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France and Italy aversion to fiscal austerity will keep dollar up

German Chancellor Angela Merkel greets US President Barack Obama ahead of a meeting with EU leaders and the US President at the Chancellery on November 18,2016 in Berlin.
Tobias Schwarz | AFP | Getty Images
German Chancellor Angela Merkel greets US President Barack Obama ahead of a meeting with EU leaders and the US President at the Chancellery on November 18,2016 in Berlin.

On his swan song tour of Europe, President Barack Obama said in Athens last Tuesday (November 15) that "austerity cannot be the formula for growth," and vowed to carry that message to the rest of the continent that is now being rescued by ECB's cheap and abundant credit flows.

By the time he flew to Berlin, I thought that Mr. Obama's spin doctors would say that this was just an ex tempore slip taken out of context by malicious media. I simply could not believe that he would take such a swipe at his German hosts and the country's leader who directed and presided over devastating euro area austerity policies.

The fact that Mr. Obama did not do that may be that he cared more about the victims. He was probably feeling for the poor Greeks who will be working in perpetuity to pay back their debt (185.3 percent of GDP) to fellow Europeans, or the French and Italian leaders he was meeting in Berlin, and who were also facing the final curtain in virtually stagnating economies crushed by unemployment rates of 10 percent and 12 percent.

Austerity's festering wounds

Whatever the motivation, some European media warmly greeted Mr. Obama in an ostensible spite at America's president-elect Donald Trump, while some widely read papers in Germany dismissed his visit as an irrelevant "nostalgia tour."

Most French and Italians, to say nothing of the Greeks, will probably think otherwise. As they head for the polls, or count their losses, they could well take Mr. Obama's statement in Athens as a fitting reminder of the huge damage the austerity diktat did to them at the time when their economies were already sinking into sharp recessions.

Italians, in particular, are facing a firestorm of a referendum on constitutional issues scheduled for December 4, 2016. An overwhelmingly negative vote is expected to vent people's discontent with a recessionary and stagnating economy over the last five years, high and rising unemployment (11.7 percent), nearly 40 percent of the country's youth without work and a meaningful future, and a debilitating public debt of 160 percent of GDP.

As things now stand, Italy could soon be in the middle of a general election on platforms that will seek some sort of fiscal stimulus to spur growth and employment. That will be met with a strong opposition from the EU Commission and euro area countries demanding strict adherence to euro area budget rules. An ugly, destabilizing and divisive European showdown lies ahead.

That looming conflict will play out in a crisis where the anti-EU political forces like the Five Star Movement, the Northern League, Forza Italia and the factions of the splintering Democratic Party continue to vie for power. A replay of a recent Spanish scenario is very likely, because none of these parties seems capable of getting a parliamentary majority or coalition partners to form a government.

France is in a similar position. At the time of this writing, the main center-right political party (Les Républicains) is running a primary to get a standard bearer who will contest presidential elections in April/May of next year. Hugely unpopular and disorganized center-left political forces appear to have been marginalized, but the extreme-right (aka "populist") National Front seems to be going from strength to strength. Opinion polls are consistently showing that its leader, Marine Le Pen, would handsomely beat many well-known contenders in the runoff on May 7, 2017.

It now seems that only the former French prime minister François Fillon of the Republican Party could win against Ms. Le Pen. Like most other presidential candidates, Mr. Fillon has moved his election platform to capture some of Ms. Le Pen's popular appeal.

A Gaullic Thatcherite

The key features of his campaign should give investors pause for thought and a pounding headache to Brussels and Berlin. Here is what he says: "I am a Gaullist, nationalist, patriot, sovereignist, liberal, attached to family values and Christian beliefs."

Gaullist means a fiercely independent foreign policy -- totally incompatible with EU's common foreign policy stands. Nationalist and patriot are code words for a "France First" policy, another anathema to EU's pretensions to "cohesion" and "solidarity." Sovereignist means not only a full stop to further sovereignty transfers -- a must for common fiscal policy to complete the institutional framework of the monetary union – but also a claw-back of administrative and political powers ceased to the EU Commission. Liberal means an attachment to market economy and a Thatcherite (the late British Prime Minister Margaret Thatcher is his political role model) social philosophy.

Family values and Christian faith are loaded with implicit messages to ruffle the feathers in a secular, multicultural and multi-confessional society.

Take that the EU. And do beware because Ms. Le Pen would be even worse. She wants – for starters -- a speedy Frexit, end to the euro, an immediate stop to immigration and a full control of French borders.

These are all well-known components of political platforms that have made Ms. Le Pen go from zero to more than one-third of the popular vote; they have also propelled Mr. Fillon from a struggling outsider to a clear front-runner in presidential elections.

What is Germany going to do in all this? I don't know, but the blows are coming. It is a pity that Germany's great contributions to the European unity, peace and prosperity made by political giants like Konrad Adenauer, Helmut Schmidt and Helmut Kohl had to come to such an end. Schmidt and Kohl have been warning about this over the last ten years. Mr. Kohl even published a book in late 2014 whose title "Out of Concern for Europe – An Appeal" says it all.

Germany's foremost contemporary philosopher Jürgen Habermas went much further. He told German authorities as recently as August 9, 2013 that the austerity policies they were imposing on Europe were like "dozing on a volcano."

President Obama, therefore, might have been on to the same analysis when he was pleading, during his re-election campaign in 2011, with Germany's Chancellor Angela Merkel to abandon her austerity policies and give some oxygen to suffocating EU economies. Sadly, he not only got a resounding no, but he was also ridiculed in the media for having dared to ask.

Perish the thought, but one might be forgiven for speculating that Mr. Obama's statement in Athens sounded like a long-delayed payback.

Investment thoughts

Italy's referendum on next December 4, and the ominous "France First" soundings of the two front-runners in forthcoming presidential elections (April/May 2017), could spell the beginning of the end of the euro area. Both countries are balking at monetary and fiscal constraints they want lifted to recover the control of policy instruments to stimulate economic growth and employment creation.

The EU's unfolding political and economic crisis is a serious existential threat to the euro, because Italian and French political leaders seem determined to deconstruct the policy coordination mechanism that underpins the viability of the common currency.

The dollar is still down about 2 percent in trade-weighted terms from its year-earlier level. The upside is wide open. The dollar-based investor has to carefully consider exchange-rate exposures on any assets denominated in foreign currencies.

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