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-George Soros on Greece and the Eurozone's inherent flaws.

-Kenneth Rogoff sees a wave of sovereign defaults in the years ahead (they tend to follow banking crises).

-There is an interesting debate at Free Exchange on the need for a European Monetary Fund.

-We cite Paul Krugman a lot of these pages; The New Yorker profiles the man and his politics.

-In the wake of another coup in Africa (Niger, this time), FP Passport asks, 'Why are coups always led by colonels?'

-In Olympics news other than US Hockey's epic beatdown of Team Canada (sorry, Dave), the NYT has an interesting analysis of the controversial (for Russians, at least) men's figure skating competition, explaining why American Evan Lysacek didn't need a quad to win gold.

I have been mulling a thorough post on the developing Eurozone sovereign debt crisis for the past two days, thinking of ways I could adequately present the necessary context, theoretical arguments and implications to the global economy. But in reading through Simon Johnson's coverage of the developments in Europe, I realized something: I can't possibly deliver a better analysis than he has. So instead of trying in vain to duplicate his efforts, I point you towards The Baseline Scenario:

-Johnson's first look at the situation asked whether US policymakers, specifically Tim Geithner, understood the risks posed by a European sovereign debt crisis to America and the global economy

-Over the weekend, Johnson looked at the likelihood of IMF involvement in Greece, the irrelevance of the G7 and the implications of European policymakers' dithering

-Today, Johnson, Peter Boone and James Kwak released their Revised Baseline Scenario for 2010, which includes a great treatment of the Eurozone's sovereign debt woes and its broader implications. This is a long post, but I recommend reading it in full for their 2010 outlook.

Markets rallied yesterday on signs the European big boys would step in and back Greece. ECB President Trichet rushed back from a trip abroad and there were rumors circulating that Germany, the only Eurozone country that really has the balance sheet and power to step in at this point, was constructing a 'firewall' of sorts that would stem any contagion from the Greek crisis. But Germany later denied any plans were in the works, which rattled investors again.

I suspect we'll get some official statements out of the ECB and Commission by the end of the day, hopefully laying out some concrete steps to resolve the situation. But if you believe Simon Johnson, it may all be too late.

Paul Krugman deconstructs the Spanish case and shows why: a) it's different from Greece, and b) how it reflects the Eurozone's broader problems.

- Facts and Myths about Greek's sovereign debt woes: this is one of the better pieces I've seen so far.

- Michael Arghyrou and John Tsoukalas argue for the creation of a "strong" and weak" euro, both managed by the European Central Bank, as a solution to the looming sovereign debt crisis in southern Europe. (possibly gated link, sorry)

- Spillover effects: as investors are betting against the Euro and possibly forcing EU governments to make some tough decisions (see below), they are simultaneously fleeing towards the safety of the US dollar. So long as the US can continue to borrow cheaply, they are less likely to be forced to make some tough decisions about their own problems.

- What if Google was a state-owned company in the Ukraine?

- Indulge yourself and set aside 12 minutes to watch this stunning video. On as big a screen as you can find. It's almost entirely computer generated (except the person, clouds and pigeons), and makes Avatar look like an etch-a-sketch drawing.

I apologize for the light posting of late. I've been preoccupied with some pretty heavy work-related stuff. But I want to devote much of this week to the developing eurozone crisis. A backgrounder will follow shortly, but to give you an idea of how serious the situation in Europe is, traders have taken over $8bn in short positions against the euro, the largest bet ever against the common currency.

That's massive, almost equal to the $10bn bet against sterling made by George Soros that 'broke' the bank of England in 1992 and ejected sterling from the European Exchange-Rate Mechanism.

The euro was supposed to be one of the big winners of the financial crisis; for the 'safety' it provided countries like Slovakia, for the credible external commitment its accession criteria provided countries like Hungary and Poland, and for its rise as a viable reserve alternative to the dollar. But all of the sudden the euro is confronted with its biggest crisis and I sense that policymakers will soon encounter a stark choice: explicitly back countries like Greece and Portugal or eject them from the common currency.

Stay tuned.

Fitch ratings has downgraded Greece to BBB+. See FT Alphaville for their reasoning.

“The Americans get the toys, the Chinese get the Treasuries and we get screwed.”

-In competing NYT op-eds, Nouriel Roubini and Anna Schwartz lay out the arguments in favor of (Roubini) and against (Schwartz) a Bernanke re-appointment.

-Funny difference a year (see: plunging output and investment) makes: foreign oil companies are suddenly welcome again in Russia.

-Balance of payments pressures + growing investor risk appetite = emerging market debt bonanza.

-While Russia's ticking demographic timebomb made the news this past weekend, Shanghai was hard at work fighting its own.

-Zsolt Darvas makes the argument for easing euro-area entry criteria.

- "The mood is going to be somewhat sober" at the Davos World Economic Forum this year, which starts on Wednesday. No kidding. In that vein, the WEF's opening speaker is someone not known for his overwhelmingly upbeat rhetoric: Vladimir Putin.

- John Hempton at Bronte Capital thinks we should stop fiddling around with metaphors and literally drop money from helicopters to induce inflation fears. Sure some people may accidentally die from the falling money packages, says John, but it might also induce consumer spending. Or, you know, cause foreign investors to dump all their US assets.

- A good discussion over at Free Exchange over whether the euro-zone is a modern day gold bloc - referring to the rigid constraints of the interwar gold standard that delayed economic recovery in 1930s Europe and beyond. The short answer is no, it is not. The takeaways:

"...because the break-up of the eurozone would involve unacceptable financial damage, the ECB and member governments are committed to the rescue of flailing national economies. Europe cannot allow Ireland or Spain to collapse, and so presumably, international capital will treat those states differently than they might Britain, which is stuck out there by its lonesome."

Moreover, the gold standard had no institutional equivalent of the ECB to help facilitate coordinated monetary easing - something that was a real sticking point. This doesn't mean the euro-zone is entirely in the clear, just that it has a set of challenges distinct from any historical precedent.

- Democracy woes from the pages of the WaPo: social unrest in Eastern Europe, and Bolivia's new constitution.

-From the Times of London: Fatah leader Mahmoud Abbas is claiming that he was President Barack Obama's first call to a foreign leader. How does he know? Well, Obama told him so. I was highly critical of then President-elect Obama's silence on Israel's operations in Gaza, so I will be the first to say that, if Abbas is correct, Obama has made a very welcome statement on his commitment to the peace process. Apparently, Obama's first round of foreign calls were to middle east leaders (Egypt, Jordan, Israel), signalling to many that the new US prez is serious about renewed US leadership in the region. On a related matter, in case anyone doubted the political considerations driving Israel's Gaza offensive, the pullout from Gaza was completed today, Obama's first day in office.

-Portugal became the third eurozone country in two weeks to be hit with a downgrade. S&P cut the country's rating to AA minus. According to the FT, the cost of insuring Portugese government bonds through credit default swaps has risen to a record high. The government quickly labeled the downgrade as "unreasonable." In the past week, S&P has issued reviews on 10 highly rated western countries, leading Wolfgang Munchau to ask"what if" a eurozone economy defaulted?

-Foreign Policy has published the Think Tank Index, developed by the IR Department at the University of Pennsylvania. It is advertised as the "first comprehensive ranking of the world’s top think tanks, based on a worldwide survey of hundreds of scholars and experts." Below, the top 5 US and non-US think tanks:

US--> 1. Brookings Institution, 2. Council on Foreign Relations, 3. Carnegie Endowement for International Peace, 4. Rand Corporation, 5. Heritage Foundation

Non-US--> 1. Chatham House, 2. International Institute for Strategic Studies, 3. Stockholm International Peace Research Institute, 4. Overseas Development Institute, 5. Centre for European Policy Studies

Minutes after posting my look at sterling and the prospects for Britain joining the common currency (see below), Nick Clegg steps out and validates one half of my conclusion: the debate will seriously reemerge during 2009.

In an interview with the FT, the Lib Dem leader echoes the main conclusions of the "10 Years of the Euro: new perspectives for Britain" report, arguing that Britain must join the Euro to "salvage the public finances and prevent the 'permanent decline' of the city." He believes public opinion could swing violently in favor of the euro should the pound's volatility continue in the face of the euro's relative stability.

“In that context of people just longing for clearer rules, for reliability, for stability, for certainty, you might just find that becoming part of the reserve currency on our doorstep might become part of the recipe . . . by which we put the British economy back together on a more sustainable footing.”

This is a bold position for the Lib Dem leader, sure to provide him with the spotlight in the days to come. Unfortunately for Clegg, his authority to influence such a decision is nonexistent. The Lib Dems occupy a seemingly permanent minority position and Clegg himself has failed to distinguish his leadership since succeeding Ming in 2007. The buzz in Westminster is that the Lib Dems are engaged in backroom negotiations with the Tories over a possible coalition government should the next general election result in a hung Parliament (conservative win short of a majority). But a Tory minority government would be an unlikely partner for the Lib Dems on Europe in general, and especially so on Euro accession.

Regardless of his or his party's prospects, Clegg has thrust Euro accession back into the British political discussion. I am eager to see how Brown and Cameron respond.

In the currency markets, the British pound has been one of the biggest victims of the financial crisis. It is down almost 30% against the USD over the past 12 months, and is hovering near parity with the Euro for the first time since the common currency's inception. The explanations are numerous: no horizon for the financial crisis, housing prices in free fall, fears of prolonged deflation, the BoE chasing the Fed, swelling deficits, etc etc etc. All the standard culprits.

While confidence in the UK economy, and currency, has been falling for some time (understatement of the year?), there is growing concern that a sterling run is imminent. Sterling fell below $1.40 today to its lowest level in over 7 years. Before paring losses in late trading, it was headed towards it worst day against the dollar since 1992. In a widely quoted interview, investor Jim Rogers summed up his thoughts on the pound, "I would urge you to sell any sterling you might have. It's finished. I hate to say it, but I would not put any money in the UK." Ouch. There is also speculation that the UK is facing a downgrade (Spain and Greece were downgraded last week, with Ireland and Portugal in the firing line).

In my opinion, this sterling pessimism is well-placed. Public sector debt is expected to balloon to more than 50% of GDP by 2011. The government just announced a second bail out of the banking system, a day after shares in RBS fell 66%, and amidst calls for a complete nationalization of RBS and Lloyds. While Brown has been more proactive than US policymakers in addressing the banking system (i.e. nationalization), he has yet to fully address the fundamental toxin in the system: bad assets. Until banks are compelled to fully disclose the steaming piles of crap they are sitting on, confidence in the banking system will remain nil.

So, if we are confronting a sterling collapse, what are the implications? Politically, Labour would be toast. Economically, a tiny boost to British manufacturing/exports would follow, but plunging consumer confidence and global demand would more than cancel this out. Financially, an already weakened City of London would see its influence as the global capital of finance (sorry New York) severely diminished. Fiscally, the government would find it increasingly difficult to finance its massive response to the crisis.

And what of the currency itself? One of the more interesting questions is whether a sterling collapse could lead Britain to reconsider the Euro. A group of academics, journalists, and politicians have revisited this argument in the report, "10 Years of the Euro: new perspectives for Britain". Organized by LSE Chairman Sir Peter Sutherland, and including contributions from LSE Prof and IPE Journal favorite Willem Buiter, the report argues that the country "should urgently reconsider the case for joining the single European currency". Buiter sums up his case succinctly, "It is time to revisit the five tests, to declare them passed and…for the UK to adopt the Euro." He dismisses the argument that an independent monetary policy is necessary for a country like Britain to respond to financial shocks, and discounts the effectiveness of exchange rate control by saying, "Even a gun fired at random by a drunk may, from time to time, hit the target. This is what we have seen in the UK with the exchange rate this past year."

Sutherland argues that Britain will lose its financial and regulatory influence under the emerging (re)regulatory consensus and eurozone fiscal convergence. His argument is essentially this: join the club and have a powerful seat at the table, or get left behind, powerless and throwing stones at the castle wall.

While Euro adoption may be in Britain's long term interest, is joining the Euro viable in the short term? I say no. Adopting the Euro would be political suicide for Labour, and it is unimaginable that Brown would risk his already shaky resurgence with such a bold stroke of statesmanship. The British also have an historic, deep attachment to the pound. Once the reserve and primary settlement currency under the gold standard, sterling's prestige is deeply ingrained in the British consciousness (nowhere more so than in the City of London). You could say it is the last vestige of the empire. And let us not forget that the Euro project itself will be under real strain in the coming year. Full and sustained eurozone fiscal coordination is anything but certain, and anti-Euro sentiment will undoubtedly rise in countries like Italy and Greece. Will the Euro enjoy the same credibility 12 months from now?

A lot of important questions. Luckily, sterling's decline guarantees that Euro adoption will return to the discourse in 2009. If the minds behind the report are correct, Britain should take a serious look at accession.

Picture Source: neftos

IPE Journal looks at the economic events that defined our socio-political landscape in 2008, the year of the subprime.

- In The Beginning there was Northern Rock - nationalized in February by the UK government following a good old fashioned bank run. Following heavy losses in the subprime mortgage market, Bear Stearns was next to go: in March, the once-proud investment bank was sold to JP Morgan for pittance. In July, IndyMac Bank went into receivership.

- September Madness. Over the course of a few short weeks, the magnitude of the crisis hit home (so to speak) as financial giants fell like so many martini-and-oyster fuelled dominos. The highlights:

• Freddie and Fannie are taken over by the US federal government
• Merrill Lynch is sold to Bank of America
• The Federal Reserve offered loans to AIG and took an 80% share in the company
• Washington Mutual is seized by the FDIC
• Morgan Stanley and Goldman Sachs become traditional bank holding companies, bringing the era of independent investment banks to a temporary close.
• And Lehman Brothers - in what now appears to have been a hugely significant decision, Lehman Brothers was allowed to fall into bankruptcy and the credit crunch prompty shifted into a higher gear.

- Keynes returns from the wilderness. The collapse in consumer demand has led governments across the globe to initiate fiscal stimulus programs. The sheer rapidity of this about-face in policymaking is breathtaking. We've come to expect such measures from the likes of France and Sweden, but from the UK, US and (gasp!) Germany? Keynes was wrong on many counts and his proclaimed followers even more so, but Keynes' insights on the role of government during economic downturns have gained a new lease on life. For better or worse, the impact of government spending programs and fiscal guarantees will be a defining feature of 2009.

- Price of oil $140 -> $40. A May 5th Goldman Sachs report predicted oil would break $200 within 24 months. Ok, still possible, but six months later the commodity bubble had burst in spectacular fashion and oil was trading under $40 a barrel. The explanations for the remarkable run up in commodity prices of recent years are manifold: historic emerging market growth, global demand, dollar weakness, financial speculation, etc. The price apex was as much about psychology as it was fundamentals, what Donald Rumsfeld would eloquently call the realization of "known unknowns". The "peak oil" moment came in the minds of consumers, politicians and traders across the world, only to be swiftly disregarded as global demand collapsed. Even repeated OPEC production cuts couldn't halt the slide into 2009. Commodity countries from Russia to Mexico are feeling the pressure, with devaluations and political instability on the way.

- Dollar down, up...down? It is awkward to speak of benificiaries of the financial crisis, but the US dollar was exactly that in 2008. By the end of 2007, there was a growing debate over whether the dollar had entered into a sustained relative decline vis-a-vis the Euro, with many concluding the common currency would soon eclipse the greenback's status as primary global reserve currency. The credit crunch had undermined confidence in the US financial system, and hot money ran wild through commodity currencies and emerging markets. But then financial crisis accelerated, and the commodity bubble burst, and investors sprinted to the safety of US dollar. It hit multiyear highs against sterling, the Euro, and a slew of emerging market currencies. Looking ahead, the outlook for dollar appears decidely weaker in 2009. The massive spending plans of Barack Obama and easy money Fed will weigh on the gains of the past year, especially vis-a-vis the Euro and Yen. But the dollar will likely retain its strenght v. emerging market currencies and sterling, as investors continue to find security in the greenback and the UK falls into the abyss.

Notable economic events which could have shaped the course of our year [Update: for the better], but failed: WTO talks & the G20 meeting in November.

***Co-written by Rory Doyle

A number of important developments in the global energy markets over the past few weeks:

-an IEA report finds that the world's oil output is declining at a rapid pace. The annual rate of decline is projected at 9.1% without a substantial increase in upstream investment. Even after recent investment, output from the world's largest oil fields is falling by over 6%. As my analysis of Russian energy production highlighted, an increase in upstream investment is neither easy nor probable. Falling global demand will only lessen the incentive to invest more in production. With little excess capacity, and OPEC voluntarily cutting production (potentially by millions of barrels of day more in the coming months), the global oil markets risk renewed volatility when demand recovers.

-Russia and China signed a landmark oil pipeline agreement on October 28th. The addition to the East Siberia-Pacific ocean trunk pipeline could ultimately carry up to 15 million tons of Russian oil to China per year. The agreement is significant on two levels: it signals Russia's desire to pursue the "China alternative", and it could portend a greater financial role for China in Russia's energy sector.

-finally, we might look back on October 13th as the beginning of a new era in European energy. The Times of London is reporting that the bloc will announce a European Energy Security Plan. The plan calls for: 1) the construction of a European supergrid, connecting power grids from North Sea wind farms to the Baltics, 2) the construction of two new gas pipelines, connecting Caspian and African gas to the bloc, and 3) a "Community Gas Ring", which would essentially allow for the pooling of European gas supplies in the event of supply disruptions. These measures will directly address import diversification (particularly in natural gas, and specifically away from Russia), security of supply issues, and fragmented national power grids.

This is a highly ambitious plan, and in my opinion, one that has absolutely no chance of being carried out in its entirety. The pipelines just aren't commercially viable yet. Furthermore, the national regulatory and interest-group challenges to EU-wide liberalization in the energy sector are formidable, and to date have blocked any substantive effort towards a single European energy market. The political will simply isn't there in France/Germany/Italy, and national interests always trump regional considerations in European energy. Despite my pessimism, the Plan is an important development, if for only one reason: it coincides with the resumption of talks between the EU and Russia over their economic and energy relationship. It looks like the EU may have finally come around to playing hard ball with Russia, and utilizing its leverage over Russian security of demand. Stay tuned for updates on these discussions over the coming weeks.