Harsh sanctions have been imposed against Russia over its invasion of Ukraine. However, the country's energy exports have largely been spared. One significant reason for this is Germany's high dependence on Russian energy, particularly natural gas. So how did Germany wind up in this situation? And why didn't it take steps years ago to start weaning itself off of this dependency? We discuss this with Matt Klein, the founder and publisher of The Overshoot as well as the author of the book Trade Wars Are Class Wars. He explains how misplaced German priorities led to years of underinvestment, and a poorly thought out energy strategy, which is now forcing Germany to pivot at a very difficult time. Transcripts have been lightly edited for clarity.
Joe Weisenthal:
Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway:
And I'm Tracy Alloway.
Joe:
Tracy. You know, on our last episode, we talked about the sanctions that are being imposed against Russia, and they're really extraordinarily dramatic. Obviously we've seen the Russian financial sector get pounded, all kinds of disruptions. Russian equities listed abroad their value, in many cases, going to zero. Numerous companies often just voluntarily sort of washing their hands of their Russia business. But of course, as everyone understands the one huge, I guess, it's the elephant in the room. One area that has not been directly targeted is energy,
Tracy:
Right. And this is really, I don't want to say the crux of the whole issue, but certainly this is something that has played into the fact that Putin invaded Ukraine in the first place. There's a huge reliance on Russian natural gas in Europe. And I think this is well understood and well established now. And even before the recent actions, prices had been going up, people were talking about inflation, an energy crisis, and then this all made it worse. But on the one hand, all of this plays into the geopolitical situation. So there's an argument to be made that Putin feels more empowered in invading Ukraine because he knows that Europe relies on his country for its gas needs. And of course, sorry, I don't know where I'm going with this! I there's a lot to say.
Joe:
There is an extraordinary amount to say. I guess one of the questions is why wasn't Europe more prepared or why hadn't Europe already taken steps to perhaps wean itself off of Russian natural gas and oil. And of course, there was the annexation of Crimea in 2014. So it's not like these geopolitical concerns suddenly just came out of nowhere.
Tracy:
No, this is where I was going with it actually. It was that Putin has a really good grasp of the energy situation and seemed to understand that Europe needs Russian gas, but at the same time, it doesn't feel like Europe necessarily understood that. Or if they understood it, it doesn't seem like they did anything about it. Everything just sort of went on as it did before. And even after the first invasion of Ukraine and, you know, the situation in Crimea in 2014, even after that, you didn't really see Europe back away from Russia in any way, even though, as we discussed with Zoltan Pozsar recently, you did see Russia take steps to sort of insulate itself from the west.
Joe:
And of course we're talking about Europe broadly, but there's obviously sort of a specific, you know, the, the key country in Europe from the sort of Russian gas reliance that a lot of this revolves around is Germany because it is an extremely rich and successful country. It also is extremely reliant on natural gas and it's sort of taken some odd energy choices because this is a country whose leadership has talked a lot about going ‘green’ and sustainability and all that. And yet it's actually really not done well on hitting some of its emissions goals. It's phased out nuclear, but that means it's more reliant on coal, more reliant on gas, and maybe in the long term one day beyond, wind power and solar power and be all renewables. But that seems very long term. Right here and now its emissions are going up and it's dependence on Russia is acute.
Tracy:
Yeah. And I think that's become very, very apparent in the way, well, just the way the whole crisis has unfolded. I will say we're recording this on March 2nd. And I'm looking at nat gas, the spot price, on the Bloomberg terminal now. It jumped 60% earlier today. And of course it's at another fresh record, but it's been at fresh records for multiple times in recent days and indeed in recent weeks. So you can feel all of these tensions and all of this pressure, all of these potentially, bad policy choices manifesting themselves in these record energy prices.
Joe:
Exactly right. So we want to push the conversation forward and get more insight into this crisis, this war and the German situation specifically. I'm very excited for this conversation. We've had our guest on one time before we are gonna be speaking with Matt , he's the founder and publisher of the overshoot, which is a phenomenal, , newsletter on, , economics and the economy. And then of course he's the co-author of the book trade wars, our class wars, Matt . Thank you so much for coming, , coming back.
Matt Klein:
Thank you very much for having me.
Joe:
You know, the last time we talked to you, I think maybe it was in 2020 and you had published this book, ‘Trade Wars Are Class Wars.’ And of course, you know, going back to 2020 and 2019, around that time, when you think trade wars, obviously you think U.S.-China tension because of course there were the various Trump tariffs and so forth, but a big part of your book was not just about U.S.- China, but also this third actor, Germany specifically. Why don’t you talk about to us about what was their role in the story before we even get to the current crisis? Why were they a key player or actor to be understood in the sort of global context?
Matt:
The basic argument of the book is that for a very long time, since maybe 20, 25 years or so, the world economy as a whole has been suffering from the systematic shortage of consumer demand. And that's ended up creating a lot of tensions as businesses are trying to capture this finite demand. And as consumers in different parts of the world try to compensate for the lack of income that is a result of this. And so one of the major drivers of this shortfall consumer demand was Germany. And then later Germany, you know, extended to the rest of Europe as a whole macro policy in terms of both business, investment, being weak in terms of government policy, essentially over taxing, underspending and squeezing demand for goods and services. And then that ended up rebounding in all sorts of different ways, in terms of higher debt levels and financial crises and stuff.
And the argument of the book being that policies in Germany, not just government policies but really the policies of business leaders and other elite actors in society, ended up leading to systematic problems for the world as a whole. And that ended up leading to problems both for people in Europe and people outside of Europe. And even if that wasn't something we think of in the trade war context, as you were saying, like the Trump and China stuff was very, you know, obvious what this was. And it was nevertheless leading to tremendous amounts of tension within Europe. And you could see that throughout the Europe crisis in terms of the conflicts and, you know, you have people like the Dutch finance minister blaming lazy Southern Europeans for things. And then you have Southern Europeans talking about fascists in the north. And that was all really, I think, a reflection of the fact that you had really bad economic outcomes driven by bad economic policy.
Tracy:
So you mentioned a bad situation caused by policy decisions. Could you maybe just elaborate on that a little bit more as it relates to the current Russia situation and the energy landscape that we were talking about a little bit in the intro. How much does a country like Germany actually depend on Russia for its energy needs?
Matt:
Germany is quite dependent on Russia. So for the European Union as a whole, if we look at basically the period right before the pandemic -- the pandemic kind of distorts things a little bit -- about 19% of all energy came from Russian imports. So a lot of that includes natural gas. That includes coal. That includes oil. Natural gas is the most significant one for these purposes because it's not easy to substitute it. You know, if Russia doesn't sell oil to Europe, someone else is gonna buy that oil. Europe can therefore buy oil from whoever, you know, previously was not buying Russian oil. So it's more fungible. Gas on the other hand is mostly transported by fixed pipelines. And so therefore you really, you know, you can substitute to a degree, but it's much more challenging to do that. Germany sort of compounded this problem in a couple of ways.
One is that they, you know, made the decision after the Fukushima nuclear disaster in Japan to start decommissioning all of their own nuclear power plants. And so a quite substantial source of clean and reliable, locally-sourced energy was shut off. And I think they basically … I think they had been currently scheduled to turn off the last of the nuclear plants, I think at the end of this year, I think now that's starting to change, but that was basically something that had been going on over the past 10 years, turning off nuclear power. Another thing that they've done, which I think we can relate sort of more to their macro policy mix, is that they didn't invest enough in coming up with replacements. So while there has been a real commitment, since I think about 2010 towards greening the energy mix, they call it the energy transition, they have invested a lot in wind and solar power, particularly wind power. It hasn't been enough to offset the loss of nuclear.
And so one of the things that actually had been, you know, bridging the difference was that they increased their coal consumption quite a bit, which is ironic given their, you know, desire to be more environmentally friendly. The other thing they did of course, is that they imported even more Russian gas. So the story, the connection between Russia and Germany on gas, goes back quite a long time. Basically you can really sort of argue that it goes back to the 1960s before even Russia had gas. When the German government under Willy Brandt decided that they wanted -- they called it Ostpolitik. And the idea that Germany would sort of be a bridge between the rest of the west and the Eastern block and have sort of friendly relations and, you know, just their own sort of distinct history and culture. And they would be try to be more friendly to the USSR and the rest of the Warsaw Pact countries.
And so one of the ways that that manifests is once Russia started developing gas fields and wanted to export it, that Germany was pretty eager in building pipelines. And this goes back to the early 1980s, they start building the pipelines. In fact, this was something that the Reagan administration criticized the German government for at the time because they thought it would be increasing Europe’s dependence on the Soviets and potentially become a security risk. The German argument was engagement is going to be better. We want to integrate Russia into, you know, the Western economy. That's going to moderate their behavior. And if you look just at the 1980s, maybe that was a good argument because the Soviet union rather did in fact become, you know, more moderate over the course of the 1980s, and that did become a, you know, constructive relationship.
Nevertheless though, as time progressed, you know, the question is why do they keep sticking with this? You know, you mentioned that the first Russian invasion of Ukraine in 2014, the annexation of Crimea, might have led to a shift in behavior. It did not. A project that Russia and German businesses had been working on for quite some time called Nord Stream 2, another pipeline basically to increase Russian gas flows to Germany, had been in progress before then and continued to accelerate after this. Total German imports through the first Nord Stream pipeline, which goes under the Baltic Sea, went up. And so actually overall energy imports of gas were significantly higher by the time you get to 2019 than you were even in 2013, which is the exact opposite of what you'd think would've happened if, you know, European policy makers were concerned about reliance on Russia. And it now puts them in a situation where it's kind of challenging, which is you could theoretically cut your gas consumption by, you know, a significant amount -- 20% or whatever, but is that actually something you can do on a dime? Maybe.
I mean, I guess the good news is that winter is mostly over, so they don't need it for heat. But you know, that does create a lot of leverage. I mean, as you mentioned, Tracy, the pricing of the natural gas is so high because the supply was already being constrained. I mean, I think one thing that isn't being appreciated enough, I was surprised to see it myself, is that until they stopped making their website publicly accessible Gazprom, which is the Russian company that produces and transports the gas, they publish daily data on how much gas they shipped to European customers and by which route, and the last data we have is the weekend before they invaded Ukraine. What you can see is that in 2021, basically starting around sort of the end of August of 2021, the gas flows started falling dramatically.
And basically if you look at the beginning of 2022, so it'd been going down kind of steadily, and by the time you get to the beginning oof 2022, so like from January 1st through February 22nd, was right before the invasion. We're talking about 30% lower deliveries to EU customers compared to the January through August, 2021 average. So it's a really dramatic drop. And basically there are a whole bunch of different pipelines, a bunch go through Ukraine. There's one that goes directly to Germany. And then there's one that goes through Belarus and Poland to Germany. The only one that really had maintained its flow was the one that goes straight to Germany. The other ones were getting really squeezed. I don't know what has been happening in the past, you know, week and a half, but those data are no longer available, but I mean, the price signal suggests that maybe they've squeezed it even further. You know, as Tracy was saying, that I think that it was reasonable for Putin to conclude that this did give them, the Russians, a fair amount of leverage and that they were in fact trying to use that.
Joe:
So it's interesting you mentioned that the German/Russia figurative and literal pipeline has gone back several decades. I learned on our last episode that we did actually, that our current Secretary of State Antony Blinken, several years ago even wrote a book called ‘Ally Versus Ally: America, Europe, and the Siberian Pipeline Crisis’ about this dispute in 1982 on this exact thing. So now I kind of want to read that book because now it's come up in two separate podcasts and so it seems highly relevant. Something I'm curious, you know, to sort of bridge this. And I guess this is really the key question, so we talked at the beginning about this sort of -- and this is what your book is about -- this sort of demand-constraining macro policy from Germany. You know, in theory you could run balanced budgets and do better on energy investments. And theoretically they could have invested more in renewables or domestic sources of energy or LNG terminals that would've allowed them to become less reliant on Russia while still maintaining a balanced budget, whether that's wiser or not. But can you talk a little bit more about the sort of macro stance that the German state has had for the last 20, 25 years and the sort of sclerotic underinvestment that they've seen in the energy sector?
Matt:
The context here is that when the Berlin Wall fell in 1989 and West Germany prepared, the Federal Republic of Germany, West Germany, prepared to absorb the states of eastern Germany into a new and large federal republic, there was a surge of spending both by the government and many businesses to make that transition happen. And you basically have the last like great boom in the German economy for, I guess at this point, over 30 years. The Bundesbank, which is Germany’s central bank at the time, responds by really aggressively raising interest rates because they're worried about inflation. Then you have, you know, a pretty dramatic reversal by the federal government in terms of spending cuts after a couple years later compounded by the fact that it turns out that, you know, a lot of the optimism that people had about the ability to transform East Germany into a part of Germany that can be as productive as West Germany, that optimism was not validated for, well, ever and not for a very long time.
There was a hope that a lot of East German businesses could be transformed. Yould get this huge boom from privatization and better management. That didn't happen. You just had the government instead ending up taking a huge loss. They finally wrote it down in 1995 and then they basically spent a long period of time afterwards. It was a really nasty recession. All these people in East Germany were losing their jobs. You have the high interest rates from the early nineties. Then you have essentially the budget restraint cutbacks, because the German government felt they just spent too much and they just signed a treaty with their European neighbors that they themselves have pushed for balanced budgets as part of preparation for the creation of the common currency. All that led to a huge squeeze. And you can look at things like, you know, construction activity, other measures of business, and that you have this massive decline in the 1990s and a very long period of stagnation.
It was really painful. And in fact was the reason why the German Left had its best elections ever in 1998 after years of, you know, despite the euphoria of reunification that was done under the German conservative party, the Christian Democrats. You know, in the beginning of the 1990s and the late 1980s that the social Democrats and the Greens come into power the first time as a coalition in 1998. And incidentally, the person who led that coalition, Gerhard Schroeder, then later went on to become a very prominent person leading the Nord Stream project. I think he's still on it.
Joe:
Yeah. I think he's technically, as of right now, I think he's still there.
Matt:
Yeah. Just kind of remarkable.
Tracy:
Awkward.
Matt:
Yeah. So that was the context there. So Schroeder comes into power with this coalition government. And one of the things they want to do is, you know, increase spending. They want to have lower interest rates. And especially after the downturn of the early 2000s, which hits Germany pretty hard, it's a global downturn, the tech bust, so it’s not unique to the United States and they can't. Ironically, you know, we think of now the Germans being the major blocks on looser monetary policy and the ECB, the Germans being the major constraint on ability for governments to borrow and spend in response to downturns because we have the recollection of how things were in say 2010, 2011, 2012.
But if you go to like 2000, 2001, or even 1998, then it was the opposite actually. The Germans were pressuring the ECB for looser policy because relative to their domestic needs, the ECB was way too tight. And the ECB they said, no, like, you know, there's a press conference you can find, I don't remember exactly what the date was. It's in the book where some journalist asked the ECB about the request they've been getting from Schroeder and from his finance minister, Oskar LaFontaine, and the head of the ECB goes, well, I hear, but I do not listen. And, you know, okay. So, you know, they have another severe downturn and, you know, they sort of push for some modest exemptions to the budget caps. So basically the EU treaty that they'd signed in Maastricht in the Netherlands back in 1992 was that you can't have a budget deficit more than 3% of GDP.
That number, as it happens, if you go back in the history was basically something that some French, relatively young French bureaucrat made up in the 1980s and thought it was, you know, three was a nice round number that reminded him of the Trinity or something. But there's no economic significance to this. But it was a constraint. And so Germany and France, which were both having, you know, rough periods, downturns in the early 2000s, slow recoveries, pushed to get the limit of that. But it wasn't really, they didn't really exceed it very much, and it didn't really help that much. They were still relatively constrained in their budgets. And the way things generally work is that if you have a limit on how much you can spend on your budget, it's easier to cut the investment side than anything else, because what the alternative is, you're gonna lay off a lot of school teachers and cut unemployment benefits to a lot of people. That compared to, well, we're gonna delay, you know, fixing this road or building that bridge or whatever.
It's much easier to cut the investment spending. And this is particularly true in a place like Germany, where, you know, in some ways like the United States, it's very much a federal system. And a lot of the spending is done by the German states or by local, even sub-local governments. And those were also subject to sort of a national constraint. And so they really are being pressured. They can't, you know, their ability to borrow is very limited. So they're gonna cut investment spending much harder. That sort of setup going in really for, you know, the past 20 years. And, you know, the German government certainly did also cut welfare spending over this period as well to try to meet its budget commitments. They later then, you know, became convinced that this was such a good idea, they actually put in what's called the debt break or the Schuldenbremse. That was, you know, very extreme, basically saying that you can't have a cyclically-adjusted budget deficit for the government as a whole of more than like half a percent of GDP. And the problem of course with this, among other things, is that it's very sensitive to how you define what the cycle is. And, you know, if you set it up, especially when they did, after a very long period of growth being very, very slow, arguably, you know, significantly below where Germany should have been, then you sort of lock yourself in permanent stagnation and that really limits your options. So even though the government did try to invest more, it didn't really get anywhere.
I mean, one thing that's really striking, and this is, we mentioned this in the book, I mentioned it more recently as well, is that if you look at investment spending in Germany after subtracting depreciation, which is an important thing to be considering, you know, what's like the new investment? Net depreciation and maintenance. It was negative for basically like 2002 until 2018. So you basically had a long situation of the, you know, the public capital stock shrinking in real terms. And, you know, unsurprisingly that's going to create problems. I mean, I don't think they anticipated this specific problem, but that's going to create problems with all sorts of things. You had bridges collapsing and roads being shut in the 2010s, because they were just unusable and they hadn't been maintained. This is obviously much more extreme, but it's a symptom of the same problem.
Tracy:
So when it comes to spending, there is this perception out there that, you know, maybe it's in the German character and they just don't like spending money that much. But as you mentioned, you know, in recent years, it does seem like we've seen inklings of a break in that attitude. And I guess my question is what are the chances that recent events build on that momentum? And you actually see a place like Germany become more willing to spend and invest in either public infrastructure or energy security?
Matt:
I'm actually very optimistic about this. I mean, I was optimistic before this recent crisis for the reasons that you're laying out. You know, this cultural thing, I mean, I'm not saying culture doesn't matter, but I think it easy to sort of over attribute economic outcomes to cultural differences. There are a lot of examples of places where, you know, people are very confident, the culture does one thing, and then later they do the exact opposite and they say, it's the same culture. And it's like, that can't be the case. So I think there was a recognition even among, I think the reason it was so challenging is because you had such political stability in Germany for so long -- stability and also stagnation. So basically in the early 2000s, partly because of these constraints, they didn't really have much of a choice.
You had the center-left parties being the ones that actually are really pushing austerity in the early 2000s, in terms of things like cutting unemployment benefits and basically squeezing investment to make room for other spending within the constraint of, you know, Europe's budget rules. And then in 2005, what happens is that you have a very weird situation where the left-wing parties as a whole end up winning a majority of the seats in the Bundestag. But, the reason that happens is because you have a split of the left, where basically people on the left side of the Social Democrats, ally with people who had been sort of like ex-communists in East Germany and were protesting these policy changes by the government at the time. So in theory, there was sort of like a, you know, majority left coalition, but in practice that would never have happen because there was, you know, an opposition of existing policies.
And so then you have the first of many grand coalitions where the conservative Christian Democrats ally with the Social Democrats, and then end up pursuing the exact same policies. And in fact, the way Angela Merkel who becomes chancellor at this point in time, you know, basically neuters the opposition for what felt like a generation because she's like, oh yeah, this was great. The stuff that the Social Democrats did was brilliant, and we want to continue their legacy and safeguard with all the good stuff they did for Germany, which basically means that social Democrats have a really hard time competing. And in fact, what ends up happening for many years is that they just keep allying as junior partners with the Christian Democrats. And so you have the two biggest parties that the center left and center right allied, doing this.
And so even though there is, and there always was, opposition within Germany, both politically and among sort of people who knew what they were talking about, it was never enough to really break through that deadlock. And it took a very long time for there to be movement there. The thing that changed was that in 2021, you finally had an election where, and this was partly due to the pandemic, partly due to sort of the good fortune of the fact that the Christian Democrats chose a singularly unpopular and incompetent chancellor candidate that they ended up losing and being cut out of power.
And that created an opening for the Social Democrats to come in, without cooperating with Christian Democrats. They had come in with the Greens. There was originally sort of a question of would they ally with the Greens alone, would they ally with the Greens and maybe the left and some sort of reconciliation, that didn't end up happening because they didn't win enough seats. What ended up happening was they allied with the Free Democrats, which there was a lot of speculation there about this being negative because the Free Democrats had long positioned themselves as being the most austere and the most committed to low taxes and budget restraint and the debt break.
But one thing that had been, you know, showed up in the campaign and I'm pleased to say that I foreshadowed this, you know, last summer before the elections in September, was that, you know, they do say these things, but they also left themselves very open to the fact that you could get around these debt break rules with some financial chicanery and they didn't seem to mind. Basically the way, Germany's debt rules work is that if you have a, you know, a sort of segregated government enterprise that does with its own budget, as long as it doesn't take money from the state because it's losing money, it can issue as much debt as it wants to fund investments. And that's within Germany's rules. It's incidentally not within the European rules, that could potentially be a problem, but within Germany's rules, it's fine.
And the FDP repeatedly said or implied they would be okay with that. And so you had a situation where the greens were very actively saying, we need to invest more and we need to get rid of the debt break to invest more. The FDP says we don't need to get rid of the debt break, but we're willing to sort of look the other way. And then the SPD, the Social Democrats, for a long time, having been sort of on the same side as the Christian Democrats, they had come into their own over the previous few years, they'd been calling for more investment. And in fact, Scholz, who's the current chancellor. He was the finance minister in the previous government, you know, from 2018 through 2021. And while he was in charge there actually investment did go up.
And it was the first time that investment appreciation was positive. So there was already kind of this positive setup here and people saying, we need more investment. There was a recognition within Germany that it needed to change, the business groups within Germany were saying there needed to be more public investment. As I said, you have enough like major road and bridge closures. You have people, you know, mocking Germany’s train systems for being terrible compared to places like Spain. That eventually does have an impact. I mean, 20 years, but people did pay attention. And so, you know, even leading up to this, there was already that momentum. And I was optimistic about that. Then we see this happens and, the German response has been dramatic, absolutely dramatic. I mean, aside from the fact that Ostpolitik is thrown out the window, which was, you know, the Social Democrats’ creation, you have a situation where the FDP, which again, is known for really strict budget discipline is saying, we are going to spend another hundred billion euros on defense. And when they were criticized by the opposition Christian Democrats in the Bundestag, Christian Lindner, who's the finance minister and the head of the FDP, he basically laughed at him and said, this is an investment in our freedom. Why are you worrying about the debt levels here? We need this for our security.
You know, this is an enormous number by the way. How it gets spread out over time is a little ambiguous. But you add that with the fact that Scholz committed to spending at least 2% of GDP on defense, which is Germany's, you know, obligation under NATO. But you know, for many years they've been spending like 1% of GDP on defense, because again, if you're feeling budget constrained, you're someone Angela Merkel, cutting defense budget is a very easy way, relatively speaking to, you know, meet your targets that would seeming like a problem. Of course the problem, you know, what the problem is that the Bundestag lost so much capability.
You hear all these stories about how they couldn't do anything. Like there was some German, I think army intelligence guy who was stuck in Ukraine, he had to get civilian transport out or something. I mean, they didn't really have a lot of capabilities and now they realize they need to do something dramatic. They didn't have, I think, you know, you were mentioning this, they didn't have any LNG import terminals, Europe as a whole does have a lot of LNG import capacity. Germany has none. So they're working on fixing this stuff. And so I think it is encouraging that they realize that, you know, the situation that they, as they understood it, is a lot different than what they'd been thinking. And that then needs a response, which incidentally is consistent with a history of many other countries where, you know, national security risks lead to radical changes in domestic investment.
Joe:
Now you mentioned that, at least the last of the nuclear plants had been scheduled to sunset at the end of this year. And maybe that'll be pushed off. If I'm not mistaken, the Green party in Germany, this is like a core thing for them, right? They were like a prime mover against nuclear for decades, I understand. Do you think that like, you know, there's gonna be some, I don't know if like you have specific views on sort of like German energy policy down to the mix, but you know, it seems unrealistic that any time soon you're going to have solar and wind really do all the lifting, especially with the lack of like utility grade battery tech. Do you sense any meaningful change on that front?
Matt:
Well, so yes. I mean, I think one thing that's interesting here is that first of all, they've said that they think they are going, you know, not turn them all off at the end of the year. And that is something that could not have been done without the consent of the Greens. The Greens have known for being anti-nuclear for a very long time. However, they also, and this is actually an arguably even more important part of their identity, at least in recent years, have been very hawkish on Russia and very much against fossil fuel dependence. And in practice, what we've seen is that turning off nuclear has not meant that Germany has gotten greener. In fact, their carbon emissions record has been among the worst in any rich country, precisely because they turned off the nuclear plants to substitute with coal.
So I think that, you know, Greens can read this just as well as anyone else. I think they know this again, the Greens have been consistently the most hawkish on Russia in part, because unlike basically every other party, they don't have any kind of weird Russia baggage in terms of either, you know, the ideological links or the oil, the gas pipelines, or supporting business interests, you know, selling manufactured goods to Russia. So they they've always been the most relatively hawkish and, you know, talking about a foreign policy of values. And in fact, the foreign minister is from the Green party right now. So I think there's definitely gonna be flexibility there. So if the choice that they face is turning on nuclear plants versus actively sending money to Russia in the middle of a situation where Russia is violently invading one of its neighbors, I would imagine, you know, they'd be more flexible on that front. And I think that we're seeing that. I mean, and also, as you mentioned, in the short term, you know, solar and wind are great, but they're intermittent and so you need something that's stable and you know, it's either gonna be coal or gas or nuclear and you know, of those three, I mean, nuclear's clearly going to be preferable.
Tracy:
So I realize we've been very focused on Germany here. Can you talk a little bit about how Russia's energy links have played into the current situation? And also one of the things that keeps coming up is this idea of, you know, the rest of the world has imposed these very strict and dramatic sanctions on Russia. But the thing they've left out is energy for obvious reasons. But now there's this sort of big question mark over whether or not that can a continue given that A) you see a lot of firms who are voluntarily self-sanctioning and just deciding that they don't want to have anything to do with Russian assets, or they're worried about clearing through the system and things like that. So they're just not dealing in Russian energy at all. And B) it's unclear whether or not Russia will be able to use the dollars and euros that it actually earns from its energy exports. And so there's a question of, well, why would they continue to do this if they're not going to be able to actually use that money? So how do you see all of that at the moment?
Matt:
Yeah, those are all great questions. I mean, it is an interesting question. Why would Russia keep pumping gas if they're getting money that they can't use? You can understand why they would keep doing it if they could use the money. And there's an argument for actually setting up sanctions in a way that they're forced to keep pumping the gas, but not really able to do a lot else with it, which arguably is what was set up, but it does create this tension. So, I mean, one theory I've heard, I have no idea if this is right, is that the Europeans actually do want Russia to cut off the gas, but they want Russia to be the ones to take the blame, which, I mean, I have no idea if that's right. I mean, that certainly would be a reasonable way of interpreting how things are playing out, but then there's a question of how you deal with that.
I mean, as I said, the good news is that winter's basically over so you don't need it for heat the way you would have before. You could imagine a situation where you're rationing electricity for industrial consumers, and then, you know, I sort of hope that things get resolved one way or another before next winter. That is definitely a tricky question, because it's not like Germany is uniquely dependent on Russian gas. In fact, if anything, many other countries are even more dependent on gas from Russia, basically all the countries to Germany's east and sort of southeast because there isn't really a lot of other sources you can get. I mean, you can get gas from, from Qatar, from Norway, the North Sea, there's some LNG coming in from the U.S., although the U.S. is sort of maxed out and we sell a lot to Asia.
You know, you could have re-routing of LNG. I mean there's a world where, you know, Australian and American LNG is rerouted from Asia to Europe, but then that's creates new problems for other people. So there isn't an immediate obvious substitute and that does theoretically give the Russians a lot of leverage. As I said, for all we know they've already been cutting off. We just don't have the hard data from like the past week, week and a half. So that's a sort of interesting question there, but it does potentially create, I mean, one of the reasons why before any of this happened, why Nord Stream 2, which was the planned pipeline – it’s basically finished -- but that would've dramatically increased Russia's ability to send gas directly to Germany under the Baltic Sea. The reason why that was so controversial before all of this was because it would've meant that Russia could have sent gas to Germany directly and bypass all the countries that are in Central and Eastern Europe that previously were able to get gas and be confident they could get a supply of gas because it's not as if there are a lot of pipelines that Germany could use if they wanted to supply, you know, Poland, Czech Republic, Slovakia, Austria, the Baltic states, Romania, those all depend on gas coming from Russia.
And then some of that gets routed to Germany. But if it all went to Germany directly, then those countries would all get hosed. And so that was like the big concern they had, you know, before any of this. So, you know, those countries are still just dependent. We’re now in a situation where at the moment you're actually having gas being routed from those countries to Ukraine, a lot of the pipelines run through Ukraine. It had been the case that the Ukrainian government earned a decent amount of hard currency basically getting a transit fee from gas sent from Russia through those pipelines that I mean, I'm guessing that's not happening right now, so you're having gas being sent the other way so that Ukraine can keep the, you know, the power on. But yeah, I mean, the situation with gas and Russia, you know, energy security is a significant problem for all of Europe right now. Basically you have to go either as far west as places like France, Spain, or north to like Sweden and Norway for it not to be an issue. And in those countries, they have a lot more hydro power and a lot more nuclear and a lot more solar, or they get LNG from elsewhere, but that's not, you know, a lot of Europe is very dependent on Russian gas.
Joe:
You know, one of the things that, and you talked about this a little bit earlier, is that with oil, there are multiple prices of oil, but they do tend to cluster. And so there's Brent oil and there's West Texas oil, and they're usually a few dollars apart, but they go in the same direction. The gas market isn't like that at all. I mean the gas, the price of what is it? Is cubic meter the standard?
Matt:
Yeah. Billions of cubic meter.
Joe:
Yeah. It's just completely different all around the world at any given time. And it's because it's so, as you described there, it’s so infrastructure specific.
Matt:
Yeah. I mean, not to like state the obvious, but one is a liquid and one is a gas and like liquids, it's pretty easy, you know, you can put them in barrels, you can put them on ships and gas is, you know, it's much harder to do that. And that's why the invention of liquefaction, which is where you turn the gas, you cool it and condense it into a liquid, then you can transport it on ships, was such a revolutionary technology because it meant that you could move the gas all over the world, but, you know, until that happened, and even then, it's still expensive to do that. Pipelines is the way you did it. I mean, prices of natural gas in the U.S. have been so much lower than in Europe and Asia for a long time, because we have a lot of gas in the U.S. and we have pipeline infrastructure that can transport it, but it's very difficult to send it over to places that don't have the pipeline. Sending it across an ocean is very expensive.
So there is a lot of liquefaction capacity in the U.S. There is a tremendous amount of liquefaction capacity that's currently been approved, but has not yet been built. If it does, the U.S. would be able to more than supply Europe and Asia with gas, and in theory, but, you know, it's expensive to do that. I mean, all the transportation costs is why the price differentials are so huge. So even if the U.S. producers are responding the way you think they would given market signals, where like, if the price of gas, is whatever, I don't know, like six times or more whatever in Europe than it is in the U.S. And they are responding to that, but, you know, there are sort of hard physical limits and you could, you know, until the liquefaction capacity builds up a lot, until the import terminals on the other side build up a lot, you know, that price differential's going to exist.
And that's why Russian gas always had appeal. Europe has pipelines to gas from North Africa as well. And and from, you know, the North Sea and stuff. So they do get other pipeline gas, but a lot of it comes from Russia. And so, I mean, it's going to be more expensive regardless, right. But LNG is always gonna be more expensive than Russian gas, but on the other hand if Russia is cutting off the gas, or if you don't want to be dependent on Russian gas, then that's a price worth paying. I mean, as Lindner would say, it's an investment in freedom. And so, you know, it's worth doing, but it is going to be more expensive.
Tracy:
So actually that leads into something else I wanted to ask, which is naturally this idea of Russia sort of leaning or looking more towards China because of the various things and pressures that are happening in Europe. So obviously Russia exporting more energy in various forms to China would appear to be an obvious option for it here?
Matt:
No, it would. I mean, but that sort of goes the other way, which is you'd need to build all the pipelines going the other direction. And so they could do that. They do have one pipeline, they call it the Power of Siberia and it runs into China and they do export pipeline gas to China, but the volumes are pretty small. So again, if you're looking at like 2019, which I think is sort of the most reasonable comp, you had like 75% of Russian gas going to the EU in 2019. And so China is a pretty small, I mean, most of China is gas. I mean, China actually has a lot of gas domestically and they get a lot of LNG, so they've definitely been trying to get more from Russia, but it will take a long time to put those pipelines together.
I don't know the exact timeframe of how long it takes to build these things, but like, I would not be surprised if the time it takes for Russia to build pipelines to China to substitute, you know, to fully divert all the gas that used to go to Europe probably would, it's probably comparable timescale, like building out the capacity for Europe to get LNG from the rest of the world. So I don't know, I mean, it's not gonna be kind of a fast thing. And of course, there's the fact that if Russia were to be doing this with China, it's in period where unlike, you know, before, Russia's a pariah statement, and as you said, they're not having access to all the Western oil and gas services companies that actually know how to do this stuff.
Because all these things were built, I mean, like Nord Stream and stuff, that was a joint venture with European companies. I mean they have technical knowhow in Russia, but a lot of it was done with, you know, European help. And so I'm sure China has the capacity as well because they have their own domestic gas industry and Russia has the gas industry for a long time. But I mean, to the extent that they would want help from anyone and that Russia has become pariah state, that would make it even, you know, comparatively more difficult for them.
Joe:
Well, the, the other element and thing I've been thinking about in this conversation is like, okay, Germany wants to spend a lot more build up, perhaps build terminals or other forms of energy infrastructure, other infrastructure. It's not a great time. I mean, it's not a great time to have to build setting aside the war specifically. It's not a great time to have to build anything physical, given the tightness in every commodity market and thinking about the metal that would have to go into new pipelines and the steel and the cement and everything else that'd have to go into a terminal. It sort of speaks to, I guess, the tragedy of having been so spendthrift for the last decade.
Matt:
Yeah. Thrifty. I mean it's funny because the Europeans have this phrase, which is so annoying. They talk about you fix the roof when the sun is shining and it's a good phrase if you think about it in the right perspective. But the way they always used it was, oh, you know, your economy is not actively contracting because we're not in depths of a global financial crisis. You should be doing budget austerity and paying down your debt, is how that was interpreted in Europe.
Joe:
So that's what fixing the roof is.
Matt:
In their view. Yeah. Fixing the roof being like lowering your debt to GDP ratio. And they talked about this all the time, you fix the roof when the sun is shining, so then you have the space to expand your debt to GDP ratio when things go bad. There's an obvious problem here, which is that you can't fix the roof if you're not spending money. Like, you know, what they literally did was not fix the roof when the sun was shining. And now that it's raining and they've saved a lot of cash, it's getting wet. I mean, I don’t want to over draw this analogy too much, they basically had an opportunity to do all these things when natural resources prices were low, when there was a lot of labor slack, when real interest rates were negative and they didn't take it, I mean real interest rates are still negative.
But other than that, I mean they completely missed this opportunity. I mean, I remember, I mentioned this in one of my research notes, it's really striking that the last time Russia attacked Ukraine in a really big way since early 2014, basically eight years ago, and eight years is a long time to make an adjustment. It just didn't happen at all. And I remember writing at that time, back when I was at Bloomberg actually, writing a piece saying, look like Russia's doing this, but long term, they're not in a great strategic position because Europe always has the option to diversify away from Russian gas. And then Russia has no leverage. Ironically, they didn't do that. But I mean, it's not like no one was talking about this back then. So they just missed their window and now they're trying to do it. And you know, as you said, now they're doing it at like the worst possible time because they're being squeezed and you know, it'll get done eventually, but it's really striking how they sort of miss the focus on the sort of financial savings and not on the fact that, you know, there's some things that are worth doing that should have been done. At some point you’re gonna do it anyway as you need to it. But you know, if you have a chance of doing it when things are cheap, that's the best time to do it. And they missed that window.
Joe:
Well, before we go -- and that was fantastic -- Obviously we've talked a lot about the energy linkages, but you just before we get out, you know, you've also written a little bit about the financial linkages and the various exposures that Europe, Germany had to Russia, all of which are now almost, you know, some of these, the value of these assets and relationships might in many cases simply go to zero. But how big are we talking about here for some of the non-energy connections?
Matt:
There's a lot of trade and financial links between Europe and Russia. And I mean, it makes sense. Russia is a large country. It's Europe's neighbor. That's sort of, you know, what you'd expect to have happen. Probably a lot of that's gonna go to zero, there's gonna be an economic hit. And I think one thing, one of the reasons I initially had been, I wouldn't say skepticical, but I was not sure that that Europe would be willing to kind of put in place the kind of sanctions that we've ended up seeing is because there is a corollary here, which that there's gonna be a real hit to European businesses, both businesses that export to Russia and to banks that have relations with Russian businesses. And so, we're talking in like the hundreds of billions of dollars in terms of potential losses here.
I mean, that's definitely manageable for an economy that’s the size of Europe and you know, again, to use Lindner’s phrase, it's an investment in freedom. So it's worthwhile to bear that cost, but it is significant. I mean, you have something like, in total global banks, which is global banks in practice, basically means U.S., UK, EU Japan, something like $150 billion of exposure to Russian borrowers, that's probably gonna mostly go to zero. I mean, the good news for them is that a lot of that exposure is through local subsidiaries. And in practice what that means is that it's Russian deposits and Russian, you know, bank bond holders, and other Russian banks that are gonna take a lot of that hit, although not all, but a bunch of it. You know, the exporters are going to get hit pretty soon.
I mean, Russia imported about $370 billion worth of goods and services from the rest of the world in 2021. The majority of that is from countries that are sanctioning Russia. So that's gonna be hit. Again, we're talking about a very large economies. So, you know, in the aggregate, it's not gonna be a huge hit, but it's gonna be notable. And of course it's gonna have, you know, multiple supplier effects as those business customers, you know, react to lost sales. So there is a hit to be taken. I mean, I think Russia was counting on these kinds of relationships preventing any kind of thing in the past. I mean, that's what happened 2014, right? Like they did something that everyone said was illegal and horrible and then nothing really happened -- I mean, things happened, but it wasn't significant the way that we're seeing now.
And I think quite frankly, if it hadn't been for the fact that the Ukrainians fought back and are still fighting back, I think there's a decent chance that Europe probably would've rolled over because you know, what would've been the point, right? From their perspective. The fact that it's now actually still a live question, I think is a lot of what's motivating this and people's willingness to, you know, bear that economic pain -- because it is real. And I think obviously if you're looking at the rest of the world globally, not to point figures at other countries, but you can imagine other countries that might be thinking potentially about invading some of their neighbors at some point in the future and wondering about, you know, how those economic linkages, will they protect them or not from Western responses. But I mean, you know, I think Putin was not crazy for thinking that this would not have happened, you know, because of those links, but at the same time, I think like, it is, you know, you do something like what he did and you see the response, I think that that it's not surprising that there's been this sort of very strong pushback and willingness to take these kind of losses.
Joe:
Well, Matt, thank you so much for coming on Odd Lots. I learned a ton from that. Very, very useful conversation.
Tracy:
Yeah, that was great.
Matt:
Thanks very much.
Joe:
You know, I always learn a lot talking to Matt and following him on Twitter and reading his newsletter. One thing that just really strikes me is he has such a good command of like the data. So a lot of, you know, it's in addition to just sort of like the theoretical big ideas, he really knows the numbers behind all of it, which is one we reason it's great to talk to him.
Tracy:
Yeah. Also, I didn't realize he had, , such historical knowledge of oil and gas pipelines. So that's always fun to discover. Yeah. But I mean, I guess I'm trying to think like what the big takeaway here is. I mean, I guess it does seem like even before the recent crisis Germany had changed some of its attitude towards fiscal spending, you know, similar to other governments in the wake of the pandemic, there seems to be a greater acceptance of spending on social systems and infrastructure and things like that. And this would seem to be something that's going to ramp that up. But at the same time, guess the offset of all of this is we're sort of talking about building up supply chain independence, energy security independence. It does feel like we're sort of, this is such a cliche, but it does feel like we’re moving away from that interconnected globalized world previously.
Joe:
You're right. It is a cliche and people talk about it a lot, but here you do have this like very sharp break and it's, you know, it's very hard. And we talked about this in our sanctions episode where even if the formal sanctions lift, it's very hard to imagine. So many of these other ancillary actions, particularly the corporate announcements, reversing. It's very hard to see, you know, Germany reversing on its plans to invest in domestic energy or increase its military. So there are a lot of actions that have been taken that, you know, we are going to be pushing ourselves into a new direction that even two or three weeks ago didn't seem very likely.
Tracy:
Yeah. And then the other thing I'm thinking about just in terms of things that didn't seem very likely two or three weeks ago, and maybe now are, is of course restarting the nuclear plants in Germany. Yeah. Because it does... Yeah, go ahead…
Joe:
I was just going to say, you know, the sort of bigger picture, the big picture thing to me was that phrase as Matt, put it, fix your roof when the sun shines. But then the question is, what is your definition of fixing the roof? So if your definition of fixing the roof is just getting your debt to GDP ratio back below some number, then it's like, okay, great. Your economy's booming, cut spending. And then the number's there, but you would hope, or you would think that maybe fixing the roof could mean something like, well, having a more sustainable energy mix, having a more sustainable domestic infrastructure and so forth. And it really is costly. And maybe it something that we have to talk about more in the context, even of U.S. infrastructure spending, which is going to go up a lot. It's like we're doing all this at a time when commodity prices are booming. Every single day I look up at the terminal and commodity prices are soaring. This is going to be much costlier from a real perspective, more difficult, more time consuming, because we're now in an era of tight commodities, it would've been much easier in a period when so many of these commodity markets were structurally losing
Tracy:
Well, totally. But it also feels like, I mean, the message certainly from the Biden administration has been that the solution for high prices is investment. And so, you know, if you want to get away from that, you're gonna have to invest and the timing's terrible and yeah, maybe we should have done it earlier, but you kind of have to do it now. Otherwise it's just gonna get worse, but it does feel like there are no easy solutions. Again, another cliche I am all about cliches today apparently.
Joe:
Yeah. That's okay. But no, I though that was great. And just the whole world, I think, you know, we want to do more, there's so much to do, I think, on energy specifically this year. Like all the different questions about LNG infrastructure alone is so fascinating. We need to find someone who can like really get into the business of, okay, energy prices might be six times in Europe, what they are here, but you don't have the infrastructure to move it because of liquefaction capacity because of terminal capacity, huge opportunities for someone. And it's just a question of like who and what is the timeframe
Tracy:
Also pipeline historians get in touch, because I'm very curious about, you know, the decisions that go into building these things, how long it takes to reverse or alter course. I think that's gonna be a pretty important thing going forward.
Joe:
Totally:
Tracy:
All right. Shall we leave it there?
Joe:
Let's leave it there.
You can follow Matt Klein on Twitter at @M_C_Klein.