Imperial Germany And The Geopolitics Of Europe by Bill O’Grady of Confluence Investment Management

Last week, we analyzed the Greek/Eurozone negotiations using game theory as an explanatory tool. In this report, we will review the basic geopolitics of Europe, the political response and the evolution of the Eurozone. Using this background, we will examine Germany’s actions in the most recent Greek crisis. As always, we will conclude with market ramifications.

The Geopolitics of Europe

To understand Europe, geography matters.

Imperial Germany And The Geopolitics Of Europe

This is a physical map of Europe. Moving from north to south, the key features are:

The Baltic Sea: This body of water separates the Nordic states from the continent. Separation allowed this region to develop independently from the rest of Europe and, much of the time, protected the Nordic states from southern powers. At the same time, there was enough proximity to allow both Nordic and continental powers the opportunity to interfere in each region.

The British Isles: These islands are close enough that the British can influence the continent but offer enough isolation to allow various British governments the opportunity to avoid deep continental entanglements. During the period of British hegemony, it acted as a balancing power for Europe, becoming involved just enough to prevent any single power from dominating the continent. At the same time, it should be noted that no outside power has successfully invaded the British Isles since 1066.

The Southern Mountains: The Alps, Pyrenees and the Carpathian Mountains act to isolate southern Europe from the rest of continental Europe. Although not an impenetrable barrier, invasions over these mountains have proven to be difficult. Switzerland’s famous neutrality is mostly due to the fact that to conquer the country, one must conduct military operations in the mountains.

The Northern Plains: From the foothills of the Pyrenees to the Ural Mountains, there is a clear corridor that is mostly flat with only rivers acting as barriers. On the one hand, nations across these plains enjoy the agricultural and transportation benefits of the landscape. Militarily, however, this corridor is very hard to defend.

Now, let’s examine the political map.

The key political feature of Europe is Germany, which sits in the middle of the continent. Most of the country is on the aforementioned Northern Plain, which means that Germany has the potential to be an economic powerhouse due to its central location. At the same time, it is in a very vulnerable position because it has no natural geographic barriers for defense. Although other nations share similar vulnerabilities—the Benelux, Poland, Belarus, Ukraine and Russia—these nations don’t have the same central location as Germany. In other words, these other states also lack natural defenses but, because they lack the economic benefit of being centrally located on the continent, they are less attractive candidates for military aggression.

Due to the Industrial Revolution and the early harnessing of fossil fuels in manufacturing and transportation, the nations of Europe were able to become the most economically powerful on earth from the early 1800s into 1945. However, due to the aforementioned geography, no state was able to dominate Europe. This did not stop the Europeans from fighting each other to establish dominance. Europe was the site of numerous wars over the years. One could argue that one of the great tragedies of humankind is that Europeans were not able to unify the continent, and this inability fostered two world wars.

Modern Europe

After WWII, Germany was separated into four parts; each was operated by one of the allied powers. Although this arrangement was initially thought to be temporary, it became clear in short order that the Soviets were not going to allow free elections in their zone. Consequently, Germany was divided into East and West and became “ground zero” for the Cold War. By being divided, it was no longer a threat to European security.

Over the postwar period, two trends emerged. First, the U.S. steadily took responsibility for Europe’s security. Over time, European nations, using the protective umbrella of NATO, were able to scale back their defense spending. After the loss of most colonies, Europe’s need and ability to project power globally became less critical.1 Thus, Europe shifted its government spending to domestic social needs and deployed “soft power” to maintain relevance on the world stage.

The second trend to emerge was the creation of inter-European groups to steadily unify the continent, at least economically. In the early 1950s, the French proposed a European Steel and Coal Union. This program was designed to create a common market between France and Germany; at its inception, it included these two countries along with Italy and the Benelux nations. The group steadily evolved, adding members and affecting more of Europe’s economy. Over time, this expanded into the European Community, the European Union, and now, to the Eurozone.

There were a number of currents behind the second trend. For France, the goal was to use this steady expansion of European unity to both project influence and contain Germany. The individual states of Europe were dwarfed by the U.S. and the Soviet Union, and were threatened by the rapidly growing nations in Asia. By banding together, the EU could project more power; the continent, as a single economic unit, was the largest in the world. By hitching itself to Germany, France could use the former’s powerful economy as a platform for global power projection.

At the same time, Germany, chastened by the horrors of WWII, accepted the role of junior partner. It allowed France to set its foreign policy and direct European spending. In practical terms, Germany acted as a fiscal transfer agent to other European Community members.

Europe was never to become the United States. Nationalism ran too deep; individual nations were not prepared to give up their sovereignty. European leaders instead tried using peace and economic prosperity to craft closer relations with each other. Ensuring that another world war did not originate from Europe was a major part of this drive for unification.

And yet, the EU unification process rests on strategic ambiguity. Unification and the preservation of individual state sovereignty are incompatible goals. The EU has been able to make progress on steady unification by focusing on economic issues. However, since the creation of the Eurozone and the removal of immigration restrictions, along with the ever increasing bureaucratic rules emanating from Brussels, state sovereignty is steadily being undermined. The rise of populist movements across Europe are a reaction to the dissonant objectives of steady unification and the preservation of state sovereignty.

When the Berlin Wall fell and German unification occurred, the German problem returned. Initially, U.K. PM Thatcher opposed unification, referring to WWII. France was cool to the idea as well. To make the unification more palatable, Germany agreed to give up its beloved Deutsche mark for a currency of Europe, the euro. France believed that this move would make Germany more integrated into Europe and less likely to dominate it.

Events since 2010 suggest that France probably made a mistake. Instead of the Eurozone acting to limit German influence, Germany has now come to dominate the Eurozone. In the various debt crises since 2010, it is becoming clear that Germany is steadily establishing

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