From Ireland’s perspective, the elections have changed nothing.

Europe is staring intently at France and Greece, hoping to learn how the election results in these countries have changed the political dynamics at the heart of Europe.

From Ireland’s perspective, the elections have changed nothing.

Socialist François Hollande was elected to France’s Presidency while a gaggle of parties in Greece now vie for coalition status. The media are calling these results referenda on Europe’s austerity policies. There are hopes in some quarters that President-elect Hollande will make sweeping changes to the current Fiscal Compact, and perhaps the entire direction of the proposed solution to the European fiscal and banking crisis.

The markets meanwhile have reacted by running away from what they perceive as ‘risky’ European assets. Stock markets across Europe have plummeted. Europe’s markets appear to be trembling in the face of political uncertainty injected by the election results, but interestingly, the currency remains strong, and 1 Euro will once again purchase over 1.30 US dollars.  So investors are more than happy to hold the Euro. The picture is a complicated one. What is going on here?

In his acceptance speech Mr. Hollande said: “austerity can no longer be an inevitability in Europe”. What can Mr. Hollande do to alter the inevitability of a series of countries, each using the same currency, with large and persistent budget deficits, growing sovereign debt burdens, and shaky national banking systems, having to shrink those deficits, borrow less, and restore their banking systems to stability?

The first face to face meeting Mr Hollande and German Chancellor Dr Angela Merkel will have will be in Asia in about 2 weeks’ time. They will speak before that, of course.

Mr. Hollande will put forward his position. I can imagine the conversation with Dr. Merkel:

Hollande: I, François Hollande, have a mandate from the French people not to pursue these austerity policies you and my predecessor have implemented for two years. Therefore, we will renegotiate the Fiscal Compact, and reorganize Europe’s institutions to focus on growth and development within the European Union. We will particularly focus on restoring growth to France and Germany, but also to the peripheral countries, many of whom are close to default.

Merkel: Well, congratulations on the win, but you can’t renegotiate the ‘debt brake’ legislation we enacted in December 2011, which forms about 80% of the Fiscal Compact legislation, and you can’t renegotiate our commitment to essentially unlimited liquidity to Europe’s banks without collapsing the system. You can of course refuse to verify the Fiscal Compact, but we only need 12 of the 17 Member States to get the Compact ratified. So we can in principle, if not in practice, go ahead without you. In France you are still bound by the important fiscal rules within the six-pack legislation, like reducing your debt to national output ratio to 60% over time, and not borrowing more than 3% of your national output in one year. In France you have and debt to national output ratio of over 86%, and if you borrow more to finance an economic expansion in France and elsewhere, you can kiss your double A plus credit rating good bye, meaning the guarantees the French have made in relation to Europe’s bailout funds become suspect. Essentially we in Germany end up holding the entire Eurozone intact. So, rather than help Europe grow, what you will do is stall its recovery and destroy its banks. We need to reduce spending, impose prudence on fiscally profligate States, and produce a bailout fund so large it can cope with large crises like banking collapses and natural disasters. Growth will come through the private markets once confidence returns.

Hollande: I don’t accept any of that. Europe’s economies need, more than anything, to grow; otherwise the peripheral States cannot pay down their debts. Indeed larger countries like Spain, Belgium, and Italy may get into trouble very quickly. Without growth heavily indebted peripheral States may well default within our monetary union, which will end up costing us—the French and German taxpayers—enormously through the European Stability Mechanism, into which the debts of these defaulted states will be thrown. The only way out of this vicious cycle is growth, Dr. Merkel. If we grow faster, we can all pay down the debts. We must grow through the public sector by expanding the role of government. Then confidence will return. That is why I oppose the austerity policies you and my predecessor, Monsieur Bling-Bling.

Merkel. Yeah, we called him that, too. But you must understand that the German taxpayer cannot be the de facto lender of last resort for French, Irish, or Greek taxpayers. We must remove or reduce the likelihood of a fiscal explosion within one member state by imposing strict rules and having tight budgetary surveillance over all States. We cannot have another Ireland.

Hollande. It is interesting that you use this State as an example. It’s almost as if you were expecting our conversation to be repeated verbatim in a large Irish daily newspaper. The Irish crisis did not begin in their public finances, as you know Dr. Merkel. The Irish crisis was primarily a private sector crisis, where households borrowed too much from banks willing to lend to them. The public finances got into trouble when these banks were joined to the sovereign. None of your fiscal rules would have applied to the Irish, who were top of the class before their unfortunate collapse.

Merkel. I know all of this. And we have helped Ireland’s public finances and its banks with extraordinary measures.

Hollande. Ireland must have growth if it is to continue without default, or without a continual bailout mechanism.

Merkel. Ireland will not have growth from German taxpayers deciding to spend more on Irish stuff. They are too expensive, still.

Hollande. Indeed. The only solution is a European growth project. I know you’re already thinking along these lines. Spain’s El Pais newspaper reported recently that the European Union is looking to invest up to 200 billion Euros in ‘infrastructure, green energy and high technology.’ Let’s decide to unveil such a plan in June at the European Summit. If I can call the growth plan my victory, you can have the Fiscal Compact largely in its current form. I can’t change much of its substance in any case.

Merkel. This is the beginning of a beautiful friendship, Mr. Hollande.

Hollande: Indeed it is. The lesson of the crisis for politicians is that austerity equals political disaster for them. So building high-speed trains from Germany to Greece will help ensure you get re-elected when your elections come around next year.

Merkel. But, François, what about Ireland?

Hollande. Ireland will get some of the 200 billion investment programme, but it will have to balance its budgets somehow, and we will still need to sort out its banks and its debt in the end. So not much will change for the Irish.

Merkel. Ah well. Champagne?

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