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If one thing has become abundantly clear over the course of the Euro crisis it is that the Euro is not going to be allowed to collapse.  While I believe it is in the best interest of some of the periphery nations to leave the Euro it’s now obvious that they have been convinced that this is not in their best interest.  The core is very concerned about the ramifications of defaults and defections as their banks remain the largest lenders to the periphery.  So, while the periphery bails out the core (and vice versa) we will continue to see this union held together with increasing attempts to create a truly unified Europe.

Luckily for Europe, there is a pretty good model for fiscal and political unification and it has worked remarkably well over a long time period – the USA.  Guggenheim Partners recently elaborated on this similarity and the increasing likelihood of unification (via Business Insider):

‘Merkel, Sarkozy, and Alexander the Great’

Admitted or not, flashing across the political mindset in Europe is the realization that monetary unification will inevitably require a greater degree of political and fiscal unification. Critics of the euro have been saying this since its inception, but the current crisis is forcing the issue to the forefront of pan-European policy.

As The Wall Street Journal aptly summarized in a front-page article on December 27:

Ever since [the creation of the euro], economists have warned that monetary union, without a parallel authority to regulate taxes and spending, was destined to fail because there was no way to enforce the fiscal discipline essential to a currency’s health. Now, as Europe’s year of crisis grinds to a close, the Continent’s leaders are contemplating what many long resisted: a United States of Europe.

The federalization of Europe isn’t as far-fetched a concept as one might think. Remember that the United States of America initially operated under a loosely constructed confederation of sovereign states.

Prior to the Articles of Confederation, the individual colonies accumulated varying degrees of debt while fighting the Revolutionary War. The colonial debt burdens were highly divergent depending on the level of commitment to the war and the economic benefits accrued as a result of independence. Similar to the situation in Europe, some states suffered under far heavier debt burdens than others and economies prospered in varying degrees.

Without a tax base or the ability to consolidate debts, the make-shift Continental Congress was unable to assist individual states. Therefore, in 1787, it convened to address the financial viability of a confederation of unified states. Broad and sweeping changes were necessary, but under the Articles of Confederation such change could not occur without great difficulty. In response, that convention seized the opportunity to forge the Constitution of the United States of America, which curiously needed only a two-thirds vote to be ratified rather than the unanimity previously required in order to amend the Articles of Confederation.

It was reported that during the debate, John Jay, an American founding-father who co-wrote the Federalist Papers, argued in favor of the fiscal benefits of federalization. He said, in effect, that without a federal government the states would no sooner become independent than they would become insolvent. He argued that it should not be said of America that “her infant glories and growing fame were obscured and tarnished by broken contracts and violated faith.”

It was this Alexandrian-style paradigm shift in American government that paved the way for the Articles of Confederation to be replaced by the United States Constitution, and for Alexander Hamilton to ultimately absorb the debts of the states as a part of the process of federalization.

As Solomon said, “There’s nothing new under the sun.” The federalization of independent sovereign states for the purpose of financial and political stability has happened before. The application to the current crisis in Europe really isn’t as crazy a concept as one might think. At the end of the day, it’s all been done before.

Returning to modern day, the escalation of the current crisis in Europe will represent the Alexandrian moment for Germany and France, who have long desired to extend their influences across the continent. I believe that politicians are on board for greater European fiscal union; however, they still need to sell it to their constituents. Ironically, their lack of action may ultimately do the selling for them as the crisis deepens. It’s only a matter of time before Germany and France find the political will to lead the European Union into a new era of fiscal unification. Ultimately, the German and French motivation is the same reason Alexander the Great cut the Gordian Knot – the promise of ruling over a unified continent.

I have to disagree somewhat here.  While power grabs are the soup du jour for most politicians, this is not merely a power grab.  This is part of the natural progression of an ever increasingly unified global economy.  In Europe, this economic interdependency is now abundantly clear.   Europe is more intertwined than most are likely comfortable admitting.

While social differences remain there is simply no denying the fact that these countries are interconnected by common banking systems and common economies.  The leaders of Europe understand this and likely recognize that this interconnection is only going to increase in the coming decades.  That makes the direction clear – we are moving towards some form of a United States of Europe.  Unfortunately for all involved, the only thing keeping this from becoming a reality is social disunity due to a long history of conflict.  This will make the road towards unification increasingly tumultuous.

For now, we will continue to see austerity on the periphery, weak economic growth and a system that is held together very loosely by an accommodative ECB.   Ultimately, they must find a way to increase fiscal and political union.  This is easier said than done, however, and while European leaders kick the can the risk of peripheral defaults and defections will continue to rise as economies suffer under austerity and citizens slowly realize that they are on the losing end of what is essentially a core banking bailout.

Europe has reached the crossroads and the direction they appear to be choosing is clear.  They are moving in the direction of some form of unity.  The social divide, however, is proving difficult to overcome.   And the more slowly we move towards unification the higher the odds of turmoil.   My guess is that I will see a unified Europe in my lifetime.  How unified?  That depends on their ability to overcome their social differences.   Ultimately, however, money rules the day and money is forcing these reluctant neighbors to learn to love one another.

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