09 November 2016

Paul Goldschmidt: Is it already too late for Europe?

Following Brexit, Donald Trump’s victory brings a bruising blow to pollsters and the media for the second time in less than 6 months. The vote is less a reflexion of support for the personality of the President-elect than of the deep mistrust and rejection of the political establishment that has held sway over the “western world” during the last half century.
 
This trend is likely to intensify, reinforcing the nationalist and protectionist arguments in the upcoming contests in Italy, in the Netherlands, in France and ultimately in Germany. The shock of Trump’s election should mobilise Europeans to take their destiny in their own hands, as had been hoped for initially after the British referendum. Failing to grab the nettle will lead to increasing subservience to the major powers (economic and/or military). President Putin was the second foreign personality – after Marine Le Pen – to congratulate the President-elect. In the coming days and months, one can expect to hear more voices advocating a closer relationship between the EU and Russia, in the name of primal “anti-American” feelings which will find “moral” comfort in the distaste for personality of the new President. Such a drift will be a major victory for Putin and will only reinforce the fragility of the new administration’s support for NATO, under whose umbrella Europe was reconstructed and has prospered since 1945.
 
The danger for Europe is to believe that giving priority to “national interests” of which Trump has become the emblematic champion, is transferable to the individual European Nation-States, when such policies can only be successful if, as for the USA, the EU speaks with one voice and defends its interests from a position of strength.
 
It is highly likely that the next major challenge to European integration will originate in France. In the interval, the EU’s position might have been further weakened if either Renzi loses the constitutional referendum in Italy or Geert Wilders Populist Party wins the Dutch elections.
 
[...] the rejection of the French politico-media microcosm, both by extremists and a growing section of the population who feel abandoned, opens an opportunity for an FN victory which, like for Trump, was considered so far to be highly unlikely. The quasi total absence of references to Europe within the right wing “primary” contest is a bad omen; it suggests that candidates avoid the topic fearing that their own “sovereigntist” positions would give credence to the anti-European “lepennist” posture.
 
The behavior of financial markets over the coming weeks should be a major indicator of the reactions to the new face of the USA. After the initial shock, markets will have to assimilate the consequences of implementing the still rather vague presidential program: lower taxes, major infrastructure spending, protectionism, etc. The reaction of the Federal Reserve Board will also be scrutinized, in particular with regard to whether the probable December rate increase will be confirmed or postponed.
 
One of the consequences of the turmoil unleashed by the Trump victory could be a significant acceleration of inflation; while inflation was a key objective meant to underpin economic growth, it could rapidly spin out of control. Tensions between interest rate and budgetary policies could increase leading to currency wars and protectionist measures on a global scale. Such an environment could upset the relationships between “inflation – interest rates and FX rates” marking the end of the era during which inflation was under control and resulted in a more or less linear relationship between interest rates and FX rates. This could lead to a return to the years 1970-80 when inflation triggered interest rate hikes in order to protect the currency. This is all the more likely to happen because Trump will let the US budget deficit soar and Europe will be under pressure to follow.
 
Such a scenario should provoke substantial increases in interest rates, raising havoc in budgetary planning as debt servicing costs increase significantly. France, Italy, Spain and Belgium will find it difficult if not impossible to abide by the “budgetary treaty”, thus validating the criticisms of nationalist and protectionist parties, and weakening the € as well as the structure of the single market.
 
The occurrence of such a scenario will also provoke anticipatory actions: thus, well before the results of the elections are known, a concerted speculative attack against the 2.300billion French sovereign debt (60% of which is foreign owned) could develop, spreading rapidly to other sovereign issuers. In the face of such a storm, the ECB would be helpless if the Eurogroupe did not unanimously authorize it to buy unlimited amounts of their sovereign paper. It would then become necessary to introduce exchange controls, a first step towards the unwinding of the € and the demise of the EU.
 
Only a unanimous voluntarist reaction of the EU 27 (28?), bowing to the pressure of events, could provide the necessary courage to confront public opinion and offer a viable federalist alternative aiming also at cooperating with the United States (but also capable of standing up to them). Unfortunately, such an outcome is highly unlikely. [...]

Full article on Paul Goldschmidt website

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