Much of the fiscal and monetary insanity that has come out of the EU over the last two years can be summated by one of my central global theses:
European policies are determined by politics, NOT economics.
What I mean by this is that economic realities do not determine political decisions as they do in the US. One can see this quite clearly in the manner in which EU leaders have pushed for bailouts and austerity measures despite the clear evidence that doing so has actually exacerbated the EU’s problems and failed to help those countries on the receiving end (Greece, Ireland, Portugal).
With that in mind, we must acknowledge that EU leaders will continue on their current path of more bailouts until one of two things happens:
1) The political consequences of maintaining this strategy outweigh the benefits
2) The European markets force EU leaders’ hands
Regarding #1, this process is already well underway for those countries needing bailouts. Investors must be aware that the Governments of Ireland, Portugal, Spain, and Italy have all watched/are watching the Greece situation closely.
Moreover we can safely assume that the topic of defaulting vs. asking for bailouts in return for austerity measures has been discussed at the highest levels of these countries’ respective Governments (more on this in a moment).
These discussions are also underway at those countries that are providing bailout funds. German politicians have won major political points with German voters for playing hardball with Greece. As I’ve stated before Germany may in fact be the country that ends up walking if EU continues down its current path of bailout madness.
With that in mind, there are three key political developments coming up.
1) Ireland’s upcoming referendum
2) Greece’s upcoming election
3) France’s upcoming elections (April and May)
Regarding #1, Ireland will be staging a referendum regarding the new fiscal requirements of the EU sometime before October. While the actual date has yet to be set, Ireland will likely stage its referendum after the French elections in (April and/or May… more on this in a moment).
Ireland has already staged two referendums which Irish citizens voted AGAINST until various concessions were made. This time around the primary concession being discussed is potential debt forgiveness (the country definitely needs it). Indeed, according the Boston Consulting Group, Ireland needs to write-off some €340 billion in debt just to make its debt levels “sustainable.”
So Ireland could easily be a wildcard here. The country is already in recession. So we need to monitor developments there as this referendum could go very, very wrong for the EU.
However, the BIG election of note is that of France where the current frontrunners are Nicolas Sarkozy (Angela Merkel’s right hand man in trying to take control of the EU) and super-socialist François Hollande.
A few facts about Hollande:
1) He just proposed raising tax rates on high-income earners from 41% to 75%.
2) He wants to lower the retirement age to 60.
3) He completely goes against the recent new EU fiscal requirements Merkel just convinced 17 EU members to agree to and has promised to try and renegotiate them to be looser.
Currently polls have Sarkozy and Hollande securing the top slots in the first round of the election on April 22. This would then lead to a second election in May which current polls show Hollande winning (this has been the case in all polls for over two months).
However, there’s now another leftist wildcard coming into the mix: communist Jean-Luc Mélenchon who is now taking 11% in the polls (he was at 5% last month). And Mélenchon’s primary campaign message? Rejecting austerity measures completely via “civic uprising.”
Now, Mélenchon could end up taking votes away from Hollande thereby allowing Sarkozy to win. It’s difficult to say how this will play out. But if Sarkozy loses to either of these candidates, then the EU in its current form will crumble as Germany loses its principle ally in pushing for fiscal reform and austerity measures.
Finally, let’s not forget Greece where politicians are now pushing for an election on April 29 or May 6 (the Second Bailout was passed based on new parliamentary elections being held soon after).
This could be yet another wildcard as it is around the time of the French elections, which Greek politicians will be watching closely. Remember, the key data points regarding Greece’s economy:
1) A 20% economic contraction over the last five years
2) Unemployment north of 20% and youth unemployment over 50%
3) Unfunded liabilities equal to 800% of GDP courtesy of an aging population and shrinking working population (which is shrinking all the time as youth leave the country in search of jobs)
These facts will not play out in a victory for “pro-bailout” politicians. So the Greece deal, which is supposed to solve Greece’s problems, could actually be in danger based on a change in politics.
Remember, as stated before, politics determine European policies, not economics. And Europe now appears to be shifting towards a more leftist/ anti-austerity measure political environment. If this shift is cemented in the coming Greek, French, and Irish elections/ referendums, then things could get ugly in the Eurozone VERY quickly.
With that in mind, I believe that the European markets will force EU leaders’ hands sometime in the May-June window. Indeed, we have a confluence of negative factors (monetary, political, technical, etc.) hitting during that window of time, which is unlike anything I’ve ever seen before. And unlike the 2008 Crisis, the Central Banks won’t be able to rein this collapse in.
Why? Because Europe’s banking system is $46 trillion in size. And the Fed and ECB are already leveraged to the max having spent all their ammunition combating the Crisis this far.
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Graham Summers
Chief Market Strategist
