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Tuesday, 19 June 2012

Ernst's Economy In-depth analysis: Will the elections in France and Greece strike a fatal blow to the Euro-zone?!

The following article was meant to be published by the Singapore-based business magazine 'World Business Magazine' in their August issue. Due to an unfortunate financial dispute, the article has been withdrawn for publication by me. I publish it therefore on Ernst's Economy for You for the benefit of my readers.The article is one month old and may contain facts that have become outdated today.

I want to emphasize that I still fully endorse the contents and editorial quality of World Business Magazine. Therefore I strongly advise interested readers in the Singapore region to grab one of the earlier issues, wherein my previous articles have been published.

Nightmare scenario in France and Greece
Sunday May 6, 2012 was a memorable day in the history of the European Union, that sent shockwaves through the Euro-zone and the financial markets.

In France, the relatively unexperienced socialist François Hollande overcame in two rounds the current, conservative president Nicolas Sarkozy. With a narrow, but decisive margin of 51.7% against 48.3%, Hollande became the next president of France. The defeated former president Sarkozy generously admitted his loss that same Sunday evening.

At the same time in Greece, the legislative elections turned into a disaster for the current government coalition, led by Prime Minister Lukas Papademos. This Sunday the leading coalition parties PASOK and New Democracy lost about half of their voters, to end with only 33% of the votes; nowhere near the majority required to form a new government.

Both the election of Hollande and the new Greek parliament can be considered as a powerful statement that the French and Greek people have had it with the current pro-austerity policy of the European Union. This signal was immediately picked up by the stockmarkets worldwide, that subsequently went through a number of days with serious losses, especially among the financials.

How did Hollande defeat Sarkozy? 

The question how François Hollande defeated sitting president Nicolas Sarkozy is not so easy to answer. Hollande after all didn’t win with a landslide victory and during the first round of the elections, both candidates lost lots of votes to extremist-rightwing candidate and ‘daughter of’ Marine le Pen.

It might be save to state that the eventual victory of Hollande is as much influenced by the past political choices of Sarkozy, as by the personality of both candidates.

In the first place, Sarkozy was a truly conservative president: tough on crime, strongly in favor of private wealth and against a large social security system protecting the poor and disabled. He was a friend towards the people with the highest incomes, while at the same time showing little compassion for the (often colored,) unemployed and undereducated youth in the ‘banlieus’ (the poor areas of the large French cities) and the French low-income factory-workers.  

Hollande promises to be more a president for all the French; a president in favor of an elaborate social security network and good medical facilities, who wants to help young students and unemployed workers by letting older workers retire earlier, instead of later.

According to Bryan Walsh in his Times article ‘Kiss austerity goodbye’, Sarkozy ‘polarized France during his five years in the Elysée Palace’. This would not have been a big problem for his re-elections, when France – just like the rest of the world – had not entered into the worst financial crisis since 1929. After the crisis started, Sarkozy decided to follow the EU policy of saving the troubled, large French banks by investing numerous billions of Euro’s in taxpayer’s money to keep them afloat. This turned the banking crisis into a direct risk for the financial stability of France.

At the same time, the general reluctancy of banks to lend money to small and medium enterprises and private persons caused a deep recession that brought many French companies in trouble and spurred the already high unemployment in France. The French voters were alienated by the fact that the ‘fat cat’ bankers seemed to escape their fate here, while the average ‘Jean-Claude’ in the street had to pay dearly for the events at the financial markets in 2008 and 2009.

Another cause for irritation at the French voters was the almost symbiotic cooperation of Sarkozy with German chancellor Angela Merkel, that delivered the couple the nickname ‘Merkozy’. While Sarkozy and Merkel had little chemistry from a personal point of view, Sarkozy understood that he had few other choices then to follow the German leadership during the crisis.

The reason that this cooperation caused so much irritation among the French, was because Sarkozy followed Merkel’s lead in almost all decisions and didn’t offer enough resistance to her. The French disliked Merkel’s policy of forced austerity without any form of econonomic rebuilding. They also disliked the strictly monetary approach of the ECB towards the sovereign crisis in Europe. While the French and the other South-European countries had been more in favor of using the European Central Bank (ECB) as a political instrument with an active role in spurring the economy, this intention crashed and burned against ‘the Berlin wall’, Angela Merkel. Sarkozy and the whole EU seemed to be on a leash with her. This annoyed the vigorous French.

Another reason that Sarkozy lost the elections might be that the French were just fed up with the personality of their president, who resembled in behavior the 17th century ‘Sun King’, Louis XIV. Again Bryan Walsh in his Time article: He [Hollande] isn't Sarkozy, the temperamental conservative with the supermodel wife and ostentatious taste for wealth […] who famously vacationed after his 2007 win on the yacht of a billionaire friend in the Mediterranean.

François Hollande doesn’t look and act flamboyant, but rather like a friendly, intelligent and very competent civil servant. He has not much charisma, but seems to bind people together, instead of alienating them by his words and behavior. Looking at the French elections, you could say that they were as much a vote against Sarkozy, as a vote in favor of François Hollande.

Impact of François Hollande’s election on France 

François Hollande started his presidential campaign in January 2012 with a programme that has been described by the British newspaper The Telegraph as: ‘Farewell to austerity’.

The pivotal points in his campaign were:
  • A more important role for the ECB in solving the European debt crisis;
  • The introduction of Euro-bonds as a new financial backstop for the union as a whole;
  • Abandoning the 3% budget deficit threshold of the European Stability and Growth Pact (SGP);
  • Deploying possibilities for elderly workers to voluntary step aside in favor of younger workers. This means in fact: lowering the retirement age for workers that want to retire voluntarily;
  • The creation of 60,000 jobs in education, in order to reduce the large number of drop-outs;
  • Reducing the general number of 10% average unemployment in France, by using fiscal and economic stimulus. 
These are very bold statements from a socialist point of view that create large expectations among the French voters. There is of course a big risk in it; when Hollande must abolish too many of his promises during the domestic and European political process, he might lose his credibility towards his grassroots.

Especially the first two bullets of his programme will fall on deaf ears in Germany, being a nightmare scenario for Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble. The general expectation is that Merkel will not give in to the demands of Hollande in these matters.

The fourth bullet will also be hard to achieve in reality. All over Europe, countries and governments are elevating their retirement age in order to fight the consequences of the ageing population and the rising mortality age among the elderly, thus keeping pensions, healthcare and social security affordable. When the French government would lower its retirement age in order to help the younger unemployed, this would be received as an odd signal by the other European leaders. Therefore it is my expectation that Hollande will be forced to drop this plan too.

The other three bullets could be achieved when Hollande shows good steermanship in France and in the European Union.

However, the true problem with all of Hollande’s plans is that they won’t help the ailing French economy a lot and might bring little extra employment, where this is needed so much.  The reason is that Hollande doesn’t seem to address the main problems of the French economy:
  • the many, often struggling, stateowned companies that are not very efficient and competitive, when compared to their German, American and Japanese counterparts;
  • the rigid labor market with its outdated laws, rules and organization;
  • the excessively strong position of the French labor unions who prevent necessary changes in the labor market from happening;
Besides that, these plans all cost considerable amounts of money; money that Hollande probably doesn’t have currently.

Therefore Hollande might have a hard time, as the first socialist president since 1995, when François Mitterand left the Elysée. Although Hollande will definitely receive the benefit of the doubt after the difficult years of ‘sun king’ Sarkozy, his star might not shine so brightly anymore when he encounters too many disappointments in this highly demanding economic situation.

Impact on the EU 

In one thing François Hollande is probably right: his attack of the rigid 3% budget deficit threshold, that is prescribed by the European Stability and Growth Pact, seems to hit bullseye in Europe. The results of four years European austerity policy, since the crisis started in 2008, have been generally disappointing and the economic situation in the whole European Union is currently deteriorating rapidly.

Everywhere in Europe the consumers are waving the white flag and unemployment is climbing to record-levels. Many youngsters feel deprived from their hope for a better future, as youth unemployment in the south of Europe is ranging from 20% - 53% and none of the government leaders seemed to care about it. This might change with Hollande as French president.

During the two weeks after the French elections, a wind of change was blowing through the European Union. Suddenly not all talks were about austerity anymore; instead, there seemed to be room for an agenda of economic growth to help the lagging European economies, like Spain, Italy and France.

Merkel and Hollande seem natural adversaries due  to their different political background, but looks could be deceiving. First, they are as much sentenced to one another as Merkel and Sarkozy were. Both are very well aware of this: Hollande’s maiden voyage as president had as destination Berlin.

Secondly, Hollande might even have one big advantage upon Sarkozy; it was an open secret that the chemistry between Sarkozy and Merkel was virtually non-existent at the beginning of Sarkozy’s presidency.  The flamboyant streetfighter Sarkozy with his supermodel wife Carla Bruni often annoyed the down-to-earth, deliberate and somewhat dull chancellor Angela Merkel. The renowned ‘Merkozy’ symbiosis since 2010 was rather a marriage out of necessity than one out of love. Sarkozy was simply too dependent on Germany to set his own course for France in Europe and Germany needed the political firepower of France to force its will on the other Euro-zone countries.

Hollande and Merkel seem to have much more in common, in spite of their political differences. François Hollande is a friendly, compassionate and somewhat uncharismatic, but seemingly competent leader; just like Angela Merkel. Both probably don’t feel the need to sling soundbites in the air before hundreds of reporters, but rather fulfill a background role. Therefore my expectation is that Merkel and Hollande will soon find a common ground to operate from, again strengthening the axis Paris – Berlin.

While it seems that the political differences between France and Germany are large, it might be not so bad after all. Hollande understands very well that some of the promises he made to the French voters, are in their current form unacceptable to Merkel.

Both leaders will find a compromise on the role of the ECB as economic pacesetter; it will probably have more room for monetary easing than in the times of Jean-Claude Trichet, but not as much room as the Federal Reserve currently has in the US.

Considering the Euro-bonds, both parties will probably find a kind of intermediate EU-bond that could help to spur the South-European economies, but will not fully depend on the Germany willingness and ability to keep the whole European economy afloat.

It cannot be predicted how the financial markets will react to the influence of Hollande on European decision-making. A peculiar phenomena is that the financial markets often applaude European austerity measures, while at the same time cheering for American quantitative easing programmes. In case you applaude both solutions, you are at least wrong once. However, if the chemistry between Hollande and Merkel will indeed be good, this will improve the process of European decision-making that suffered from the cool relations between Sarkozy and Merkel. The financial markets will note this as a positive factor.

The ‘Merkellande’ cooperation will have to proof itself in the very demanding coming months, as tough political decisions seem to ly ahead for the European Union. The best thing that Europe can do now is chosing one direction decisively. When the uncertainty gets out of the financial markets, the spreads on interest rates will diminish for all Euro-zone countries. Partially abandoning the austerity programme in favor of intelligent economic stimulus might be a viable solution for the Euro-zone as a whole.

Greek elections overview 

The results of the Greek elections on May 6 came hardly as a surprise: the Greek citizens were outraged about the relentless and humiliating austerity measures that were deployed on Greece by the so-called troika, consisting of the European Union, the International Monetary Fund (IMF) and the European Central Bank (ECB). Many of them decided to give their vote to the neofascist party Golden Dawn and the extremist-leftwing party Syriza, in what may be considered a protest vote against austerity. The political landscape in Greece that emerged from these elections made it impossible to form a viable government. That is the reason that the date for new elections has been set already.

The socialist PASOK and conservative New Democracy formed with the rightwing-nationalistic LAOS a transitional government, after PM Giorgios Papandreou retired in November, 2011. Papademos, a former counsel to Papandreou, was a well-respected economist and former vice-president of the ECB. He seemed the ideal person to guide Greece through the difficult financial and economic reforms, as his reputation was not stained by scandals or dirty hands that he had to make in the past. His main assignment was to make clear to the Greek population that the harsh austerity measures were a necessary evil, in order to secure Greece’s position in the Euro-zone. He seemingly failed at this task, as the Greeks decided to send his government home.

 Will Greece default from the EU now? 

Many analysts agreed that the outcome of the Greek elections brought the country at least one step closer to an exit from the Euro-zone. The left-wing Syriza party, led by Alexis Tsipras, stated that it didn’t feel bound to the austerity deal that had been posted by the troika and didn’t want to confirm to it. This statement provoked an enraged reaction from Antonis Samaras, the leader of the conservative New Democracy party: “This party asked me to sign for the destruction of Greece. I refuse that”.

The northern Euro-zone countries were already alienated by the reckless Greek spending behavior in the past and the blatant lies in Greece’s Eurostat statistics, painting a much too optimistic financial situation, compared to reality. These countries all approved with heavy toothgrinding the rescue plans for Greece.

Now these countries are getting fed up by the current political flip-flopping of Greece: one day Greece pleas in favor of the strict austerity measures and promises to keep every one of those; the next day, it doesn’t. Empty promises mean empty hands and the Euro-zone’s worst fear is that Greece leaves it empty-handed after investing billions of Euro’s in rescue-packages.

Logically, the European Union shows little understanding for the economic difficulties and financial hardship that Greece is experiencing currently. To put it straightly: Greece should shut up and follow the posted austerity measures to the last syllable. No more discussions. The EU respects the democratic desires of the Greek population, but doesn’t want to renegotiate any subject anymore. If Greece can’t create a government that delivers, it should leave the Euro-zone.

The reason for this firm stance of the EU is that a Greek exit from the Euro-zone is now considered a manageable problem. It hurts badly from a financial point-of-view, but it won’t bring the Euro-zone to its knees, like it would have back in 2010. The ECB and the European emergency funds EFSF (European Financial Stability Facility) and ESM (European Stability Mechanism) have brought the financial backstops that were necessary to contain the Greek situation. Although the EU officials and political leaders from the leading Euro-zone countries officially denied that they aim towards a Greek exit strategy, the signs and hidden messages in the official statements can hardly be misunderstood. This explained the very tense situation on the financial markets during these early weeks of May.

Whatever happens, a EU policy change towards more economic growth that might have been ignited by François Hollande, will probably come too late for Greece. This country seems destined to leave the Euro-zone and subsequently  turn into a third-world country within Europe. The distrust between Greece and the other Euro-zone countries is simply too big to heal in the coming years.

Although many European leaders consider a Greek exit not to be fatal to the European Union, this opinion is not shared by all economic analysts. Especially renowned analysts like Paul Krugman and ‘Doctor Doom’ Nouriel Roubini are very pessimistic on the future of the Euro-zone. The former stated recently in a New York Times article:   Suddenly, it has become easy to see how the euro — that grand, flawed experiment in monetary union without political union — could come apart at the seams. We’re not talking about a distant prospect, either. Things could fall apart with stunning speed, in a matter of months, not years. And the costs — both economic and, arguably even more important, political — could be huge.

So while I don’t expect the election of François Hollande  to strike a fatal blow towards the Euro-zone, it still might be that a Greek exit from the Euro-zone is. That isn’t a very promising prospect.

Epilogue June 19, 2012:
In the meantime the second round of the Greek legislative elections have been held. These elections delivered a workable majority for the parties Pasok and New Democracy. Although this seems good news for Greece, it brought little relief at the financial markets. 

There are four good reasons for this disappointing reaction:
  • The situation in Spain is still considered to be too serious for relief. Interest has been soaring above 7% today and everybody is expecting the European Central Bank to step in to prevent from further damage;
  • The winner of last weekend's election, Antonis Samaras' New Democracy, is considered to be the bad genius behind the massive fraud with statistical data in Greece in past years. Although Samaras stated to follow the measures of the troika IMF, EU and ECB to a tee, his track record is hardly promising for real progress in the Greek situation;
  • There are no signs that the Greek economy is improving currently. To the contrary: the economic situation is only deteriorating currently and there is a serious capital-flight going on in Greece;
  • Finally, there is still no united stance within the European Union. The Netherlands, represented by PM under resignation Mark Rutte, is persevering its role as cross-grained agitator that is stopping real political progress within the European Union, even when Merkel seems prepared to take the necessary steps.
Therefore I am afraid that the inevitable outcome will be that Greece leaves the Euro-zone. Something that might be considered a historical mistake in years to come.

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