By Harald Malmgren
In the last two years, European leaders took personal responsibility for the performance of the Eurozone economy by holding innumerable “summits” and proposing a variety of actions.
In effect, the leaders took personal “ownership” of successes or failures of their economies and financial markets.
European voters, no longer confident in their political leaders, are turning out incumbent governments one after another. This seems not so much approval of candidates with new names and faces, but rather disaffection with the names and faces that have been in power during the continuing deterioration of economies since the financial crises began.
A voter rebellion is now overwhelming all of the financial bailouts and ECB monetary innovations that have been at the center of Eurozone leaders efforts to address the financial crises of the last two years.
The recent French and Greek elections brought voters into direct confrontation with the fiscal austerity regime promoted by Germany and the IMF.
But these were not the only elections to have gone against the commitments made by Eurozone leaders.
- Shortly before the French and German elections the Dutch government fell over Eurozone bailout policies “dictated by Berlin.”
- Voters in Italy and Spain tossed out their leaders late last year.
As of May, 11 of the 17 Eurozone member governments have fallen as a result of voter resistance to fiscal austerity measures imposed by the Eurozone’s leaders.
In France, voters chose Socialist Francois Hollande as their next President, ousting Sarkozy and thereby ending the “Merkozy” mutual support arrangement between President Sarkozy and German Chancellor Merkel.
Hollande has promised to reopen the “fiscal pact” which was laboriously negotiated among the Eurozone leaders last year. Merkel declared that renegotiation of the fiscal pact is “not permissible.”
This hard German stance is the result of growing voter discontent inside Germany in opposition to more “bailouts” of Germany’s neighbors. It is also driven by German Constitutional Court rulings that financial transfers among EU members are not permitted by European treaties and German law.
German demands for draconian budget deficit cuts by all Eurozone members as a precondition of any further Eurozone and IMF assistance has been a response of German politicians to their own voters.
In spite of her seemingly dominant role in Eurozone policy making, Merkel’s domestic political power has been eroding as she pursued demands for Euro-wide fiscal discipline.
Merkel sent her new Eurozone fiscal pact to the Bundestag with a request for approval by the end of June.
But politicians in the Bundestag, worried about growing German voter unrest and signs of slackening domestic economic growth, suggested the vote on the fiscal pact should be delayed until much later in the year. It was evident that German politicians had grown wary about the ultimate outcome of Merkel’s “fiscal pact.”
In the background, Merkel’s own CDU party continues to suffer reversals in regional (Länder) elections. On the same day as the French elections her party lost its leadership position in Schleswig-Holstein. On May 13, elections in North-Rhine Westphalia, Germany’s most populous state resulted in yet another CDU loss to the opposition SPD. This leaves the CDU in majority control in only 6 of the 16 Länder.
Thus, Merkel’s grip on German domestic politics is weakening. Ironically, the opposition SPD holds views similar to those of Francois Hollande, the newly elected President of France.
If a clash of Hollande and Merkel over the fiscal pact takes place, and if Hollande demands some new form of economic stimulus to focus on growth alongside fiscal order, German politics will become further complicated.
Germany is scheduled to have national elections next year. To survive personally, Merkel could decide to seek a “Grand Coalition” with the SPD. The SPD supports continued German membership of the Euro and supports the idea of additional measures to assist in maintaining the coherence of the Eurozone membership.
Ironically, the SPD also shares Hollande’s view that fiscal austerity by itself is not politically sustainable, and that a growth agenda is also necessary for the survival of the Eurozone.
Thus, if Merkel were to embrace a Grand Coalition, she would also need to bring her own CDU party into closer alliance with Hollande’s agenda.
This would likely cause ruptures within her own party, and potentially bring confrontation between the government and the Bundesbank, and possibly even the Constitutional Court.
The French Presidential election is likely to reopen all of the fundamental controversies among Euro members during the last couple of years, including fiscal policy, monetary policy, collective responsibility for debt in the form of Eurobonds, etc.
However, the size of the gap between Paris and Berlin will depend upon June parliamentary elections in France. It is not yet clear whether Hollande’s party can craft a powerful coalition in support of his own agenda, or whether voter may shift the parliamentary balance by increasing the numbers of centrists and extreme rightists. In the latter scenario, the French President’s power would have to be shared with a center-right Prime Minister.
The Greek elections had a surprising outcome, with a strong showing of an extremist party of the left, Syriza.
Its leader, Alexis Tsipras, defiantly announced rejection of the IMF/EU bailout packages, and refused to participate in a coalition government. Pasok and the New Democracy Party had wanted to form a government to approve the bailouts, but they failed to gain a majority. If an alliance of other small parties can be formed in support of the bailouts, a confrontation with Germany and the EU could be postponed for a few weeks.
Ultimately, a new Greek election is likely, in mid-June or later, and at that time the Syriza party is likely to take control. Sooner or later, other Eurozone governments will have to decide to try to keep Greece in the Eurozone with further changes in the bailouts, or expel Greece from the Euro and possibly the EU itself.
In the meantime, the new Spanish leadership unilaterally declared noncompliance with the EU’s budget deficit targets.
In response to growing voter rebellions, some EU officials are already talking about providing “flexibility” in interpretation of budget deficit targets. ECB President Draghi has joined in the public debate in support of new emphasis on “growth” in parallel with “fiscal austerity.”
No one has yet elaborated on how “growth” might be supported without tax cuts or increased spending, which would undermine fiscal austerity.
German Finance Minister Schauble just raised the possibility of further monetary easing by declaring that the ECB could tolerate a somewhat higher inflation rate of 3%, and German wages could be allowed to rise within that framework. This opens the way for further innovative monetary measures by the ECB.
All of this political turmoil has taken place even before fiscal austerity has been fully felt.
Up to now, no significant spending cuts have actually taken place. The voter rebellion is primarily about what is planned, rather than what has already happened.
The rebellion is really about rejection of incumbent leaders.
In this context, investors should be mindful of growing uncertainties about politics inside Germany, and not only concentrate attention on the bond markets of Spain, Italy, and France.
In the background, increased attention should also be paid to severe credit contraction spreading through Europe and to other geographic regions as Eurozone banks shrink their assets, sell off major lines of business, and stash their Euros in deposits at the ECB.
These are signs not only of major deleveraging but also of growing fears among bankers of systemic challenges from flight of depositors, continued malfunctioning of interbank lending, and inadequacy of short-term funding upon which Eurozone banks rely.
The EU Commission is forecasting a short, moderate recession coming to an end in Q3. A more likely scenario will be deep, long recession lasting through 2012 and 2013, as the global economy slows alongside significant slowdown in world trade.
It is unlikely that Eurozone political leaders will be able to renegotiate their fiscal and monetary relations with such shaky political foundations under almost all Euro leaders and their parties.
The politics of social unrest will now drive policy making in the Eurozone.
For Dr. Malmgren’s comprehensive look at developments in China associated with a hard economic landing and its political consequences as well as the impact of such dynamics on the evolution of Asian security please see Strategic Inflection Points #1