On July 7th, the French chose electoral uncertainty.
With no clear majority, the French President, Mr Macron, can only hope for an administrative government to keep the country ticking over for a year, by which time he could resort, eventually, to a ‘new’ general election for a clearer political mandate.
This paradigm will keep the news channels busy, without fundamentally changing the current set up. It is the European Union (EU) that is acting as ‘Overlord’ in the country’s affairs.
However, what this election result unveils is a ‘new’ structural financial weakness in the European project. From 2009 to 2012, the EU was plagued by the limits of its own monetary ‘fits all’ policy, which had pushed massive capital flows into and then out of the zone’s periphery. The infamous PIIGS nations.
Now it is France, a ‘core’ nation, that is in difficulty. Its 3 trillion Euro debt footprint could be financed with a backdrop of zero interest rates in the region. With European interest rates now on the rise, to which one can add the loss of its AAA rated status down to AA-, France’s debt is becoming a menace to the entire financial system. To make matters worse, Saudi Arabia, in an unveiled threat, warned it could dump its European bond portfolio starting with French sovereign debt, as a reprisal to the seizure by the G7 of Russian assets. Basically, Ryad could potentially hit the EU where it would hurt the most.Â
Where does this leave us? On the one hand, frugal countries such as Germany and Netherlands look to be a safer investor bet, without having a sufficient debt footprint to absorb the Union’s savings. On the other, the financial overindebted nations such as France and Italy could be unable to fund themselves without further risk premiums to attract investors, making their indebtedness worse over time.
Only the European Central Bank (ECB) has capacity to manage this potentially unstable situation internally. But this policy comes at a cost. The ECB would have to overweight on French and Italian assets on its books making the Union overexposed, via its own central bank, to misfortunes of these two borrowers.
A European Federal debt market could have been the solution. But certain countries refused to go down this road. By forcing this federalized debt outcome indirectly through the central bank back door could lead to a ‘new’ political crisis at the heart of the Union.
In the meantime, international confidence in the European Union’s current and future monetary arrangements will be reflected in the value of the Euro on the currency markets.