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Germans say, “Nein danke”


A very wise friend asked me yesterday to rate the likelihood of the following results in the French election, which takes place in April. (Each event is dependent on the other from first to last.)

  • Marine Le Pen, of the National Front, wins the Presidency

  • President Le Pen calls for a referendum on leaving the European Union (EU)

  • France votes yes for “Frexit”

  • EU breaks up

  • Germany re-denominates its debt

I responded with:

  • 50% chance that Le Pen wins,

  • 100% chance she calls for a “Frexit” referendum if she wins

  • 30% chance that France votes “yes” on the referendum

  • 100% chance that the EU breaks up

  • 100% chance that Germany re-denominates its debt

Essentially, it is an exercise in finding the probability of the end of the European Union, its common currency, and a financial and economic cataclysm. My back of the envelope calculations say the probability is about 15%. While the “experts” say that Le Pen will win the first round of voting, in the all-important second round (when French voters have “always” come to their senses and voted against the fringe candidate), Le Pen will be trounced. Therefore, if you listen to the political “experts,” you would assign a zero probability to the end of the euro and the European Union. Personally, at first blush, I can’t see a majority of French citizens voting to “Frexit.”

However, we have to remember that France has been traumatized by terrorism the last two years. Over 200 people were murdered in brutal terrorist attacks, many initiated by European Union citizens or long-term residents moving freely from one EU country to the next. Since one of the basic tenets of the European Common Union is the freedom of movement of people, is it really crazy to think that a slim majority of French citizens might, after electing a politician like Le Pen (whose platform is centered on France leaving the EU), vote “yes” toFrexit? If anything, the probability shouldn’t be zero.

The two most important members of the European Union (EU) are France and Germany. I ask myself what do the Germans think the odds are of the EU breaking up due to a “Frexit”? Currently, the German 2-year bond, the Schatz, has a negative yield of negative 96 basis points. The German 5-year yields negative 56 basis points. The German 10-year yields a whopping positive 20 basis points. The EU is as vital for Germany as it is for France. The Germans know that European Central Bank monetary policy has done all it can do to keep at least some level of economic growth going in Europe. The monetary stimulus machine has run out of gas. The only thing that could bring real economic growth to the EU is fiscal stimulus, and the only country that could provide it is Germany. As Germany’s cost could be funded essentially at zero percent or even lower, if the Germans believed that restoring prosperity to Europe through stimulus would not be threatened by a “Frexit,” wouldn’t they step up and save the system that their entire financial system and economy is built around? My thoughts are that the Germans believe that the probability of Frexit is at least high enough to the point where they would be just throwing good money after bad.

The Germans are telling us to assign a probability of the EU breaking up greater than zero. If the Germans are thinking that, why aren’t the risk markets?

Member SIPC & FINRA. Advisory services offered through SWBC Investment Company, a Registered Investment Advisor.

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