Austro-Italian ironclad arms race
Austria's defeat in the Seven Weeks War forced Austria to determine a new set of foreign and domestic policies for the future, as Austria's interests since the days of the Holy Roman Empire had primarily been found in Italy and Germany. The Empire thus reformed itself into the Austria-Hungarian Empire following the adoption of the Austro-Hungarian Compromise of 1867 (German: "Ausgleich"), which re-established the sovereignty of the Kingdom of Hungary and placed Hungarians within the Empire on an equal footing with Austrians. Under the "Ausgleich", Emperor Franz Joseph I would be crowned as King of Hungary, while a separate parliament at Pest with powers to enact laws for the lands of the Holy Crown of Hungary would be established.
Luxembourg Crisis
When Austria and Prussia did go to war in 1866 (the so-called Seven Weeks' War), the result was a shock to Europe. Prussia quickly defeated Austria and her allies, forcing Austria to the negotiating table. Napoleon III offered to mediate, and the result, the Treaty of Prague, dissolved the German Confederation in favour of a Prussian-dominated organisation, the North German Confederation.