A new Ukraine was born a year ago in the pro-European protests that helped to drive President Viktor F. Yanukovych from power. And today, the spirit that inspired hundreds of thousands to gather in the Maidan, Kiev’s Independence Square, is stronger than ever, even as it is under direct military assault from Russian forces supporting separatists in eastern Ukraine.
The new Ukraine seeks to become the opposite of the old Ukraine, which was demoralized and riddled with corruption. The transformation has been a rare experiment in participatory democracy; a noble adventure of a people who have rallied to open their nation to modernity, democracy and Europe. And this is just the beginning.
This experiment is remarkable for finding expression not only in defending Ukraine’s territorial integrity from the separatists, but also in constructive work. Maidan’s supporters have moved from opposition to nation building.
Many of those in government and Parliament are volunteers who have given up well-paying jobs to serve their country. Natalie Jaresko, a former investment banker, now works for a few hundred dollars a month as the new finance minister. Volunteers are helping Ukraine’s one million internally displaced people as well as working as advisers to ministers and in local government.
The new Ukraine, however, faces a potent challenge from the old Ukraine. The old Ukraine is solidly entrenched in a state bureaucracy that has worked hand in hand with a business oligarchy. And the reformers are also up against the manifest hostility of Russia’s president, Vladimir V. Putin, who wants at all costs to destabilize Ukraine.
One drawback is that the new Ukraine is a well-kept secret, not just from the rest of the world but also from the Ukrainian public. Radical reforms have been hatched but not yet implemented.
It is instructive to compare Ukraine today with Georgia in 2004. When he became president that year, Mikheil Saakashvili immediately replaced the hated traffic police and removed the roadblocks used to extort bribes from drivers. The public recognized straight away that things had changed for the better.
Unfortunately, Ukraine has not yet found a similar demonstration project. Kiev’s police force is to be restructured, but if you need a driver’s license, you must still pay the same bribe as before.
Mr. Saakashvili was a revolutionary leader who first stamped out corruption but eventually turned it into a state monopoly. By contrast, Ukraine is a participatory democracy that does not rely on a single leader but on checks and balances. Democracies move slowly, but that may prove an advantage in the long run.
The big question is, will there be a long run? Although Russia is in a deepening financial crisis, Mr. Putin appears to have decided that he can destroy the new Ukraine before it can fully establish itself and before an economic downturn destroys his own popularity.
The Russian president is stepping up the military and financial pressure on Ukraine. Over the weekend, the city of Mariupol came under attack from forces that NATO said were backed by Russian troops, undermining the pretense that the separatists are acting on their own.
Ukraine will defend itself militarily, but it urgently needs financial assistance. The immediate need is for $15 billion. But to ensure Ukraine’s survival and encourage private investment, Western powers need to make a political commitment to provide additional sums, depending on the extent of the Russian assault and the success of Ukraine’s reforms.
The reformers, who want to avoid the leakages that were characteristic of the old Ukraine, have expressed their wish to be held accountable for all expenditures. They are passing extensive legislation but also want the International Monetary Fund to go on exercising oversight.
Unfortunately, just as democracies are slow to move, an association of democracies like the European Union is even slower. Mr. Putin is exploiting this.
It is not only the future of Ukraine that’s at stake, but that of the European Union itself. The loss of Ukraine would be an enormous blow; it would empower a Russian alternative to the European Union based on the rule of force rather than the rule of law. But if Europe delivered the financial assistance that Ukraine needs, Mr. Putin would eventually be forced to abandon his aggression. At the moment, he can argue that Russia’s economic troubles are caused by Western hostility, and the Russian public finds his argument convincing.
If, however, Europe is generous with its financial assistance, a stable and prosperous Ukraine will provide an example that makes clear that the blame for Russia’s financial troubles lies with Mr. Putin. The Russian public might then force him to emulate the new Ukraine. Europe’s reward would be a new Russia that has turned from a potent strategic threat into a potential strategic partner. Those are the stakes.
The sanctions imposed on Russia by the US and Europe for its interventions in Ukraine have worked much faster and inflicted much more damage on the Russian economy than anybody could have expected. The sanctions sought to deny Russian banks and companies access to the international capital markets. The increased damage is largely due to a sharp decline in the price of oil, without which the sanctions would have been much less effective. Russia needs oil prices to be around $100 a barrel in order to balance its budget. (It is now around $55 a barrel.) The combination of lower oil prices and sanctions has pushed Russia into a financial crisis that is by some measures already comparable to the one in 1998.
In 1998, Russia ended up running out of hard currency reserves and defaulting on its debt, causing turmoil in the global financial system. This time the ruble has dropped by more than 50 percent, inflation is accelerating, and interest rates have risen to levels that are pushing the Russian economy into recession. The big advantage Russia has today compared to 1998 is that it still has substantial foreign currency reserves. This has enabled the Russian Central Bank to engineer a 30 percent rebound in the ruble from its low point by spending about $100 billion and arranging a $24 billion swap line with the People’s Bank of China. But only about $200 billion of the remaining reserves are liquid and the crisis is still at an early stage.
In addition to continued capital flight, more than $120 billion of external debt is due for repayment in 2015. Although, in contrast to 1998, most of the Russian debt is in the private sector, it would not be surprising if, before it runs its course, this crisis ends up in a default by Russia. That would be more than what the US and European authorities bargained for. Coming on top of worldwide deflationary pressures that are particularly acute in the euro area and rising military conflicts such as the one with ISIS, a Russian default could cause considerable disruption in the global financial system, with the euro area being particularly vulnerable.
There is therefore an urgent need to reorient the current policies of the European Union toward Russia and Ukraine. I have been arguing for a two-pronged approach that balances the sanctions against Russia with assistance for Ukraine on a much larger scale. This rebalancing needs to be carried out in the first quarter of 2015 for reasons I shall try to explain.
Sanctions are a necessary evil. They are necessary because neither the EU nor the US is willing to risk war with Russia, and that leaves economic sanctions as the only way to resist Russian aggression. They are evil because they hurt not only the country on which they are imposed but also the countries that impose them. The harm has turned out to be much bigger than anybody anticipated. Russia is in the midst of a financial crisis, which is helping to turn the threat of deflation in the eurozone into a reality.
By contrast, all the consequences of helping Ukraine would be positive. By enabling Ukraine to defend itself, Europe would be indirectly also defending itself. Moreover, an injection of financial assistance to Ukraine would help stabilize its economy and indirectly also provide a much-needed stimulus to the European economy by encouraging exports and investment in Ukraine. Hopefully Russia’s troubles and Ukraine’s progress would persuade President Vladimir Putin to give up as a lost cause his attempts to destabilize Ukraine.
Unfortunately neither the European public nor the leadership seems to be moved by these considerations. Europe seems to be dangerously unaware of being indirectly under military attack from Russia and carries on business as usual. It treats Ukraine as just another country in need of financial assistance, and not even as one that is important to the stability of the euro, like Greece or Ireland.
According to prevailing perceptions, Ukraine is suffering from a more or less classical balance of payments crisis that morphed into a public debt and banking crisis. There are international financial institutions devoted to handling such crises but they are not well suited to deal with the political aspects of the Ukrainian situation. In order to help the Ukrainian economy, the European Union started preparing an Association Agreement with Ukraine in 2007 and completed it in 2012, when it had to deal with the Viktor Yanukovych government. The EU developed a detailed roadmap showing what steps the Ukrainian government had to take before it would extend assistance. Ukraine has undergone a revolutionary transformation since then. The roadmap ought to be adjusted accordingly, but the cumbersome bureaucratic processes of the European Commission do not allow for that.
Accordingly, Ukraine’s problems have been cast in conventional terms:
• Ukraine needs international assistance because it has experienced shocks that have produced a financial crisis. The shocks are transitory; once Ukraine recovers from the shocks it should be able to repay its creditors. This explains why the IMF was put in charge of providing financial assistance to Ukraine.
• Since Ukraine is not yet a member of the EU, European institutions (like the European Commission and the European Central Bank) played only a secondary part in providing assistance to it. The IMF welcomed the opportunity to avoid the complications associated with the supervision by a troika consisting of the EU, the European Central Bank, and the IMF that was used to deal with Greece and others. This new arrangement also explains why the IMF-led package was based on overly optimistic forecasts and why the IMF’s contribution of approximately $17 billion in cash to Ukraine is so much larger than the approximately $10 billion of various commitments associated with the EU, and even smaller amounts from the US.
• Since Ukraine has had a poor track record with previous IMF programs, the official lenders insisted that Ukraine should receive assistance only as a reward for clear evidence of deep structural reform, not as an inducement to undertake these reforms.
• From this conventional perspective, the successful resistance to the previous Yanokovych government on the Maidan and, later, the Russian annexation of Crimea and the establishment of separatist enclaves in eastern Ukraine are incidental. These events are seen as simply temporary external shocks.
This perspective needs to be altered. The birth of a new Ukraine and the Russian aggression are not merely temporary shocks but historic events. Instead of facing the remnants of a moribund Soviet Union, the European Union is confronted by a resurgent Russia that has turned from strategic partner into strategic rival. To replace communism, President Putin has developed a nationalist ideology based on ethnic grounds, social conservatism, and religious faith—the brotherhood of the Slavic race, homophobia, and holy Russia. He has cast what he calls Anglo-Saxon world domination as the enemy of Russia—and of the rest of the world. Putin has learned a lot from his war with President Mikheil Saakashvili’s Georgia in 2008. Russia won that war militarily but was less successful in its propaganda efforts. Putin has developed an entirely new strategy that relies heavily on using both special forces and propaganda.
Putin’s ambition to recreate a Russian empire has unintentionally helped bring into being a new Ukraine that is opposed to Russia and seeks to become the opposite of the old Ukraine with its endemic corruption and ineffective government. The new Ukraine is led by the cream of civil society: young people, many of whom studied abroad and refused to join either government or business on their return because they found both of them repugnant. Many of them found their place in academic institutions, think tanks, and nongovernmental organizations. A widespread volunteer movement, of unprecedented scope and power unseen in other countries, has helped Ukraine to stand strong against Russian aggression. Its members were willing to risk their lives on the Maidan for the sake of a better future and they are determined not to repeat the mistakes of the past, including the political infighting that undermined the Orange Revolution. A politically engaged civil society is the best assurance against a return of the old Ukraine: activists would return to the Maidan if the politicians engaged in the kind of petty squabbling and corruption that ruined the old Ukraine.
The reformists in the new Ukrainian government are advocating a radical “big bang” reform program that is intended to have a dramatic impact. This program aims to break the stranglehold of corruption by shrinking the bureaucracy while paying the remaining civil servants better and by breaking up Naftogaz, the gas monopoly that is the main source of corruption and budget deficits in Ukraine.
But the old Ukraine is far from dead. It dominates the civil service and the judiciary, and remains very present in the private (oligarchic and kleptocratic) sectors of the economy. Why should state employees work for practically no salary unless they can use their position as a license to extort bribes? And how can a business sector that was nurtured on corruption and kickbacks function without its sweeteners? These retrograde elements are locked in battle with the reformists.
The new government faces the difficult task of radically reducing the number of civil servants and increasing their pay. Advocates of radical reform claim that it would be both possible and desirable to shrink the ministries to a fraction of their current size, provided that the general population would not be subjected to severe cuts to their living standards. That would allow the discharged civil servants to find jobs in the private sector and the employees retained on the payroll to be paid higher salaries. Many obstacles to doing business would be removed, but that would require substantial financial and technical support from the EU. Without it, the “big bang” kind of radical reforms that Ukraine needs cannot succeed. Indeed, the prospect of failure may even prevent the government from proposing them.
The magnitude of European support and the reforming zeal of the new Ukraine are mutually self-reinforcing. Until now, the Europeans kept Ukraine on a short leash and the Arseniy Yatsenyuk government did not dare to embark on radical structural reforms. The former minister of the economy, Pavlo Sheremeta, a radical reformer, proposed reducing the size of his ministry from 1,200 to 300 but met such resistance from the bureaucracy that he resigned. No further attempts at administrative reform were made but the public is clamoring for it.
That is where the European authorities could play a decisive role. By offering financial and technical assistance commensurate with the magnitude of the reforms, they could exert influence on the Ukrainian government to embark on radical reforms and give them a chance to succeed. Unfortunately the European authorities are hampered by the budgetary rules that constrain the EU and its member states. That is why the bulk of international efforts have gone into sanctions against Russia, and financial assistance to Ukraine has been kept to a minimum.
In order to shift the emphasis to assisting Ukraine, the negotiations have to be moved from the bureaucratic to the political level. The European financial bureaucracies find it difficult to put together even the $15 billion that the IMF considers the absolute minimum. As it stands, the European Union could find only €2 billion in its Macro-Financial Assistance program, and individual member states are reluctant to contribute directly. This is what led Ukraine to pass on December 30 a stopgap budget for 2015 with unrealistic revenue projections and only modest reforms. This is an opening bid in the negotiations. The law allows for modifications until February 15, subject to their outcome.
European political leaders must tap into the large unused borrowing capacity of the EU itself and find other unorthodox sources to be able to offer Ukraine a larger financial package than the one currently contemplated. That would enable the Ukrainian government to embark on radical reform. I have identified several such sources, notably:
1. The Balance of Payments Assistance facility (used for Hungary and Romania) has unused funds of $47.5 billion and the European Financial Stability Mechanism (used for Portugal and Ireland) has about $15.8 billion of unused funds. Both mechanisms are currently limited to EU member states but could be used to support Ukraine by modifying their respective regulations by a qualified majority upon a proposal by the European Commission. Alternatively, the Commission could use and expand the Macro-Financial Assistance Facility, which has already been used in Ukraine. There is indeed a range of technical options and the European Commission President Jean-Claude Juncker should propose a way forward as soon as the Ukrainian government has presented a convincing set of priorities.
2. Larger matching funds from the European Union would enable the IMF to increase its lending to Ukraine by $13 billion and to convert the existing Stand-By Agreement into a longer-term Extended Fund Facility program. This would bring the total size of the IMF program to fifteen times Ukraine’s current IMF quota, an unusually large multiple but one that already has a precedent in the case of Ireland, for example.
3. European Investment Bank project bonds could yield €10 billion or more. These funds would be used to connect Ukraine to a unified European gas market and to break up Naftogaz, the Ukrainian gas monopoly. These changes would greatly improve Ukraine’s energy efficiency and produce very high returns on investment. It would help create a unified European gas market and reduce not only Ukraine’s but also Europe’s dependence on Russian gas. The breakup of Naftogaz is the centerpiece of Ukraine’s reform plans.
4. Long-term financing from the World Bank and the European Bank for Reconstruction and Development for restructuring the banking sector. This should yield about $5 billion. The 2009 Vienna Initiative for Eastern Europe, which proved to be highly successful in limiting capital flight and stabilizing the banking system, should be extended to Ukraine. The foundations for such an extension were already laid at the inaugural meeting of the Ukrainian Financial Forum in June 2014.
5. Restructuring Ukraine’s sovereign debt should free in excess of $4 billion scarce foreign exchange reserves. Ukraine has almost $8 billion in sovereign debt coming due in the private bond markets in the next three years. Instead of a default that would have disastrous consequences, Ukraine should negotiate with its bondholders (who happen to be relatively few) a voluntary, market-based exchange for new long-term debt instruments. In order to make the exchange successful, part of the new financial assistance should be used for credit enhancements for the new debt instruments. The foreign assistance needed for this purpose would depend on what bondholders require to participate in the exchange, but it could free at least twice as much foreign exchange over the next three years.
6. Ukraine must also deal with a $3 billion bond issued by the Russian government to Ukraine coming due in 2015. Russia may be willing to reschedule the payments by Ukraine on the bond voluntarily in order to earn favorable points for an eventual relaxation of the sanctions against it. Alternatively, the bond may be classified as government-to-government debt, restructured by the group of nations officially called the Paris Club, in order to insulate the rest of Ukrainian bonds from their cross-default provisions (which put the borrower in default if he fails to meet another obligation). The legal and technical details need to be elaborated.
Perhaps not all these sources could be mobilized in full but where there is a political will, there is a way. German Chancellor Angela Merkel, who has proved to be a true European leader with regard to Russia and Ukraine, holds the key. The additional sources of financing I have cited should be sufficient to produce a new financial package of $50 billion or more. Needless to say, the IMF would remain in charge of actual disbursements, so there would be no loss of control. But instead of scraping together the minimum, the official lenders would hold out the promise of the maximum. That would be a game-changer. Ukraine would embark on radical reforms and, instead of hovering on the edge of bankruptcy, it would turn into a land of promise that would attract private investment.
Europe needs to wake up and recognize that it is under attack from Russia. Assisting Ukraine should also be considered as a defense expenditure by the EU countries. Framed this way, the amounts currently contemplated shrink into insignificance. If the international authorities fail to come up with an impressive assistance program in response to an aggressive Ukrainian reform program, the new Ukraine will probably fail, Europe will be left on its own to defend itself against Russian aggression, and Europe will have abandoned the values and principles on which the European Union was founded. That would be an irreparable loss.
The sanctions on Russia ought to be maintained after they start expiring in April 2015 until President Putin stops destabilizing Ukraine and provides convincing evidence of his willingness to abide by the generally accepted rules of conduct. The financial crisis in Russia and the body bags from Ukraine have made President Putin politically vulnerable. The Ukrainian government has recently challenged him by renouncing its own obligations toward the separatist enclaves in eastern Ukraine, under the Minsk cease-fire agreement, on the grounds that Russia failed to abide by the agreement from its inception. After Ukraine’s challenge, Putin immediately caved in and imposed the cease-fire on the troops under his direct command. It can be expected that the troops will be withdrawn from Ukrainian territory and the cease-fire will be fully implemented in the near future. It would be a pity to allow the sanctions to expire prematurely when they are so close to success.
But it is essential that by April 2015 Ukraine should be engaged in a radical reform program that has a realistic chance of succeeding. Otherwise, President Putin could convincingly argue that Russia’s problems are due to the hostility of the Western powers. Even if he fell from power, an even more hardline leader like Igor Sechin or a nationalist demagogue would succeed him.
By contrast, if Europe rose to the challenge and helped Ukraine not only to defend itself but to become a land of promise, Putin could not blame Russia’s troubles on the Western powers. He would be clearly responsible and he would either have to change course or try to stay in power by brutal repression, cowing people into submission. If he fell from power, an economic and political reformer would be likely to succeed him. Either way, Putin’s Russia would cease to be a potent threat to Europe. Which alternative prevails will make all the difference not only to the future of Russia and its relationship with the European Union but also to the future of the European Union itself. By helping Ukraine, Europe may be able to recapture the values and principles on which the European Union was originally founded. That is why I am arguing so passionately that Europe needs to undergo a change of heart. The time to do it is right now. The Board of the IMF is scheduled to make its fateful decision on Ukraine on January 18.
Europe is facing a challenge from Russia to its very existence. Neither the European leaders nor their citizens are fully aware of this challenge or know how best to deal with it. I attribute this mainly to the fact that the European Union in general and the eurozone in particular lost their way after the financial crisis of 2008.
The fiscal rules that currently prevail in Europe have aroused a lot of popular resentment. Anti-Europe parties captured nearly 30 percent of the seats in the latest elections for the European Parliament but they had no realistic alternative to the EU to point to until recently. Now Russia is presenting an alternative that poses a fundamental challenge to the values and principles on which the European Union was originally founded. It is based on the use of force that manifests itself in repression at home and aggression abroad, as opposed to the rule of law. What is shocking is that Vladimir Putin’s Russia has proved to be in some ways superior to the European Union—more flexible and constantly springing surprises. That has given it a tactical advantage, at least in the near term.
Europe and the United States—each for its own reasons—are determined to avoid any direct military confrontation with Russia. Russia is taking advantage of their reluctance. Violating its treaty obligations, Russia has annexed Crimea and established separatist enclaves in eastern Ukraine. In August when the recently installed government in Kiev threatened to win the low level war in eastern Ukraine against separatist forces backed by Russia, President Putin invaded Ukraine with regular armed forces in violation of the Russian law that exempts conscripts from foreign service without their consent.
In seventy-two hours these forces destroyed several hundred of Ukraine’s armored vehicles, a substantial portion of its fighting force. According to General Wesley Clark, former NATO Supreme Allied Commander for Europe, the Russians used multiple launch rocket systems armed with cluster munitions and thermal-baric warheads (an even more inhumane weapon that ought to be outlawed) with devastating effect. * The local militia from the Ukrainian city of Dnepropetrovsk suffered the brunt of the losses because they were communicating by cell phones and could thus easily be located and targeted by the Russians. President Putin has, so far, abided by a cease-fire agreement he concluded with Ukrainian President Petro Poroshenko on September 5, but Putin retains the choice to continue the cease-fire as long as he finds it advantageous or to resume a full-scale assault.
In September, President Poroshenko visited Washington where he received an enthusiastic welcome from a joint session of Congress. He asked for “both lethal and nonlethal” defensive weapons in his speech. However, President Obama refused his request for Javelin hand-held missiles that could be used against advancing tanks. Poroshenko was given radar, but what use is it without missiles? European countries are equally reluctant to provide military assistance to Ukraine, fearing Russian retaliation. The Washington visit gave President Poroshenko a façade of support with little substance behind it.
Equally disturbing has been the determination of official international leaders to withhold new financial commitments to Ukraine until after the October 26 election there (which will take place just after this issue goes to press). This has led to an avoidable pressure on Ukrainian currency reserves and raised the specter of a full-blown financial crisis in the country.
There is now pressure from donors, whether in Europe or the US, to “bail in” the bondholders of Ukrainian sovereign debt, i.e., for bondholders to take losses on their investments as a pre-condition for further official assistance to Ukraine that would put more taxpayers’ money at risk. That would be an egregious error. The Ukrainian government strenuously opposes the proposal because it would put Ukraine into a technical default that would make it practically impossible for the private sector to refinance its debt. Bailing in private creditors would save very little money and it would make Ukraine entirely dependent on the official donors.
To complicate matters, Russia is simultaneously dangling carrots and wielding sticks. It is offering—but failing to sign—a deal for gas supplies that would take care of Ukraine’s needs for the winter. At the same time Russia is trying to prevent the delivery of gas that Ukraine secured from the European market through Slovakia. Similarly, Russia is negotiating for the Organization for Security and Cooperation in Europe to monitor the borders while continuing to attack Donetsk airport and the port city of Mariupol.
It is easy to foresee what lies ahead. Putin will await the results of the elections on October 26 and then offer Poroshenko the gas and other benefits he has been dangling on condition that he appoint a prime minister acceptable to Putin. That would exclude anybody associated with the victory of the forces that brought down the Viktor Yanukovych government by resisting it for months on the Maidan—Independence Square. I consider it highly unlikely that Poroshenko would accept such an offer. If he did, he would be disowned by the defenders of the Maidan; the resistance forces would then be revived.
Putin may then revert to the smaller victory that would still be within his reach: he could open by force a land route from Russia to Crimea and Transnistria before winter. Alternatively, he would simply sit back and await the economic and financial collapse of Ukraine. I suspect that he may be holding out the prospect of a grand bargain in which Russia would help the United States against ISIS—for instance by not supplying to Syria the S300 missiles it has promised, thus in effect preserving US air domination—and Russia would be allowed to have its way in the “near abroad,” as many of the nations adjoining Russia are called. What is worse, President Obama may accept such a deal.
That would be a tragic mistake, with far-reaching geopolitical consequences. Without underestimating the threat from ISIS, I would argue that preserving the independence of Ukraine should take precedence; without it, even the alliance against ISIS would fall apart. The collapse of Ukraine would be a tremendous loss for NATO, the European Union, and the United States. A victorious Russia would become much more influential within the EU and pose a potent threat to the Baltic states with their large ethnic Russian populations. Instead of supporting Ukraine, NATO would have to defend itself on its own soil. This would expose both the EU and the US to the danger they have been so eager to avoid: a direct military confrontation with Russia. The European Union would become even more divided and ungovernable. Why should the US and other NATO nations allow this to happen?
The argument that has prevailed in both Europe and the United States is that Putin is no Hitler; by giving him everything he can reasonably ask for, he can be prevented from resorting to further use of force. In the meantime, the sanctions against Russia—which include, for example, restrictions on business transactions, finance, and trade—will have their effect and in the long run Russia will have to retreat in order to earn some relief from them.
These are false hopes derived from a false argument with no factual evidence to support it. Putin has repeatedly resorted to force and he is liable to do so again unless he faces strong resistance. Even if it is possible that the hypothesis could turn out to be valid, it is extremely irresponsible not to prepare a Plan B.
There are two counterarguments that are less obvious but even more important. First, Western authorities have ignored the importance of what I call the “new Ukraine” that was born in the successful resistance on the Maidan. Many officials with a history of dealing with Ukraine have difficulty adjusting to the revolutionary change that has taken place there. The recently signed Association Agreement between the EU and Ukraine was originally negotiated with the Yanukovych government. This detailed road map now needs adjustment to a totally different situation. For instance, the road map calls for the gradual replacement and retraining of the judiciary over five years whereas the public is clamoring for immediate and radical renewal. As the new mayor of Kiev, Wladimir Klitschko, put it, “if you put fresh cucumbers into a barrel of pickles, they will soon turn into pickles.”
Contrary to some widely circulated accounts, the resistance on the Maidan was led by the cream of civil society: young people, many of whom had studied abroad and refused to join either government or business on their return because they found both of them repugnant. (Nationalists and anti-Semitic extremists made up only a minority of the anti-Yanukovych protesters.) They are the leaders of the new Ukraine and they are adamantly opposed to a return of the “old Ukraine,” with its endemic corruption and ineffective government.
The new Ukraine has to contend with Russian aggression, bureaucratic resistance both at home and abroad, and confusion in the general population. Surprisingly, it has the support of many oligarchs, President Poroshenko foremost among them, and the population at large. There are of course profound differences in history, language, and outlook between the eastern and western parts of the country, but Ukraine is more united and more European-minded than ever before. That unity, however, is extremely fragile.
The new Ukraine has remained largely unrecognized because it took time before it could make its influence felt. It had practically no security forces at its disposal when it was born. The security forces of the old Ukraine were actively engaged in suppressing the Maidan rebellion and they were disoriented this summer when they had to take orders from a government formed by the supporters of the rebellion. No wonder that the new government was at first unable to put up an effective resistance to the establishment of the separatist enclaves in eastern Ukraine. It is all the more remarkable that President Poroshenko was able, within a few months of his election, to mount an attack that threatened to reclaim those enclaves.
To appreciate the merits of the new Ukraine you need to have had some personal experience with it. I can speak from personal experience although I must also confess to a bias in its favor. I established a foundation in Ukraine in 1990 even before the country became independent. Its board and staff are composed entirely of Ukrainians and it has deep roots in civil society. I visited the country often, especially in the early years, but not between 2004 and early 2014, when I returned to witness the birth of the new Ukraine.
I was immediately impressed by the tremendous improvement in maturity and expertise during that time both in my foundation and in civil society at large. Currently, civic and political engagement is probably higher than anywhere else in Europe. People have proven their willingness to sacrifice their lives for their country. These are the hidden strengths of the new Ukraine that have been overlooked by the West.
The other deficiency of the current European attitude toward Ukraine is that it fails to recognize that the Russian attack on Ukraine is indirectly an attack on the European Union and its principles of governance. It ought to be evident that it is inappropriate for a country, or association of countries, at war to pursue a policy of fiscal austerity as the European Union continues to do. All available resources ought to be put to work in the war effort even if that involves running up budget deficits. The fragility of the new Ukraine makes the ambivalence of the West all the more perilous. Not only the survival of the new Ukraine but the future of NATO and the European Union itself is at risk. In the absence of unified resistance it is unrealistic to expect that Putin will stop pushing beyond Ukraine when the division of Europe and its domination by Russia is in sight.
Having identified some of the shortcomings of the current approach, I will try to spell out the course that Europe ought to follow. Sanctions against Russia are necessary but they are a necessary evil. They have a depressive effect not only on Russia but also on the European economies, including Germany. This aggravates the recessionary and deflationary forces that are already at work. By contrast, assisting Ukraine in defending itself against Russian aggression would have a stimulative effect not only on Ukraine but also on Europe. That is the principle that ought to guide European assistance to Ukraine.
Germany, as the main advocate of fiscal austerity, needs to understand the internal contradiction involved. Chancellor Angela Merkel has behaved as a true European with regard to the threat posed by Russia. She has been the foremost advocate of sanctions on Russia, and she has been more willing to defy German public opinion and business interests on this than on any other issue. Only after the Malaysian civilian airliner was shot down in July did German public opinion catch up with her. Yet on fiscal austerity she has recently reaffirmed her allegiance to the orthodoxy of the Bundesbank—probably in response to the electoral inroads made by the -Alternative for Germany, the anti-euro party. She does not seem to realize how inconsistent that is. She ought to be even more committed to helping Ukraine than to imposing sanctions on Russia.
The new Ukraine has the political will both to defend Europe against Russian aggression and to engage in radical structural reforms. To preserve and reinforce that will, Ukraine needs to receive adequate assistance from its supporters. Without it, the results will be disappointing and hope will turn into despair. Disenchantment already started to set in after Ukraine suffered a military defeat and did not receive the weapons it needs to defend itself.
It is high time for the members of the European Union to wake up and behave as countries indirectly at war. They are better off helping Ukraine to defend itself than having to fight for themselves. One way or another, the internal contradiction between being at war and remaining committed to fiscal austerity has to be eliminated. Where there is a will, there is a way.
Let me be specific. In its last progress report, issued in early September, the IMF estimated that in a worst-case scenario Ukraine would need additional support of $19 billion. Conditions have deteriorated further since then. After the Ukrainian elections the IMF will need to reassess its baseline forecast in consultation with the Ukrainian government. It should provide an immediate cash injection of at least $20 billion, with a promise of more when needed. Ukraine’s partners should provide additional financing conditional on implementation of the IMF-supported program, at their own risk, in line with standard practice.
The spending of borrowed funds is controlled by the agreement between the IMF and the Ukrainian government. Four billion dollars would go to make up the shortfall in Ukrainian payments to date; $2 billion would be assigned to repairing the coal mines in eastern Ukraine that remain under the control of the central government; and $2 billion would be earmarked for the purchase of additional gas for the winter. The rest would replenish the currency reserves of the central bank.
The new assistance package would include a debt exchange that would transform Ukraine’s hard currency Eurobond debt (which totals almost $18 billion) into long-term, less risky bonds. This would lighten Ukraine’s debt burden and bring down its risk premium. By participating in the exchange, bondholders would agree to accept a lower interest rate and wait longer to get their money back. The exchange would be voluntary and market-based so that it could not be mischaracterized as a default. Bondholders would participate willingly because the new long-term bonds would be guaranteed—but only partially—by the US or Europe, much as the US helped Latin America emerge from its debt crisis in the 1980s with so-called Brady bonds (named for US Treasury Secretary Nicholas Brady).
Such an exchange would have a few important benefits. One is that, over the next two or three critical years, the government could use considerably less of its scarce hard currency reserves to pay off bondholders. The money could be used for other urgent needs.
By trimming Ukraine debt payments in the next few years, the exchange would also reduce the chance of a sovereign default, discouraging capital flight and arresting the incipient run on the banks. This would make it easier to persuade owners of Ukraine’s banks (many of them foreign) to inject urgently needed new capital into them. The banks desperately need bigger capital cushions if Ukraine is to avoid a full-blown banking crisis, but shareholders know that a debt crisis could cause a banking crisis that wipes out their equity.
Finally, Ukraine would keep bondholders engaged rather than watch them cash out at 100 cents on the dollar as existing debt comes due in the few years. This would make it easier for Ukraine to reenter the international bond markets once the crisis has passed.
Under the current conditions it would be more practical and cost-efficient for the US and Europe not to use their own credit directly to guarantee part of Ukraine’s debt, but to employ intermediaries such as the European Bank for Reconstruction and Development or the World Bank and its subsidiaries.
The Ukrainian state-owned company Naftogaz is a black hole in the budget and a major source of corruption. Naftogaz currently sells gas to households for $47 per thousand cubic meters (TCM), for which it pays $380 per TCM. At present people cannot control the temperature in their apartments. A radical restructuring of Naftogaz’s entire system could reduce household consumption at least by half and totally eliminate Ukraine’s dependence on Russia for gas. That would involve charging households the market price for gas. The first step would be to install meters in apartments and the second to distribute a cash subsidy to needy households.
The will to make these reforms is strong both in the new management and in the incoming government but the task is extremely complicated (how do you define who is needy?) and the expertise is inadequate. The World Bank and its subsidiaries could sponsor a project development team that would bring together international and domestic experts to convert the existing political will into bankable projects. The initial cost would exceed $10 billion but it could be financed by project bonds issued by the European Investment Bank and it would produce very high returns.
It is also high time for the European Union to take a critical look at itself. There must be something wrong with the EU if Putin’s Russia can be so successful even in the short term. The bureaucracy of the EU no longer has a monopoly of power and it has little to be proud of. It should learn to be more united, flexible, and efficient. And Europeans themselves need to take a close look at the new Ukraine. That could help them recapture the original spirit that led to the creation of the European Union. The European Union would save itself by saving Ukraine.
* I am deeply disturbed by a report in the NY Times quoting the Human Rights Watch that subsequently – on October 2 and 5- Ukrainians also used cluster bombs, which I condemn. NATO should clarify both alleged Ukrainian and Russian use of such munitions.
Comments Off on Britain Needs Greater Unity Not a Messy Break-Up
This is the worst possible time for Britain to consider leaving the EU – or for Scotland to break with Britain.
The EU is an unfinished project of European states that have sacrificed part of their sovereignty to form an ever-closer union based on shared values and ideals. Those shared values are under attack on multiple fronts. Russia’s undeclared war against Ukraine is perhaps the most immediate example but it is by no means the only one. Resurgent nationalism and illiberal democracy are on the rise within Europe, at its borders and around the globe.
Since world war two the European powers, along with the US, have been the main supporters of the prevailing international order. Yet, in recent years, overwhelmed by the euro crisis, Europe has turned inward, diminishing its ability to play a forceful role in international affairs.
To make matters worse, the US has done the same, if for different reasons. Their preoccupation with domestic matters has created a vacuum that ambitious regional powers have sought to fill.
The resulting breakdown of international governance has given rise to a plethora of unresolved crises around the globe. The breakdown is most acute in the Middle East. The sudden emergence of the Islamic State in Iraq and the Levant, or Isis, provides the most gruesome example of how far it can go and how much human suffering it can cause.
With the Russian invasion of Ukraine, military conflict has spread to Europe. Two radically different forms of government are competing for ascendancy. The EU stands for principles of liberal democracy, international governance and the rule of law. In Russia, President Vladimir Putin maintains the outward appearance of democracy by exploiting a narrative of ethnic and religious nationalism to generate popular support for his corrupt, authoritarian regime.
As a major power and global financial centre, Britain ought to be centrally involved in crafting a European response to this threat. But like the US and the EU itself, Britain has also been distracted by internal matters. Conservative Prime Minister David Cameron has been persuaded by anti-European zeal – not least within his own party – to put UK membership in the EU to a vote in 2017. A poll on Scottish independence is only days away. Just when Britain should be confronting grave threats to its way of life, it is preoccupied with divorce of one type or another.
Divorce is always messy. A vote for Scottish independence would weaken – in political and economic terms – both a truncated UK and Scotland. An independent Scotland would be financially unstable, especially if threats to renege on debt repayments were carried through.
For Scotland and the rest of the UK to enter into a currency union without a political union, after the euro crisis has demonstrated all the pitfalls, would be a retrograde step that neither side should contemplate. Yet without it, an independent Scotland could not benefit from the low interest rates that a strong pound has brought. These considerations ought to outweigh whatever possible benefits independence might bring.
Yes, there are significant policy differences between Scotland and the rest of the UK. There is a more left-leaning approach to many issues, notably education, north of the border. But Scotland would be better placed to attain its political goals as part of a united Britain that is part of the EU.
The same applies to a British exit from Europe. Policy differences can be mediated. A divorce would weaken the UK. Those who call for separation seem to have forgotten that Britain currently enjoys the best of all possible worlds. Being part of the EU but not part of the euro allows the UK to enjoy the trading benefits without the currency constraints.
Furthermore, Britain has always played a balancing role between hostile blocs. Its absence would greatly diminish the weight of the EU in the world.
The EU has proved to be the best guarantor of peace and human security since the end of the second world war. The importance of preserving the shared values underpinning a whole way of life far outweigh any possible advantages of independence. The difficult times we are facing call for increased unity, not divorce.
Only if Britain fails to resolve its differences with the EU, and if the pro-European Scots (having voted to remain within the UK) thus find themselves unwillingly excluded from Europe in 2017, would there be just cause for Scots to call for a new referendum. If it comes to that, Scotland will be in a different position – one that could legitimise a split.
But to vote for independence from the UK now would be to prematurely surrender Scottish leverage in London, and Britain’s leverage in the world.
Continued discrimination against Roma in Europe not only violates human dignity, but is a major social problem crippling the development of eastern European countries with large Roma populations. Spain, which has been more successful in dealing with its Roma problem than other countries, can take the lead this month as it assumes the European Union presidency.
Up to 12 million Roma live in Europe today, primarily in the east. Despite the region’s overall economic growth over the past two decades, life for many Roma is worse now than ever. During the communist era, Roma received jobs and housing. But the heavy industries in which many were employed have now closed, and unemployment is widespread. Many Roma live in deplorable conditions unworthy of modern Europe.
These economic hardships are deepened by social tension. The majority population is very hostile towards Roma, and discrimination against them occurs at every level. For example, Roma children are often automatically put into classes for the mentally disabled, simply because they are Roma. Despite court rulings ordering reform, Roma are regularly denied equal access to housing, education, and healthcare, creating a vicious cycle of poverty and marginalisation. Reality and stereotype reinforce each other in a reflexive fashion.
The EU is slowly realising that it has a major social problem on its hands. Denied opportunities in the east, many Roma have moved to western Europe, fuelling a new wave of hostility. In Italy, the Berlusconi government’s treatment of Roma settlements – destroying homes and fingerprinting Roma based solely on their ethnicity – blatantly violated human rights. This prompted the EU to create the new position of fundamental rights commissioner, with confirmation hearings set to begin in January. In the meantime, violations continue.
On a positive note, the “Decade of Roma Inclusion”, established in 2005, is receiving strong support from the structural funds administered by the European commission and is making some inroads. Yet this is not enough to reverse a rising tide of violence and discrimination, compounded by the recent economic recession.
What is needed now is a comprehensive European strategy to address Roma issues across borders. This strategy must address both intolerable living conditions for Roma and the hostile stereotypes that prevail within majority populations, because they mutually reinforce each other.
This is not only a human rights issue, but an economic one. Following current demographic trends, by 2040, Roma will comprise roughly 40% of Hungary’s working-age population. Statistics are similar for neighbouring countries. Unless the Roma are well-educated and socially integrated – in stark contrast to the reality today – these countries’ economic future is bleak.
The key to success is the education of a new generation of Roma who do not seek to assimilate into the general population, but deliberately retain their identity as Roma. Educated, successful Roma will shatter the prevailing negative stereotypes by their very existence.
I speak with some authority on this subject. My foundation network has made the education of Roma a priority since its inception in Hungary in 1984, and across the rest of eastern Europe since 1989. These efforts have produced a small, well-educated Roma elite who are now making an important contribution to the emancipation of Roma. These leaders have blazed a trail for future advocates, but there are far too few of them.
In conjunction with the launch of the Decade of Roma Inclusion in 2005, my foundation network formed an alliance with the World Bank and transferred its Roma educational programmes to a newly established Roma Education Fund. Last year, the fund directly assisted 30,000 Roma children and 800 university students. It also provided invaluable support to member countries’ public education systems to strengthen Roma inclusion. The fund plans to double its activities in the next five years, but, again, this is not enough. Given the need, it ought to grow tenfold.
The scale of this challenge demands a comprehensive, institutional response from the EU that goes well beyond the “decade” and the capacity of my foundations. While the European Roma Platform launched last year paid lip service to Roma issues, it did not go far enough. Europe must develop a long-term strategy tied to programmes and monitoring mechanisms that will deliver real change on the ground.
Spain can be justly proud of the way it has dealt with its own Roma minority. I hope that the Spanish EU presidency will build on this experience to champion the launch of a comprehensive European Roma strategy. If Spain leads the way, all of Europe will ultimately reap the benefits.
As a speculator, George Soros is perhaps most famous for bringing the Bank of England to the brink of collapse in 1997, raking in over $1 billion in a single day. As a philanthropist, he’s indelibly associated with any number of political causes. But in his new book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means, Soros confesses he’s always “desperately wanted” to be taken seriously, not as an investment guru or as a political agitator, but as a philosopher. Soros recently spoke with Macleans.ca.
Q: You’ve come to some grim conclusions about the market in the book. For example, you write that the bottom of the housing market is still “further than people think.”
A: Behind the housing bubble, there’s a super bubble which has been growing for the last 25 years. Every bubble has an element of reality and an element of fantasy, of misinterpretation. The reality has been a trend of ever-increasing use of credit, of credit expansion. The misconception is that markets tend toward equilibrium and can be left to their own devices, to take care of their excesses. In the boom phase, it’s very pleasant because you enjoy credit creation and, with that, comes wealth creation. In the bust phase, it’s very unpleasant because you have credit contraction, a reduction of leverage, a decline in the value of collateral, etc. and that involves wealth destruction. I’m afraid that I am a prophet of doom. I don’t like it and I don’t think I’m predicting anything unconditional because I think that how the situation will evolve depends on how the authorities respond to it. But, unfortunately, we are in that phase of the super bubble.
Q: You raise an interesting paradox in the book’s introduction: When interest rates were really low, banks were eager to lend people money. But at the same time, they were repeatedly repackaging those loans to avoid the risks that come with lending people money.
A: They thought they were reducing the risk by packaging it and slicing it. In actual fact, by transferring it from people who were familiar with the risks to people who were not familiar with them, they were actually increasing the risks.
Q: Were the financial institutions playing a shell game?
A: Well, I think a lot of it was self-deception. There was a certain amount of deliberate exploitation, but most of it was self-deception, a false interpretation of reality, a misconception. But it’s a convenient misconception, because leaving markets to take care of their own excesses is very convenient for people in control of the financial institutions.
Q: Can you give me a sense of what those misconceptions were?
A: The main misconception was what I call market fundamentalism, [the idea] that markets are perfect. Or, at least, that they are better than regulators and therefore we should leave it to markets and we should deregulate.
Q: You argue that freedom of thought doesn’t mitigate the misconception problem—that is, that an open society can’t produce a perfect market. Does it actually do the opposite?
A: It’s a somewhat different issue. I discovered a misconception in my own ideal of open society, which I kind of took over from Karl Popper. We all took it for granted that the purpose of critical thinking is to improve our understanding of reality. That’s the cognitive function. Then there’s this manipulative function, which is to change reality to meet your own desires, to influence people in a way that they’ll follow you. Politics is dominated by the manipulative function. You can’t take it for granted that critical thinking will give you a better understanding of reality. What you took for granted, you have to introduce as a requirement. I’m not abandoning open society at all; I’m just taking another step in what is necessary to bring about a well-functioning open society. America, because of the adversarial, competitive nature of the political and economic system has really lost sight of the importance of understanding reality. The proof of it is Karl Rove and the Bush machine, which was fabulously successful in manipulating people, spinning the events, as manifested by the fact that Bush got 90 per cent popularity when he declared war on terror and could take the country to invade Iraq under false pretenses. It achieved the exact opposite of what he hoped to achieve. He wanted to demonstrate American supremacy and America’s influence in the world has suffered a terrible blow. He thought that he would make his brand politically dominant and his name is dirt. It shows how important it is to recognize reality and not distort it.
Q: According to your book, “We are in the midst of a financial crisis the likes of which we haven’t seen since the Great Depression” and that “the entire financial system is on the brink of a breakdown.” Can you give me an idea of what that’s going to feel like?
A: I actually think the acute phase is behind us. We had a pretty serious breakdown. The very core of the system was malfunctioning, and it’s still sputtering pretty badly. But the full effect of the damage is yet to be felt, both for the financial institutions and for the real economy. As far as the financial institutions are concerned, they’ve recognized a lot of losses. But they perhaps haven’t fully recognized all the losses they may incur from holding mortgages if the decline in housing prices hasn’t run its course, which I believe is the case. We are probably halfway in the decline and that decline is going to be quite steep—steeper than currently anticipated because housing prices are going to overshoot on the downside as they overshot on the upside. How far they overshoot depends on how the authorities react to the problem, because what causes the overshoot is foreclosures. It unbalances the supply. In my estimation, there could be something like two million foreclosures in the foreseeable future, half of it from subprime sector and half of it from option adjustable rate mortgages. So you need to take steps to try to reduce the number of defaults and the number of foreclosures. It’s possible to do something about it.
Q: There’s very little discussion about widespread reform of the credit sector. Instead, the authorities seem more inclined to argue about whether or not there’s a recession looming. Is the recession argument a red herring? Is it diverting attention from a more fundamental crisis?
A: No, it’s not a red herring. For the moment, the economy is actually showing considerable resilience and people think the worst is over. I’m afraid that that is not the case; we are heading for a recession, but we are not there yet.
Q: Credit expansion seems to have been an outgrowth of the American dream: it was supposed to mean everyone would be able to afford a big house, a gas-guzzling car, a luxurious vacation. Does the end of credit expansion mean the end of the American dream?
A: Well, hopefully not. I think America has been a country of great opportunity and a great ability to learn. I’m very hopeful that Barack Obamawill be able to provide that leadership.
Q: Did income inequality play any role in credit expansion?
A: It was a side effect of allowing markets a free-hand. I suppose I should say it was a side effect of market fundamentalism.
Q: What I mean is whether credit expansion was intended as a mechanism to offset the disparity in income?
A: The idea was that subprime mortgages, etc. would increase house ownership and so on. It’s the people who bought into it who are the worst affected by the bubble. Prince George’s County in Maryland—it’s sort of the yuppie black community—is the worst affected. They bought into the ownership idea and the first object was a house. They don’t have other assets, so they don’t have anything to fall back on.
Q: How can Obama guide the U.S. through the crisis?
A: He can provide leadership, I hope.
Q: Is this a partisan issue?
A: No, no, I don’t think so. I mean, it is in a way, because market fundamentalism is associated with the Republican party. It has deeper roots than Bush. The super bubble was really launched by Reagan.
Q: That’s an interesting point about how the super bubble is about 25 years old. A little over a quarter of the U.S. population is under 20, meaning they’ve never known anything else than the super bubble as an economic system. What does the future hold for them?
A: Well, I think it’s still the land of opportunity. I wouldn’t mind being a young man today.
Comments Off on Soros: Global Investing’s Godfather
George Soros retired as a multibillionaire. But now he’s back, hedging his wealth against what he calls the worst economic crisis in 75 years.
(Money Magazine) — Broke and friendless in postwar London, having just spent his last penny on food, 22-year-old George Soros made the first of a lifetime of prescient economic calls. “I have touched bottom,” he told himself, “and I am bound to rise.”
As it turned out, the Hungarian-born survivor of both Soviet and Nazi occupations would do more than merely rise. He would parlay an uncanny flair for anticipating global economic trends into one of the great investing records of all time – not to mention a fortune estimated at $9 billion.
Soros retired in 2000 from running hedge funds and delegated control over a large part of his endowment fund to outside managers. But when subprime defaults began to ricochet around the world, he decided, at 77, to start investing again and to put his take on the crisis into a book, “The New Paradigm for Financial Markets.” He recently spoke to managing editor Eric Schurenberg.
Question: In your 50 years in finance you’ve seen any number of crises. Why is this so bad?
Answer: Because two bubbles are deflating at once. There’s the collapse of housing prices, of course. On top of that there’s the end of what I call the superboom of credit expansion that has been going on for 25 years. That was made possible by a stable global financial system in which the dollar was the world’s primary currency. Now, for many reasons, the system is in question and nothing has taken its place. That has created great uncertainty.
Q. And for us regular people it means…?
A. The days of rapid financial wealth creation are over. We’re now in a period of wealth destruction. It is going to be very hard to preserve your wealth in these circumstances.
Q. Don’t feel you have to sugarcoat your answer just for my sake.
A. Since the 1980s, the global financial system has been dominated by an ideology I call market fundamentalism – the idea that markets are perfect and regulations are always flawed. But markets aren’t perfect. Left to their own devices, they always go to extremes of either euphoria or despair. The Federal Reserve and other regulators should recognize this, since they’ve had to bail out the markets in crisis after crisis since the 1980s.
Q. Can’t the Fed just bail us out again?
A. The Fed’s first duty is to prevent the financial system from collapsing. It’s shown it can do that, and the markets are breathing a sigh of relief. But we can’t avoid the fallout in the real economy. We’re facing not only recession but also inflation and a flight from the dollar. To fight recession, the Fed needs to increase the money supply, but that only makes the dollar weaker and inflation worse. That’s why I think this crisis is so serious. The Fed’s power to intervene is limited.
Q. Where is your money now?
A. Mostly in my endowment fund, a good portion of which I had farmed out to other money managers. When I saw what I considered the most serious financial crisis of my lifetime, I came out of retirement and set up an account to hedge their positions.
Q. How?
A. I went short [bet against] the dollar, U.S. and European stocks and Treasury bonds. I went long [invested in] emerging markets. That worked last year, but this year bonds kept going up and emerging markets down. So I’m about even.
Q. Should Money readers do the same?
A. You’d have to be pretty nimble. I think most investors would be best off in safe, inflation-indexed Treasuries, even though they’re quite expensive now.
Q. Growing up in Nazi-occupied Hungary must help you keep today’s risky markets in perspective.
A. I’d agree that the prospect of extermination was a formative experience for me. [Laughs.] The Nazis taught me that the abnormal can become normal.
Q. And the lesson in that?
A. It’s important in life and in investing always to question yourself. Understand that you may be wrong, especially when you believe too firmly that you’re right.
Q. Have your billions made you happy?
A. I’m reasonably happy, but the money’s not the point. It’s an indication that I’ve succeeded in the grand adventure of understanding reality.
Comments Off on Remarks delivered at the EPC – OSF Policy Dialogue
“Europe as a Prototype for a Global Open Society ”
Europe is in search of its identity. I don’t think one needs to look very far. To my mind, the European Union embodies the principles of an open society and it ought to serve as a model and motive force for a global open society.
Let me explain what I mean.
The concept of open society was first used by the French philosopher Henri Bergson in his book The Two Sources of Morality and Religion published in 1932. One source is tribal and that leads to a closed society whose members feel an affinity for each other and fear or hostility toward the other tribes. By contrast, the other source is universal and leads to an open society which is guided by universal human rights and seeks to protect and promote the freedom of the individual.
This scheme was modified by the Austrian-born British philosopher, Karl Popper in his seminal book The Open Society and Its Enemies published in 1944. He pointed out that open society can be endangered by abstract, universal ideologies like communism and fascism which claim to be in possession of the ultimate truth.
Popper was a philosopher of science and he argued that the ultimate truth is beyond the reach of the human intellect. Even scientific theories cannot be verified beyond doubt; they can only be falsified and it is only the fact that they can be falsified that qualifies them as scientific. We cannot base our decisions on knowledge alone and our imperfect understanding introduces an element of uncertainty into the world in which we live that is very difficult to cope with.
Ideologies like communism and fascism seek to eliminate uncertainty but they suffer from a fatal flaw: They are bound to be false and misleading exactly because they claim to be in possession of the ultimate truth. These ideologies can be imposed on society only by using various forms of repression. By contrast, an open society accepts the uncertainties inherent in our imperfect understanding (or fallibility), and seeks to establish laws and institutions which allow people with divergent views and interests to live together in peace. The distinguishing feature of these laws and institutions is that they safeguard the freedom of the individual.
The Second World War resulted in the defeat of the Nazi regime and its ideology. Europe was rebuilt with the generous help of the United States and eventually a process leading to the formation of the European Union was set in motion. The European Union became a textbook example of the open society. It consists of a number of nations and nationalities, none of which occupies a controlling position and all of which are pledged to maintain democratic institutions and protect individual freedoms and human rights. Even this may be appropriate to an open society because, as Karl Popper argued, our imperfect understanding does not permit permanent and eternally valid definitions of social arrangements. The arrangements must reflect the will of the participants and they must be open to adjustment and improvement. Accordingly, he refused to provide a definition of open society.
The European Union was brought into existence by a process of piecemeal social engineering, the method Karl Popper considered appropriate to an open society. The process was directed by a far-sighted and purposeful elite which recognized that perfection is unattainable. It proceeded step by step, setting limited objectives with limited timetables knowing full well that each step would prove to be inadequate and require a further step. The process was helped along first by the threat from the Soviet Union and then by the globalization of the economy which tended to favor larger economic units. That is how the European Union was constructed, one step at a time.
The process has now ground to a halt. The European Constitution was defeated by the referenda held in France and the Netherlands.
The Constitution may have been, in any case, an over ambitious step. The Union is now left in an untenable condition with an enlarged membership of twenty-seven and a governing structure that was originally designed for six, although it managed to function for fifteen. The political will to keep the process moving forward has eroded. The memory of past wars has faded and the threat posed by the Soviet Union has disappeared.
The prevailing arrangements are too cumbersome and-unless the forward momentum can be regained-the dissatisfaction with the present state of affairs is liable to generate momentum in the opposite direction. That is already happening. Nationalist, xenophobic, anti-Muslim sentiments are on the rise almost everywhere, aggravated by the failure to integrate immigrant communities.
The situation is all the more disturbing because the disarray within the European Union is matched by the disarray in the world order. The United States used to be the dominant power in the world. It used to set the agenda for the world. But after the terrorist attacks of 9/11, President Bush declared war on terror and that was the wrong agenda executed the wrong way.
As a result, the United States has lost power and influence in a precipitous manner and is no longer in a position to set the agenda of the world. Nor is it in a position to project overwhelming military power in any part of the world as it was when President Bush announced the Bush doctrine, and as a result the world order has become much less stable. Indeed, it is threatening to descend into world disorder.
The proper role for the United States would be to lead the world in a cooperative effort to deal with the problems that confront humanity and can be dealt with only by greater international cooperation-such as the threats posed by rogue regimes, the breakdown of the nuclear non-proliferation treaty, climate change and the need to maintain stability in the global economic system and reduce poverty.
In the past, the United States fulfilled its role as the leader of the free world. After the Second World War, the United States used its power and influence to establish the United Nations and the Bretton Woods Institutions and to engage in The Marshall Plan. That is what made America great. The Bush doctrine and the war on terror was a sharp break with the American tradition. It left the world leaderless and the world is in disarray.
The EU needs to play a more active role in the world than it has in the past. The EU is used to taking its lead from the United States, reacting to its agenda, sometimes positively, sometimes negatively, but it basically accepted the world order as given. That has to change and it cannot be achieved by individual countries acting on their own.
The European Union cannot possibly take the place of the United States as the leader of the world. But it can set an example for the world in international cooperation both within its own borders and beyond. Indeed, it has already done so. Member states have delegated some aspects of their sovereignty in order to create a common market and they have kept the prospect of membership open to others. This has been a powerful tool in turning candidate countries into open societies.
All that is needed now is for the people of Europe to be inspired by the idea of the European Union as the embodiment of the open society ideal and the motive force for a global open society.
What does this mean in practice? I believe the debate about the Constitution should be shelved; that is not what the people are interested in. Whatever the reason, the Constitution was defeated in two referenda. To try and force it down people’s throats now would undoubtedly arouse renewed resistance. Perhaps it was too big a bite to be swallowed in one piece. It needs to be unbundled and presented piecemeal. That is in keeping with the method of the piecemeal engineering which proved so successful in the past.
The most valuable and most needed piece is a common foreign policy which would guide a common defense policy. That is the baby that was thrown out with the bath water. That should be the priority and it would not require a referendum. I see the merit of a bill of rights but it does not have the same sense of urgency about it because there are so many declarations already in force. If giving the Charter the force of law requires referenda, it may be better to wait until Europe has regained its momentum. Simplifying the decision-making process is more urgent, but that is something for the Member States to negotiate with each other in a revision of the Nice Treaty and it is unlikely to interest the general public. What is of general interest is to improve the integration of immigrant communities. These are the outlines of a practical program for moving the European Union forward again.
In the meantime, the absence of institutional reform should not be allowed to serve as a pretext for inaction.
The European Union already possesses ample resources to make an impact on the world stage:
* half of the world’s overseas development assistance;
* the biggest single market in the world;
* 45,000 diplomats;
* almost 100,000 peacekeepers serving on every continent;
* and the prospect of using trade, aid and the prize of membership as catalysts to encourage neighboring states to become open societies.
Regrettably, the EU has not made full use of its potential. Europe has made little progress in formulating a common energy policy. As a result it is increasingly dependent on Russia, and Russia has not hesitated to exploit its bargaining position. The EU has failed to give adequate support to Georgia or to impose adequate sanctions on Uzbekistan for the massacre in Andijon. The European Neighborhood Policy never gathered any momentum and the treatment of Turkey is pushing an important ally into the wrong direction.
Needless to say, a common European Union foreign policy should not be anti-American. Such a posture would be self-defeating because it would reinforce the division of the international community that the Bush administration has initiated. I am speaking about the European Union setting an example in international cooperation that eventually the United States under a different leadership-which is on the way-would emulate.
By the same token, a global open society emphatically does not mean global government. Government inevitably interferes with the freedom of the individual. A global government could not avoid being repressive even if it were built on liberal principles. A global open society could not even be as closely integrated as the European Union because the affinity among the member states would be less pronounced.
What a global open society does stand for is the rule of law on an international scale. According to the neoconservatives who have exercised such a nefarious influence within the Bush administration, international relations are relations of power, not law. According to them, international law merely ratifies what military power has accomplished. To some extent that is true today. For instance, the United Nations has ratified the occupation of Iraq which had been brought about by illegitimate means. But it ought not to be true tomorrow. International relations, including the exercise of military power, ought to be governed by international law more effectively than it is today.
Europe as the prototype of a global open society is an abstract idea. Whether it is strong enough, persuasive enough, to serve as the unifying force guiding the European Union forward, remains to be seen. One thing is certain, the process that has carried the European Union so far cannot be revived in the same form as before. It was driven by an elite and the population at large has felt left out. This cannot continue if for no other reason than on account of the referenda that are used with increasing frequency. A referendum expresses the people’s will in a raw, capricious form without the intermediation of an elite. Therefore, if the European Union is to revive, it has to be by popular demand. One way or another, civil society has to be mobilized. The elite has a role but it is to shape public opinion.
I can only speak for myself. I find that the idea of Europe as a prototype for a global open society is very inspiring indeed. Although I am not a European citizen, I am a believer in the open society. I have a network of foundations inside and outside the European Union committed to promoting that idea. I am ready to support an Open Society Initiative for Europe that would mobilize civil society behind the idea of Europe as a model and a motive force for a global open society. The world badly needs a more united Europe committed to the principles of open society and I hope Europe will rise to the challenge.
“I got lost in philosophical abstractions,” writes 75-year-old billionaire philanthropist George Soros, about his attempt, decades ago, to compose a philosophical treatise. “I decided to quit and devote myself to making money.”
That Soros succeeded in the latter endeavor-making a fortune in financial markets-is common knowledge. But readers of his new book, “The Age of Fallibility: Consequences of the War on Terror” (PublicAffairs), will discover quickly that he never abandoned philosophy. If you have a taste for such things, you will almost certainly be impressed, for example, by his deft juxtaposition, in a single paragraph, of Leo Strauss, guru of the neoconservatives, and Karl Popper, a social theorist whose profound impact on Soros can’t be overstated.
In fact, much of Soros’s philosophizing is spurred on by his desire to hone ideas that so impressed him, when, as a young man fleeing Communist Hungary after World War II, he studied under Popper at the London School of Economics. Before the Communists took over, Soros’s Jewish family survived the Nazi occupation of Hungary. Popper’s writings-especially his 1945 book, “The Open Society and Its Enemies”-gave Soros an enduring framework for understanding totalitarian regimes.
According to Soros, the surest way to grasp the meaning of an open society is to come to one from a closed society-the difference hits you in a flash. But he does offer hints for those without that experience. “In my definition,” he writes, “an open society is an imperfect society that holds itself open to improvement.”
Imperfection is a keynote for Soros. In human affairs, he says, people are simultaneously observers and players, which makes objectivity impossible and error inevitable. In a sense, philosophy and finance have converged for Soros: His analyses of how investors’ expectations shape financial bubbles and boom-bust cycles helped him make his fortune.
The new book is a passionate plea for us to accept our fallibility. The alternative-whether expressed in political dogma or religious fundamentalism-makes for a closed society. Soros thinks that America-the world’s exemplary open society, in his view-shows worrisome signs of closing under the current administration, which led him to spend a lot of money trying to defeat George W. Bush in the last election. That, along with other controversial interventions (support of needle exchange programs in New York and the legalization of marijuana, to name two) by his Open Society Institute, have made him the billionaire philosopher the right-wing most loves to hate.
IDEAS: Do you see yourself as an unusually reasonable person?
SOROS: Yes, though I see that our grasp of reality is fundamentally flawed. Given that we are observers and participants at the same time, we can never reach ultimate truth.
So I don’t have faith in reason. I have faith in critical thinking. That’s why I believe in democracy-so that governments can be changed if they don’t perform-and in market economies, to give us feedback so we can correct our mistakes.
IDEAS: You seem apologetic about the philosophical section of “The Age of Fallibility.” Why?
SOROS: Because of how little the general public here is interested in philosophy. It’s amazing that in China, people really respond; the philosophical discussion is really important to Chinese intellectuals. American intellectuals tend to skip it.
IDEAS: Are you unique in being a billionaire whose philanthropy consists of pinpoint political interventions? Are there other versions of you-right-wing versions?
SOROS: There are several billionaires who have devoted considerable amounts of money to political purposes using philanthropic drives. Richard Mellon Scaife, for example, is a Pittsburgh billionaire who devoted large amounts of money to persecuting the Clintons, and is doing the same, though possibly not with the same amount of money, to me.
IDEAS: There are times in the book when it seems you are opposed to the global economy and to what is often called globalization. Is that so?
SOROS: No. I’m not opposed to globalization. But I consider the current form of globalization flawed. It’s flawed because we have global markets but don’t have political institutions to match.
People who believe in what I call market fundamentalism think that the common good is best served by everybody pursuing their own self interest. This thesis happens to be false, because there are common interests that are not taken care of by markets. You need separate institutions to take care of common interests in a national economy. Now we need them in an international economy.
IDEAS: Do you favor some sort of global government?
SOROS: I’m against global government. Now [laughing] if you don’t like a national government, you can move someplace else. A global government would probably interfere with our freedom more than national governments.
But you do need international law and international institutions, and today, international law is very weak. The American supremacists argue that international relations are relations of power, and that international law merely recognizes what power has wrought.
IDEAS: You attribute that view to Dick Cheney and Donald Rumsfeld, and say that they have “successfully manipulated a born-again president and a feel-good public.”
SOROS: They gave President Bush very bad advice, and it has turned out badly.
IDEAS: Do you think they see the invasion of Iraq as a failure?
SOROS: Cheney and Rumsfeld continue to take a very anti-international approach and want to use force. They are actively agitating for military action against Iran, which has really terrified the uniformed military. There’s no question that they are disappointed that Iraq wasn’t easier, and so you’ll find neocons who have turned against that policy. But the hard core, Cheney and Rumsfeld, want to push on.
IDEAS: It’s hard to see the American people supporting a war with Iran.
SOROS: The danger cannot be discounted. Iranian president Mahmoud Ahmadinejad has more influence than his predecessor in Iran, Mohammad Khatami. And here we have Cheney. Extremists on both sides are playing off each other, and the moderates are shut out by the escalation.
IDEAS: You have one thing in common with the right-the belief that American leadership is essential to the world.
SOROS: If we want to be the leader of the free world, we have a unique responsibility not only to protect our relative advantages but to the common problems of humanity. Solutions to problems like global warming require cooperation. That cooperation cannot be successful without the United States. But for the right, American leadership is just military leadership.
IDEAS: You describe the war in Vietnam as an aberration from America’s fundamentally sound leadership style, and argue that the war on terror is much worse, nullifying our global leadership status.
SOROS: It dismays me to come to that conclusion.
IDEAS: How do you defend against pessimism?
SOROS: I am rather pessimistic. But I’m optimistic, too, because it’s possible to do something about it. We are a democracy, and can correct our mistakes. We can change our policy. We still are an open society. That makes me hopeful.
Harvey Blume is a writer based in Cambridge. His interviews appear regularly in Ideas. E-mail [email protected].