“Europe was created by history. America was created by philosophy.”

– Margaret Thatcher

“Nobody in Europe will be abandoned. Nobody in Europe will be excluded. Europe only succeeds if we work together.”

– Angela Merkel

Today we’ll continue our world tour with more advice for the next president. Speaking of whom, lLast week’s primaries narrowed the race a bit. Marco Rubio is out of the GOP running, and Bernie Sanders is lagging further in the Democratic delegate count. The next few weeks will be interesting. An open Republican convention in Cleveland is very possible, a possibility I wrote about in a recent letter from the point of view of someone who has been deeply involved in very large, raucous, and open political conventions. I was trying to give you some insight into the mechanics of such an event. While an open convention might be fun from an entertainment perspective, I think I would prefer a clean win prior to the convention. I find it really fascinating to think that the race might actually come down to California, the last state primary and one with a potentially deci sive number of delegates.

One thing is sure: somebody will take the ball from Barack Obama next January 20. Whoever it is will face a world full of challenges, economic and otherwise. Last week we flew west and reviewed Japan and China. Today we’ll continue the trip.

By the way, please don’t take offense if I skip over your country or region. It likely means your problems are relatively minor on the global scale of things. You may not want whatever “help” our new president offers, anyway. Now, on with the letter.

An Open Letter to the Next President (continued)

Dear Presidential Candidates:

One of you may move into the White House next January, and you’re going to have your hands full. Last week I gave you my thoughts on Japan and China. Today we’ll take Air Force One further around the challenging world you hope to lead. I hope you’re ready.

We’ll start with a dip Down Under. Australia is an important American ally. It was also, until recently, a big resource supplier to China. Its huge, high-quality iron ore reserves and convenient location ensured Australia an important role in China’s massive infrastructure binge.

With that binge now winding down, Australia’s economy and currency are struggling. The country spent several years gearing up to accommodate Chinese demand that is now gone, or at least greatly reduced. On the plus side, wealthy Chinese citizens are finding Australia a convenient place to buy real estate, propping up what to the rest of the world looks like a housing bubble. This trend could persist for some time if China maintains its capital controls. But as you enter office, Australia will be economically fragile.

Your challenge, Mr. or Mrs. President, will be to help Australia economically so that they can afford to continue their cooperative stance as our allies in various endeavors around the world. The same goes for New Zealand, for whom China is now an important agricultural customer. The Aussies and Kiwis I know typically want strong ties with the US, and I believe those ties will remain close. These two countries have been willing partners of the US, but their budgets are being strained, and domestic priorities are coming to the forefront.

This observation brings me to an important point. You will find as president that your power is not absolute. Circumstances are going to dictate what you can and can’t do. You won’t be able to fix everything, but you will be able to make every situation worse. Resist the urge to “do something” simply because you can.

Subcontinental Opportunity

When your predecessor, Barack Obama, promised a “pivot to Asia,” he was talking mostly about China. India is equally important, but many Americans forget about Asia’s other mega-state. You need to pay attention to it.

India and China may look like neighbors on a map, but they are worlds apart. George Friedman explained recently how the Himalayas make a China-India military conflict all but impossible. Neither country has ever been able to invade the other or even conduct very much cross-border trade across the world’s largest mountain range, so the two nations have grown to their present gargantuan size independently. India has been regularly growing at 7%-plus GDP per year.

Your Indian counterpart, Narendra Modi, is now almost two years into a much-needed economic reform plan. India does not have China’s vast export industries. Services comprise almost a third of India’s exports, mainly call centers serving the English-speaking  West. Modi is wrestling with an entrenched bureaucracy, crumbling infrastructure, and a fast-growing labor force. But he is making progress. Roadbuilding has accelerated to more than ten miles a day from barely one mile a day just a few years ago. Modi is beginning to put a damper on the rampant corruption in the bureaucracy and is actually making the bureaucracy accountable. His has been a very tough job.

In an experiment to watch, India is assigning a biometric digital identity to every citizen so that the government can pay subsidies directly into citizens’ bank accounts and thus prevent the money from falling prey to a corrupt and incompetent bureaucracy. India is also putting money into its banking system, which has needed a boost. Indian banks are under pressure (a story that is being repeated all across the world, highlighting the fragility of our global financial system).

Geopolitically, India bridges South Asia with the Middle East. Its uneasy relations with Pakistan give India an interest in promoting Middle East stability and trade, but given everything else that is happening in the Middle East now, achieving that end won’t be easy.

Mideast Maelstrom

American presidents since Nixon have tried to bring peace to the Middle East. Some came closer than others. You will have to try your hand, too, but the odds are against you. The entire region remains a powder keg, and the situation you inherit will have added complexity and instability.

Saudi Arabia’s oil wealth once let it enforce relative calm on its neighbors. That era is now over, as George Friedman and I explained in our recent report.  Oil prices stuck at $40–$50 per barrel are forcing a massive Saudi budget shift and draining enormous amounts from their sovereign wealth fund. By some estimates, if the country maintains its current budget, it will run out of cash by 2021. Which of course means it can’t maintain its current budget. The Saudi royal family is trying to build a cushion for the inevitable hard landing. Their success, or lack of it, will be outside your control, but the outcome will dictate your options.

Saudi Arabia has been offering major financial support to Egypt and other Middle East countries. How long the Saudis will be able to continue to do so is a question that you will need to answer in order to be prepared for whatever exigencies arise.

Across the Gulf from Saudi Arabia is Iran, where implementation of the Obama nuclear deal is proceeding at an unsteady pace. Here you have an opportunity to make something happen. There are two schools of thought. One posits that the single best way to keep Iran from threatening its neighbors, including Israel, is to reintegrate the country into the global economy, since countries that trade with each rarely resort to war. A big barrier to that process is decades-old US economic sanctions on Iran that Congress refuses to lift. The other school of thought asserts that renewed sanctions and further financial repression are required to force Iran to give up its nuclear ambitions. While most people focus on the political implications of the US–Iran deal, the economic implications might have even more far-reaching consequences. Formulate your Iran policy wisely.

The Middle East is, of course, complicated by the presence of ISIS. Fighting ISIS requires money, and the nations that have been working with us are going to be financially constrained. For the moment, fear of ISIS is spurring many in the Muslim world to flee toward Europe, a continent with its own problems. Dealing with the refugees in cooperation with the Europeans may be one of your greatest challenges as president.

The Russian Dilemma

Russia is another commodity exporter that is under tremendous economic pressure. The Russians are running through their dollar reserves at a rapid rate; the country is in recession; and a turnaround doesn’t appear imminent. They are reportedly cutting their budgets by 10%, including education and social welfare. Just think about how hard it would be to get through the US Congress a bill that would halt increases in spending for a few years—never mind cutting spending by 10%. Theoretically, Russia’s military budget will actually grow a bit, but the realities on the ground mean that the country’s projected 1% growth won’t go very far. Inflation in Russia is now down to just under 10% but has averaged much higher than that over the past year. Everyone is feeling the squeeze.

The fact that Russia is economically challenged does not make the country any less challenging to US interests. Ukraine is clearly in Russia’s backyard, and Russia is obviously opposed to Ukraine’s becoming a NATO member. Thus, Ukraine is now a divided country in a semi-anarchic state.

Let me offer an economic solution to Ukraine. Instead of supporting the various oligarchs who are squabbling over Ukrainian spoils, why not get Ukraine to open up its agricultural industry to outside investment? If Ukraine became productive along the lines of US farms, it could be the breadbasket of all of Eurasia. There has been enormous resistance to outside private capital, but Ukraine could become prosperous in less than 10 years if the country were opened up. This initiative would also create significant new employment and whole new industries supporting agricultural growth in Ukraine, stabilizing the country. And this objective is something that could be achieved without a shot’s being fired. It would mean that entrenched interests would have to be negotiated with, but continuing to pursue the present policy just isn’t working. Just a thought…

European Unity Crumbling

Europe is in economic and political crisis. The last European financial crisis exposed a façade of unity that was never sustainable. The façade will almost certainly collapse before you finish your first term in office. The Eurozone’s breakup has the potential to be the biggest economic crisis you will face. How you handle it will make or break the entire global economy. The problem is that there is nothing you can do to prevent the coming crisis. All you can do is help steer Europe on a course that will result in the least damage to the US economy in particular and the global economy in general.

The European Union was a noble dream, but as happens with most dreams, reality eventually sets in. It is simply not possible to maintain economic unity and a single monetary policy among a collection of states each of which sets its own fiscal policies. The EU subset that shares the euro currency already sees this. The rest of the members will follow soon enough.

Europe’s sovereign debt crisis was the first sign that something was structurally wrong. Germany spent years loaning euros to poorer Eurozone countries so they could buy German-made goods. Other exporting nations within the EU did the same. The resulting trade imbalance had to show itself somewhere. It did, in the government debts of countries like Greece, Italy, Spain, Portugal, and Ireland.

To this point, the attempted solution for outsized debt has been to impose “austerity” measures on those countries while they supposedly restore fiscal discipline. The European Central Bank has bought struggling nations time by depressing interest rates to artificially low levels, but that policy carries its own unintended consequences. The results have been mixed at best. Spain and Ireland are recovering somewhat; Greece, Portugal, and Italy are not.

Italy will probably be your main headache. Its banking system is already breaking down as nonperforming loans proliferate. Nonperforming loans make up almost 20% of Italian banking system assets. Not surprisingly, as you go from north to south in Italy, the percentage of bad loans increases. Some southern banks hold nearly 40% nonperforming loans. (By contrast, you should be thankful that nonperforming loans of US banks are down to a somewhat manageable 1%. During the worst of our banking crisis, US nonperforming loans never rose above 31Ž2%. Italy’s level is almost six times greater, and there is not an economic crisis yet.)

A collapse of the Italian banking system is a systemic risk for all of Europe, which means that it is also a systemic risk for the global economy. Italy is the eighth-largest economy in the world, only slightly smaller than India. But, whereas the world could probably tolerate a major setback in India, Italy is extremely critical because of its economic impact on Europe and thus on the global economy.

Italian government debt is already 132% of GDP and rising. The Italian economy is roughly the same size it was in 2000. Economists have been projecting growth for Italy for nearly all the intervening time, but that elusive growth just keeping slipping farther into the hypothetical future. Italian nonperforming loans represent just under 20% of GDP, yet Italian banks are literally too big to save. Further, another 10% of GDP and more would likely go up in smoke in a banking crisis, in the form of Italian bank bonds that have been sold to the general public as safe-yield vehicles.

There are negotiations underway to create a “bad bank” in Italy and somehow sell its paper to the public. That bad-bank debt would of course come with government guarantees, but these would cover only a portion of the nonperforming loans. There is still no agreement for a total solution. Germany is especially wary of committing to cover bad-bank loans of another country, because to do so would set a precedent that could be staggeringly expensive.

Italy is not the only European country with problematic nonperforming bank loans; it is just the biggest such country with the largest pile of debts. There is a laundry list of countries in Europe whose economic problems may not be as big as Italy’s but whose woes are certainly significant and will become much worse if another financial crisis hits Europe. Crises have a way of cascading beyond national boundaries.

Compared to Italy, Greece will seem quite manageable. Obama was able to watch from afar as Merkel and the EU dealt with Athens. You will not have that luxury when Italy craters. It is much bigger than Greece and far more important to the world economy.

Greece remains important for another reason, though. It is the main gate through which fleeing Syrians, Iraqis, and others try to enter Europe. The wealthier states need Greece’s cooperation to keep the flow of refugees manageable.