10/2/12 – How Europe Fails

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Oct 2, 2012 11:16:34 AM

and tagged Europe

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I have written many times about Europe and its problems, but always with a provision: because the European Union is ultimately a political project, rather than an economic one, politics will trump the many economic problems and the eurozone will survive because of that.

I still hold that view, but as I have also noted many times, this is a 55/45 view rather than a 90/10 view. As problems continue to mount, I have given more thought to exactly how Europe would fail. Not so much the details of what happens afterwards—although that would be interesting, it is so path-dependent that it is almost impossible to forecast—but rather, which present conditions and trends could result in one or more major countries deciding that Europe, as a project, is no longer worth it.

The decision process is the key point here. Thus far, it has been designed and driven by the elites. The recent decision by the German constitutional court is a good example of this: the political process acted at a high national institutional level to verify a rescue plan that had been designed at a supranational level for a supranational institution, with no direct political input from the populations.

This is now changing. For the first generation of the European project, prosperity allowed the elites to proceed with their own plans, while the general population continued to get wealthier and achieve better lives for their children. The deal was essentially the same as in China: we will let you get rich if you let us run things. Unfortunately, that deal is now broken. Looking at today’s papers, which is what prompted me to continue my European series, we see the following:

  • “Europe’s Economic Outlook Worsens,” Wall Street Journal (WSJ), page A9
  • “Jobless Rate at Record 11.4% in Euro Zone, Suggesting Deeping Recession,” New York Times (NYT), page B8

The average family in most of the eurozone is now suffering economically, and the prospect of better lives for their children is fading fast. Politics is attempting to respond, as follows:

  • “Greek Government Proposes Deep Budget Cuts in Bid to Please Foreign Lenders,” NYT, page A10
  • “Greece unveils painful draft budget,” Financial Times (FT), page 4

We have seen similar headlines in the past week for France, Italy, and especially Spain. Ireland is also on the list.

The existing institutions are responding, not to alleviate the pain of the ordinary citizen, but to deepen the cuts and exacerbate the pain. I understand the economic arguments and necessity behind this; the money simply is not there. It is impossible, however, to deny the political effects of the economic realities.

Greece is the farthest along this path, with Spain, Portugal, Cyprus, and others close behind. A good case can be made that Italy and France are farther along than is generally appreciated. Even Germany is slowing and, given the liabilities it has already assumed to support other members of the eurozone, it may also be at risk.

If Greece is the farthest along, it can serve as a potential guide for the future of the other countries in failure mode. Which brings us to “Right Wing Party Is Growing Rapidly as Greece Simmers” on page A4 of the NYT.

The Golden Dawn party is best known outside Greece for violence against immigrants and especially for a YouTube video in which the party spokesman attacked two older women on a political panel on a morning TV show. Golden Dawn is fairly typical for its type—anti-immigrant and nationalist. It has recently gotten an electoral foothold in parliament and is gaining in the polls.

Other countries have similar parties—the National Front in France, the True Finns in Finland—not perhaps as violent or extreme, but with similar political bases. The trend is most advanced in Greece because the economy is worst, suggesting that as the economies of other countries weaken, right-wing parties may show similar gains.

The rise of extreme parties focused on nationalism cannot be good for supranational institutions. It is in the disconnect between the elites and the population that such parties grow and in the failure of existing policies that their remedies become attractive. The fact that we are in such a period and that these parties are indeed growing suggest that at least one failure mode for Europe could be a new rise of nationalism and a return to an earlier era.

Tomorrow, I will take a deeper look at some of these parties in other countries and at what that means for the European project.

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