by Adriano Bosoni
December 14, 2016

By this time next year, the eurozone could be defunct. Despite the small chances of it actually happening, the fact that the collapse of the currency union is even possible speaks volumes about the size of the problems Europe faces. Since financial, economic and political crises descended on the Continent almost a decade ago, Europe has endured many difficult moments. But 2017 will be the most important year yet for the continuity of the eurozone as political and economic risk reaches the bloc’s very core in Germany, France and Italy.

Threats to the European Union and the eurozone become more acute as they spread to the bloc’s key members. While Europe’s supranational structures could probably survive Greece’s departure from the eurozone or Britain’s exit from the European Union, for example, they probably couldn’t overcome the withdrawal of Germany, France or Italy. These countries not only have the largest economies in Europe, but they are also the main forces driving the process of European integration.

Next year, a series of events will put the European Union’s foundational structures to the test. The bloc’s most serious challenges will come from France and Italy, which are dogged by low economic growth rates and relatively high unemployment. Anti-globalization sentiments are strong among large swaths of their populations, who want to protect their economies from the perceived threats of immigration and free trade.

Meanwhile, many French and Italian voters are skeptical of the European Union and the mainstream political parties that back it. Both countries are fertile ground for political forces that vow to fight globalization and reverse the process of European integration.


Two Scenarios for France and Italy

France will hold its two-round presidential election in April and May, while the resignation of Italian Prime Minister Matteo Renzi has opened the door to general elections in Italy. In each vote, nationalist and anti-globalization parties will make a strong showing. But the bigger question is whether they will gain enough support to defeat the electoral systems that were designed to keep them from power.


Even in the likely event that National Front leader Marine Le Pen receives enough votes to make it to the second round of France’s presidential election, she will have trouble exceeding the 50 percent threshold needed to win, considering moderate voters will probably align against her.

Italy, meanwhile, is essentially operating without an electoral law. A statute passed in 2015 aimed at reforming the country’s previous legislation has never been used and is currently being reviewed by the country’s Constitutional Court. In the coming weeks, the Italian Parliament will probably introduce a proportional electoral system that will force parties to form coalitions to enter government. This law likely will be tailor-made to reduce the Five Star Movement’s chances of accessing power, since the anti-establishment party refuses to form alliances with other political parties.

Therefore, France and Italy will see one of two scenarios unfold. In the first, the National Front and/or the Five Star Movement rise to power, bringing their respective countries even closer to leaving the eurozone. To quit the currency area, the new governments would have to organize and win a referendum on the euro.

But the mere announcement by the French or Italian government of an intent to exit the currency union might precipitate its collapse before a vote could even be held. Notice of a referendum would probably be enough to trigger a run on banks in Southern Europe as depositors move their money from weak economies in the south to havens in the north.


The effects of such a bank run would ripple far beyond the countries directly involved in the referendum. Many people with money in Spanish or Portuguese banks, for example, would rush to move it to northern banks. If the eurozone disappears and bank deposits are converted to national currencies, account-holders would rather have their euros be turned into deutsche marks than into pesetas or escudos.

Data from the European Central Bank (ECB) shows that money in Europe already has been migrating from southern to northern banks for a few years now. An announcement by a core eurozone member of plans to hold a referendum on euro membership could therefore force the ECB to introduce capital controls preventing the movement of money in order to buy time for EU leaders to decide what to do with the currency area.

In the second and more likely scenario, moderate parties in France and Italy stay in power. While this would defuse an immediate crisis in the eurozone, it may provide only a temporary respite. Even moderates in France and Italy are defending a restructuring of the European Union to weaken central institutions in Brussels and return some powers to national parliaments. Considering such reforms seem unlikely under the current circumstances (EU governments want to avoid the risk of opening the process of treaty reform), their next-best option would be to act unilaterally and selectively challenge — or directly ignore — the authority of the European Commission and other EU institutions.

But the main issue to keep in mind is that unless these economies experience a strong recovery — and fast — the rise of a nationalist party to power will only be postponed until the next election. In France, this could mean five years, should the moderate government that will likely emerge in 2017 manage to complete its constitutional term. In Italy it could mean only a few months, since governments there rarely see the end of their tenures.


A More Isolated Germany?

Germany will also hold general elections in 2017, but depending on how the future unfolds, the vote could have the least impact of the three on Europe’s fate. By the time Germans head to the polls in September or October, events elsewhere could have already triggered a eurozone crisis. Germany will have little influence over the electoral outcomes in Italy or France, and the government in Berlin will likely have to react to events rather than have the chance to shape them.

Should moderate forces keep control of France and Italy, Germany’s campaign season will be relatively normal, focusing on issues such as immigration and security. The country’s leaders are aware that their French and Italian neighbors are becoming more and more uncomfortable with the direction of the eurozone, but they will avoid making any meaningful reforms until after the elections are over.

Though the European Union’s northern and southern members agree that the bloc needs to be reformed, they have different views on what approach it should take. Electoral pressure in Germany will make Berlin reluctant to compromise with its southern peers on a host of issues, including a more flexible interpretation of EU deficit targets, the introduction of a eurozone-wide stimulus package or the backing of ECB expansionary policies.

This will do little to bridge the gap between northern and southern members of the eurozone. For Germany, the best-case scenario would be to postpone any real EU reforms until 2018, but even that will only delay the bloc’s problems rather than solving them.

At the headquarters of the European Central Bank in Frankfurt, the bank's officials are mulling changes to its bond-buying regimen, which supports its quantitative easing program.

At the headquarters of the European Central Bank in Frankfurt, the bank’s officials are mulling changes to its bond-buying regimen, which supports its quantitative easing program.

On the other hand, a populist victory in France or Italy would dramatically change Germany’s calculations. Berlin’s first reaction would be to try to accommodate a new government in Paris or Rome in a bid to prevent the eurozone’s collapse. But Germany cannot put its economic future in France’s or Italy’s hands, meaning it would have to simultaneously craft contingency plans for a post-eurozone world.

Germany’s initial reaction to a disintegrating eurozone would be to find allies with which to collaborate on future trade and currency blocs. But this could prove difficult as well. Austria is a natural partner for Germany, but the country is grappling with its own nationalist forces, which could reduce its leaders’ appetite for participating in new supranational endeavors. Nordic Europe is economically and ideologically close to Germany, but in the context of a widespread political crisis, the region could decide to focus on its own integration efforts. Consequently, Germany could find itself negotiating the creation of a “northern eurozone” with the Benelux and Baltic countries.

In such a complicated scenario, German voters could turn in droves to Angela Merkel for protection, launching her into a fourth term in power. But this would offer little relief to a country facing an existential crisis. Germany’s export-dependent economy relies on access to foreign markets to create jobs at home. The dissolution of the eurozone would generate considerable uncertainty that would weaken economic activity across the Continent and cut into German exports.

The real threat for Germany, though, would not be the dissolution of the eurozone but the reintroduction of trade tariffs in Europe. The argument could be made that no matter what happens to the eurozone, people will still want to buy German cars and will be willing to pay for them with deutsche marks. But protectionist measures instituted in other countries would hurt German exports and lead to higher unemployment. While trade partners outside the European Union such as the United States and China could help mitigate the damage somewhat, they could not fully compensate for lower sales in Europe.

It is no surprise, then, that the wave of anti-globalization sentiment sweeping across Europe and the United States is particularly concerning for Germany, a country that depends on globalization to thrive.


Several Threats at Once

The most drastic of these scenarios — those in which Euroskeptic forces win next year’s elections — are unlikely to materialize. But even if French and Italian moderates stay in power in 2017, their populations are becoming increasingly dissatisfied with the European status quo. Calls for EU reform will grow louder, and for the first time those dissenting voices will demand the repatriation of powers to national governments instead of greater European integration. Governments will act unilaterally more often, and central institutions in Brussels will continue to lose their relevance. More important, the electoral and political systems that will probably keep anti-establishment forces from power in 2017 may not continue to block them for much longer if economic conditions on the Continent do not improve.

Like a piece of classical music in which the instruments and melodies are introduced one by one, building to a harmonious crescendo, several of the themes that have arisen in Europe in the past few years may soon all be playing at once. Next year, a combination of nationalist and anti-establishment sentiments, unresolved north-south frictions, a lurking migration crisis, regionalization, fragile banking sectors and inefficient decision-making could surface, widening the cracks in the Continental union.

In theory, none of these problems alone would be serious enough to destroy the eurozone within the next 12 months. But together they could prove too much for the eurozone to withstand. Though the collapse of the currency union next year isn’t likely, it is possible, ensuring that 2017 will be the most crucial year for European integration since the Continent’s many crises began.


The Year That May Decide Europe’s Fate is republished with permission of Stratfor.