These Are the 3 Main Issues for Europe in 2017

By: John_Mauldin

BY GEORGE FRIEDMAN AND JACOB L. SHAPIRO : What will the year ahead look like for Europe? 2017 will be another chapter in the European Union's slow unraveling… a process that has been underway for over a decade.

The EU is a union in name only. The transfer of sovereignty to Brussels was never total, and member states are independent countries… each with their own interests at stake.

Here are the major forces at work.

The Italian Crisis

Italy's banking crisis has played a key role in the destabilization of its domestic politics. The main problem is the Italian banking sector’s high rate of non-performing loans (NPLs). Approximately 17% of all loans from Italian banks are NPLs, according to the European Banking Authority. The bank currently making headlines, Banca Monte dei Paschi di Siena, had 45 billion euros ($47.4 billion) worth of NPLs and other doubtful loans when its problems came to light in 2016.

But the issue here is not simply money. The balance sheets of Italian banks don’t exist in a vacuum. If the European Central Bank were to bail out Italy, it would mean, in effect, that all of Europe would be paying for the bailout.

Greece, which had austerity forced upon it, would cry foul. The German public would object, and Chancellor Angela Merkel’s position would be severely weakened.

Declining German Exports

The major economic issue we expect to see in 2017 is a decline in German exports. The latest World Bank data shows that Germany’s exports-to-GDP ratio is 46.8%.

Neither China nor Russia will be increasing demand for German goods due to their own economic woes. And while Germany has managed to survive thus far by increasing exports to the UK and the US, this is not sustainable. This affects not just Germany, but all of Europe.

The EU is built around a massive exporter: Germany. That makes the EU vulnerable to drops in demand for German exports. It also creates a particular kind of political relationship between Germany and the rest of the EU. This is especially true for countries that are markets for German goods and those that are in the German supply chain.

This dependency and economic architecture has worked in the past. But now, it faces two key challenges. The first is how to increase demand for the products in question (which is not in any single country’s control). The second is that many of Europe’s economies are still struggling due to the 2008 financial crisis.

The EU’s growing socio-economic problems, in turn, are leading to increased nationalism. We saw this manifest in Brexit in 2016. In 2017, this dynamic already is affecting elections in France and Germany. The conversation has shifted from an internationalist position to a nationalist one—even for those who historically have been most committed to the EU (like Merkel).

The Security Question

Security will be an issue for the EU… and here, too, member states’ interests diverge. Some countries are more concerned with refugees than others, and Brussels is still unable to present a universally accepted plan for dealing with the refugee crisis.

There is also the question of Eastern Europe. It wants its security prioritized as it faces an increasingly aggressive Russia. Western Europe is less concerned with Russia on a daily basis and more concerned about Islamic terrorism.

Meanwhile, a Trump presidency is about to shine a very bright light on the future of NATO. This will mean hard choices for many European countries.

The security issues are not as serious as the economic and political issues for Europe right now. But they loom in the background and feed the strain on the EU rather than unite member states in common cause.

The Weakening of the EU

When we look at Europe today, we see less of a move toward EU dissolution than the gradual ignoring of EU directives. At the beginning of last year, George wrote the following, and it remains the general frame through which we view events in Europe:

The EU will survive, and one day you will be able to visit a dusty office in Brussels, much like the European Free Trade Association’s offices in Switzerland, where it still exists. [The EFTA was a British-led alternative to the European Community in the late 1950s and ’60s that is irrelevant today despite the continued existence of its offices.] I am sure the staff will be doing something, writing directives that no one will follow, or even care to object to. I once expected ‘Götterdämmerung,’ the ‘Twilight of the Gods,’ to move the EU. Today I became convinced, not that the EU couldn’t continue this way, but that it really isn’t continuing in any significant way.

Italian banks, German exports, nationalism affecting domestic elections, and divergences on security issues will be the main issues in 2017. But these are really just small parts of a much larger forecast that is slowly hulking toward fruition.

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