The Brexit debate is nothing if not insular. While the business, media and political elite in London obsess over the kind of future relationship the UK should have with Brussels, few seem to have noticed that the EU itself may soon collapse. If and when it does, the fall will be all the more shocking precisely because so many eyes have not been kept on the ball.
The stark truth is that since the financial crisis of 2008 eurozone leaders have tried and failed to put the single currency on a secure footing. President Macron’s attempt to promote a fiscal union is a recognition of this failure and an attempt to do something about it, but his plan has already been killed off by a combination of the German economic policy-making elite and the Italian voter. If it goes ahead at all now, it will be in largely insignificant form.
The attempt to build a banking union is meeting a similar fate. Its bail-in provisions for failing banks are not being consistently implemented and its fund for recapitalising failing banks is far too small. In Italy in particular, the political will does not exist to comply with is strictures. No progress has been made on a European Deposit Insurance Scheme either. And work to build a Capital Markets Union is painfully slow and is, in any case, the work of decades.
The common thread across all these stalled attempts at eurozone reform is a reluctance on the part of national authorities to pursue genuinely European solutions. What this means in practice is that if and when a new crisis comes, there will be no common European response. Individual eurozone countries will be largely left to fend for themselves while EU leaders, as in the last crisis, seek to make decisions largely on the hoof. The question now is for how long eurozone leaders can get away with it? And the answer is not, perhaps, for much longer.
A scan of the horizon suggests it is all too possible to identify the triggers for what could quickly become a eurozone and wider EU collapse. On the economic side one obvious path to crisis is via the onset of a new recession. Eurozone growth is already slowing, and the international environment is clouding badly.
Both a transatlantic trade war provoked by Trump, or a Chinese financial crisis on the back of spiralling public and private debt could cause massive and sudden damage to eurozone economies. A severe recession would in turn undermine the public finances in many already heavily indebted eurozone member states, raise their borrowing costs prohibitively, and wipe billions off the balance sheets of their banks, many of which have been heavy investors in bonds issued by their own governments. Amid falling asset values and a generalised increase in non-performing loans, many banks would be in trouble.
They would once again need help from already strapped governments who would struggle to provide it. There is therefore a clear path from a recession to a new banking and sovereign debt crisis in the eurozone, raising the prospect of euro exits, contagion and an existential crisis for the single currency as a whole.
If a recession does not trigger a banking and sovereign debt crisis there is a non-negligible possibility that a new banking crisis could be the trigger for a recession. Globally, warnings from senior policy-makers over asset bubbles, unregulated shadow banking in Asia, and excessive risk-taking in global financial markets are rife.
If a further crisis emerges out of this morass, the opaque and complex lending arrangements that characterise the system will mean a generalised loss of confidence and a crunch in the availability of credit. Again, weak banks in the eurozone would be knocked over by both declining asset values and a lack of liquidity.
Italy is a particular worry. The Italian government could, in principle, attempt to deal with such a scenario with bail-ins but is unlikely to do so, since many Italian retail investors are heavily invested in bonds issued by Italian banks and would be massive losers. It would therefore have to attempt taxpayer-funded bail-outs.
Amid its already high debts it would quickly find it almost impossible to borrow. It could appeal to other eurozone member states for loans in return for years of austerity and structural reform but after two decades of little growth and with a population already voting in large numbers for eurosceptic parties, that path appears politically undeliverable. The alternative would be for Italy to leave the single currency and print its own money.
There is therefore a plausible path to a major euro exit, contagion to other parts of the eurozone, and an existential crisis for the euro buried in a new financial crisis, whether that crisis starts in Europe or somewhere else in the world. Politically, other paths to break-up exist too. A straightforward electoral breakthrough by eurosceptic forces that want to leave the European Union still cannot be ruled out in countries like Italy and France.
Upwards of 20 million people voted for one form of euroscepticism or another in the first round of last year’s French presidential election. It was only the two-phase voting system that eventually made Macron look like a convincing winner. In Italy, eurosceptic forces in the form of the Five Star Movement and the Northern League are rampant.
Across much of Europe, such movements could be given a further massive boost, and the concept of free movement dealt a fatal blow, if the volatile President Erdogan of Turkey decides at any point to turn the flow of migrants and refugees into the European Union back on. Even a crisis like that in Catalonia, which has the potential to ruin the Spanish economy, could trigger a sovereign debt crisis and wider unravelling.
Considering the possibilities and vulnerabilities faced by the EU overall, observers and participants alike might look back from a future vantage point to see that Brexit was a mere footnote in a much more fundamental period of European upheaval. British negotiators may strain every sinew to get a deal, only to discover the entity they’ve agreed it with soon no longer exists.
