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Europe’s Hotel California Dilemma
News From Around the World
Tuesday, September 13, 2011
Ed DeShields

The grand European Union experiment may be coming to an end; at least in its present form. 

The economic woes and social calamity in Europe is unrelenting.  Each day’s news delivers a new reality of crisis and uncertainty.  Europe’s debt crisis has evolved into a frantic search for answers about how Europe found itself in this miserable position in the first place. 

The news of the actual make-up and nature of a new Europe has yet to be written.  One thing is for sure.  The crisis will divide the Union into a new universe of strong countries versus weaker ones.  Less abundant countries will be ripped from the Union by their roots – one way or another -- and left to survive with their crumbling economies a mere shadow of their previous size and strength. 

Historically speaking, the breakup of economic unions devastate the output of a nation as the availability of capital dries up and taxes rise rapidly in a desperate attempt to offset the damage.  The cost of a member nation trying to exit the EU today could equate to a loss of economic output reaching 50% or more.  

But, just how this destruction of Europe, as we know it, will affect the world’s global economic and political system is equally unclear.  It is clear, however, this isn’t going to be a pain-free era of global realignment ahead.  The effects of a structure change of this magnitude will be felt on every continent as investors flee Europe while withdrawing the capital it needs to weather the storm.    

As the word gets out the markets will act decisively. 

The core issue is the realization that the very foundation for Europe’s structural problems are complex and, as it turns out, malformed.  Under the current structure and with the current membership, the Euro simply does not work.  Hence, either the current structure will have to change, or the current membership will have to change.

The monetary unit of Europe’s grand plan was the Euro denomination of a unified fiat currency that promised to create a super-state economy giving borrowing power and capital strength to even the smallest member country.   In reality the smallest countries became locked into the standards of the richer, more powerful countries and left unable to compete.  With their pockets stuffed with borrowing power created by the Euro system they borrowed to survive; until the whole system caved in that is. 

Now the leaders of the Euro grand plan are realizing there is not only no easy fix, there is no way out.  

For the time being there is no provision in the European treaties for a country to exit the Euro. There is no provision for a country to be expelled from the Euro. Those who casually suggest that a weak country could be forced to leave either have not read the relevant legislation, or do not understand its implications of such a move. 

Any mistake in membership is permanent.  According to Swiss investment bank, UBS, the failure to specify a technical mechanism for an exit, created a Hotel California effect: “you can check out … but you can never leave”.

The economic cost is, in many ways, the least of the concerns investors should have about a break-up.  Fragmentation of the Euro is going to incur great political costs.  Again, UBS predicts Europe’s “soft power” influence internationally would cease as the concept of “Europe” as an integrated polity becomes meaningless. 

The loss of Europe’s soft power will leave a void to be filled by other emerging powers particularly Russia’s influence in the east. 

UBS continues with its theory;

“At a time when the world faces global economic, environmental and political risks there is much to be said for global influence. The globalization of the last two decades, even if it stalls (perhaps particularly if it stalls) argues for as loud a voice on the global stage as is possible. Environmental issues require global solutions, and informed politicians need to speak with as much volume as is possible if they are to be heard above the cacophony of competing opinions.  After a Euro breakup, Euro countries – even the more populous – would have barely a whisper on the world stage.”

It is worth noting that no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.  

The fracturing of the Czech and Slovak monetary union in 1993 led to an immediate sealing of the border, capital controls and limits on bank withdrawals.  Slovakia saw deterioration in the assessment of its political rights and civil liberties.  Similarly the break-up of the Soviet Union saw authoritarian regimes in the resulting states.

The question is not how the EU will survive this crisis, but whether its democracy could withstand the social turmoil that surrounds a monetary union fracturing and what the new Europe will look like.  Under whose control will the pieces fall?

Unfortunately, there are more questions than answers at this time.

About Ed DeShields

Last article: Why raising taxes on rich people won't work



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