Commentary 6/15/2012

This weekend the most important elections in the short history of the Euro zone will take place, not to mention a crucial election in Egypt. Many believe that the Greek election will have the most influence on the future of the Euro currency, but agreement among the remaining Euro Zone members will surely play a larger role. France’s parliamentary elections, also held this weekend, may play a large role in the ability of Euro Zone member states to come to an agreement or, in the short run, affect the perception of consensus among the members.

Greeks have an impossible decision to make. Do they want radical, inexperienced, leadership or do they want to go back to the party that created the mess they are currently in. The SYRIZA Party wants to call Europe’s bluff by breaking the bailout deals they’ve made while expecting the aid they need will continue to flow. This is a highly unlikely scenario. The most important thing lost in the media coverage of the Euro Crisis is that Germany is a democracy, and the leaders of Germany have to represent their constituents or they will no longer be the leaders of Germany. Bloomberg News reported earlier this week that 60% of Germans want Greece to exit the Euro Zone. If the Greeks call Europe’s bluff by putting SYRIZA in power, they will be out of the Euro Zone or Angela Merkel will have a very difficult time being re-elected next year.

A Greek exit from the Euro may be priced into equity markets to a certain extent. While a Greek exit will certainly be disruptive to financial markets, it appears that the world’s central banks are preparing for the worst and may be prepared. They do have the financial crisis of 2008 to look back upon. It is very difficult to say with any certainty how markets will react to a Greek exit. The world’s financial system remains opaque and the linkages among the large financial institutions are still impossible to sort out.

The French parliamentary election may be more important than the Greek election. Markets may react more negatively to a socialist victory if it means France will no longer stand with Germany in pushing Spain and Italy to reform themselves fiscally. We do believe that even if Hollande has a socialist parliament working with him to further their agenda the French will stand with Germany when it counts. They may continue their rhetoric until the markets make it clear they must regain common ground with Germany but this may be painful for investors.

Nations across Europe have been calling for the German leadership to support the Euro Crisis’s silver bullet, Euro bonds. If France stands with them, against Germany, the markets will not react favorably. Euro Bonds would allow Greece, Spain, and Italy to borrow using the credit worthiness of the entire Euro area thereby lowering their borrowing costs to sustainable levels and aiding their struggle to lower their deficits. Germany will not agree to support such a measure unless all European countries are willing to give up some sovereignty by allowing a European body to have a say in member countries’ budgets. Even if the Euro Zone agreed to tighter fiscal integration, it would take years to renegotiate the EU Treaties and for the individual countries to ratify the new treaties.

It appears that Euro bonds are off the table at this point. Bloomberg also reported that 79% of Germans are against Euro Bonds. It seems that the majority of Germans believe there should be a mechanism in place to prevent Euro Zone countries from running up unsustainable deficits. They are not willing to give up their low borrowing costs and stellar credit rating without such mechanisms. The good news from the polls is Germans do believe efforts to stem the crisis should be focused on aiding Spain and Italy. It appears Germans feel Greece is beyond saving if they vote not to be saved. The next few months may well decide Europe’s fate.