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Tension between Italy, Germany, and the EU Is Growing

Politics / European Union Feb 10, 2017 - 02:09 PM GMT

By: John_Mauldin

Politics

BY ANTONIA COLIBASANU : As mentioned in our 2017 forecast, Geopolitical Futures said that the evolution of the Italian banking crisis will force a confrontation between Italy, Germany, and the European Union. The groundwork for this confrontation was laid last year, and the face-off has further evolved already this year.

In December 2016, two Italian members of the European Parliament (MEPs) from the populist Europe of Nations and Freedom groups asked the European Central Bank (ECB) in a letter to explain the “widening balance divergences between individual countries [in the eurozone] since the 2008 crisis.”


They also asked the ECB “how the balances would, technically, be settled, especially those in net debtor countries, should a Member State participating in the system decide to quit the single currency.”

This is the first time MEPs have asked about what leaving the eurozone would look like. ECB President Mario Draghi replied in a letter to the two politicians on January 19. He said in part, “if a country were to leave the Eurosystem, its national central bank’s claims on or liabilities to the ECB would need to be settled in full.”

For the Italians, this issue has more to do with national politics than the EU. Italy will hold general elections in 2017 or 2018. Its internal debate regarding EU membership will be central to its dialogue with the EU. The power dynamics between the two entities will continue to unfold throughout the year.

Renegotiating Deals

Power is a key concept in geopolitics. The extent to which a country has—or lacks—power dictates which deals (including treaties) can be made, broken, or left in place. To reverse a deal, power is needed. Understanding how you gain power is key to assessing if change is possible.

Deals, in the form of treaties, are often signed after wars are fought. These deals are difficult, if not impossible, to reverse because the road to reaching such a deal entails high costs—including loss of life and a country’s physical destruction. Other deals seem easier to undo as they appear to be mostly political.

The EU is essentially a deal between nation-states to form a union with the hope that peace and prosperity would result. Political cooperation, first inspired by fear of renewed war and later by hope for growth, led to the bloc’s formation. The fear of renewed war led to the founding of the European Coal and Steel Community through the Paris Treaty in 1951. Hope for growth led to the Maastricht Treaty, signed in 1992. This treaty led to the EU’s founding and the creation of the eurozone.

Both treaties aimed to create a level of peace and prosperity that member states did not have the power to produce on their own. They feared renewed conflict, as they remembered World War II’s impact on the Continent. They also understood they could not afford massive destruction and rebuilding efforts for a third time.

The Promise of Peace and Prosperity Wanes

Today, neither prosperity nor peace is guaranteed through EU membership. The days of European politicians promising prosperity through integration ended with the 2008 financial crisis. The refugee crisis and terrorist attacks in Europe have threatened to disrupt peace. The EU couldn’t effectively address either crisis and citizens started questioning whether membership was worth the cost.

With public discontent growing, populism and nationalism are on the rise. Anti-establishment, populist parties have won seats not only in national parliaments, but also in the European Parliament. A number of the politicians from these parties represent countries that have experienced severe effects from the economic crisis—such as Italy, Greece, and Spain—or countries that have seen a dramatic rise in Euroskepticism in the last few years—such as the United Kingdom.

Draghi’s response to the Italian MEPs’ question marked one of the first instances in which a European authority acknowledged parameters for leaving the bloc. In fact, the European treaty does not have a provision detailing how a member would exit the eurozone, and this is not a mere oversight.

The monetary union was considered irrevocable and irreversible. When the Maastricht Treaty was signed, member states thought it was inconceivable that any country would want to withdraw from the eurozone.

Including such a clause in the treaty would have meant acknowledging that membership may have negative effects on states in the future. This would have implied that prosperity was not a given and undermined the promise and purpose of the treaty. Countries would have been forced to question their transfer of powers to the bloc.

But at the same time, member states didn’t want to give up their authority over fiscal policy—and thus only gave the ECB control over monetary policy. That was their deal: They wanted to hold full political power at home and transfer power over one area, which they thought would limit the costs of financial transactions between member states.

They dismissed the fact that these transactions were unbalanced, as the level of trade between countries was unequal and members’ socio-economic environments were very different. But while members maintained hope that the EU would bring growth and prosperity, their deal worked out well.

A New Norm

This is no longer the case, which is glaringly apparent in the letters exchanged between the Italian MEPs and Draghi. Problems appeared as the 2008 crisis hit, and economic differences became visible. While Draghi has rarely mentioned the possibility of a country leaving the eurozone, it was discussed in official spheres during the summer of 2015, when Greece faced its own financial crisis.

Italy is far from being in a similar position at the moment. But Europe has grown accustomed to nationalism and populism since the Greek crisis, and radical positions by politicians are no longer the exception but the norm.

The European Union’s economic crisis is political. The deal that was signed in the early 1990s in Maastricht—and updated in Amsterdam, Nice, and Lisbon—seems to be no longer relevant. There are no ideas on how to improve or reverse it. But political deals can be changed, and the will to make this happen is growing as countries see that it may be in their national interests to reclaim their monetary power… for better or worse.

Grab This Free Report to See What Lies Ahead in 2017

Now, for a limited time, you can download this free report from Mauldin Economics detailing the rocky roads that lie ahead for three globally important countries in 2017—and how the economic fallout from their coming crises could affect you. Top 3 Economic Surprises for 2017 is required reading for investors and concerned citizens alike. Get your free copy now.

John Mauldin Archive

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