The EU is Dead, Long Live Germany (and Britain)

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Richard L. Wottrich, CEO & Senior Consultant, International Services, Atlanta USA

The European Union (EU) has been ruled out of Brussels since 1993 a bit like the lyrics to the Eagles famous song “Hotel California” – “You can check-out any time you like, But you can never leave!”

After Prime Minister May triggered article 50 this week, initiating a two-year ‘check-out procedure’ from the ‘Hotel EU’, Brussels released an eight-page draft proposal of negotiating guidelines required for Britain to reach talks on EU free trade. The draft insists that during this transition Britain must follow EU rules, submit to judicial oversight, continue budget contributions ($64 billion hotel bill), and continue to observe the EU “four freedoms”, which include Britain accepting free immigration from the continent. These are some of the key constraints that led Britain to vote for Brexit in the first place.

Pay No Attention to the Man Behind the Curtain

The world is preoccupied with the heat and noise of Trumpism, but Europeans fail to note the genius of the American political system. President Trump is being blocked at every turn – federal courts have stopped his immigration orders; the FBI and House of Representatives are investigating Trump Administration ties to Russia; the Conservatives in the House have stopped his healthcare agenda; the Senate is thwarting his Supreme Court nomination; cities and states are suing the administration to stop the defunding of Sanctuary Cities; and the list goes on and on. In other words, U.S. Federalism works very well in containing an electoral aberration.

Such is not the case with Brexit. Brexit is the direct result of the failure of the European Union to adapt to changing political winds. Brexit is a failure of EU federalism.

Britain represents almost 15 percent of the EU GDP. Their departure is a significant economic event over and above its political implications. A similarly-sized GDP exit in the U.S. would require California and Florida to secede from the union. America’s Civil War settled both secession and federalism in America 152 years ago and its federal structure has evolved in step with the times ever since.

The fact is that the EU never accepted Britain as a full and equal partner and that is the stark truth that drove them to Brexit.

The Day the European Union Died

There is perhaps an argument regarding exactly when and if the European Union died. It is my considered view that the EU was dead on arrival, as its original premise was intellectually bankrupt.

The historical roots of the European Union grew out of the Second World War (1939-1945). Europeans were determined to prevent such massive killing and destruction from ever happening again, which was code for containing Germany. After World War One (1914-1918) the Allies ground Germany into the dust in retribution and created a Frankenstein as a result – Adolf Hitler. After World War Two, Russia usurped Eastern Europe, formed the Soviet Union, and the 40-year-long Cold War began (1947-1991).

Western European nations created the Council of Europe in 1949 as the first step of cooperation in the quest to control Germany. On 9 May 1950 (Europe Day), French Foreign Minister Robert Schuman presented a plan for deeper cooperation. Based on the Schuman plan, six countries then signed a treaty to control their heavy coal and steel industries. The idea was that none of its founding member states – Germany, France, Italy, the Netherlands, Belgium and Luxembourg – would turn their weapons of war against each other. This was a bit like the hens inviting the fox to collect eggs.

On 1 November 1993, under the third Delors Commission, the Maastricht Treaty created the European Union. Its fatal flaw was that the EU took the original heavy industry containment mandate of the Council of Europe and turned it into a pseudo-federal economic and political mandate. There was no democratic consensus for this transformation beyond the Maastricht luxury resorts and fine dining venues frequented by European leaders at the time.

The EU euro currency was introduced in 1999 and has been adopted by only 19 member states to date. This would be a bit like Virginia issuing its own ‘Julip’ currency and Texas printing ‘Alamo’ notes while the rest of the U.S. accepted dollars.  The euro is a unique currency in that EU national central banks (NCBs) and the European Central Bank (ECB) issue euro banknotes on a joint basis roughly proportionally to the size of their economies, with the ECB issuing just 8 percent of all euros. Euro banknotes do not show which central bank issued them and yet technically Eurosystem member states are not required to accept euros they did not issue.

The euro’s fatal flaw is that no single central bank backs the euro and every member state issues its own sovereign debt and directs the actions of its own respective central bank. In contrast to the ECB the U.S. Federal Reserve is America’s central controlling bank, is independent, and issues and backs all currency and federal debt. As a result the EU, its 28 member states and the ECB have endured a long term fiscal crisis to contain EU sovereign debt and their Greek tragedy sideshow.

The EU is somewhat similar to the United States prior to the Civil War. Certain states were then powerful economic centers that acted in their own interests. Led by Virginia, the southern agrarian feudal slavery system was pitted against the northern cheap immigrant-labor fueled industrial revolution. Federal power was nascent and weak, as the very concept of federalism incubated in the young American democratic framework. The tragedy of slavery exploded this chasm into one of the world’s bloodiest wars, the Civil War, from which emerged a strong federal model that has dominated America ever since.

The EU has had no such transformative event, but rather was spawned by World War Two. In reality, without America’s Marshall Plan injection of $12 billion ($120 billion in today’s dollars) into Europe (1948-1952) there arguably would not be an EU today. But the EU was born with its two fatal flaws – lack of a ‘federal’ economic and political mandate followed on by its Tower of Babel currency and sovereign debt.

Long Live Germany

The result has been that Germany lurks as an economic black hole at the center of the EU – as the EU’s largest economy, fiscally sound, shielded by the open EU and weak euro. Germany’s statistics office, Destatis, reported that 2016 was best year in history for German exports and its trade surplus. German exports were $1.3 trillion; with a surplus record of $252.9 billion.

Germany has benefited mightily from its “Accidental Empire.” The EU swept away all tariffs and opened up borders across the continent, creating a huge market of 500 million consumers for Germany’s manufacturing colossus. This puts the weakest EU member states at serious competitive disadvantages and has led directly to the loss of manufacturing across the rest of the EU since its inception.

The euro also buffers Germany from the price of a robust economy. Two thirds of Germany’s goods are exported out of the EU. If Germany were still using its Deutsche Mark its currency would have soared in value, dampening its own recovery in the global recession. Instead of pocketing its huge trade surplus, Germany’s Deutsche Bundesbank would be defending the Mark in much the same way Switzerland has been forced to defend its Franc as the price for its economic efficiency and proficiency.

Germany thus has huge incentives to maintain the EU and the euro. Germany’s membership price tag is easy to calculate, as the rest of the EU expects Germany to pay a disproportionate share of the recovery costs of resuscitating the weakest six southern EU member states – Cypress, Portugal, Spain, Italy, Malta and of course the EU’s court jester, Greece.  Germany is like a rich uncle asked to co-sign one too many family loans. All of Germany’s ‘relatives’ in the EU want Germany to continue to ‘co-sign’ (back stop) their sovereign debt bonds.

Germany is doing the math. The moment the teeter-totter tips too far and the German balance sheet spirals into a deficit, they will leave the EU. Germany is the EU’s last firewall. After Germany there is no solution.

Why the EU Has Failed

The devil is in the details, as a democracy is doomed the moment its citizens discover that they can raid their treasury with impunity. As the EU evolved its weakest member states discovered that they could raise sovereign debt in global financial markets at blended interest rates kept artificially low by the economic might of Germany. The erroneous assumption was that the EU would somehow backstop sovereign debt even though they had no centralized mechanism to do so.

Goldman Sachs came screeching out of the sky like a Nazgûl in “The Lord of the Rings”, facilitating EU sovereign debt offerings. Goldman for example showed Greece how to monetize (in euros) just about every revenue stream that government had, or pretended it had, and then shorted those positions after they created them. Billions were borrowed and Goldman made hundreds of million in fees. The pinnacle of this fiscal madness were the Greek Olympics in 2004, for which Greece spent $11 billion – most of it borrowed. Greece’s debt soared to over 160 percent of its GDP. Greece has since become the EU’s first vassal state, as Greece’s purse strings are controlled by Germany’s Finance Minister, Wolfgang Schauble.

When the bubble burst in 2008 interest rates for the weak EU member states skyrocketed and its member states’ economies cratered. Today the EU is still arguing about issuing so-called ‘Eurobonds’, which member states should back them (Germany), and how to absorb trillions in sovereign debt. The ECB continues to inject billions via quantitative easing (QE) in support of weaker EU members, while influencing interest rates into negative territory.

As Norman Davies, author of “Vanishing Kingdoms: The History of Half-Forgotten Europe” said, “All states and nations, however great, bloom for a season and are replaced.” As Davies sees it, the decisions of the EU are still being made behind closed doors by the leaders of a few rich nations that look after their own interests.

As a result, member state economies have stagnated and the EU cannot employ its young people, grow their economies past an anemic one percent per annum (excepting Germany), while its member states are trapped in an arthritic death embrace of bloated elitist bureaucracies and moribund unions led by their “shining city upon the hill” Brussels.

Back to the Original Premise

Germany has been at the heart of world wars for a century, starting with World War One and World War Two – conflagrations driven by Germany in which 65 million to 100 million people died. Essentially European-centered conflicts, the bestiality and sheer horror of these two wars resulted in the Cold War – essentially a struggle between the West (NATO) the Soviet Union (Warsaw Pact) for global dominance. The essence of this stalemate was to avoid open warfare in Europe, thus moving conflicts to Third World venues.

But here again, Germany was at the heart of the Cold War, resulting in the East and West acting as an amebic King Solomon, splitting the baby in two – creating East and West Germany – and impoverishing both. Wars were fought by proxy across the globe in Viet Nam, Afghanistan and elsewhere, rather than sully Europe. Berlin became the symbol of the Cold War, as American leaders traveled there and declared, “Ich bin ein Berliner” (President Kennedy, 1963) and “Mr. Gorbachev tear down this wall” (President Reagan, 1987).

The Cold War ended because of the economic power of the West (U.S.) and the corruption that is and was Russia. The USSR dissolved into chaos and Germany was reunited to continue its amazing recovery to the fourth largest GDP in the world today.

Today the EU refuses to invest in its own defense, defined as 2 percent of GDP per year. Most EU member state armed forces are unionized and ill-equipped to meet the Russian threat in Eastern Europe. Russia has annexed portions of Georgia, the Crimea, and is actively waging war in the Ukraine. The EU is playing at sanctions and rationalizing the conflict into a personality cult about Putin. But Hitler did not invade the Low Countries 77 years ago – his armies did. Europe? The EU? Europe is just being Europe, Russia is just being Russia, Germany is just being Germany and Britain will be just fine.

Richard L. Wottrich