Pando Perspectives: France and the Euro1

by Catherine Trinder Miller, March 24, 2017

As I read many notes this morning assessing the implications of the first round French election results yesterday showing the ascent of political-upstart and Centrist, Emmanuel Macron, I found the comments of First Trust's Chief Economist, Brian Wesbury, particularly noteworthy. Please find those comments below. Macron, now favored to win the May 7 (Macron/LePen) final runoff election for the Presidency of France, embodies a movement away from the far left towards the middle in recognition that economic prosperity is more likely achieved through less bureaucracy and better fiscal policies.

Should Macron secure the French Presidency on May 7, France is expected to remain in the European Union. As Wesbury details in his comments below, stimulative European monetary policy, combined with improving economic growth and lower relative valuation, support European equities as a strong potential source of positive longer-term total returns. For clients with equity allocations, we continue to commit capital to this region as we recognize this value and potential opportunity.

It's also important to remember that these political outcomes are binary and largely unpredictable. We therefore don't trade on expected (political) outcomes, but rather remain vigilant and clear on risk positioning in advance of these events and prepared to capitalize on investment opportunities that can subsequently unfold.

As always, we welcome your thoughts and questions.

When the French elected Francois Hollande as President in 2012, the global left rejoiced. Mr. Hollande ran on a platform of protecting workers from capitalism. He wanted to raise the top income tax rate to 75%. Analysts predicted a political turn to the left across Europe, if not beyond.

But, anti-capitalist policies create blowback. We argued that in the high-tech age, Hollande's policies simply wouldn't work. If enacted, they would almost immediately do so much harm that others would not follow. The pendulum would swing the other way soon.

As we now know, Hollande figured this out. As a self-interested politician, he reversed himself to prevent a tailspin in the French economy. France's top income tax rate is 45%, not 75% and instead of increasing labor market regulation, Hollande made it easier for businesses to fire workers. He also gave companies the flexibility to reduce workers' hours and pay when the economy was in recession.

None of these shifts made France a free-market juggernaut. But, in the end, Hollande's Administration bears a resemblance to that of German Socialist Gerhard Schröder. He ran as a man of the economic Left, but governed as a man of the Center, enacting much of the labor-market deregulation that has made Germany the strongest economy in Europe.

Now, the pendulum has swung even more. In an election over the weekend, the French Establishment lost, while a political-upstart, Emmanuel Macron, emerged from a crowded field and is likely to win a run-off in two weeks to be the new president of France. Macron supports expanded free trade, a lower corporate tax rate, a lower payroll tax rate, limits on France's wealth tax, and more labor market deregulation.

From the standpoint of free markets, Macron was not the best candidate in the race. That title belonged to Francois Fillon, who ran on a platform as close to Margaret Thatcher and Ronald Reagan as any Frenchman could ever get. Fillon faced allegations he gave family members no-show jobs in his political office. In spite of this, he finished a strong third in this past weekend's election after leading in the polls last year.

Fillon received 19.9% of the vote, while the "French Trump" Marine Le Pen received 21.4% of the vote. Le Pen will now challenge Macron, who won with 23.9% of the vote, in the run-off election. As a group, these three candidates show the people of France clearly voted for a shift from France's historically left-leaning policies.

Our view is that this is a further vindication of the Euro. Countries like France are no longer able to let their currencies depreciate to temporarily hide the economic damage done by high tax rates, too much spending, and too many regulations. Just like in the U.S., if a French president wants to preside over a more prosperous economy, he has to tackle the burdens of a large bureaucratic state. There's no other choice.

Some argue that the Euro is too strong for countries like Italy, Portugal, Spain, and Greece. But voters in these countries want to keep the Euro in order to make sure their local leaders don't confiscate their hard-earned wealth through inflation.

What this does is force European leaders to find better fiscal policies. It's true that many countries were enticed to join the Euro with subsidies and rules that treated their government debt like it was German or U.S. debt. But this is bad fiscal policy, it has nothing to do with monetary policy. It may have been the political cost of creating the Euro, but it doesn't negate the benefits of a monetary union.

That Union is now bearing fruit as citizens realize the benefits of a single currency and understand the terrible cost of left-leaning fiscal and immigration policies. In spite of all the doom and gloom you've heard about Europe, and in spite of many real problems with governments that are still way too big, the European economy has better days ahead. 2

1 International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

2 Consensus forecasts come from Bloomberg. This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Catherine Miller and Teri Benson and not necessarily those of Raymond James. The information above was developed by Brian Wesbury of First Trust, an independent third party. Views expressed are the current opinion of the author, but not necessarily those of Raymond James & Associates or your financial advisor. The author's opinions are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected. No investment strategy can guarantee success. Past performance may not be indicative of future results.

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