The Emerging Crisis in Europe: Part Three

Publisher’s Note: Last week your Daily Reckoning editor Callum Newman interviewed geopolitical analyst George Friedman about his new book Flashpoints: The Emerging Crisis in Europe on the DR podcast. Last Friday, we ran the first part of the conversation. On Saturday, we ran the second. See below for the third part of the conversation or listen to the whole thing on iTunes here or Stitcher here.

Callum Newman: One of the other countries that you include in the European scope, if you like, is Turkey. Turkey is another one that you see rising. Are people surprised when you tell them that?
George Friedman: They shouldn’t be at this point, because Turkey has been the fastest growing country in Europe for over ten years. It has had a fantastic growth rate.

It is now in the Islamic world the second largest economy, just barely behind Indonesia and certainly towering over Saudi Arabia. When you see that the Arab world has been brought under control, that is, has stopped the kind of violence that you see in Syria and Iraq, for around 500 years, it was Turkey that was managing this.

You also have to remember that Turkey, centuries ago, pushed its influence as far north as Vienna and Budapest. They are normally a European power. Now their influence is again moving into the Balkans. As the Europeans are self obsessed, they’re not noticing the tremendous spread of European influence.

Callum Newman: Turkey for a long time wanted in the EU. Are those days gone? Are they going to do their own thing now, or how do you see that?
George Friedman: Their great fortune was that they weren’t admitted. They wanted to be admitted. Had they been admitted, there’s no question that they would not be in the economic condition they’re in.

They’ve retained their own currency, they made their own policies. Turkey is the primary example of the cost you pay for being a small country in the EU, because none of the other small countries like Spain, like Greece, like Italy, which is not a small country, have done nearly as well as the Turks. I think the Turks had absolutely no interest in getting involved in the EU.

Callum Newman: That trend of countries wanting to join the EU, do you think that’s over? Is it just a matter of holding the ones in that they’ve got?
George Friedman: The EU serves two purposes. One, it made newly independent states in the east Europeans, and it promised a kind of prosperity and a kind of peace. It still promises the kind of prosperity that we’re thinking about, but more to the point, it really doesn’t give them that any longer. Yes, habits are die-hard. They will talk about joining the EU, but, first, the EU is not going to admit anybody, and second, they don’t really want to be members.
Callum Newman: One of the things I get from your work, and we’ve talked a little bit about the debts and how that’s driven some of the behavior, but you don’t seem, as an analyst, overly preoccupied with the state of various national debts and deficits at any given time. Do you think other analysts get preoccupied with that too much and not the deeper historical trends that you look at?
George Friedman: Debt is a very complex issue. The question is who you owe your money to and what the money is denominated in. If you’re Australian, and for example would owe a tremendous amount of money to your own Australians, and it’s all denominated in Australian dollars, how you pay it off and how you manage it depends on the price you set.

The problem you have is when it has a very large debt, it is denominated in someone else’s currency. But I’m also not worried about it because I know something very much about history. If the debt becomes too onerous, countries will default, just like American Airlines went bankrupt.

We’ve taken for granted that corporations sometimes are in much better shape, logically, not paying their debts than paying their debts. We’ve learned from Argentina that the fact that you haven’t paid your debts doesn’t mean that Western banks won’t lend you money.

I don’t take it that seriously, because where the debts really become a problem in the end is the creditors. We talk about the irresponsibility of the borrowers, we should also talk about the irresponsibility of the lenders.

They put themselves in the position that they can’t withstand default. Greece is a perfect case, where it’s not clear that default is not the best thing for the Greeks, but it’s certainly not the thing the creditors want. Power shifts the more debt you have, and the more debt you have, the more you can withstand the default, the more rational it becomes. Yes, I don’t regard debt necessarily from a very broad point of view necessarily.

Callum Newman: One of the things that you did in your previous book, The Next 100 Years, a terrific book, you gave a timeline for the next century. You haven’t done that so much this time around. Is there a reason you haven’t tried to date when you think various flash points could arise?
George Friedman: I was very clear in The Next 100 Years that I felt that we would begin seeing this crisis with Russia develop in 2015. I also said there that I don’t think that Russia could survive this crisis. In other words, their internal weakness, the same thing that crushed the Soviet Union, is going to crush the Russian Federation.

I was saying there that by 2020, 2025, in that range, we’re going to see a crumbling of the Russian Federation. This book begins with the assumption of that time frame, and starts looking at that crisis and other crises that could occur in that time frame.

Callum Newman: I just want to bring it back a little bit to a practical sense. You’re a macro-analyst and you look at the broad picture, and that’s part of your business and what you write about. Does it have a practical investment application for you? Do you go and buy Turkish lira or invest in Polish stocks, or is it more of a canvas?
George Friedman: No, it’s really much a view of what is going to have value in the next few years. For the trader who wants to make a great deal of money tomorrow, the only value was the crisis pushing things up and down. It’s not for them.

Even Warren Buffett and value trading that takes a look at the growth of value over five, ten years, you really want to know what countries not to be in, what countries to be in. If you take that view, then you really don’t want to be in Germany. Germany is kind of at the top of where it’s going to be. You may well be making investments in Turkey and Poland. It’s the kind of investor you are.

I’ll put it differently. If you’re a speculator looking for every advantage within the next week, you should take a look at what we do. If your intention is to build a portfolio of assets in countries that you monetize over five, ten years, then certainly it becomes very helpful to know what to get out of.

Callum Newman: I’m always curious when I have analysts on, et cetera, how do you sort out all the information and data we receive? What do you look for?
George Friedman: First, it’s not the data we look for. We have a model, what we call a geopolitical model, that tells us how the world works. In trying to forecast Germany’s behavior, we don’t look for a million facts, we look for the core reality of Germany, which, as I’ve been talking about here, is 50% exports. Then, you ask the question, ‘Well, how long can that sustain itself?’ You examine that. If you sit there with an avalanche of information without any model or any system to plug them into, it’s very hard to figure out what matters and what doesn’t.

What we do is to take a look at a country like Russia, ask, ‘What is its fundamental problem?’, and realize that it depends entirely on energy exports for about 50% of government spending.

That government spending goes out to the villages and to the oblasts, and if energy prices fall, Russia can’t sustain itself. We have a kind of principle, we call it being stupid. Which is to say, in being stupid, don’t become so sophisticated that you’re looking for every tiny fact and trying to construct it. See the obvious. See the thing that can’t be avoided.

For example, one of the predictions we had is the United States will remain the dominant power in the world. Why do we say that? Well, first, the United States is almost a quarter of the world’s GDP. Second, it controls all the oceans of the world.

Third, it is the only coherent continental-sized nation that functions fairly consistently. You may find that Obama or George W. Bush or whoever is an idiot, but it doesn’t matter. The underlying strength, the same way as you look for the underlying strength in the market and not spend a whole lot of time talking about personalities, the same thing applies to geopolitics.

Callum Newman: You did touch on America there. America does have its libertarian and non-interventionist tradition. What do you say … Because your basic premise is that America will disrupt areas around the globe if they look like they’re getting too strong. Do they have a voice in politics at all?
George Friedman: They have a voice in politics, without a doubt, but I think it’s very important to recognize that presidents aren’t very powerful in the United States, or most countries. You take a look at all the things that Obama wanted to be when he was elected.

He turned into George W. Bush. George W. Bush wanted a very different presidency than he had, and if you go back, this is not the presidency he wanted. Presidents must live in the world that they exist in. It’s not just that previous presidents create problems, the world creates problems. When you take a look at what Obama wanted and promised and what he had the power to do, or what Bush wanted to do, they’re a world apart.

We pay very little attention to what political leaders want, because when they actually get power, they discover they have much fewer choices. This is like, in economics, the invisible hand. You may want all sorts of things, but to be successful you are compelled by the invisible hand to behave in a certain way. Adam Smith didn’t invent that idea, Machiavelli did. We really are interested in who’s president, but not very.

Callum Newman: Just to draw it back to Europe, we’re seeing a lot of independence movements and critics of the EU. There’s Podemos in Spain, etc. Do you expect that to get stronger?
George Friedman: There are two trends. One is secessionist trends and the shocking 45% who voted for secession from Great Britain in Scotland. There is a tremendous secessionist set of movements in Spain, in Catalonia, among the Belgians, the Flemish and the Walloon, in Transylvania, the Hungarians and the Romanians.

You also see very radical, anti-Europeanist parties rising. You saw it in Greece. You see Podemos on the left in Spain. You also see it in France, where the National Front may well have a dominant position in the next election.

And UKIP, of course, in Britain. The mainstream parties, the parties that had been the Europeanist parties, have lost all credibility. They have promised ever since 2008 to solve the problem. It’s now 2015. No one believes that they’re going to solve the problem, except for I’ll say The Financial Times.

The reason that you have this problem is the Europeanists are utterly focussed on the health of the banking system. What they don’t realize is that Greece has 26% unemployment, Spain has 24% unemployment, Southern Italy has 22% unemployment. These are the same levels of unemployment that the United States reached during the Great Depression.

They don’t seem to understand that Southern Europe in particular is in depression, and that the rest of Europe is not doing particularly well, the French particularly, and that only the Germans are really flourishing in this environment. They believe that somehow or other this can be reconciled.

I think the mainstream parties of Europe are in effect destroying themselves, and what will come is the same thing that happened in the 1920s in Europe, very radical parties from the right and from the left that speak to the public’s fear, honestly address the issues that are on the table, which is that the European Union not working. No one any longer believes the reassurances of the Europeanists that this will all work out. Yes, it’s a bad place.

Callum Newman: Just to finish, you’re a very keen student of history. You know Australia got caught up in a couple of European entanglements over the last 100 years. Can a country as far away and distant from Europe…can we stay untangled from all this?
George Friedman: Not really, because in fact you’re not far away. The Australian illusion is that it is kind of distanced from the world, but in fact you’re a major trading power and you live on both your exports and your imports. I like to say that Australia is like a creature with its circulatory system on the outside. If those imports/exports fell, Australia would have great difficulty maintaining many of the amenities of its life. It could get even worse.

Australia also always has to be alliant with the preeminent maritime power. Until 1945, it was Great Britain. Now it’s the United States. That’s, whether you like it or not, a requirement for Australia, because it is so vulnerable to the international system.

Therefore, if the United States finds it necessary to involve itself in Iraq or Afghanistan or perhaps Europe, in order for you to, if you will, purchase the US Navy, you have to put something on the table. This has been from the Boer War onward the reality of Australia.

The psychological paradox of Australia is that it is one of the countries that’s most vulnerable to the international system, and yet finds itself extremely secure, but in fact, then, in a third level, does the things it needs to do to assure that at least someone is protecting its interests.

Callum Newman: Fascinating stuff. Unfortunately, we have to leave it there. I’ll just mention again that your new book is called Flashpoints: The Emerging Crisis in Europe. Thank you so much for your time today.
George Friedman: Thank you very much. Bye.
Callum Newman: Talk to you soon. Buh-bye.

If you’d like to hear the latest episode with real estate expert Catherine Cashmore, check out the DR podcast on iTunes here or Stitcher here.



Callum Newman
for The Daily Reckoning Australia


Join Markets and Money on Google+

Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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