Why the Euro Took a Dive After Merkel's Re-Election - Philip Bagus (10/05/2017)

After the German elections held on the 23rd of September, the euro started a pronounced decline. But why was there such a sharp fall of the common currency?

At the end, the election´s result does not seem to bring dramatic changes. Despite its losses, Merkel´s party, the CDU, remained the strongest force in the parliament. Merkel will continue to be German chancellor. It is true that the AfD (Alternative for Germany) with both a nationalistic and a libertarian wing won a spectacular 12.6% of the votes and made it into the parliament for the first time. Nevertheless, the euro-critical AfD is light years from being part of the government. All other parties ostracize them for supposedly being extremists.

The next German government will likely be formed by a “Jamaica” coalition of CDU, FDP (free democrats) and the Greens, because the up to now governing social democrats (SPD) will abstain from attempts to renew their coalition with Merkel.

So with Merkel remaining chancellor why did the euro take such a large dive in the wake of the election? The answer is related to French President´s Emmanuel Macron´s speech only two days after the German election, in which Macron argued in favor of a new foundation for Europe. Among other proposals, Macron called for a European financial transaction tax and for the harmonization of social security and corporate taxes within the European Union. His statist proposals also include a common budget for the 19 Eurozone member as well as a Eurozone finance ministry and eventually some sort of Europe-wide taxation.

Why did Macron wait with his speech until after the German election? The answer is straight-forward. A large part of German population is against an European Superstate and the transfer of sovereignity to Brussels as envisioned by Macron. If Macron had held his speech before the election, Merkel would have had to react to it. If she would have approved Macron´s plans, she most likely would have lost many more votes. As Macron expected resistance from German voters, he waited. He was speculating on a renewed pro-EU coalition of the SPD with Merkel to push forward his agenda. He rightly feared the entrance of the FDP into the government. According to Le Monde Macron stated in July: “If she allies with the FDP, I am dead.

His fear is well-founded. In the FDP´s party program, we find a call to limit bail-outs in the Eurozone, to introduce a sovereign bankruptcy procedure for the Eurozone, as well as firm opposition to Euro-bonds and a plea for market deregulation.

If the FDP finally gets into the German government, the plans for more centralization, bailouts and a European super state will suffer a major setback. And this is the reason why the euro has taken a dive after the election and why the Greek banking stocks plunged in September.

Priced into the euro is the expectation that there will be more centralization in the EU, and that Germans will bail out over-indebted governments. The public debt to GDP ratio in France, Spain, Italy and Greece stand at 96%, 99%, 132% and 179% respectively (for 2016). If these countries default on their debts, they will take down their respective banking sectors with them. Losses for the ECB will be enormous. The euro will implode.

For years European governments have kicked the can down the road building up their debts thanks to the extremely expansionary monetary policies of the ECB. The structural problems like over-indebted governments, bubble sized public sectors, public debt loaded insolvent banking sectors or inflexible labor markets have not been solved. Indeed, the ECB´s policies permitted to delay the solution of these problems. Once, the ECB normalizes its policy and interest rates return to a more normal level, it is game over for highly indebted countries. Someone will have to foot the bill. Markets think it will be Germany. Or to put it the other way around: Before the ECB´s monetary policy stand can be normalized, European debts socialization should be secured.

Today, it is basically the German support that keeps the over-indebted governments afloat. The expectation of centralization, debt socialization and a European super state is what keeps the Euro alive. The expectation of Macron and market participants that further centralizing steps are imminent after the German election have become less likely on the 23rd of September by the possible entrance of the FDP into the next government.

Philipp Bagus is an associate professor at Universidad Rey Juan Carlos. He is an associated scholar of the Mises Institute, an IREF Scholar, and the author of numerous books including In Defense of Deflation, Blind Robbery!, The Tragedy of the Euro, and is coauthor of Deep Freeze: Iceland's Economic Collapse.
Contact Philipp Bagus


This article originally posted here.

Grab This Free Report: My Top Options Trading Setup

This free special WSW report is devoted to my top options trading setup. I do this one simple trade at least once a month.

Grab it and get along with it our future stock market action updates. Do not think about buying any other stocks or options before you read this report. To get this report click here