by Alexander Green, Investment U Chief Investment Strategist
Monday, May 7, 2012: Issue #1767
Winston Churchill famously said “You can always count on Americans to do the right thing – after they’ve tried everything else.” Now we can say the same about the European Union.
Global financial markets are down sharply this morning in response to election results over the weekend. In France, French Socialist candidate Francois Hollande narrowly squeezed out President Nicolas Sarkozy and his unpopular austerity measures.
Yet Hollande insists his campaign was not about the incumbent. “My real enemy,” said the President-elect, “is the world of Finance.”
He has chosen the wrong antagonist.
Governments can control fiscal policy. They can control monetary policy. But they cannot control financial markets. French voters have voiced their opinion about Hollande. And now financial markets will voice their opinion of him.
He’s not going to like it.
We’ve all the heard the nattering between economists about Europe’s choice between austerity or growth. Stronger countries, like Germany, want southern members of the Eurozone to demonstrate fiscal responsibility and cut out-of-control spending. But the citizens of these countries – especially Spain with its unemployment rate of 25% – want jobs. They want growth.
Fortunately, austerity and growth are not incompatible. Unless you believe it’s achieved through still more reckless spending and painful taxes on risk takers.
Recognize that France already has one of the highest overall tax burdens, yet it continues to bleed red ink. Debt is 90% of GDP. Trillions in unfunded pension and retiree health-care obligations loom in the not-too-distant future.
Hollande’s answer to this budget crisis? Still more spending and a proposed 75% tax rate on job creators.
To be sure, this has populist appeal among some voters, especially those who believe national governments are giant candy stores funded by millionaires and billionaires.
Let’s set aside the obvious folly of piling new debt on top of old in the midst of a fiscal crisis. Entrepreneurs and other business owners – being rationally self-interested like the rest of us – will take every step imaginable to avoid a punitive 75% tax rate. Many, in fact, will choose to take their money out of the country – or not invest it at all.
A businessman or businesswoman under a high-tax regime always does a simple back-of-the-envelope calculation. It goes like this: If I start or expand my business, I will face the risk of substantial losses for which I will be solely responsible. But if through hard work, enterprise and a bit of luck I beat the odds and succeed, the government will take up to three-quarters of what I make.
Many will choose to punt. Their businesses will not be expanded. The unemployed will not be hired. Tax revenue will not be raised. Economic growth will not expand. And neither will corporate profits. That bodes ill for Europe’s equity markets.
And it gives us a foretaste of what lies ahead in the United States if our so-called leaders in Congress don’t get their act together. Politicians on both sides of the aisle don’t want to confront the reality of our unsustainable budget deficits. Yet, ultimately, financial markets will force them to. As you can see today, the purple thunderheads are gathering.
It’s funny how words and expressions enter and leave the language. A few years ago, for instance, no one had heard the phrases “Great Recession,” “the one percent,” or “the Arab Spring.”
Want to know my prediction? You’ve already heard the last U.S. economist or politician say he favors “the European model.”
Alexander GreenFrancois Hollande and the Flight of French Capital,