Can a French Socialist Save Europe?

04/27/2012 9:00 am EST


Jim Jubak

Founder and Editor,

The austerity plan to save the Eurozone from its debt crisis is failing, but does anyone have a better idea? An upstart candidate in France just might, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.

So what’s Plan B, Europe?

Austerity, the Eurozone’s Plan A for ending its debt crisis, looks to be falling apart. And my fear is that there is no Plan B.

How scary and potentially dangerous can life be without a Plan B?

During the last family vacation I ever took with my parents, I remember calling out from the back seat, "Hey, the gas is on empty, and that signs says ’Next exit last gas for 46 miles.’" My dad, who never wanted to stop once he got rolling, was driving, and my mom, who loved to plan, was riding shotgun.

Needless to say, we passed that exit without slowing. I watched, fascinated in the way that a mouse is fascinated by a rattlesnake, as the needle sank further and further below "E."

My mom, I’m sure, was fuming. And my dad? Did he have a Plan B?

This was 1965, and we were on an almost-empty stretch of newly completed interstate in Montana. What could we have done except coast to a stop and wait for a state trooper to come along—eventually?

I can still feel my relief as we finally rolled in to a gas station. I don’t think my father was joking when he said, "I’ve never seen this car take so much gas." I know my mother didn’t find it funny. (And, as I said, it was the last family vacation we ever took.)

My dad lucked out. His lack of a Plan B didn’t leave us stranded on the side of a deserted highway. The Eurozone countries don’t look like they’re going to be that lucky. If they want to avoid another—and quite possibly more damaging—round of the Eurozone debt crisis, they need a Plan B.

And maybe, just maybe, there’s a glimmer of a Plan B emerging from the unlikeliest of sources: French Socialist and anti-European-fiscal-discipline-pact presidential candidate François Hollande.

A Pact That Can’t Stay Intact
On January 30, 25 of the 27 European Union countries agreed to sign on to a German-sponsored pact designed to ensure budget discipline among Europe’s economies.

It was a moment of triumph for German Chancellor Angela Merkel, who had pushed to make a promise of budget discipline binding. It was also a win for Eurozone politicians who had argued that a tighter fiscal union with stricter limits on the budgets of member nations was the way to solve the Eurozone debt crisis.

"It is the first step toward a fiscal union. It will certainly strengthen confidence in the euro area," European Central Bank President Mario Draghi said then.

The logic was simple—countries would demonstrate discipline by passing austerity budgets with big cuts to spending and significant increases in taxes, and that would restore financial market confidence in Ireland, Portugal, Greece, Spain, Italy, and France. That would in turn enable these countries to borrow in the financial markets at reasonable interest rates.

Growth would then resume—aided by economic reforms passed along with the austerity measures—and the debt crisis would be over.

But now, about six weeks after European leaders signed the treaty embodying that "solution," it is in tatters:

  • Spain has already tried to unilaterally reset its budget deficit targets for 2012.
  • A coalition government in the Netherlands resigned when a coalition member refused to support a budget designed to get the country’s 2013 budget deficit down to the 3% European Union target.
  • On April 25, Ireland’s union movement said it couldn’t support the treaty in the upcoming referendum. Opinion polls show 30% of Irish voters in favor, with 23% against and a huge 39% undecided.

An Irish no vote—like that of 2008, when Ireland initially rejected the Lisbon treaty amending the basis treaties that are the foundation of the European Union—wouldn’t kill the budget-responsibility pact.

But it would create a financial market crisis, since the pact says that any country that rejects the pact is ineligible for funding from the European Financial Stability Facility, which currently underwrites Ireland’s rescue package.

But the biggest blow to Plan A has come from France. Challenger Hollande has run on renegotiating the pact, and incumbent Nicolas Sarkozy has moved closer and closer to that position in an effort to catch up before a second round of voting, on May 6, decides who will be the next president of France.

To stand any chance of winning, Sarkozy must move closer to the anti-Eurozone stance of the National Front’s Marine Le Pen. Le Pen’s extreme right-wing party came in a strong third, with 18% of the vote (to Sarkozy’s 27% and Hollande’s 28.6%).

NEXT: Austerity Leads to More Austerity


Austerity Leads to More Austerity
Plan A has run into two big problems. One is economic. The pain of austerity budgets has produced shrinking economies and more pain, which combine to create a need for even more austerity.

To use Greece as an example of how this has worked: On April 24, the Bank of Greece forecast that the Greek economy will shrink by about 5% in 2012, for a fifth consecutive year of contraction. That’s worse than the 4.5% drop for 2012 that the bank had previously projected.

Unemployment, the bank predicted, will rise to 19% in 2012 from 17.7% in 2011. Some 250,000 of the 1 million companies in Greece in 2009 have closed since then.

Some of that contraction is due to the budget cuts and tax increases introduced by the Greek government as it attempts to cut its deficit to meet the targets set by the International Monetary Fund, the European Commission, and the European Central Bank.

You can see the process at work if you compare the most recent figures and projections on the Greek economy and budget deficit to where the country thought it stood in November 2011, when the coalition government presented the 2012 budget plan to parliament.

At that point, the government thought the budget deficit for 2011 would be 9%—not the 10.3% it turned out to be. The government then thought the cuts and taxes in that budget would reduce the Greek budget deficit to 5.4% in 2012.

But at that point, the government was projecting that the Greek economy would contract by just 2.8% in 2012, with an unemployment rate of 17%. If everything goes according to plan, Finance Minister Evangelos Venizelos told a press briefing that November, the government would not need to introduce further austerity measures.

It didn’t go according to plan. As the economy shrank, Greece had to find an additional $4.4 billion in budget cuts in February to keep rescue funds flowing.

And it looks as if whichever party wins the May 6 national elections will have to come up with an additional $14.5 billion (about 5% of Greece’s gross domestic product) in budget cuts for 2013-2014, according to the International Monetary Fund. Those cuts could shrink the economy yet again.

No One Votes for Austerity
The other problem is political. Voters aren’t in a mood to sign on to what is apparently an endless round of budget cuts and falling living standards.

They have thrown out governments in Ireland, Portugal, Spain, Greece, and Italy. And it looks as if they’re about to throw out governments in France and the Netherlands. In countries where they’ve already replaced a government once—such as Spain—the new governing parties are seeing support erode.

The new governments are either coming into office with hostility toward the austerity of Plan A or are being pushed in that direction by the rise of smaller parties running on platforms of "No to the euro, No to austerity, No to immigration, No to globalization, and (as one columnist in the Financial Times said of the French election) No to the 21st century."

This first eroded and then, with the fall of the Dutch government and the likely defeat of Sarkozy in France, crippled the political alliances that pushed Plan A through. Germany has lost critical French and Dutch support, and finds itself increasingly isolated, with only the Finnish government reliably in its corner.

Some in Germany have reacted to this by simply repeating, in a louder voice, prior arguments for fiscal discipline. For example, on April 23, Jens Weidmann, the head of Germany’s central bank, responded to calls by the European Central Bank to do more to support the Eurozone economy by saying that the central bank has already done a lot, that monetary policy is not a panacea and that action by central banks can’t substitute for inaction by governments on budget cutting.

I don’t know how Weidmann’s comments on "inaction" on budget cutting went down with voters in Greece and Spain, for example. But I think the head of the Bundesbank is lucky he’s not a politician.

Saying No to a Growth Plan
German Chancellor Merkel is unlucky enough to be a politician. She is faced, on the one hand, with deep opposition in her own party to any more money from Germany going to rescue other Eurozone countries, and, on the other hand, with understanding the disintegration of her alliance behind Plan A.

In recent days, that has pushed Merkel to endorse European Central Bank President’s Draghi’s call for a growth pact to go with the already approved fiscal pact. But if you looked at what Merkel has actually proposed, and the details provided by other German officials, this growth pact is really just warmed-over Plan A.

The austerity package has always called for structural changes to national economies that are intended with time—a decade or more—to increase the competitiveness of these economies. Plan A’s growth plan is to reduce wages in these economies enough to make their products competitive on world markets, and to introduce economic reforms that would increase the global competitiveness of these economies.



If that’s what Merkel and her government mean by a growth package, it’s sure not what France’s Hollande has proposed.

While not backing away from France’s pledge to reduce its budget deficit to 3% of GDP (because that would freak out the financial markets), Hollande has suggested that the European Central Bank’s mission be expanded to include economic growth along with inflation fighting—which would bring the bank in line with the Federal Reserve’s dual mandate. This has been emphatically rejected by the German members of the European Central Bank’s governing board.

He has also said he would favor giving bank status to the European Stability Mechanism, the Eurozone rescue fund that is to go into operation in July, so it could borrow from the European Central Bank. Merkel has rejected that idea.

Hollande has also brought up the idea of Eurozone bonds that would be backed by the Eurozone economies as a whole. That’s an idea that Germany has repeatedly rejected.

Does Hollande Have a Viable Plan?
And that’s where we stand now. Plan A no longer has the political support to form the backbone of the Eurozone response to the crisis.

It increasingly strikes the financial markets as a failed policy. And it has produced so much pain in the countries now struggling to meet austerity targets that it threatens to push governments in those countries into positions that are hostile to the Eurozone project as a whole.

Doing nothing is not an option. Politics aren’t standing still, and the French and Greek elections on May 6 will likely shift the balance of power against Plan A.

Economies aren’t standing still, either—the negative feedback loop of the austerity measures of Plan A make it almost certain that Greece and Portugal, and probably Spain and potentially France, won’t meet their budget targets on time.

And the financial markets aren’t standing still —the lack of a Plan B will lead to another round of this crisis if the markets become convinced that Plan A isn’t working or is, in practical terms, a dead issue.

So is the Eurozone doomed? Will Greece begin an exodus from the euro that will ultimately lead to the demise of the single currency? Will Spain need a bailout that’s bigger than the current rescue funds can provide?

All those are real dangers. But are they doomed? No. Because I actually see a viable Plan B, one the Germans could endorse, in some of the growth proposals put forward by France’s Hollande.

Besides his calls for a shift in the mission of the European Central Bank and for Eurozone bonds, Hollande’s economic team has also suggested such growth ideas as boosting funding for the European Investment Bank, with the new money to be used to finance big infrastructure projects. (Would German voters go along with their money going to that?)

Along with Eurozone bonds, Hollande has proposed "project bonds" to finance economic development and research in areas such as new energy technology. These bonds could not be used to finance sovereign debt.

A package of ideas like that—focused on growth and infrastructure—could be added to the Plan A austerity pact as a kind of growth sidebar. In effect, what could emerge is Plan A/B, and that might be enough to prevent the current crisis from developing a political momentum that would make it all but impossible to save the Eurozone.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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