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More on Britain’s eventual departure from the European Union

The theme I highlighted in the daily post on Friday seems to be everywhere today, namely the United States of Europe and Britain’s inability to go along with such a concept. Angela Merkel keeps telling us she wants “more Europe”. And of course that will mean less national sovereignty. In truth, this is the only way Europe can work because you need more instituional structures than just a central bank to deal with the troughs of economic cycles, as we are now seeing, with half of the euro zone (including Portugal, Italy, Ireland, Spain, Slovenia, Greece, and Cyprus) in need of bailouts or support.

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As I said in a weekly last week, Europe is moving closer to the endgame.  I wrote that “it is now clear that the EU is putting processes and institutions in place that will make the euro zone even harder to leave in a panic. The euro zone will break up only as a result of universal agreement and using an explicit pre-designed mechanism for expulsion. I still believe, however, that Greece will use this mechanism down the line. But there will not be an imminent euro zone departure now. Nor is it likely that any other countries will exit. I know we have a long way to go. And the economy in Europe still stinks. But I see the light at the end of the tunnel because of all of the policy choices now being made. All of this is cause for optimism.”

But, before we get too optimistic, let’s look at some caveats here.

First, the way that Merkel is trying to arrange this is driven by a continued belief in the German economic model and a feel for German domestic politics.  Let’s remember that after World War 2, Germany was shattered economically, politically, psychically and otherwise. Anyone who knows their German history knows that the Marshall Plan and the tough-minded economic stewardship of Ludwig Erhard are credited for bringing Germany back to economic prowess. And a strong Deutsche Mark was a key part of this German economic miracle. German inflation fears are not just about the 1923 hyperinflation but are also rooted in this long and recent post World War 2 economic history.

Merkel has said from day one that she wants a fiscal union that is a souped-up version of the stability and growth pact. What the Germans want is a strong currency, low inflation and low government deficits. And they want to be able to intercede in countries within the euro zone that don’t follow this model. The Super SGP vision for fiscal union was already laid out for us earlier this year in an ECB paper.  As I wrote when that paper surfaced, “the long-held view in German policy circles has been that the European sovereign debt crisis is a clear indication that the stability and growth pact (SGP) was not sufficiently robust in addressing fiscal discipline. The goal for two years has been to eventually make changes to European treaties to create a Super SGP that includes penalties, oversight and now potentially expulsion for serial violators. Expect to see Germany push for this policy to be formalised as part of the growth pact compromise between Hollande and Merkel.”

That’s where Europe’s fiscal union is now headed. And we see this in the negotiations.

The Super SGP model is negative for growth and will increase rifts within the euro zone and the wider European Union – the main reason I see Greece leaving the euro zone. And clearly, not everyone is onboard with this grander vision. Hans Werner-Sinn, for one, has expressed scepticism about this kind of United States of Europe model that older European leaders like Helmut Schmidt and Valery Giscard D’Estaing have been promoting for the last 35 years. Sinn’s view is that “the assertion that the eurozone could be transformed into a United States of Europe is no longer convincing. The path toward joint liability is far more likely to lead to a deep rift within Europe.” I agree. However, Sinn claims that the reason this rift will develop is “because turning the eurozone into a transfer and debt union that can prevent the insolvency of any of its members would require more central power than currently exists in the US.” I think that’s an interesting point. Sinn is saying in effect that Illinois is to Spain as Texas is to Italy. And centralising European power to prevent Spain’s or Italy’s default and bakruptcy is like the US centralising power to prevent Illinois’ and Texas’ . I actually think those days are coming in the US. So I am not sure I agree with Sinn. But the crux of his argument holds that this centralisation of power is politically controversial and will cause rifts to develop in Europe.

The rifts are most apparent in Britain. Ambrose Evans-Pritchard has written a piece in which he claims that Britain has left the European Union in all but name. He goes on to cite some serious anti-centralisation opt-out moves by the British government. Here’s the heart of his argument:

To all intents and purposes, the UK is already out. We stayed still. Europe galloped away without us.

No doubt we can find some elegant formula to paper over the split. As my friend Daniel Hannan puts it, we could devise a Swiss arrangement while pretending that we are still EU members. No point frightening the horses.

For those readers who missed it, the UK is preparing to pull out of almost all areas of “Justice and Home Affairs”, the so-called Pillar III of EU jurisdiction. (Pillar I is the single market, and Pillar II is foreign affairs)

This is revolutionary. We are withdrawing from 130 directives, covering everything from the European Arrest Warrant, the European Public Prosecutor, to the European justice department (Eurojust).

These opt-outs are huge. And it shows the fundamental disquiet building in Britain against the authoritarian and anti-democratic direction the European Union has taken. My sense is that Britain won’t go along with a United States of Europe model. Ambrose is right that Britain will increasingly move toward a Swiss kind of arrangement in which it has a confederation with the EU but is not really an integral part of its institutions, making it an EU member in name only. I see this as the only way really. Europe is in an “Articles of Confederation” period. During the Revolutionary War, the proto-nation of the US operated under a loose arrangement called Articles of Confederation. The central government was weak and had limited financing options. There was no President and no Supreme Court. This arrangement was unworkable because it made the United States vulnerable economically and militarily. So eventually the nationalists in the US won out and the US Constitution saw greatly enhanced centralisation of power to the US government. Europe is moving in the same direction, understanding that the looser framework was flawed. Britain, however, will not broker such a threat to its national sovereignty. And so Europe will move inexorably toward a multi-speed system. Core members will be on the euro and in the EU, with mutualised debt and fiscal oversight arrangements. Tier 2 will not be on the euro but will permit free labor and capital movement to and from other EU states. However, a third tier will soon emerge where much less cooperation will reign. Britain will lead the way to that end. Others like Denmark and Sweden could join.

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Could an EU breakup happen? I don’t believe it will happen because there is no advantage to this. Britain will stay in. But a breakup is something to keep in the back of your mind as an outlier scenario.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.