The Emerging Crisis in Europe: Part One

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Publisher’s Note: Last week, Daily Reckoning editor Callum Newman interviewed geopolitical analyst George Friedman about his new book, Flashpoints: The Emerging Crisis in Europe, on the DR podcast. See below for a taste of the conversation or listen to the whole episode on iTunes here or Stitcher here.

Callum Newman:

Welcome to the latest episode of the Daily Reckoning Podcast. I’m absolutely thrilled today to have geopolitical analyst and author George Friedman on the line. George … Should I address you as George or Dr. Friedman?

George Friedman:

George is just great.

Callum Newman:

George is good? OK, cool. Thank you for coming on the show, and welcome back to Australia.

George Friedman:

It’s always good to be here.

Callum Newman:

We’re going to talk about your new book today, Flashpoints: The Emerging Crisis in Europe, but I’d like to start with a forecast you made in a previous book of yours which was called The Next 100 Years. You wrote that in 2009.

In a slightly later edition, you described the 2008 crisis then as ultimately a cyclical recession for the US, and one that it would eventually leave behind, but for Europe, it exposed more structural and long-lasting flaws, which leads to your new book. Can we begin with why you think that was and is the case?

George Friedman:

It’s because of Germany. Germany is the fourth largest economy in the world. It exports 50% of its GDP. That’s a staggering level of exports. For Germany, half of its exports go to the Free Trade Zone in Europe.

First, that means that Germany desperately needs to hold on to a free trade regime in the region. Secondly, it means it’s very difficult for some of the smaller countries, particularly in Southern Europe, to develop their own industrial base when in competition with a very sophisticated and capable German structure.

Right there, creating a Free Trade Zone around a massive exporter is like trying to build a solar system around a black hole. It just sucks everything in.

Contrast that to the United States and NAFTA, where the United States is a net importer. But reverse it, imagine if the United States exported half of its GDP to Mexico and Canada, what their economic condition would be.

So when there was prosperity between 1992 when the European Union was really created and 2008, a lot of these defects were hidden. But as soon as the financial crisis hit, countries like Greece, obviously, and Spain and Italy and others, suddenly couldn’t pay their debts. That really was what was revealed in 2008, and it’s a deep structural issue.

Callum Newman:

You describe in the book how you think the Euro is flawed, basically, as in the currency. Do you actually expect it to survive?

George Friedman:

It’s hard to back out of this currency, but its very existence creates a problem. It’s this. When you have your own currency, when Australia has its currency, and international market conditions shift, the value of the currency rises and falls relative to that.

That allows you to adjust to make your exports cheaper or your imports more expensive, or whatever it is that is going to happen. The market does it. Your central bank does it. For these countries in Europe, they don’t have their own currency, and German political power is pretty substantial, so they’re setting the price of the Euro, when they can, at the price that’s optimal for Germany — that is, not creating inflation, but on the other hand facilitating their exports.

It creates this huge debt problem where these countries face the issue of not so much staying in the Euro or not staying in the Euro, but defaulting on their debts. At a certain point, with individuals, with corporations, and with countries, it becomes more rational to default, to go bankrupt, than to fulfill your obligations.

What happens when a country that is in the Eurozone because of the pricing of the Euro can’t pay its debts? Well, it either prints its own money and offers to repay in their own money, or else it simply doesn’t repay under any circumstances, and then it’s not clear what value the Euro has for them or anyone else in relation to them.

The problem is it’s a very big messy thing now that they’ve created it. No one really knows how to back out of it, and for many of these countries, they don’t know how to live with it.

Callum Newman:

One interesting angle to this is the Euro’s the only legitimate rival to the US dollar as the reserve currency as the world. How do you think the US views this? Do they want to see a weak Euro or a strong Euro or see it fail?

George Friedman:

IThe US doesn’t really love being the reserve currency of the world, because it puts a tremendous amount of dollars in the hands of people outside the United States, and makes the kind of management of the currency that Australia has much more difficult.

On the other hand, with crises going on inside of China now, with the massive crisis in Europe, the only place to put your money if you’re an institution or you’re an individual is the United States, because they’re the only system that’s both stable and large enough to control it.

Whether anybody would want to denominate a five-year note in Euros who’s outside the Eurozone, you’d be taking a double risk, the normal business risk of lending money, and the political risk of what happens to the Euro. Certainly, there is no contest in what the reserve currency is. There can’t be. But on the other hand, it’s not necessarily the most pleasant thing for the United States.

Callum Newman:

That’s definitely interesting. One of the forecasts that you made back in 2009 in your previous book, which leads to your new book, was that by roughly 2015, the US would be again obsessed with Russia, and one of the flash points would be Ukraine. Can you tell us, especially for people who haven’t followed the news recently, why Ukraine is important for Russia, and vice versa, why it’s important from the European and US perspective?

George Friedman:

For Russia, it is the buffer against the West. It is one of the ways in which Russia protects itself. It’s been invaded by Napoleon, it was invaded by the Kaiser, it was invaded by Hitler. It survives because of its strategic depth.

If the Ukraine were to become a pro-Western country with, for example, NATO forces present in it, they’d be 50, 100 miles away from Stalingrad, 50, 100 miles away from the city of Volgograd. There would be a clean, flat empty plain between the border of Ukraine and Moscow.

Right now, NATO is only 90 miles away from Saint Petersburg now that the Baltics have been included. From the Russian point of view, if Ukraine is lost, they go back to the borders they had in the beginning of the 18th century, the 1700s, and that was not a very comfortable time.

They have built up not so much an empire, but a structure to protect themselves. For the Russians to simply let go of Ukraine, whatever the moral claims are or the rights are or anything else, is something that is fairly unthinkable for them. I like to compare it to the idea of Texas deciding that it really would rather be part of the Warsaw Pact during the Cold War. It would cause consternation, and it has in Russia.

If you’d like to hear the rest of the conversation, check out the DR podcast on iTunes here or Stitcher here. You can pick up the conversation from here at the 8 minute 36 second mark.

Regards,

Callum Newman,
for The Daily Reckoning Australia

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Callum Newman

Callum Newman

Callum Newman is the editor of The Daily Reckoning and Associate Editor of Cycles, Trends and Forecasts. He also hosts The Daily Reckoning Podcast. Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect. To have Callum’s thoughts and insights on the current state of the currency, commodities and stock markets delivered straight to your inbox, take out a free subscription to The Daily Reckoning here.
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