The State of the Pandemic: Europe

You can also read the State of the Pandemic series’ take on the United States, Latin America, the Persian Gulf, East Asia and the BRICS. 

There is no such thing as “Europe.” Yes, there’s this political-economic grouping called the EU, but two of Europe’s most important countries are not members. Yes, there’s this political-military grouping called NATO, but it is functionally run from a different hemisphere. Recent developments might – emphasis on might – change this, but the Europeans aren’t there yet. 

With over 30 different political and decision-making systems, there is plenty of room to find fault with any broad assessment. But as regards the ongoing coronavirus pandemic, the fact remains that overall, Europe has been moving in the direction of fewer and fewer cases. 

(Many, many thanks to the Financial Times for providing the data interface that makes this graphic possible. You can visualize your own data pulls here.)
 
The early phases of the epidemic were harsh in many places. In large part, it was because the Europeans had, at best incomplete information from which to base their policies. For the Italians and Spanish who suffered through coronavirus’ initial assault, they were simply caught off-guard. The result? Much of Europe enacted lockdowns whose intensity and airtight nature was only surpassed by the 1984-style lockdowns in Wuhan. (In Paris, you had to apply for a government permit to leave your home to shop for food. The permit only lasted for one hour.)
 
There’s also the issue of vectors. The suspected patient zero in Italy was initially misdiagnosed and so went from the hospital almost directly to a massive soccer game, becoming Europe’s first superspreader. Most people came to and left the game via bus, enabling the virus to spread liberally. A few of those buses went to Spain, which is why Spain became the second hardest-hit country in Europe.
 
In contrast, Austria and Germany’s superspreaders were a bunch of 20-somethings at ski parties in the Alps. The Austrians and Germans not only had a bit more warning than the Italians and Spaniards, but their epidemics were also among young millennials – a group that COVID doesn’t impact that harshly. The Austrians and Germans locked down their elderly populations, ran a rigorous testing and tracing program, and more or less nipped the problem in the bud.
 
Of course, despite caseloads moving in the right direction overall, this is not over. The variation of Europe’s COVID policies to date will also define the epidemic’s future:
 
Germany is playing it safe and has retained its de facto ban on all extra-European travelers until at least August 31st. Considering caseloads in the Western Hemisphere and the Middle East show no signs of dropping, expect this date to get pushed back. 
 
In contrast, consider Portugal. Portugal is one of the many European countries suffering from a terminal demography; its birth rate crashed back in the late 1970s, never recovering, and the Portuguese economy is now a moribund mess. Since Portugal lacks the industrial base of a country like Germany, Portugal’s only growth sector is tourism. COVID killed tourism. Portugal recently released all restrictions in a desperate attempt to forestall what threatens to be an unending economic depression…which means Portugal is one of only three EU countries where caseloads are increasing.
 
Nor did everyone in Europe follow even remotely similar lockdown protocols. As mentioned earlier, the Europeans were working with incomplete information as the pandemic started, and not everyone came to the same conclusions. The British and Swedes balked at the economic damage full lockdowns would cause, and reasonably believed any effective vaccine would not be available for years. Add in that coronavirus has the highest infection rate of any public health threat since measles and a fairly low mortality rate, and both governments felt containment was a fools’ errand. They opted for management. Both decided to pursue herd immunity in an attempt to build a firewall against the virus within their populations.
 
Britain ultimately blinked, largely due to the carnage being wrecked in Italy which suggested much higher death counts than initially suspected. The Brits belatedly followed a more traditional lockdown approach. The delay landed the Brits with one of Europe’s highest infection rates as well as a lengthy plateau. It was only in mid-May that the Brits finally got COVID cases bending downward. The Swedes, on the other hand, stuck with the plan. Sweden now faces infection rates among the world’s highest, recently surpassing even the United States. 
 
The real tragedy in Sweden was that knowing what we all knew back in April, the herd immunity strategy wasn’t silly, but instead a calculated risk. The Swedes assumed a functional vaccine would remain unavailable for years, and so concluded that building immunity within the population was the only sustainable route forward. Now it appears a functional vaccine will be available before the end of 2020, with mass distribution beginning (although not being completed) in 2021. The facts as we understand them have changed. Sweden’s sacrifice may have been for nothing.

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A Faint Flicker of Hope in Europe

The past few several weeks have been busy for the Europeans, easily generating more events of consequence than at any time since at least the 2007 financial crisis. There is no specific trigger event here that makes much sense without absorbing the context first, so I’m just going to do what I do and start at the beginning.
 
Germans aren’t normal.
 
I don’t mean that as a condemnation of their weather or dourness or food or their linguistic tendency to link a dozen or more words together into typographical nightmares, but instead that Germany’s peculiar geography has made the Germans somewhat…peculiar.
 
Germany’s geography is the best and worst of all worlds. Best in that it boasts four major and a dozen minor rivers as well as ample stretches of flat land to both ease internal transport and make for cheap development. Worst in that Germany’s most rugged terrain is in the country’s interior while its flattest lands are on its borders, making it easier (historically speaking) for most Germans to integrate with their (non-German) neighbors rather than their own co-ethnics.
 
Historically, this has made German lands among the most bloodsoaked in Europe, with the whole area being preyed upon over and over and over. The first “Germany” was Charlemagne’s, and it only lasted so long as the great monarch was alive. The Holy Roman Empire was a primarily German entity (occasionally referred to as the First Reich), but it wasn’t even remotely united, comprised as it was by sometimes over 1000 (often mutually warring) statelets.
 
It was only with the onset of industrialization in the 1800s that Germans were able to use rail and electricity to overcome their internal geographic complexity and achieve unity. But unity doesn’t automatically translate into happy-fun-play-time. The second and third Reichs were Germany’s Imperial and Nazi incarnations. Those governments’ attempts to impose writs on the wider European neighborhood resulted in the most catastrophic wars humanity has ever experienced. For the following 45 years, Germany was the very definition of not united – split into two pieces to serve as mutually-opposing frontline states in the Cold War.
 
In the years since the Berlin Wall fell, the newly-united Germany – or Fourth Reich if you prefer – has been taking a wonderous vacation from history. It doesn’t need to fight to remain unified; America’s imposition of a global Order makes that unnecessary. It doesn’t need to protect its borders; American-dominated NATO takes care of security issues. It doesn’t need to fight for access to either raw materials or consumer markets. The Americans’ global structure has enabled the rise of the European Union within Europe, and has allowed German firms access to a worldful of consumption. All Germany needs to do to be Germany today is…be. And so the Germany of today is united, free and at peace…without the Germans needing to do a damn thing.
 
For those of you who would like Germany to exercise more decisionmaking power and take security matters into its own hands, I refer you to literally any book on European history between 1848 and 1945 to highlight why that might not be the fabulous idea you assume it to be.
 
Anywho, there are now three intersecting problems that all independently threaten Germany’s blissful existence.
 
First, the Americans are done holding up the collective civilizational ceiling of the world. The United States created the global Order to fight the Cold War, and that war ended when the Berlin Wall fell. The Americans have been edging away from, well, everything, ever since. The day of final abandonment was always going to come, it is now here, and everyone who used to shelter under the American security umbrella or benefit from a globalized economy must figure out a new way forward. That applies to Germany as much as everyone else.
 
Second, the German economic model of mass exports is running out of road. Mass exports requires a large, highly-skilled workforce heavy with people in their late-40s through early-60s. Germany has had that for the past 15 years, but those skilled workers collectively are crossing the retirement threshold this decade. With no replacement generation coming up through the ranks, Germany can neither consume what it produces today, nor maintain its current production for much longer. That eliminates both the basis of the German economy and the German tax base. Something new, something radical, something that utilizes resources beyond Germany, is required.
 
Third, the EU – the only meaningful piece of the Order the Americans do not directly control and so the only possible anchor the Germans have keeping them in a safe, peaceful, united Europe – is in mortal danger. In part it is because much of Europe faces the same security and export dependence upon the Americans as the Germans do. But there’s another problem.
 
Geography.

Northern Europe is flat and well-rivered and so countries there can achieve efficiencies and economies of scale. Southern Europe is rugged and lacks rivers and so cannot. Exceptions abound in a continent as varied as Europe, but the bottom line is that Southern Europe will never be able to compete with Northern Europe economically, just as Northern Europe cannot hope to compete with Southern Europe when it comes to sun, fun, food and flair. (France has a foot in both worlds which is part of what makes the French…well…French.) Anywho, the bottom line is that there is no European Union without both parts of Europe, so the question becomes how to keep it all stitched together without either the American-led Order or the ability to access markets from far beyond Europe?
 
There is no good answer. Even more problematic, what might prove a good answer for Ireland would be hilariously inappropriate for Croatia. What most everyone can agree on, however, is that Europe as a combined entity will be better able to get what it needs than the EU’s constituent members acting independently. And so Europe has been limping along since the 2007-2009 financial crisis, economically suppressed, strategically adrift, politically riven…but with no one (save the Brits) willing to pull the plug on the whole project.
 
In my new book, Disunited Nations, I’ve got a whole chapter on called “Superpower, Backfired” on the hows and whys Germany ended up in this situation and where it is likely to lead.
 
And then there’s the coronavirus.
 
Just as there are differences in European financial and economic structures on a country-by-country basis, so has the virus impacted EU members differently.
 
It comes down to vectors and weather. Most of the cases in Germany originated at a series of Alpine ski parties for 20-somethings. When the virus started to spread, it spread among the population most able to survive it. In addition, late-winter and early-spring in Germany isn’t exactly tourist season, so most elderly stayed locked up at home. Germany was able to address the virus outbreak relatively quickly and move on.
 
Not so in Italy. Patient zero went to a massive outdoor soccer game and became one of the first COVID superspreaders. Elderly Italians are also more likely to live in a multi-generational household than elderly Germans because…well… sun, fun, food and flair. It wasn’t long before the Italian health care system was overwhelmed.
 
Finances matter too of course. Germany has been whittling away at its national debt for twenty years, and so had plenty of dry powder to apply to the crisis without needing to ask anyone for help. Italy…hasn’t. When the crisis exploded upon the Italians they almost instantly ran out of cash and had to turn to the EU hat-in-hand for help.
 
The response was underwhelming. The Germans – backed up by the European Central Bank (ECB) chief – told the Italians that saving Italy wasn’t their job. As a point of comparison, across the Pond the Americans slapped together humanity’s largest-ever stimulus program in a matter of days.
 
It didn’t take long for German Chancellor Angela Merkel to realize that the situation was untenable. It wasn’t so much that Italy and others were facing fiscal collapse because of COVID (although they were), it was that Merkel knows full well that the road the EU is on means that Italy and others would inevitably face fiscal collapse. COVID just brought the end forward by a few years. The question Europe has been struggling with since 2007 – now that we are certain this is unsustainable, what do we do? – had moved from the hazy future to the here-and-now. And Merkel simply didn’t have an answer. If she had, she would have produced it. Years ago. And so the demurring and dithering continued.
 
Ironically, it took events within Germany itself to force the issue. On May 5 the German Constitutional Court ruled that methods the ECB were using to keep some of Europe’s weaker states on life support were unconstitutional. Specifically, the ECB can only purchase government debt if it does so proportionally to the size of all eurozone economies. Since the Germans have been paying their debt down, there wasn’t much German debt left to buy. And since the Italians were in a COVID pickle, the Italians needed to issue more debt. The ECB did the logical thing and put its resources where they were needed. The German court ruled that the ECB’s logic violated European law in general and the German constitution in specific, and that the German government must cease all cooperation on the issue within 90 days.
 
Running the European Central Bank without the participation of Europe’s largest economy would open up a hilariously huge barrel of worm-ridden monkeys, taking us down paths so convoluted and impractical as to be positively Venezuelan. But those monkeys and paths all take us to the same place: no European bond market, no European currency, and – very likely – no EU.
 
A world without America. A Europe without the EU. Germany left to look after its economic and security issues on its own, likely in competition with its current EU partners. That is nothing less than Merkel’s worst-case scenario, and so she did the only thing she felt she could:
 
On May 20 in a joint presser with French President Emmanuel Macron, Merkel proposed the EU’s first mutualized debt. For those of you not in finance, that’s a fancy way of saying that not only will Germany co-sign for some Italian borrowing, but that Berlin will agree up front to use the EU’s common budget to pay for some Italian spending. Simply put, Merkel committed Germany to paying for the ongoing existence of the EU in general and the EU’s weaker members in specific in the hopes of buying more time to find a better solution.
 
Many many details remain.
 
How big of a fund are we talking about? At present the combined floats of the Germans, French and the EU Commission total something around 1.5 trillion euro. (Right now that’s about $1.65 trillion US, so, you know, real money.) That’s roughly ten times the current total EU budget. That would probably cover the EU’s current needs this year, but only this year. And all the proposals to date are nothing more than one-offs designed to counter COVID impacts. This doesn’t actually help the EU survive in the long-run. For this to work and for the EU to function as a true superstate, the EU needs a full transfer union of at least these volumes annually.
 
Who would get the funds, and who would pay the funds back and how? At present the idea is to funnel everything through the European Commission, with funds being dispersed into (suddenly engorged) EU programs, while payback would come from the various member states who fund the Commission directly. Needless to say, that would be wildly inefficient and cumbersome, although it would wildly strengthen the EU’s administrative core and take Europe a few big steps down the road to full federalization on the American model.
 
Can this – institutionally – happen? It doesn’t look great. Big things like this normally require a treaty, and the EU has rarely managed negotiating and ratifying a treaty on anything less than a decade timescale. Moving forward without a treaty would still require unanimity, and several EU states have already voiced their vociferous opposite to the plan.
 
But, again, let me be clear here. Between the Americans’ withdrawal and Europe’s demographic implosion, the very existence of the European Union is at stake. This was always true. This was always inevitable. But COVID and the German court ruling makes the crisis imminent. In a Europe without either America or the EU, Germany must reorganize into a form that enables it to protect and further its own interests without outside support. This isn’t “simply” an existential crisis for the Germans. It is an existential crisis for all Europeans.
 
And historical annihilation tends to focus the mind.
 
So let’s take a brief look at the four hard-nos in this debate: Austria, the Netherlands, Denmark and Sweden.
 
The bulk of Austria’s population lives on the southern watershed of the Danube. The entirety of the Netherlands lies atop the delta of the Rhine. Those two rivers are core Germany population, industrial and transport zones. The Austrians and Dutch have zero geographic insulation from Germany.
 
Neither country may like the financial implications of where the debt-mutualization path leads, but both are deeply, painfully aware of precisely where European collapse leads: a Germany forced or induced to seek out German national interests to the detriment of its neighbors. Historically speaking, once the Germans get rolling, maintaining an independent Austria or Netherlands is pretty much impossible. The Austrians and the Dutch know this. Both can be armtwisted into accepting Merkel’s (costly) logic.
 
And that assumes Merkel doesn’t do her traditional thing. Unlike most leaders, Merkel tries to shun the spotlight and instead lead from behind. She allows her opponents to stake out bold positions, and then unobtrusively steps back from the shouting and quietly cobbles together a majority position that doesn’t include the troublemakers, leaving them with the option of joining the crowd or screaming into the void. She’s done this (repeatedly) to consolidate control of her political party in Germany. She’s done this (repeatedly) to defang troublesome governing coalition partners. She’s done this (repeatedly) to guide Europe through the financial crisis. It is highly likely that the Austrians and Dutch will be Merkel’s next void-screamers.
 
Denmark and Sweden are a different sort of challenge. Sweden doesn’t border Germany, while the bulk of the Danish population lives not in peninsular Denmark, but instead on the island of Zealand. Culturally, economically, and above all strategically both only have one foot in Continental Europe. In particular, both have historically been closer to the United Kingdom (and dare I say, the United States) on defense issues than to Germany. As such neither are even members of the eurozone. That makes the pair less likely to be cajoled into participation, but it also means there is another potential path.
 
Rather than run the funds and the debt through the EU budget, the funds could be kept aside as a purely eurozone project which could exempt any EU state that didn’t also use the European currency. (In addition to Denmark and Sweden, this list also includes a variety of Central European states such as Poland, Hungary and Romania.) It’d be messy organizationally, and arguably unnecessarily so, but the EU does tend to excel at spawning unnecessarily messy organizational structures.
 
Anywho, lots of details to work out. What Merkel and Macron are attempting on the fly is the first real step towards federalizing the European Union. Europe has a common currency (which not everyone is a part of) and a common foreign policy (which requires unanimity) and a common market (regulated by national governments), but until it has a common budget it is most certainly not a superstate and it is most certainly not pooling its national resources into a more powerful, more cohesive whole.
 
That more powerful, more cohesive whole is the only thing that matters if the EU is to persist through contorting geopolitical and demographic circumstances. There is no guarantee the current plan will be adopted, much less work, much less expand into something that would make the EU a true, durable power. But the fact remains that for the first time in years I have a faint glimmer of hope that this thing we call the European Union might, just might, survive.

On June 3 Melissa Taylor and Peter Zeihan will be hosting a video-conference on Manufacturing in a New Era. We’ll address the future of automotive, automation, reshoring, COVID’s shattering of supply chains, consumption shifts, as well as get you an update on the deepening trade war.
 
For those of you who don’t want to pop for the fee, we’ve recently completed a video on our projected shape of the COVID epidemic to come. You can watch it for free here.
 
Our June 3 manufacturing video-conference is only the first of a series which will include events focusing on Mexico, China, Energy and Agriculture. Scheduling and sign up information can be found here.

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World Leaders at Risk

The British government announced March 27 that Prime Minister Boris Johnson tested positive for coronavirus, making him the first world leader to do so. As the United Kingdom is an advanced democracy, here at ZoG we are not overly concerned with Johnson’s isolation and perhaps incapacitation or even death. Part and parcel of democracies is that succession is part of life. The UK will get through this one way or another. 

However, there are many countries that are not democracies and there are many world leaders far older than Johnson…

Click to view countries by age PDF

Coronavirus, the Europe Guide

In the age of coronavirus, Europe’s near-term future is bleak.
 
European headlines in coming weeks will be about coronavirus deaths. In large part the issue is demographic. Coronavirus is far more likely to kill those over aged 60. The average European is approximately a half-decade older than the average American. Only the Japanese are older.
 
Specifically, Italy hosts the world’s second-oldest population, while Germany ranks 5th. Meanwhile, many of the “new” European countries in Central Europe are not all that much younger, while also lacking German- or Italian-quality health care. Others, Ireland, Greece and Spain come to mind, have had to deal with financial crisis by cutting services. Services like health care. The United Kingdom, courtesy of the dual forces of Brexit and coronavirus, are seeing many health care professionals who are not UK citizens but who were able to work in the UK during the Kingdom’s EU membership, fleeing back to their home countries at the worst possible time.

CLICK TO VIEW COUNTRIES BY AGE PDF

The demographic issue will hurt Europeans on more than simply mortality figures.

People under 45 tend to be a society’s big spenders. They buy cars and homes. They go to university. Such consumption is what drives most modern economies. But not in Europe. Europe’s young cadre is thin and getting thinner by the year. Most European countries – Italy and Germany most notably – have already aged to the point that any sort of demographic rebound is now impossible. They simply don’t have enough people who could even theoretically have children. There certainly aren’t enough people of the right age demographic to drive a consumption-driven rebound.

Which makes mitigating the economic damage of coronavirus structurally impossible. The sort of consumer stimulus which is the backbone of consumer-focused, anti-recession efforts in the United States simply wouldn’t work in Europe. On the whole, the European Union has aged into being little more than an export union. And in a time of global travel restrictions and virus-forced collapses in income and consumption, there just isn’t anyone to export to. All Europe can do is shelter in place, pray their health systems hold, and wait for the world to restart. So long as the coronavirus is impinging activity anywhere, a sustained European economic recovery is impossible.

But even if Europe had a favorable population structure, it lacks the institutional structure to hold the line against the virus anyway. It comes down to money.

Having its own currency enables the United States to print however much money it wants to risk, using that money to fund its own deficit spending. Neither W Bush nor Obama nor Trump would ever be confused with fiscal conservatives, but even now at the very beginning of the process we are seeing spending bloat unprecedented in American history – even at the height of World War II. By the second week of April, the Americans will have pumped over $2 trillion in financial relief into their system, or roughly 10% of GDP, in addition to monetary stimulus of a volume that stuns the imagination. The current spending wave has already seen the Federal Reserve hoover up over $1 trillion in securities, while the federal government is putting up to $1200 into the hands of the vast supermajority of American adults, with a $500 kicker for each child. Nor will this be the last such infusion. Expect another one sometime in the summer.

Europe lacks that sort of power and flexibility.

Part of the network of treaties that underpin the common European currency mandates not only fairly strict deficit ceilings (although those ceilings were suspended over the weekend) but far more importantly the Maastricht Treaty on Monetary Union took monetary responsibility out of member governments’ hands. European states can’t print currency. If they want to deficit spend, they have to raise the funds themselves. That takes time. That takes investors willing to put their money into governments’ hands.

Now technically, the European Central Bank can expand the money supply, and it will, but there are two problems. First, Europe never truly recovered from the 2008 financial crisis. Eurozone interest rates have been negative for years. What about unconventional measures? Much ballyhoo has been made in the United States about how the Federal Reserves purchased scads of bonds to prop up markets, purchases which peaked at just shy of 25% of GDP at the height of the financial crisis. The ECB’s balance sheet as of January 1, 2020, after a decade of calm and before coronavirus erupted, was twice that in relative size. It isn’t clear the ECB has much ammo to use here, conventional or unconventional.

Second, any ECB action raises the issue of whose bonds will the ECB buy? Will it be the country with the most likely chance of repayment (Germany), or the country facing the worst health crisis today (Italy), or the country likely to see the highest death rate (Spain), or the country in the worst financial position (Greece)?

Every time the Europeans face any sort of question that bridges the monetary and the budgetary, the eurozone finance and prime ministers have to meet to hash out their disagreements in marathon negotiating sessions that take days (if not months). In times of calm this is a questionable system which often borders on the comical. In times of crisis it is really really really really stupid.

It shows in the outcomes. During the 2008 financial crisis the Americans did more mitigation in three weeks than the Europeans did in nine years. This time around, the Americans did more in 48 hours than they did during the entire financial crisis.

The funding America’s Small Business Administration made available to provide bridge financing for America’s small businesses is a case in point. On day one $50 billion was unleashed, with another $350 billion to be available by April 1. The EU has no such established facility. Individual European governments are scrambling to raise the necessary cash for their own small businesses. Weaker EU states are unlikely to be able to raise the requisite funds without raiding their already rickety banks. With quarantines in place, entire countries shut down. Add in Europe’s far less flexible labor market and a workforce which remains wedded to old-style set-location facilities means European firms have more need for bridge financing than American ones, yet even Europe’s capacity to provide that financing is far lower.

Europe today is just getting going with its Rube-Goldberg-like-decisionmaking machine, and this time around coronavirus quarantines prevent the European leadership from even meeting in person to hash out a plan. The only European leader with gravitas, German Chancellor Angela Merkel, is in isolation due to potential coronavirus exposure.

Which means “Europe” cannot be part of the mitigation process.

That leads us six places, none of which are good. First, European investors know all this and they aren’t flooding their money into European assets. Instead, it’s a massive flight to US dollar assets. Expect the USD to continue to rise throughout the crisis.

Second, an exception to that rule will only increase the light between the various European governments. Germany, unlike most of Europe, has steadily whittled away at its debt levels to the point that pre-crisis there was a shortage of high-quality, low-risk government debt on European financial markets. With Germany loosening the purse strings, investors will purchase German debt. It is the bulk of the rest of Europe that’s likely to be shunned. Deep, visceral splits between how the Germans and the bulk of the Union viewed finance existed before coronavirus.

Debates on the topic are already taking on the stench of desperation. On March 25 the leaders of France, Italy, Spain, Portugal, Ireland, Luxembourg, Slovenia, Belgium and Greece (aka countries who consistently find balancing their checkbooks difficult) called upon the EU to issue a joint debt instrument to deal with coronavirus. Germans are likely to have a different opinion.

Third, when the scale of the capital flight and budgeting shortfalls becomes apparent, when European governments realize the money they need to try to save their systems is leaving, they will take action. Expect strict European capital controls at all levels. (China of course already has capital controls. Expect them to intensify.)

Fourth, the controls won’t be nearly enough. Even if the Europeans could prevent capital from leaving, raising capital to fund emergency spending the old-fashioned way isn’t as quick or effective as the American method of simply flipping the switch on the printing press. Firms would fold in the thousands, and the damage will not be limited to the small players. To stave off the subsequent economic and cultural carnage, expect mass nationalizations throughout European economies. Unsurprisingly, the French are already discussing the mechanics of how to manage this. Peugeot, Renault and Airbus have already indicated they will fight the process (although they’d still love help with recapitalization and operating costs).

Fifth, this is likely the end of “European” manufacturing. The European manufacturing system, especially the German manufacturing system, is based on the free movement of goods, people and capital across borders. That simply isn’t possible in an environment of national quarantine, capital flight, capital controls and nationalizations. Post-crisis things will still be made in Germany and Bulgaria and Sweden and so on, but not all that much is likely to be the result of a multi-national European supply chain.

This is doubly problematic in the short term as most European countries lack even small pieces of the medical supply chain. While the US can retool and China can get back to work, many European states simply don’t have anything within their borders they can use.

The dream of Europe was that open borders would enable Europe to have economies of scale of the Chinese or American type. But these are still separate countries, and the utter inability of the EU to ride to the rescue leaves individual states more or less on their own at the worst possible time. Germany, for one, is a major exporter of medical equipment, and it has already barred exports of many coronavirus-related materials. Even to its EU partners. Many Europeans already resent Germans’ unwillingness to share their wealth. Imagine how refusal to share medical equipment will go over once the death toll gets seriously scary.

Sixth, this is the end of the European economic and social model, and it risks being the end of “Europe” as an entity.

  • Europe’s demographics make consumption-led growth impossible, even as coronavirus blocks export-led growth.
  • The Americans were backing away from the global security rubric that makes Europe’s export-led growth model possible before coronavirus, and the virus is only accelerating America’s turning-inward.
  • Europe lacks the institutional capacity to manage crisis response.
  • Europe lacks the financial capacity to cope with the crisis, much less apply the sort of financial fire-hose the Americans did almost reflexively.
  • Dealing with the virus’ spread has already forced the Europeans to abandon the free movement of people.
  • Dealing with their financial shortfalls will force them to abandon the free movement of capital.
  • Dealing with mass nationalizations and the loss of export markets will force them to abandon the free movement of goods.

That’s three of the four freedoms upon which modern Europe relies. The fourth freedom – movement of services – was largely something that only the UK cared about, and the Brits are gone.

There is one possible “solution” to these problems: drop the euro.

If the Maastricht Treaty were abrogated (or at least suspended) and national control over monetary policy reintroduced, individual European countries could then engage in unlimited quantitative easing, both to mitigate the current crisis and to help manage the subsequent damage and recovery. This would (obviously) hold (many) downsides, but if the goal is to have the necessary capital required to address the current crisis, this is the only path I see that still results in salvaging Europe’s current economic and social structure.

In theory, once coronavirus was in the rear-view mirror, Europe could go through the process of re-merging their currencies (perhaps this time without basket cases like Greece). Yes, I realize this would be monumentally messy, but we’re already in a world where economic and financial norms are in abeyance. Most of contemporary Europe’s “messes” require extensive multi-national negotiations. This “plan” has the advantage of countries doing things themselves.

Regardless of the path forward (or down) coronavirus is just the beginning of Europe’s problems. Demographics, economics, financials, supply chains, none of it works under coronavirus – and coronavirus is going to be with us until we either get a vaccine, herd immunity or mass serological testing, none of which is particularly likely to happen in 2020. Even then, it is far from clear that Europe as we know it can reconstitute in the world after coronavirus. And never forget that all Europe is not created equal. Germany is not France is not Italy is not Poland is not Sweden is not Portugal is not Romania.

An end to the concept of “European” being singular represents more than simply the return to the norm of European history, it removes one of the central pillars of the world we know. That cascading failure and the reordering to come will be a subject in subsequent installments in our Coronavirus Guides series.

And now the pitch: the Coronavirus Guides are our primer documents, intended not to finish the discussions of this or that topic, but to launch them. Contact us at Zeihan.com/consulting to inquire about rates and scheduling options for teleconferences, videoconferences and in-depth consulting calls.

Coronavirus: Epidemic Guide, The American and European Edition

Not all epidemics are created equal, even when everyone is battling the same pathogen. Let’s start with timing and intensity. The imminent coronavirus wave of cases about to hit the United States is going to hurt, but it will hurt less than what’s about to occur in Europe.
 
Despite all their similarities, there are sufficient differences between America and Europe demographically, geographically, economically and institutionally to generate significantly different epidemic experiences.
 
Let’s start with connectivity. Despite being all under a single political authority, the US has considerably less connectivity than either China or Europe.
 
First, because of its failure of national infrastructure. The US has no meaningful passenger rail system aside from creaking Amtrak in the Northeast corridor, and it has no highspeed rail at all. If Americans want to travel long distance, their choices are limited.
 
Passenger aircraft: While it hasn’t officially been shut down (yet) American carriers have already reduced their flight schedule by over two-thirds, and most of America’s smaller airports are already closed. Expect several of the larger ones to follow suit.
 
Automobiles: Car travel is slower and outside of summer vacation season (which is likely suspended for 2020) is largely limited to short-haul travel. It is also incapable of serving as robust of a disease vector as passenger aircraft.
 
Second, it’s a simple issue of size. China is physically larger than the United States, but some 95% of its population lives on less than one-third the land area. Europe’s usable land is one-third less the size of America’s while its population is one-third larger. That makes America’s functional population density roughly half that of Europe and one-fifth that of China. Social distancing is simply easier when there is already some distance baked in to living conditions. Those hell commutes many Americans factor into their lives at least have one silver lining.
 
Third, the “normal” function of the American economy is a bit more resistant to viral spread than the European or Chinese equivalent. America’s economy is primarily service based, and roughly one-third of its workers can work remotely. Yes, that’s a low number, but it is significantly better than the figure in more industrial China or more manufacturing-based Europe.
 
Even within manufacturing, arguably the economic sector most impacted by the virus because staff must come to the facility to work, the Americans have a bit of insulation.
 
In part it is because the outsourcing of manufacturing jobs to China means the US manufacturing base is smaller in the first place and so less likely to serve as a disease vector. American manufacturing largely limits itself to North American needs. It isn’t nearly as export-driven as Europe or China and as such simply has fewer personnel to expose.
 
In part it is because the America’s manufacturing is integrated with Mexico, a country with which the US has a hard border that limits personnel exchange. For their part, China’s system is largely self-contained within its borders, while the German manufacturing system enjoys passport-free access to all its manufacturing partners throughout Europe.
 
None of which means the Americans are incapable of having an epidemic, obviously, but it does mean that epidemiologically segregating America’s cities from one another is a far simpler task than doing so in China or Europe.
 
The road forward will look something like this:
 
Europe is next up. Best guess is Europe had more – perhaps several times more – coronavirus cases than the United States. What is occurring now in Italy with high numbers of deaths and higher numbers of cases, will repeat in northern Europe on a much grander scale. Americans will get a good hard look at what the virus can do to a place of similar socioeconomic development before the virus crashes into the United States. From the point of large-scale movement restrictions, the peak in cases and deaths is typically two weeks out with notable declines in three weeks. Europe didn’t begin their restrictions until the week of March 16, so expect the epidemic to likely peak in the first or second week of April. In the meantime, Spain is following closely in Italy’s footsteps. Madrid is at the heart of the outbreak with a rapid increase in hospitalizations and a rising mortality count now well above what the US experienced on September 11, 2001.
 
One to two weeks later comes the United States. For the reasons noted above, the virus’ penetration into the United States will likely be somewhat less intense in terms of number of cases with several metro regions unlikely to experience severe outbreaks, but that doesn’t mean the Americans are in for a softer ride. There will be plenty of population centers that will feel the pain: Seattle, San Francisco, New York and New Orleans are particularly high on our watch list.
 
American deaths will fall into two general buckets.
 
First, the elderly. This group will feel disturbingly similar to cases elsewhere. Best data out of Italy suggests the average age of mortality from coronavirus is 80. On the somewhat bright side, however, is the simple fact that the Americans have fewer elderly. Birth rates in most of Europe cratered over 30 years ago, meaning that the average American is about a decade younger than the average European.

The second category for mortality are those with impaired respiratory health. Mild (and easily survivable) cases involve “only” the upper respiratory system and often involve “only” a dry cough and fever. Severe and critical cases (which require hospitalization) see the virus migrate into the lower respiratory system, inducing pneumonia and lung failure. Americans may be younger than Europeans on average, but they are also in poorer health. America teems with “lifestyle” diseases such as obesity and diabetes. Over half the American population has restricted respiratory health, making much of the population more vulnerable to the virus’ effects.
 
Once the initial peak passes, we’ll start peeking out from under our rocks and start venturing back into the sun. We’ll loosen our quarantines on both sides of the Atlantic, but the virus won’t be done with us. Europe’s higher connectivity means the virus is likely more entrenched more deeply within the population than the United States. Europe’s quarantine will need to last longer, and Europeans’ close proximity to one another means a local flare-up can easily go national or transnational. Distance and the de facto suspension of air travel means the United States can – will – have local flare ups and they will jump cities. But the combination of the virus’ relatively long incubation period combined with the fact that most US cities are at considerable remove will make the post-quarantine period feel like a giant game of whack-a-mole instead of a nationwide secondary (and tertiary, and quaternary…) epidemic.
 
There’s one additional difference worth noting. Leadership at the national level in the United States and the supernational level in Europe is sorely lacking.
 
Ideologically, the Trump administration is fairly opposed to government, and as such has refused to fill – three years into its term – many top spots throughout the federal system. Mr. Trump is also pretty hard on what staff he has; Even within his cabinet Trump has a bit of a revolving-door policy for top personnel. For example, the president is already on his fourth chief of staff. Don’t-shoot-the-messenger is a concept largely lost on the American president and he is allergenically opposed to information that doesn’t match his worldview or whim.
 
That makes epidemic mitigation – something that to be done right requires seeking bad news – damnably difficult. Trump’s decision to stop air traffic first to China and later to Europe was probably the right decision, that bought the United States a month of time to prepare. But then the Trump administration returned to business as usual and, a month later, here we are. Functional action on the epidemic, therefore, falls to the states and cities who are now competing for resources to combat the virus.
 
Europe isn’t any better, but it is less because of ideology or personality and instead because of constitutional law. The European Union has no indigenous disaster response capabilities, and what little it has are held within the NATO alliance. Since NATO’s backbone is US troops and since not all EU members are NATO members, it is highly unlikely we’ll see NATO forces enforcing quarantines across Europe.
 
Making decisions about novel situations at the EU level typically requires multiple all-night summits of all EU heads of government to hash out ad hoc legal and financial compromises. Under quarantine, that’s simply impossible. With the exception of Italy, the Europeans didn’t even begin travel restrictions until a week ago. Legally and functionally, the EU’s member states are entirely on their own, and most lack even scant bits of the supply chains required to ramp up medical services.
 
These differences in health, age, governing and health care systems abound and are giving us a real-life compare-and-contrast case study between two similar-yet-different systems that is simultaneously large-scale, amazing and disturbing. These differences will also generate radically different consequences in finance, manufacturing, currency and governance – all of which will be the subject of subsequent installments in our Coronavirus Guides series.
 
And now the pitch: the Coronavirus Guides are our primer documents, intended not to finish the discussions of this or that topic, but to launch them. Contact us at Zeihan.com/consulting to inquire about rates and scheduling options for teleconferences, videoconferences and in-depth consulting calls.

The Cutting Room Files, Part 7: Europe

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.

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Why So Negative?

Bonds are sliding toward negative territory across the developed world.  Among the largest industrialized economies, only the United States is offering over 2% yields on 30-year bonds. And it’s not just the global economic pillars pushing rates down, but even in places like Poland that stretch the definition of “developed” market. Or Italy, which push the boundaries of concepts like “balanced budgets.” And even in Greece, which stretches the definition of… pretty much damn near everything. 

What gives? 

First, the technical answer. 

Part of the shift toward negative territory is quantitative easing (QE). QE is, in essence, the expansion of monetary supply above and beyond what the economy says it needs, and then using the newly “printed” currency to purchase various bonds. This artificially drives down borrowing costs of all kinds and inflates financial markets. The idea behind it is that cheaper borrowing costs and an inflated finance market will boost business and consumer confidence and from that, spending — thereby boosting demand in the real economy. 

Between the American, European and Japanese programs, the equivalent of some $15 trillion has been dumped onto markets through QE since the 2007 financial crisis. One reason for the dollar’s strength under Trump is that the United States’ QE program largely came to an end several years ago and the US has reverted to using more traditional monetary tools. In contrast, Europe has been at near-zero interest rates for a decade (and Japan for twice as long), leaving QE or things like it as their only means of using monetary policy to stimulate economic activity. The Eurozone, after a brief hiatus, just restarted QE again a few weeks ago. Japan never really stopped. 

It all adds up to a lot of money chasing limited investment opportunities. That boosts stock and property markets, while the surge into bonds pushes yields negative. 

Second, we have the traditional answer. 

There is a whiff of instability surrounding everything. Germany is undoubtedly in recession and will drag much of the Eurozone down with it. Japan hasn’t seen reliable, sustained economic growth since the 1980s. The American-Chinese trade war has collapsed global confidence in the Chinese economy while the HK protests have collapsed Beijing’s soft power. Meanwhile, it seems that nearly every country in the Middle East is facing some degree of crisis. Even if you’re an aficionado of my brand of Kool-Aid and believe that the US is largely resistant to global upheaval, “resistant” is not synonymous with “immune.” While I still do not see an American recession on the horizon, the American economy has most certainly slowed. 

Recessions — even fears of recessions — have consequences for capital. Spooked investors tend to push money into assets backed by either long-term income streams, government guarantees, or both. Fewer stocks, more bonds. High bond demand pushes yields down towards, to, and through zero. 

It isn’t so much that either answer is wrong. In fact, they are dead on. But they are not the whole picture. There’s something else going on. Something much bigger than QE and much more structural than the normal ebb and flow of economic cycles. 

It’s demography. 

People act differently depending on their age. There’s aren’t a lot of retirees at spin class, nor do college students frequent buffets that specialize in creamed vegetable products. In a “normal” economy there’s a set balance of roughly four children to three young adults to two mature adults to one revered elder. So long as that proportion holds the economic system has some somewhat straightforward characteristics: young workers spend and borrow, mature workers invest, while retirees shift their financial holdings into decidedly less interesting and volatile holdings. Fewer stocks — more t-bills and cash. 

The problem, if “problem” is the correct word, is that the onset of the Second Industrial Revolution roughly 140 years ago both pushed people off of the farm and into urban environments while vastly, dramatically increasing lifespans. As the decades rolled by our definition of “normal” has shifted. Families became smaller and smaller until most of the developed world slipped below the replacement level of 2.1 children per family. Among the developing world the process started latter, but the downward shift in fertility has been two and three times as fast. The partial exception? The United States. Its wealth of arable land has made it an industrialized country that urbanized slowly. The result? China’s population is already older on average than America’s, while Indonesia and Brazil’s will surpass America’s average ages in about a quarter-century.

The problem (and this time “problem” is certainly the correct word) is that the demographic shift has altered the structure of capital. From roughly 1970 to 2010 the decline in birth rates steadily increased the proportion of mature workers in the population relative to everyone else. It is this block that saves the most both in relative terms and in aggregate. Those savings are the bulk of the world’s working capital. Left unchecked, the growth of the mature worker cohort will eventually oversupply the world with capital.

Well, “eventually” is here. Right now, the population of mature workers as a proportion of global population is at its peak. As this cohort inexorably edges toward retirement, they are shifting their portfolios into less risky assets. Less venture capital, more bonds. The veritable tsunami of capital into the bond space has pushed the safest of those bonds — government debt — firmly into the negative.

Don’t get used to it.

The biggest thing that separates mature works from retirees is time, and in 2022 the majority of the world’s Baby Boomer cadre will have aged into mass retirement. Denied much in the realm of fresh income, the incoming tsunami of government-bond-capital won’t so much recede as evaporate.

Without those inflows, capital costs will — must — rise.

That’s the best-case scenario. It assumes no disruptions. No breaks in global continuity. A rapid climbdown from the trade war. That Italy doesn’t implode. That the Eurozone holds together. That the Brexit debacle calms down. That the Japanese economy can manage its aging and shrinking worker pool via automation and robotics. That the Chinese political center holds. That the broad swathe of the developing world can somehow double their standards of living in under a decade without sacrificing family size. That there’s no shock to energy markets. That the economic contortions of mass aging somehow magically avoid touching banking and finance. That the Americans elect a mild-mannered accountant to be their next president.

Anything that injures either globalization in general or employment and wealth levels specifically immediately imposes burdens, both in terms of raising financing costs directly and preventing capital created in one region from pouring into another. Fragmenting global capital markets will, all by itself, turn regions that have recently become used to ultracheap capital (sub-Saharan Africa, Brazil, and India come to mind) once again into capital deserts.

That’s still a pretty good scenario.

It assumes the global system while beaten and bloodied ultimately holds. Historically speaking, the downturns an instability we’ve experienced to date — and this includes the Great Recession — are pretty minor stuff. The global Order is what has enabled many countries to exist in the first place, and if you cannot exist you cannot issue bonds. A heartily inconvenient fact of economic history is that before the Order (that is, 1946), it was pretty common for markets to not simply fail but go to zero.

The first time that happens the financial markets will come face-to-face with a level of risk and risk pricing that no one alive has any expertise in managing.

Brexit: The End of the Beginning

The United Kingdom stands at the precipice of its greatest change since the collapse of empire. It will be just as painful.

This week Britain got a new parliamentary grouping – the Independent Group – that might in time form the kernel of a new political party. It started with a breakaway of seven opposition Labor MPs, and on Feb 20 picked up an eighth defector as well as three MPs who ditched the ruling Conservatives.

The environment shaping the splintering, unsurprisingly, is Brexit.

Let’s start with the Conservatives. Prime Minister Theresa May arguably has the worst job on the planet right now. May believes the 2016 referendum in favor of the United Kingdom leaving the European Union obliges her to lead the United Kingdom to leave the European Union. We can debate whether referendums truly are the will of the people (I’d argue that since referendums ask explicit questions they are purer gauges of the popular will than elections), but the point is that May’s interpretation of the results are that hell-or-high-water the UK will leave.

It was always going to be messy. There was never going to be a divorce deal with the European Union. EU policy dictates that in any big issue each individual EU member must approve of the final text. The Irish want to maintain restriction-free access to Northern Ireland. The Spanish want a path to recovering Gibraltar. The Dutch want the British as close to the common market as possible, but not if it means they have to follow rules the British do not. The French want to gut the British geopolitically. The Germans seek to maintain market access but deny London any rule-making influence.

There simply is no iteration of any deal that can satisfy all these divergent interests, much less in the short two-year timeframe the Brexit negotiations allowed. Getting a comprehensive trade deal with Canada took the EU a decade. Even if there were a path forward that would please all of Europe, any such deal couldn’t get through the British Parliament. In losing those three MPs, May has lost her majority – which was already razor thin and only in existence at all with the help of a minor Northern Irish party which has some pretty uncompromising views on issues Irish.

No, there is zero way forward here that is anything other than a hard crash out. I’ve held this position from the beginning, but now the United Kingdom cannot get anything done that requires a parliamentary majority.

Those of you on the political left, don’t get cocky. British Labor’s mess is just as bad with the added problem of not being in power. Between 2016 and 2018 the Labor Party came back from the bleeding edge of dissolution under the leadership of Jeremy Corbyn by tacking to the hard left and bringing in a lot of youthful energy.

The problem is that young Brits tend to be exceedingly pro-Europe while Corbyn is anti-…. pretty much everything, with Europe near the top of his list. When you’re not in power it is easier to paper over such differences, but with many in the Labor Party agitating for a second referendum to undo the first one and with Brexit the issue of the moment, it is getting harder to hold the party together. The seven Labor MPs who founded the Independent Group did so expressly because they want the UK to remain in the EU and felt their leader was on the wrong side of the issue.

I see a few things here:

First, the United Kingdom’s party structure is in freefall. Neither the Conservatives nor Labor are unified on the issue of the day and so MPs are breaking off in an attempt to form new poles of power. Something similar is occurring in the United States, but features of the British system enable the shift to occur much more quickly.

The United States distributes power among local, regional and national levels, while the presidency is elected independent of Congress. In such a system the level of direct/local democracy is higher, but on the big issues change tends to come more slowly because a party breakdown doesn’t immediately or necessarily change the national government. (This design quirk is part of why any American administration always seems so tone deaf while Congress seems so feckless.) The biggest shock to the American system, the end of the Cold War, is only now – three decades later – working its way through the political framework. And it has taken that combined with things like digitization, the ongoing Baby Boomer mass retirement, and the rise of China to force a long-overdue political reshuffling.

In contrast in British national elections the various elected representatives meet in Parliament and select the national leader from among their own number. If the ruling party cracks, it can no longer command a majority in Parliament. A vote of no confidence can bring the government down in a day, force new elections in a month, and voila! New parties, new government, new policies.

Second, in the United Kingdom the next few weeks to months will be utter political paralysis. May has lost her majority so even if the European Union could stomach a Brexit deal more favorable to the UK, May can no longer get any deal approved. Only five weeks remain until Brexit occurs. With the reality of a hard Brexit belatedly sinking in, Parliament should be incredibly busy with a mass of enabling legislation that would help smooth the process within the United Kingdom in preparation for what happens after nearly a half-century of laws and regulation are invalidated in a day. No such luck. This is going to make the transition much more difficult than it needed to be and it was already going to be very difficult.

Third, if anyone wants to take advantage of the United Kingdom, now is the time. Upon leaving the EU the Brits will lose access to half of their trade portfolio and there is zero vision within the country’s political and cultural structures as to how to move forward.

Politically, the Brits cannot chart a route forward. May undoubtedly is not in it for the long haul, and Brexit challengers within the Conservative Party are, how shall I put this, not exactly carved out of honesty, thoughtfulness or creativity.

On the other side, Labor is led by a man who makes Donald Trump look honest, thoughtful and inclusive. The defectors who formed the Independent Group had some choice words for their former leader that included things like bigot and Stalinist. Considering how fast a single election in the United Kingdom can change policy paired with the epic possibilities for rapid change that Brexit provides, the election of Jeremy Corbyn would be a disaster that would take the United Kingdom a generation to recover from.

For Brits reading this, please take to heart that this criticism of Corbyn’s character and policy preferences comes from a citizen of the United States, a country with a well-documented and respected track record in recent decades of selecting the absolute worst candidate from among a wide range of suitable options. I know a damp squib who is chuffed at his own chunder when I see one.

The country most likely to seek advantage over the Brits is a country that has done it before: the United States. In World War II the Americans nailed the Brits to a borderline-usurious deal known as Lend-Lease in which the Brits received some shoddy, outdated ships in exchange for almost every bit of the British Empire in the Western Hemisphere. That deal subjugated the United Kingdom to American strategic preferences for the next two generations.

Post-Brexit Britain will be its most geopolitically desperate since those dark days when it stood alone against the Nazis, and the American administration is already in the process of rewiring all its foreign relations. Any deal negotiated in the post-Brexit chaos will be at least as disadvantageous as Lend-Lease and will – at a minimum – result in most of the British financial sector decamping to New York City.

Finally, a few words about what the Brits are leaving. The drama of Brexit has enabled the Europeans to shift attention from all those issues that were already past the point of no return in 2016: immigration, refugees, the Ukraine War, Russian aggression, the Syrian War, overloaded pensions, demographic collapse, sovereign debt, Greek insolvency, Italian banking, the failure of the German political center, the deliberate destruction of liberal democracy in Poland and Hungary, the end of productive relations with Turkey, etc.

Not only have none of these issues gone away, all have gotten worse. Many are fully capable of killing the European project independently. All of them combined simply make the end of the EU an issue of a betting pool for the date. With the Brexit “process” about completed, all European eyes will refocus back upon these unsolvable issues. For Europe, the year 2019 will suck as much as it will for the Brits. The EU was always going to end, so the Brits getting out before the collapse and getting a head start on whatever is next will a decade from now broadly be remembered as the right call.

But it didn’t have to be nearly this hard.

I Think They Get It Now, Part Cinque: Italy

Jump to other parts of this series: Intro, France, Germany, UK, Japan, and Canada.

In any discussion of foreign affairs the same list of powerful countries have been bubbling up for decades, if not centuries. The order often shifts, but the countries themselves tend to hold on: the United States, Russia (aka the USSR), Japan, the United Kingdom (aka the British Empire), France, Germany (aka Prussia). There’s also a secondary list of largely regional powers: Iran, Turkey, India, Mexico, Brazil, Argentina and Sweden. Israel, Korea and Pakistan are relative newcomers to the second list while China has graduated from the latter list to the former.

One country that most don’t spare thoughts for, however, has been one of the world’s top ten economies ever since humanity developed sufficient command of statistics to come up with the list in the first place. That country is Italy, and it is about to crash back into the world as a significant player.

But first, it has to…crash. Hard.

Contemporary Italy is beyond dysfunctional.

  • The country is flat out broke — only Japan and Greece have national debts that are higher in relative terms.
  • Its banking sector is arguably the most overextended in the world, with a relative weight of bad loans that is eighty times that of the United States at the height of the subprime crisis.
  • Unemployment is at a level that would spawn riots in the United States.
  • The birthrate collapsed thirty years ago and never recovered. Its population is one of the ten most rapidly aging on the planet, and already well past the point of meaningful recovery.
  • The country’s current pension overhang is already among the worst in the world, and that before the Italian Baby Boomer generation even begins to retire.
  • Italy suffered greatly during the European financial crisis and its economy hasn’t seen appreciable growth since 1998.
  • Citizen trust in government is so low as to barely register in opinion polls.

And the political situation is an utter circus, complete with actual clowns or, more accurately, a populist comedian but you get the idea. The Italian equivalent of the Republicans and the Democrats have been gutted to the point of extinction, being displaced by an alliance that could only happen in Italy: a pair of parties that most closely resemble Texan secessionists (the Northern League) and Bernie Sanders…if Bernie Sanders was a career comedian who used a lot of racist jokes and opened rallies with the song “America-F*** Yeah” (the Five Star Movement).

What’s the way forward here? There isn’t one, except national collapse. Italy as a modern political economy is already over. The only reason it has not passed into history already is that it is lashed into the European Union. There are many structural issues embedded within the European system that could bring the entire edifice down. The United States withdrawing from the global order is one. The death of Italy is another. Weighing in at over $2 trillion dollars, the Italian system isn’t too big to fail — it is too big to save.

But from the rot of the current system, from the end of a Europe that is united and free, something new is about to arrive. Or perhaps it is more accurate to say that something old is about to return.

The Italian core territory is unlike anything else in the world. The Po Valley is a rich land with a perfect climate nearly encapsulated by some of the world’s most rugged mountains. The Po’s entire northern horizon are the European Alps. Even with today’s technology and centuries of infrastructure building in what was until very recently the world’s richest continent, the Alps still remain a massive barrier to communication, much less armored columns. To the south the Apennine Mountains of the Apennine Peninsula are certainly less imposing, but the utter lack of large chunks of flat land (and the fact that southern Italy is a peninsula of peninsulas) make it both a non-challenge to the economic and political supremacy of the Po as well as an at best imperfect invasion route.

In the Po’s near neighborhood there are no meaningful threats. To the north — across the Alps — are Switzerland and Austria, a Germanic pair of countries far more concerned with issues on the Northern European Plain than in the Po. To the east are the minor and often failed states of the Western and Southern Balkans: Slovenia, Croatia, Bosnia, Serbia, Montenegro, Macedonia, Kosovo and Greece. None of which — individually or in concert — can hold a candle to Italy’s economic heft, and none of which — individually or in concert — pose even a modicum of a security threat. (If anything, their bickering chaos provides Italians with a massive strategic buffer.) To the south across the Mediterranean is Northern Africa, a region that has not posed a meaningful danger to Southern Europe since Christopher Columbus was a teenager.

That just leaves its western neighbor, France. The Italians may have some differences of opinions with the French, but since the Franco-Italian border is a chunk of the Alps and the Po’s window on the world lies far to France’s east via the Adriatic, it is rare for the pair to butt heads. Add in a moderate sized navy of moderate skill — which the Italians have — and the Po is if anything more secure than the United Kingdom.

And that’s how we must think of the Po — as an island. Separate from Europe, separate even from the rest of Italy. Within that distinction lies the Italians’ future.

In the world before World War II the Po Valley was one of, and at many times the, economic powerhouse of the both Europe and the Greater Mediterranean. Its physical separation and inviolability made it the logical location to broker deals, to install infrastructure central to the economic health of the broader region, and to serve as trade middlemen for everything that mattered.

Part of the attraction of the Americans’ installation of a global security order was that geography mattered less, so countries with often-compromised geographies could shine — in many cases for the first time. For the Po Italians whose geography was their ticket to centrality and wealth, this sort of sucked. Had they not been on the wrong side during the war and not already been issued an opinion on the matter, they may well have sat out membership.

As the Bretton Woods order expanded, as the European Continent unified under the aegis of the European Union, as stability spread, what made the Po special became less so. Italy as a whole saw its position slide. With the end of the Cold War the Po is little more than a rich backwater. Italy as a whole hasn’t seen meaningful economic growth in nearly two decades, and its end is nigh.

But Trump’s actions at the G7 indicate that the system that has so enriched the rest of the world and so stabilized Europe — in part at Italy’s expense — is at its end. Remove global stability, remove the European Union and NATO, break the supply chains that supply the global system with everything from cars to crude, and all of a sudden the Po’s island-but-not-an-island geography combined with its relative centrality makes it the place to be.

So what kind of place will the Po become? What does it have to offer?

First, a step back to frame the discussion:

Just as the Po Valley and “Italy” are not the same thing, the Po Valley itself isn’t one place. The cities of Northern Italy in many cases have identities and histories just as distinct from one another as full-blown European countries. Verona, Trento, Parma, Bologna, Milan, Venice, Turin, and Genoa were all independent players from the fall of the Roman Empire right up until Italian Unification in the 1870s. That means they only rarely act as a unit, and the emphasis of all things Italian has always been on diversification and differentiation.

In the world of energy it means the Italians maintain one of the most varied set of refineries in the world, able to take in any crude stream and process it into any end product. Today Italy boasts roughly double the refining capacity they need. Toss in the sort of economic adjustment that comes from state collapse and dollar to donuts the Italians’ surplus capacity will soon make them the largest source of available refined product within three thousand miles in a world where energy security for most is a long-faded dream.

In the world of manufacturing it means the Italians make things a bit differently. For Italians wares are not about assembly lines or efficiency — that requires economies of scale and integration. The Italian cities compete with one another instead. They don’t share. They keep all the steps in house, so it is all about expression and perfection. The sort of long, gangly, multinational supply chains that can only survive in a world of stability and global market access are not the sort of things Italians do well. Think Fiat. So instead of mass producing serviceable items, the Italians hand-craft products that could easily be mistaken as art. Think Lamborghini and Versace. That sort of “manufacturing” does just fine when the world falls apart.

The problem with this machinery-as-art model is labor. It literally takes a lifetime to train a Ferrari craftsman. It is something the new manufacturing techniques that are sweeping the American industrial space cannot integrate into. The Italians don’t hate immigrants for simply the standard religious, ethnic and economic reasons, but also because immigrants simply cannot help with the problem the Po faces.

Nor is this new. Nor is it constrained to outsiders.

The Po Valley versus Italy’s south is a study of polar opposites; the Po’s sophistication and productivity contrasts sharply with the statist rot, civil breakdown, organized crime, and poverty of the South. Between unification and 1940, southern Italians moved en masse to work in northern factories. This was at a time when Northern Italian sentiments toward many in Southern Italy was racist in a generous sense. Even Mussolini’s son-in-law is said to have privately mused that perhaps it would have been better to be born a Jew than a Sicilian in Fascist Italy (against the backdrop of the Holocaust, no less). Today, the south’s population is smaller, older and sicker relative to the north than ever before. It is already on the ragged edge of failed statedom, and northerners fear southern in-migration nearly as much as they resist boatloads of migrants from Africa.

Northern Italy doesn’t need Southern Italy for anything in the traditional sense: labor, market, capital, technology, food, even strategic depth. What the Po does need is free access to the Mediterranean for oil inflows and trade outflows (and perhaps the refineries that dot the southern coastlines). It needs Southern Italy to be in a box that also contains the Southern Italians and blocks would-be migrants from the world beyond. It needs to be able to treat the south as an occupied territory.

There’s really only one governing system that can fit that bill: Fascist. Again, this isn’t new. Fascism was well established in Italy a decade before Adolf Hitler’s rise to power in Germany for much of the same reasons.

Assuming the Italians of the Po can constrain and contain the Italians of the south, there is little need to venture further out. The Po will again become the lynchpin between the Middle East and Africa on one side, and Europe on the other. The Italians’ very lack of strategic ambition makes them the perfect middleman. About the only weakness in such a system is ensuring sufficient inflows of crude so that Italy can be a large refining center. There’s nothing new here either: The Northern Italian cities have been brokering deals with whoever controls the Eastern Mediterranean for the commodities of the day for over a millennium.

To paraphrase an old European saying: Italy is dead. Long live Italy.

I Think They Get It Now, Part Four: The UK

Jump to other parts of this series: Intro, France, Germany, Italy, Japan, and Canada.

The United Kingdom has been the United States’ firmest and most capable ally for over a half century. As such many often think of the British Prime Minster as a sort of Washington Whisperer. The Brits, so the thinking goes, are a civilized people who can bring the oftentimes erratic Americans around to a saner course of action.

As one of the United Kingdom’s great statesmen, Winston Churchill, famously put it: “You can always count upon the Americans to do the right thing… after trying everything else.” The quote is as much an homage to the immense power of the United States, as it is to the trademark patience, dry humor and stiff upper lip of the English.

And so it is with no surprise that many world leaders have called upon British Prime Minister Theresa May to intervene on humanity’s account with U.S. President Donald Trump. But it is no surprise to me that she has done nothing of the sort. Nor will she. It is all wrapped up in why the United Kingdom is a major power in the first place.

The United Kingdom matters not simply because Great Britain is an island, or because the Kingdom has the naval power to defend its island, but because the Kingdom has sufficient naval strength to project power well beyond its island. That enables the Brits to pick the time and place of the conflicts they choose to engage in. Even if they choose poorly, they can always pack up, sail away and try again later. Clashes that leave most in ruin at most force an early election in the Kingdom.

There are only two things that could undo this strength. First, the United Kingdom’s flexible strength could be overwhelmed by a more powerful navy. Since the only Atlantic Ocean navy that is more powerful is the American Navy, this is a low risk. Second, the United Kingdom could for whatever reason find its navy degraded to the point that it can no longer project power. And that is precisely the challenge facing the United Kingdom today.

Ironically, painfully, the UK’s current naval weakness comes directly from an attempt to generate strength.

It is difficult for any student of global strategy who is not willingly blind to ignore the role played by the American supercarriers. The Nimitz class carriers are not simply the largest combatants ever floated, as a rule they pack at least seven times the combat capabilities of any rival naval vessel – including the largest carriers floated by other countries. The Nimitz ships have enabled the Americans to project power not just anywhere on any ocean or coast, but in most cases several hundred miles inland as well. Without nuclear weapons they are the most powerful conventional weapons systems any country has ever fielded, and just one of them if nuclear-armed has more firepower than the entire military of France. (No, that is not a France slam. The supers are simply that cool.) The Americans have ten of them. The combined rest of the world? Zero.

So long as the Nimitz carriers (or their soon-to-be successors in the Ford class) are the top shelf of military capacity, anyone seeking to oppose the Americans has to find a way to push the Americans at least a thousand miles away from shore (ergo why the Chinese are so heavily invested into long range anti-ship missiles). And should any naval power seek to ally with the Americans, they will always be entirely in the shadow of the massive, raw American power that the Nimitz ships provide. So long as the Americans are the only people with fully-operational supercarriers, no one but the Americans gets a vote as to how the Americans and their allies perform global strategic policy – even if you are one of the allies.

There are a lot of non-blind students of global strategy in the United Kingdom, and about two decades ago they all came to the same conclusion: if the UK is to matter at all, we must have our own supercarrier. And since, like any other vessel, ongoing refits are part of the process, we must have at least two. The end result was the launching of the Queen Elizabeth carrier program. Weighing in at 65,000 tons displacement they will be the largest combat ships ever floated with the notable exceptions of their inspirations: America’s Nimitz and Ford classes. Fully operational, they will give the Brits exactly what they are after: a seat at a table for two, the only table that matters. When the first ship of the new class started sea trials in December 2017, a veritable army of bubbly erupted at Whitehall.

Just one problem. The Brits screwed it up a little bit.

Maintaining weapons development systems over multiple decades and multiple administrations is difficult. In the time since the plans for the Queen Elizabeth class were first floated, the Brits have had a dozen elections and five prime ministers (and unless my political tea-leaf reading has gone completely off the rails, they’ll have a sixth before long). With each change of leadership there is a change in priorities, and oftentimes life rudely intervenes. Financial crises of the Asian, European and global kind have competed with the British Navy for resources. The Iraq War, the Afghan War and the Libyan intervention ruthlessly pulled British defense prerogatives away from the sea and towards land. The Joint Strike Fighter development program has gone egregiously, criminally, hilariously over budget.

At each step the Queen Elizabeth carrier program had to re-justify itself and fight for funding anew. In the process the Brits found themselves forced to mothball their existing jump carrier fleet in total in order to funnel resources to the new supercarriers’ construction effort. The Brits had to transfer their navy aircraft, pilots and flight crews to the U.S. Navy in order to maintain any hint of naval aviation capacity. And now, with Brexit looming, they’re having to slim the rest of the naval force to keep their supercarrier program on track.

Which means the Brits no longer have sufficient ships to protect their new supers once they are fully operational.

Carriers are not just massive and massively capable combatants, they also represent years if not decades of investment into equipment and personnel, and while they cannot be sunk easily, sunk they most certainly can be. As such every carrier is but the nucleus of a battle group, with all the other vessels’ primary purpose to ensure the carrier does not sink. The British Navy has atrophied so much for so long that it can no longer assemble two credible battlegroups and still defend Great Britain itself.

For the Queen Elizabeths’ deployments, this is nothing short of a Charlie Foxtrot. The new British supercarriers dare not venture further away from shore than the reach of British air power, whether that air power be launched from the United Kingdom itself or from the territory of a trusted ally. Support ships can certainly be built up more quickly (and cheaply) than the supercarriers themselves, but ships don’t grow on trees. This will be the state of the British Navy for at least a decade. Probably two.

This presents London – the naval power par excellence of earlier eras – with a galling choice:

  1. Abandon all hope of ever projecting power, and treat its shiny new supercarriers as the same sort of idiotic chest-beating paperweights the old Soviet “carrier” was,
  2. Fold its supercarriers into the Americans’ battle groups and de facto merge with the United States on all strategic policy… and hope against experience, culture and hope itself that the Americans will listen to your strategic opinions because you contributed a couple big boats.

The decision has already been made. The Brits know better than to fly solo, and they certainly know better than to fly solo against the Americans. The key memory is the 1956 Suez Crisis.

At that time the Brits were certain when the Americans said under the Bretton Woods system all the empires would be disbanded, that it didn’t apply to the British Empire. The British assault on Egypt inadvertently forced the Americans to choose between maintaining the British Empire and their own new global order. It wasn’t a hard choice. The result was strategic castration – with the Americans using all their ample political, financial and military strength to force the United Kingdom into a permanent, subservient position within the alliance that has lasted ever since.

To underline how annoyed the Americans were, they also forced the Brits to stick to the letter of the deals signed to support the United Kingdom against Nazi Germany in the early days of World War II before the Americans themselves were involved. The terms of such loans were so onerous that the Brits didn’t finish paying them off until the 2000s.

And so the Brits have no choice but to stiffen that lip and march forward into the very much known.

  • They will seek a direct bilateral trade deal with the Americans in order to replace the European Union at the core of their economic strategy. It may have fewer regulations, but it won’t enable the United Kingdom to be as wealthy as they have been, and the Americans will offer few concessions because the Brits are economically and strategically without options.
  • They will surrender the financial centrality of London to New York City either as part of the trade negotiations in the hopes they can glean a few concessions on other topics, or because without a firm Brexit deal the financial sector will up and leave London anyway.
  • Should the Trump administration manage to extract a final NAFTA deal from the chaos of the current negotiations, the Brits will grudgingly sign on knowing full well that direct competition from Mexico will do to the United Kingdom what Team Trump says Mexico has done to the United States. The alternative is to be a forgotten side deal only tenuously linked to the American market.
  • And no matter what military adventure the Americans go on, the Brits will be there. They know better than anyone it is far better to be in the Americans’ shadow than in the Americans’ way.

Put simply: what Trump wants, Trump gets. It’s that simple, because if the goal is security and stability for the British people, there is no other option.

This might sound humbling, horrible even. But it really is not. So the Brits don’t matter strategically on their own. They are still safe. They are still wealthy. With the world crumbling down there are worse sides of history to be on than being an adjunct to the Americans. And isn’t it the fate – if perhaps not the goal – of most parents to eventually move in with the kids?