The Accidental Superpower

by Peter Zeihan

  The end of the Cold War had any number of impacts on the world writ large, but in Europe it was absolutely wonderful. Europe was the primary Cold War battle line, so defense outlays were far higher there than anywhere but in the United States, the Soviet Union, and the Koreas. With the Cold War’s end, resources dedicated to defense could be redirected to investment. A belt of states from Estonia to Bulgaria ceased being Soviet property and started down the road to European Union membership, eventually providing an infusion of over 100 million new consumers and low- and mid-cost workers. But most of all, the Cold War’s end made the French and Germans sufficiently confident in a future without war that they launched their most ambitious unification project yet: a currency union.

  Which is where contemporary Europe’s problems begin.

  Problem One: Enter the Euro

  In the United States, finance is somewhat nondenominational. There are so many rivers servicing such a substantial population that capital practically grows on trees. Everyone is in the same river network and so is in the same resultant financial system. It is considered perfectly normal for a Nebraska bank to fund a Vermont mortgage or a Georgia credit union to enable credit card use in Idaho.

  Not so in Europe.

  Europe’s river systems are not integrated, and the differences that fact spawns do not end with different languages and identities. French trade travels on French rivers with French profits deposited in French banks where they are used to further French goals. Rivers, trade, and banks are all considered national assets. As one would expect from any such national asset, the banks’ responsibilities are first and foremost to look out for the interests of the state. In 1992 the Europeans may have committed themselves to launching the euro era, but they never united their disparate financial and banking systems into a cohesive whole. That split is the root of the European financial crisis.

  Once again, it comes down to the balance of transport, but this time from an economic rather than a strategic point of view. The balance of transport isn’t easily swayed by political agreements—even ones as potent and far reaching as Bretton Woods. The NEP remained the economic hub of the European wheel, but not everyone in Europe had rivers and so not everyone in Europe could generate the surplus capital that made everything from infrastructure to education possible. Geographically less-endowed areas like Iberia, southern Italy, and Greece were perennial laggards. European “structural adjustment” monies poured into these areas to help close the gap, funding everything from highways to olive groves, but the capacity created by this assistance couldn’t hope to keep up with what the richer portions of Europe invested into their home systems simply as a matter of course. On anything remotely resembling a level playing field, well-rivered, flat, and integrated Northern Europe would always be more thoroughly educated and more productive and richer than highland, arid, and disconnected Southern Europe.

  But in a common monetary system, capital could flow nonetheless. Currency unity meant that the surplus capital generated in the north could be lent out to southern economies that had no experience using it wisely at rates normally reserved for countries like Germany. Currency unity meant that Northern European exporters had unrestricted access into southern economies that couldn’t hope to compete with the northerners’ superior infrastructure and workforces. The result was the buildup of mountains of debt among southern economies, consumers, and governments at the same time that the hollowing out of southern economies made it impossible for the debt to be paid back. Far from being the crowning achievement of united Europe, the euro was guaranteed from day one to destroy it.

  The ensuing calamity was as harsh as it was predictable. Less than a decade after the euro’s 1999 launch, all it took was a recession to crack the finances of many countries to pieces. The now-infamous bailouts of Greece and Ireland—and the less notorious bailouts of Latvia, Portugal, Hungary, Cyprus, Romania, and Spain—have (as of February 2014) collectively totaled over 600 billion euros in funds transfers and write-offs.

  At the time of this writing, the Europeans are not (quite) to the point that they can admit to the inanity of the euro; most serious efforts are still focused on helping a broken system limp along. Unfortunately, Europe’s corporate, government, and consumer debt crisis is only one of seven challenges that the Europeans face, and it is probably their most manageable.

  Problem Two: Banking, the Sick Man of Europe

  The European financial crisis has had many economic impacts, but the results have been worst in banking.

  Because the Europeans see banking as a national prerogative, concerns such as national infrastructure needs, maximum employment, and government budgetary stability are tossed into the mix of bankers’ concerns right along with concerns of collateral and profitability. This has encouraged—and oftentimes actually required—Europe’s banks to put national directives above corporate decision making, particularly on topics like due diligence.

  This enables European governments to use their banks as a means of speeding investment in this or that targeted sector, to construct or repair infrastructure sooner than if they had to raise capital from private sources or taxes, or to help maintain governmental budgets in times of stress by simply directing the banks to invest in government bonds. Unsurprisingly, many of Europe’s banks are state-owned in majority or in part, and even those that are not are often used as slush funds for various political interests at the local, regional, and/or national level. In essence, the various governments see the financial sector as a tool of governance and use it as such.

  An excellent example is that of Belgian-French bank Dexia. Many Belgian communities purchased shares in the bank to ensure that they would always have strong “private” demand for their local debt.1 As the European financial crisis deepened in 2008, it became obvious that investors were shunning the bonds of highly indebted governments (such as Belgium, where the national debt was rapidly approaching the country’s total GDP). Dexia did not join the exodus. Far from it. Its owners—Belgian government entities—directed Dexia to purchase even more Belgian debt. As the financial crisis proceeded, Dexia assets soured—especially its government debt—the bank ran out of operating capital, and in September 2008 it was forced to apply for bailout assistance. When all was said and done, the bank’s assets were so overvalued and its operating capital so negative that it cost taxpayers 6 billion euros over two bailouts to close the thing down.

  As regards geopolitics this has two inevitable outcomes. First, in Europe finance writ large is state-directed rather than market-directed. That maximizes the presence of the state-linked banks in the broader system, while minimizing the involvement of nongovernment financial sectors such as stock markets and corporate bonds. This is the opposite of the American system where finance is somewhat agnostic and government’s involvement in the sector is normally limited to regulatory matters. Consequently, approximately 70 percent of all private credit in Europe is obtained from banks, while in the United States it is the faceless stock markets that generate fully half of all credit, with banks playing only a supporting role.

  The second outcome of this bank-centric system is that when Europe suffers from a recession, its banks’ highest priority is to keep governments functioning. That means that they must double down on financing government deficits. Couple a financial crisis with a recession, and banks simply have no resources remaining to lend to businesses and consumers. This means that until Europe can rectify the financial imbalances the euro has caused, any growth in Europe must occur without more than middling participation from its banking sector—a sector that controls nearly all of the system’s available credit.

  That would be bad enough if everyone involved still agreed what the goal of a united Europe was. That, alas, is a degree of unity that no longer exists.

  Problem Three: Two Drivers, No Steering Wheel

  The European Union, and its predecessor, the European Economic Community, has always been a strange animal. Any organization that was forme
d in the early years of Bretton Woods was going to have an economic underpinning considerably different from the previous era, and in this the EU did not disappoint. But more than an economic grouping designed to take full advantage of the security and trade network the Americans had created, the EEC/EU ultimately had a political rationale.

  That rationale belonged to Paris. While France had always been near the top of the European pile, it had only rarely been actually on top, and even when it was during the Napoleonic era, the other European powers ruthlessly tore it down from its perch. After Napoleon’s fall from grace, France refounded itself and attempted to resume its position as the premier European power. It never made it. The British stymied the French in the wider world just as the Prussians did within Europe, and in 1871 Paris found itself not simply under German occupation but being forced to cede territory and the authority to manipulate Central European affairs to Berlin. The rest of the story includes French devastation in the world wars.

  But the American-forged security arrangements of the post–World War II era provided Paris with some interesting opportunities. Austria had been split off from Germany and both had been parceled up and occupied. Italy was cast adrift. The British had gone home. The Iberians and Turks had skipped the war and were languishing under their own local authoritarian governments. The Russians loomed large, but rather than manipulate European events, they had drawn the Iron Curtain and were busy digesting Central and Eastern Europe. The only truly involved powers on the Continent were the Low Countries of the Netherlands, Belgium, and Luxembourg, a trio that could not resist French power without considerable assistance, and there was no assistance to be found.

  And so the French launched the “European” integration process. I use quotes there because the initial goal very clearly was not to create a truly European system, but to band together countries that the French could dominate into a grouping that the French would dominate. The Low Countries were weak. Italy was a mess. Germany was divided, occupied (in part by France), and its opinion was neither allowed nor issued. After over a century of coming in second or worse in the European game, France finally reigned supreme. For the next two generations, German industrial profits were funneled via the EU budget to fund French national and geopolitical goals. France was able to count upon Germany to back any position Paris wanted to stake out, and the two NEP heavyweights were able to impose French desires upon the rest of the Union.

  But the gravy train couldn’t last forever.

  In time the artificial circumstances of the Cold War ended. The Iron Curtain collapsed and the Central European states joined the EU in the 2000s. All of them remembered what French security guarantees had meant in the run-up to World War II, and so were not willing to sign away their newfound independence to a French-dominated institution. Sweden and Finland, fiercely independent from decades of resisting the Soviets without the NATO umbrella, joined in 1995 and were not interested in being springboards for French ambition. France no longer automatically got its way, but with the Germans reflexive, silent partners, Paris could still fairly easily forge ad hoc coalitions to get whatever it wanted.

  Then, in 2008, a process that had begun twenty years earlier culminated in disaster for Paris. In 1989, the Cold War ended. In 1993, Germany began the reunification process, which was completed in 2003. And then in 2008 the Germans elected a two-party coalition led by politicians unencumbered by any connection to wartime or Cold War German politics. These new German politicians still saw themselves as allied with France, but no longer beholden to it. The days of Paris telling the Germans what the German position was were over.

  France and Germany are still partners, allies even, but the relationship is thinning. By far the biggest point of disagreement is on Union control. The Germans are still willing to foot the bill for a united Europe, bailouts and all—but now they want a few things in exchange for their commitment. They want reforms to be hardwired into EU treaty law and even the constitutions of the EU’s members that will outlaw budget deficits. They want approval of national budgets to be the responsibility of EU institutions, institutions that are beholden to German norms. Collectively these “reforms” would lock all of the European countries into how the Germans do things, and since many of the weaker states are weaker because of geography, they would become permanently servile to German supply chains and financial might. In essence, the Germans want to use German money to solidify German control of the European system. And the Germans have the gall to insist that France is not exempt.

  The French, in contrast, want to go back to how things were before 2008, back to the era of French exceptionalism and control. They want the Germans to keep paying to keep the EU afloat, but to do so without significant changes in how it operates, and certainly how France operates. They want budgetary control to remain at the national level and for deficit restrictions to remain somewhat loose. They want to keep getting financial transfers from Germany, even though France is one of the Union’s richest members. In essence, they want to reachieve what they once had: to use German money to support French control of the European system.

  Until and unless the French and Germans can close ranks, everything else about the European Union degrades into near pointlessness. The EU hasn’t enacted a meaningful foreign policy stance since the financial breakdown of 2007. Critical needs such as a banking union have been negotiated (due to French insistence), but not armed with the money or authority required to make them functional (due to German insistence). Bailouts have been awarded (as Berlin realizes they must), but the terms have been so constantly abrogated that the weaker countries (often due to French intervention) have been able to enjoy a revolving door of fresh credits. This furious running in place will last until the Franco-German relationship heals.

  The Franco-German disconnect would be bad enough if German money were sufficient to fix the European system, but it isn’t.

  Problem Four: Out of Money (and Time)

  There are three routes a country can take to economic growth: consumption-led, export-led, and investment-led. Germany in the 2010s is very similar to the Germany of the late nineteenth century in that it is an investment-and export-led system. Most German capital is poured into its industrial base and educational system, leaving little money in the hands of the people to spend. This was a wonderful model (for the Germans) in the 2000s: The unity of the eurozone allowed all of the Europeans—and in particular Southern Europeans—to access German credit to finance the purchase of German goods. Also, Europe, and in particular Southern Europe, had a demographic hot-wired for mass consumption.

  But that was then. What is rapidly taking root in Europe is a near-perfect storm of economic challenges:

  • The countries that face the most systemic financial pressure—Greece, Portugal, Spain, and Italy—are among the most rapidly aging European states. Of the danger states, only Spain still has a bulge in its population profile that is under forty, and even they are already in their late thirties. Consumption-led growth in Southern Europe is now largely impossible.

  • For Germany and other heavily technocratic European states like Finland and the Netherlands, their development policy combined with a lack of young people means that a local-consumption-driven model hasn’t been possible for twenty years. And with no replacement generation growing into adulthood, such a model cannot be returned to within the next thirty years.

  • Aggressive German exports limited industrial expansion across Southern Europe, meaning fewer local jobs for the few twenty- and thirty-somethings who remained. Southern Europe was never competitive with Germany in the first place. Now, with all of Southern Europe in the eurozone, these countries cannot devalue their currencies to compete on cost. Southern Europe cannot have export-led growth.

  • The aging of Europe across the board has denied Germany its traditional captive market, forcing it to look beyond Europe for external markets to sustain export-led growth.

  • For Southern Europe, the only remaining op
tion is investment-led growth, but the debt crisis prevents Southern European governments from raising the necessary funds themselves. The only source of such investment is now Northern Europe, with the primary mode of financial transfer being bailout packages designed to manage Southern European debt rather than actually invest in the productivity of Southern European systems.

  All of this means that these countries can only support their current systems so long as German largess continues. The Germans may be (reluctantly) willing to fund bailout after bailout to keep the Union together, but their ability to subsidize the Continent is not endless. The Germans too are aging. As of 2014, the German population bulge is in its early fifties, at the height of its technical skill and taxpaying capability. That’s making German tax coffers flush with cash and allowing the German export machine to outcompete nearly everyone on not just the European but also the global stage.

  Fast-forward a decade, however, and this cadre will be retiring en masse and drawing pensions. German competitiveness, German exports, and above all the German government’s ability to fund the never-ending bailout of the European Union will evaporate.

  The Europe of today is at the high point of a system that is now in a period of permanent shrinkage. Between banking dysfunction and aging demographics, credit will never be as accessible in Europe as it is now, and growth will never be as strong as it is now. Germany’s ability to generate growth from exporting goods within the European system has ended. Even assuming that the Europeans solve all of their political and financial problems, only the Germans can afford the bill to keep Europe together economically, and they can only afford that for at most another ten years.