The United States of Europe

"I never think of the future, it comes soon enough." -- Albert Einstein

When talking and guesstimating about what will happen in 2012 with the Euro and the European Union one plausible method could be to look at EU history in order to predict what comes next.

The United States of Europe was born out of a speech by Sir Winston Churchill in Zurich in 1946 which he starts with: “I wish to speak to you today about the tragedy of Europe”. The most important and relevant part of the speech refers to The League of Nations (Predecessor to United Nations): “The League of Nations did not fail because of its principles or conceptions. It failed because these principles were deserted by those States who had brought it into being. It failed because the Governments of those days were afraid to face the facts and act while time permitted. This disaster must not be repeated.  "There is, therefore, much knowledge and material with which to build; and also bitter dear-bought experience”. What a clever man that Sir Winston was! (See also a transcript of Churchill's speech.)

Abandoned principles
The real issue of the EU and the Eurozone is that the principles of the related treaties and the entire foundations of these conctructions have been deserted. The European Central Bank is today intervening in the bond market on a daily basis to prop up the peripheral nations' government debt. It is printing money which goes against its statues. Furthermore the proposed fiscal compact is designed to nationalistically protect the surplus countries from having to help deficit ridden partners.

We have a defacto fiscal union for the “weak countries” of Europe. No one can argue that Spain, Portugal, Ireland, Greece, Italy and soon France are conducting independent fiscal policies. Rather they are in a fiscal union where the Troika (EU Commission, ECB and International Monetary Fund) dictates their policies. (Note that none of the Troika officials are publicly elected!)

EU founders turning in graves
It is clear that democracy in Europe as such is under attack. There is a non-elected government in Italy because the former Prime Minister there was distrusted and disliked... by the EU. Greece also has a non-elected government which came into power after the former Prime Minister there wanted a referendum on austerity - something that didn't suit ….. the EU! The fiscal policies of the majority of countries in Europe are partly dictated by a Supranational institution like the IMF.

The founding fathers of Europe must be turning in their graves. Europe today has so much public/government debt that its creditors run Europe, not its politicians. The principles of solidarity, common interest and values have never sounded more hollow than now. Trust me I am a big Europe fan, for all the reasons Sir Winston listed, but the EU and Eurozone stopped making sense when creditor protection became a higher priority than democracy and principles.

EU voter dissent
We have reached a point politically where the voters of Europe no longer want to be part of repairing Europe, and even less willing to make a bigger Europe. The politicians and policymakers are desperate to move along the Austerity Compact, which really is another term for: more of the same, increased hardship, deflation and no outlook for growth.

How can the average Spanish worker who is lucky to take home  EUR 750 per month deal with higher taxes, higher energy prices and with no outlook for improvement? More than 1 million people in Spain live on less than EUR 500 per month. (The only way to survive is to 'prey' on family!)

The policymakers are in Sir Winston’s words not facing up to reality: "It failed because the government of those days feared to face the facts and act while time remained”. A total of 18 (I repeat, eighteen meeting!) on the EU debt crisis have been held so far. The solution so far has been: Solve the solvency issue with liquidity. Print money! It’s free!

From bad to worse
The signs or facts are clear: By insisting on austerity Europe is only going to go from bad to worse. The current account surplus of the northern countries will expand and the deficit of the southern will weaken further. Basically the rich will get richer and the poor poorer.

We have two disconnected systems. An almost Ponzi-like scheme to the investment cycle where underfunded banks are given “free money” to invest in underfunded governments while seeing improvements on their balance sheets through risk-free interest rate arbitrage and with obscure tax treatment. The only “minor” problem is that they have ceased to solve the main function banks should handle - namely, lending money. I, and also many small and medium sized companies miss the good old 3-6-3 banking days. Taking in deposits at 3 percent, lending out at 6 percent and hitting the golf course at 3 o’clock. Banks should be a long credit play. Instead they are now an extended financing tool of governments. Banks are “saved” and governments receive money via the European Central Bank through them.

Where does this leave Europe and the EUR?
First, we need to acknowledge that politicians will do anything and I mean anything, including violating Treaties and national Constitutions to keep thiings going. Secondly, we also need to understand that they are running out of time. The debt service, i.e.: interest payments alone are now so big that many countries could end up not being able to access enough financing to meet them. The debt trap is here!

Servicing debt absorbs an ever increasing part of all the growth EU countries produce, so the game is not changing from being one “free of charge” but rather it remains one of having ultimate costs like: lower growth, higher unemployment, record high private savings, record high public 'dissaving' – a virtual self-feeding negative cycle which will end badly unless politicians 'listen' to Sir Winston and correct the tragedy of Europe.

Likely scenarios

• The EUR will survive but will be changed in 2012 in that some countries will leave the Eurozone, with the odds on favourites being Greece and Portugal.
• The EU will survive but only if austerity is combined with tapping into huge private savings through tax rebates/incentives and stopping the circular funding of underfunded governments through underfunded banks and finally through redefining or moving back to the what all can agree on: the good reasons for having a United States of Europe as defined by 'my hero' Sir Winston.
• The most likely scenario however remains that policymakers will continue to print money, do their PowerPoint presentations but ignore the facts. This will lead to some panic during the second or third quarters of this year. The financial markets will be closed for a week or more and only then will we have a fair chance to get started on the constructive road outlined above.

History tells us that politicians only know one thing: how to spend money – they rarely question the premises and as such the likely ending to all of this is bad but there are also potentially some good possibilities for the future. Sometimes we need to break things in order to appreciate their true value - herein lies the best chance for the EU and the Euro!