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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.

Ukraine is awaiting a run-off in its presidential election to be held on February 7th between leader of the opposition Viktor Yanukovych and current Prime Minister Yulia Tymoshenko. The winner will succeed President Viktor Yuschenko, who is leaving office with an approval rating in the low single digits, a dramatic fall from grace for the leader of the Orange Revolution. His successor will inherit a country in crisis: economically, financially and existentially. This election could not be more important for Ukraine's future.

Yuschenko's presidency was an utter failure. Granted, he had little domestic support, as his current prime minister (Tymoshenko) is also his fiercest political rival. But his economic record has been dismal in response to the Ukraine's crisis, sacrificing his early achievements in attracting FDI and cutting unemployment. While he has succeeded in turning Ukraine away from Russia and set the country on a path towards European integration (WTO accession, a promise of future NATO membership and negotiations over an FTA with Brussels), he has also presided over near-annual gas wars with Russia that threaten Europe's supplies, a total economic deterioration (GDP contracted about 15% in 2009) and non-observance of key conditions to Ukraine's $16.4 billion IMF program. This led the IMF to suspend its fourth disbursement or $3.8 billion, leaving Ukraine on the brink of default. Yuschenko also managed to swing public opinion decisively against NATO and EU accession, undermining his key foreign policy successes.

Conventional wisdom therefore interprets the current election as a repudiation of Yuschenko's pro-Western agenda, with the two leading candidates representing a more Russia-oriented foreign policy in the years ahead. But according to Samuel Charap's recent article in Foreign Policy, this assumption overstates the degree to which either Yanukovych or Tymoshenko will turn to Russia. Neither candidate is a 'pro-Russian stooge,' even Yanukovych, who according to Charap did little to endear himself to the Kremlin during his stint as prime minister, even if he was the Kremlin's 'preferred' candidate the last time around. Further, the interests that back Yanukovych are heavily invested in EU trade, so one can expect a lot of pressure on the potential president to deepen Ukraine's economic integration into Europe. This is far more critical to Ukraine's future than the immediate prospects for NATO accession.

Tymoshenko's presidency would hold the most promise, as she is likely to fashion a commanding political majority that would leave her free to enact key economic policy reforms, most importantly the 2010 budget and energy sector reform, that would unlock the remaining IMF funds and set Ukraine on a path to recovery. She would also prioritize Ukraine's relationship with Russia, but in the interest of rapprochement, which is as important to Europe (see: gas) as it is to Russia. Thus, both candidates are likely to conduct a more balanced foreign policy, which would be in the interest of all parties. But economics will determine Ukraine's future, and neither candidate can afford to ignore the pressing challenges at home. Both the EU and Russia have a role to play in stabilizing Ukraine's economy.

One of the fundamental insights of IPE is that domestic politics matter as much in the international arena as they do internally. They either enable or constrain foreign policy decisions, and Ukraine's current situation highlights this perfectly. The EU/Russia dichotomy that Yuschenko spent so much time constructing has clouded our perspective on the current candidates and their impact on Ukraine's future, as Charap's article illustrates. Their presidencies will be dominated by jobs, energy and trade. Rapprochement with Russia is likely and welcome, but there are powerful interest groups in favor of further economic integration with the EU. This will check any drift eastward.

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

The NYT provides important context to the Swiss vote in favor of a constitutional amendment banning new minarets:

Of 150 mosques or prayer rooms in Switzerland, only 4 have minarets, and only 2 more minarets are planned. None conduct the call to prayer. There are about 400,000 Muslims in a population of some 7.5 million people. Close to 90 percent of Muslims in Switzerland are from Kosovo and Turkey, and most do not adhere to the codes of dress and conduct associated with conservative Muslim countries like Saudi Arabia, said Manon Schick, a spokeswoman for Amnesty International in Switzerland.

The Lede looks at the reaction around Europe.

European leaders are gathering in Brussels to appoint their first permanent president and foreign affairs high representative under the Lisbon Treaty.

Belgian PM Herman van Rompuy is the favorite for the presidency, and the presumed German preference. A German-Franco consensus would all but decide the post.

The foreign affairs post is wide open, after British foreign minister David Miliband, the consensus favorite, ruled himself out.

Updates and implications to come...

The G20 summit in Pittsburgh produced a consensus that, while complacency is dangerous and risks remain, the worst of the financial crisis/global recession has passed us by. So, what's next?

-World Bank President Robert Zoellick on life after the storm.

-Marko Dimitrijevic argues that the term 'emerging markets' is obsolete; the rising giants have arrived.

-Quickly shift your gaze from Germany to Ireland, where a hugely important re-do will affect Europe for decades to come.

-A sterling slide is good for Britain.

-Is China the developed world's new engine of growth?

- For those polled in OECD countries, universal health care gets good grades.

- Arguments for why Europe is a great place to visit, but it's better to live in America. I would add that surburban America may be more comfortable, but it's also more boring (i.e., not as good for young adults without families) and suburban sprawl has big downsides. I do think that his secondary point - that it's better to get rich in America, but be rich in Europe - is easier to defend.

- How the financial crisis has altered the relationship between China and the US. Good source of information, annoying font.

- Arsenal is off to a good start, but haven't really been tested thus far. Watch out for Burnley, though....

Le Monde has produced this little interactive map showing the outcomes of the recent European Parliamentary elections (warning: c'est en francais).

Electoral participation ranged from a dismal 19.6% in Slovakia to a whopping 91% in Belgium. The average, however, was closer 40%. For analysis, see The Economist's article here.

The FT identifies 30 'Eurostars' who wield and influence power in Brussels.

-Last week, Michael Skapinker wrote a piece in the FT entitled 'Britain's years of progress were no illusion.' It remembers 1970s Britain and asks us to retain a little perspective on the tremendous progress of the past three decades (in Britain and beyond).

-The NYT looks at the likely response of the US credit card industry to regulatory reform.

-Brazil and China will begin using their own currencies in official trade transactions, accelerating an intended shift away from the dollar by two of the world's (emerging) economic powers.

-How the Russian military (and pop stars?) sees the country's energy diplomacy with Europe, set to song and dance. Funny, and frighteningly true.

-Say it aint so, Arsene.

Other, traditional media outlets will provide you with more comprehensive coverage of the G20 meeting in London. While a lot of bloggers would have you believe otherwise, newspapers still offer the best access, authority and overall coverage of events like the G20. I have no illusions to the contrary. So over the next few days, I'll instead aim to provide our readers with some of the more interesting, hilarious and overlooked anecdotes of this important meeting.

-It is fascinating to watch the public relations machines in overdrive ahead of the meeting: downplay the differences (US, UK), demand your red lines are met 'or else' (France, Germany), the other side just doesn't get it (Japan), mumble about the dollar to avoid taking a vocal stance on the most controversial issues (Russia, China), sit back and avoid the collateral damage (everyone else). Summits are always about image/message management, and unfortunately only rarely about radical or decisive action. As a colleague noted to me this week, 90% of a multilateral summit is completed before the principals even sit down at the table (sherpas do the heavy lifting in advance of the meeting itself). Each leader knows this, and thus positions him/herself accordingly ahead of the final communique, speaking directly to their domestic audience. The fact that such deep divisions are so publicly aired ahead of this particular summit suggests that there will be few major breakthroughs in London. Regardless of the post-summit rhetoric, increasing the regulation of hedge funds, while important, isn't going to solve any of our most immediate problems. Increasing IMF funding would occur with or without this meeting.

-The City of London was fighting back!! ahead of the protests, although I wonder how many are actually hanging around Bank and Moorgate after work this evening.

-Dan Drezner's April Fool's Day joke would be a lot funnier if it wasn't so, sadly, improbable.

-For two leaders with a chilly relationship, Merkel and Sarko have forged quite the formidable alliance at this summit. This front was built on tax havens in Europe and seems to be carrying through quite strongly to global financial regulation.

-Sarkozy, in fact, claimed today that China was the main obstacle to a deal on global regulation, blocking a provision on...wait for it...tax havens (which, by relation, is an issue directly connected to hedge fund regulation). Who would have guessed that tiny alpine kingdoms, English Channel rock formations and tropical islands would collectively sink a summit? And does it not seem a little too convenient for China to be cast as the problem when such deep divisions exist between the US/UK and France/Germany?

The relative health of the Canadian banking system has been getting a lot of attention these days. Yves Smith notes with approval the "decidedly retro" nature of the system while referencing a NYT op-ed that praises "The Great Solvent North." On a bigger scale, the Europeans seem to have latched on to the success of Canadian banking system as a guide for banking reform - they may very well use it as a stick with which to beat the Americans over the head while promoting their new joint economic agenda for the G20. Finally, with the World Economic Forum recently ranking it the soundest in the world, the boys of Bay Street have become the envy of the global financial system.

It's easy to understand why. After witnessing the fallout from what happens when the world's largest banks leverage their assets 30-, 40-, or 70-1, some policymakers are positively drooling at Canada's cautious reserve requirements. And if it weren't enough that their levels of market capitalization now rival their major American counterparts, some of these cheeky Canuck banks are still making profit! In a recession!

So why have Canadian banks so far remained (relatively) insulated? From the NYT article:

The five major chartered banks, the few regional banks and handful of large insurance companies are all regulated by the federal government. Canadian banks are relatively constrained in the amounts they can lend. Canadian banks are required to have a bigger cushion to absorb losses than American banks. In addition, Canadian government regulations protect the domestic banks by limiting foreign competition. They also keep banks broadly owned by public shareholders....

Canadian banks are known to be risk-averse, and this has served them well. While their American counterparts were loading up their books with risky mortgages, Canadian banks maintained their lending requirements, largely avoiding subprime mortgages.... The big five Canadian banks... [have] survived the recent turmoil relatively unscathed.

Politique
-As the world limped into the new year, IPE Journal looked back at the defining political stories of 2008.

-Israel's Gaza operation entered its second week. A ground invasion is now underway to topple the Hamas regime and prevent further rocket attacks on Israel. The UN Security Council failed to reach a consensus position this weekend, despite an humanitarian situation characterized as "desperate."

-Czech President Vaclav Klaus assumed the rotating EU Presidency this week. After a widely praised and robust Sarkozy presidency, Brussels watchers are anxious that the "prickly" Klaus will undermine EU consensus on the financial crisis, climate change and, well, the EU itself.

-The Chinese government moved to silence the signatories of Charter 08, a "wide-ranging blueprint for peaceful political, legal and economic reform in China." The crackdown reflects the deep anxiety carried by the Chinese leadership into 2009.

Economia
-Entering 2009 with much economic and financial uncertainty, IPE Journal looked back at the economic stories of 2008.

-Another price dispute between Russia and Ukraine resulted in the suspension of natural gas deliveries to Ukraine, with reports of growing shortages from Turkey to the Czech Republic. Both Moscow and Kiev are courting European support for their position in the dispute.

-Sterling neared Euro parity for the first time, a milestone that might spark a much deeper sterling sell-off.

The Rest
-Now more than ever, we need distractions. IPE Journal looked back at the cultural, sporting and down right random things that captured our attention in 2008.

-In the FA Cup, Arsenal go forward on a Van Persie brace, while Man City crashes out in spectacular fashion. Notable 4th round ties: ManU v. Spurs, Liverpool v. Everton.

-40 drunken passengers run "riot" on Cuba bound flight from Gatwick. "Drunk", "Gatwick" and "riot" are three words I am not surprised to find in the same sentence.

-The Obama's arrived in Washington...let the parties, galas and Republican exodus begin.

IPE Journal looks back at the people who, behind the scenes and often without great fanfare, shaped the events that defined 2008.

-Nicolas Sarkozy: Super Sarko got things done in 2008. His leadership (national, European, and international) exceeded that of any other world leader. His hyperactivity, once the subject of ridicule and criticism, drove European action and coordination in response to the financial crisis. His performance as EU president is universally praised, and let us not forget that it was his insistence that pushed Bush to call the G20 meeting in November (although Bush outflanked Sarko by calling a G20, not G8, meeting). Case in point: a critical EU summit, with Lisbon's revival top of the agenda, began on Thursday December 11th with heads of state and ministers hunkering down for marathon, weekend-long negotiations. A "three shirt" summit? Not with Sarko in charge. They were headed home the next night with compromises on everything from Lisbon to climate change to the financial crisis. The French president was big in 2008.

-David Plouffe and Howard Dean: Plouffe, Barack Obama's campaign manager, and Dean, the Democratic National Committee Chairman, orchestrated a 50 state strategy in the 2008 US Election (which Dean laid the groundwork for in 2006) that brought historically Republican states into the Democrat's column. Virginia, North Carolina, Indiana, etc. More importantly, Western states with growing, young and Hispanic populations have swung decidedly democratic. The national political map is now deep blue, and if history is any indication, it will be a generation before Republicans get it back. This strategy is as responsible as any factor for Obama's victory (just look to Iowa, where it all began).

-Lord Peter Mandelson: Mandy returned to Whitehall in 2008, drafted by his old friend turned enemy Gordon Brown (now frenemy?) to join the House of Lords and assume the business portfolio in Brown's cabinet. Mandy's impact on British politics and the government's response to the financial crisis has been substantial: he sits on 31 of 39 Parliamentary committees, has been Brown's point man for negotiations with the banking sector and auto firms and reportedly holds private meetings with the Prime Minister more than once a day. Also, Labour's internal revolt against Brown disappeared at exactly the moment Mandy returned. Coincidence?

-Kamal Nath: The Indian commerce minister/trade negotiator's "destructive intransigence" is blamed by many for Doha's collapse. He is praised by others for defending the interests of Indian farmers. Whatever your opinion of him, he made an inarguable impact on the DDA in 2008.

-Zhang Yimou: The Chinese filmmaker left an indelible impression on the world as choreographer of the Olympic opening ceremonies. The spectacular display marked China's "return" to the global stage and instantly made Yimou a hero in his homeland.

Natural gas negotiations between Russia and Ukraine collapsed Wednesday, with Russia preparing to cut gas deliveries tomorrow. This would be the second time in 3 years that Gazprom has cut deliveries to Ukraine over a price dispute, in turn threatening supplies to the EU. Ukraine is the EU's major transit route for gas deliveries, with over 80% of the bloc's external gas supply traveling over its territory.

The latest Russo-Ukrainian gas row is a reminder that despite the current (low) price levels, energy security remains a major issue, particularly to countries with heavy reliance on external supplies. It may also presage a more aggressive Kremlin in 2009, one that seeks to renegotiate gas contracts (particularly with former Soviet republics paying below market prices) with more frequency and adopts a less compromising position.

As Russia's budget comes under greater pressure, the rouble is devalued further (by as much as 10%, as many economists believe is necessary to account for the loss of petro/gas revenues, a cut the Kremlin has resisted with all of its will) and political unrest rises, the Kremlin will struggle to prop up the Russian economy. It will almost certainly turn to its energy leverage to plug the shortfall and boost spending.

Putin's authoritarian consolidation and economic nationalism have relied on a middle class complacency derived from petro/gas riches. The boom years were financed by the commodity bubble. Over this period the Russian government failed to adequately diversify, liberalize and modernize its economy. This made the Kremlin overly reliant on companies like Gazprom for tax revenues (and spending). Due to excessive state intervention and legal uncertainty, particularly when dealing with foreign investors, Russian industry became overly reliant on the Kremlin for finance and favor. What developed was an economy fundamentally underpined by high commodity prices. This house of cards was always vulnerable to a price collapse. Now that its here, the tight societal weave of Putin's Russia is starting to fray. It is unclear whether Putin/Medvedev are prepared to mend it.

Russia's resurgence has as much to do with oil and gas as it does with Putin. The major question for Russia in 2009 is: how does Putin respond?

IPE Journal looks back at the political events, people and trends that defined our world in 2008.

- The worst financial crisis since the Great Depression sets in motion a paradigm shift in global power and authority. The state reoccupied the commanding heights of the global economy through stimulus packages, banking nationalizations and automotive bailouts. The IMF regained relevance, and political fortunes were turned in response to the crisis. The G20 replaced the G8 (but for how long?), and the WTO sadly threw in the towel for 2008.

- Barack Obama was elected the 44th President of the United States in one of the largest electoral landslides in decades. He is the first African-American elected to the highest office. He quickly established a "team of rivals" cabinet, bringing together the best, brightest and (slightly) bipartisan to implement his foreign policy and economic agenda. This agenda will likely be defined by what has been called a "21st century New Deal".

- Russia invaded and briefly occupied much of Georgia. The conflict reasserted Russian influence in its "near abroad", exposed EU divisions over Russian relations and raised tensions over NATO expansion and US missile defense in Eastern Europe. It also exposed the real power dynamics in Russia, with Putin effectively orchestrating, commanding and negotiating throughout the conflict. However, by the end of 2008, the financial crisis would for the first time raise questions over Putin's rule as the country was forced to devalue the rouble and ripples of unrest began to sprout up.

- Parts of Africa continue their descent into hell. Kenya erupts, Somalia struggles, and Darfur is a humanitarian disaster. Fighting has resumed in the DRC with Rwandan support, and Mugabe has maintained his iron grip on power, squeezing Zimbabwe dry in the process. Mbeki left office in South Africa, paving the way for Zuma in 2009. The world now looks to Ghana in the final days of 2008, and hopes for a victory for African democracy.

- The Treaty of Lisbon, an attempt to streamline and bolster the EU, is rejected by Irish voters, temporarily killing the process. While certainly a setback for further European integration, Europhiles promise to continue holding referendums until the voters get it "right." A December summit laid out the blueprint/compromise for Lisbon's revival in 2009, and, for possibly the first time in EU history, ended with universal praise of a French president.

- Attacks in Mumbai: as of yet, not a defining geopolitical event since Pakistan and India worked hard to prevent the situation from escalating. Nevertheless, this is a potential touching-off point for the nuclear rivals in 2009. It also might (by design??) divert Pakistani attention away from fighting terrorism in the northwest tribal areas, and reignite violence in Kashmir. The implications of Mumbai are vast, and potentially destabilizing for the entire world.

- Israel, in response to repeated rocket attacks, and in advance of national elections, pounds Hamas and infrastructure in Gaza. The year's final week produced one its most explosive events, as the fighting in Gaza risks wider political instability and a humanitarian crisis in the territory. Many analysts believe that Israel's overwhelming aerial assault is an attempt to dictate a new truce with Hamas, but its military establishment is signalling that the shock and awe may be only the first phase in a wider operation aimed at removing Hamas from power.

***Co-written by Dave Hart

"Support for conventional modernization programs is deeply embedded in the Defense Department's budget, in its bureaucracy, in the defense industry, and in Congress. My fundamental concern is that there is not commensurate institutional support -- including in the Pentagon -- for the capabilities needed to win today's wars and some of their likely successors."

In an essay to be published in Foreign Affairs, US Secretary of Defense Robert Gates outlines his vision for American foreign policy. I purposely say foreign policy (as opposed to military/defense policy), because Gates wants to balance the Pentagon's institutional preference for grand, high end (low probability, high impact) projects with a greater capacity to fight unconventional, low-end (high probability, low impact) conflicts. For Gates, this includes a renewed commitment to the soft power America deployed so effectively during the Cold War. He is likely the first defense secretary in history to call for the defense budget to be cut in favor of greater funding for State.

I am a big fan of Gates. His vision, pragmatism and action have all helped repair some of the damage inflicted by Donald Rumsfeld. His call for the Pentagon to confront "inescapable tradeoffs and opportunity costs" is a refreshing alternative to defense spending under the Bush administration. As a former intelligence officer and head of the CIA, he seems to posses a higher level understanding of what American power is and how it must adapt to a dynamic and complex world.

Gates doesn't dismiss high end programs and his call for "balance" doesn't imply their scrapping all together. That would be crazy. But if he is serious about developing new US defense priorities and standards, he must extend his metrics universally and tackle the most bloated, strategically questionable and institutionally embedded programs. Unfortunately, he seems to exclude one very big conventional program: the missile defense shield.

His clear desire to temper the Pentagon's institutional preference for conventional modernization programs contrasts with his public support for the US missile defense shield. I believe the location of US missile defense installations in Eastern Europe is a strategic mistake. It is also irrelevant to the "wars of today". I'm sure his robust public support for the program is in part a power play directed at Russia. After the war in Georgia, the US has little direct leverage in the region. With the EU effectively ruling out a further eastward expansion, and the incorporation of Ukraine and Georgia into NATO too explosive an issue, the missile defense shield might be America's only bargaining chip in the region.

The importance of countering Russia in Eastern Europe and the Caucasus is clear. But the US has other tools in its diplomatic arsenal, and a little backbone by the EU would go a long way towards re-balancing the power dynamics. Which brings us back to Gates. The missile defense shield is exactly the kind of program Gates wants to move the Pentagon away from. If he simply applied his own metrics to the program, its utility in fighting "today's wars" would be evident. The question is whether the opportunity costs of the program, and the strategic costs of its location in Europe, justify its position at the top of the US defense/foreign policy agenda. In my opinion, it does not. Bob Gates is a terrific defense secretary. But he is wrong on missile defense.

Politique
-US President-elect Barack Obama unveils details of his "21st century New Deal". The Economic Recovery Plan is preliminarily based on 5 pillars: energy, roads and bridges, schools, broadband, and electronic medical records. Many, including prominent members of his own party, are becoming increasingly frustrated with his "there is only one president at a time" line, as the sitting President appears to have checked out while Rome burns.
-The terrorist attacks on Mumbai end, the Indian investigation expands, and at least 29 people die from a car bomb in the Pakistani city of Peshwara. Blame for the attacks has focused on Pakistan-based Lashkar-e-Taiba (the likely perpetrators), the Indian government (early warnings, poor response, failure to hold Pakistan accountable), and the Pakistani regime (failure/inability to address sources of terrorism and militancy within its borders).
-A deliciously intriguing affair in the British House of Commons has ignited a fierce debate over Parliamentary independence, opposition politics, and police powers. Meanwhile, Canada has its own legislative controversy to deal with (find Dave's take here).

Economia
-The US learned it has been in recession since December 2007 (something everyone but this guy has been well aware of) and lost 533,000 jobs in November, the largest jobs decline in 34 years.
-Angela Merkel grew increasingly isolated in Europe as French President Sarkozy unveiled a €26bn stimulus package. UK Prime Minister Brown and Sarkozy will meet in London on Monday to renew their call for a coordinated European stimulus.
-An historic week in European central banking: BoE cuts 100 basis points to 2.0% (lowest level since 1951), ECB goes with 75 basis points to 2.5% (its largest single cut ever), and Sweden slashes a record 175 basis points to 2.0%.

The Rest
-In the Prem: Arsenal continue form following famous win at Stamford Bridge, Liverpool stay top, and ManU and Spurs on track for Carling Cup final. In Europe: Cristiano Ronaldo wins Ballon d'Or, reveals he was "an inch away" from being a Gunner in 2003.
-This week in Japanese innovation: omelets with the Motoman SDA10.
-"Experienced bandits" steal €85mn in luxury jewels from Harry Winston store in Paris. According to Reuters, the heist occurred almost a year to the day of a similar $16mn robbery at the store.