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Jun 18 2012

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For EU, a Relief Without a Respite

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Clarification Without Resolution

In Europe, and in financial markets globally, officials braced yesterday for a crash that was ultimately averted.

After weeks of uncertainty, Greek voters gave a plurality majority to the pro-EU bailout New Democracy party.  Today, New Democracy will seek out coalition partners to gain a majority in Parliament, and renew efforts to stabilize Greece’s economy within the EU.

By denying the anti-bailout Syriza Party a victory, Greek voters prevented an immediate economic and political showdown with the EU, and the destabilizing, cascade effect such a conflict would have within Europe, rippling on to the US and other countries and potentially leading to a severe worldwide economic downturn.

Also yesterday, French voters provided Francois Hollande’s Socialist party with a strong majority in Parliament. First round voting last week had indicated that the Socialists might not win an outright victory and be forced in to coalition with other parties on the left.  The strong showing brings stability to France’s political balance, and will allow Hollande to implement his campaign promises, domestically.

Despite the hope engendered in clarifying elections, larger, structural issues still loom over the EU as a whole that cloud any hope for a successful conclusion to the sovereign debt crisis.

In Greece, the New Democracy party will likely form a coalition with the former, opposition Socialist party – PASOK, providing a narrow, 12 seat majority in Parliament.

While both parties are committed to the EU austerity program and bailout, the inherent tensions between a free market party and a socialist party will cause potential problems in any implementation of the EU’s terms. The last grand Greek coalition government tried to “slow walk” required reforms, taking the cash from the EU but resisting the wholesale change needed to meet the austerity pact.

That will not be possible this time around.

In addition, the Greek economy has deteriorated badly since the bailout was agreed to, while the terms of the bailout require punishing new cuts in already strained Greek government spending. In addition, with Syriza in vocal opposition, the governing coalition will have to fend off support-draining political attacks while managing the delicate task of requiring more from Greek citizens, with less.

While the Greeks have voted sensibly, there is no immediate path forward that does not require difficult economic contraction and volatile politics, which will catalyze dynamic and uncertain social forces in the weeks and months ahead.

In much the same manner, the Socialist victory in France’s parliamentary elections complicates Germany’s efforts to maintain its EU policy of “austerity for bailouts.” Francois Hollande campaigned on policy positions that fly in the face of the German sponsored approach of spending cuts and tax increases to close budget deficits. Specifically, Hollande promised lowering the retirement age, hiring more public sector workers, He also promised more “stimulus” but at the same time promised to raise the top marginal tax rate in France to an economic growth killing 75 percent.

Hollande himself will have to contend with a restive Angela Merkel, who will be unwilling to subsidize European social largess on the backs of German taxpayers, as well as the potential impact of his proposed reforms on the French budget and economy.  If these policies lead to deficits and increased national debt, the Hollande plan could ultimately jeopardize France’s credit rating and raise the cost of international borrowing to fund France’s debt, triggering a financial crisis in France.

And nothing in the Greek or France elections last night helps the economic problems in Spain and Italy. This morning, interest rates required to attract capital for Spanish 10 year notes exceeded the unsustainable 7 percent level. This after the EU proposed a $125 billion bailout for Spanish banks.

In Italy, new taxes intended to close a budget hole have caused sporatic protests, while concern about Greece and Spain have forced up the interest rate on Italian bonds, bringing Italy to the precipice again.

So despite constructive election results, the underlying economic crisis continues to fester and grow. At the same time, leaders of the G-20 will be meeting today and tomorrow in Mexico, where the EU sovereign debt crisis will be a pivotal topic.

There appears to be an emerging consensus that something radical must be done in order to avoid the type of financial panic that triggered the 2008 Wall Street crash. The question remains whether Europe has the political courage and the institutional structures to take action before it is too late.

One thing is certain.  Time is no longer on their side.

 

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