2008, and its occupation of a province, both Germany and France agreed to sell advanced weapons and training systems to Russia.  They were only rescinded after a civilian aircraft was shot down in Ukrainian airspace, and after international pressure was brought to bear. 

It is likely that the debate will be re-opened in Q2 16.  The sanctions are likely to be diluted when the current six-month extension lapses.  The targets of the sanctions were Russian banks, energy firms, and arms producers.  There were curbs on access to international credit and technology transfers.  

The Financial Times alerts us (here and here) of another budding divergence.  This one involves China.  The decision to join China's Asian Infrastructure Investment Bank (AIIB) over the objections of the US may have been only the tip of the proverbial iceberg.  The new issue is whether China should be granted "market economy status" (MES) at the World Trade Organization.  After getting into the WTO in 2001, and being included in the next SDR basket, getting the MES designation is China's next major international goal.  It is significant because it would make it more difficult for other countries (like the US and Europe) to charge Chinese companies with dumping.  

Without MES status, the US and Europe can largely determine by themselves the "fair cost" of Chinese production for setting anti-dumping charges.  If China is granted MES, it will be more difficult to impose steep tariffs on Chinese goods.    That would leave several industries vulnerable to a deluge of Chinese goods.    Germany's Merkel, who is sympathetic to China's desire, recognizes the vulnerability of Europe's steel and solar industries.  

The US warns Europe that granting MES to China is tantamount to a unilateral disarmament of trade defenses.  Some European officials argue that the US exaggerates.  There are other trade remedies for MES countries, and anti-dumping charges brought by the EU have been limited in any event.   

US officials argue that China's statist economic model does not warrant MES.  China sees MES as an automatic designation after being in the WTO for fifteen years.  The key issue is whether Europe agrees with the Chinese interpretation.

The US does not want to take any action and is pressuring Europe not to either.  It wants China to challenge this before the WTO.    Under this course, China would have to bear the burden of proof that it meets the market economy criteria.  

If Germany is sympathetic, the UK is a vocal advocate.  The UK was also the first to break ranks to join AIIB, and once it did, many other European countries joined as well.   The UK was the first Western sovereign to issue a yuan-denominated bond.  The UK seeks to secure its role as the preeminent financial center.  Some other European countries seek Chinese investment in its 300 bln euro infrastructure project.  There may also be enticing commercial opportunities. 

Europe is divided, though.  Reports indicate that Italy is very much opposed.  Key industries, including steel, ceramics and textiles are lobbying against MES for China.  Many unions are also opposed.  The Economic Policy Institute argues that as many as 3.5 mln jobs in Europe are at risk if MES is granted.  While European producers who compete directly with Chinese producers, and their workers may be opposed, but those companies that use Chinese input may be supportive of granting MES. 

Reports suggest that the EC may make their recommendation as early as February to accept China's interpretation of the WTO and MES.  That would start a process that requires the 28 members and the European Parliament consent. 

US-European Threat Perceptions Diverge US-European Threat Perceptions Diverge Reviewed by Marc Chandler on December 29, 2015 Rating: 5
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