May 07, 2012

Quick & Dirty Scenarios: Francois Hollande, Greece, and Us

Patrick Marren
Partner

The elections this past weekend in Greece and France were supposed to spook the markets. So far this morning, that has not really occurred. As of about 2PM French and German time, the French CAC 40 index is actually higher, and the German DAX index is off only 0.6%. Let's examine some possible alternative scenarios here.

 

To sum up the events of the weekend, French Socialist presidential candidate Francois Hollande defeated the austerity-favoring incumbent Nicolas Sarkozy; and the two previously dominant opposing parties in Greece, the conservative New Democracy and the leftish Panhellenic Socialist Movement (PASOK), which had previously ruled, and negotiated a set of harsh austerity measures, in a government of national unity, were dealt a historic blow, receiving together less than a third of the vote. (Although the neo-Nazi Golden Dawn party has received an inordinate amount of attention, they actually finished in 6th place with less than 7% of the vote -- behind the far left Syriza party (which actually finished second, ahead of PASOK) and the even farther-left KKE, the old Greek Communist Party.)

 

Hollande promised to meet swiftly with German prime minister Angela Merkel to try to negotiate a new Franco-German consensus on a way forward. The Greeks, meanwhile, look unable to form a government given the fragmented results of their poll. Not only do no two parties approach 50%, no THREE parties on either the right or left approach 50%. The top five leftist parties together only account for some 46%. 

 

Some possible quick and dirty scenarios of how all this plays out:

 

1. The Economist Scenario. This scenario reflects not necessarily the opinions of economists, but rather of the Economist magazine of the UK, which sported a cover story entitled "The Rather Dangerous M. Hollande." "[France] has been the swing country in the euro crisis, poised between a prudent north and spendthrift south, and between creditors and debtors. And it is big. If France were the next euro-zone country to get into trouble, the single currency's very survival would be in doubt." Presumably, the scenario that results from Hollande's victory is a repudiation of the previous "Merkozy" rather hard line on austerity, and a more growth-oriented policy designed not to squeeze the Greeks, Spanish, Irish, Italians and Portuguese (and French), but rather to enhance general European growth prospects, in turn enhancing the ability of the "PIIGS" to pay back what they owe. The Economist warns that this easing up on austerity could lead to a more general meltdown on euro zone debt, taking down not only the PIIGS but also France itself and the European currency. This in turn would presumably cause more general chaos worldwide, whacking the US financial system and causing a true double-dip world recession (or worse).

 

2. The Krugman Scenario. Paul Krugman of Princeton and the New York Times, a Nobel-winning economist (as opposed to "Economist"), has a quite different opinion. The end of "Merkozy," the Rather Dangerous M. Krugman writes this morning, "would be a 'dangerous' development if that strategy were working, or even had a reasonable chance of working. But it isn't and doesn't; it's time to move on. Europe's voters, it turns out, are wiser than the Continent's best and brightest." Krugman feels that the most likely scenario would be a loosening of the monetary policy of the European Central Bank, which he admits would be resisted by the inflation-obsessed Germans. But even though the Germans will resist, Krugman feels that the odds of a more "rational," growth-oriented policy are now better than they were a few days ago. Result, supposedly: Europe starts to grow again, muddles through, and the world economy is spared a second dip into recession.

 

3. The Mitterand Scenario. Francois Mitterand was elected as the last Socialist President of France back in the 1980s. After muddling a bit in his first two years, and suffering some severe defeats in by-elections, Mitterand, so the story goes, came around to the wisdom of aligning French Socialist objectives with the more dominant and German-favored fiscal conservatism. This scenario has the Franco-German Merkande (or Hollel? ...no) relationship resulting in an adjustment of Hollande's socialism to fiscal and economic reality; austerity and the deals with Greece and others would be respected, with some adjustments; and Europe - and the euro - would muddle through, with major suffering at its periphery, but restored health at the center.

 

4. The Argentina Scenario. Greece has clearly spit the bit on austerity. With the jobless rate at 21% and its politics in disarray, the deal with the Germans and others is obviously in danger. The French have clearly, to a lesser extent, rejected the rigid German approach to austerity. This is quite reminiscent of the situation in Argentina from 1999-2002. Argentina had tied its currency, the peso, to the US dollar in a one-to-one ratio; this is somewhat like the various European countries tying themselves to Germany, which dominated not only the European economy, but also the European Central Bank and therefore the value of the currency. When the value of the dollar fluctuated due to exogenous US monetary policies, austerity was needed to maintain the one-to-one ratio of peso to dollar. By 2001, there were riots in Buenos Aires; within a year, the peg to the dollar was gone, and economic growth resumed. The Argentine scenario in the present case would mean that the euro is abandoned by Greece and probably several other smaller nations. If this happens, it may be extremely difficult to keep the currency together for everyone else. The results in this case might not be all that terrible for the U.S. - or they might be a bit unpleasant, depending on our banks' exposure to euro-denominated securities.

 

What seems clear to this particular scenario-writer is that austerity is not working in Europe. This does not, however, necessarily mean that abandonment of austerity, still less abandonment of the euro, would be a quick and painless (or even a superior) route to economic prosperity and political stability. Our earth logic, in which applying the opposite policy should bring about opposite results, often doesn't seem to apply to Planet Money. 

 

One lesson from Argentina, and this weekend in Europe, might be that, at a certain point, all the equations on all the white boards in all the economics classrooms in Europe and America will not stop the people from hitting the streets. When this happens, economic logic curiously ceases to function, and politics takes over. Politics is probably the leading contaminant in economic spreadsheets in the wild. 

 

To paraphrase Clausewitz, these days, politics might be seen as the continuation of economic policy by other means.  One of the great scenario questions of our time is whether this will progress, as it did in 1914 and 1939, to the continuation of politics by other means. 

 

Edited to add: A few choice ironies of the current European situation:

 

(1) Who is being treated with more severity by whom: the admittedly improvident Greeks, with their 21% unemployment rate, by the Germans and the European Central Bank; or the Germans of 1947, flat on their backs after destroying Europe, by the Marshall Plan?

 

(2) World War II might be said to have been partly the result of German overreaction to the hyperinflation it suffered in the 1920s. Fear of hyperinflation is said to influence German austerity policies vis-a-vis Greece and other Euro Zone members today. The world seems to keep paying for this multigenerational German inflation-phobia.

 

(3) Now that warlike fascist tendencies have been thoroughly purged from Germany itself, German economic policy seems to be creating fascists in the shadow of the Acropolis.

Comments  | 

M.B. Culver
Politics may be the leading contaminant in economic spreadsheets in the wild, but that's not necessarily a bad thing. Could be helpful to inject some of the reality of the streets into the theory of the "rational actor" always doing the right thing "all things being equal"...
pmarren
Reality is the biggest problem with any spreadsheet-based activity. As one DOD client told us once: "The mortal enemy of every great war story is an eyewitness."

Thoughts?