Beware the Ides of March

by Jeff Thomas

Idus Martiae is the Latin term for 15th March from the traditional Roman calendar. Since 44 BC, the Ides of March has held a dark reputation, as that was coincidentally the date of the assassination of Julius Caesar.

In December of 2016, the chairman of the Federal Reserve announced that the Fed was likely to raise the interest rate several times in 2017. The next such rise is anticipated to take place on 15th March.

This is also an interesting date, as it’s the date upon which the US government reaches its debt ceiling. This was cast in stone by the previous administration, back in 2015. Although they put into place an automatic freeze on any increase in debt after that date, they did nothing to either cut back on expenditure or prepare for further funding. Therefore, the Ides of March once again has become ominous, as the US government is set to come to a grinding halt as soon as the money presently in the Treasury runs out.

On 15th March, the US Treasury will hold roughly $200 billion and will be unable to borrow more.

When that $200 billion runs out, that’s it. Although this amount may sound sizeable, the US government spends roughly $75 billion per month, which means that it is due to hit the wall around the 1st of June.

As the date of the freeze is passed in law, it will be difficult to alter.

Many American voters became concerned in recent years that their government was not behaving in a prudent manner with regard to spending and, when Donald Trump ran for president, he promised to “Make America Great Again” and to “drain the swamp.” This was encouragement enough for voters to elect him. However, he also promised to increase spending on infrastructure, border controls, law enforcement, veterans’ benefits, and the military. In addition, he assured America that he would not cut back on benefits such as Social Security.

He promised to make these spending expansions at the same time as he planned to make drastic cuts in revenue in the form of taxation.

Dramatic cuts in taxation added to dramatic increases in expenditure plus a mandatory freeze on the increase in debt amounts to an economic Bermuda Triangle. Looked at in this light, it’s difficult to see the Ides of March as anything but an economic disaster waiting to happen.

Mister Trump’s ascendancy was an odd one. As an outsider, he was opposed by many Republicans who hold office. It’s understandable that the more indebted any Republican office holder is to his party, the more Mister Trump would appear to be a threat.

Although his candidacy was at first treated as a joke by both parties and the media, he did the unthinkable, beating out the pre-anointed Hillary Clinton. Democrats were horrified and remain so.

Although any new president is allowed a honeymoon period in which he has time to assemble his cabinet and get his programmes underway, this has not been the case for this president.

He’s been attacked from all sides on a daily basis, before, during, and after his inauguration. If ever there was a president whose head the political class wanted to see on a spit, it’s Mister Trump.

And that will most certainly affect the degree to which they’re willing to come to his aid, should he find himself in a pickle.

It should be stressed that he’s in no way responsible for the setting of the debt limit; however, it does appear as though he’s ignored it, focusing instead on “hitting the ground running” with regard to his promised programmes. It’s also true that, whenever economic disaster occurs, all and sundry tend to blame the political leader of the day, regardless of whether he was the cause.

As they’re already predisposed to relish the prospect of Mister Trump’s downfall, the Democratic Party and many in the Republican Party will be unlikely to sympathise with the fact that the debacle occurred on his watch inadvertently.

At present, those who voted for Mister Trump are still in party mode, celebrating what they hope will be the saving of America. It’s unlikely, however, that they understand the gravity of the events that are to occur on 15th March and will be blindsided when the Treasury hits the wall.

They’ll turn on the news each evening to learn what’s happened and will view one pundit after the other on a variety of stations describe Mister Trump’s “utter failure.”

We cannot foresee whether the government will, at some point, attempt a solution. This may depend upon whether or not they understand that the bubble cannot be inflated forever—whether they realise that a crash in the system is overdue and inevitable.

If they do realise this fact, they’ll recognize quickly that they have a golden opportunity to pass the buck for the fiscal damage they’ve done. Then they can use Mister Trump as the fall guy for the debacle. If they use the media well, they’ll rise up in righteous indignation at the damage caused by “the arrogant billionaire” and point to the mess that they’re left to clear up as a result of his abject failure.

If they do so, they’ll be likely to follow up with the institution of capital controls and the creation of a new currency. In addition we’re likely to see the confiscation of deposits (as per Cyprus) and rationing of withdrawals (as per Greece) by banks. They’ll additionally institute travel controls and ramp up the police state.

All of this can be presented as “necessary” under “emergency conditions.” Of course, the period of the emergency is likely to be lengthy, as there is, at present, no solution in place to address an economic collapse.

If the government, with the assistance of the media, do go this route (as they would have everything to gain and little to lose), they’d be likely to further take advantage of the situation.

They’d be in a position to insist that, had the election not been lost to Mister Trump, the debacle would never have taken place. (Yes, that would be a lie of epic proportions, but, as Adolf Hitler correctly observed, if you make the lie big enough and keep repeating it, people will believe it.)

This provides the opportunity to assure that the next president is an avowed collectivist. Voters will support whoever promises the most security, regardless of whether that candidate can actually deliver on the promise.

It’s important to note that my observations as to how the events of the Ides of March will be handled are just that—my observations. It’s possible that the path that’s ultimately taken could be a different one. (They may pass emergency measures that will delay the inevitable once again, but ultimately make the situation far worse.)

What we can say with absolute certainly, however, is that the US government is about to face a deadline which threatens to be devastating for the American people, who are in no way prepared for its arrival on their doorstep.

In March, the Fed is likely to raise rates at a time when debt levels are at an all-time high. They did this in 1929 and, as history has shown, this did not turn out well. Worse, at that same time, the debt ceiling will be reached.

If they can delay the inevitable a bit longer, they most certainly will. But history may later show that this was the point at which the house of cards began to fall. For those who have seen it coming, this may be the moment that you check to see that your seat belt is fastened.

Food for thought

In praise of quinoa

The spread of exotic grains is evidence that globalisation Works

PEOPLE are funny about food. Throughout history they have mocked others for eating strange things. In 1755 Samuel Johnson’s dictionary defined oats as “a grain, which in England is generally given to horses, but in Scotland supports the people”. Nineteenth-century Japanese nationalists dismissed Western culture as bata kusai, or “stinking of butter”. Unkind people today deride Brits as “limeys”, Mexicans as “beaners” and French people as “frogs”. And food-related insults often have a political tinge. George Orwell complained that socialism was unpopular because it attracted “every fruit-juice drinker, nudist, sandal-wearer [and] sex-maniac…in England”. In many countries today, politicians who wish to imply that their rivals have lost touch with ordinary voters sneer that they are latte-drinkers, muesli-munchers or partial to quinoa.

This South American grain gets a particularly bad rap. To its fans, it is a superfood. To its detractors, it is like the erotic sci-fi murals found in Saddam Hussein’s palaces—pretentious and tasteless. An advertisement for Big Macs once riffed on this prejudice. “Foodies and gastronauts kindly avert your eyes. You can’t get juiciness like this from soy or quinoa,” it said, adding that “while [a Big Mac] is massive, its ego is not.” Even those who love quinoa sometimes fret that scarfing it may not be ethical. What if rising hipster demand pushes the price up, forcing Andeans to eat less of their beloved grain? Or what if the price falls, making Andean farmers poorer? A headline from Mother Jones, a left-wing magazine, perfectly captured the confusion of well-meaning Western foodies: “Quinoa: good, evil or just really complicated?”
This newspaper takes no view as to whether quinoa tastes nice. But its spread is a symptom of a happy trend. More and more people are chomping unfamiliar grains (see article). Rich Westerners are eating less wheat and more of the cereals that people in poor countries traditionally grow, such as millet, sorghum, teff and yes, quinoa. Middle-class Asians are eating more wheat, in the form of noodles or bread, instead of rice. West Africans are eating 25% more rice per head than in 2006; millet consumption has fallen by the same share.

All this is to be celebrated, for it is a symptom of rising prosperity and expanding choice. The spread of better farming techniques has raised yields, helping humanity feed itself despite a rising population. Rapid urbanisation means that fewer people grow their own grain, and more have the cash to try new varieties. Globalisation has allowed food and farming techniques to cross borders, meaning that people on every continent can experience new flavours and textures. Migration and tourism have broadened people’s culinary horizons: Chinese visitors to France return home craving baguettes; Americans who live near Ethiopian immigrants learn to love injera (a soft teff flatbread that doubles as an edible plate).

Food for thought
The globalisation and modernisation of agriculture have contributed to a stunning reduction in hunger. Between 1990 and 2015, the proportion of children under five who were malnourished fell from 25% to 14%. People who are still underfed are less severely so: their average shortfall in calories fell from 170 a day to 88 by 2016. And between 1990 and 2012 the proportion of their income that poor people worldwide had to spend on food fell from 79% to 54%. As for those quinoa farmers, don’t worry. A study by Marc Bellemare of the University of Minnesota found that Peruvian households became better-off because of the quinoa boom, even if they didn’t grow the stuff, because newly prosperous quinoa farmers bought more goods and services from their neighbours.
Granted, rising prosperity has allowed an increasing number of people to become unhealthily fat. But the solution to that is not to make them poorer, which is what the backlash against globalisation will do if it succeeds. Rather than sniping snootily about Donald Trump’s taste for well-done steaks slathered with ketchup, liberals should worry about the administration’s plans to erect trade barriers and possibly start a trade war. That would make the world poorer and hungrier.

Discussions on the Fed Put

Doug Nolan

Market focus this week turned to troubled healthcare legislation, with the GOP Friday pulling the vote on the repeal of Obamacare. This “Republican Catastrophe” (Drudge ran with a Hindenburg photo) provided a timely reminder that Grand Old Party control over the presidency and both houses of congress doesn’t make it any easier to come to a consensus for governing a deeply-divided country. The reality is that it’s a highly fractious world, nation, Washington and Republican party – and the election made it only more so. Perhaps Monday’s sell-off was an indication that reality has begun to seep back into the marketplace. If repealing Obamacare is tough, just wait for tax reform and the debt limit.

CNBC’s Joe Kernen (March 20, 2017): “For a guy that was there trying to deal with the housing Bubble - that would be the other thing that people would bring up to you. That you don’t know what low rates are really doing. You don’t know where the next dislocation is going to be. You’re not seeing a lot of benefits from zero, and who knows if you might be inflating something somewhere that comes home to roost in the future. That’s probably what they’d say: ‘You must know there’s nothing on the horizon then.’”

Neel Kashkari, Minneapolis Federal Reserve Bank president: “It’s a very fair question and people point to the stock market’s been booming. And my response to those folks is, we care about asset price movements if we think a correction could lead to financial instability or financial crisis. If you think about the tech Bubble - the tech Bubble burst. It was not good for the economy – obviously it hurt. But there was no risk of a financial collapse, not like the housing Bubble. So, the difference is the housing market has so much debt underneath it. It’s much more dangerous if there’s a correction. If equity markets drop, it’s going to be painful for investors. But there’s so little debt relative to housing, it doesn’t look like it has a risk of leading to any kind of financial crisis. So, our job is to let the markets adjust.”

Less than an hour later Kashkari appeared on Bloomberg Television: “Some people have said we should be raising rates because markets are getting hot – and the stock market keeps climbing. I think we should only pay attention to markets if we believe it could lead to financial instability. So, go back to the tech Bubble, when tech burst it was painful for the economy; it was painful for investors. But it did not lead to any kind of economic collapse or financial instability. So, if stock markets fall it’ll hurt investors. But that’s not the Fed’s job. The Fed’s job is not to protect stock market investors. We have to pay attention to potential financial instability risks, and the fact is there’s a lot more debt underlying the housing market than underlying the stock market. That’s why the housing bust was painful for the economy. A stock market correction will probably be a lot less painful.”
Neel Kashkari these days provides interesting subject matter. It’s no coincidence that he’s been discussing shrinking the Fed’s balance sheet while also addressing the “Fed put” in the stock market. I’m sure Kashkari and the FOMC would prefer that market participants were less cocksure that the Fed stands ready to backstop the markets. Too late for that.

The Fed is not blind. They monitor stock prices and corporate debt issuance; they see residential and commercial real estate market values. Years of ultra-low rates have inflated Bubbles throughout commercial real estate – anything providing a yield – in excess of those going into 2008. Upper-end residential prices are significantly stretched across the country, also surpassing 2007. They see Silicon Valley and a Tech Bubble 2.0, with myriad excesses that in many respects put 1999 to shame. I’ll assume that the Fed is concerned with the amount of leverage and excess that has accumulated in bond and Credit markets over the past eight years of extreme monetary stimulus.

The Fed is locked into a gradualist approach when it comes to normalizing rate policy. At the same time, they must of late recognize that speculative markets might readily brush aside Fed “tightening” measures. This might help to explain why the Fed’s balance sheet is suddenly in play. And it’s not just Kashkari. From Bloomberg: “Fed’s Kaplan Says MBS and Treasuries Should Both Be Rolled Off” and “Bullard Says Fed in Good Position to Allow Balance Sheet to Fall.” From Reuters: “Cleveland Fed President Says She Supports Reducing the Balance Sheet.” And from Barron’s: “Fed's Williams: Balance Sheet Shrinkage Could Begin Late this Year.” And my favorite: “Fed’s Kashkari: Everyone on FOMC ‘Very Interested’ in Balance Sheet Policy.”

I struggle taking comments from Fed officials at face value. Kashkari shares a similar revisionist view of the Tech Bubble experience to that of Ben Bernanke, Alan Greenspan and others: Basically, it was no big deal – implying that Bubbles generally don’t have to be big deals. They somehow banished 2002 from their memories.

The Fed collapsed fed funds from 6.50% in December 2000 to an extraordinarily low 1.75% by the end of 2001. In the face of an escalating corporate debt crisis, the Fed took the unusual step of cutting rates another 50 bps in November 2002. Alarmingly, corporate Credit was failing to respond to traditional monetary policy measures (despite being aggressively applied). Ford in particular faced severe funding issues, though the entire corporate debt market was confronting liquidity issues. Recall that the S&P500 dropped 23.4% in 2002. The small caps lost 21.6%. The Nasdaq 100 (NDX) sank 37.6%, falling to 795 (having collapsed from a March 2000 high of 4,816). No financial instability?

Years later it’s easy to downplay consequences of the bursting “tech” Bubble. Yet there were fears of a deflationary spiral and the Fed running out of ammo. It was this backdrop in which Dr. Bernanke introduced unconventional measures in two historic speeches, the November 21, 2002, “Deflation: Making Sure ‘It’ Doesn’t Happen Here” and the November 8, 2002, “On Milton Friedman’s Ninetieth Birthday.”

I revisit history in an attempt at distinguishing reality from misperceptions. Of course the Fed will generally dismiss the consequences of Bubbles. They’re not going to aggressively embark on reflationary policies while espousing the dangers of asset price and speculative Bubbles. Instead, they have painted the “housing Bubble” as some egregious debt mountain aberration. And paraphrasing Kashkari, since today’s stock market has nowhere as much debt as housing had in 2007, there’s little to worry about from a crisis and financial instability perspective.

Well, if only that were the case. Debt is a critical issue, and there’s a whole lot more of it than back in 2008. Yet when it comes to fragility and financial crises, market misperceptions and distortions play fundamental roles. And there’s a reason why each bursting Bubble and resulting policy-induced reflation ensures a more precarious Bubble: Not only does the amount of debt continue to inflate, each increasingly intrusive policy response elicits a greater distorting impact on market perceptions.

I doubt Fed governor Bernanke actually anticipated that the Fed would have to resort to “helicopter money” and the “government printing press” when he introduced such extreme measures in his 2002 speeches. Yet seeing that the Fed was willing to push its monetary experiment in such a radical direction played a momentous role in reversing the 2002 corporate debt crisis, in the process stoking the fledgling mortgage finance Bubble. And the Bernanke Fed surely thought at the time that doubling its balance sheet during the 2008/09 crisis was a one-time response to a once-in-a-lifetime financial dislocation. I’ll assume they were sincere with their 2011 “exit strategy,” yet only a few short years later they’d again double the size of their holdings.
From a friendly email received over the weekend: “I think the Bernanke doctrine ended up being wildly successful beyond anyone’s imaginings, even Dr. Ben’s.” This insightful reader’s comment is reflective of the positive view markets these days (at record highs) hold of “activist” central bank management. It may have taken a while, but it all eventually gained the appearance of a miraculous undertaking – reminiscent of “New Era” hype from the late-nineties. “Money” printing works – and all the agonizing about unintended consequences proved sorely misguided!

So easy to forget how we got here. We’re a few months from the nine-year anniversary of the 2008 crisis, yet there’s still huge ongoing global QE and rates not far from zero. It’s a monetary inflation beyond anyone’s imaginings, even Dr. Ben’s. To say “the jury’s still out” is a gross understatement.

There’s a counter argument that stimulus measures and monetary inflation got completely away from Dr. Bernanke - and global central banks more generally. Peak global monetary stimulus today equates with peak securities market values and peak optimism – all having been powerfully self-reinforcing (“reflexivity”). Global debt continues to expand rapidly, led by exceedingly risky late-cycle Credit growth out of China. I suspect that unprecedented amounts of speculative leverage have accumulated globally, led by excesses in currency “carry trades” and derivatives. “Money” continues to flood into global risk markets, inflating prices and expectations. Worse yet, excesses over (going on) nine years have seen an unprecedented expansion of perceived money-like government and central bank Credit (the heart of contemporary “money” and Credit). Meanwhile, global rates have barely budged from zero.

Despite assertions to the contrary, the bursting of the “tech” Bubble unleashed significant financial instability. To orchestrate reflation, the Fed marshaled a major rate collapse, which worked to stoke already robust mortgage Credit growth. The collapse in telecom debt, an unwind of market-based speculative leverage and the rapid slowdown in corporate borrowings was over time more than offset by a rapid expansion in housing debt and the enormous growth in mortgage-related speculative leverage (MBS, ABS, derivatives).

Understandably, Kashkari and the Fed would prefer today to ween markets off the notion of a “Fed put.” It’s just not going to resonate. Markets will not buy into the comparison of the current backdrop to the “tech” Bubble period. The notion that today’s securities markets operate without major instability risk is at odds with reality.

Markets are keenly aware that the Fed’s balance sheet will be the Federal Reserve’s only viable tool come the next period of serious de-risking/de-leveraging. At the same time, Fed officials clearly want to counter the now deeply-embedded perception of a “Fed put” – that the Federal Reserve remains eager to counter fledgling “Risk Off” dynamics. And while its’s not surprising that markets hear Kashkari’s comments and yawn, things will turn interesting during the next bout of market turbulence. Expect the Fed to move hesitantly when coming to the markets’ defense, a dynamic that significantly raises the potential for the next “Risk Off” to attain problematic momentum. It’s been awhile.

March 20 – Financial Times (Robin Wigglesworth): “On Wall Street, bad ideas rarely die. They often go into hibernation until resurrected in a new form. And portfolio insurance — a leading contributor to the 1987 ‘Black Monday’ crash — is, for some, making a return to markets. Institutional investors are allocating billions of dollars to ‘risk mitigation’ or ‘crisis risk offset’ programmes that are designed to act as a counterweight when markets are in turmoil. They mostly comprise long-maturity government bonds and trend-following hedge funds, which tend to do well when equities plummet. But some analysts and fund managers worry that if taken to extremes, allocations to trend-following ‘commodity trading advisors’ hedge funds, in particular, could play the same role as an investment concept called portfolio insurance did in 1987, when it was blamed for aggravating the worst US stock market collapse in history. ‘There’s a big portfolio insurance industry that no one is talking about . . . CTAs are dangerously close to portfolio insurance,’ argues Robert Hillman, the head of Neuron Advisors…”
Writing flood insurance during a drought is an alluringly profitable endeavor. The “Fed put” has encouraged Trillions to flow into the risk markets. Trillions of “money” have gravitated to “passive” trend-following securities market products and structures. Yet the most dangerous Fed-induced market distortions may lurk within market hedging strategies. The above Financial Times article ran under the headline “Rise in New Form of ‘Portfolio Insurance’ Sparks Fears.” Fear is appropriate. To what degree has it become commonplace to seek profits “writing” various types of market “insurance” in a yield-hungry world confident in the central bank “put.” How much “dynamic hedging” and derivative-related selling waits to overwhelm the markets in the event of a precipitous market sell-off (concurrent with fear that the Fed has stepped back from its market backstopping operations)?

The speculative bull market confronted some Washington reality this week. The S&P500 declined 1.4%, the worst showing in months. The banks (BKX) were slammed 4.7%, with the broker/dealers (XBD) down 4.3%. The broader market was under pressure, with the mid-caps down 2.1% and the small caps 2.7%. It’s worth noting the banks, transports and small caps are all now down y-t-d. Curiously, bank stocks underperformed globally. Japan’s Topic Bank index was hit 3.5%. The Hong Kong Financial index fell 1.3%, and Europe’s STOXX 600 Bank index lost 0.9%.

Ten-year Treasury yields dropped nine bps to a one-month low (2.41%), as sovereign yields declined across the globe. Just when the speculators were comfortably short European periphery bonds, Spanish 10-year yields sank 19 bps, Italy fell 13 bps and Portugal dropped 15 bps. Crude prices traded this week to the low since November. The GSCI Commodities Index declined to almost four-month lows. Time again to pay attention to China? This week saw a “super selloff” in Chinese iron ore markets. Copper fell 2.2%, and the commodities currencies (Australia, Canada, Brazil) underperformed. Meanwhile, precious metals outperformed, with gold up 1.2% and silver rising 2.1%.

March 23 – Financial Times (Gabriel Wildau): “China’s financial system suffered a cash crunch this week as new regulations designed to curb shadow banking caused big lenders to hoard funds, highlighting the danger of unintended consequences from official moves to lower their debt. Analysts have warned of rising risks from banks’ increased reliance on volatile short-term funding rather than customer deposits to fund loans and other investments. If money market interest rates spike in times of stress, institutions can be forced to dump assets in order to meet payments due to creditors. Tightening liquidity prompted the seven-day bond repurchase rate to hit a three-year high of 9.5% on Tuesday, versus an average of below 3% since the beginning of 2014.”

March 21 – Bloomberg: “This week’s squeeze in Chinese money markets is proving especially painful for the country’s shadow banks. While interbank borrowing rates have climbed across the board, the surge has been unusually steep for non-bank institutions, including securities companies and investment firms. They’re now paying what amounts to a record premium for short-term funds relative to large Chinese banks… ‘It’s more expensive and difficult for non-bank financial institutions to get funding in the market,’ said Becky Liu, …head of China macro strategy at Standard Chartered Plc. ‘Bigger lenders who have access to regulatory funding are not lending much of the money out.’”

March 23 – Wall Street Journal (Shen Hong): “A new specter is haunting China’s financial system: the negotiable certificate of deposit. An explosion in banks’ use of the bondlike loans, whose durations range from a month to a year, is testing Beijing’s resolve to cure the economy of its addiction to debt-fueled growth and investment booms. As authorities push up key short-term interest rates in their campaign to deflate asset bubbles swelled by borrowed money, the interest rates charged on these NCDs is rising so fast that it is starting to expose banks to the risk of investment losses and abrupt funding squeezes. This is causing worries about a potential repeat of the crippling cash crunch of 2013. ‘NCDs carry a lot of risk, and if not handled properly they could lead to a systemwide liquidity crisis,’ said Liu Dongliang, senior analyst at China Merchants Bank. Banks, mostly small or midsize ones, have been raising record sums via NCDs, selling 4.4 trillion yuan ($639bn) worth this year, 65% more than in the same period of 2016.”
The risk of financial accident in China has anything but dissipated. The People’s Bank of China this week injected large amounts of liquidity to stem a brewing funding crisis in the inter-bank lending market, only then to reverse course back to tightened policy later in the week. Over recent years, each effort to restrain excess in one area has been matched by heightened excess popping out in another. In general, financial conditions have remained too loose for too long – leading to recent Credit growth in the neighborhood of $3.5 TN annualized. Efforts to rely on targeted tightening measures have proved ineffective.

It appears there is now heightened pressure on Chinese monetary authorities to tighten system-wide financial conditions. The stress that befell the vulnerable corporate bond market over recent months is now pressuring small and medium sized banks with problematic exposure to short-term “money-market” borrowings. There were also further indications this week of “shadow banking” vulnerability.
I’ve never felt comfortable that Chinese authorities appreciate the types of risks that have been mounting beneath the surface of their massively expanding Credit system. Global markets seemed attentive a year ago, but have since been swept away by the notion of the all-powerful “China put” conjoining with the steadfast “Fed put.” These types of market perceptions create tremendous inherent fragility.

A multi-speed formula will shape Europe’s future    
The best option is a structure with an integrated core and a looser outer layer
by: Wolfgang Münchau

Back in the 1990s, I used to discuss the future of Europe with friends and colleagues. We had different aspirations. Some of us, me included, wanted a narrow, federal Europe with a central government and parliament; others preferred a wider, decentralised Europe; and then there was a third group in favour of what they called “variable geometry” — a multi-speed Europe in which overlapping groups of countries would integrate in different policy areas.

The debate is back on the official agenda, this time not out of choice but necessity. The EU is in trouble. Its monetary union crawls from one crisis to the next. Its immigration policies are a mess. One member voted to leave. Another, Poland, is isolating itself diplomatically. Beata Szydlo, the Polish prime minister, last week vetoed a resolution of the European Council in protest over the re-election of Donald Tusk, an erstwhile political rival. She is holding Europe to ransom over a battle that is really about domestic politics. In France and Italy, some leading opposition politicians are advocating a withdrawal from the euro.

A few days before last week’s summit, the leaders of France, Germany, Italy and Spain met to express a preference for a multi-speed Europe, on lines similar to the variable geometry some of my friends favoured two decades ago. They arrived at this conclusion through a process of elimination. A federal Europe of 27 member states is out of the question because that would require deep changes to the European treaties that would stand no chance of being approved by all. Doing nothing is not much of an option either. So there is no alternative to variable geometry. But what would it mean in practice?

We should distinguish between different varieties. The first would consist of deeper integration based on the enhanced co-operation clauses in European law. These allow a group of at least nine member states to press ahead with legislation with each other. This excludes areas of common interest, such as the single market or the customs union.

While enhanced co-operation sounds like a good idea, a word of caution is in order. It has been around since the 1990s and was given more prominence in the Lisbon treaty. One of the authors of this particular clause told me that he wrote it to provide a legal foundation for the eurozone to develop into a closer political union. But the clause has only been used three times — for divorce law, the European patent and on property rights for international couples. Not exactly an ambitious list.

It is worth studying the failures of the procedure. A group of member states wanted to use enhanced co-operation to agree on a financial transaction tax. They became bogged down by disagreements, before the realisation dawned that, if only nine countries signed up to such a tax, they might put themselves at a competitive disadvantage compared with those member states that refused to take part.

The second version of variable geometry is more radical and, in the final analysis, the only one that respects the political constraints and the need to solve the EU’s problems. European integration belongs to the category of things that are simultaneously inevitable and impossible.

More integration is needed if Europe is to manage an economically divergent monetary union; to strengthen defence-co-operation at a time when Donald Trump, the US president, is casting doubt on the future of Nato; and to remain credible when confronted by assertive neighbours, notably Russia and Turkey. At the same time it is impossible because the kind of treaty change needed to construct such an edifice is unrealistic.

The way out of this trap is to accept a process of disintegration followed by reintegration. The EU as constituted is monolithic. It is stuck with a legal framework for everybody that suits nobody. The best option would be a structure with a reasonably integrated core, surrounded by a less integrated outer layer. All member states would be part of a customs union and the single market but not necessarily the single currency or the interior and foreign and security policy apparatus. Freedom of movement could be defined as a right obligatory for members of the inner group but voluntary for the others.

Countries in the outer sphere would have the right, but not the obligation, to join core policy areas. The outer layer would thus not be monolithic either. Such a structure would even allow the UK to rejoin after it leaves the bloc. But it would be rejoining not the EU as we know it but a more flexible successor organisation, with a different legal basis.

Europe’s dilemmas are solvable if one opens up the institutional fabric. Otherwise, there is no alternative but to muddle through in the hope that nothing happens. And we know where that ends.

France as a Northern and Southern European Power

By Antonia Colibasanu

The country holds a unique position on the Continent.

France is the only country in Europe that is both a northern and southern power. The Continent’s northern and southern regions have developed in relative isolation. Two geographic features help pull the Continent in separate directions. The first is the North European Plain – an expansive stretch of land extending from the Russian steppe in the east to the French Pyrenees in the west. Northern Europe, with the densest navigable waterways in the world, is the Continent’s wealthiest region. The second feature is the Mediterranean Sea. Southern Europe is mountainous and lacks a robust coastal plain. Therefore, while rich by global standards, it is poorer than Northern Europe.

France is unique because it is part of both of these European regions. The Rhône, which begins at the Mediterranean and serves as a trade corridor to Northern Europe, is the only river that unites the south with the north. The Garonne River, with its head of navigation in Toulouse, is only about 90 miles from the Mediterranean and flows west into the Atlantic. This makes France the only country that can project power in any part of Europe. However, France’s status as both a northern and southern European country has posed internal problems due to a disconnect between France’s north and south.

This picture taken on June 4, 2013, shows the Wilson bridge on the Rhône River in the center of Lyon. PHILIPPE MERLE/AFP/Getty Images

This disconnect can be seen in the issues facing southern France today. The south of France is a key region that highlights the challenges the next government in Paris will face after upcoming elections in just over a month. Its experience and problems embody the country’s key concerns.

Currently, the media and the public in southern France are more focused on local issues, and the election is of secondary importance. It is no longer a topic of conversation in French cafes, taking a back seat to more immediate concerns for the average French voter. Apathy over the election is widespread: About 40 percent of French voters have not decided whom they will support. But the most important themes in the current campaign are French identity, security and unemployment. These are all key issues in Provence, where populism is on the rise.

The south of France is one of the most populous regions in the country, with a population of more than 5 million. While its economy has been growing, so have the unemployment rate and the popularity of the National Front, a nationalist party. Positive growth figures have not translated into better economic conditions for French citizens.

The structure of this region’s economy partly explains this disconnect in Provence. While tourism in Côte d’Azur accounts for 7 percent of France’s GDP and 11 percent of the region’s GDP, according to France’s National Institute of Statistics and Economic Studies (INSEE), the education sector is the predominant source of income for the rest of the region. Education and tourism sectors together employ about 80 percent of the region’s workforce. Other industries that employ workers here – pharma, gas and water distribution, and electrical and electronic components – are important, but more than 90 percent of the enterprises affiliated with these sectors are small and only employ up to 10 people. These sectors have suffered less than others since the 2008 financial crisis.

The region does not have large automobile and textile industries, which were hit hard by the crisis, forcing companies to lay off personnel and implement restructuring programs. Real estate and construction were the only sectors in southern France that slowed down as a result of the crisis. But these sectors only account for 12 percent of the region’s GDP and have rebounded according to the latest data from 2016. All in all, the economy has shown positive signs, registering a growth rate of 2 percent last year, according to INSEE.

However, southern France has one of the highest unemployment rates in the country – between 11 and 13 percent. The Provence-Alpes-Côte d’Azur region has the fastest-growing population in the country, increasing by 73 percent since the 1960s compared to France’s national average of 35 percent. Immigration has increased even though other regions in southwestern France have become more appealing for immigrants in the last 10 years. The region also has one of the highest poverty rates in the country, with more than 15 percent of the population living below the poverty line, according to French statistics from 2013. During tourism’s off-season, economic stagnation is more visible: Local restaurants close early, shops adapt to the slow provincial pace of life and the only lively areas are near universities and business centers.

Geography offers another explanation for the contradiction between the region’s economic development numbers and social realities. Much of the region’s economic activity is concentrated along the 400-mile coastline, which encompasses just 10 percent of the region’s territory and is home to more than three quarters of the population. Last year’s terrorist attack in Nice hurt the tourism industry, and a slowdown in global trade and investment had a negative impact on Marseille and its shipbuilding industry. “For Sale” signs scattered around neighborhoods in Nice also indicate the negative effects of real estate’s slowdown.

Half of Provence is mountainous and most of the population is urban, relatively decoupled from the realities of tourist-heavy Côte d’Azur and the major port of Marseille. Universities, the center of gravity for these urban communities, are dependent on international students – many of whom came to France through European Union exchange programs before 2010. But because European demographics no longer supply a steady flow of students to these universities, they have begun marketing to Middle Eastern countries and, less successfully, Asia. All of this ties into the region’s new challenges, particularly regarding immigration.

The region has been the traditional point of entry into the country for North Africans. This has helped the economy, since companies can take advantage of lower-cost labor, but it also has contributed to a growth in nationalism. While immigration from North Africa is not new for the region, security concerns have grown over the last several years, especially since the Nice terrorist attack. Job creation in this region is limited, and youth unemployment is high. As elsewhere in Western Europe, migrants often get jobs faster than locals because they are willing to accept lower salaries.

These local realities create regional problems that pull campaign discourse toward issues like identity, security and unemployment. The region, fearful of the negative effects of immigration, has long been wary of European Union integration, especially its impact on the economy. Small shops in Provence complain just as much as small businesses in rural Britain about the problems that have arisen from policies made in Brussels. Small business owners argue that they will never get access to the EU market, as rules governing the market have killed their chance to be competitive.

For these reasons, the region’s attitude toward EU integration should be no surprise. In 1992, Provence voted against the Maastricht Treaty. In 2005, more than 55 percent of people in Provence voted against an EU draft constitution. The region has historically voted for the French right, and support for the National Front has grown over the last two elections. In 2015 local elections, the party received 20-25 percent of votes. As the economy weakened, nationalism and populism became more prominent in Provence, as they did throughout France and Europe. However, apathy and disengagement from politics also have grown.

France’s position as both a southern and northern European country will continue to present challenges, even though it is also an advantage for the country’s position in Europe. Provence’s development will depend on how both economic and security challenges evolve. France needs to take a broader view and balance between looking to its east (and preparing for any threat that may come from the North European Plain) and looking to the Mediterranean – which presents its own security challenges.