The European Union has finally hit a brick wall

Hollande Wins and Europe Descends Into No-Man's Land

By Paul Roderick Gregory,

Socialist candidate Francois Hollande has won the French election as expected. His high-tax, pro-stimulus, welfare-state-protection platform, in effect, scuttles the Eurozone rescue program engineered by Merkel and a reluctant Sarkozy.

Hollande’s election leaves the European Union with three stark choices, none of which are good: 1) Germany and the European Central Bank cave and bail out any and all debtor countries under the cover of some fictitious future fiscal discipline, or 2) The Eurozone countries muddle along from one band-aid fix to the next as the bond vigilantes breathe down their necks while they hope to catch a break, or 3) Germany and the Nordic states withdraw from the Eurozone to their own currency. The rest of the Eurozone can stay on the devalued Euro or revert to their own currencies.
My guess is that the muddle-along approach will be selected by default. No one is prepared for drastic action at this time. The Germans and Nordic states do not want to bear the brunt of the Euro bonds that they must guarantee for the bail outs. The European Central Bank is reluctant to abandon its single inflation-fighting mandate. The breaking up of the Eurozone takes all of Europe into uncharted territory.

The European Union has finally hit a brick wall. It had hoped to repair a flawed foundation with an enforceable austerity fiscal pact, but it can no longer do so. Major European Union actions require evidence of popular support such as elections. The electorates, we see from the French election and the poor showing of the two major parties in today’s Greek vote, will not support even a whiff of real austerity. The electorates of the debtor nations will simply deliver an ultimatum: Bail us out so we can continue our wastrel ways or we’ll all go down with the EU ship together. The German and Nordic electorates will not budge, and there is no way out of the stalemate.

There are two wild cards: Merkel’s government could fall, making way for a Social Democratic-Green coalition, which takes a less firm stand on austerity. Merkel’s coalition also suffered a major defeat in Sunday’s  Schleswig Holstein state election. The second wild card is the fight for the soul of the European Central Bank. Can it be persuaded to emulate the Fed’s quantitative easing and bow to the anti-austerity crowd?  At that point, all bets are off.

The European Union has been a bold experiment. It has moved forward by ad hoc decision making, periodic treaties, and unclear rules. It still lacks a consensus constitution. It has now reached the point where ad hoc rules and consensus building are no longer possible.

Hollande’s election brings this into focus. It is notable that early accounts suggest that wealthy French businessmen have begun moving their assets out of France. If France’s own citizens react in that way, I can imagine what the international bond vigilantes will do. In the meantime, we can sit on the sidelines and watch Hollande test drive Obama’s election platform. Europe’s stimulus-austerity debate serves as a proxy for Obama’s calls for more stimulus versus the Republicans’ call for deficit reduction.