Economic News & Analysis—May 7, 2012
Eurozone reforms: Easy does it
By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist, and John Manley, CFA, Chief Equity Strategist

Brian Jacobsen photo

Summary:

  • Election results in France and Greece show a lack of popular support for the previous deals struck by politicians in the eurozone.
  • To keep the eurozone together, governments must get their deficits under control—not abruptly but in a gradual way.
  • Growth in Europe depends not only on a fiscal compact—which requires balanced budgets of the member countries’ governments—but on fiscal transfers from countries like Germany to countries like Greece.
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Nicolas Sarkozy, the president of France, lost to the socialist contender, Francois Hollande, in yesterday’s election. In Greece’s parliamentary elections, no party received an absolute majority of the votes, but Pasok—the center-left party primarily responsible for negotiating Greece’s bailouts—came in third, behind New Democracy (the center-right party) and Syriza (the much more left-leaning coalition party). Because New Democracy will probably not be able to stitch together a coalition government to elect a prime minister, a new set of parliamentary elections in June is likely. Coincidentally, France will have legislative elections in June, making it a politically important month.

The official positions of the parties elected were not anti-euro but rather anti-incumbent and anti-austerity. I think the fabric of the eurozone will be stretched with these election results and resulting renegotiations, but I don’t think it will tear—at least not yet. To keep the eurozone together, governments must get their deficits under control—not abruptly but in a gradual way.

If the Greek parliament rejects the austerity measures that were agreed to as part of the bailout the government received from the “troika” of the European Central Bank, the European Union, and the International Monetary Fund (IMF), it is possible that the funding will dry up and, unless it can negotiate a lifeline from an organization like the IMF, Greece will default on more of its debt. The one benefit of an IMF-only arrangement would be that it would not be complicated by the appearance of other eurozone governments dictating reforms in Greece.

Voters across the eurozone—not just in France and Greece—seem to be rejecting the focus on austerity. With eurozone unemployment at 10.9%, and with some countries, such as Germany, having historically low unemployment while others are suffering historically high unemployment—as in Spain—voters appear to want some growth to accompany the austerity. I think growth in Europe depends not just on a fiscal compact—which requires balanced budgets of the member countries’ governments—but on fiscal transfers from countries like Germany to countries like Greece. They may walk down that path, but only if they can agree to uniform rules around unemployment and pension benefits. It’s likely a long and winding road ahead for the eurozone.

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