The Independent Market Observer

7/9/13 – Economics and Political Risk

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jul 9, 2013 8:00:02 AM

and tagged Politics and the Economy, Yesterday's News

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I wrote on July 3 that the U.S. is the only continental power with voluntary economic integration. By that, I meant that the fiscal transfer mechanisms have been in place for a long time and are generally accepted. Few people know, for example, how much their state pays to the federal government versus how much it receives. It has come up in the past, of course, usually in stressed economic times, but it has never become a long-term political issue.

The comparison with the European Union is stark. When times were good, transfers were no problem; now that times are tough, conflict over fiscal transfers might well break up the EU. One of the best writers on EU economics is Ambrose Evans-Pritchard of Britain’s Daily Telegraph newspaper. I regularly read his columns, and glancing at the summary page, I realized that the headlines alone provide a good indicator of what is happening there. Let’s look at the last couple of weeks:

  • June 18: “EU car sales at 20-year low amid record unemployment”
  • June 19: “Germany’s ascendancy over Europe will prove short-lived”
  • June 21: “Another shameful day for Europe as EMU creditor states betray South”
  • June 24: “Italy could need EU rescue within six months, bank warns”
  • June 27: “Tempers fray in France as drastic cuts loom”
  • June 30: “France’s ‘Joan of Arc’ vows to bring back franc”
  • July 8: “French business leaders lash out at Hollande”

There were other articles as well, on the Fed and China, but Europe is clearly the big problem Evans-Pritchard is focused on—and most of his focus, despite his role as the International Business Editor, is on political risk. From his location (both emotional and physical) in London, Evans-Pritchard is neither a supporter nor a particular detractor of the euro, but a reporter, which makes him unusual in the commentariat.

The risk for the euro and the EU remains political, driven by growing disenchantment with the economic costs, on both the creditor and debtor sides. Given the overall stability of most European countries, we can expect things to continue to work well—until they don’t.

The same story, in different contexts, is playing out in the rest of the world as well. We have read about riots in Turkey and Brazil—from a Western perspective, two emerging markets success stories—where large parts of the population were clearly more discontented than they seemed. We are seeing it now in Egypt, which cannot feed its population, physically or economically. Trends continue until they become unendurable; then people lash out.

Much of what’s happening in European politics is channeling the lashing out, to the extent possible, through existing political structures and processes. In Italy, we have the Five Star movement; in Greece, Syriza and the Golden Dawn; in France, the National Front—anarchists, Communists and Fascists, and recovering Fascists, respectively, according to their critics. Nonetheless, all are getting more votes. Germany also has a growing and respectable anti-euro movement.

As I mentioned yesterday, we also have political risk here in the U.S. Currently, Congress is unable to agree on or pass a farm/food stamp bill, which, until just now, was pretty much sacrosanct. We also have an immigration bill that may fail due to political gridlock. And, of course, we have the pending debt ceiling debate coming up, not to mention the political aspects of the appointment of the next chairperson of the Federal Reserve.

Unfortunately, as much as the U.S. economy is moving in the right direction, the politics are not. In many other countries, neither is moving in the right direction. I generally focus on economics here, but, just as with the election last year, we’ll be spending an increasing amount of time on politics over the next couple of months, as that will drive much of the economics.

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