Europe's Political Climate Impacts the Debt Crisis Response

The policy response to the European debt crisis is critical and that response is function of European politics. There have been a number of developments in European politics that investors should be aware of.

Germany: The crisis has revealed the Germany's economic and financial power, but the elite and people seem divided about projecting commensurate political power. This tension is threatening the FDP itself. A reshuffle last week, produced a new economic minister for Germany-Philipp Roesler, the new leader-designate of the party. Westerwelle, the former head of the FDP remains as foreign minister, but is clearly in a weakened position. The FDP garnered almost 15% of the vote in the last national contest, but now is polling less than 5%. The FDP appear to be transitioning from a sober centrist party to giving voice to euro skepticism. While parliament approval of Portugal's aid package is likely, support for additional measures for Greece and approval of the ESM will be an uphill fight. These will be important votes later this year.

Spain: Goes to the polls this weekend. The governing Socialists, who have enacted austerity measures and wage cuts are likely to be punished at local and regional polls. The risk is that the change in governments, at the regional level, will reveal large deficits and debts than the outgoing governments had indicated. Moreover, ahead of this election, may local and regional governments appear to have slowed the enactment of their own austerity measures. The firewall around Spain, protecting it from the contagion of the periphery remains intact. It may be challenged if the deficit/debt levels are significantly higher.

Italy: Local election results are not full tabulated, but it appears that Berlusconi is being delivered a setback. The impact though on Italian national policy is likely to be minimal. Italy has weathered the peripheral debt crisis remarkable well. Moreover, while a low probability at the start of the year, Italy's central bank chief Draghi took another step toward the ECB presidency yesterday with the endorsement of the euro zone finance ministers. Bini-Smaghi, is the other Italian with a ECB board seat. He indicated yesterday his term expires in 2013, which means he does not want to vacate it so that France, the second largest euro zone economy, could have one board member. The French may not like that, but Germany probably does not have a problem with that and it may demonstrate ECB independence from political pressures.

Denmark: In the context of the rise of the Tru-Finns and other anti-immigration voices in Europe, Denmark's decision last week to unilaterally restore border controls is shocking. The Schengen treaty that allows border free travel for more than a decade in Europe was a core achievement of policy harmonization. Although the direct economic impact may be minor, it does illustrate the broader political tensions in Europe.