The Cutting Room Files, Part 7: Europe

| February 17, 2020
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After three years of drama, on midnight Jan 31 the Brits finally left the European Union. The next piece of the Brexit drama will be a decidedly non-European affair, instead being between a family debate between London and Washington.
 
Which leaves it to the European Union – now with 27 members – to attend to its own drama.
 
When discussing the challenges facing the European Union it is…difficult to know where to begin.
 
I guess it makes the most sense to start at the top. The European common currency – the euro – is a spectacular achievement, but unfortunately it was insufficient to the needs of binding Europe together economically. Because the union has no complimentary tax or banking regime, each country follows its own economic strategies. In most circumstances, the currency cannot adapt to changing economic norms, while for their part the various eurozone members lack the tools to fine-tune their systems with monetary tools.
 
In simple terms, at any given time some eurozone members are growing gangbusters and for-them-too-low eurowide interest rates spur overheating, inflation and asset bubbles, while others are in recession and for-them-too-high interest rates make growth impossible. On both sides eurozone members are left to experiment with less-than-fully-safe tax and banking policies which generate their own bubbles, recessions and distortions. Twenty years on, the much ballyhooded macroeconomic alignment the euro was supposed to bring about is further away than ever.
 
This has blown up most spectacularly in Greece. Thirteen years on on from Greece’s debt blowup, the country is still on the hook for over 339 billion euros in state debt, or 185% of GDP. A few horrific points of comparison:
 
  • In relative terms, this is roughly double the relative American debt load.
  • The total EU annual budget is just under 170 billion euros. The Greek economy is less than 2% of the total EU economy.
  • Nearly all of this debt has been offloaded by financiers, and is now directly held by European institutions or supported by EU payouts. In effect, the entire country is in receivership.
  • Under the best-case scenario assuming no funding crunches, no problems with the euro and no recessions in Greece or Europe, this receivership will run for decades. The European Commission does not expect Greece’s debt to drop below 100% of GDP until 2048.

 
It’s worse than it sounds. The EU’s selective and partial integration enables EU citizens to change residency (and to a degree, citizenship) with ease, so the top 5% of Greeks as regards wealth and educational standards shifted legal status, while less-rich Greeks have kept their legal status to maintain access to Greek transfer payments, but physically relocated to avoid Greek taxes. Greek politics are too complicated to call merely Byzantine, and for the most part have simply collapsed into a Greek tragedy.
 
Greece will never recover. Greece’s agricultural, energy, financial and industrial sectors are for all practical purposes, gone. Greece only continues as a state because the EU shells out money for it to exist. This is the price that must be paid for the euro to have any international credibility whatsoever.
 
As big as a problem as Greece has become, it is peanuts compared to Europe’s banking problems. While not nearly as bad as what passes for banking in China, in the EU banking is a de facto arm of state policy, with loans on preferential terms regularly being handed out to achieve this or that (un)official state goal.
 
In many cases there is at least something sane in mind, such as boosting economic activity or expanding infrastructure. Sometimes sanity gets stretched, such as when EU member states throw money to failing companies or help finance expansion into markets – whether geographic or product type – they probably should have stayed out of. And sometimes the loans simply go to purely political, even partisan, activities. Spin down to the regional and local levels and regional and local banks are regularly used by regional and local politicians of all stripes as personal slush funds.
 
While the details differ from country by country and year to year, it adds up to a banking sector so moribund, so overexposed to unrecoverable risk that EU’s sector-wide assessments of banking health suggest that if the top 300ish EU banks were located in the United States, that the FDIC would have closed down all of them.
 
The Europeans are notoriously squirrely about the specific numbers behind their banking crisis, using myriad statistical models and definitions as to what actually comprises a “bad loan” to make things look less dire than they are. But pretty much everyone with a pulse agrees that by far the worst of the problems are in Italy. Semi-officially, even with over a decade of debt write downs and government funds injections, Italy still holds about half of the total stock of bad loans of the entire eurozone. Officially, the figure peaked – using Italian numbers and definitions – at 360 billion euro in 2016. The real figure, is undoubtedly higher. Double? Triple? More? (My bet is on more, especially if you use American definitions and thresholds.)
 
Remember, the more local the bank, the more likely local politicians are to tap them for personal needs, and the mafia are quintessentially local “politicians.” For comparison, the U.S. subprime real estate market during the 2007-2009 crisis generated bad debt worth $600 billion – a figure that was remediated considerably by the liquidation of housing stock that backed all the bad debt – for an economy seven times as large. Even if you believe completely the Italian data (and, HA!) that makes Italy’s debt crisis at least triple that of US subprime. Use US definitions and we’re easily talking an order-of-magnitude higher.
 
At its core, many of Europe’s chronic problems come down to competitiveness. For all their vaunted educational systems, Europeans have a devil of a time translating high learning into high skills that generate economic activity. In part it is a legal system that strongly favors the old or employed over the young or unemployed. In part it’s an overly-burdened, overly-generous pension system that is a (the?) leading source of the political system’s legitimacy for the middle class. In part it is a tangled thicket of multi-level regulatory burdens. In part it is statism. In part it is protectionism. In part it is a rigormortized labor market. In part it’s an economic system that discriminates against new economic sectors in favor of state support for the largest players of old industries.
 
The competitiveness issue isn’t simply between Europe and the rest of the world, but within Europe as well. Much of this is policy, but much of it also reflects simple geography. Flat, well-rivered northern Europe can easily lay down roadways and railways and canals that quickly knit together major urban centers to achieve economies of scale. That’s simply not possible in the highlands of Scotland, Spain or Sicily. Put them all into the same regulatory space and lots of places get left behind.
 
The bottom line is no part of the competitiveness issue started up recently, and so meaningfully addressing it would be a horrifically painful multi-decade effort.
 
These are all real problems. Mortal threats even. But at least theoretically it would be possible to grow out of these problems. Generate enough economic activity for long enough and even the worst of banking disasters lose their sting, while infrastructure and industrial plant and educational standards in weaker geographies can be brought up to snuff. Buy enough time and maybe, just maybe, Europe can integrate itself to a point where the euro can be part of the solution rather than part of the problem.
 
Or maybe not, for Europe faces additional problems that rob it of the one thing it really, truly needs: time.
 
Birth rates started dropping in some of Europe’s more advanced economies as long as five generations ago, and in most cases slipped below replacement levels in the 1970s. Fewer children then, meant fewer young workers and consumers by the 2000s, means fewer mature workers and taxpayers in the 2020s, with mass retirements – and national economic collapse – coming within the single digits of years.
 
It is worse than it sounds. Europe’s current debt, currency and state spending crises are occurring before the mass retirements generate far larger debt, currency and spending crises. Soon most of Europe will simply be unable to support its ever-aging population while also carrying out other tasks necessary for the existence of modern, functional states whether that issue is education or infrastructure or health care or defense.

Of the EU states, demographics have already turned irrecoverably past terminal in Austria, Luxembourg, Portugal, Belgium, Germany, Italy, Estonia, Latvia, Lithuania, Poland, Malta, Slovakia, the Czech Republic, Hungary, Romania, Bulgaria, Croatia, and Greece. Barring historically unprecedented baby booms, Denmark, Finland, Ireland, Sweden, the Netherlands, the United Kingdom, Spain, Greece and Cyprus are less than 15 years behind (while not EU states, Norway, the UK and Switzerland fall into this second group). Few government policies are good at bolstering birth rates, and even runaway success wouldn’t generate a new crop of consumers for a quarter-century.
 
Obviously, demographic collapse has its own implications for Europe’s competitiveness crisis, but it also makes the Europeans far more vulnerable to global shifts than they otherwise would be. Having a population structure which is heavy on soon-to-be retirees means Europe today is currently heavy on mature workers. Such workers are productive, but they lack European consumers to absorb their production. The EU has in effect aged into an export union, one that is utterly dependent upon exporting its excess output to the rest of the world. Germany in particular is heavily dependent upon sales to China.
 
So long as the Americans are holding up civilization’s ceiling and absorbing scads of output, this works. But the Americans are letting the global system collapse. For the EU this is tragic – it exports upwards of half of its manufacturing output and imports roughly 90% of its oil and natural gas needs, this imminent shift is flat-out disastrous. Sure, fold in Norway and the UK and the North Sea and the numbers get a bit better, but remember, there were energy winners and losers in Europe before the UK left. Now the differences are far more dramatic.
 
There is no European economy without global integration. Europe simply cannot retreat behind the walls of Fortress Europe and wait for the storm to pass, yet neither does Europe have the military capacity, economic reach or political unity required to venture out and shape the world – or even its own neighborhood – to its needs.
 
Securing markets for sales or energy for purchase in a world without Order ultimately requires some sort of security policy. Not only has Europe proven incapable of crafting such a common policy, even if the policy existed on paper the EU couldn’t implement it. Defense spending across Europe as a percentage of GDP is at historical lows for all EU countries who are not on the border of the Russian sphere of influence, and the country who holds the vast majority of the EU’s long-range-deployable forces – the United Kingdom – is now more likely to be a competitor than a partner.
 
In times of economic degradation – in particular the sorts of broad-spectrum economic collapses that are on deck for Europe – governance tends to get dicey. The idea that the EU’s pan-governmental system will survive the economic collapses-to-come is, in a word, hyper-optimistic. Even now, in times of relative wealth and stability, democracy is failing in Poland and Hungary, while the far right is becoming politically respectable in Austria, Italy, the Netherlands and France. The political fringes in Germany – both left and right – have even odds of dominating the next national elections at the expense of the centrist parties which have ruled since the war.
 
This isn’t “just” about democracy, but instead a reminder that when the Continent cracks apart it doesn’t die, but is instead reinvented in ways many find problematic. Germany, France, Italy – just to name the historical experiences most Americans find graspable – have histories rich in, shall we say, creative governance when the economic road gets rough.
 
Put in that light, I’m almost tempted to ignore Europe’s “other” problems. Russia continues to push towards Europe’s eastern frontier while assiduously working to drive wedges between the Europeans and Americans on one hand, and between the various European nations on the other. Not far behind is Turkey, firmly in the hands of its own autocrat.
 
The two have teamed up after a fashion in both in the Levant and North Africa – most aggressively in Syria and Libya – to sow chaos, expunge European influence, threaten European energy supplies, and meter the flow of migrants to the Continent in order to extract concessions from Brussels, Paris and Berlin. It is working. Well.
 
For now.
 
This is an exceedingly dangerous game which willfully ignores both countries’ histories vis-à-vis Europe. Europeans are near-pacifists…until they snap, at which point they become anything but. Both the Russians and Turks seem hell-bent in recreating the conditions that would rekindle some serious European fire and fury. As locations directly adjacent to the Continent, this seems to me the height of inanity.
 
All of Europe – hell, all the world – should have been worrying about all these issues for years, but instead everyone has been obsessed with Brexit. All these issues existed before the Brits’ referendum in 2016. None have been addressed. All are worse. Perhaps the brightest silver lining from Brexit’s completion is Europe can again at least perceive these issues.
 
And yet there is something new under the sun. America is becoming a problem, and not simply in its fall into narcissistic populism. The UK was by far the most free-market member of the EU, and its presence alone bolstered the European Commission’s efforts to keep many of the EU members from their statist instincts. That’s gone. And since demographic decline has in essence demoted the EU to being an export union, the two trends are putting the EU directly into the Trump administration’s crosshairs.
 
This was probably inevitable. Now that US Trade Representative Robert Lighthizer is done with Korea  and Japan and Mexico  and Canada, and has at least put a pin in China talks for the time being, his attention has turned to the UK and the EU. Considering Lighthizer and Trump’s amply-earned reputation for using America’s command of global trade, transport, finance and energy as cudgels for use in trade talks, it isn’t an experience the Europeans will enjoy.
 
Individually these are all monstrous (lethal?) challenges. Put together, it would take a strong leadership with a strategic vision and popular support to survive them. But not only can I not recall the last time I heard the words “strong leadership” or “strategic vision” or “popular support” used to describe the European Union, the EU doesn’t even have an elected executive who might be able to rule by order in a crisis. Even worse, on anything important, each individual EU member state enjoys full veto power. The EU literally has the worst conceivable organizational structure for dealing with the soon-to-be future.
 
(Incidentally, the same organizational mismash which makes it impossible for the EU to truly address their many issues also makes it impossible for the Europeans to negotiate trade deals on anything shorter than a decade time frame. There will be no US-EU deal at all.)
 
That will leave the future less to the European Union, and more to its individual member states. Two are worthy of call out, with both meriting an entire chapter in Disunited Nations.
 
In most ways that matter, Germany is the poster child for what’s gone so hideously wrong.
 
Absolutely catastrophic demographic structure? Check. A geography woefully in appropriate to greentech? Utter dependence upon energy imports? Check. Almost comical dependence upon global markets for its exports? Check. Reliance upon Russian and Turkish cooperation for its economic and physical security? Check.
 
And that’s not even the big problem. It has always been an open question whether an American-led NATO could defend Europe from the Russians in a real war, but there has never been any doubt that NATO sans the Americans would have much of a chance. Failing to invest in one’s own security in today’s strategic environment is the very definition of blind and arrogant and stupid.
 
The award for most-blind, most-arrogant and most-stupid clearly goes to Germany, who has lectured the US both publicly and privately on how it should deploy its forces in the Middle East despite having a broadly non-functional military that Berlin is squeamish about stationing outside of Bavaria.
 
Of course, this isn’t entirely fair. Germany is squeamish about security issues for good, solid, historical reasons. But honestly that is now besides the point. Newer historical trends are about to wash away everything that makes modern Germany modern Germany. Chancellor Angela Merkel is likely the last meaningful leader of a unified, peaceable, wealthy, democratic Germany. The question for the next decade is, in what order with those adjectives break?
 
In contrast, in most ways that matter, France is the exception to everything that’s gone so hideously wrong in Europe.
 
France’s economy is statist – it defends its local markets from competitions both European and global. During the global Order this was a massive waste, but with the Order breaking down the French have the least distance to fall. France is the only European state not only boasting birth rates above replacement levels, but strongly so; it is the only EU state that can look forward to a meaningful consumer market both in terms of size and growth for decades to come.
 
France’s location at Europe’s western extremities means not only that France isn’t dependent upon anything the Russians or Turks control, but its proximity to North and West Africa even grant it a high degree of energy security. And with the Brits now gone from the EU, France is the only EU member boasting a military capable of independent, expeditionary action. It isn’t anywhere near enough to help Europe, but it roughly right-sized for the sorts of issues France will face.
 
While French voters are as fickle as their American counterparts, President Emmanuel Macron could well be the first leader of a post-European France. But regardless, he certainly will not be the last.

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