The Fate of the Eurozone Hangs on Sunday's French Elections

By: Money_Morning

Martin Hutchinson writes: It now looks as though Nicolas Sarkozy's days are numbered. In the balance lies the fate of the Eurozone itself.

It appears Socialist Francois Hollande will win the French election runoff on Sunday and that June's legislative elections will give the Socialists a powerful position in France's parliament.

Added to these developments is the good chance that both the major existing parties in Greece's parliament, which had jointly agreed to the bailout deal, will be voted out of office on Sunday as well and replaced by a motley set of far-lefties.

So while the Eurozone has been quiet this week, the calm is deceptive with the elections on Sunday.

Meanwhile, most of the worry in the Eurozone centers on Spain - which is quite foolish.

Spain recently elected a center-right government with a large majority, which is clearing up the mess left by its predecessors. The country does have a 25% unemployment rate, but that's a function of Spanish labor law and excessive welfare payments, both of which the current government is addressing.

Spain's budget deficit is also smaller than France's, as is its debt level. In fact, Spain's debt and deficit burdens are lower than both Britain and the United States. Spain is not the issue.

Considerable Danger in the Eurozone
As for Greece, it is a shambles.

The truth is it should have been chucked out of the Eurozone two years ago, when it was first revealed that its governments had been consistently lying about its budget numbers.

Had that happened, the new drachma would have sunk to about a third of its former value, and Greek living standards would have reduced by half, all without anything but market forces to be blamed.

Now hundreds of billions of euros have been poured into the country, and its ungrateful electorate is determined to elect every nut-job it can rake up. The whole Greek rescue project has been a complete waste of time and money, and should be ended forthwith.

Fortunately, throwing Greece out of the Eurozone will not destroy the euro - after all, nobody was relying on the strength of the Greek economy in their calculations of the euro's value.

However, France is a different matter entirely.

Unlike Greece, if France gets into serious trouble, the remaining "solid" euro economies led by Germany are not big enough to save it.

And, led by Hollande, France looks to be in considerable danger.

Hollande wants to increase the top rate of tax to 75% and to reverse the one significant reform of the Sarkozy presidency - the raising of the retirement age from 60 to 62. Needless to say, in Germany, where the retirement age is 67, there will be little sympathy for France's predicament.

Hollande also objects to the emphasis on austerity in the bailout plans put together by the Eurozone leadership led by Sarkozy and German chancellor Angela Merkel.

So if France gets into trouble, the willingness of the German populace to put up yet more money for a further bailout looks doubtful, to say the least.

What's more, as I discussed last week, the brewing "Target-2" scandal has blown another hole in the euro.

As it turns out the foolish design of the "Target-2" euro payments system has left German taxpayers potentially liable for $800 billion, the amount of paper the German Bundesbank is holding from southern European central banks that may be forced to default.

This additional potential cost to German taxpayers is larger than the bailouts themselves and should cause a rebellion against another bailout "solution" - and rightly so.

German politicians, facing an election next year and seeing the fate of their Greek billions, will not dare push through yet another bailout if the call comes in from France.

The Euro's Days are Numbered as Well
At that point the euro will break up, with Greece leaving it altogether, defaulting on its debt and becoming a European Argentina without the resources. Spain and Italy will also leave the euro.

In Italy's case, this may also result on a default on the country's debt, since the debt is very large and the current government of EU-appointed "technocrats" will be thoroughly discredited.

In Spain's case, a modest devaluation from the euro's exchange rate may well prove sufficient to revitalize the economy without a default on the country's moderate debt, although the Spanish banking system's bad debts, left over from its real estate bubble, may yet sink it.

As for France, leaving the euro will not automatically bring debt default, but it will allow Hollande and the socialists to engage in an orgy of left-wing policies similar to those of Francois Mitterrand's first government from 1981-1983.

Given that France's debt position is already somewhat precarious and its government already far too large, that will bring a French debt default, but probably not for a year or two.

Germany, the Netherlands and Scandinavia, meanwhile, will do fine, although the new strength of their currencies, whether separate or still combined into a "strong euro" may in time make their industries somewhat uncompetitive. Still, their debt remains top quality and in general, if they continue pursuing sound policies, they will prosper.

As for U.S. prospects, the break-up of the euro won't affect much over the long term, although European debt defaults will draw unwelcome attention to the U.S. deficits and spiraling debt.

In the short term, however, European turbulence will inevitably have an adverse effect, both on the U.S. economy and on the stock market.

"Sell in May and go away" may never be better advice than this year, at least until we see how the Eurozone debt crisis pans out.

Sunday's French elections are going to be critical.

Source :http://moneymorning.com/2012/05/04/the-fate-of-the-eurozone-hangs-on-sundays-french-elections//

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