Blog Post
The Future of the Euro (or Lack Thereof)
Kevin Rejent • May 20, 2020
Covid-19 is exposing deep cracks within the Eurozone. Can the divide be bridged?
*This article is best viewed in its PDF format, which is available here.*
Executive Summary
The COVID-19 crisis has laid bare disagreements in the Eurozone regarding nations’ obligations to each other as the continent contemplates the enormous task of economic recovery. Old prejudices in the north developed when southern nations were more fiscally reckless than they are at present have tied the hands of politicians on both sides of the divide. The hardest-hit nations, Italy and Spain, are seeking a joint recovery effort while fiscally prudent nations such as the Netherlands and Germany believe loans to impacted areas are sufficient. Despite token gestures and speeches praising European unity, the great divide remains.In this article, we look at the issue through the eyes of two nations that best represent the views of their respective “side” of the discussion: The Netherlands and Italy. Divergent economic and cultural priorities have resulted in prejudices and resentment between the populations which must be manifested in the actions of politicians if the politicians wish to remain in power. Without the political ability to overcome these positions, the Euro could be in trouble.
The most likely course for the Euro is to continue some version of the status quo. The members would patch over their differences and hope resentment would die down in the post-COVID era. However, this “easiest” path poses plenty of issues for the fiscally prudent northern nations since the trajectory of European institutions is almost always towards further integration, and potential new Eurozone members much more closely resemble the zone’s southern members. A less likely, but still possible, scenario sees politics in Italy causing it to go down an unfortunate path of reintroducing the Lira as a parallel currency and eventually redenominating its debt. In this scenario, Greece might also leave the Eurozone, but with the assistance of the remaining Eurozone members. A final scenario sees the Euro broken into three regional Euros under the auspices of the ECB. While this is also unlikely, it would solve some political issues and leave little doubt that the regional Euros meet the requirements of an Optimum Currency Area.
The Promise of Europe
As they met on Capitoline Hill to sign the Treaty of Rome in 1957, the leaders of Italy, France, the Netherlands, Belgium, Luxembourg, and West Germany dreamed of a cooperative Europe where continental advancement triumphed over petty national gain. These nations were joined thirty-five years later by six others in Maastricht, Netherlands to bind monetary policy through the Euro. Since then, sixteen more European nations have joined the EU (with the UK subsequently leaving), and nineteen nations now belong to the Eurozone. But now, the nations that hosted the signing of the treaties upon which the great European experiment is based, Italy and the Netherlands, embody the continental disagreements on the EU and the Euro that the current COVID-19 crisis has laid bare…disagreements that just may lead to the end of the Euro.
It is hard to imagine a world without the Euro, since most level-headed analyst would agree it has been a rousing success. However, it has only been in use for eighteen years, and several of those were spent handling crises in specific nations or Eurozone-wide. But handle them it has, and history will judge the actions of the European Central Bank kindly, or at least neutrally. Of course, it will never satisfy everyone, and hindsight provides plenty of hiccups, but overall, the ECB has been a force for good in Europe. It should continue to play a central role in the European economy, regardless of the paths taken by member states in the post-COVID future.
Recent European History
(like…past few months recent)
(like…past few months recent)
With the spread of COVID-19 and subsequent economic crash, European nations have been forced to consider both national and continental responses to achieve the most effective recovery. While there have been some incredible shows of pan-European unity, the crisis has also accelerated and deepened intra-continental divides and tested the strength of institutions. The fact that Italy and Spain, two frequent targets of fiscally prudent northern Europeans’ derision, were the first and hardest hit on the continent only complicated matters.
When the virus first hit northern Italy, there was some confidence that it could be contained quickly and not cause much disruption outside of the initially impacted regions Lombardy and Veneto. But it crept out of those areas and, within a few weeks, forced Italy to lock its citizens into their homes and basically shut down the economy. Other nations, initially Spain and then France, followed, and the pandemic was now continent-wide and spreading fast.
The ECB wobbled in its first COVID-19 test, with President Christine Lagarde first stating that the role of the ECB was not to minimize the bond spread between nations. This caused Italian borrowing costs to shoot up as investors feared the ECB would not come to Italy’s aid. Lagarde quickly realized the errors of her statement and leapt into action to defend Italy and other nations whose bonds were under pressure. Eventually, the ECB implemented a bond-purchasing program of over $750B, and even started buying non-sovereign bonds, which is similar to the US Federal Reserve’s actions (although on a smaller scale). So thus far, the EBC has done its best to stabilize the Eurozone and provide the monetary foundation for recovery.
In the US, there has also been a multi-trillion-dollar fiscal response to avoid the worst-case scenarios and position the nation for recovery. Europe obviously needs something similar, as the individual nations are not, with a few exceptions, capable of raising the amount of money that will be needed to keep their people fed and working while digging out of the crater left by COVID-19. The first suggestion was the oft-discussed Eurobonds, which would create an attractive new vehicle to mutualize some portion of European debt. The northern nations could not be more opposed to this, and that idea was quickly replaced by a proposal to issue limited-time bonds specifically to aid in recovery: Coronabonds. Once again, however, northern nations shot down this idea as edging too close to the mutualization line. Then Spain devised a popular compromise solution that paid for recovery out of future EU budgets instead of debt obligations. This has also stalled, as northern nations would rather promote a package, including loans with strings attached, that is completely unacceptable to the countries in need. Therefore, the EU response has been nothing but solemn talk and unfulfilled potential.
What Does This Have to do With the Euro?
When evaluating the overlapping European structures, mischievous situations that were certainly not contemplated by their architects come into focus. And while exploiting these cracks in the system would be dangerous, a desperate nation that perceives that it has been abandoned by its fellow Europeans just may take that chance.
As this Venn diagram from the European Council on Foreign Relations demonstrates, Europe is a jumble of institutions and agreements.
A nation can be a member of several European institutions without being required to join others. There are currently nine members of the European Union that are not members of the Eurozone, and four members of the EU Customs Union that are not even members of the EU. While sliding between these groups is challenging and has generally been in the direction of more integration, theoretically one could go the other way.
These institutions craft policy to varying degrees of integration, but none are more impactful than the ECB crafting of monetary policy for the nineteen Eurozone members. The system is based upon the work of Nobel Prize winner Robert Mundell on Optimum Currency Areas, or geographic areas that would most benefit from sharing a currency, regardless of national borders. According to Dr. Mundell, there are four criteria for an optimum currency area:
1. A large, available, and integrated labor market which allows workers to move freely throughout the area and smooth out unemployment in any single zone.
2. The flexibility of pricing and wages, along with the mobility of capital, to eliminate regional trade imbalances.
3. A centralized budget or control to redistribute wealth to parts of the area which suffer due to labor and capital mobility.
4. Similar business cycles in the participating regions and timing for economic data to avoid a shock in any one area.
Criteria 1 and 2 are mostly satisfied by the wider European Union’s mandate of free movement of people, capital, and goods between member states. Criterion 3 is somewhat satisfied by the EU, with supplements to member state budgets to promote economic harmony, but is also often a primary issue of concern in the Eurozone. Criterion 4 is more theoretical, and thus the easiest upon which to craft arguments for or against the Euro as an Optimum Currency Area. But it is important to note that the Euro is managed by the ECB, which only controls monetary policy. Fiscal policy is left to the individual nations. Thus, the monetary policy of one Eurozone nation is directly impacted by the fiscal policy of another. Herein lies the crux of virtually every Eurozone disagreement this century.
Further fiscal integration is often discussed as the next step in European integration, with Mario Draghi campaigning for it in his final speech as ECB President. Despite the appearance of momentum for this idea pre-COVID, a deeper look indicates further integration was unlikely then and even more unlikely now. While the UK was never in the Eurozone, its issues with deeper European political integration and loss of sovereignty made Brexit inevitable. This concern for sovereignty is not contained to the west side of the English Channel. Eurosceptics are sizable blocks in most nations and their ranks would swell if citizens saw their countries run more and more by European entities. For example, the Gilets Jaune protests are an example of citizens opposing the actions of their own government. How much more intense would the protests be if they were protesting actions imposed upon them by European central bankers? For these and many more reasons, deeper fiscal integration of the Eurozone economies is unlikely, and Europe is stuck navigating the COVID-19 crisis under current institutional constraints.
While the current institutions have done some things well, rifts have existed from the beginning, and the long process of fracturing has accelerated in the current crisis. Historically, northern European nations such as the Netherlands, Luxembourg, Germany, Austria, and Finland have taken southern European nations such as Italy, Greece, and Spain to task for irresponsible spending, and they’ve often had good reason. However, since the financial crisis of 2008-10, these nations have been pretty responsible, and their budget deficits have been consistently improving. Most of these nations are actually running surpluses when debt service is removed.
But Europe’s current financial malaise has nothing to do with reckless spending in southern Europe, nor can it be solved by northern European frugality. It is the result of a calamity that knows no borders and is not any European nation’s “fault.” So why the hesitation to fight the economic impact together, which would absolutely benefit everyone? Politically, the Dutch and Luxembourgian and, to some extent German, electorate are deeply suspicious of southern Europe, and being seen as “giving in” to their requests for money can be politically costly. At the same time, voters in southern nations question the value of a union with “partners” who constantly lecture them about prudence while stacking the deck against their growth through either aggressive tax competition (Netherlands or Luxembourg) or trade practices (Germany). Viewing the political, economic, and social issues through Dutch and Italian eyes clarifies the conflict and provides insight regarding why the Euro is in a precarious position.
The Dutch Position
Former Eurogroup President and Dutch Finance Minister Jeroen Dijsselbloem made headlines (negative abroad but wildly positive at home) when he said about southern countries’ indebtedness, “you can’t first spend all your money on drinks and women, and subsequently ask for financial support.” This view was long held but rarely spoken, and is the view of a large share of the Dutch electorate.
Since this is the popular view in the Netherlands, politicians are constrained to act in accordance with this belief. To be seen as acceding to southern needs would be viewed as selling out Dutch pensioners for undisciplined spendthrifts. And this opinion is not without some basis in truth. The Netherlands, along with Germany, Luxembourg, and Austria, have much higher net national savings rates than Italy, Greece, and Spain. The Dutch value financial constraint over immediate quality of life experiences, and do not believe the citizens of southern nations work hard enough or appropriately value saving for the future.
These institutions craft policy to varying degrees of integration, but none are more impactful than the ECB crafting of monetary policy for the nineteen Eurozone members. The system is based upon the work of Nobel Prize winner Robert Mundell on Optimum Currency Areas, or geographic areas that would most benefit from sharing a currency, regardless of national borders. According to Dr. Mundell, there are four criteria for an optimum currency area:
1. A large, available, and integrated labor market which allows workers to move freely throughout the area and smooth out unemployment in any single zone.
2. The flexibility of pricing and wages, along with the mobility of capital, to eliminate regional trade imbalances.
3. A centralized budget or control to redistribute wealth to parts of the area which suffer due to labor and capital mobility.
4. Similar business cycles in the participating regions and timing for economic data to avoid a shock in any one area.
Criteria 1 and 2 are mostly satisfied by the wider European Union’s mandate of free movement of people, capital, and goods between member states. Criterion 3 is somewhat satisfied by the EU, with supplements to member state budgets to promote economic harmony, but is also often a primary issue of concern in the Eurozone. Criterion 4 is more theoretical, and thus the easiest upon which to craft arguments for or against the Euro as an Optimum Currency Area. But it is important to note that the Euro is managed by the ECB, which only controls monetary policy. Fiscal policy is left to the individual nations. Thus, the monetary policy of one Eurozone nation is directly impacted by the fiscal policy of another. Herein lies the crux of virtually every Eurozone disagreement this century.
Further fiscal integration is often discussed as the next step in European integration, with Mario Draghi campaigning for it in his final speech as ECB President. Despite the appearance of momentum for this idea pre-COVID, a deeper look indicates further integration was unlikely then and even more unlikely now. While the UK was never in the Eurozone, its issues with deeper European political integration and loss of sovereignty made Brexit inevitable. This concern for sovereignty is not contained to the west side of the English Channel. Eurosceptics are sizable blocks in most nations and their ranks would swell if citizens saw their countries run more and more by European entities. For example, the Gilets Jaune protests are an example of citizens opposing the actions of their own government. How much more intense would the protests be if they were protesting actions imposed upon them by European central bankers? For these and many more reasons, deeper fiscal integration of the Eurozone economies is unlikely, and Europe is stuck navigating the COVID-19 crisis under current institutional constraints.
The Rift
While the current institutions have done some things well, rifts have existed from the beginning, and the long process of fracturing has accelerated in the current crisis. Historically, northern European nations such as the Netherlands, Luxembourg, Germany, Austria, and Finland have taken southern European nations such as Italy, Greece, and Spain to task for irresponsible spending, and they’ve often had good reason. However, since the financial crisis of 2008-10, these nations have been pretty responsible, and their budget deficits have been consistently improving. Most of these nations are actually running surpluses when debt service is removed.
But Europe’s current financial malaise has nothing to do with reckless spending in southern Europe, nor can it be solved by northern European frugality. It is the result of a calamity that knows no borders and is not any European nation’s “fault.” So why the hesitation to fight the economic impact together, which would absolutely benefit everyone? Politically, the Dutch and Luxembourgian and, to some extent German, electorate are deeply suspicious of southern Europe, and being seen as “giving in” to their requests for money can be politically costly. At the same time, voters in southern nations question the value of a union with “partners” who constantly lecture them about prudence while stacking the deck against their growth through either aggressive tax competition (Netherlands or Luxembourg) or trade practices (Germany). Viewing the political, economic, and social issues through Dutch and Italian eyes clarifies the conflict and provides insight regarding why the Euro is in a precarious position.
The Dutch Position
Former Eurogroup President and Dutch Finance Minister Jeroen Dijsselbloem made headlines (negative abroad but wildly positive at home) when he said about southern countries’ indebtedness, “you can’t first spend all your money on drinks and women, and subsequently ask for financial support.” This view was long held but rarely spoken, and is the view of a large share of the Dutch electorate.
Since this is the popular view in the Netherlands, politicians are constrained to act in accordance with this belief. To be seen as acceding to southern needs would be viewed as selling out Dutch pensioners for undisciplined spendthrifts. And this opinion is not without some basis in truth. The Netherlands, along with Germany, Luxembourg, and Austria, have much higher net national savings rates than Italy, Greece, and Spain. The Dutch value financial constraint over immediate quality of life experiences, and do not believe the citizens of southern nations work hard enough or appropriately value saving for the future.
Politicians that may disagree with this sentiment cannot express that disagreement if they want to remain in office. Great policy ideas do not benefit anyone if their champions are not in office to implement them. And historically, Dutch domestic financial concerns take precedent over European harmony, so placing European well-being ahead of Dutch priorities is a politically dangerous path.
With a general election scheduled for March 2021, and potentially earlier if snap elections are called, Prime Minister Mark Rutte cannot afford to be seen as giving away Dutch financial stability in the middle of a global crisis. The far-right PVV and FvD are threats to his VVD-led coalition, and would pounce on any action that could be twisted into a pro-southern Europe giveaway by Dutch leaders. So while it is easy to suggest he stand up for the nation’s European brethren and convince his people to deepen integration, Mr. Rutte and his government must walk the tightrope between doing what they believe is best and what will allow them to remain in power (and thus allow them to continue to do what they view as good for several more years.)
The Dutch want to be a key player in European institutions. They do not want European institutions to cost them any more than the Dutch view them as currently costing. Thus, the Dutch will not take steps to leave the Euro, but their mindset, as demonstrated in their policy positions, may just drive other nations out.
The Italian Position
The Italian perspective is shaped by a prevailing view that its Eurozone partners treat it as a problem to be managed instead of with the level of respect that the third-largest economy in the group deserves. Italians resent the view that they are shirking work and partying the piazzas all night. They are well-aware of the nation’s economic history and also keenly aware of how challenging it is to dig out, especially when “partners” engage in actions some view as economic sabotage. Most Italians understand the value of EU and Eurozone membership, but feel underappreciated and frustrated by paternalistic treatment from northerners.
Italy is currently the third-largest economy in the European Union and the Eurozone. Thus, it contributes more to the ECB than all nations but Germany and France, and is far and away a net contributor to the European Union. Additionally, Italy and other southern nations bear the brunt of Europe’s biggest crisis pre-COVID: migration. In 2017, Italy spent €3.2B on increased naval activity and care of refugees that landed on its shores. Despite EU promises to share the burden financially and disperse refugees throughout the Union, Italy has received less that €1B in support from the EU for the care of migrants since 2015, and other nations (except Germany) have been slow to accept new refugees from the southern countries.
Despite being one of the largest contributors to the EU and ECB and shouldering more than its share of the refugee burden for the EU, Mr. Dijsselbloem’s attitude that Italians are spending their money on vices is hard to shake. Sure, bad decisions such as the “Baby Pensioni” arrangement that allowed government workers to retire with full lifetime pensions in their 30s and 40s needed to be corrected and have left a costly legacy. But Italian governments since the financial crisis have reigned in spending and attempted to reform labor laws to permit more employer flexibility. And Italian workers are not idle. In fact, they work quite a bit: fourth most hours in the Eurozone at 1,723 per year. This is behind leader Greece’s 1956, but well ahead of the 1,433 hours worker by the average Dutch worker per year and 1,363 worked by an average German.
With a general election scheduled for March 2021, and potentially earlier if snap elections are called, Prime Minister Mark Rutte cannot afford to be seen as giving away Dutch financial stability in the middle of a global crisis. The far-right PVV and FvD are threats to his VVD-led coalition, and would pounce on any action that could be twisted into a pro-southern Europe giveaway by Dutch leaders. So while it is easy to suggest he stand up for the nation’s European brethren and convince his people to deepen integration, Mr. Rutte and his government must walk the tightrope between doing what they believe is best and what will allow them to remain in power (and thus allow them to continue to do what they view as good for several more years.)
The Dutch want to be a key player in European institutions. They do not want European institutions to cost them any more than the Dutch view them as currently costing. Thus, the Dutch will not take steps to leave the Euro, but their mindset, as demonstrated in their policy positions, may just drive other nations out.
The Italian Position
The Italian perspective is shaped by a prevailing view that its Eurozone partners treat it as a problem to be managed instead of with the level of respect that the third-largest economy in the group deserves. Italians resent the view that they are shirking work and partying the piazzas all night. They are well-aware of the nation’s economic history and also keenly aware of how challenging it is to dig out, especially when “partners” engage in actions some view as economic sabotage. Most Italians understand the value of EU and Eurozone membership, but feel underappreciated and frustrated by paternalistic treatment from northerners.
Italy is currently the third-largest economy in the European Union and the Eurozone. Thus, it contributes more to the ECB than all nations but Germany and France, and is far and away a net contributor to the European Union. Additionally, Italy and other southern nations bear the brunt of Europe’s biggest crisis pre-COVID: migration. In 2017, Italy spent €3.2B on increased naval activity and care of refugees that landed on its shores. Despite EU promises to share the burden financially and disperse refugees throughout the Union, Italy has received less that €1B in support from the EU for the care of migrants since 2015, and other nations (except Germany) have been slow to accept new refugees from the southern countries.
Despite being one of the largest contributors to the EU and ECB and shouldering more than its share of the refugee burden for the EU, Mr. Dijsselbloem’s attitude that Italians are spending their money on vices is hard to shake. Sure, bad decisions such as the “Baby Pensioni” arrangement that allowed government workers to retire with full lifetime pensions in their 30s and 40s needed to be corrected and have left a costly legacy. But Italian governments since the financial crisis have reigned in spending and attempted to reform labor laws to permit more employer flexibility. And Italian workers are not idle. In fact, they work quite a bit: fourth most hours in the Eurozone at 1,723 per year. This is behind leader Greece’s 1956, but well ahead of the 1,433 hours worker by the average Dutch worker per year and 1,363 worked by an average German.
Hours worked is not necessarily the best gauge of productivity, however, as the efficiency of workers in the different nations and type of work they are performing are vital components. German manufacturing is among the most technologically advanced and efficient in the world, and the well-educated German workforce creates incredible products for sale throughout Europe and beyond. These sales create a large trade surplus, meaning the Germans are causing their trading partners to go into debt. Many Europeans believe their unwillingness to adjust the trade strategy violates the spirit, if not the letter, of EU and ECB agreements.
Similarly, Italians and other Europeans refuse to listen to northern European lectures on public debt when those nations’ tax structures greatly contribute to the southern nations’ need to take on debt. The Netherlands, Luxembourg, and Ireland, with a combined 4.4% of the EU’s population, house more than 50% of global foreign direct investment. This is often in the form of holding companies to exploit the favorable tax regimes and corporate law in these three nations. Italian companies will domicile in the Netherlands and pay corporate taxes there while performing almost all operations in Italy. Even former Prime Minister Silvio Berlusconi has moved the “headquarters” of his Mediaset empire from Milan to Amsterdam. Thus, the tax haven nations receive the lower corporate taxes but need to provide virtually no services to the taxpayer, while the nations that must provide services to the employees of those taxpayers are left without the tax revenue they should have to provide them.
It is often challenging to measure the strength of these opinions, and even harder to determine how citizens would like to act upon the opinions if given the opportunity. Fortunately, Davide Angelucci and Vincenzo Emanuele recently conducted a detailed survey of Italian attitudes towards to EU for Centro Italiano Studi Electtorali. According to the survey, a shocking 85% believe the EU is not helping Italy in its fight against COVID-19. 42% of Italians have a negative opinion of the EU, 23% are neutral, and only 35% hold positive opinion of the EU. Additionally, 35% would like to leave the EU, 18% prefer to leave the Euro but not the EU, and 47% would choose to stay in the EU. Anti-EU sentiment in Italy is growing, and failure of the EU and ECB to support Italy in near future could push it out of the Euro.
When considering how these divides might impact the Euro, it is important to begin any analysis with an understanding that *nobody* who would experience real consequences, financial or electoral, wants even a partial failure of the Euro. Of course, populist politicians like Matteo Salvini rattle sabers because 65% of the voters for his Lega party would like to leave the EU; but the financial and industrial giants in Lega’s northern Italian strongholds would certainly do all they could to kill any Italeave movement. So there is a strong desire to patch over any differences and retain the status quo. But disagreements occur, intentions are misread, ill-advised ultimatums are made, offenses are taken, and history happens. It is therefore no certainty that the current structure of the Eurozone will survive the next decade. The COVID-19 crisis has shown that some cracks were deeper than previous believed and accelerated the impact of long-term structural issues. It is no longer crazy to believe that the Euro might fail.
Central to any contemplation of the future of the Euro is the concept of Optimum Currency Areas discussed above. Whether the Euro or any successor currency can succeed is dependent upon 1) integration and mobility of labor, 2) price, wage and capital flexibility, 3) centralized budgeting to redistribute wealth to parts of the area which suffer due to labor and capital mobility, and 4) similar business cycles throughout the zone. The first two are basically satisfied through the EU and Customs Union. The third is somewhat satisfied by the EU. But the fourth requirement leads to much debate regarding how much the members’ national economies must move in harmony with each other.
With this in mind, and considering current and future economic, political, and social conditions in the various European nations, some potential paths are worthy of discussion. Of course, there are variations and complications with all potential paths, including these; but discussing multiple options before they evolve will allow smoother resolution of the complications.
Status Quo
When imaging how things might be in the future, it is easiest to revert to a future version of the current. This, however, rarely occurs, as evolution and events pull the course away from the narrow range of “likely” towards somewhere on the very wide range of “possible.” But let’s assume that this time is different, and the Euro continues in its current form without any substantial change in mandate or course alterations since that is close to what most stakeholders would prefer. Specifically, the frugal nations are likely operating under the assumption that southern nations will accept the best relief package they can get and, after a period of hard feelings, eventually return to business as usual. And that assumption might be correct.
However, as all European institutions have since the European Coal and Steel Commission in 1952, the ECB is likely to expand and integrate further. All EU members except Denmark are technically obligated to adopt the Euro at some point, with Bulgaria and Croatia already taking the necessary step of joining the Exchange Rate Mechanism (“ERM”). The other nations that “must” at some point join the Euro are Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, and Sweden.
Viewed through the Optimum Currency Area lens, the expansion of the Eurozone will stretch the requirements of budgeting/redistribution and common business cycles. Since the Euro’s introduction, experts including monetary theorists, political scientists, and econometricians have weighed in on whether the Eurozone is an Optimum Currency Area. The idea of breaking it up, however, has never been seriously discussed because all members are relatively affluent and have integrated financial systems. It may, however, be challenging to sell the notion that the business cycles and financial systems in Sofia, Strasburg, Lodz, and Lisbon operate in harmony. And if the nineteen current Eurozone economies are finding it challenging to redistribute capital to nations that are lagging now, adding seven new members that are net recipients from the EU compared to only one net EU contributor may prove impossible.
Unfortunately for the frugal members that currently exert great sway in the ECB, the potential new members are much more like the southern Euro members, with Sweden an exception. Thus, the frugal nations would be wise to ensure any long-term division in the ECB falls along the lines of original vs. new member instead of frugal vs. everyone else. This will require them to give a little to their current ECB partners, with the Spanish proposal of spending through the EU budget currently the most palatable plan on the table. Otherwise the status quo, which is a state of perpetual expansion of European institutions, will cause the frugal nations much more heartburn in the future by causing the same issues to arise during the next global financial crisis, only with more partners seeking financial support.
Italy and Greece Leave Euro
Matteo Salvini will likely be the next Prime Minister of Italy as the head of the Lega party, supported by coalition partners Fratelli d’Italia (Brothers of Italy) and former Prime Minister Silvio Berlusconi’s Forza Italia. Lega and Fratelli d’Italia have been vocal in their Euroscepticism, and while Forza Italia is very pro-EU and Euro, Berlusconi tries to stay relevant any way he can, so he would join with these parties in the hope that issues with other European nations would blow over.
The coalition would know that it could not just leave the Euro, but would feel immense pressure to both stand up to what Italians view as northern European callousness and inject some life into the economy hardest hit by COVID-19. Living up to its political promises could cause it to take drastic action: reintroducing the Lira as a parallel currency for domestic transaction. To give those who spend money in Italy (specifically Italian businesses) an advantage, it would likely peg the value of the Lira (or a certain number of lira) at something like .95 Euro per Lira. Employers would seek to pay wages in the cheaper currency, but debts would still be owed in Euros. The ECB would almost certainly refuse to recognize the Lira and prohibit banks in the Eurozone from accepting it as payment even though its value would be pegged to the Euro. Italian leaders could argue that, unless it is expelled from the Eurozone after being declared a member state in derogation, its membership and full participation cannot be hindered; but the rest of the Eurozone members would be in no mood for legalities and do what they could to punish Italian behavior. Eventually, tensions would escalate with Italy halting payments to the ECB, and the ECB suspending Italy from its bond-purchasing program.
Such a move would be bad for the Eurozone, but catastrophic for Italy. The COVID-19 crisis has shown its leaders that fellow Europeans do not believe the nation to be so systemic as to require significant financial support in an emergency. With no support coming, Italian banks would face a double mismatch problem of liabilities short-term in Euros and assets long-term in Lira. The economy would need a lot of Euros cycling through it, but Italy’s trade to GDP ratio is only around 60%, which places it dead last in the EU, meaning banks would burn through their Euros quickly. Banka D’Italia would do everything it could to keep Euros in the system, defend the Lira to Euro peg, and keep the spread on Italian bonds manageable, but it would eventually burn through what reserves it possesses outside of those dedicated to the ECB (including nearly €90B in gold) and need to allow the currency to float. With this action, Italians would lose a significant portion of savings not held in Euros, and the economy would deteriorate even further.
There could be a silver lining in this scenario, however. Italy could decide to try to take advantage of the crisis to shed its debt and become more competitive. It could agree to expulsion from the Eurozone and fully transition to the Lira. Its populist government might then seek to redenominate its debt at the new depreciated exchange rate. Much like Argentina in 2005, Italy would likely offer to swap outstanding bonds for either a bond with a discount rate of around 60% of face value to mature at its original maturity date, or a longer-term bond at 100% value with smaller coupon payments.
Since it would be burning investors and would pay a large premium to access capital markets, Italy would need to be aggressive in creating growth. To do so, it could rely on a key membership it would not shed: the European Customs Union. With its cheaper yet well-educated workforce, complete access to the European market, and a willingness to provide special incentives to boost employment, Italy would be primed to attract employers looking to operate in the EU at lower costs than those in Eurozone countries. The economic warfare between Italy and the Eurozone would be vicious, but at least Italy could provide its citizens some hope.
Similarly, Italians and other Europeans refuse to listen to northern European lectures on public debt when those nations’ tax structures greatly contribute to the southern nations’ need to take on debt. The Netherlands, Luxembourg, and Ireland, with a combined 4.4% of the EU’s population, house more than 50% of global foreign direct investment. This is often in the form of holding companies to exploit the favorable tax regimes and corporate law in these three nations. Italian companies will domicile in the Netherlands and pay corporate taxes there while performing almost all operations in Italy. Even former Prime Minister Silvio Berlusconi has moved the “headquarters” of his Mediaset empire from Milan to Amsterdam. Thus, the tax haven nations receive the lower corporate taxes but need to provide virtually no services to the taxpayer, while the nations that must provide services to the employees of those taxpayers are left without the tax revenue they should have to provide them.
It is often challenging to measure the strength of these opinions, and even harder to determine how citizens would like to act upon the opinions if given the opportunity. Fortunately, Davide Angelucci and Vincenzo Emanuele recently conducted a detailed survey of Italian attitudes towards to EU for Centro Italiano Studi Electtorali. According to the survey, a shocking 85% believe the EU is not helping Italy in its fight against COVID-19. 42% of Italians have a negative opinion of the EU, 23% are neutral, and only 35% hold positive opinion of the EU. Additionally, 35% would like to leave the EU, 18% prefer to leave the Euro but not the EU, and 47% would choose to stay in the EU. Anti-EU sentiment in Italy is growing, and failure of the EU and ECB to support Italy in near future could push it out of the Euro.
Possible Outcomes
When considering how these divides might impact the Euro, it is important to begin any analysis with an understanding that *nobody* who would experience real consequences, financial or electoral, wants even a partial failure of the Euro. Of course, populist politicians like Matteo Salvini rattle sabers because 65% of the voters for his Lega party would like to leave the EU; but the financial and industrial giants in Lega’s northern Italian strongholds would certainly do all they could to kill any Italeave movement. So there is a strong desire to patch over any differences and retain the status quo. But disagreements occur, intentions are misread, ill-advised ultimatums are made, offenses are taken, and history happens. It is therefore no certainty that the current structure of the Eurozone will survive the next decade. The COVID-19 crisis has shown that some cracks were deeper than previous believed and accelerated the impact of long-term structural issues. It is no longer crazy to believe that the Euro might fail.
Central to any contemplation of the future of the Euro is the concept of Optimum Currency Areas discussed above. Whether the Euro or any successor currency can succeed is dependent upon 1) integration and mobility of labor, 2) price, wage and capital flexibility, 3) centralized budgeting to redistribute wealth to parts of the area which suffer due to labor and capital mobility, and 4) similar business cycles throughout the zone. The first two are basically satisfied through the EU and Customs Union. The third is somewhat satisfied by the EU. But the fourth requirement leads to much debate regarding how much the members’ national economies must move in harmony with each other.
With this in mind, and considering current and future economic, political, and social conditions in the various European nations, some potential paths are worthy of discussion. Of course, there are variations and complications with all potential paths, including these; but discussing multiple options before they evolve will allow smoother resolution of the complications.
Status Quo
When imaging how things might be in the future, it is easiest to revert to a future version of the current. This, however, rarely occurs, as evolution and events pull the course away from the narrow range of “likely” towards somewhere on the very wide range of “possible.” But let’s assume that this time is different, and the Euro continues in its current form without any substantial change in mandate or course alterations since that is close to what most stakeholders would prefer. Specifically, the frugal nations are likely operating under the assumption that southern nations will accept the best relief package they can get and, after a period of hard feelings, eventually return to business as usual. And that assumption might be correct.
However, as all European institutions have since the European Coal and Steel Commission in 1952, the ECB is likely to expand and integrate further. All EU members except Denmark are technically obligated to adopt the Euro at some point, with Bulgaria and Croatia already taking the necessary step of joining the Exchange Rate Mechanism (“ERM”). The other nations that “must” at some point join the Euro are Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, and Sweden.
Viewed through the Optimum Currency Area lens, the expansion of the Eurozone will stretch the requirements of budgeting/redistribution and common business cycles. Since the Euro’s introduction, experts including monetary theorists, political scientists, and econometricians have weighed in on whether the Eurozone is an Optimum Currency Area. The idea of breaking it up, however, has never been seriously discussed because all members are relatively affluent and have integrated financial systems. It may, however, be challenging to sell the notion that the business cycles and financial systems in Sofia, Strasburg, Lodz, and Lisbon operate in harmony. And if the nineteen current Eurozone economies are finding it challenging to redistribute capital to nations that are lagging now, adding seven new members that are net recipients from the EU compared to only one net EU contributor may prove impossible.
Unfortunately for the frugal members that currently exert great sway in the ECB, the potential new members are much more like the southern Euro members, with Sweden an exception. Thus, the frugal nations would be wise to ensure any long-term division in the ECB falls along the lines of original vs. new member instead of frugal vs. everyone else. This will require them to give a little to their current ECB partners, with the Spanish proposal of spending through the EU budget currently the most palatable plan on the table. Otherwise the status quo, which is a state of perpetual expansion of European institutions, will cause the frugal nations much more heartburn in the future by causing the same issues to arise during the next global financial crisis, only with more partners seeking financial support.
Italy and Greece Leave Euro
Matteo Salvini will likely be the next Prime Minister of Italy as the head of the Lega party, supported by coalition partners Fratelli d’Italia (Brothers of Italy) and former Prime Minister Silvio Berlusconi’s Forza Italia. Lega and Fratelli d’Italia have been vocal in their Euroscepticism, and while Forza Italia is very pro-EU and Euro, Berlusconi tries to stay relevant any way he can, so he would join with these parties in the hope that issues with other European nations would blow over.
The coalition would know that it could not just leave the Euro, but would feel immense pressure to both stand up to what Italians view as northern European callousness and inject some life into the economy hardest hit by COVID-19. Living up to its political promises could cause it to take drastic action: reintroducing the Lira as a parallel currency for domestic transaction. To give those who spend money in Italy (specifically Italian businesses) an advantage, it would likely peg the value of the Lira (or a certain number of lira) at something like .95 Euro per Lira. Employers would seek to pay wages in the cheaper currency, but debts would still be owed in Euros. The ECB would almost certainly refuse to recognize the Lira and prohibit banks in the Eurozone from accepting it as payment even though its value would be pegged to the Euro. Italian leaders could argue that, unless it is expelled from the Eurozone after being declared a member state in derogation, its membership and full participation cannot be hindered; but the rest of the Eurozone members would be in no mood for legalities and do what they could to punish Italian behavior. Eventually, tensions would escalate with Italy halting payments to the ECB, and the ECB suspending Italy from its bond-purchasing program.
Such a move would be bad for the Eurozone, but catastrophic for Italy. The COVID-19 crisis has shown its leaders that fellow Europeans do not believe the nation to be so systemic as to require significant financial support in an emergency. With no support coming, Italian banks would face a double mismatch problem of liabilities short-term in Euros and assets long-term in Lira. The economy would need a lot of Euros cycling through it, but Italy’s trade to GDP ratio is only around 60%, which places it dead last in the EU, meaning banks would burn through their Euros quickly. Banka D’Italia would do everything it could to keep Euros in the system, defend the Lira to Euro peg, and keep the spread on Italian bonds manageable, but it would eventually burn through what reserves it possesses outside of those dedicated to the ECB (including nearly €90B in gold) and need to allow the currency to float. With this action, Italians would lose a significant portion of savings not held in Euros, and the economy would deteriorate even further.
There could be a silver lining in this scenario, however. Italy could decide to try to take advantage of the crisis to shed its debt and become more competitive. It could agree to expulsion from the Eurozone and fully transition to the Lira. Its populist government might then seek to redenominate its debt at the new depreciated exchange rate. Much like Argentina in 2005, Italy would likely offer to swap outstanding bonds for either a bond with a discount rate of around 60% of face value to mature at its original maturity date, or a longer-term bond at 100% value with smaller coupon payments.
Since it would be burning investors and would pay a large premium to access capital markets, Italy would need to be aggressive in creating growth. To do so, it could rely on a key membership it would not shed: the European Customs Union. With its cheaper yet well-educated workforce, complete access to the European market, and a willingness to provide special incentives to boost employment, Italy would be primed to attract employers looking to operate in the EU at lower costs than those in Eurozone countries. The economic warfare between Italy and the Eurozone would be vicious, but at least Italy could provide its citizens some hope.
The battle between Italy and the rest of the Eurozone would not go unnoticed in the nations that “must” join the Euro, and they would probably be hesitant to enter into a monetary union that cannot be undone without economic warfare. Simultaneously, Greece would feel like even more of an outlier in the Eurozone and realize that it is a populist government away from enduring the same fate as Italy. Eurozone leaders could use this as an opportunity to show how a nation can leave the Euro on friendly terms. The parties would both be happy to negotiate a Grexit through which the ECB supports Greece’s transition back to the Drachma and keeps its debts payable in Euros. The Drachma is tied to the Euro, and the ECB would agree to provide a certain level of capital to defend that peg for several years.
Regional Euros, With or Without Italy and Greece
Regardless of whether Italy and Greece leave the Euro, COVID-19 is exposing existential deep divides between Eurozone nations that will not be easily overcome. Two camps of nations led by Germany and France fundamentally disagree on the role of the ECB and integration. Additionally, if Italy leaves and redenominates its debt, the redenomination risk priced into the bonds of nations like Spain and Portugal would skyrocket. The spread between bonds in the Eurozone could become much too expensive for the ECB to manage. Risk would need to be localized instead of socialized, and the only way to effectively do this would be to break the Eurozone into Euro regions under the auspices of the ECB: essentially live in the same neighborhood but not the same house.
Breaking the Eurozone into three smaller but closely regulated monetary regions under the auspices of the ECB would both stabilize the nations’ monetary policy through more regionally-appropriate methods and contain any events that arise within those areas. They would be designed to take advantage of the attributes that make them Optimum Currency Areas, and cultural ties would facilitate easier resolution of issues.
Baltic Euro
The first region, the Baltic Euro, is by far the smallest. It would consist of Finland, Estonia, Lithuania, and Latvia and would be relatively stable as fiscal policy has always been conservative in these nations. Further, if any unforeseen issues arise in this region, assistance from the other regions will be very effective given the small size of aid that would be needed to resolve a crisis.
Breaking the Eurozone into three smaller but closely regulated monetary regions under the auspices of the ECB would both stabilize the nations’ monetary policy through more regionally-appropriate methods and contain any events that arise within those areas. They would be designed to take advantage of the attributes that make them Optimum Currency Areas, and cultural ties would facilitate easier resolution of issues.
Baltic Euro
The first region, the Baltic Euro, is by far the smallest. It would consist of Finland, Estonia, Lithuania, and Latvia and would be relatively stable as fiscal policy has always been conservative in these nations. Further, if any unforeseen issues arise in this region, assistance from the other regions will be very effective given the small size of aid that would be needed to resolve a crisis.
Coastal Euro
The next region is the most diverse and potentially most volatile; but share a vision of European unity and fiscal cooperation. France, Spain, Portugal, Malta, Cyprus, and Ireland work incredibly well together, and have made the political commitments necessary to defend each-others’ ability to borrow. They would likely even issue joint bonds to obtain the benefits of pooled risk. They are happy to work with the Germans through the ECB, but are also happy to determine the region’s monetary policy in a more democratic manner.
The next region is the most diverse and potentially most volatile; but share a vision of European unity and fiscal cooperation. France, Spain, Portugal, Malta, Cyprus, and Ireland work incredibly well together, and have made the political commitments necessary to defend each-others’ ability to borrow. They would likely even issue joint bonds to obtain the benefits of pooled risk. They are happy to work with the Germans through the ECB, but are also happy to determine the region’s monetary policy in a more democratic manner.
If Italy and Greece were to remain in the Euro, this is the region they would join, which would skew all of the chart’s numbers towards more debt and higher bond spreads. These nations have worked well together in the EU and ECB, so it is fair to assume they would continue to cooperate through this regional Euro.
Central Euro
The final region is the Central Euro, consisting of Germany, Austria, the Slovak Republic, the Netherlands, Belgium, Luxembourg, and Slovenia. Belgium’s fiscal policy fits more comfortably with the previous region, but the investments in and deep connections to the Benelux ideal draws it into this one. Germany and the Netherlands make most decisions in this region; but unlike the entire Eurozone before the breakup, their partners are happy to defer since they greatly benefit from their monetary association with Germany. Sovereign bond spreads between the nations would decline significantly, and the members would be more likely to assist each other in an emergency since they share values and a history of fiscal prudence.
Central Euro
The final region is the Central Euro, consisting of Germany, Austria, the Slovak Republic, the Netherlands, Belgium, Luxembourg, and Slovenia. Belgium’s fiscal policy fits more comfortably with the previous region, but the investments in and deep connections to the Benelux ideal draws it into this one. Germany and the Netherlands make most decisions in this region; but unlike the entire Eurozone before the breakup, their partners are happy to defer since they greatly benefit from their monetary association with Germany. Sovereign bond spreads between the nations would decline significantly, and the members would be more likely to assist each other in an emergency since they share values and a history of fiscal prudence.
Coordination
The Euro and non-Euro EU nations would coordinate their exchange rates through an enhanced European Exchange Rate Mechanism (the ERM). Hard feelings would likely exist on all sides; but like divorced couples with common debts, it would be best to work together on a limited basis instead of refighting old battles that do not benefit anyone. Additionally, all nations would remain members of the EU and Customs Union, so there are ample opportunities to work together on continent-wide issues and engage in initiatives between the Euro regions.
The COVID-19 crisis has forced Europeans to reevaluate what it means to be both their nationalities and European, and exposed their fellow Europeans’ beliefs on that issue. As a result, they have learned that old prejudices linger and, in many cases, national well-being trumps continental recovery. Such revelations make the fractures in the Eurozone difficult to mend, and make the unthinkable – the end of the Euro – slightly more possible. The issues exposed by the COVID-19 crisis will not disappear, and will almost certainly arise again at a most unfortunate time if not properly addressed now. Thus, it would behoove leaders on all sides of the debate to honestly confront the Eurozone’s structural problems before the promise of Europe fades away.
The Euro and non-Euro EU nations would coordinate their exchange rates through an enhanced European Exchange Rate Mechanism (the ERM). Hard feelings would likely exist on all sides; but like divorced couples with common debts, it would be best to work together on a limited basis instead of refighting old battles that do not benefit anyone. Additionally, all nations would remain members of the EU and Customs Union, so there are ample opportunities to work together on continent-wide issues and engage in initiatives between the Euro regions.
Hard Choices Ahead
The COVID-19 crisis has forced Europeans to reevaluate what it means to be both their nationalities and European, and exposed their fellow Europeans’ beliefs on that issue. As a result, they have learned that old prejudices linger and, in many cases, national well-being trumps continental recovery. Such revelations make the fractures in the Eurozone difficult to mend, and make the unthinkable – the end of the Euro – slightly more possible. The issues exposed by the COVID-19 crisis will not disappear, and will almost certainly arise again at a most unfortunate time if not properly addressed now. Thus, it would behoove leaders on all sides of the debate to honestly confront the Eurozone’s structural problems before the promise of Europe fades away.
Unemployment, population decline, changes in immigration, and world events like the COVID-19 pandemic and the wars in Syria and Libya strengthen Italian anti-immigrant and anti-EU parties and their chances for national power. Significance: Domestic Italian issues (unemployment, rural emptying, population decline) and world events (COVID-19 pandemic, wars in Syria and Libya) will increase the power of anti-immigrant and anti-EU political parties in Italy. This trend heightens the chance of anti-immigrant and anti-EU parties winning elections and gaining ruling power in Italy to the detriment of European integration and open Italian markets. Forecast: Immigration and anti-EU rhetoric will play an increasingly important role in upcoming regional and national elections in Italy, helping Matteo Salvini and his anti-immigrant League party and Giorgia Meloni and her Brothers of Italy party win elections in regions that historically supported left-of-centre parties. The combination of domestic concerns and international events surrounding immigration issues will further allow the League, the Brothers of Italy, and the 5-Star Movement to gain national power in Italy, move Italian politics to the right, and harm Italy’s relations with the EU. Subsidiary impacts: • Increased anti-immigrant sentiment will cause more attacks against immigrant populations in Italy and create harsher anti-immigrant policies at all levels of government • Italy will further pursue an “Italy first” foreign policy lead by Salvini, Meloni, and conservative elements of the 5-Star Movement • Italy will take steps to tighten its borders including against other EU member states • International companies in Italy will find it more difficult to find qualified workers even as Italian unemployment remains very high • More fighting in Syria’s Idlib province and Libya will push an increasing number of immigrants to Italy and other EU nations causing infighting between EU member states on how to deal with the crisis Immigration in Italy by the numbers: Total immigration to Italy was 515,000 in 2007 compared with 300,000 in 2017. Illegal immigration has also dropped in recent years. 181,000 migrants arrived in Italy by boat in 2016 compared to 11,500 in 2019. Salvini claims this drop is due to his tough policies. Despite the drop, Italy’s anti-immigrant parties continue to call for stronger border enforcement, more deportations of migrants already in Italy, and changes to asylum rules. Even though Salvini failed in his attempt in August to bring his League party to power, their anti-immigrant platform continues to make advances in regional elections. The election in Umbria in October 2019 of Donatella Tesei, backed by the League, is one example. More recently in Emilia-Romana, the League came close to unseating the center-left regional government which has been in power for seven decades. Although the center-left won a majority, when you look at the distribution of votes across parties the League is only 2 percentage points behind the center-left. The League candidate lost by about 100,000 votes, of more than 2.2 million votes cast. Anti-immigrant policies were a main plank of their candidate’s platform. Domestic concerns: Italy’s domestic population is in decline. In 2019, Italy’s overall population fell by 116,000 to 60.3 million. There was a steady rise in immigrant births helping to offset the declining domestic birth rate, but the decline remained. The loss of population can be seen most clearly in rural Italy, especially in the South, a phenomenon referred to as rural emptying. Between 2000 and 2018 rural Italy lost almost 800,000 residents. Young Italians move to larger cities or other countries leaving only older people in the villages. Some rural villages even resort to selling properties for one euro if the buyer promises to live in the town and maintain the property. The decline of Italians living in these areas, combined with immigrant arrivals cause some Italians to claim Italy is becoming less Italian. These trends cause anxiety among ordinary Italians who feel their way of life is threatened and must be protected from outside influence. Anti-immigrant sentiment is felt among the youth as well older Italians, even in prosperous regions. One cause for this sentiment is high youth unemployment. At 29% even before the COVID-19 pandemic, Italy’s youth unemployment rate is one of the highest in the Eurozone. Many Italians leave Italy to find work in other countries. In 2018 over 150,000 Italians left the country. Many of the unemployed blame immigrants and EU policies for the situation. They feel the centre-left parties have failed them so the League, the Brothers of Italy, and 5-Star Movement draw some of the youth vote. In recent pre-polling election data, the 5-Star Movement won the support of 31 percent of those aged 18 to 22 and 35 percent of those aged 23 to 28. With the 5-Star Movement dropping in recent polls, some of the youth support will go to the League and possibly to the Brothers of Italy. Even in the wealthy university town of Bologna you hear middle class Italians speak negatively of immigrants. Where immigrants to Italy come from has also changed. In the years after Bulgaria and Romania joined the EU, many migrants to Italy came from those countries. In 2019, the largest number of official migrants came from Tunisia (2,654) followed by Pakistan and Ivory Coast with more than 1,100 each. Many Pakistanis and Tunisians in Italy own, run, and maintain vegetable stands and other small shops. The newly arrived immigrants find it more difficult to integrate than did previous waves because they are culturally, racially, and religiously more distinct from Italians. Bulgarians and Romanians tend to be Orthodox, more similar to Roman Catholic Italians, while Pakistanis and Tunisians tend to be Muslim. According to one survey most Italians describe their country in negative terms. More than half of Italians believed that “weak” was an accurate description of Italy, followed by “angry” and “divided.” Population decline, globalization, high unemployment, and the changing demographics of immigrants will create more voters sympathetic to anti-immigrant views and policies. International events: In addition to domestic issues, international events help anti-immigrant parties. The COVID-19 outbreak means 60 million Italians only recently exited government-imposed lockdown, isolation, and travel bans. Italy has had more deaths than any country in Europe. Italy has more cases than any other country in Europe, and the outbreak was centered around the northern economic hubs of Lombardy, Veneto, and Emilia-Romagna. The effects on the Italian economy have been extreme and are not yet fully felt. Additionally, Salvini, Meloni and other anti-immigrant anti-EU politicians have used the crisis to call for tighter borders and to blame immigrants and foreign tourists for bringing the virus to Italy. They also blame the EU for acting too slowly and ignoring Italy. Meloni quipped “When the coronavirus was just an Italian problem it didn’t interest anyone in the European Union. They only did things when the virus arrived in Germany.” Salvini for his part has called for a tough approach, such as closing borders and shuttering all businesses, and the ruling coalition followed through with similarly tough actions, which Salvini claims he precipitated. As the true scale of the damage to the Italian economy becomes clearer and unemployment increases, anti-immigrant parties will find more support for the view that Italy must protect itself from the outside world. The latest Politico poll shows the League polling at 26%, with the 5-Star Movement at 16%, and the Brothers of Italy at 14%. Other world crises also have an effect. Continued fighting in Idlib province in Syria created 1 million new refugees, with many of them heading to Europe, as evidenced by recent migrant clashes on the Greco-Turkish border. Turkey now allows Syrian refugees to pass through its territory unimpeded. As cracks in Syria’s ruling elite begin to increase, it is likely there will be more unrest. Additionally, the conflict in Libya hardens as both sides procure arms and prepare for a long fight. Foreign powers (Turkey, Russia, Egypt) send arms, mercenaries, and troops into the country, and UN flights with humanitarian assistance have recently been blocked from entry. Any large uptick in fighting is sure to cause refugees and increase the number of migrants seeking to reach Italy by boat. Additionally, Libya is a transit point for migrants from other sub-Saharan African countries so more chaos there will impede any efforts by Libyan authorities to stop the migrant flow across the Mediterranean. Both Italy and the EU need to form coherent policies on these matters quickly and have so far failed to do so. Italy is a unique bellwether for anti-immigrant and anti-EU feeling across Europe. Anti-immigrant and anti-EU politicians in Italy are adept at exploiting the local issues and world events currently driving “Italy First” feelings. Salvini and Meloni are the Italian politicians to watch in the coming months as domestic concerns and international events further allow their parties to gain national power, move Italian politics to the right, and severely harm Italy’s relations with the EU . Michael Guterbock worked for a decade in disaster preparedness and global health for the US Government. Michael currently works as a country risk manager for Booz Allen Hamilton and is pursuing his Doctorate in International Affairs from Johns Hopkin University's School for Advanced International Studies.
This will be my last article for a while, and potentially ever. I have enjoyed writing them, and loved discussing the issues they raise even more. However, an incredible opportunity has arisen that requires me to step away from Maggiore Risk. While I am excited to deal with the challenges this new position will present (which I will discuss at another time), I will greatly miss working on the broad range of global risk issues Maggiore Risk has allowed me to ponder. After some time of adjustment, if it is permitted by my new employer and appropriate, I may return to share my thoughts again. In the meantime, my colleagues at Maggiore Risk will continue to provide the same excellent service to their clients, and may even post articles here occasionally. While I will be unable to provide risk services, I can get you to the right person or organization, either with Maggiore Risk or elsewhere, to address your issues. In closing, please allow me to say farewell, and thank you. Thank you for allowing me to assist you with your organization’s most pressing concerns. Thank you for reading my thoughts. Thank you for challenging my views. Thank you for sending me a short “hey I loved the article” message, which usually hit my inbox at the time I needed it most. I am forever grateful for my time here, and hope to remain close to everyone I have had the privilege of interacting with through this company. Farewell, and thank you.
So far, we’ve looked at the US fiscal and monetary response to COVID-19 and the European response , of which we have vastly diverging opinions. Now we’d like to take a step back from the technical and look at some bigger picture changes COVID-19 is forcing upon the world, for good or for ill. Will this alter the established global order? A bit ambitious of a question to ask us in this format, eh? Oh well, let’s take a shot at answering. Yes, but not in the way some are expecting. As we previously discussed, the EU is in tatters, and the US monetary policy (if not fiscal policy) has been a lifeline to struggling nations. China will be throwing around money like confetti to buy friends after the crash of trust caused by its lack of transparency regarding COVID-19. Politically, we will truly be what the father of political risk, Ian Bremmer, calls a “G-Zero world,” with no clear leadership or unity. But financially, there was, is, and will be a dominant economy for a while: the United States. In the midst of financial collapse, the first thing every investor sought were US dollars. Foreign central banks have needed one thing to keep their economies afloat and pay for the COVID-19 fight: US dollars. And when the US needed to pay for its measures, it went over $2 trillion (that’s $2,ooo,ooo,ooo,ooo.00) deeper into debt. If most nations were to issue debt equal to 10% of its GDP overnight, the interest rate investors would demand to hold that nation’s bonds would skyrocket, the currency would likely weaken, and inflation would be a real concern. What has happened to US debt? The interest rate has gone down, the dollar has gotten stronger versus all other currencies, and the overall economic picture removes the threat of inflation. Regardless of whether political leaders are playing nice with their foreign counterparts, the US will emerge from this crisis with even greater dominance in the world economy that when it began. What about China? As mentioned above, it has lost significant credibility given its early suppression of information regarding the virus and reporting of cases and deaths that is widely viewed as deceptive, which allowed the virus to spread more widely than it may have otherwise spread. Additionally, its economy, possibly more than others, has been impacted, and its currency has “cracked 7,” which means it has passed a mythical ceiling in exchange rate with the US dollar, and the regime probably could not case less given everything else it must deal with. We identified cracks in the Chinese authoritarian system as our #3 risk to watch in 2020 before anyone knew about COVID-19, and that risk has only increased in the past few months. With the US dollar dominant, China floundering, and Europe trying to figure out what it is, there are some natural realities Americans need to prepare for. First, Americans will be able to buy anything from anyone cheaper than we could before and travel like kings. Unfortunately, that means nobody can afford to buy as much of America’s stuff as they could before or visit the USA. Thus, to the great chagrin of President Trump and others obsessed with trade deficits, they are going to get *YUGE* in the next few years. But fortunately for those concerned about US relations with the rest of the world, even a lack of moral authority won’t overcome the ability to guide global decisions due to the dominant financial power. So while many are opining that COVID-19 will decrease US geopolitical power, we believe it will actually increase it. The rest of the world may think US leaders are a bunch of jerks, but it’s the only nation that can buy their goods and fund large international projects, so they’ll swallow their pride and smile for the pictures. (Now if we could have dominant financial power AND some moral authority…) What industries will be the most changed? Virtually no industry will be untouched by this crisis; but thinking through societal changes that COVID-19 will cause shows what areas of the economy will be most impacted. Of course, current stay at home orders have really hurt restaurants, bars, and brick and mortar retail. But people have gathered to eat together in public establishments since before Greek and Roman times and people will always need to buy stuff, so these will recover to some extent. Looking to history for a guide, anyone who has spoken to an elder about the Great Depression is struck by how their illusion of financial strength were shattered, resulting in their incredible efforts to avoid taking unnecessary risks with their money. Similarly, modern society has had its complacency that we can treat all potential illnesses stripped away. All of us who experience this pandemic will be focused on protecting our health in the same way those who lived through the Depression protected their money. How? First, we will clean more and invest in our health like never before. No, we probably won’t work out more or eat healthier, but sanitize everything and reward businesses that promote excessive cleanliness in their operations. For example, look for hotels to provide videos of room cleanings and airlines to make a show of new filtration systems. Like security after 9/11, we will engage in excessive public sanitation theater to make people comfortable coming out of their homes. Second, we will avoid unnecessary events. Sporting events will return in full force (with maybe some negligible downturn), and let’s be honest, casinos would still be full if they could stay open. But with more people learning how to exercise at home with online assistance (such as Peloton and apps), along with concerns of sweaty people leaving bugs everywhere, gyms might find fewer members when they reopen the doors. And concerts and festivals do not lend themselves to the social distancing people will want to practice for the next few years, driving away casual participants and leaving only serious fans and festival devotees in attendance. Third, with people learning they can be productive at home, companies might see work from home as both an enhanced benefit and cost-cutting move. If employees only come to the office a few days per week for meetings, there would be no need to dedicate office space for everyone, allowing smaller workspaces (and lower rent). Employees seeking human interaction but hoping to avoid the bugs transmitted in crowds would be relieved on both counts to have an office to visit, but without mandatory attendance. Finally, if more people are both working outside of a daily office and hoping to have room to avoid pathogens, real estate in city centers will be less in demand. Since the commute into an office will only be a few days per week, people will be more willing to sit in traffic on those days as a trade off for a more controllable health environment. When can I leave my house? That one is a little outside of our (and everyone’s) wheelhouse. Just check this page often and watch this to pass the time, and we’ll be back on the streets before you know it. Stay strong, stay healthy, and stay home! Do you agree or disagree with our assessments here? What important topics did we miss? What else would you like to discuss?
In the month since Italy closed its borders, Europe has faced economic calamity unlike anything it has seen since World War 2. The continent’s economy has been shut down, and nations have faced incredible costs to both fight the virus and keep society from descending into chaos as life has grinding to a halt. Digging out of this mess will take time, patience, and lots and lots of money. But Europe’s willingness to commit that money has been lacking, and failure to present a common approach could end up undoing the European Union. Has Europe’s response been effective? Has the monetary response been appropriate and sufficient? After a rocky start (like saying the European Central Bank was not interested in lowering Italy’s bond spread), Christine Lagarde and the ECB got it right, injecting liquidity into the financial system and implementing creative solutions similar to the United States Federal Reserve’s. So while there might be room for improvement, they are a part of the solution, not the problem. The political/fiscal response, however… In a few years, we may be able to direct you to one of the numerous articles we will write on the subject, or a large collection the Ph.D. theses or books on the topic with titles such as “The Death of the Euro”, “Modern Dutch Disease”, or “Divided We Fall.” Until then, however, we’ll just touch on some of the issues and leave so, so many hanging out there because there is no adequate way to summarize the historical, political, social, and economic roots of the disunion of the European Union in a Q and A article. Historically, northern European nations such as the Netherlands, Luxembourg, Germany, Austria, and Finland have taken southern European nations such as Italy, Greece, and Spain to task for irresponsible spending, and they’ve usually had a good reason. If your nation’s monetary policy is dependent upon another nation’s fiscal policy over which you have no control, you’d get salty watching loads of irresponsible spending, too. However, since the financial crisis of 2008-10, these nations have been pretty dang responsible, and their budget deficits have been consistently improving.
Although it seems like ages ago, Italy issued its “stay at home” order less than one month ago , and the world has caught up, shutting down shops, events, and well…life. While obviously societies are going through collective disruption during the shutdown, what are the short-term ramifications on societies and economies as restrictions are loosened? More importantly, what long-term changes and risks should we prepare for as a weary world settles into post-pandemic life? We have spoken about these issues with clients and colleagues over the past month, and have put together a Q & A to stimulate thought and discussion by a wider group. We originally planned one article addressing several issues, it just kept growing, so we have broken it up into three shorter pieces on the US response, European response, and other important issues and will share them throughout the week. Has the US response been sufficient? That depends on your definition of sufficient. Has it saved the economy from any pain resulting from Covid-19? No, of course not. But has it removed worst case societal possibilities and reassured both the real economy and financial system that it will do whatever it takes to keep the world functioning? Yes, it has. The Federal Reserve’s response has been an A+. By lowering rates to 0, entering new bond markets, and opening up lines for other central banks to convert their treasuries to much needed liquid dollars (more on the significance of this later), the Fed has been creative and effective at keeping the financial world running while everyone in the real economy stays home and watches Tiger King. There are limits to what monetary policy can accomplish, and the Fed has used every tool at its disposal very well to get the most out of its resources within its limits. The political/fiscal policymakers’ response has also, surprisingly, been solid. While there was plenty of drama and give and take, the three rescue packages passed thus far have addressed the biggest potential problems posed by COVID-19. By providing cash payments to Americans, leaders are keeping money flowing through the economy. By adding $600 per week to any state unemployment payment, they are making sure people do not worry about starving (and thus have no reason to cause unrest). And by providing loans to businesses that are forgivable if they pay their employees, they are keeping people away from those unemployment rolls and keeping the number of those $600 per week payments as low as possible. And the packages have committed hundreds of billions to health care organizations to prevent and fight COVID-19. Plenty more will need to be done; but if the initial goal was to provide peace of mind that there would be no mass starvation and financial ruin, the initial packages have succeeded. What more does the US need to do? Governments’ responses will be used for decades to come in game theory textbooks to explain Bayesian games, where leaders make their best choices based upon incomplete information and modify their actions to match new knowledge. As we are living through this, asking “what else needs to be done” is like asking “what will the weather be like next November?” Sure, we can make an educated guess, but precision is nearly impossible. There are some steps we can reasonably anticipate the government will need to take to maintain order and protect small businesses (and their employees) after the pandemic is “over.” First, it will need to address immediate shortages in medical supplies and equipment. Stories of COVID-19 patients dying because basic supplies are lacking, or medical professionals contracting the disease because of a lack of PPE can only add to the general feeling of unrest. Even if people are confident their jobs will be there when this is “over,” they need to be confident that they will be here when it’s “over.” While too much is unknown to write this risk off as manageable, we are cautiously optimistic that American health professionals, manufacturers, and ingenuity will at least mitigate it to stop any large-scale social issues. Second, and more important, it will need to ensure that our food supply chains remain strong. The first few weeks of this pandemic have been marked by runs on toilet paper, hand sanitizer, and flour, which the government has attributed to people purchasing everything at once instead of spreading those purchases. However, if shortages continue, people will grow more and more tense, and unrest could flare up at first in isolated locations, then spread. However, just like with medical equipment, we believe that while some chains may be disrupted, enough will be maintained to keep general order. Additionally, conversations with supply chain experts and have eased our concerns. We are also heartened by the example of Italy, which has much more fragile supply chains and more personal restrictions. The only items suffering from any type of shortage in their supermarkets are wine and liquor. Finally, more will likely need to be done to protect small businesses. Offering forgivable loans to allow businesses to pay employees was a very good idea and will keep millions of people off out of the unemployment system. However, businesses have expenses other than wages that do not necessarily go away, so plenty of businesses will do whatever they need to do to stay alive, including using the loan money to pay other bills. We identified the popping of a business debt bubble as our fourth most impactful global risk of 2020 , and adding even more debt to this mountain is unlikely to solve much. Unless more is done to help businesses that are bringing in no revenue because of mandated stay at home orders, a curve of business closings may be flattened, but the number will not be decreased.
In January 2018, I was asked to write about the confluence if Irish history, politics, and economy. The nation was on top of the world as one of the leading and most educated economies in Europe and running circles around the UK on Brexit issues. It was running budget surpluses and had fantastic leadership, specifically Finance Minister Pascal Donohoe, that understood the nation’s historic boom-bust cycle and the need to break it. Examining history and modern politics, I had no choice but to rain on the parade, concluding: “Today’s Irish have a unique opportunity to break the boom-bust cycle, and in the process, bury the ghosts of their past that perpetually haunt them. Unfortunately, political expediency and jolts of happiness almost always win the battle for the hearts and minds of people everywhere over difficult, paradigm shifting change. Thus, the likelihood of the Irish government refraining from excessive spending in the next few years is slim. They are likely, therefore, to perpetuate the boom-bust cycle that has dominated their economy since independence.” I hoped against hope that I was wrong, and held onto that hope as Taoiseach (Prime Minister) Leo Varadkar and Mr. Donohoe continued their prudent governing while standing firm (and bringing EU partner along) during Brexit discussions. The economy continued to grow at a healthy but sustainable rate, and the government was preparing for both Brexit and the eventual slowdown of the global economy. Unfortunately, the government did not effectively address the housing shortage and prices, and in fact promoted policies that deepened the crisis. As Brexit became less novel and the economy appeared normal, it became evident the type of policies that Irish voters were looking for, and neither of the two primary parties, Fine Gael or Fianna Fail, were advancing them. This created an opening for nationalist/socialist Sinn Fein to fill the void. Issues Facing Ireland, Near and Far The Irish people know sacrifice. The Viking arrival in the ninth century exacerbated the perpetual clan warfare already raging on the island. According to the Irish, this would be preferred over the injustices suffered in the 800 years of British domination. They have had their land taken, their leaders killed, their crops sold abroad during famine, their farmers essentially enslaved by absentee British landowners, their population halved by starvation and emigration, their culture suppressed, and their beloved religion declared illegal. They then fought a war to evict the British only to have them keep a chunk of the island, lived through a Civil War, and have experienced more economic turmoil than most of their European brethren. The Irish people can endure suffering; but they endure it so they can enjoy the prosperity that suffering later allows. That, paradoxically, is the biggest threat currently facing Ireland. As succinctly stated by former Minister of Finance Charlie McCreevy: “when I have it, I spend it.” It is no coincidence that Ireland traditionally runs its biggest budget deficits in years immediately preceding elections, as the party in power seeks to buy their way into the electorate’s good graces. For a ruling party to retain power, it needs to do what governments in Ireland have done during every boom portion of the boom-bust cycle: deliver payment for the people’s suffering when the public purse is full. Fine Gael, however, did not take that approach leading up to this election. Instead it worked on negotiating the best Brexit deal possible and providing tax cuts instead of increasing government spending. While arguably prudent, they avoided the biggest economic crisis facing Ireland today: housing. Since independence, owning land has been an obsession of the Irish. Of course, this is understandable given Oliver Cromwell’s confiscation of Irish land for his British soldiers and the ensuing centuries of landlord-tenant disputes. Thus, the Irish government’s programs to assist first-time homebuyers in achieving this dream are understandable, and even laudable. However, when there are not enough homes to buy, government incentives to increase home sales have the perverse effect of artificially inflating prices and making home ownership less accessible while potentially creating another housing bubble like the one generated by the Celtic Tiger in the early 2000s. Experts estimate that Ireland needs more than 50,000 new housing units each year to alleviate its shortage. 2019 saw the most units built in over ten years: 21,241 units, and Mr. Varadkar appeared to be in no hurry to promote building. This bit Fine Gael, as housing shortages have pushed the cost of rent to an unacceptable level of workers’ incomes, and ownership has slipped even further out of reach.
On a recent trip to Azerbaijan, we landed at Baku’s Heydar Aliyev Airport, took Airport Road to Heydar Aliyev Avenue, drove past the Heydar Aliyev Cultural Center to Heyday Aliyev Boulevard, and then past the Heydar Aliyev Sports Hall to our hotel, the lobby of which was decorated with pictures of Heydar Aliyev and his son and current Azerbaijani President, Ilham.
As every fan of Hamilton can tell you, a few people met in “the room where it happens” and voila, a useless patch of swamp between Virginia and Maryland became the capital of the United States. Now Washington D.C. is the sixth largest metropolitan area in the U.S. with the highest per capita income of any city in the country. Clearly, holding the seat of power has served D.C. well, as it has capitals of other nations. But what if that seat weren’t permanent? What if a nation’s capital moved to better accommodate the business of government and spur economic development? Crazy, right? Well, it has been done before and a plan to move the capital is currently underway in Indonesia. Moving a capital city seems radical, but several nations have done just that with varying levels of success. Some of these projects were driven by necessity, others by vanity, but all were obviously massive undertakings that changed the face of the nations. The most recent capitol relocation occurred in Myanmar in 2005. The government (OK, military…same difference) built a fresh city, Naypyidaw, away from the former capital of Yangon to give the government (military) distance from the cosmopolitan atmosphere of Yangon and be closer to “rebels” in the northern portion of the country. The cost to build Naypyidaw is rumored to be between $4-$5 billion, which sounds like a steal; but when you consider that amount is approximately the current total annual tax revenue for the nation, the cost is staggering. A few years earlier, in 1998, Nursultan Nazarbayev moved the capital of his newly independent Kazakhstan from Almaty, in the far southern portion of the country, to a more central location and named it “Astana,” which simply means “Capital” in Kazakh. Only he didn’t spend $4B on this grand endeavor. No, he spent an estimated $40B. However, since Kazakhstan has considerable oil and gas revenue to tax, the hit was not as pronounced as in Myanmar. President Nazarbayev has retired, and to honor his contributions to the nation upon his retirement, Astana was renamed Nur-Sultan. Two other large nations that have purpose-built capitals are Nigeria and Brazil. Moves to Abuja and Brasilia were necessitated by overcrowding in the previous capitals (Lagos and Rio de Janeiro), a desire to place a capital in a neutral area, and security from attacks by sea. While both have been described as somewhat stale and isolated, they now boast populations of over 3 million and generate healthy portions of their nations’ GDPs. Which brings us to Indonesia and its plans to move the capital from the incredibly overpopulated Jakarta to a purpose-build city on the island of Borneo beginning in 2024. The costs have been announced at $33B, of which the state will directly fund approximately 20% with the rest coming from public-private partnerships and private development. The new city’s central location, along with increasing concern surrounding Jakarta’s pollution, overpopulation, lack of adequate water, and sinking of 25 cm per year make the move appear reasonable. All of this movement raises the fun questions: what if the US moved its capital? Why would it do that? Would that eventually result in the same conditions that led to the movement out of Washington, D.C.? Where would it go? “Drain the swamp!” supporters of President Donald Trump say, referring to the entrenched government class they not so affectionately refer to as the “Deep State.” “Get money out of government!” say liberal activists disgusted by the appearance that wealth drives government decisions. Moving the seat of government away from the location where power and money has concentrated for the purpose of influencing and profiting from that government would be a grand experiment in good governance, just as the US was once a grand experiment in democracy. But if the capital were to relocate, wouldn’t the new capital attract the same wealth and power that has taken root in D.C.? Perhaps, but this is where a potential moderating force comes into play: what if the move was not permanent? What if the capital was purpose build and moved every 100 years? The new city could be designed for modern transportation and societal needs (hyperlink hub and fully wired?) instead of shoehorning modernism into older cities. The price tag on this experiment would undoubtedly be large; but building this city from scratch is probably worth the expenses if we know that it will serve such an important function for a century and would spur economic development. An entrenched class of government elites would inevitably develop. However, it could not firmly establish itself because as soon as it fully evolved, the capital would move again and start over elsewhere. As for where this new capital could be built, that is a political decision that would rely upon good old-fashioned politics and compromise. Ideally, the nation would divide into five regions, Northeast, Southeast, Midwest, Mountain, and West Coast, and rotate the capital between the regions. Since the city would need to be a new build, it should be located between other cities to create a strong regional grouping that could both help in the building of the new city and foster economic integration. For example, it could be built in northeastern Iowa, close to Chicago, Milwaukee, Minneapolis, and Des Moines. Or it could be placed in southern Oregon, making a continuous link of cities between Seattle and San Diego. These are mere suggestions; but the idea is to create something new that could remain viable after the capital moves. Ah, there’s the problem! What happens to D.C. after the move, and what happens to the other capital cities? In short, D.C. would take a large hit. However, vibrant non-governmental industries have developed that could continue to thrive after the move due to the concentration of talent and advantageous location. The new cities would also face challenges after the government left; but since it would be known that the government was leaving and the cities would be in strategic locations, they would be better prepared to deal with the changes. Of course, this is a crazy idea that would need to be developed more fully, and the political wrangling would be epic. But if America wants to keep its edge as an innovator of democracy and good governance, the most effective location of the capital should be discussed to refresh our democracy, just as it was when the three men met in “the room where it happens” two hundred years ago and saved our fledgling democracy.
Sanctions have been hitting headlines quite a bit lately, but the explanation of who/what is being sanctioned, how sanctions work, and whether they can be an effective method of getting the sanctioned person, company, or even country to bend to the sanctioning country’s demands has been absent. This is understandable, because the complex web of laws, regulations, entities, and consequences are nearly impossible to summarize in a pithy article. However, considering their increased use and potentially severe consequences (as we are currently seeing in Iran), informed citizens should at least attempt to understand these important tools of foreign policy. Let’s begin by pointing out that tariffs are not sanctions. Tariffs are an economic tool intended to benefit the economy of the issuing nation while sanctions are a political tool intended to punish the sanctioned party for bad behavior. If you are reading this article hoping for a discussion of US-China trade, you will be disappointed, but can raise your spirits by reading our previous article on that topic here. Once we are firmly in the realm of sanctions, the first question is “who can sanction?” Technically, any nation can impose sanctions and try to enforce them; but only three entities have the practical ability to impose meaningful sanctions: United States, European Union, and United Nations. Often the sanctions overlap, as the excellent model from the Council on Foreign Relations below indicates.
When King George V surveyed his empire before World War I , he saw approximately one-quarter of the Earth’s land mass and people under his crown. The sun truly never set on the British Empire, and Pax Britannica had stabilized the world for several decades. But then history happened as nations sought to rule themselves and far-flung territories became more of a burden to rule than benefit to the empire. Over the next century, the United Kingdom shrunk from 13,700,000 square miles to 93,628 square miles, or .68% of its summit, and rules over .88% of the world’s population. Hong Kong was the most recent defection in 1997, leaving the United Kingdom with essentially its population base in the British Isles, a few strategic ports, and some nice Caribbean vacation spots. This is not an effort to denigrate Great Britain as a has-been power clinging to relevance. It is still one of the world’s foremost military, economic, and cultural powers. This history is provided to demonstrate that time has a way of changing things, and “permanent” truths are subject to unforeseen events and forces even the most visionary leaders cannot control. And when perceived community interests diverge from those of the larger nation, division is sought and, sometimes, obtained. The United Kingdom may be approaching another such point after last week’s Parliament vote. Last week’s vote leaves no doubt: Brexit will happen. And Boris Johnson, a man about whom we have written in the past, will be the person to pilot that ship out of the European Union. The certainty of the exit ends a period of volatility that has hampered British politics and business for several years, and certainty is good . However, the certainty of Brexit has unleashed related uncertainties that will plague the United Kingdom for the next decade or longer, potentially leading to a further contraction of Great Britain and, eventually, the forming of a rival firmly planted within the European Union. Scotland Scottish independence is not a new passion. The two neighbors have centuries of conflict and cooperation, and since the Treaty of Union merged the nations in 1707, Scottish nationalists have been clamoring for a reversal. Most recently in 2014, a referendum on independence resulted in a 55-45 vote to remain within the United Kingdom. But that was before the Brexit referendum. In that election, Scottish voters voices a strong desire to remain within the EU, only to be overruled by their British and Welsh countrymen. In last week’s Parliamentary elections, the Scottish Nationalist Party, formed to promote an independent Scotland, won 48 of Scotland’s 59 seats in Parliament, 13 more seats than the previous election. Its percentage of the vote increased 8% to 45%. Leader Nicola Sturgeon has already asked Prime Minister Boris Johnson for a second referendum, which he has refused. While there would seem to be movement towards independence, it should not be forgotten that, just five years ago, Scottish voters rejected leaving the UK by 10 percent. And the SNP’s 45 percent of the 2019 vote, while impressive, is the same percentage of those who voted for independence; thus it is unclear how much public opinion has shifted. Further, the electorate is likely exhausted with no appetite for another bruising campaign after the 2014 independence vote, 2016 Brexit vote, and 2017 and 2019 Parliamentary elections. However, if Scottish nationalists are patient, Brexit may advance their cause far more effectively than any campaign. 62% of the voters in Scotland voted Remain. Further, Boris Johnson’s breed of Conservatism is often interpreted as English nationalist and paternalistic towards Scotland, Northern Ireland, and Wales. He was forced to work with everyone prior to the election since he was leading a minority government; but now that he has a large Parliamentary majority composed almost exclusively of English members, he may pay less attention to the other nations within the Kingdom. Further, Brexit will harm the British economy, and leaving the UK to join the EU will become more appealing in time. If Scottish nationalists spend the next several years linking independence with EU membership (and a reversal of the difficulties Brexit will bring) and give the electorate time to get over the recent wave of monumental elections, another vote on an independent Scotland could occur within the next five to ten years. Northern Ireland More surprising than the SNP’s success in Scotland were the victories of Nationalist parties in Northern Ireland. For the first time in Northern Irish history, they won more seats than Loyalist parties, 10 to 8 (with one additional seat going to a compromise party). Additionally, Northern Ireland voted 56-44 to remain within the EU in the 2017 referendum. Northern Irish voters understand that, regardless of the extremely tumultuous religious conflicts within its nation and with the Republic of Ireland, its economy is intimately linked to that of the Republic, which requires it to be a member of the EU to continue unfettered trade. The Brexit process has exposed deep cracks in the English-Northern Irish relationship, but the Conservatives’ need of the Democratic Unionist Party’s support to remain in power prior to the recent election meant that any plans needed to meet with the approval of at least some Northern Irish leaders. Mr. Johnson, like his predecessor Theresa May, was consistently flabbergasted that the EU did not disregard the interests of Ireland during Brexit negotiations, but were unable to disregard their own Irish’s considerations since they were needed to govern. With his large England-based majority, Mr. Johnson is free from those shackles. On the most perplexing issues of the negotiations, such as customs complications and a backstop to EU regulations, Mr. Johnson has already shown himself to be more concerned with getting a deal than finding solutions that benefit Northern Ireland. As the EU exercises tougher negotiation tactics (since it will be negotiating with a third party instead of a member state), the UK will find itself with less and less leverage, and Northern Irish interests are politically the easiest for Mr. Johnson to disregard. With it already being the nation absorbing the largest blow from Brexit, the lack of concern from Westminster might be enough to soften some Unionist positions. Of course, *might* is the operative word here. Centuries of conflict followed by several decades of violence are not swept away simply because one side wants access to markets for their widgets. The Good Friday Accords have greatly improved relations between Northern Ireland and the Republic of Ireland, and common EU membership has provided a neutral setting for the nations to jointly prosper. But removing EU membership does not mean that the parties will be drawn together in common cause and Northern Ireland will abandon the United Kingdom. What About Wales? Recent polling puts support for Welsh independence at around 30%. Additionally, Wales voted in favor of Brexit. Wales is comfortable within the UK, and the nations of the potential future Celtic Union should not waste energy attempting to extract it from the Kingdom. Toward a Celtic Union On paper, a Celtic Union of Scotland, Ireland, and Northern Ireland makes perfect sense. The three nations are much more culturally similar to each other than England, economically invested in the EU, and Northern Ireland and Scotland would be able to exert more control over their national affairs. It would form the world’s 21st largest economy, and its GDP per capita would fit between Sweden and the Netherlands.
