Just a week ago we brought readers' attention to the fact that Francois Hollande, the Socialist Party candidate who is leading most opinion polls in the French presidential election, was extending his lead; well the lead is growing, to now 58-42 in the second round. In a must-read discussion this evening, George Magnus of UBS points to the significance of the French elections and how Hollande's victory could unleash 'a new wave of instability and uncertainty, and that the relative calm or optimism in financials markets since the turn of the year would prove short-lived'. Specifically Magnus highlights how the politics of Europe could well trump the liquidity of the ECB as the main determinant of the Euro Area's prospects. While not playing down the role of the initial (and forthcoming second) LTRO, the UBS senior economic adviser has grave concerns of the much bigger and less tangible issues of sovereignty and national self-determination that will not only impact Greece (very shortly) but also Germany, France, and the Euro-zone itself. The French election could be a catalyst for Franco-German (Merkande? Hollel?) divisions which 'would not sit comfortably inside the ECB or in the minds and actions of investors' and is evidently an unpriced and under-appreciated risk in global markets currently.
Enter Francois Hollande, Stage Left
George Magnus, UBS
The French Socialist Party candidate for the presidency has recently nailed his colours unequivocally to the mast, with a bellicose approach to the cult of finance and financial firms, a promise to promote state-funded industrial policies and employment growth, including an additional 60,000 teaching jobs and 150,000 subsidised jobs for the young, and a proposal to reverse the recently agreed rise in the retirement age from 60 to 62 years. He intends to continue the programme of budget deficit reduction, but wants to boost state spending by EUR20 billion by 2017, though within the context of largely tax-related measures on banks, higher incomes and wealth.
The presidential contest is focused on both sensitive social issues and France's sense of economic and political vulnerability in a globalised world. This year, for example, China will displace France as Germany's biggest trade partner, while the latter has roughly 5 times as many firms doing business in China. But in many ways, the election is almost like a plebiscite on France's role and future in Europe.
President Sarkozy represents continuity. Francois Hollande wants to renegotiate the current European fiscal compact that was hatched in Brussels in December. At an economic level, he wants more emphasis on economic growth and employment goals, an integrated European energy policy, a bigger agricultural budget, and measures to counter unfair trade competition. But at a political level, his support for more activist ECB monetary and financial policies, the introduction of joint and severally issued E-bonds, and a well-resourced bail-out fund contrasts sharply with the stated position and constraints expressed by Germany, and to which Sarkozy has lent his imprimatur.
If he wins and intends to press his strongly held campaign opinions and intentions, a new rift could open up between France and Germany over how to manage the sovereign debt crisis and in the medium-term, to reshape Europe. Like other Eurozone countries, France feels pressured by the rising power of its large neighbour to the east. After the December Heads of State summit in Brussels, Hollande, and the overtly anti-Eurozone Front National leader, Marine Le Pen, both accused the President of betraying French sovereignty and democracy. If Hollande, as leader of the Eurozone's second economy, were to try and stand up to the German government, he would not only feel he had a popular mandate to do so, but doubtless act as a lightning rod for a wave of sympathy and Euro-angst from other Eurozone countries, such as Italy, which are becoming increasingly worried about the character and consequences of the current German-dominated approach to the Eurosystem crisis.
Italy, in fact, has made a remarkable come-back since Mario Monti took over as leader, pending national elections in April 2013. He was won the trust of Angela Merkel, and the admiration of Europe's political elite. While Italy's economy may be in poor shape, the country has regained respect and seriousness. So much so, that Monti's clever statement at his meeting with the German leader, reported in the Financial Times (16th January), was poignant. After acknowledging Germany's example of fiscal discipline, he said, presumably referring to Italy's recent initiatives to follow suit, maybe others too:
'If this strong movement towards discipline and stability is not recognised as taking place, and a certain approach to financial aspects does not gradually evolve, then there will be a powerful backlash in the countries which are being submitted to a huge effort of discipline.'
This is surely a polite way of saying something to the effect of 'Thank you for your trust. I'm trying to do my best but if you don't help and change your behaviour too - cue another reference to symmetric adjustment - then promising my people perpetual austerity will backfire spectacularly at home, and probably on you too'.
Mario Monti is a serious and talented operator. But having France on board would make a big difference. And then what?
The key point is that any sort of rift between France and Germany, or inconclusive negotiations or weakening of resolve on the current fiscal compact in general, would immediately go down like a lead balloon at the ECB, which would doubtless feel more constrained. Beyond, the central issue would be the reaction and behaviour of Germany, and Angela Merkel's government in the face of a French agenda, key components of which would be politically difficult and resisted. German national elections are, after all, not that far away, in the autumn of 2013. Would Germany accommodate France and cross more red lines, accepting an implicit demand for higher inflation as part of balanced economic adjustment, and giving in on matters of fundamental political and constitutional significance to the Federal Republic? Or would it dig in its heels, deeming French demands to be an unacceptable intrusion into its own sovereignty and democratic processes?
There is much at stake here. For financial markets, the French elections are one of Donald Rumsfeld's known unknowns. Sarkozy could yet win, sustaining the leadership status quo, but not really clearing up any of the current imponderable or impossible challenges to the future of the Eurozone. But if Hollande wins, the difficult progress towards European fiscal integration, including the building of firewalls, could become mired in new arguments, or stall. This would have important consequences for Europe, and not least for the newly pro-active ECB, which would have reason to doubt that politicians were fulfilling their pledge to create permanent fiscal discipline.