The French Connection

Dear colleagues,

Pendulums can be problematic once physics kicks in. Such could be the case in the coming years as the populist movement sweeping the developed world swings to the far right. In the event this possibility seems remote, grab today’s Financial Times and have a read of, “Austrian Election Tests Support for European populism in Trump Era.” 

This Sunday’s vote will determine the victor of a race first held in May which vied Austria’s Green party candidate against the far-right Freedom Party. The first go-round went to the Green party, but separated the two by a mere 31,000 votes. And that was pre-Brexit and pre-Trump. The Freedom party is decidedly anti-Islamist and was initially formed by former Nazis in the 1950s, hence the alarm in many circles. Though the president’s role is largely ceremonial, the power to call parliamentary elections could see the Freedom Party’s taking of parliament by the fall of 2018. 

Suffice it to say, the world’s focus this Sunday will be on a country that borders Austria to the south, that is, Italy. Though the referendum will not decide any sort of exit from the EU or the euro, the results nevertheless have far reaching political and economic implications. Investors will be laser-focused on the euro, which is hovering close to its 52-week low, and the difference between the Italian and German 10-year bond yield, which has gapped out as the referendum approaches. 

As for what’s to come, a ‘no’ vote should trigger the dissolution of the current government and prompt Italian elections as quickly as early next year. More importantly, a ‘no’ will be one more sign that populism is not a flash in the pan but rather a deepening trend.  

By all indications, France is headed down the same path come spring despite the constant chastising in the media and on the part of the intellectual powers that be who contend the electorate is confused and ill-informed. Of course, the linchpin of future elections, that of Germany, will not arrive until the fall. The establishment can only hope voters will have come to their senses by then, that the pendulum’s momentum has finally faded, that a move back towards the center is underway. 

For more on this delicate dynamic, please read on to this week’s The French Connection. 

Best, 

Danielle 

The French Connection

Should you be overwhelmed with the urge to pick your feet in Poughkeepsie, or if you’d prefer, maybe ripping off a piece of baguette after shooting a French detective point blank in the face, then ‘tis the season.

For a dose of not so jolly Christmas cheer, you can actually experience the cinematic pleasure of both simultaneously in the dual opening scenes of the first Rated-R movie to win the Oscar for Best Picture. That is, if you’re keen to watch for the first or umpteenth time 1971’s The French Connection. This raw, gritty semi-documentary film chronicles what was then the largest narcotics bust of all time. The 1962, $32 million seizure equates today to over $256 million.

But don’t watch the film as an exercise in calculating the street and time value of money. Rather sit back and enjoy the display of contrasts between the good(ish) cops and the bad guys. Gene Hackman commands his first Best Actor Oscar as Jimmy “Popeye” Doyle alongside his partner Buddy “Cloudy” Russo, an exceedingly young Roy Scheider. These two relentlessly pursue Alain Charnier, portrayed elegantly by Fernando Rey, and his ruthless hitman Pierre Nicoli, played by Marcel Bozzuffi. The cops tend to eat cold pizza on street corners in the brutal winter cold as they surveil the smug smugglers indulging in the finest cuisine on offer in the cozy warmth of Manhattan’s fanciest restaurants. Thankless pursuits to be sure, but ultimately for the greater good except for the glaring fact that in the end, Charnier escapes.

And as for the greater good in the here and now? Well, despite what we’re told by the mainstream media and the condescending tone they refuse to renounce, a cresting wave of discontent has crashed onto our country’s shores. This repudiation of perceived injustice will no doubt also be manifest at European polls in the year to come. Voters are increasingly convinced that the bad guys have been winning for a very long time. So they continue to reject the status quo even given the lack of viable alternatives other than pure and simple ‘change,’ regardless of the form that change happens to take.

It will therefore come as no surprise if the Italians vote down the balloted referendum this Sunday. Forget for a moment the relative irrelevance of what’s the vote actually addresses. OK, if you must know, at issue is gridlock that allows legislation to enter a perpetual cycle, as in nothing ever gets done. The two chambers of Italy’s parliament can effectively veto each other’s decisions in perpetuity. Separately, the regions retain great powers. A ‘yes’ to Prime Minister Matteo Renzi’s constitutional reform referendum brain child would limit both the powers of the Senate and local governments.

The funny thing is, the Italians pass a lot of laws -- more than their peers in France, Germany, the UK and the US. They just aren’t enforced. That nagging detail helps explain why the country has had over 60 governments in the past 70 years. Add to this the high stakes game of chicken Renzi is playing. A ‘yes’ vote will also award the party that wins future elections bonus seats in the dominant chamber of parliament and a guaranteed majority for five years, laying the groundwork for the rise of a strongman. It’s safe to say the Italians have long and bad memories of past dictators.

A recent visit to Italy and chats with men and women on the street revealed a general mistrust of Renzi and his Machiavellian ways. One PhD-educated Florentine resident was bitter in recounting that Renzi, the city’s former mayor, took his current post by force, pushing his party colleague Enrico Letta to resign as prime minister. This shrewd move prompted Italy’s President to ask Renzi to form a government, which he gladly did with himself as head of the leading party. He maneuvered his way into office with no say on the people’s part. For some reason, this act enraged the electorate.

In fact, the majority of those in the Five Star Movement, the main opposition party, are generally well-educated. They wholeheartedly support their leader, former comedian Beppe Grillo, who enjoyed wild success before he was banished from publicly owned television for his satirical political attacks. Rather than skip a beat, Grillo began to blog and became a powerful voice of the people, demanding freedom of speech and speaking out against political and corporate corruption, child labor and globalization. Given its druthers and a power seat, Five Star has promised to give Italians a vote to leave the euro, the currency bloc, rather than the European Union. Not surprisingly, the media and establishment relish in besmirching Grillo’s name, which of course only serves to endear him to the people that much more. Sound familiar?

Atop this icy slope, Renzi precariously teeters; he has vowed to step down if his referendum fails, which seems likely. This would open the door for general elections, possibly as soon as early next year. Grillo could then conceivably ally with another opposition party and rise to become the next prime minister. Connect the dots and you see what has markets so worried and that’s without one word of mention of the tenuous state of Italian banks.

That brings us north, to France, the next major country scheduled to hold elections come May. How will the outcome of the Italian referendum connect the French to the Italians, and by extension, the rest of the world’s economy and financial system? It sure would be nice to know the answer to that question, especially if your first name is Angela and your last, Merkel.

According to the German newspaper Die Welt, French banks’ total exposure to Italian debt is in excess of €250 billion, three times that of Germany (though Deutsche Bank alone has €12 billion of exposure, which raises yet another red flag on the bank’s viability.) Spain (€45 bn), US (€42 bn), the UK (€30 bn) and Japan (€28 bn) follow. If these numbers seem rather large, it bears repeating that after the US and Japan, Italy boasts the world’s third largest sovereign bond market, hence the potential to inflict damage on the masses in one fell swoop.

If you think populist pugilism is rampant now, imagine what a banking crisis would stir up among the protestors. While a far-right Marie Le Pen might have seemed a stretch to be France’s next president, the surprise victory of the less-right Francois Fillon all but ensures France will follow in the footsteps of Great Britain and America in electing dark horses. Lest you suffer undue levels of suspense, yes, Fillon was publicly derided. Nicolas Sarkozy, the ex-president, was assured by his advisors that Fillon was not to be taken seriously, nicknaming the front runner, “Mister Nobody.”

Are you beginning to detect a trend? Do you think the so-called elites also sense a meme? Or will they continue to label the rise of change agents as one-offs, maintaining their arrogant dismissiveness that continues to work against them?

The most startling development that’s shot up through the grassroots is the identity of those raising their fists in concert. Fillon didn’t just win his primary run-off; he ran away with two-thirds of the vote. That’s saying something for a candidate who has vowed to curb union power, end France’s 35-hour work week, shrink the country’s labor code to 150 pages from 3,000 (!), and by the way is a social conservative and practicing Catholic. In other words, he’s the last person you’d expect the French to embrace. Public spending as a percentage of France’s GDP is 57 percent, appreciably higher that the generous Eurozone average of 49 percent.

And yet…

Perhaps the true underlying message is that globalization, for all of its merits, simply didn’t work out the way it was designed on paper. The hollowing out of the middle class is anything but contained to one country or even a handful of them; it too is a global phenomenon as evidenced by the breadth of the countermovement. It can’t help that the monetary policy response has not only widened the global inequality gap further, but managed to do so in such a deeply insulting way as to incite economic riots.

When, thus, does political risk become economic, financial and the dreaded systemic? And how far does the contagion spread? Technocrats under the influence of truth serum must be asking themselves if populism will be contained within the developed world or spread to the likes of Cuba and Venezuela. Is blood shed within the realm of possibilities? Has it really come to that?

One thing is for certain. Angela Merkel will run for a fourth term just in case. More than anyone else, she ties her legacy to the survival of the euro. Her moment of truth arrives as the leaves begin to turn next fall, as Germans head to the polls. Merkel will bank on her savvy Deutschland constituents’ appreciation of the economic benefits of an artificially weak currency. Surely they will not bite the hand that’s fed them so well all these years.

If you prefer a bit of certainty to second-guessing the future, do yourself a favor and bookmark the spread differential between Italian and German bonds first and French bonds second. They’ve widened dramatically in recent weeks and will be your most reliable gauge as to whether prosciutto or steak tartare will be on the never-to-be-served list in the Merkel household a year from now. For good measure, keep Deutsche Bank on your radar in the event tough choices lie ahead (“My precious € or my fatherland’s biggest bank? If only the balance in the country’s checking account could cover both!”)

Gene Hackman’s Popeye also came up shy in the end. But he did seize the drug stash, and as a bonus, got to whack that nasty hit man employed by the drug smuggler mastermind. But alas, the bad guy, that slippery Frenchman, slipped away, severing the Connection by living for another day. Ask yourself: Will the establishment have such luck?

For a full archive of my writing, please visit my website Money Strong LLC at www.DiMartinoBooth.com 

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