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Merkozy On the Verge of Losing Sarkozy
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Merkozy On the Verge of Losing Sarkozy

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Merkozy On the Verge of Losing Sarkozy

The Sarkozy half of the Merkel-Sarkozy alliance, a pairing that's jokingly referred to as "Merkozy," is on the verge of fading into history.

And that spells risks for the sanctity of the euro.

French President Nicolas Sarkozy is trailing socialist Francois Hollande in his bid for re-election, a danger for the euro zone that markets appear to have overlooked.

Hollande "will be more hesitant to toe the hard line and may even have a hard time passing a constitutional budget amendment," says Sassan Ghahramani, president and chief executive of SGH Macro Advisors, a think tank based in New York.

Hollande has pledged to renegotiate Europe's "new agreement on fiscal discipline" and has called for the European Central Bank to play a larger role, including issuing a common euro bond.

Both ideas are strongly opposed by both Chancellor Angela Merkel and the German parliament.

On top of that there's a financial split. Nothing is more damaging to a partnership than a divergence in incomes of the senior partners, in this case France and Germany. And nothing stands out more in an election year than jobs.

In December, the unemployment rate in Germany reached 6.8%, a low not seen since 1991, while in France the unemployment rate rose to 9.3%. Some 2.85 million French voters are now unemployed.

Germany's bonds are also looked upon more favorably. The spread between 10-year German and French bonds has widened by more than 100 basis points since this time last year as contagion from the euro-zone debt crisis has started to eat at France's fiscal credibility. The very real possibility of a downgrade for France's debt rating will keep that differential in place and could drive an even-deeper wedge between the two key economies at the euro zone's core.

Germany's narrative is that its success came from a large restructuring of its work force and austere reforms that took place in the middle of the last decade when German unemployment was as high as 11.5%. It is this example that Merkel has tried to impress upon the rest of Europe to follow. The problem is that Germany rightfully embarked on reform during a global boom time; the rest of Europe is being asked to do so at the moment of highest stress in financial markets.

Will France follow suit or will French voters--many of whom are now giving a lift in the polls to Marine Le Pen, the daughter of far-right National Front founder Jean-Marie Le Pen--reject Berlin's advice and upend the alliance with Germany?

To be sure, even if Franco-German tensions rise in this way, it doesn't necessarily spell the end of the euro zone. Many observers share the view of David R. Kotok, chairman and chief investment officer of Cumberland Advisors, who believes "Europe will find a way" to stick together because "they do not have a death wish."

But even with political elites cognizant of the chaos that a breakup in the currency union would bring, politics have a habit of driving things toward the abyss--as we've seen throughout this crisis. And if the politics shift, the relationship that is the fulcrum of the euro zone is put in jeopardy.

The euro zone exists "only if France and Germany closely cooperate," says Daniel Stelter, senior partner of the Boston Consulting Group based in Berlin.

Stelter argues that eventually "austerity will fail," with German-prescribed fiscal belt-tightening producing larger, not smaller, deficits, and so thrusting the region into a "doom loop."

If the pain becomes too great, it gives a boost to anti-euro candidates such as Le Pen, which in turn raises the political pressure on more mainstream politicians.

Although Stelter does not see a Franco-German rupture as imminent, his analysis of the forces that could bring us closer to that moment is a reminder that foreign exchange traders should start paying close attention to the French electoral campaign


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