Financial markets will be on high alert this week after two major political events in Europe on the weekend clearly showed that the eurozone debt crisis is about to embark on a new political phase.

The first, of course, was the victory of French Socialist candidate François Hollande in the first round of France’s presidential elections.

Hollande’s strong showing in the first round makes it increasingly likely that French president Nicolas Sarkozy will suffer the same fate as the Italian, Greek, Spanish, Portuguese and Irish leaders, all of whom have been booted out of office since the start of the eurozone crisis.

The second major development was the collapse of the Dutch governing coalition on the weekend, after the far-right politician Geert Wilders pulled out of negotiations on cutting the budget deficit. He declared that it was not in Netherland’s interest to cut its deficit to 3% of GDP in order to meet the conditions of the Europe’s fiscal pact — which was devised by German Chancellor Angela Merkel with the backing of Sarkozy in an attempt to imposing impose stringent budgetary discipline on eurozone countries.

The Netherlands has been a staunch supporter of the austerity agenda, but a slowing economy means that the country is at risk of breaching the budget rules it has fiercely advocated for other debt-laden eurozone countries.

These two political upheavals come at a time when an increasing number of economists are querying whether the German-backed austerity approach actually works. Critics argue that the stringent austerity plans that are being imposed on countries such as Portugal, Spain and Italy are socially and economically dangerous, because they impose budget reduction targets that are simply unachievable.

Imposing brutal spending cuts and tax hikes on debt-laden eurozone countries forces them into a recessionary spiral, causing welfare payments to soar while government revenues dwindle. As a result, budget deficits continue to climb.

Critics argue that continuing to force countries to follow on the austerity track will lead to an implosion of the eurozone. Debt-laden countries will have no option but to leave if they are to avoid economic ruin and riotous social uprisings.

Many economists argue that the eurozone needs to stop insisting on annual austerity plans that impose brutal conditions. Instead, debt-laden countries should commit to multi-year budgetary strategies — approved by Brussels — that impose much less ambitious, but more realistic, goals.

They also want the European Central Bank to commit to cutting borrowing costs for debt-laden countries by buying up huge quantities of government bonds of countries, such as Spain and Italy, that are facing higher interest rates.

The two major political developments on the weekend have greatly increased the political power of the anti-austerity camp.

Hollande has already signalled that he wants to amend the fiscal pact so that it puts more emphasis on economic growth. He’s also argued that the ECB should be more active in pushing down the borrowing costs for debt-laden eurozone countries. And you can be sure that Hollande will enjoy the backing of Italian leader Mario Monti and Spain’s Mariano Rajoy.

At the same time, the collapse of the Dutch coalition government means that Germany — the long-standing champion of fiscal orthodoxy — has lost an important ally.

But even within Germany, opinion is divided as to the best approach. Last week, the five leading German economic research institutes were unable to hide their differences when they presented their latest economic outlooks.

Two of the institutes even risked provoking the ire of the powerful German Bundesbank by arguing that the ECB should play the role of “lender of last resort” to debt-laden eurozone countries. And the major German opposition parties, the Social Democrats and the Greens, also support the idea that austerity plans should contain measures that promote economic growth.

Even Gerhard Schröder, the former German leader who is credited for laying the foundations of the “German economic miracle” through his economic reforms in the early 1990s, has voiced his support for Hollande’s plan to change the fiscal pact.

*This article was first published at Business Spectator

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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