The Real Risk of Brexit
In February, we presented an analysis of Brexit, which is shorthand for Britain’s potential departure from the European Union (EU). The referendum is slated for June 23. In general, the points discussed in the aforementioned report on the economy, trade, regulatory policy, immigration and the U.K.’s geopolitical “footprint” all still hold. There are potential risks to the U.K. political system and economy from leaving the EU. However, there is also, in my opinion, an underappreciated risk to the EU as well.
The problem can be summed up in this question–what if the U.K. leaves the EU and prospers? This has the potential to be a major problem for the postwar European political environment. In this report, we will discuss the role of the EU in shaping the postwar geopolitical environment in Europe and the multiple threats Britain’s exit presents for the EU. As always, we will conclude with the impact on financial and commodity markets.
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The EU Response to World Wars
Following two world wars, most of Europe lay in ruins. Both wars failed to address the “German Problem,” the problem of an economic powerhouse situated in a region of Europe that was completely indefensible. Germany’s rising economic prowess after its unification in 1871 became a growing threat to the established order of Russia, France and Britain. Germany was well aware of its precarious geopolitical position and, in response, built a formidable military. Its defense doctrine was based on the Schlieffen Plan, which called for a massive attack on northern France by crossing through neutral Belgium and the Netherlands to knock Paris out of any war and then shift to attacking Russia on the Eastern Front. The goal was to avoid the dreaded two-front war.
In WWI, the plan failed. The French military managed to prevent the German Army from capturing Paris and controlling the country. WWI soon devolved into a war of attrition characterized by trench warfare. After more than four years, the war ended with the Treaty of Versailles. The treaty was deeply flawed—harsh enough to hurt the German economy and breed resentment but not so draconian as to prevent Germany from rearming and threatening the European continent again. In addition, mostly due to the work of President Woodrow Wilson, the concept of self-determination was unleashed on Europe, which led to rising nationalism. In less than two decades, the German Problem resurfaced through the rise of Adolph Hitler and the Nazi Party. The continent was soon plunged into WWII.
European leaders had two goals in the aftermath of WWII. First, they wanted to foster the economic recovery of the devastated continent. Second, they wanted to prevent the conditions that led to two world wars being fought on their soil from occurring again. This included addressing the German Problem.
Economic recovery came by tying the European economy to the United States economy. Bretton Woods, which established the dollar as the free world’s reserve currency, and the Marshall Plan both supported European rebuilding. The latter gave direct aid to Europe to boost its recovery, and the former gave European firms a ready market for exports. These two policies supported the European postwar recovery.
The second goal was ultimately met by a series of steps whose objective was to weaken nationalism within European states. Nationalism is a strong force everywhere, and in Europe, the notion of the nation and the “people” can be very close. As we have noted on numerous occasions, if one comes to the U.S., takes the citizenship test and passes it, one becomes an “American.” But, in Europe, this is less common. Yes, one can move to France, learn the language and pass the citizenship test to become a citizen of France, but one will never truly be “French.”
Full report below