Victory for Hollande could fatally destabilise the euro zone
Never make forecasts, especially about the future â€“ wise advice, which Iâ€™m reluctant to ignore. But I will say I think the risk of a panic in the financial markets at some point in the next three or four weeks is extremely high. Wherever you look, there are icebergs on the horizon â€“ small ones, like Greece, Portugal and Ireland, and giants, like Spain and Italy, and now most menacing of all, France.
If the opinion polls turn out to be correct, the French election will mark a turning point in the euro zone crisis. It is not just because the new president will be committed to leading the nation in the opposite direction to every other developed country, increasing government spending, reducing the pension age and the working week, raising the minimum wage by more than inflation and introducing a 75 percent tax rate, all of which are bound to threaten Franceâ€™s creditworthiness which is already so low that it is paying nearly 3 percent to borrow compared to Germanyâ€™s 1.75 percent rate. More important in my view is what a Socialist victory will mean for the balance of power inside the euro zone.
The crisis has cruelly exposed the split in the euro zone between the parsimonious North and the spendthrift South, with France under President Sarkozy uneasily straddling the divide. There is a long history to this situation. Back in 1992, when the Maastricht Treaty was originally negotiated, France refused at the last moment to sign the Stability Pact until it was rechristened the Growth and Stability Pact, making the rift with Germany public to anyone who cared to pay attention and clearly pointing the way forward to the current mess. The only real surprise is that it has taken as long as twenty years to reach this point.
An election victory for Francoise Hollande will mark the end of Franceâ€™s balancing act. It will have given up its increasingly desperate effort to keep abreast of Germany at the heart of Europe, and definitively signed up to ClubMed, a shift which will be fatally destabilising for the euro zone as a whole. Quite simply, the Northern bloc of Germany, Netherlands, Finland and Austria will be outgunned by opposition from the other thirteen member countries.
As ever, the politics are just as important as the economics. German reluctance to carry the burden of financing ClubMed is matched by the unwillingness of the Southern European countries to accept externally-imposed constraints on their fiscal policy. In fact, only a few weeks ago, the always-unrealistic hopes of fiscal integration were killed off by the new Spanish Government as cleanly as a matador finishing off a bull â€“ the preceding administrationâ€™s agreement to a deficit target of 5.3 percent of GDP was unilaterally raised to 5.8 percent, leaving the other European leaders spluttering in impotent rage. But even without Spainâ€™s mutiny, can anyone now imagine France accepting a fiscal constraint which would be seen as a German diktat? Is Paris really going to become Athens-on-Seine?
So far, the ECB has bribed the markets not to precipitate a crisis, but this strategy may now be unravelling, because the liquidity it has so liberally supplied to keep Europeâ€™s banks afloat seems to be encouraging those in ClubMed to load up on â€śsafeâ€ť German debt, thereby increasing the yield gap between North and South and making the situation worse, not better.
Where will it all end?
In the media, in academia and in forums like the recent Institute of Economic Affairs Conference on the Future of the euro, I see a welter of comment predicting everything from euro zone meltdown to salvation-through-integration and all stages in between. None of these opinions nor the tide of events in the markets have shaken my conviction that the most likely outcome remains competitive devaluation and all-round inflation. The euro zone can easily be â€śsavedâ€ť, by the simple expedient of printing as many euros as needed to recapitalise the banks and the bankrupt sovereigns â€“ and keeping on doing it, as long as the euro zone governments keep overspending. In the short term, money creation will provide the necessary liquidity to keep the euro going, and in the medium-to-long run the inflation it generates will reduce the debt burden to manageable proportions.
The only serious obstacle to printing money is a tiny coterie of isolated German eggheads surrounded in their Frankfurt bunker. Certainly the mass of German voters are averse to inflation â€“ far more averse than those of any other country with the possible exception of Switzerland. But, faced with a painful choice between paying an unlimited, unending tax to support their neighbours (including France) or watching the euro zone disintegrate in a tide of anti-German bitterness, my guess is that they will jump at the offer of monetisation, produced like a rabbit out of a hat by a political magician. The inflation escape route will be all the more tempting, given that they will be able to see Britain and the USA already way ahead on the same road to ruin.
Will it end with hyperinflation?
I doubt it, at least not for a few years yet. If there is a lot of ruin in a nation, as Adam Smith said, there is an awful lot more in a continent. A gradual build up of inflation will give Germany, Netherlands and co. time to plan the reintroduction of their old currencies or possibly start a new DM-based North European monetary union â€“ which is probably how many in Frankfurt think it should all have worked in the first place.
Image — Francois Hollande, Socialist Party candidate for the 2012 French presidential election, attends a campaign rally in Cenon, near Bordeaux, April 19, 2012. REUTERS/Stephane Mahe