The Left Leaves

A terror attack in the United Kingdom May 23 killed at least 22, and injured dozens more. As the attack targeted a youth pop concert, a high proportion of the deaths were among children and teenagers. United Kingdom Prime Minister Theresa May immediately cancelled all her ruling Tory Party’s campaign events — national elections are June 8 — so her government could focus on the crisis. The country’s other parties quickly followed suit.

As of yesterday, the Tories had this election locked up to the degree that a generational shift in UK politics was in the offing. If the polls are accurate, the Tories would have eaten deeply into the holdings of other parties not just in England, but in Wales and Scotland as well. Ongoing Brexit talks have justified and energized the Brits separate-and-superior mindset, and Theresa May has been using that energy to reshape the UK political space. That means, among other things, the British Labour party moving into the political wilderness, the de facto absorption of the anti-EU UK Independence party into the Tories, the Liberal Democrats’ return to the fringes of British power, and the evisceration of the Scottish National Party’s stronghold on Scottish politics and an end (for now) of talk of Scottish independence.

That was before the attack.

Between the rally-round-the-flag effect of terror attacks and the fact that the ruling Tories are the law-and-order party, the UK is now on the cusp of a complete overhaul. Barring some truly unprecedented revelations that bring down May and the entirety of the Conservative leadership, the Tories will walk away from the June elections with the strongest showing of perhaps the last century. In the election’s wake, Labour will not simply be weak, it will be gone and it is unlikely to come back in a meaningful way.

What’s going on in the United Kingdom is hardly unique; Center-left parties are collapsing across the developed world. It is a symptom of a wider change in the way we all live.

Contemporary political systems are an outgrowth of the economic structures established by the industrial revolutions of the 18th and 19th centuries.

Before those economic revolutions the world was a constellation of fairly small places. Low-output per hour of work in agriculture forced most of the population to be farmers. Life before semis and railroads and globalized supply chains meant that foodstuffs needed to be lugged around by horse and backpack. Cities — places where you could not grow your own food — were small as well as, well, revolting. Cram a bunch of people in a small space with no running water or plumbing, make them dependent upon food that has to be carried in from somewhere else, and things get gross and violent pretty quickly. In such a world, there weren’t a lot of mass-mobilization politics. Either you were a landowner or other flavor of aristocrat who ruled, or you were a pleb who didn’t get a vote.

The First Industrial Revolution of roughly 1760 to 1820 upended that system. The introduction of mechanized energy such as steam engines enabled us to shift from producing goods by hands to producing them with machines. Such mass outputs increased worker efficiency while concentrating the geography of production. The result was mass urbanization and mass worker concentration. Within a few decades these economic evolutions shifted the balances of power. The “Left” catered to those who provided the labor in the new order, while the “Right” represented those who controlled the land and capital. There are many different ways to categories the Left and the Right, but the transition to industrialization is where the political cleavages in the modern world started, and have remained the most powerful delineating factor in Western politics ever since.

Plenty of folks vested in the pre-industrial order fought tooth and nail against the emerging political landscape, but they faced two insurmountable challenges. First, the winds of history were blowing and you cannot un-invent technology without removing the bedrock of the civilization that supports it (i.e. devolution into anarchy). As the new Lefters and Righters gained power, these older groups fought back. Political instability and even revolutions were the rules of the day. And even when the old-order folks won, its isn’t like their areas suddenly de-industrialized. New challenges arose the very next day until all the old world was swept away.

Second, there was a new country on the scene that had the gall to let the people decide who would be in charge. Those pesky Americans devised a political system — democracy — that was (quite accidentally) able to reshape itself, contain and ultimately harness the new economic-political lines of identification. Democracy quickly became a way to accelerate the shift from the old world of aristocrats, plutocrats and royals to a newer system with a deep economic rationale that enjoyed broader support.

The Second Industrial Revolution of 1860 to 1945 was the equivalent of rocket fuel in a station wagon. Machine tools gave way to assembly lines. Coal gave way to diesel and gasoline. Railways, telegraphs and ocean-going fuel-burning cargo ships took over global commerce. Many of the new developments — in transport, medicine and sanitation — were expressly designed to counter some of the more disgusting aspects of early industrialization. Antibiotics, sewers, electricity and new distribution techs didn’t just make cities bigger, but also removed some of the features that made them death traps when compared to the countryside — accelerating urbanization. The countryside, where Left-Right classifications weren’t entirely appropriate, became systematically less important as populations en masse shifted into the urban worker-capital categories.

This broad system of political alignment then held until about ten years ago.

The financial crisis of 2008 was a watershed because it seized up traditional capital markets. That disruption damaged everything that the economic structures of the industrial revolution sustained: life-long careers (and even jobs), labor unions, traditional manufacturing, employment patterns…and the Left-Right split that represented all those things in the political arena. The 2008 crisis occurred just as computerization was really hitting its stride, and the link between capital and capital-owners has blurred. Unequally distributed wealth isn’t the point — it is that capital is no longer linked at the hip to organized industry. Capital is now free-flowing. It goes to any place in any industry in any volume based on what looks promising.

That is exciting, but it is also disruptive. Less Walmart, more Amazon. Fewer assembly lines, more 3D printing machine shops. Fewer accountants, more TurboTax. Fewer unions, more Uber. Fewer financial firms and more AI-driven stock trading. Fewer supermajors and more tiny firms using infotech to wrestle oil out of shale formations. Fewer landlines and all the labor and mammoth companies that go along with them, more iPhones that just require the odd cell tower. We are now in a Digital Revolution that is redefining the relationship between labor and capital. Sure, it means that you can do more with less and have fancy gadgets, but it also means that anyone who had a stake in the old system — whether a line worker or a bank teller or a secretary or a stock broker or a roughneck — has to abandon not just their job, but their career. And that has political consequences.

The new technologies are far less labor intensive — meaning fewer workers. The new technologies have far lower barriers to entry, so there is no monolithic employer — meaning no unions to support, and no employer to bargain with or fight against. The traditional “Left” just doesn’t fit in the world rapidly unfolding, and so it is collapsing. Everywhere.

  • In the United States the populist uprising that elected Donald Trump is a textbook case of how economic evolution shapes political choice. Line workers — even union workers — deserted the Democrats en masse for Trump. What’s left of the Democrats — and they’ve lost over 1000 elected positions at state and national level since 2008 — is now incapable of taking any stance save a general opposition to all things Trump. That’s not enough to hold, and they face a generational wipeout in the 2018 by-elections that is likely to hand the Republicans their strongest Congressional majority in decades.
  • French presidential elections in May eradicated the ruling Socialists. Their candidate didn’t only not make it to the second voting round, he only garnered an 6% share of the first-round vote. Parliamentary elections in June may well reduce them from the dominant party in the National Assembly to the fourth-largest.
  • The European financial crisis has gutted the political stability of Europe’s peripheral countries. Greece is ruled by the nationalist-communists. Italy will likely have a comedian as prime minister by year’s-end. The Spanish Left is being displaced by a party that takes its developmental cues from Greece.
  • In Israel the economic shift has been so holistic that it has nearly banished the Israeli Labor party — the party that founded Israel — from the Knesset.

The only significant country where the Left is holding any ground is Germany, a country artificially re-constructed after World War II to have a very specific — and durable — political system. And even there the Social Democrats are on course to lose their fourth consecutive election this fall. (Yes, the center-left actually rules Canada — the only place of note that it still does. but Canada both lives in strategic nirvana and is disastrously complicated from a domestic political organizational point of view so I’d not draw too many lessons from the Great White North.)

What’s left of the economic Left is being subsumed by populism, a movement that broadly speaking is unhappy with the current state of affairs, thinks that everyone is out to get them, wants change, wants it now, and wants to use a mass government overhaul in order to force the issue (in the 1930s we would have called this national-socialism). Populism has managed to capture much of the Left’s thunder in a wide variety of countries including — but hardly limited to — Hungary, Poland, Austria, Finland, Israel, France, Italy, the Netherlands and Turkey. Yes, Trump is a symptom of the Populist rise. But so too are Bernie Sanders and Elizabeth Warren. (There are many types of populists. None have ever ended up delivering what they promise.)

It is tempting to say that politics is cyclical and the Left will recover, or that it botched the chance to rule in the past two decades and it just needs a little time in the wilderness to reconnect to its roots, or that the Left can embrace other issues like identity politics and social issues to reinvigorate itself. But that misses the point. The economic Left has lost power everywhere. The grab bag that remains is important and will obviously color political and social evolutions, but it cannot define the era. Such awkward coalitions can garner votes, but not in the quantities sufficient to govern. The term “Left” itself may be appropriated by new and varied causes — the most likely is to support the coalition of those devastated by Apple, Amazon, Uber and the rest — but those are not workers, but instead the opposite. The rubric that has defined the Left for nearly two centuries is gone.

And before those of you on the Right get too excited, just because the Left disappears doesn’t mean the Right wins. The Left is not alone in dissolving into the Digital Revolution. The Right as we understand the term is finished too. Trump won by running against the Republicans. May is in charge in the UK because the traditional Right collapsed in the Brexit vote. France’s Right is in just as much trouble as the French Socialists. The Right parties of Poland, Israel, Austria and Japan are now more nationalist and/or populist than that the classical Right in the labor-capital divide.

It is about to get a whole lot worse. As the global demographic flips into mass retirement around 2022, the availability of capital that has made the Digital Revolution so broad and deep will drastically shrink. Currently, changes in capital allocation are breaking down our “normal” Left-Right political systems, but the Digital Revolution’s advances at least maintaining an economic structure. Remove all the capital that makes the Digital Revolution possible and we’re in for a world of hurt…with populism the only political movement that has traction.

The last time our economic-political systems faced this much evolution and upheaval, the disruption lasted over a century and culminated in the world wars. The issue is that you can’t have normal political parties unless you have a grand vision, and you can’t form a grand vision unless you understand the rules of the game. As the developed world moves into a post-industrial economic system — and one in which the global population structure shifts from young, working tax-payers to retirees — we don’t know what those rules are. And until we do, we cannot begin process of exploring how to rule ourselves.

France Dodges a Bullet…By Catching a Bullet

The results are in:

Emmanuel Macron defeated Marine Le Pen of the National Front by 66% to 34%, making him the youngest president in French history.

Many were worried about the implications of a Le Pen presidency as the right-wing, pseudo-racist, anti-European populist has called bluntly for an immigration ban, a withdrawal from the euro and EU, the severing of most economic connections with the wider world, and a general break with the whole French system since World War II.

But while there were admittedly a couple of big gulp moments during the campaign, I wasn’t ever really that worried about such an outcome. France’s pro-European instincts are still pretty strong, and the French political center is robust as well. As soon as it became apparent that the center-right wasn’t going to go down the rabbit-hole, I was pretty sure that Le Pen didn’t have a serious chance. The bullet would be dodged.

Which isn’t the same as me saying that all is good in the state of France.

Just because the center remains strong in the French electorate doesn’t mean it remains strong in the French political system. In the first of France’s presidential election’s two rounds, the two parties that have ruled France since the formation of the Fifth Republic only scraped together 26% of the vote between them. And Marine Le Pen increased her father’s share of the vote – when he made the second round a decade ago – by half.

So should the French be congratulated, even celebrated, for their election results? Sure. But let’s not get ahead of ourselves. All the trends in play that enabled the National Front to so hugely improve its vote take remain fully in force, and all will push France in a much darker direction in the months and years to come.

Automation at home and abroad continues to erode the earning power and job prospects of French workers. So long as the global trade system and EU survive, the French system’s lack of competitiveness continues to hollow out the French economy. France’s vulnerability to energy shocks continues to deepen.
Europe’s sovereign debt crisis is loads worse than it was in 2007, and continues to sap economic activity in France’s Spanish and Italian neighbors. Inward immigration from France’s colonial legacies continues to flow as those former colonies face issues of systemic collapse. Germany remains shielded from the worst of most of this, and so long as it is the heart of the EU not just geographically, but also economically, financially and politically it will continue to ascend at France’s expense. France is trapped in a system it cannot control and that system is in terminal decline. I’d be scared and angry too.

And let’s not understate the challenge the new president faces. The entirety – yes, the entirety – of the parliament is made up of parties that were just wholly discredited on the national scene. The new president doesn’t have a single legislator in office. The comparison is imperfect, but can you imagine if Donald Trump ran on a third-party ticket to become president? How do you think the Democrats and Republicans would treat his priorities when they hold all the legislative cards?

Sure Macron can try to capture the French imagination (and some seats) in the June parliamentary elections, but so too can Le Pen. And now that one-third of the French electorate has broken the seal and voted for the National Front, it is highly likely that Le Pen’s (massively) more organized and institutionalized party will do just as well as Macron’s neophyte on-a-shoestring En Marche. When we get to the next presidential election, France is likely to have a president with few successes, an ossified and discredited center-left and center-right, and a National Front that has racked up dozens of electoral successes in both national and regional bodies.

Doesn’t take a pessimist to guess how that will turn out.

Part II: The End of Europe

EU’s institutions are rearranging the Titanic’s deck chairs during a Godzilla attack with a tsunami on the horizon.

President Donald Trump entertained his first foreign dignitary Friday, January 27: UK Prime Minister Theresa May. The primary outcome of their trip? The two pledged to work towards the formalization of a “quick trade deal.”

This takes us all kinds of interesting places.

First, from a strategic point of view anything that binds the United Kingdom closer to the United States is phenomenal for U.S. power. Britain maintains the world’s third-most powerful navy, and soon will float the only functional supercarriers in the world not in the U.S. fleets. London is the world’s second-largest financial hub, and the chief route out for capital fleeing Continental Europe. London has centuries of bred-in experience manipulating political and economic systems the world over. Add in a wealth of preexisting bilateral political, economic and cultural ties, and if there is one country that is a natural complement to American power projection, it is Britain.

Second, the EU is spotlighting the path to its own end with a bizarre sort of enthusiasm. Technically, the May-Trump summit is illegal; under EU law only the European Commission — the EU’s executive — can engage in trade talks on behalf of its members, and the UK’s exit negotiations haven’t yet begun. Just to be sure that the Europeans know that this isn’t an accidental oversight, May has also announced the commencement of trade talks with Canada, Australia, New Zealand, Turkey and India.

 

 

The Commission and EU Parliament are bubbling with fury about how this won’t be allowed to stand, will poison the UK’s pending Brexit talks with the EU, and that Britain will be punished for it. But considering May has indicated that she prefers simply walking away from the EU to any sort of divorce deal that doesn’t serve London’s interest, the EU is absolutely bereft of leverage.

If there was an issue that could prove that the EU had some flexibility, a flat-out Brexit negotiation was it. It will be a negotiation that is predominantly economic in which the EU has lots of leverage and for which the EU has lots of options to choose from. This should be easy.

Guess not.

Such obstinacy pretty much dooms the EU in its grappling with its far larger problems: the EU faces a demographic implosion, a sovereign debt crisis that only increases by the year, anemic-at-best economic growth, a rising banking crisis, an aggressive Russia, an increasingly belligerent Turkey, waves of refugees as Mideast countries crumble, and so on. Rather that start reimagining the Union or getting on with the very real work ahead, the EU’s institutions are doing the equivalent of rearranging the Titanic’s deck chairs during a Godzilla attack with a tsunami on the horizon. Britain is already moving on, yet it looks like Brexit will consume all the EU’s emotional bandwidth for months (years?). Such ossification makes it scarily easy to predict how this will all go: everything that happens in the EU is now an institutional crisis.

Third, after decades of Continental military downsizing, the UK and U.S. are Europe’s security policy. May still went through the motions of pledging her support for NATO, which literally earned no more than a curt nod from the new American president — a man that, since his election, has made no secret of his belief that the alliance is already over. So long as Europe cannot come to terms with Brexit, it is a mighty reach to assume that the UK will continue going to bat with Trump for the sake of the Continent. Expect American drawdowns of its warfighting capabilities in Europe to begin in the not-too-distant future. The only question now is whether this is done in league with evolutions in U.S.-Russian relations or not.

 

 

Where does this leave Europe? Trump probably put it best by calling the EU a “vehicle for Germany.” That may sound harsh. After all, the EU is nothing if not a constant multi-lateral tug of war among all the EU’s 28 members. But consider what’s happened in the past year: The Brits are leaving. NATO is all-but-gone. There’s political stall — if not outright breakdown — in Italy, Spain, Austria, Belgium and the Netherlands. Poland and Hungary are wallowing in their moves away from democracy. Like it or not, planned or not, Germany is the center that holds.

And a quick glance through history indicates that a German center to Europe never holds for long.

The Absent Superpower

It’s finally arrived!

I’m happy to announce that The Absent Superpower: The Shale Revolution and a World Without America is finally in print and in stock. Here is a link to the purchase page on Zeihan.com. We will have a digital version ready by February 1st. Additionally, book format issues limit me in terms of graphics capacity to only black & white images but many of the topics I write about are in screaming color, so here is the map room for The Absent Superpower.

Which brings me to my next announcement: the Zeihan on Geopolitics website has had a face lift for the New Year. We’ll be populating it with more material during the next few weeks, particularly as the Know Your World section expands. Feel free to explore.

And if all that wasn’t tease enough, in lieu of a New Year’s newsletter, we’ve instead opted to share the introduction for The Absent Superpower…

Absent-Super-Power-book

INTRODUCTION


The Journey to The Absent Superpower

EVERYTHING IS CHAOS!

At least, that’s what it seems like every time you turn on your TV, radio, computer, or smart phone.

The European Union is falling apart, Syria is in meltdown, cybercrime is an hourly occurrence, the Chinese economy is gyrating wildly, Russia is on the march, the election of Donald Trump has Americans of all political stripes wondering what comes next, and the Kardashians get more press time than Congress. It’s enough to give anyone a panic attack.

Well, not quite anyone. Unlike the average person, all this craziness puts me in my happy place. Where most see the world turning itself upside down and inside out, I see a long-overdue shift in the global order. New trends emerging. New possibilities unfolding. For me, change is good for business.

That’s because my job is a bit…different than the standard. You see, I’m a geopolitical strategist. That’s a fancy way of saying I help organizations understand what challenges and opportunities they will be grappling with across the world in the years to come. As such I’m sort of a professional apprentice, rarely a master of any particular craft but needing to be able to hold my own in conversations about manufacturing and transport and health care and finance and agriculture and metals and electricity and education and defense and such. Preferably without pissing off anyone whose living is based off of manufacturing or transport or health care or finance or agriculture or metals or electricity or education or defense.

In many ways those conversations make me who I am. From the Air Force to the Pickle Packers, every interaction gives me a good hard view of the world, yet each of these interactions originates from a radically different perspective. Combine all those angles and interactions and perspectives and the unique information that comes from them with my private intelligence experience, and I’m granted the privilege of seeing something approximating the full picture — how the world’s myriad pieces interlock — and catch some telling future glimpses to boot. More than anything else, what I sell is context.

That picture and those glimpses and that context formed the bones of my first book, The Accidental Superpower, which was published in November 2014. In Accidental I made the case that the world we knew was at a moment of change: The Americans who had created, nurtured, enabled, maintained and protected the post-WWII global order were losing interest. As they stepped back the world we know was about to fall to pieces.

At any time in history such a shift would have had monumental consequences, but the American retrenchment is but one of three massive shifts in the global the order. The second is the rapid greying of the entire global population. Fewer people of working age translates directly into anemic, decaying economies — enervating global trade just as the Americans stop guaranteeing it. Third and finally, the American shale revolution has changed the mechanics — if not yet the mood — of how the Americans interact with the energy sector. Surging petroleum output within the Lower 48 is pushing North America toward outright oil independence; in the past decade the total continental shortfall has narrowed from roughly 10 million barrels of oil per day (mbpd) to about 2mbpd.

In the two years since Accidental published, I’ve had ample opportunity to re-examine every aspect of my work — some of my critics have been (over) eager to assist in such endeavors — and I fear that I may have been off the mark on a couple of points.

First, the American shale sector has matured far faster and more holistically than I could have ever expected.

Despite a price crash in oil markets, despite ongoing opposition to shale among a far from insignificant portion of the population, despite broad scale ignorance about what shale is and what shale is not, shale has already overhauled American energy.

In 2006 total American oil production had dropped to 8.3mbpd while demand was touching 20.7mpbd, forcing the United States to import 12.4mpbd, more than Japan and China and Germany combined. By 2016 U.S. oil output had breached 15mbpd. Factor in the Canadians and Mexicans, and total American imports of non-North American oil had plunged to about 2mbpd — and that in the teeth of an oil price war. And that’s just oil specifically. Take a more comprehensive view and include everything from bunker fuel to propane, and the continent is less than 0.8mbpd from being a net energy exporter.

The end of American dependence upon extra-continental energy sources does more than sever the largest of the remaining ties that bind America’s fate to the wider world, it sets into motion a veritable cavalcade of trends: the re-industrialization of the United States, the accelerated breakdown of the global order, and a series of wide-ranging military conflicts that will shape the next two decades.

This book’s opening section contains the long and the short of this Shale New World, the greatest evolution of the American industrial space since at least 1970. For the financiers and accountants and policy wonks out there, this was written with your geeky brains specifically in mind.

Second, the isolationist trickle I detected in American politics has deepened and expanded into a raging river. Of the two dozen men and women who entered the 2016 presidential race, only one — Ohio Governor John Kasich — advocated for a continuation of America’s role in maintaining the global security and trade order that the Americans installed and have maintained since 1945. The most anti-trade candidate on the right won his party’s nomination, while the most anti-trade candidate on the left finished a close second in the Democratic primaries to the Clinton political machine. Last night (now President) Donald Trump and Hillary Clinton met in New York to debate economic policy. What struck me as self-gratifying and horrifying in equal measure was that their core disagreement on trade issues wasn’t whether trade was good or bad for the United States, but how much to pare it back and which reasons for paring cut it the most with the electorate. (The pair of them obviously disagreed — colorfully, vehemently and often — on other issues.)

The world has had seven decades to become inured to a world in which the Americans do the heavy lifting to maintain a system that economically benefits all. The world has had three decades to become inured to a world in which the Americans do not expect anything of substance in return. As the Americans back away, very few players have any inkling of how to operate in a world where markets are not open, transport is not safe, and energy cannot be secured easily.

The stage is set for a global tailspin of epic proportions. Just as the global economy tips into deflation, just as global energy is becoming dangerous, just as global demographics catastrophically reduce global consumption, just as the world really needs the Americans to be engaged, the United States will be…absent. We stand on the very edge of the Disorder.

The Disorder’s defining characteristic is, well, its lack of order. Remove the comfortable, smothering American presence in the world and the rest of humanity has to look out for its own interests. As many of those interests clash, expect devolutions that are deeply-felt and disastrous in equal measure. Part II breaks down the breakdown. I’m equally proud and terrified to report that some of the darker shades in Accidental are happening sooner rather than later. For generals — armchair or otherwise — who prefer jumping directly into the fight, Part II is what you’re after.

In the final section we will circle back at take a good hard look at the United States. Energy independent, economically robust, physically secure, and — above all — strategically unfettered, the United States will be taking a break from the world writ large for the most part.

Yet “for the most part” is a far cry from a full divorce from all things international. The Yanks will still find bits of the world worth their time, effort, money and ammunition. Section III explores the American Play: where the Americans will still be found, why they will be there, how they’ll act, and what they’ll be up to.

It may be small comfort, but the acceleration of the shale revolution as well as the American political shift towards populism has illuminated a great deal, sharpening my view of the future. The various glimpses that made up Accidental have somewhat merged, lingering to the point that they now constitute a bit of a roadmap.

That roadmap is the core of this book.

Peter Zeihan
September 27, 2016
Somewhere over Kentucky

>>BUY THE ABSENT SUPOWER POWER NOW<<

Europe’s Next Crisis

The world got a harsh reminder last week that the European financial crisis, about to enter its eleventh year (that’s right, it started before the 2007 subprime meltdown) has yet to get truly serious.

After failing to find new strategic investors, the Italian government announced its intention to nationalize (read: bailout) the major bank Monte dei Paschi.

Ok, so this leaves most people asking, so what? It’s just one bank, and it isn’t like Monte dei Paschi is a globally systemic institution like the Royal Bank of Scotland or Bank of America. So bad for Italy and not great for Europe, but why should anyone else care?

The real problem is that Monte dei Paschi is hardly an outlier in the Italian banking sector, or even the broader European banking sector. There is no shortage of reasons why Europe’s banks are doomed.

First, the euro. When the euro became the European Union’s common currency at the turn of the century, a number of countries with weaker financial and economic systems (read: Italy) were allowed to join when they probably shouldn’t have been. This enabled consumers in these countries to borrow at rates that in most cases were one-third (or less) the previous rates. Consumption skyrocketed, and growth with it, but that consumption was driven by debt — not by increases in production or productivity. After a few years these countries suffered debt hangovers that they couldn’t possibly repay, and they’ve barely had any economic growth since. All that debt is held by banks like Monte dei Paschi.


Second, the debt binge wasn’t limited to consumers. The banks themselves took part, particularly secondary financial players in the European markets like Sweden, Austria, Greece, and Italy. With the major markets of Germany, France, and Spain already controlled by local institutions, banks in these secondary states sought market share on the frontier: the Baltics, Hungary, Albania, and the former Yugoslavia. Such locations were hit particularly hard in the 2007 global financial crisis, souring massive holdings and serving as deadweight on the banks’ balance sheets to the current day. A fair chunk of Monte dei Paschi’s borrowing went to … Serbia.

Third, foreign currency lending. Banks in these secondary countries often borrowed from stronger banks in euros, U.S. dollars, or even Japanese yen and then made loans in those currencies into countries with independent currencies. The bet was that the weaker currencies (the Hungarian forint, Polish zloty and such) would appreciate over time, reducing the relative weight of the retail loans and increasing the locals’ purchasing power. Unfortunately, currency movements are not always one-way. When local currencies crashed, those loans immediately soured because the lendees couldn’t pay. Local governments often intervened with regulations expressly designed to help their citizens and stick the foreign banks with the bill. Monte dei Paschi was known to dabble in loans denominated in Swiss francs — a currency that has since strongly appreciated against pretty much everyone else because it is a top destination for capital flight out of Europe.

Fourth, subprime was hardly limited to the United States. Europe had its own that was far more serious, in part because Europe cannot assimilate migrants as well as America. In the United States nationality is largely defined by the migrant (I choose to be American) and so the American dream, upward mobility, societal inclusion, and home ownership are more or less standard. In Europe nationality is largely defined by the dominant ethnicity (we choose to accept you as French), erecting a massive cultural and even legal barrier to inclusion. One, among many, results is low home ownership among immigrants into Europe. With that potential demand removed, any housing boom has to get by with far less demand, which often leaves speculation driving things. In the United States, new homeowners (read: migrants) have helped eat through the surplus housing stock and restored balance. In Europe surplus housing sits empty. Italy had a housing boom in the early 2000s, but migrants into Italy tend to be of the poorer sort.

Fifth, European banks are not free agents like American banks, but are instead beholden to government interest. The United States is a common financial space because of its geography. Trade happens on rivers and banks process that trade; and since the American river system is interconnected, the banking system isn’t divvied up by the states but is truly national. Not politically beholden, American banks can focus on risk management and making money. In contrast, most of Europe’s rivers are national affairs, home to a specific people and a specific government. Europe’s banks reflect this structure, and as a rule don’t do much business outside of their home markets. This results in a small fleet of problems:

  • Most governments lean on the banks to invest in government debt in order to fund the government budget. That’s somewhat ok during normal years, but during recession (when government funding needs balloon) it means the banks lack the capacity to lend to the private sector. Growth pretty much dies.
  • National bailouts become problematic, if not impossible. Should a government try and bailout a failing bank, it must either find money from beyond the banking sector (which would normally lend the government money) or convince its European partners the bailout isn’t a subsidy (which, by definition, it is).
  • EU-level bailouts are even more problematic, and not simply because no one wants to pay for a bailout in another state. In a “normal” system the state takes control of a damaged bank until that bank can be rehabilitated, and then releases it back to the wild. In essence the government buys low and sells high. You can’t do that when the bailout funds come from another country. Part of the rehabilitation often means rationalizing the books, a process that tends to gut the bank’s original investors (the government) and even depositors (the citizens).

The Monte dei Paschi is expected to run at least 20 billion euro, and that’s just to hold things steady, not actually rehabilitate the lender.

The only long-term solution to this sort of ingrained dysfunction is to grow out of the problem by making healthy loans over a decade of time. But that is now flat out impossible. Banks make money on the spread between the cost of their funds and the cost of their loans, and most loans are taken out by people under 40 — such young people are the source of most of the car loans, house loans, and college loans that drive a modern economy. Europe is at negative interest rates and Europe faces demographic collapse. That’s less income per loan on a smaller volume of potential loans.

The collapse in Europe’s birth rate is now 40 years strong, with Italy in particular having aged past the point of any possible demographic recovery.

Officially, over 18% of the loans held by Italy’s banks are non-performing, but because all a bank has to do to push a loan into the “performing” category is show that it received a partial payment within the past three months, that real figure is undoubtedly far higher. As a point of comparison, U.S. regulatory authorities close down banks when non-performing rates breach 5%.

Bottom line? The Greek sovereign debt crisis was only the warm up. The Europeans could — and did — build a financial wall around the place to block it off from the rest of the Union. The cost of that wall has already been about $500 billion for an economy whose GDP is but $200 billion. Italy’s sovereign debt is six times that of Greece. Italy’s economy is nine times, and its banking sector something like twenty times.

Greece could only kill Europe if there was gross mismanagement on Europe’s part (although it was touch-and-go there for awhile). Italy can only not kill Europe if there is a miracle.

Brexit

With 28 countries it is easy to get lost in the geopolitical maelstrom that is the European Union. Over the next few days (and couple of years) there will be literally thousands of stories to tell about the Britain-EU breakup. All will matter hugely to someone, but only a few will matter hugely to everyone. So let’s focus on the major points.

The United States is withdrawing from the world. The United States created and maintained the global free trade order. Without the United States’ smothering security presence, much of the world either will devolve as local powers fight for the scraps or return to their pre-1945 state of affairs. In Europe it will be a bit of both. One outcome among many is that the geopolitical environment of enforced peace and open trade that enabled the Europeans to form the EU in the first place is disappearing. For reasons well beyond the Europeans’ control, the EU is ending.

And for reasons well within the Europeans’ control, the EU is ending. If there is anything that the European Union has shown us in the past decade, it is that even in the face of an existential crisis its constituent members cannot come up with a common plan, much less a common vision. The European financial crisis — complete with the Greek crisis — began in 2006 and slides further down the rabbit hole with every passing year. The continent has suffered five recessions since this all started with most of its members now possessing smaller economies than before the Great Recession.

Europe is also dying for reasons independent of geopolitics and policy. All but six of its 27 members (the UK is one of the six) have already aged past any hope of demographic recovery. Germany — the country the EU seems to be pinning its hopes on — has the world’s most distorted population structure, with more people in their 50s than 40s than 30s than 20s than teenagers than children. Which means that all three forms of economic growth — consumption, investment and export — are about to prove beyond them. In essence, Europe’s aging is transforming it into a collection of old folks’ homes.

It isn’t hard to make the case that the UK jumping ship might not be all that bad of an idea.

So what happens next?

  • The Brits will need a replacement trade association. There are two options. The easier of the two is a broad scale reinvigoration of the Commonwealth which will give the UK greater access to its old empire with countries large and small, near and far. The second is both simpler and more complicated: joining NAFTA. Simple in that the Canadians will make Brentrance a cause célèbre but complicated in that the Americans will make the Brits pay through the nose (think Lend-Lease). The Brits will ultimately succeed at both. Expect the Brits to be the only country in the world with a meaningful trade deal with India, and expect all the former British colonies that trade with the EU to shift loyalties.
  • The EU leadership will want to hurt the UK, and hurt it badly, in order to dissuade others from following suit. In this they will fail. As the UK demonstrates that the EU isn’t inevitable a number of countries will see their own political systems reorder to the new reality. In particular, I’d keep my eye on Hungary (whose political system is departing from democracy and so just doesn’t fit in the club any longer), France (who feels the whole European project has gotten away from them), and Sweden (who only joined the EU because a united Europe served as a hedge against Russia).

  • The UK was the one big country constantly pushing for the EU to expand and liberalize. Without London’s influence the EU’s slide towards parochialism, protectionism and a Fortress Europe mentality will harden. No more expansions. No more common foreign policy. No more Airbus.
  • Expect the broad scale weakening of the European financial sector. Most of the EU’s financial business is settled in London and undoubtedly some of that will now relocate to the Continent. But most — to the EU leadership’s chagrin — will not. This will induce the EU to attempt to force its relocation using regulatory means. Considering that capital flight from the eurozone is already at record highs, expect such regulatory efforts to backfire. Horribly.

Brussels Attacks Are Just a Symptom

Coordinated terror attacks rocked Brussels this morning, following a successful raid earlier this week that saw French and Belgian security forces capture the surviving would-be suicide bomber and participant in Paris’ November 2015 terror attacks. ISIS affiliates have claimed responsibility for the attack, leaving today’s coordinated bombings at a metro station and the Brussels airport the latest of the organization’s high profile actions in Europe.

Belgium’s Arab community have come under greater scrutiny in recent months, as have many of Western Europe’s Muslim and Arab communities, but Brussels faces an uphill climb in guaranteeing its own security. The basic definition of statecraft is the ability to control one’s borders—as the de facto capital of the European Union, Belgium sits in the middle of a conglomeration of relatively wealthy European governments with little to no border controls. Add to this years of political deadlock and a police system that favors human rights and adheres to strict privacy protections at the expense of security, and it’s easy to see why Belgium and terrorism have been occupying headlines so frequently as of late.

Europe is still clinging to a world that functionally no longer exists. European capitals are digging in their heels and pushing for civility and, well, Europeaness while the Continent’s broader periphery rapidly devolves into chaos. The most obvious (but far from the only) source of the disruption is Syria, a state that is rapidly de-civilizing. Considering the weakness of next-door Iraq, Lebanon and Jordan, this is only the beginning of a larger civilizational breakdown.

So morally, the European position is worthy of respect and acclaim. Functionally, however, it is idiotic.

The problem — well, part of the problem — is that there’s been a geopolitical shift immediately on Europe’s southeastern border. Turkey, for all intents and purposes, is no longer part of the civilizational block that is known as the “West.” You can certainly argue (accurately) that Turkey never fully joined the West in whole — there were always a host of linguistic, religious, ethnic, historical and cultural barriers to true merger — but in the past decade Europe and Turkey have slid further and further apart, and in recent weeks the Turkish government took over the last remaining independent media outlet of significance. From an ethical point of view, the split is now complete.

Persian Gulf Image

Turkey is now unhinged — as seen by last week’s suicide bombings in Ankara and Istanbul — eliminating any chance that the Europeans had of managing their terror or migration problems. For now, the best case scenario for the Europeans is that Turkey rounds up the migrants into camps, and then invades and occupies Syria in order to destroy both the Assad government and the Islamic State.

Put simply, the EU’s anti-terror, migration and strategic policies are now little more than hope that Turkey, a freshly illiberal state that doesn’t think very highly of Europe (and is technically in a state of war with one of its members) fully militarizes and starts invading its neighbors.

This will end (very) badly.