The Bear’s Lair: Merkel-Macron Axis lacks a majority

Following the G7 meeting last week, Angela Merkel declared that the EU would need to deepen, and should cease relying on the U.S. and Britain. Judging by his macho “handshake” of Donald Trump, a man 31 years older, Emmanuel Macron agrees. Their dream has two problems: it would lead Europe into poverty and it almost certainly doesn’t have a majority among EU member states.

German-led coalitions leading Europe away from close relations with Britain and the United States have been tried twice in the last hundred years, and neither attempt ended well. Still, we must not allow the dead hand of history to dictate our attitudes. Maybe Merkel and Macron have a vision for Europe that is attractive to the other 25 members of the European Union (post Britain’s departure) and will lead the union to new success.

Or maybe not. Economically, Merkel’s and Macron’s policies are different, but a synthesis of the two does not appear especially promising. Germany has followed admirable fiscal policies, at least in terms of fiscal balance, with low debt and one of the very few balanced budgets in today’s world. However, the EU economic Solons and fashionable opinion are unanimous that Germany needs to abandon this virtue and engage in “fiscal stimulus”, possibly transferring some of the money to less competently run EU members such as Italy and Greece.

Theoretically, Germany could achieve the desired fiscal imbalance by cutting taxes. However, Merkel has resisted cutting taxes for more than a decade, and unless she ends up in a coalition with the Free Democrat Party alone, there is no reason to expect her to abandon the prejudices of a lifetime. Once the state has collected money from its citizenry without outright rebellion, politicians like Merkel brought up in a Communist country are very unwilling to relinquish control of those resources.

In any case, tax cuts would make Germany even more competitive and would very likely increase its balance of payments surplus, thus worsening imbalances between Germany and its EU partners. This would damage the French economy, which has taxes significantly higher than those in Germany. Thus, Germany is likely to lose her position of fiscal virtuoso, and do so by means of spending increases that will load her economy with an even larger government.

European Central Bank President Mario Draghi said this week that the eurozone still needed “an extraordinary amount of monetary support.” That means the weak sisters of the EU will get an automatic investor for their budget deficits, while productivity growth will remain anemic or nonexistent, as resources are diverted into the public sector and private projects made profitable by a distorted capital market.

In this respect also the EU may be decoupling itself from the United States. Now President Trump and a Republican Congress are in office, the Fed appears to have rediscovered monetary discipline, and is showing signs of raising interest rates considerably more rapidly than under President Obama. Of course, the economic principles on which the Fed is operating are cockeyed; the higher interest rates may in the short term cause a stock market downturn and a recession, but in the medium term they (together with a modest trend towards deregulation) will restore U.S. productivity growth closer to historically normal levels. This will make the U.S. economy bound ahead after at most a short recession, widening the gap between U.S. living standards and those in sclerotic Europe.

In another area, too, the Merkel-Macron Axis will find itself in agreement: the need to override the squawks of their domestic voters and most of their EU partners and import an ever-increasing flood of refugees and other illegal immigrants, forcing other EU members to take ever-increasing quotas. This flood will both over-burden the social systems of the importing countries and push down EU wage rates, as the more productive of the immigrants flooding in take low-end jobs at wages below those prevalent in the host country.

Probably the feature of Donald Trump’s personality that most rankled Merkel during the G7 weekend was his refusal (at that time) to sign on to the Paris Treaty propagated by the global warming scam artists. From the U.S. viewpoint, he was undoubtedly right to refuse to sign; the treaty was designated as aspirational, in order to avoid ratification by the U.S. Senate, but the U.S. trial lawyers and Obama-era leftist judges would force the U.S. to abide by even its silliest provisions unless the country pulls out.

If Trump holds firm, the EU economy will be further hobbled by its regulators forcing compliance with the Paris Treaty. In this area, Merkel is a true believer; she has already pushed German electricity prices up to hopelessly uncompetitive levels by forcing compliance with clean-power directives while shutting down the country’s nuclear power program. Regulators, encouraged by Merkel and Macron will ensure that the EU complies completely with the Paris Treaty, even though its provisions are aspirational, and no backsliding by the heavy industries of Eastern Europe will be allowed.

In general, the Merkel-Macron Axis will be highly regulatory. Germans are not just Brits without a sense of humor; they have a passion for an orderly society dating back to the 1516 Reinheitsgebot regulating the purity of beer. The EU regulators also are passionate about their regulatory opportunities for controlling the lives of ordinary citizens. In France and southern Europe, enforcement of these regulations will be lax to non-existent, but they will be draconianly enforced in Eastern Europe, and will exert a major drag on the economic performance of the EU as a whole.

Overall, an EU managed by the Merkel-Macron axis will have slow growth, declining living standards, massive immigration and stifling bureaucracy. Unlike the two previous German-dominated versions of Europe, it will also spend an inadequate amount on defense – Germany’s spending is only 1.2% of GDP far below the 2% of GDP that is the NATO standard. This feeble, sluggish, pacifist Europe is presumably what its sponsors desire, and is the logical consequence of their policies. They have just one problem in achieving this; they may not be able to bend the EU to their will. For major decisions, the EU requires a “qualified majority” of 55% of the states, representing 65% of the population, to vote in favor.

With France and Germany following their leaders, the population restriction may not be a problem, but in today’s EU, Merkel-Macron may have difficulty getting 15 of the 27 states, the number required for 55%. On the one hand, in southern Europe, there are a number of countries, notably Greece, Cyprus and Malta, that are dependent on EU handouts and so can be expected to vote the “right” way. Conversely, there are 11 former East European states, for whom Communism is a living memory, the United States is generally regarded favorably, and, normally because of their population’s homogeneity and lack of past immigration, refugees are regarded with strong distaste. In addition, Austria is about to elect the Freedom Party to government, and several other countries have shown themselves resistant to the EU’s collective wisdom. With most of Eastern Europe voting against Merkel-Macon, getting another 2-3 countries aboard the resistance train should not be too difficult, therefore.

There will be areas in which the Merkel-Macron Axis pursues policies that are popular with its EU partners. For example, the EU is clearly lining up to gouge as much as possible out of the UK in “Brexit tax,” which pro-British EU members will be told will come to them in subsidies. Needless to say, Theresa May’s ability to be a “bloody difficult woman” in resisting this outrage will be key to maintaining her political position, and is very likely to result in a “no deal” Brexit, which would certainly be better for Britain than any deal satisfactory to Merkel-Macron.

Outside France and Germany, electorates are waking up to the dangers of the failed over-regulatory statist policies that Angela Merkel and Emmanuel Macron represent. Regrettably, the people of the EU seem likely in the years ahead to suffer another intensification of them, in the face of all the economic and scientific evidence. The last two German-dominated attempts to break free from the grip of economic and social reality ended in dismal failure; let us hope this one, too meets a sticky albeit peaceful end in the nearest possible future.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)