Tuesday, May 8, 2012

Forget France, the Greek Elections Are the Beginning of the End for Europe

And that means big trouble for U.S. banks as well.

While much of the world's attention was concentrated on France's presidential election last Sunday, the real action was in Greece. French President-elect François Hollande may be promising 75 percent income tax rates and a renegotiation of the European Union's fiscal treaty, but it was the result of the Greek elections that will determine the future of Europe.

The irony is that Greece should never have been allowed into the euro in the first place. It did not meet the entrance criteria, but Eurocrats in Brussels turned a blind eye because they viewed the creation of a European identity as more important than financial stability. When the process began to unravel, a panicked EU, along with the International Monetary Fund, responded by throwing money at the problem, in exchange for a promise of austerity.

The result of the Greek elections was a resounding rejection of the coalition government -- comprised of mainstream socialists and conservatives -- that engineered an EU/IMF bailout. The Conservative New Democracy (ND) party, the junior party in the coalition, received the most support of any party, but only 20 percent of the total votes cast. The coalition socialist party, PASOK, placed third, behind a coalition of other leftist parties calling itself Syriza. The Independent Greeks, a pro-Russian, anti-Turk conservative group led by a former ND legislator placed fourth, with the Communist KKE in fifth, the neo-fascist Golden Dawn sixth, and yet another leftist block seventh. No other parties achieved enough support to gain representation in parliament. Fully 66 percent of votes cast were for anti-bailout, anti-austerity parties.

Thanks to a bizarre quirk in the electoral system, ND gained 50 extra seats in parliament for coming in first. This measure, designed to aid the creation of coalition governments, could plausibly have resulted in a pro-bailout government forming despite the overwhelming rejection of the bailout parties. By Monday afternoon, however, ND leader Antonis Samaras had conceded defeat in his efforts to find a majority, which will allow the Syriza faction to attempt to form a coalition of the anti-bailout groups.

The upshot? Greeks have exchanged a democratic crisis for a financial crisis with far-reaching implications. If an anti-bailout government is formed -- a big if, as that would require the various anti-bailout groups to overcome their considerable ideological differences -- the subsequent rejection of the austerity policies demanded by the EU and IMF would almost certainly lead to a Greek sovereign default, Greece leaving the Eurozone, and the return of the Drachma.

If this happens, Greece will experience severe short- and medium-term financial pain, likely exacerbated by confiscatory leftist or autarkic policies -- or some combination thereof.

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