Europe's Geopolitics

The New Drivers

For the past two weeks, the focus was on the growing fragmentation of Europe. Two weeks
ago, the murders in Paris led to the discussions about the fault line between Europe and the
Islamic world. Last week, it was the turn of the nationalism that is rising in individual European
countries after the European Central Bank was forced to allow national banks to participate in
quantitative easing so European nations wouldn't be forced to bear the debt of other nations.

This is the week to speak of the political and social fragmentation within European nations and
its impact on Europe as a whole. The coalition of the Radical Left party, known as Syriza, has
scored a major victory in Greece. Now the party is forming a ruling coalition and overwhelming
the traditional mainstream parties. It is drawing along other left-wing and right-wing parties that
are united only in their resistance to the EU's insistence that austerity is the solution to the
ongoing economic crisis that began in 2008.

Two Versions of the Same Tale

The story is well known. The financial crisis of 2008, which began as a mortgage default issue in
the United States, created a sovereign debt crisis in Europe. Some European countries were
unable to make payment on bonds, and this threatened the European banking system. There
had to be some sort of state intervention, but there was a fundamental disagreement about what
problem had to be solved. Broadly speaking, there were two narratives.

The German version, and the one that became the conventional view in Europe, is that the
sovereign debt crisis is the result of irresponsible social policies in Greece, the country with the
greatest debt problem. These troublesome policies included early retirement for government
workers, excessive unemployment benefits and so on. Politicians had bought votes by
squandering resources on social programs the country couldn't afford, did not rigorously collect
taxes and failed to promote hard work and industriousness. Therefore, the crisis that was
threatening the banking system was rooted in the irresponsibility of the debtors.

Another version, hardly heard in the early days but far more credible today, is that the crisis is
the result of Germany's irresponsibility. Germany, the fourth-largest economy in the world,
exports the equivalent of about 50 percent of its gross domestic product because German
consumers cannot support its oversized industrial output. The result is that Germany survives
on an export surge. For Germany, the European Union — with its free-trade zone, the euro and
regulations in Brussels — is a means for maintaining exports. The loans German banks made to
countries such as Greece after 2009 were designed to maintain demand for its exports. The
Germans knew the debts could not be repaid, but they wanted to kick the can down the road
and avoid dealing with the fact that their export addiction could not be maintained.

If you accept the German narrative, then the policies that must be followed are the ones that
would force Greece to clean up its act. That means continuing to impose austerity on the
Greeks. If the Greek narrative is correct, than the problem is with Germany. To end the crisis,
Germany would have to curb its appetite for exports and shift Europe's rules on trade, the
valuation of the euro and regulation from Brussels while living within its means. This would
mean reducing its exports to the free-trade zone that has an industry incapable of competing
with Germany's.

The German narrative has been overwhelmingly accepted, and the Greek version has hardly
been heard

Regardless of which version you believe to be true, there is one thing that is certain:
Greece was put in an impossible position when it agreed to a debt repayment plan that its
economy could not support. These plans plunged it into a depression it still has not recovered
from — and the problems have spread to other parts of Europe.

Seeds of Discontent

There was a deep belief in the European Union and beyond that the nations adhering to
Europe's rules would, in due course, recover. Europe's mainstream political parties supported
the European Union and its policies, and they were elected and re-elected. There was a general
feeling that economic dysfunction would pass. But it is 2015 now, the situation has not gotten
better and there are growing movements in many countries that are opposed to continuing with
austerity. The sense that Europe is shifting was visible in the European Central Bank's
decision last week to ease austerity by increasing liquidity in the system. In my view, this is too
little too late; although quantitative easing might work for a recession, Southern Europe is in a
depression. This is not merely a word. It means that the infrastructure of businesses that are
able to utilize the money has been smashed, and therefore, quantitative easing's impact on
unemployment will be limited. It takes a generation to recover from a depression. Interestingly,
the European Central Bank excluded Greece from the quantitative easing program, saying the
country is far too exposed to debt to allow the risk of its central bank lending.

Virtually every European country has developed growing movements that oppose the European
Union and its policies. Most of these are on the right of the political spectrum. This means that in
addition to their economic grievances, they want to regain control of their borders to limit
immigration. Opposition movements have also emerged from the left — Podemos in Spain, for
instance, and of course, Syriza in Greece. The left has the same grievances as the right, save
for the racial overtones. But what is important is this: Greece has been seen as the outlier, but it
is in fact the leading edge of the European crisis. It was the first to face default, the first to
impose austerity, the first to experience the brutal weight that resulted and now it is the first to
elect a government that pledges to end austerity. Left or right, these parties are threatening
Europe's traditional parties, which the middle and lower class see as being complicit with
Germany in creating the austerity regime.

Syriza has moderated its position on the European Union, as parties are wont to moderate
during an election. But its position is that it will negotiate a new program of Greek debt
repayments to its European lenders, one that will relieve the burden on the Greeks. There is
reason to believe that it might succeed. The Germans don't care if Greece pulls out of the euro.
Germany is, however, terrified that the political movements that are afoot will end or inhibit
Europe's free-trade zone. Right-wing parties' goal of limiting the cross-border movement of
workers already represents an open demand for an end to the free-trade zone for labor. But
Germany, the export addict, needs the free-trade zone badly.

This is one of the points that people miss. They are concerned that countries will withdraw from
the euro. As Hungary showed when the forint's decline put its citizens in danger of defaulting on
mortgages, a nation-state has the power to protect its citizens from debt if it wishes to do so.
The Greeks, inside or outside the Eurozone, can also exercise this power. In addition to being
unable to repay their debt structurally, they cannot afford to repay it politically. The parties that
supported austerity in Greece were crushed. The mainstream parties in other European
countries saw what happened in Greece and are aware of the rising force of Euro skepticism in
their own countries. The ability of these parties to comply with these burdens is dependent on
the voters, and their political base is dissolving. Rational politicians are not dismissing Syriza as
an outlier.

The issue then is not the euro. Instead, the first real issue is the effect of structured or
unstructured defaults on the European banking system and how the European Central Bank,
committed to not making Germany liable for the debts of other countries, will handle that. The
second, and more important, issue is now the future of the free-trade zone. Having open
borders seemed like a good idea during prosperous times, but the fear of Islamist terrorism and
the fear of Italians competing with Bulgarians for scarce jobs make those open borders less and
less likely to endure. And if nations can erect walls for people, then why not erect walls for
goods to protect their own industries and jobs? In the long run, protectionism hurts the
economy, but Europe is dealing with many people who don't have a long run, have fallen from
the professional classes and now worry about how they will feed their families.
For Germany, which depends on free access to Europe's markets to help prop up its export-
dependent economy, the loss of the euro would be the loss of a tool for managing trade within
and outside the Eurozone. But the rise of protectionism in Europe would be a calamity. The
German economy would stagger without those exports.

The argument about austerity is over. The European Central Bank ended the austerity regime
half-heartedly last week, and the Syriza victory sent an earthquake through Europe's political
system, although the Eurocratic elite will dismiss it as an outlier. If Europe's defaults —
structured or unstructured — surge as a result, the question of the euro becomes an interesting
but non-critical issue. What will become the issue, and what is already becoming the issue, is
free trade. That is the core of the European concept, and that is the next issue on the agenda as
the German narrative loses credibility and the Greek narrative replaces it as the conventional
wisdom.

It is not hard to imagine the disaster that would ensue if the United States were to export 50
percent of its GDP, and half of it went to Canada and Mexico. A free-trade zone in which the
giant pivot is not a net importer can't work. And that is exactly the situation in Europe. Its pivot is
Germany, but rather than serving as the engine of growth by being an importer, it became the
world's fourth-largest national economy by exporting half its GDP. That can't possibly be
sustainable.

Possible Seismic Changes Ahead

There are then three drivers in Europe now. One is the desire to control borders — nominally to
control Islamist terrorists but truthfully to limit the movement of all labor, Muslims included.
Second, there is the empowerment of the nation-states in Europe by the European Central
Bank, which is making its quantitative easing program run through national banks, which may
only buy their own nation's debt. Third, there is the political base, which is dissolving under
Europe's feet.

The question about Europe now is not whether it can retain its current form, but how radically
that form will change. And the most daunting question is whether Europe, unable to maintain its
union, will see a return of nationalism and its possible consequences..

To even speak of war in Europe would have been preposterous a few years ago, and to many, it
is preposterous today. But Ukraine is very much a part of Europe, as was Yugoslavia.
Europeans' confidence that all this is behind them, the sense of European exceptionalism, may
well be correct. But as Europe's institutions disintegrate, it is not too early to ask what comes
next. History rarely provides the answer you expect — and certainly not the answer you hope
for.