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Post-Election Insights from Europe
05/14/2012 7:00 am EST
Two European Union countries that have had a tough economic go of it have now had elections, and the results are showing countries tired of austerity without the backingof their central bank, observes Axel Merk of Merk Insights.
With the hangover from elections in the Eurozone lingering, which answer is correct?
- A socialist is in charge in France
- Nobody is in charge in Greece
- None of the above
The good news about a socialist running France is that his honeymoon shall be rather short. It took the previous socialist President, François Mitterrand, two years before he shelved his activist agenda and became a moderate.
The market won’t be that patient; that’s why we pick answer C above: the language of the bond market will be the only language policymakers listen to. The bond market is in charge.
What about Greece? It might be possible to put together a minority government of Antonis Samaras' “New Democracy” and the former ruling “PASOK” party that is tolerated by the “Independent Greeks.” Panos Kammenos founded Independent Greeks after disagreeing to the terms of his country’s bailout when he was a member of the New Democracy.
In the eyes of the Greeks, Germany and the International Monetary Fund (IMF) appear to be in charge. With anger over yielding to demands of those with money, German flags are frequently put on fire during Greek elections.
One way to manage Greece’s future would be to give Greece money with no strings attached, except to tell them that no more money will follow suit. That way, the Greek people will own their own problems and can no longer blame others for their plight.
In practice, Greece is likely to fall into chaos at some point, as the country has been unable to achieve a primary surplus, i.e. be able to operate before making interest payments. The question in our view is where the resulting anger will be focused.
The odds of more liquidity provisions from the European Central Bank (ECB) have increased. We believe the euro will underperform other European currencies; note, though, that the world, including the US, will remain awash in money. The rocky road will continue as policymakers hope for the best, but plan for the worst.
This should bode well for commodity currencies in the medium term; Of these, the Canadian Dollar, Norwegian Krone, and New Zealand Dollar are currently our favorites.
Easy Money Isn't So Easy
Central banks around the world have been under pressure to cover shortfalls in fiscal policy.
At his monthly press conference, European Central Bank President Mario Draghi stuck to his guns, telling politicians to focus on structural reforms to stimulate growth, rather than raising hopes for more easy money from the ECB. Interest rates remain at 1%; the euro reacted positively to Draghi's comments.
Pointing to the experience of how stagflation in the 1970s was overcome, Draghi points out structural reform, not increased spending, is the the proper course of action. Specifically, Draghi calls for fiscal balances, fiscal stability, and competitiveness.
Having said that, the prepared introductory statement of the press conference mentions "growth" 13 times, stressing that "growth and growth potential in the euro area need to be enhanced by decisive structural reforms.
"In this context, facilitating entrepreneurial activities, the start-up of new firms and job creation is crucial. Policies aimed at enhancing competition in product markets and increasing the wage and employment adjustment capacity of firms will foster innovation, promote job creation and boost longer-term growth prospects.
"Reforms in these areas are particularly important for countries which have suffered significant losses in cost competitiveness and need to stimulate productivity and improve trade performance."
Draghi also calls for a vision of how the Eurozone ought to look in a decade, so that such vision can be implemented. A fiscal compact, not a "transfer union" is the appropriate starting point of how fiscal sovereignty can be delegated over time to a central Eurozone authority. The press conference was ahead of this weekend's national elections in France and Greece, as well as regional elections in Germany.
In our assessment, austerity is the easy part. Structural reform is the tough part. With regard to monetary policy, Draghi was notably light. He shed cold water on the notion of re-activating the peripheral bond purchase program (Securities Markets Program, SMP).
He also dampened expectations of a rate cut by emphasizing balanced inflation risks, as well as a gradual economic recovery, albeit with downside risks. He suggested the European banking sector is improving, not only visible in reduced intra-bank refinancing (repo) rates, but also apparent in an increase of the deposit base in peripheral Eurozone countries.
Curiously, just about all actions suggested by Draghi are really outside of the purview of the ECB. We may want to add a comment recently made by Bundesbank President Jens Weidmann: the higher cost of borrowing can also been seen as an encouragement to engage in reform. It appears that the ECB is in line with our view that the one language policymakers listen to is that of the bond market.
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