The relative calm enjoyed by European financial markets over the past two months appears to be coming to an end.
Back in February, Euro leaders closed on the second financial bailout for Greece, plugging the grave uncertainty surrounding tenuous Greek finances, and putting the best possible face on a horrendous financial situation.
At the same time, the European Central Bank (ECB) flooded the market with cheap credit. The move allowed the continent’s at-risk banks and financial institutions to significantly strengthen their balance sheets/profits, in part by arbitraging the ECB’s virtually cost-free money in at-risk (high interest) European sovereign debt, and in the process, solving a second European problem, as a fresh wave of investment into these sovereign bonds kept borrowing costs for at-risk nations from rising, providing an artificial sense of security against another sovereign default.
The measures were structured to ease intense market pressure and buy time for troubled EU economies to get a handle on their deficits and debt, and implement plans to enable economic growth and job creation, with rebalanced national budgets. But because the measures did not address fundamental structural reform, they appear to have run their course, with the reality of recession, high unemployment, missed deficit targets and increasing debt again taking center stage.
On Monday and Tuesday, interest rates on the sovereign debt for Spain and Italy were again on the rise, as concerns about recession and debt mixed with increasing fear of the impact of austerity measures in Spain, Italy and Greece.
The social and economic impacts of government sponsored austerity in the EU are profound and consequential.
Unemployment in Spain and Greece hovers at 20 percent with youth unemployment topping 50 percent. In addition, the Greek economy has contracted by 20percent in the past five years. The Italian economy has shrunk 10 percent or $245 billion since 2008.
This economic shock compounds problems with national debt. Greek debt as a percentage of GDP is over 120 percent. The Italian ratio is 119 percent, meaning that the countries owe significantly more than they produce in an entire year.
Negative growth, high unemployment and continuing EU-enforced government austerity have made for a combustible mix across southern Europe.
Now enter the great variable – elections.
On May 6th, both France and Greece will hold national elections.
This will be the first time, in both countries, that there has been a national election since sovereign debt crisis began, and European leaders imposed significant austerity in return for financial bailouts.
In Greece, the cradle of the debt crisis, the two major political parties – New Democracy and PASOK, together are polling less than 40 percent. By way of comparison, in the last election, the two parties polled more than 70 percent.
With the collapse of support for the traditional parties, smaller, fringe parties have seen growth. The communists, an even further leftist party – the Syriza – and the nationalist LAOS party, all opposed to the terms of the EU bailout, are collectively polling at 28 percent. Nine parties meet the three percent requirement.
The likely outcome looking at the election from today, is one of stalemate.
It appears that neither PASOK or New Democracy – both committed to the terms of the EU bailout – can win an outright majority. A grand coalition appears difficult to implement given the intense rivalry between the two long-time political antagonists. Worse, a coalition of either the two major organizations with smaller parties will almost certainly require Greece to walk back certain portions of the European debt agreement; a non-starter for the EU which could stop payments that keep Athens afloat.
All this would be happening at just the time that the new government will be called upon to identify an additional $16 billion in budget cuts for the period of 2013-14. This on top of the higher taxes and budget cuts already announced to secure EU and IMF financing.
It has all the ingredients for a perfect storm where populist political choice meets harsh economic reality.
On the same day, France will be selecting a new President.
The campaign thus far has not gone well for French President Nicholas Sarkozy, who is seeking a second term. Sarkozy, Angela Merkel’s political partner in managing the debt crisis across the continent, has been the underdog in a race against a resurgent Socialist party, represented by Francois Hollande.
In the French system, if no one candidate reaches 50 percent in the first round of voting, a second round with the top two finalists is held a few weeks later.
The first round of voting is scheduled for April 22nd.
In addition to Sarkozy and Hollande, France, like Greece, has seen a significant uptick in fringe parties dedicated to opposing the EU bailout. Jean Luc Melenchon, a hard line leftist, is polling well, as is Marine Le Pen, the daughter of France’s right-wing nationalist party, a sign of greater than normal unrest.
Currently, Sarkozy is expected to win the first round of balloting with Hollande a close second. In the second round, held May 6th, Hollande is predicted to beat Sarkozy by six points or more.
Such a result would be a tectonic shift in Europe.
Hollande has committed to re-negotiating the EU bailout pact, ironically in which France wa an original co-architect. He has promised to raise the top tax rate in France from 41 percent to 75 percent, and lower the retirement age to 60; moving in a direction opposite of most of Europe at this time.
Thus the election results in France and Greece will have the power to undermine the incremental steps that have been put in place over the past two years to prevent sovereign collapse, and set the stage for a period of political uncertainty that will exponentially increase economic anxiety across Europe, to the US and China.
The sad truth is that “confidence” is all that stands between Europe and economic collapse. An ephemeral, paper-thin confidence, projected by leaders who have pledged to hold the EU together, protect the euro, restructure the finances of indebted countries and pave the way for robust economic growth; to do these things, even as the EU contracts economically, and continent wide sovereign debt outstrips even the most optimistic plans to bring it under control.
The coming elections in France and Greece threaten to undermine that confidence permanently, leaving a cupboard bare of any meaningful tools to manage or repair the resulting economic carnage.
Time to begin seriously thinking about Plan B.