The conversation might be different, too, if the youth turnout had been higher. Voters under 25 went decisively for Remain – but most of that age group didn’t vote at all. There were lots of stories about young people complaining about the vote, but they shouldn’t be complaining about older people’s leanings; they should be complaining about their cohort’s not voting.

We should also note that the Brexit vote very nearly didn’t occur at all. David Cameron made a terrible mistake by promising a referendum if his Conservative Party took control in 2015. He did win, so of course he had to deliver, but his original promise was to allow a vote by 2017. He could have delayed another year or more. The outcome might have been the same, but at least he would have had more time to make his case.

As it happened, the whole process unfolded very quickly. Cameron announced the referendum date on February 22, so Brexit went from “unlikely” to “certain” in just four months. It’s a good reminder of how fast the world can change.

The Six Surrender

I spent considerable time last week discussing Brexit with my good friend George Friedman of Geopolitical Futures. If you haven’t done so already, check out his Monday This Week in Geopolitics letter and the Outside the Box Special Edition I sent on Tuesday.

George’s opinion is invaluable to me because he is the most dispassionate person I know. He analyzes geopolitics by looking at facts and following them wherever they lead. George is no one’s cheerleader or nemesis. He calls the shots exactly as he sees them, and he’s usually right.

As for Brexit, George says it is the logical consequence of the European Union’s decisions in recent years. Some country was going to take this step. As it turned out, the UK was first, but it would have happened somewhere eventually.

George also excels at distinguishing between political posturing and actual messages. He was not at all surprised to hear the EU bureaucrats in Brussels instantly take a hard line after the vote. Of course they say they’ll treat the UK harshly. Bureaucrats, and especially those of the EU Commission, always resist when someone tries to escape their grasp.

The important point to remember is that the EU Commission, which is the executive body that implements policy, is not in charge of the EU. The leaders of the member states, collectively called the European Council, are the real power. (Europe is a hodgepodge of governmental authorities. You need a cheat sheet to know who is doing what to whom.) And within the European Council is a smaller group of powerful states that usually get their way. Their opinion is what counts. So what did they think of Brexit?

Last Saturday the foreign ministers of the so-called “EU 6” original members (Belgium, France, Germany, Italy, Luxembourg, and the Netherlands) issued an unusual joint statement. For Europe, that is moving lightning fast. The statement leads off with the usual platitudes about the EU’s magnificent achievements, then expresses regret at the UK’s decision to leave. But then we see reality begin to seep in. These Inner Six countries basically said, “Okay, we get it, some people are justifiably upset. Maybe we haven’t run this railroad quite as well as we should have. We are going to listen to you and change.” Now here’s the key paragraph of this short statement (emphasis mine):

It is to that end that we shall also recognize different levels of ambition amongst Member States when it comes to the project of European integration. While not stepping back from what we have achieved, we have to find better ways of dealing with these different levels of ambition so as to ensure that Europe delivers better on the expectations of all European citizens.

This is a big deal. The Brexit vote made it inevitable that smaller and less wealthy members will try to follow the UK out. The EU 6 have little choice but to drop their hard line and look for compromise. George and I both read that statement Saturday afternoon, sitting around his pool in Austin, and we came away with the same “aha!” moment. The acknowledgement of “different levels of ambition” was a message to those less-advantaged countries, essentially saying, “Don’t go away. We can negotiate.”

But that wasn’t the end of it. The full European Council met to discuss Brexit on Wednesday, with the UK’s David Cameron leaving the meeting early as the other 27 countries pondered their next moves. Their statement reads much like the earlier one from the EU 6.

Here is the key part, again with my bold highlights.

5. The outcome of the UK referendum creates a new situation for the European Union. We are determined to remain united and work in the framework of the EU to deal with the challenges of the 21st century and find solutions in the interest of our nations and peoples. We stand ready to tackle any difficulty that may arise from the current situation.

6. The European Union is a historic achievement of peace, prosperity and security on the European continent and remains our common framework. At the same time many people express dissatisfaction with the current state of affairs, be it at the European or national level. Europeans expect us to do better when it comes to providing security, jobs and growth, as well as hope for a better future. We need to deliver on this, in a way that unites us, not least in the interest of the young.

7. This is why we are starting today a political reflection to give an impulse to further reforms, in line with our Strategic Agenda, and to the development of the EU with 27 Member States. This requires leadership of the Heads of State or Government. We will come back to this issue at an informal meeting in September in Bratislava.

Strip away the banalities and we again see the EU leaders recognizing how the game has just changed and acknowledging that they need a different approach to governance.

The conclusion of the statement is important, too. They will “come back to this issue” in September. What happens between now and then? Probably a series of informal, closed-door meetings among the members. Factions may form as they each set priorities and seek allies.

We’ll probably hear a lot of conflicting rumors in the coming weeks, but the important point is clear: Brexit changed everything. Formerly settled issues are back on the table. They won’t be resolved next week or even next month. The resulting uncertainty won’t be good for markets, but I think it’s likely the situation will fall off the front pages as the media move on to other stories. We have two political conventions coming up in the US, for example. That will take the spotlight off Brexit for a while.

That being said, pay very close attention to whether it is the EU Council or the EU Commission that gets to take the lead role in negotiating with Britain. This point is already the subject of a very acrimonious debate in Europe. If the Commission (basically the Brussels bureaucracy) wins, they will want to punish Britain. If the EU Council gets the right to be the lead negotiator, they will want to try to figure out a way to make it all work, especially trade and commerce. The lawyers from both sides are arguing forcibly that it’s their team that should be responsible for the negotiations. This is a legal battle with real consequences.

Fundamental Reality

While the other 27 plot their next moves, the UK will be dealing with its own leadership vacuum. David Cameron’s resignation set off a frenzy of activity within his Conservative Party as well as the opposition Labour party. This New York Times story explains some of the parliamentary maneuvering. It is a mess. One scenario would involve Cameron’s party having to vote no-confidence in itself.

There have been several people that have thrown their hat in the ring, but notably Boris Johnson made it clear he was not running. It is also clear that he would like to be prime minister some day, but (my speculation) knows that whoever actually is tasked with negotiating with the EU is likely to make everyone mad, because any ultimate resolution is going to require numerous compromises. He doesn’t want to appear to be compromising. But the compromise required for resolution ultimately means everybody’s ox is going to be gored a little, or maybe even a lot. Given the nature of British politics, being associated with this agreement, unless we see some miraculous changes of heart all around, is not the material from which a long-term residence at 10 Downing St. is gained.

In any case, someone will eventually become prime minister and have to deal with Brexit. Whoever it is will face the same fundamental reality as the EU. Neither side can afford to sacrifice trade with the other. Germany in particular must maintain free trade with both the UK and the rest of the EU. That part is non-negotiable.

Exports account for around half of Germany’s GDP. This is already presenting challenges as economic weakness reduces sales to China and the rest of the EU. If barriers go up to reduce trade with Britain and the US slips into recession (which I think is quite possible in the next year or two), Germany will have two very serious problems.

First, unemployment will rise and tax revenue will fall, stretching the country’s social insurance programs.

Second, unemployment will rise in other states that trade with Germany, sending workers from those places to what will still be the EU’s strongest (or least-weak) economy: Germany. And Germany can’t very well complain about the influx of foreigners at the same time it scolds the UK for resisting foreign workers.

How that situation will sort out is anyone’s guess. The German economy is an industrial export machine, one of the best in history. That’s great as long its customers keep buying – and a huge problem if volume dries up. China is dealing with shrinking export volumes right now. Germany will face a similar challenge soon.

This is why, whatever Angela Merkel says for public consumption, I expect her to be very flexible in dealing with the UK. To this point she and the other EU core have tried to hold a hard line, threatening dire consequences for the UK as a signal to other potential defectors. Tough talk isn’t working, and I think they now realize that tactic won’t ever work.

Merkel, or indeed anyone who might take her place in the coming years, is in a box. Germany must keep the export machine running. That means preserving free trade with every large market in the world, including the UK. Germany will sacrifice whatever it takes to accomplish this.

The result could be a very different Europe a few years down the road. But other problems will pop up first.

The Italian Job

Italian banks have a big problem: something like €400 billion in nonperforming loans. Imagine a much larger version of Greece (in terms of total government debt and banking problems) only a few years ago, and that’s Italy. The Italians have successfully extended and pretended for years, but working that magic gets harder every day. With the banks, government debt, the refugee crisis, and now Brexit, Italian Prime Minister Matteo Renzi has his hands full.

The EU’s harsh demands haven’t helped. Do you remember the Cyprus bank crisis back in 2013? Italians do. They saw EU authorities enact “bail-in” arrangements that forced large depositors to take haircuts on their accounts.

For Americans, recognize that the EU has no central deposit insurance comparable to our FDIC. They consider deposit insurance a responsibility of each nation. EU rules prohibit members from bailing out banks with taxpayer money and practically force bail-ins.

Italians know this very well. They also saw what happened in Cyprus. Renzi has been asking for a Band-Aid of €40 billion for quite some time. The EU bureaucrats have basically been saying no. But that was before, and this is now. In a surprise move late Thursday, they somehow figured out that maybe they could find a rule or two in their big old rule book that would allow them individually to help Italy. Voila: “The European Commission on Sunday authorized Italy to use government guarantees to provide liquidity support to its banks, a spokeswoman said, disclosing the first intervention by a European Union government into its banking system following the UK vote to leave the EU.” (WSJ)

Then, just a few minutes ago, Pippa Malmgren tweeted this, from Zero Hedge. Seems the Band-Aid is now the original €40 billion in direct capital injections plus €150 billion in Italian government guarantees to its banks; and Angela Merkel, who just last Monday stated emphatically that there would be no bailout for Italian banks, will apparently have nothing more to say about it. Oh, and (says the Commission) “… only solvent banks would qualify for the liquidity support program, which has been authorized until the end of the year.” As Zero Hedge wryly notes, “The problem is that with €360 billion in NPLs, every bank in Italy is insolvent, which implicitly means that they will all be found to be solvent or otherwise nobody will benefit.”

This is just the beginning of accommodation in Europe. New Europe, new rules.  Given the two public statements above by the EU Council and then the unusual banking relief given to Italy in the space of a few days, it is obviously beginning to dawn upon European leaders that, if they want to hold it together, things are going to have to change.