Odd Lots - Matt Klein on How Germany Wound up So Dependent on Russian Gas

Episode Date: March 7, 2022

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.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. Tracy, you know, of course, 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 the 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. Right. And this is really, I don't want to say the crux of the whole.

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 and 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. There's a lot to say. There is an extraordinary bit to say. I guess one of the questions is why wasn't

Europe more prepared or why wasn't, why hadn't Europe already taken steps to perhaps wean itself off of Russian natural gas and oil and coal. 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. No, this is where I was going with it, actually, was that Putin has a really good grasp of the energy situation. It 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. 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 meaningful way, even though, as we discussed

with Zoltan Pozar recently, you did see Russia take steps to sort of insulate itself from the West. And of course, we're talking about Europe broadly, but there's obviously sort of a specific, you know, 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, you know, it's sort of taken some odd energy choices because this is a country whose leadership has taught. 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 it also, that means it's more reliant on coal, more reliant on gas. And maybe in the long term, it will one day be on 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 its dependence on Russia is acute. 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 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. Exactly right. So we want to like 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're going to be speaking with Matt Klein, is the founder and public. of the overshoot, which is a phenomenal newsletter on economics and the economy. And, of course, he is the co-author of the book, Trade Wars, Our Class Wars.

Matt Klein, thank you so much for coming back. Thank you very much for having me. So, you know, the last time we talked to you, I think maybe it was in 2020. And you had published this book, Trade Wars or Class Wars. And of course, you know, going back to 2020 and 2020, 20, 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, of course, but also this third actor, Germany specifically, what do you like talk about to us about like, what was their role in the story? Before we even get to the current crisis, why were they like sort of like a key player or actor to be understood in the sort of. of global context. 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 the shortfall of 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 and in terms of government policy, essentially overtaxing, underspending and squeezing demand for goods and services. And then that ended up redounding 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. And the argument of the book, 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 can 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. 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? 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, because the pandemic kind of distorts things a little bit, about 19% of all energy came from Russian imports. So that's 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 going to 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, some of which, one is, 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. and reliable locally sourced energy was shut off. And I think they basically, they're either about to, I think they had been currently scheduled, had been 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 of 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,

the call the energy transition, they have invested a lot in wind and solar power, particularly wind power, 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 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 is, you know, 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 Willie Brandt decided that they wanted, they called Austaolitic. 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 try to be more friendly to the USSR and the rest of the Warsaw-packed countries. And so one of the ways that that manifest 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 is 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 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 Russia, in fact, did, you know, the Soviet Union rather did, in fact, become, you know, more moderate over the course of 1980s. And that did become a, you know, constructive relationship. Nevertheless, though, as time progressed, that, 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. The 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 fuels or Germany had been in progress before that 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 have happened if European policymakers 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 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 that does create a lot of leverage. I mean, as you mentioned, Tracy, the pricing of natural gas is so high because the supply was already being constrained. I mean, I think one thing that isn't been appreciated enough, I was surprised to see it myself, is that until they stopped making their website publicly accessible, Gasprom, which is the Russian company that produces and transports the gas, they publish daily data on how much gas they shipped to European Union customers and by which route.

And the last data we have is the weekend before they invaded Ukraine. But 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 you've been going down kind of steadily, and by the time you get to the beginning of 2022, so like from January 1st through February 22nd, I was right before the invasion, we're talking about 36% lower deliveries to EU customers compared to the January through August 2021 average. So it was 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. And with the exception, 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 saying, like 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. A lot of short daily news podcasts focus on just one story. But right now, you probably need more. On Up First from NPR, we bring you three of the world's top headlines every day in under 15 minutes. Because no one's story can capture all that's happening in this big, crazy world of ours on any given morning. Listen now to the Up First podcast from NPR. What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example,

we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps. Listen to leading by example, executives making an impact. on the IHeart Radio app, Apple Podcast, or wherever you get your podcasts. 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, Anthony Blinken, several years ago, even wrote a book called Ally v. Eli, 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, you know, something I'm curious, you know, to sort of like bridge this. And I guess this is really the key question is, 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 nuclear, or sorry, do better on energy investments. And theoretically, they could have invested more in renewables or domestic sources of energy or LNG terminals that would have allowed them to become less reliant on Russia while still maintaining a balanced budget, whether that's wise or not.

But can you talk a little bit more about the sort of like 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? 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 East Germany into a new and large federal republic, there was a surge of spending both by the government and by businesses to make that transition happen. And you basically have the last great boom in the German economy for a decision 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, pretty dramatic reversal by the federal government in terms of spending cuts after a couple of years later, compounded by the fact that it turns out that, you know, a lot of the optimism that people had about ability to transform East Germany into a part of Germany that would be as productive as West Germany, that optimism was not validated for, well, ever enough for a very long time. There was a hope that a lot of East German businesses could be transformed. You'd get this huge boom from privatization and better management. That didn't happen.

You just had the government instead ended up taking a huge loss. They finally wrote it down in 1995. And then they basically spent a long period of time afterwards. There's a really nasty recession. All these people in East Germany losing their jobs. You have the high interest rates from the early 90s. 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,

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 investment. 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 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 of Gasprom and leading the Nord Stream 2 project. I think he might still be on it. Yeah, I think he's technically, as of right now, I think he's still which is kind of remarkable. Awkward. 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 it's Germany pretty hard, it's a global downturn, the tech bust that's not unique to the United States. And they can't. Ironically, you know, we think now to Germans being, you know, the major blocks on, you know, looser monetary policy and the ECB, the Germans being the major constraint on the ability for governments to borrow and spend in response to downturns because we have a remit.

the recollection of how things were in, say, 2010, 2011, 2012. But if you go to like 2000, 2001 or even 1998, that was the opposite, actually. The Germans were pressuring the ECB for looser policy because relative to their domestic needs, ECB was way too tight. And if ECB just, 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'd been getting from from Schroeder and from his finance minister Oscar 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 like severe downturn. And, you know, they sort of push for some modest exemptions to the budget caps. So they're basically the EU treaty that they'd signed in Maastricht and 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, it 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 they reminded him of the Trinity or something.

There's no economic significance to this. But it was a constraint. And so Germany and France, which are both having in a rough period, you know, downturns in early 2000, 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 these 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 going to lay off a lot of school teachers and cut unemployment benefits to a lot of people. That compared to, well, we're going to 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 of a federal system. And a lot of the spending is done by the German states or by local, even sub-local, you know, sub-stated local governments. And those were also subject to sort of a national constraint. And so they really are being pressured because they can't, you know, their ability

to borrow is very limited. And so they're going to cut investment spending much harder. That sort of the setup going in really for the, you know, the past 20 years. And, you know, the German government certainly did also cut, you know, 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 that they actually put in what's called the debt break or the Schulten Bremse. That was 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, you know, 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. and arguably, you know, significantly below where Germany should have been, then you sort of locked yourself in permanent stagnation. And that really limits her 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, you know, 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. basically some 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 the specific problem, but that's going to create problems all sorts of things.

You had bridges collapsing and roads being shut, you know, 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. So when it comes to spending, there is this percentage. out there that, you know, maybe it's something 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. 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, these cultural, I mean, I'm not saying culture doesn't matter, but I think it's very 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 that culture does one thing, and then later they do the exact opposite. And they say it's the same culture.

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 that they didn't really have much of a choice, you had the center left parties being the ones that actually were 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, 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, a majority left coalition, but in practice, that would never have happened because it was, you know, an opposition in existing policies. And so then you have, you know, 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 Merkel, uncle, uncle who becomes prime chancellor at this point in time, you know, she basically neuters the opposition for what felt like a generation because she's like, oh, yeah, this was great. The stuff 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 the social Democrats have a really hard time competing. In fact, what ends up happening for many years is that they just keep outlying as junior partners with the Christian Democrats.

And so you have the two biggest parties at 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 amongst 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 is 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 ally with the Greens and maybe the left and some sort of reconciliation that didn't end up happening because they didn't want enough seats or what ended up happening was ally 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 see 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. They didn't seem to mind. It was basically the way the Germany's debt rules work is that if you have a, you know, a sort of segregated government enterprise that does its own, with its own

budget, as long as it doesn't take money from the state because it's losing money, you 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 with 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 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 SDP, which for, excuse me, SPD, for a long, 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, Schultz, who's the current chancellor, he was the finance minister in the previous government, you know, from 2018 through 2021. And while that was, he was in charge there, actually investment did go up. It was the first time that investment net appreciation was positive. So there was already kind of a positive setup here. And people saying we need more investment. There was a recognition of the Germany that need to change. The business groups in Germany were saying there need 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, it took 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 Austin politics is thrown out the window, which was, you know, the Social Democrats creation, you have a situation where the FDP, which again, known for really strict, you know, 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 Linder, 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. I mean, I don't, you know, how it gets spread out over time is a little ambiguous, but you add that with the fact that Schultz committed to spending at least 2% of GDP on defense, which is Germany's, you know, obligate. under NATO, but for many years, they've been spending like 1% of GDP on defense. Because, again, if you're feeling budget constrained or someone like Aguilar 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 was that the Bundeswurst lost so much capability.

You hear all these stories of how they couldn't do anything. And like there was some German army intelligence guy who was stuck in Ukraine. He had to get like a 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 are 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, you know, is a lot different than, you know, what they'd been thinking in that needs a response, which incidentally is consistent with a history of many other countries where, you know, national security risks lead to radical changes and domestic investment.

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, like this is like a core thing for them, right? Like they were like a prime mover against nuclear for decades, I understand. Do you think that, like, you know, there's going to be some, I don't know of like, you have specific views on sort of like German energy policy down to the mix. But, you know, it seems unrealistic that anytime soon you're going to have solar and wind really

do all the lifting, especially in the lack of like, with the lack of like utility grade battery tech. Do you sense any meaningful change on that front? 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 to, 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 been known for being anti-nuclear for a very long time.

However, they also, and this is actually 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 emissions, carbon emissions record has been among the worst in any rich country precisely because they turned off the nuclear plants. substitute with coal. So I think that, you know, the Greens can read this just as well as anyone else. I think they know this. Again, the Greens have been the, but 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, ideological links or the oil, the gas pipelines, or supporting business interests of, you know, selling manufactured goods to Russia. So they, they've

always been the most, you know, 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 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. I think that we're seeing that. I mean, also, as you mentioned, like in the short term, you know, solar and wind are great, but they're intermittent. And so you need something that's staple. And, you know, it's either going to be coal or gas or nuclear. And, you know, of those three, I mean, nuclear is clearly going to be

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Make us part of your weekend routine on Bloomberg television, radio, and wherever you get your podcasts. What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really, acknowledge where you don't and find people who can fill those gaps. Listen to leading by example, executives making an impact on the IHeart radio app, Apple podcast, or wherever you get your podcasts. 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 a sort of big question mark over whether or not that can, A, continue given that 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? 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 are 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, I certainly would be a reasonable way of interpreting, you know, how things are plowing out. You know, but then there's a question of how you deal with that. I mean, as I said, I mean, the good news is that winter is 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 sort of hope that things get resolved one way or another before next winter. That is definitely a tricky question.

I mean, 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 Qatar. Gas 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 could have rerouting of LNG. I mean, there's a world where Australian and American LNG is rerouted from Asia to Europe, but then that 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. 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 have 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 have meant that Russia could have sent gas to Germany directly and bypassed. 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 Poland, Czech Republic, Slovakia, Austria, the Baltic states, Hungary, Romania. Those all depend on gas coming from Russia and then some of that gets rooted to Germany, but if it all went to Germany directly, 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 a dependent. We're now in a situation where at the moment you're actually having gas being rooted from those countries to Ukraine. A lot of the pipelines run through Ukraine. It had been the case that the Ukrainian government made a decent amount of, earned a decent amount of hard currents of 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.

And so you're having gas being sent the other way so that, you're having gas being sent the other way that Ukraine can keep the, you know, the power on. But yeah, I mean, it's a, it's a, it's a, the, the situation with gas and Russian, you know, energy security is a significant problem for all of these, all of Europe, really. It's basically you have to, you have to go either as far west as places like France and Spain or north to like Sweden and Norway for it not to be an issue. And in those countries, they have a lot more hydropower and a lot more nuclear and all more solar, but that's, you know, or they get LNG from elsewhere. But that's not, you know, but that's a lot of Europe is, is very dependent on Russian gas.

You know, one of the things that, and you talked about this a little bit earlier, is that, you know, 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 price of, what's that, cubic meter? Is that a standard? Yeah, billions of cubic meter. Yeah, it's just completely different all, it's just completely different all around the world. given time. And it's because it's so, as you described there, it's so infrastructure specific.

Yeah. I mean, not to like be sort of 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 like gases, you know, it's much harder to do that. And that's why, you know, 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, and you know, it's still expensive to do that. Pipelines is the way you did it. I mean, natural gas in the U.S. prices of natural gas in U.S. are 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 a pipeline infrastructure that can transport it.

But it's very difficult to send it over to places that don't, you know, 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 liquidation capacity that's currently been approved, but it has not yet been built. If it does, the U.S. would be able to, more than supply Europe and Asia with gas in theory. But, you know, it's very expensive to do that. I mean, all the transportation causes why the price differentials are so huge. So even if the U.S. producers are responding the way you think they would to market signals, where like the price of gas, whatever, it's on it, like, six times or more or 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 can, 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 is going to exist. And that's why Russian gas always had appeal. Europe has pipelines to gas from North Africa as well. And that's, 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 the LNG is always going to be more expensive than Russian gas. But on the other hand, 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 Linder would say, it's, you know, it's investment in freedom. And so that's, you know, it's worth doing. But it is going to be more

expensive. So actually, that leads into something else I wanted to ask, which is naturally this idea of Russia's 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. Yeah, 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 EU in 2019. And was not. And so China is pretty small. I mean, most of China 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 and put those pipelines together. I mean, basically, I don't know the exact time frame of how long it takes to build these things, but 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, I would not be, it's probably comparable time scale, like building out the capacity for Europe to get LNG from the rest of the world.

So I don't know. Like it's, I mean, it's not going to be kind of a fast thing. And of course, there's the fact that if Russia would be doing this with China, it's at a period where, unlike, you know, before Russia is a pariah state. And as you said, they're not having access to all the Western oil and gas services companies 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. That's where a lot of the, I mean, they have technical know-how 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 a prior state, that would make it even, you know, comparatively more difficult for them. Well, the other element, the thing I've been thinking about in this conversation is like, okay, Germany wants to spend a lot more and build up, perhaps build up terminals or other forms of energy infrastructure and 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 markets and thinking about the metal that would have to go into new pipelines and the steel and the cement and everything else that have to. to go into a terminal. It sort of speaks to, I guess, the tragedy of having been suspended for at least the last decade. Yeah, thrifty, yeah.

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 the depths of a global financial crisis. you should be doing budget austerity and paying down your debt is how that was interpreted in your So that's what fixing the roof is. In their view, yeah, fixing the roof being like lower your debt to GDP ratio.

And they talked about this all that. Like you fixed the roof and the sun is shining. But so then you have the space to expand your debt to GDP ratio when, you know, 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 then now that it's raining and they've saved a lot of cash, it's getting wet. I mean, if I don't ever draw this analogy too much. Like, I mean, 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, It was in early 2014, basically eight years ago. And eight years is a long time to make an adjustment. And 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, Russia is doing this, but long term, they're not in a great strategic position because Europe always says 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. They just missed their window. And now they're trying to do it. And as you said, now they're doing it like the worst possible time because they're being squeezed.

And it'll get done eventually. But, you know, it's really striking how they sort of miss the, you know, 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 going to do it anyway because you need to do 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 miss that window.

Well, before we go, and that was fantastic. Obviously, we've talked a lot about the. energy linkages. But just before we get out, you know, you've also written a little bit about the financial linkages and the various exposures that Europe and Germany have 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? 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 happen. That is probably a lot of that's going to go to zero. There's going to be an economic hit. I think one thing, one of the reasons I initially had been, was not sure. I wouldn't say skeptical. I was not sure 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 is that there's going to 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 business. 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 lenders phrase, it's an investment in freedom. So it's worth, it's a worthwhile to bear that cost. But it is, but it's significant. I mean, you have something like in total global banks, which is global banks in this, in practice basically means U.S., UK, EU, Japan, something like $150 billion of exposure to Russian borrowers. That's probably going to mostly go to zero. I mean, the good news for them is that a lot of

that exposure is through local subsidiaries. And so in practice, what that means is that it's Russian depositors and Russian, you know, bank bondholders and other Russian banks that are going to 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 going to be a hit. Again, we're talking about a very large economy. So, you know, in the aggregate, it's not going to be a huge hit. It's going to feel going to be notable.

And, of course, it's going to have, you know, multiplier effects as those businesses, customers, you know, react to the lost sales. So there is a hit to be taken. I mean, I think Russia was counting on this, 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 like we're seeing now. I think, quite frankly, if it hadn't been for the fact that, that the Ukrainians fought back and are still fighting back, I think there's a decent chance that Europe probably would have rolled over because, you know, what would have 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, you know, point figures in any 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, whether protect them or not from, you know, Western responses. But, I mean, you know, seeing this is, I think, 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, once you do something like what he did and you see the response, I think that it's not surprising that there's been this sort of very strong pushback and willingness to take these kind of losses. Well, Matt, Matt Klein, thank you so much for coming on Oddlods. I learned a ton from that very, very useful conversation. Yeah, that was great. Thanks very much.

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's 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, like, who really knows the numbers behind all of it, which is one reason that's great to talk to him. Yeah. Also, I didn't realize he had such historical knowledge of oil and gas pipelines. So that's always fun to discover. Yeah. Yeah. But I mean, I guess I'm trying to think like what the big takeaway here is. I mean, I guess like 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. of spending on social systems and infrastructure and things like that. And this would seem to be something that's going to to ramp that up. But at the same time, I 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 are moving away from that interconnected, globalized world previously, right? 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, you know, 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. it's 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, didn't seem very likely. 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 because it does, yeah, go ahead. 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 on

the sunshines. Yeah. It's very interesting. It's like, well, yeah, 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 is booming, cut spending, and then the number is 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 there's 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 commodity. days, it would have been much easier in a period when so many of these commodity markets were structurally looser. 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 going to 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 going to get worse. But it does feel like there are no easy solutions. Again, another cliche. I am all about cliches today, apparently. Yeah, that's okay. But no, I thought that was great. And just the whole world, I think, you know, I 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, like, you know, 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 time frame. 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 going to be a pretty important thing going forward.

Totally. All right. Shall we leave it there? Let's leave it there. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway.

And I'm Jill Wisenthal. You can follow me on Twitter at the stalwart. Follow our guest, Matthew Klein. He is the founder and editor of the overshoot. He is at M underscore C underscore Klein. Follow our producer, Laura Carlson. She's at Laura M. Carlson. And very sad news, we have to report.

This is Laura's last episode as our producer. She's returning to history. her true love of history. So very sad news. Laura, are you there? I am. I'm here. Can you say if you were, we're going to miss you so much.

We're going to, we're going to, it's unbelievable. This is devastating. We're going to miss you. You've been an amazing producer the last, I think. How long has it been three years? You've been the outlawed producer? Yeah, well, you know, in COVID time, it's actually been about two decades. So, yeah, just about three years.

Yeah, that's exactly right. What are you going to be doing next? As you said, I'm going back to my roots in history. I'm writing a book. I'm going to be doing some teaching and lecturing. Unfortunately, on nothing related to markets or anything like that, it's all culinary history. So good. Food history, stories of restaurants, those kinds of things.

So, yeah. You definitely got to be a guest one day. I would love that. I am there for that. Anytime you want me to talk food history on odd lots, I mean, it'd be the best combination of my various world, so I'm up for it. Great. We will definitely make it happen.

Thank you so much, Laura. It's been a real pleasure working with it. Thank you both. This has been great and a wild ride. Yeah. Well, we're definitely going to continue to follow your work. Everyone, even after this episode, she won't be our producer anymore. Follow Laura Carlson at Laura M. Carlson.

Follow all her work. Thank you so much, Laura. Be sure to follow the head of podcasts at Bloomberg. Francesca Levy at Francesca Today. And check out all of our podcasts here at Bloomberg under the handle at podcasts. Thanks for listening. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris.

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