France
When you’re electioneering you can make lots of promises, but the reality is that France now has a choice between being a part of northern Europe or southern Europe. They can become the leader of the “problem children” such as Italy, Spain and Greece or they can become the heart of Europe with Germany. For the last 60 years, France and Germany have acted together to form a strong Europe.

The reality is however as much as President Hollande wishes to be pro-growth he must be responsible – he needs Europe to remain whole and not be broken up and he needs the support of Germany in this process. The only way he can spend more money is to issue more bonds. The only way he can issue more bonds is to keep the interest rate low, and the only way to do this is to keep Germany involved.

To achieve his goals, Hollande will have to get German chancellor Angela Merkel to agree to some inflation, to open the purse strings and at the same time keep Germany happy and involved, so that interest rates are low and France can afford to spend.

So we are at an interesting point now in terms of what Hollande has promised the electorate and what he will be able to deliver. The lesson of history is that Socialist leaders in France have not been irresponsible in terms of finances – we need to make a distinction between the political rhetoric and actual financial policy. Hollande will likely ask for some compromise from Germany but not too much, in terms of relaxing austerity. Hollande is a realist. He cares passionately about the French people and the average man on the street, he does not want to destroy France. We will see higher taxes and some people and companies potentially leave France. But I think Hollande is pragmatic.

Greece
Greece is a much more dangerous situation. Here the two main political parties have lost all support. Basically anyone who agreed with the main body of Europe beforehand has lost the backing of the people. Now we have all of these small factions growing in strength and they all want to re-word the deal with Europe over their support. This may well be the cause that will see Greece break away from the rest of Europe. All of the new parties are saying they are willing to tear up the deals signed beforehand.

Greece needs to make spending cuts of around US$3 billion (A$3bn) in the next few weeks. Unless these are agreed, Greece won’t get the next tranche of funding from Europe, and if this doesn’t happen the situation becomes very dangerous.

I think most people realise that this is a tragedy for Greece but has very little impact on the rest of the world or even Europe, it is very small – but only as long as this problem can be isolated from Italy and Spain.

The risk of a disorderly exit of Greece from the eurozone has increased yes – because there is no political cohesion, Europe doesn’t know who’s in charge. It’s very hard now to get an agreement, with so many different parties and so many different deals, making it difficult to negotiate. Mrs. Merkel must be thinking what to do. If a deal is done, the government could change in a matter of weeks and we’re back to square one, it’s very tough.

However, these events have largely been priced into the bond market. The reconstructed bonds in Greece are trading way below the issue price, about 50% below. The market doesn’t believe these bonds are going to be repaid in full, but in reality there are very few retail and institutional investors involved in this market.

What is the likelihood that Greece will exit the eurozone? 

That’s a difficult question, I’d say around 50:50, but with this type of thing it’s all about politics and it’s not something you can analyse too much. Politics changes things. Public opinion is driving the agenda. If you’re a politician in Greece you must listen to the public otherwise you don’t have a job. The public are saying we don’t want anything to do with Europe.

Portugal has issues, but we believe they will stay within Europe, as will Ireland, because the support is strong and there are very few other elections coming up in the near future.

On the whole people need time. The problems of the eurozone will need working out over a number of years. We need growth, we need a re-pricing of labour in Italy and Spain, and some banks probably need more help with restructuring and bad loan portfolios. It’s very hard to see this sorted out in less than 3-5 years.

It also depends on how fast the US, Chinese and other external economies grow. If you look at recent German industrial production data, it’s quite good, the German economy is doing well. A relatively weak euro is good for Germany, so we’re seeing a transfer of assets from Germany to southern Europe. Germany is paying for a cheap euro by subsidising the periphery.

Fiscal integration would be the ultimate goal so you can have a harmonisation of taxation, fiscal policy and budgetary responsibility. That takes time and it takes time for the electorate to realise that it’s in their interest.

I think the risk of the whole eurozone system collapsing is small, as it would cause so many other problems and the cost would be huge.
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