Sunday, May 6, 2012


The French presidential election may prove a significant turning point in how France, and thus the rest of the Euro-zone's 17 governments which use the common currency, address their continuing economic crisis. The French economy has slipped back into recession after two consecutive quarters of negative growth in Gross's Domestic Product (GDP). Socialist candidate and France's next president, Francois Hollande, campaigned against the high unemployment rate(10.1%) and public anger over the Euro-zone wide policy of “austerity” which requires significant cuts in government spending to reduce sovereign debt. The logic of such cuts is to maintain or increase the confidence of bond markets to facilitate the financing of future government borrowing at reasonable interest rates, as well as too reduce the risk of inflation. However, the chorus of economists who support abandoning austerity in favor of stimulus i.e. government spending, even while increasing government debt, is growing louder. Public opinion is on their side as unemployment continues to rise and government benefits continue to decrease.

The French election will have a ripple effect throughout the Euro-zone and the wider 27 member European Union. Hollande has promised to discard the austerity program and increase government spending. He has also promised to renegotiate the Euro-zone's recently adopted agreement to reduce government deficit levels to 3.5% and maintain them at, or below, that level permanently. This program was lead by Germany, who has the only significant European economy not mired in crisis level debt. The debt/recession conundrum is currently being debated in the U.S. and could feel the impact of the November federal elections if either party were to gain control of both houses of Congress and the White House. If not, the current legislative grid lock will surely continue.

The fundamental problem is that cutting government spending takes money out of the economy, which in times of recession or just slow growth, goes against conventional Keynesian wisdom, and central bank history, because it contributes to declines in consumer spending and thus job creation and ultimately economic growth. However, the enormous government debt which profligate spending has created in several of the Euro-zone countries (Greece, France, Spain, Portugal, Ireland) demands attention before it reaches a “point of no return” where interest on the debt increases as confidence in each nation's ability to guarantee payment decreases, and demands for even higher interest rates based on risk assessments by investors create a spiral of cascading debt and possible insolvency. Such a scenario in the relatively small economy of Greece already threatens the Euro as a viable currency throughout the zone. The failure of the debt burdened Greek economy at the same time as an abandonment of French efforts to deal with it's own Euro denominated debt, and an attempt to restructure Euro-zone agreements for fiscal responsibility, would threaten the very continued existence of the Euro as a common currency.

The choices for dealing with both sides of the coin are limited. Attempts to deal with the multinational Euro-zone debt crisis have centered around austerity measures combined with “bailouts” of short term debt by loans from the European Central Bank, the International Monetary Fund (IMF) and contributions by the few healthier economies to an emergency fund. Germany, which has the largest and healthiest European economy, with cooperation from France, has led the effort. But the German people are tiring of bailing out lesser, mismanaged economies, and German Chancellor Angela Merkel has been insistent that bailouts be accompanied by harsh spending cuts in recipient countries.

Paul Krugman, an American Nobel prize winning economist turned liberal political writer, has been arguing for at least two years for the abandonment of efforts by Republicans to make large cuts in federal deficits and debt through spending cuts. He has advocated another “stimulus” and is supported by former Clinton Administration Secretary of Labor and University of California, Berkeley professor and liberal columnist, Robert Reich, as well as most of the public policy activists in the Democrat Party. It will take a long time for any change in French economic policy to produce results, good or bad, but it is also unlikely that the fiscal policy gridlock occurring in the U.S. Congress will change in the short term, so French policy changes and their related fall-out in the Euro-zone could bolster the arguments of either Democrats or Republicans in 2013 after the November elections.

Of course the debt/spending cut debate has a significantly different character in the U.S. if nothing else because of the enormous size of the U.S. economy and the size of the federal debt which exceeds U.S. GDP. While the U.S. central bank (Federal Reserve) had manipulated interest rates to historic lows, they have run out of room and further cuts are not possible. There are indications that some nations in the global trading system are changing from use of U.S. dollars exclusively for the payment of international debts which could diminish the role of the dollar as the major international reserve currency. While this is not likely to be a wholesale trend, it could decrease international demand for dollars, reduce foreign governments' dollar reserves and thus their need for U.S. government bonds as a “storehouse” investment. Efforts to cut U.S. debt thus become even more important before refinancing that debt runs into demand problems which would in turn create a need for higher yields which would stimulate the debt spiral described above.

Currently the U.S. economy is growing slowly and unemployment is very slowly decreasing but remains high at 8.1%, based on those workers still looking for employment (over 14% when dropouts are included). Thus, while the urge to speed up growth through spending remains important, especially in political terms for President Obama's reelection efforts, efforts to deal with federal debt seem to be more important in the long term.

Still, the problems of Europe, and the new wild card of a change in the French executive, will continue to be a factor in the U.S. recovery. A failure of the Euro system or even a return to recession in several more of the larger economies would have a significant negative effect on the U.S. economy. Thus U.S. markets will be on “France watch” after this elections.

As an interesting aside, the differences between French and even British political culture are on display with the candidacy of Socialist Party leader Francois Hollande. There is a subtle irony that this new president who will have so much influence in the European Union and possibly the U.S. economy for the next five years, would not even be a viable presidential candidate in either Great Britain or the U.S. He is not the most left wing candidate in France which has a Radical Left Party and a Communist Party but he has tapped into the social unrest of the electorate with a class warfare, anti-free market and anti-corporate rhetoric much like Obama has attempted to do with his “Buffett rule”, and frequent attacks on “millionaires and billionaires” and corporations not “paying their fair share” of taxes. But while Republican nominee to be, Mitt Romney, attempts to court the social conservatives who remain unenthusiastic about his commitment to their cause, and President Obama seeks to balance his support for the political Left while convincing more moderate Independents that he does not reside in the far Left ideological fever swamps populated by the likes of Katrina vanden Heuvel (“The Nation”); Nancy Pelosi, Barbara Boxer and the Daily Kos, the new French President has not even had to address the fact that he has fathered four children out of wedlock and has for several years lived with his new female “partner”. This is not a big deal in France where the press, unlike the media headhunters in the U.S., is discouraged from reporting on the personal lives of politicians, and obviously voters don't care. The difference is made even more emphatic by the fact that the mother of his four children, with whom he no longer has a relationship, Segolene Royal, was herself the 2007 Socialist Party nominee for the French presidency. She was defeated by current French President Nicholas Sarkozy, but not because of her unusual , by American standards, domestic circumstances. Of course, those circumstances, on the part of either her or Hollande, do not say anything about their qualifications to govern, but it does emphasize the cultural gulf that separates U.S. and French society which may help explain why a candidate in France can be successful with a far Left secular, populist appeal while in the U.S. even liberal candidates must meet a minimum standard of religiosity and avoid personal peccadilloes i.e. John Edwards.

In any case, no matter who is elected the next U.S. president, the next president of France may well have a serious impact on the U.S. economy.

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