DAVID MALPASS;EUROPE’S ELECTIONS: THE LOW END OF EXPECTATIONS
The result of today’s European elections was at the low end of expectations.
Greece’s traditional parties did poorly. Conservative New Democracy got less than 20% of the vote and socialist Pasok less than 14%, falling into third place behind a new leftist coalition party. The Greek president will give first place New Democracy three days to form a pro-compliance coalition government, which is unlikely. The president will then turn to the second place party to see if it can form a coalition pulling together the anti-compliance parties.
Whatever the eventual coalition structure, we don’t think Greece will comply with its typically anti-growth IMF program (i.e. VAT tax increase, property tax imposed, large debt payments and continuation of big government.) One early test: under the austerity program, Greece’s government is supposed to lower the minimum wage in an effort to regain competitiveness and boost employment, but will have trouble carrying that out. We think Greece’s austerity program, especially in the first rounds, should have been applied mostly to the government itself including the large lifetime pensions for politicians, parliament’s staff, the Brussels’ staff, and government-owned assets.
With a diminished chance of the third quarter EU/IMF disbursement, we expect the Greek government to run short of cash because: 1) the election results will further depress tax payments, causing a near-term deterioration in Greece’s still-large fiscal deficit; and 2) the results discourage making investments in Greece and holding bank deposits there, increasing the flow of euros from Greece to German and Swiss banks and into euro paper money. The action-forcing-event is how long Germany, the Bundesbank and the ECB continue to allow Greece to fund its cash shortfall by hollowing out the remaining assets of its commercial banks and the Bank of Greece. (The fragile euro-system forbearance process is discussed in our previous pieces and relates to under-collateralization, ELAs, target 2 imbalances, the ability of banks to operate with declining or negative net worth, etc.) Complicating the issue, the election results included 20 neo-nazis among the 300 Greek parliamentarians.
In France, President-elect Francois Hollande won 52% to 48%. We think the fiscal pact will proceed toward ratification, but Europe will now begin work to add an undefined “growth compact,” causing more summits, delays and policy uncertainty. The growth pact might involve more funding for the European Investment Bank and more pressure for an EU-wide financial transactions tax with the proceeds spent on government investments. We think Germany will try to work with France’s new government, pushing the UK further to the outside. We don’t expect ECB bond buying or EU joint liabilities to come out of the growth discussions (see discussion of Germany’s election below).
Regarding France’s domestic policy, Hollande will probably get a honeymoon from voters, though whether he gets much of one from bond markets depends on his opening policy statements. Hollande displays an attractive personal frugality and has promised to lower his own salary and other government wages. This would be a symbolic plus if he can carry it out quickly. We think austerity for the government is pro-growth whereas the impact of austerity imposed on the private sector during a slowdown depends on the details.
Holland’s growth program probably can’t add much to the government’s direct spending given the growing fiscal deficit and widening bond spread. Instead, we expect more mandates on the private sector in an effort to force increased investment and hiring. If aggressive with this, we think it would have the opposite effect, pushing France more quickly into a double dip recession (joining the UK and Spain.) In addition to advocating a 75% millionaire’s tax, Hollande has advocated an extra corporate tax on un-reinvested profits (i.e. dividends and excess retained earnings) as a way to force corporations to invest more in France.
One unknown is how the French election will affect structural adjustment programs in the periphery. Hollande has criticized austerity. This may influence the relationship between the troika (IMF, ECB, EU) that evaluates structural reforms and the governments of Ireland, Portugal and Greece. In Italy and Spain, the new French viewpoint might undermine and give justification for keeping big governments. If so, it could widen bond spreads and accelerate credit downgrades.
The most important long-term issue is whether the change in Europe’s political direction ends up undercutting Europe’s clear resolve to keep all 17 countries in the euro until the broad crisis is over. We think Europe could someday develop an orderly, legal, voluntary exit strategy for say Greece, but not until credit spreads in the other 16 are much narrower. If social and economic conditions in Greece deteriorate to the point of a disorderly departure from the euro, we think it has very negative implications for the periphery and the global outlook.
Germany held a state election in Schleswig-Holstein today. The election result will swing the state government from CDU to a likely CDU-SPD coalition. The Christian Democratic CDU took 30.5%, Social Democratic SPD roughly 29.5%, a much-diminished FDP 8.3% and the new Pirates party 8.2% (it advocates internet privacy and freedom).
Even so, we think Chancellor Merkel, whose popularity is higher than her CDU party’s, a rarity, will have substantial control of debt policy through the November 2013 elections. Her views will probably hold sway on European policies on structural reforms, greater official resources, EU joint liabilities (i.e. EU bonds, euro-zone bonds, euro-zone bills, EU guarantees of sovereign debts) and even the tolerance of the ECB and Bundesbank for euro-system imbalances and under-collateralization. We don’t think Merkel’s views will change based on today’s elections, but will instead evolve with developments. Greece’s election poses immediate problems, while France’s creates a longer-term challenge to the euro-zone’s policy direction.
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