I know, I know. The clash of civilizations is purportedly about the struggles between the Islamic World and that of Judeo-Christian-based beliefs. But from our global-macro perspective it is the open battle between France and Germany for domination of the EU State. It has always been about the which of the two nations was going to control the European agenda. [NOTE: PLEASE GO BUY A COPY OR TWENTY OF THE ROTTEN HEART OF EUROPE BY BERNARD CONNOLLY FOR SALE FROM AMAZON AT $8.00 or directly from me for $10.00 including shipping.] For the past five years Germany has been the dominant voice in Europe because of the weakened condition of the southern European nations who were burdened with massive debt loads following the 2008 financial crisis. In 2011, French President Sarkozy prevailed over German Chancellor Merkel by installing Mario Draghi as ECB President rather than the hard-money Bundesbanker Axel Weber. The Sarkozy victory came at a steep price, German intransigence over the budgets of the debt-burdened European nations. If MONEY WAS GOING TO BE CHEAP, THEN FISCAL AUSTERITY WOULD BE THE PRICE FOR INSURING BERLIN’S ACQUIESCENCE.
The Berlin Doctrine has left Europe in a state of economic malaise as budget tightening has kept nations from stimulating demand through the proverbial “pump priming.” The German position has been and will be: If our savers are going to suffer financial repression by lowering yields below the German rates of growth and inflation then the debt-plagued nations were going to suffer what economists call AN INTERNAL DEVALUATION, which means a period of high unemployment which pushes down wage rates in order for a country to become more competitive. (The existence of the EURO prevents any EU member in the euro from devaluing its way to prosperity.) Greece is the poster-child of internal devaluation as joblessness is high, taxes are rising and economic pain is being shared by the over-indebted Greek economy. This is the present state of Europe and while Germany is correct in demanding austerity because it is the major guarantor of the ECB, the political fallout is causing pain across the nation-states of Europe.
President Hollande is in very difficult straits as the French just announced record unemployment and there is regional elections this month in the country in which the National Front is expected to prevail in some districts, making Marie Le Pen a strong candidate for the 2017 French presidential election. If Le Pen were to win it would spell doom for the European Union as she has promised to take France out of the EURO as it destroys French sovereignty over its economic and financial affairs. The question going forward: What steps will be taken by Mario Draghi and President Hollande to attempt to lift the French economy and collaterally, Spain, Italy, Portugal and several others? As I have written for the last few months, with interest rates at the zero bound political decisions become paramount. Here are some issues fraught with political intrigue but certainly have economic implications:
1. After sending a few BOMBS toward ISIS, President Hollande announces that because of increased defense expenditures, France would not be able to meet its budgetary promises to Brussels for 2015 or 2016. France had no intention of meeting its promise of a 3% deficit/GDP as mandated by the Maastricht Accord, but Hollande is hopeful that sympathy for the plight of a France at war who hold back the fiscal austerians in Berlin and elsewhere. Will President Hollande’s call to arms will the stimulus needed to rouse the French economy?
2. European Commission President Jean-Claude Juncker purportedly wrote to Russian President Putin suggesting that French-Russian comradeship in the battle against the Isis terrorists could result in diminished sanctions imposed on Russia for its intrigue in the Ukraine. The EU elite seem willing to trade Ukrainian independence for support in Syria. Increased trade with Russia as a payoff for the use of Russian brutality against the terrorists will probably result in Russia requesting that the previously cancelled sale of the Mistral-helicopter ships be honored. The ship issue will be a barometer about how far the Eurocrats will go to protect the French President;
3. The fallout from the breaking of budget agreements in times of war would generally result in elevated bond prices, especially when France is already in a precarious fiscal situation. But will European bond yields RISE? No chance. The ECB has already purchased 540 billion euros in sovereign debt as it meets its QE commitments. French 10-year yields closed at 0.78% today, even in the face of Hollande’s move to war footing. The problem in Europe–as in the U.S. and Japan–is that bond yields reveal nothing about economic realities. As French yields decline in response to ECB purchases, how long will the Bundesbankers allow the good credit standing of Germany to finance the public spending programs of so many other nations? The Germans will play along as being good Europeans until the popular mood in the Bundestag begins to turn against Merkel.
Germany is attempting to resettle a million Syrian refugees and if the social and fiscal costs become a burden the political fallout will give rise the voices of Europhobia, such as the AfD party. Draghi may pretend he controls the European financial markets but it is the creditors in Berlin who control the entire European project. Think back to July 2012 and Draghi’s NO TABOOS AND WHATEVER IT TAKES announcement. Before Draghi served allegiance to the EURO at all costs, borrowing costs in Spain, Italy, Ireland, Greece, Portugal were soaring as 10-year debt yields were all above 6%. Without the German credit card, the ECB will be sitting on a mountain of losses as it has been the biggest buyer of EU sovereign debt. French President Hollande needs to be very aware that his situation grows more precarious everyday.
***Tomorrow morning the Bank of Canada announces its interest rate decision. The consensus is for no change and rates to remain at 0.5%. I will not argue with that as today’s GDP number in Canada was weaker than expected, but with the Canadian dollar DOWN 15 percent on the year, the BOC can remain patient and not do QE or lower the rates anymore. It can wait for the lag effects of currency depreciation to try to stimulate Canadian exports. The Canadian energy has been devastated by the dramatic drop in OIL and gas prices but the BOC has the luxury of time .