The Next Euro-Zone Crisis – The “France-Germany-Greece-Portugal” Disconnect in 2012Q3

I recently wrote a series of posts on the political, economic and social risks in Europe. There was a lot of information in it so it took me some time to digest them. Having done so, I have come to see a pattern of approaching events that I have not yet heard about.

In the following lines I describe how a dysfunctional Franco-German relationship in the early days of the Hollande presidency is likely to lead to European political deadlock. This is likely to coincide with Greek elections and a second bailout request from Portugal. Clearly, any ensuing political crisis or financial turbulence will be transitory, as either the ECB or the EFSF will, most likely, intervene. The issue is not whether the resources exist to rescue countries, but whether the political willingness is present to provide it in a prompt manner. I venture a guess that there is a good chance it will not.

The Core: Franco-German Deadlock

I believe that there is sufficient evidence pointing towards the emergence of a synchronized Franco-German political cycle. While France’s presidential system points to the reemergence of the left led by Mr Hollande, Germany’s parliamentary system and the present popularity of Mrs Merkel creates a certain level of uncertainty about the future. If the present pattern holds it is possible to envisage a CDU-Green, SPD-Green, CDU-SPD or even a CDU majority government. While the only certainty is that the FDP is likely to suffer a crushing defeat, it is also possible that the present coalition government may fall before September 2013, which is a scenario understated by analysts. It is my view that such an event becomes more plausible with the rise of a socialist government in France. This is where the likely fusion of the French and German political cycles, as exemplified by the Merkozy axis and by the cross national socialist cooperative agreement, is relevant.

Initial Franco-German relations after an election in either of the countries are always tentative and marred by lack of synchronicity. Sarkozy and Merkel were famously at odds in the beginning of their terms. The same is likely to be the case with Hollande. Moreover, while the partisan and personal animosity that exists between Mrs Merkel and Mr Hollande is likely to recede somewhat after the French election, I believe relations will remain tense and distant at best, conflictuous at worse. Much as Merkel has taken a stake in Sarkozy’s election campaign, Hollande is likely to retaliate in favour of his German socialist comrades. I believe that he will put an emphasis on growth and fiscal expansion, which Merkel and her coalition partners are uncomfortable with. The apparent conflict, if well-coordinated, could provide the necessary pressure to tarnish Merkel’s image as an effective leader. Given the past coordination between the French PS and the German SPD, I believe that the fall of the German government becomes increasingly likely. This could lead to a standstill in European decision making. Under the right economic circumstances this stagnant political environment could bring about another crisis.

The Periphery: Greek Elections and Portuguese Bailout

Despite the recent optimism surrounding the prolonged negotiations of its second bailout, it is all but certain that the looming elections in Greece, rumoured for April-May 2012, will result in political chaos and deadlock.

In parallel to these political developments, Portugal is likely to require a further bail-out. While the country has been relatively proactive and compliant in its implementation of the Troika’s Adjustment Programme, its economic situation is still precarious. While austerity is expected to push GDP to its trough in 2012, unemployment may only reach its peak in 2013, putting pressure on expenditure and revenues. This has put pressure on the government’s debt which is expected to peak at close to 120% of GDP in 2013. As a result, sovereign debt yields on all maturities have continued to hold above pre-bail-out levels.

All these facts conspire to obstruct the country’s access to bond markets at affordable levels by 2013, when it is expected to raise €10 Bn to pay maturing debt on its own. Aware of this fact and despite public statements to the contrary, Portugal’s government will be keen to move towards requesting further assistance from the Troika. While the recent display of support by Germany’s finance minister is encouraging to Portugal, the prospect of contrary forces from partners South and North of the Rhine, and domestic political tensions within the German coalition should create a protracted period of uncertainty that could disrupt the markets.

Given the rush to conclude the second Greek bailout in 8 months (July 21, 2011 –March 2012), Portugal would be well advised to move faster. In light of the Troika’s disbursement schedule and of its quarterly reviews I would venture a guess that Portugal is likely to request a second bailout between July and October 2012, at the latest.

Conclusion: A trasitory crisis, but still a likely crisis

I should also mention that I could be wrong. The second Portuguese bail-out, although likely, is not certain. The Greek election is not legally due until 2013, despite the lack of democratic legitimacy of the present technocratic government. May be Hollande and Merkel will put their differences aside. Unfortunately, I doubt it…

It seems to me that all this creates an extremely fertile ground for “Crisis” to return to the front page of Europe’s newspapers as early as the second half of 2012Q2. Clearly, the timings of these events are uncertain at this stage. However, whether they are desynchronised or fall on the same week is irrelevant. All these events are likely to materialize and their interaction promises a substantial amount of political, financial and economic turbulence for the Euro-Zone. The chaos resulting from a Portuguese Bailout and from the Greek elections demands compromises, which would be difficult to achieve under calm and trusting conditions.

That being said, there is no reason why the EFSF/ESM, flexible and fully financed would not be able to intervene. Even in the likely event that it does not, the ECB has a virtually infinite fire power, which it could use to stabilise markets. The issue is not whether the resources exist to rescue countries, but whether the political willingness is present to provide it in a prompt manner.

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N.B.: Correction – Austria

I should mention quickly that a previous version of this post contained a section discussing an Austrian parliamentary election which was supposed to take place in September 2012. This was an unfortunate error caused by the fact that the Austrian electoral system was reformed  to  extend the electoral cycle by five years. Although the timing issues that I discussed then were wrong, the observations about the popularity of the FDO still hold. Hopefully the election will indeed take place in 2013 rather than in 2012.