08 May 2012

French Elections: the Aftermath

I was wrong about the results and in this, case, I am happy to be worng.

I thought the fear factor was such that at the last moment a slight majority of French voters were going to hold their noses and vote for Nicolas Sarkozy despite their deep hatred for the man.

A retired French ambassador once told me that when it comes to politics, French people seem stupid individually but collectively, they make very astute choices. And this outcome makes me agree with him.

Good on them.

This is especially remarkable since, in the short run this is likely to be not very good for France. Markets reacted predictably to Hollande's election. It is quite possible (though by no means certain) that France's borrowing cost could go up and it could get its debt downgraded by one of those bankster-financed rating agencies.

But Hollande's victory will almost certainly be good news for Spain, Italy, Portugal, Ireland and Greece as it is likely to break the decision making monopoly of the two largest economies in Europe, namely Germany and France. Without the Merkozy consensus, it would be difficult for Merkel to continue to argue that austerity is the only way out of the current crisis.

To tell you how bad things were before 6 May, on that day the IMF posted an opinion piece online (by Anders Borg and Christine Lagarde no less) and the second paragraph read as:
We are now seeing some signs of stabilization. Most countries are reducing their deficits and even if debt ratios are still rising, the return back to fiscal health has begun. 
(via Economist's View, h/t Eschaton
In case it is not self evident, they are making the contradictory claim that (a) debt ratios rising and (b) the return to fiscal health has begun. This means that, these economies are shrinking faster than their ability to pay back their debt and therefore their debt to GDP ratio is getting higher.

What part of this is good news?

And this is IMF claiming this nonsense. No wonder Krugman is talking about confidence fairies.

The other interesting piece of news was the Greek electoral results. Not unexpectedly, the two largest pro-austerity parties were reduced to a combined minority status. It is only through the quirky rule of handing 50 bonus seats to the party that received the most votes that the New Democracy got 108 seats.

Even with that advantage, the New Democracy could not form a coalition government and now the left wing Syriza is attempting the same feat by bringing all the anti-austerity parties together.

As I kept repeating for a year now, Greece should have defaulted early on and if necessary, exit the Eurozone.  Despite all the fanfare and lurid (and false) anecdotes about lazy and greedy Greeks, the bailout was never about the Greek economy, it was about making sure that German and French banks (with their heavy exposure to Greek sovereign debt) would not go belly up. Despite having charged risk premium to lend money, at the end of the day they wanted to get paid fully.

The problem Greece is facing right now is the fact that they waited too long and the other side had enough time to shore up their banks and squeeze the Greeks in a corner. Moreover, it is clear that Greek voters do not want to leave the Euro. Despite all of that, I would still urge them to threaten the European "austerians" with default and perhaps even with an eventual exit and insist on better terms. The current arrangement is like the infamous Pentagon dictum: it is design to save Greece by destroying it. Staying on that path is probably the worst case scenario for their country.

If Greece refuses to go along, there is a serious contagion risk and I am not sure that Germany could face that risk alone. So, Hollande's election could be important as he could isolate Germany and force some changes.

In the short term, how Hollande will handle a series of upcoming appointments to important financial posts will give us some clues to his thinking.

Will he back Wolfgang Schaeuble as the new head of Eurogroup, which is the structure that brings together the finance ministers of Eurozone countries since the Lisbon treaty?

(That's him on the right talking about the Greek economy)

Will he support the appointment of Yves Mersch to European Central Bank's Executive Board (something everyone thought was a done deal at the end of March but Sarkozy did not want to deal with it during elections and refused to ratify his nominations. He is said to be a favorite of Merkel's.)

Who will he support to replace the outgoing president of European Bank for Reconstruction and Development (EBRD) Thomas Mirow (a German)?

The current CEO of the European Stability MechanismKlaus Regling, (another German) was supposed to be renewed, unless Schaeuble got the nod for Eurogroup.

Regling is also mentioned as the President of the European Central Bank.

Clearly, there are many German candidates and not all of them can be appointed. What will be critically important is which one these people will be appointed to what position? Equally importantly, will Hollande be able to leverage his compromise for one post to insert someone who shares his priorities to an another position.

Given France's relatively precarious financial position and a large part of its debt being held by foreign financial institutions, Hollande's room of maneuver is not very large.

But he can still bring some changes to the austerian status quo.

And his election made things very interesting indeed.

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