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Alex Cho

The Two Likely Scenarios: Europe Unifies or it Falls Apart

With the exit of Britain from the EU, the fears of additional referendums across various EU member states is prompting investors to re-examine the political risk in the immediate near term. While it’s not clear whether other EU member states have enough political support to leave the EU, some countries are at greater risk of exiting the EU.

EU politics is getting messy, according to Morgan Stanley:

Referendums to exit the EU: These have typically been called by party leaders of protest anti-EU parties who are trying to capitalise on their image of anti-establishment forces, giving a new voice to people. Indeed, within hours from the results of the British referendum, the French far-right Front National had already called for a 'Frexit' vote, the Dutch anti-immigration VVP had said that the Netherlands deserved a 'Nexit', and the Italian separatist Northern League claimed that "Now it is our turn". The Italian Five Star Movement wants a referendum on the euro (not on EU membership) and Danish party leader Kristian Thulesen Dahls said if the Danish parliament cannot agree on reforms with the EU, a referendum could give Denmark a new opportunity.

There’s further risk of contagion based on the mounting political support of other separatist parties across the EU. While none of the political heads are supporting the notion of an EU exit, the political parties that represent anti-establishment are gaining momentum due to the broad unpopularity of migration from middle east countries into the EU and economic instability for lagging EU members. That being the case, the British already exited based on those concerns, and it’s becoming increasingly unlikely that the EU will extend the same economic privileges to the UK upon the finalized negotiations of a British Exit.

To counter the various parties supporting referendums of exiting the EU, there’s mounting political support for further centralization of monetary and fiscal policy among EU member states. In other words, the EU will undergo major reform, which implies further centralization of political power among an elected council that will govern over EU member states. Further acceleration of the timeline for a “unified Europe” would be the most optimistic scenario as it diminishes political risks and allows for a governing body over geopolitical issues among member states.

In this more ideal scenario, Europe will pave a path that’s eerily similar to the formation of a unified country, *cough* like the USA? In either case, the path to a unified sovereign under a group of nation states hasn’t even been attempted since the 18th century, so the timeline for further integration could span over the course of decades requiring catalysts like Brexit, declaration of war, or economic uncertainty to drive further consolidation of political power among EU member states.

The timeline for a “unified Europe” is indeterminate at the present juncture in time. But, further political reform is implicit of greater centralization, which progresses us further along the timeline for a single EU state, excluding the UK. The other alternative is the collapse of the EU with member states exiting from the EU over the foreseeable decade. In other words, the EU will either collapse or a sovereign federation of States will form in response to contagion/geopolitical risk. Pretty soon we may refer to the EU as the United States of Europe or United Federation States of Europe. Either way, the outcome seems extremely binary as political factions are forming on polar opposite spectrums.

Investors would be wise to anticipate further bifurcation of political parties in response to Brexit, and on-going political uncertainty to weigh on US stocks with direct European exposure.

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