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Dailies and Weeklies, a project of Raul Marroquin for “Inside the City” Weserburg Museum für moderne Kunst, Bremen July 18 – October 12 2015.

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Geopolitical Weekly: Spain, Debt and Sovereignty

Eurozone countries on June 9 agreed to lend Spain up to 100 billion euros ($125 billion) to stabilize the Spanish banking system. Because the bailout dealt with Spain’s financial sector directly rather than involving the country’s sovereign debt, Madrid did not face the kind of demands for more onerous austerity measures in exchange for the loan that have led to political instability in countries such as Greece. 

There are two important aspects to this. First, yet another European financial problem has emerged requiring concerted action. Second, unlike previous incidents, this bailout was not accompanied by much melodrama, infighting or politically destabilizing threats. The Europeans have not solved the underlying problems that have led to these periodic crises, but they have now calibrated their management of the situation to minimize drama and thereby limit political fallout. The Spanish request for help without conditions, and the willingness of the Europeans to provide it, moves the European process to a new level. In a sense, it is a capitulation to the crisis. 

 

Read more at Stratfor.com

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Worry for Italy Quickly Replaces Relief for Spain

VENICE — Concerns grew on Monday that Italy could be the next victim of Europe’s financial infection, leading nervous investors to sell Italian stocks and bonds and damping euphoria over a weekend deal to bail out Spain’s banks.

Italian officials privately expressed concern that the 100 billion euros, or $125 billion, that Europe pledged to Spanish banks might not stop the troubles from spreading.

Italy’s main stock index was Europe’s worst performer on Monday, a day when United States stocks were also dragged down and investors flocked yet again to the safe harbor of American and German government bonds. Even the Italian prime minister, Mario Monti, a European technocrat who came to office after the euro crisis forced out Silvio Berlusconi last November, has begun to acknowledge the dangers posed to his country’s 1.56-trillion-euro economy ($1.95 trillion).

The main fear is that Italy cannot grow its way out of arecession fast enough to pay a mountainous national debt. Other concerns include the fact that Italy, with the third-largest euro zone economy after those of Germany and France, will have to shoulder a large portion of the bailout bill even as it grapples with its own sharp economic downturn.

Because Italy does not have enough economic growth to generate the money itself, the government will probably have to borrow it at high interest rates, adding to an already heavy debt load.

“There is a permanent risk of contagion,” Mr. Monti told an economics conference near Venice over the weekend, speaking by telephone. “That is why strengthening the euro zone is of collective interest.”

Prices of Italy’s government bonds reached their lowest level in months. Investors apparently found little assurance that the euro currency union was any closer to solving its underlying problems — not with parliamentary elections in Greece this weekend that could determine whether the currency union is strong enough to retain its weakest members.

Investor euphoria in Europe over the Spanish bailout deal Monday morning was short-lived, giving way to an essentially flat day on many European stock markets. But Italy’s benchmark index was the Continent’s worst performer, ending down 2.8 percent.

Italian 10-year government bonds dropped in value for a fourth consecutive trading session. The yield — a measure of the government’s borrowing costs and of investors’ perception of risk — climbed 0.26 of a percentage point Monday to just over 6 percent. That is the highest level since January and a level that Italy could not afford for long.

The Spanish government’s 10-year bond yield also rose, closing up 0.30 of a percentage point, to 6.466 percent.

“There’s no doubt contagion will come to Italy,” Daniele Sottile, a managing partner at the financial advisers Vitale & Associati in Milan, said at the same conference, which was convened by the Council for the United States and Italy on an island near Venice. “It’s proof that the European mechanisms designed to stop the crisis are not working.”

Sergio Marchionne, the chief executive of both Fiat and Chrysler, was more blunt at the conference. “Somebody better do something before we get to the point of no return,” he said.

Although Mr. Monti, a former European commissioner, has a reputation as a skilled leader trusted by international officials, he faces a host of problems at home.

Few question Mr. Monti’s competence: Within the first six weeks of coming to power, he managed to pass more economic measures than Italy had in a decade, including increasing the retirement age, raising property taxes, simplifying the operation of government agencies and going after tax evaders. Still pending are economic changes meant to spur growth, including an effort to overhaul Italy’s inflexible labor rules.

But Mr. Monti’s government is also shackled by a legacy of political unwillingness to make painful changes.

As a result, “market attention looks set to shift to Italy,” Commerzbank analysts wrote Monday in a note to clients. Combined with weak growth, they said, the difficulties Mr. Monti faces in getting lawmakers to make economic changes mean “it may be just a matter of time before Italy also seeks help.”

Italy’s dominant political parties, the center-right People of Liberty and the center-left Democratic Party, are participating in Mr. Monti’s government but are averse to being too closely associated with the tough measures he has already put in place and the others he is still pushing for. Some opposition parties have been pressing for new elections to be held before Mr. Monti’s term ends in 2013.

Since Mr. Monti came to power, the Italian economy — like most of those in Europe — has grown weaker. It is expected to contract 1.5 percent this year and increase just 0.5 percent in 2013. Italian banks have sharply curtailed lending, pushing thousands of small and midsize Italian businesses into bankruptcy.

Italy’s unemployment rate has marched above 10 percent, well above Germany’s 5.4 percent, according to Eurostat, the European Union’s statistical agency.

Its government debt, already at 120 percent of gross domestic product, will almost certainly continue to rise, especially if Italy must pay a larger portion of the bill for shoring up the monetary union. In many respects, Italy is still better off than Spain and the three other bailout recipients — Greece, Ireland and Portugal. Its annual budget deficit has shrunk to 2.8 percent of G.D.P., which is down from 4.2 percent a year earlier and below the 3 percent level required by the euro union.

Italy has Europe’s second-largest manufacturing and industrial base, after Germany’s, and is one of the biggest export-oriented economies in the euro zone. “Made in Italy” is still a valuable brand the world over, led by icons like Ferrari cars, Gucci handbags and Ducati motorcycles. The country is also filled with state-owned assets like power companies and the national postal service that could bring in billions of euros should the government manage to privatize them.

Despite recent downgrades by the ratings agency Moody’s Investors Service, Italian banks are relatively sound — at least compared with Spain’s — because they are not saddled with bad debts from a real estate bubble. And even though the Italian government issues more bonds than any other euro zone country, the Italian public owns about half that debt, meaning banks are less vulnerable to fluctuations in the bonds’ value than banks in Spain, which are heavily invested in their government’s risky bonds.

Even so, deposits have been fleeing Italian banks for havens in Switzerland, according to several bankers at the weekend conference, on concern that Mr. Monti will raise taxes for the wealthy and as a hedge if the euro zone economy takes a turn for the worst.

Contagion is as much about fear as economic fundamentals, which is why if Mr. Monti cannot muster the political backing soon to push through his changes, there is a widespread assumption that the crisis will quickly breach Italy’s borders.

“Monti has a good agenda, and has clear in his mind what should be done for Italy,” said Cinzia Alcidi, a research fellow at the Center for European Policy Studies in Brussels. But his approach is that of a technocrat, “and when it is confronted with political and social reality, that makes things more difficult.”

Across Italy’s political spectrum, support for Mr. Monti has been tepid. But many observers agree that any attempt to hold early elections would be disastrous, blocking Mr. Monti’s efforts at change and thrusting Italy back into political mayhem. It is unlikely that any other party or coalition would receive enough support to govern comfortably.

“The good news” said Sergio Fabbrini, director of the school of government at Luiss Guido Carli University in Rome, is that Italy has veered away from becoming a “failed state in Europe” because of Mr. Monti.

The bad news, he said, is that Italy’s embedded politicians have still not acknowledged the reasons for Italy’s problems. “And when the quality of the political elite is as low as it is in Italy, or in Greece, it is difficult to create the structural conditions for growth.”

Via Nytimes

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I.M.F. Releases Report Early to Push Spain to Accept a European Bailout

BRUSSELS — In an apparent bid to raise pressure on Spain to accept a European bailout for its wobbly banks, the International Monetary Fund announced the banks would need nearly $50 billion in extra capital just to guard against a deepening of the country’s economic crisis.

The release of the estimate Friday night, several days early, came hours before finance ministers from the 17 euro zone countries were holding a conference call to try to persuade the Spanish government to swallow its pride and ask for help.

Officials have said the bailout being discussed was at least $100 billion, according to a person with knowledge of the negotiations, and is meant to provide enough of a cushion to reassure jittery markets. The I.M.F. estimate did not include costs associated with the need for banks to restructure, or to book losses on loans. Those costs would drive up the needed infusion of cash to as much as 100 billion euros, or about $125 billion, according to estimates by private firms.

 Spain’s euro-zone partners have been pushing the government in Madrid to bolster the country’s fragile banking system ahead of elections in Greece next week — the outcome of which could further destabilize the shared currency. European officials hope an infusion of cash for Spain will strip some uncertainty from the markets, which will be roiled enough if the Greek election ushers in a government that upends the country’s bailout agreement.

In what some have seen as a game of brinkmanship, however, Prime Minister Mariano Rajoy of Spain has delayed seeking outside help, trying to use the fear of economic contagion to get financial aid under better terms than those that Greece, Ireland and Portugal received when they were bailed out.

Spanish officials had been saying they first wanted to review audit by the I.M.F., as well as ones by two independent consulting firms, whose first results are not due until June 21. Spain wants to avoid a repeat of the miscalculation of the problems at Bankia, a giant Spanish mortgage lender that was nationalized last month because of the growing number of bad loans on its books.

The I.M.F.’s early release of its report was a sign of the urgency felt in Europe. It estimated the banks would need to raise at least 37 billion euros, or about $46 billion.

“The extent and persistence of the economic deterioration may imply further bank losses,” Ceyla Pazarbasioglu, deputy director of the fund’s monetary and capital markets department, said in a statement. “Full implementation of reforms as well as establishing a credible public backstop are critical for preserving financial stability going forward.”

Spanish banks are struggling with significant losses in their real estate loan portfolios, and they have been hurt by the country’s broader economic malaise, which has helped push Spain’s borrowing costs close to record highs.

On Friday, President Obama urged European leaders to stabilize their financial sector and end their long-simmering sovereign debt crisis.

“These decisions are fundamentally in the hands of Europe’s leaders, and fortunately they understand the seriousness of the situation and the urgent need to act,” Mr. Obama said at a news conference. “They’ve got to stabilize their financial system. And part of that is taking clear action as soon as possible to inject capital into weak banks.”

The Obama administration is concerned continued upheaval in Europe will further destabilize the world economy, hurting the United States and the administration’s chances for re-election.

In a speech in New York on Friday, Christine Lagarde, the managing director of the I.M.F., warned that global economic conditions had again deteriorated, with growth and financial stability at stake. Tensions are “now threatening the very existence of the European project,” Ms. Lagarde said.

The person close to the talks among euro zone officials said on Friday that they wanted Madrid to ask for help “pre-emptively,” allowing Europe to contain the problem now, with details of the package to be worked out later.

Since the start of the euro debt crisis more than two years ago, three governments — in Greece, Ireland and Portugal — have had to request bailouts. And those came with stringent budget and spending conditions imposed by the European Commission, the European Central Bank and the International Monetary Fund. Those conditions have caused political upheaval in Greece, where the Coalition of the Radical Left, or Syriza, the party led by Alexis Tsipras, has vowed that if it comes to power it will refuse to live up to the nation’s bailout terms.

But Spain may be able to avoid the strict fiscal oversight that Greece had to accept. The euro zone’s bailout fund was empowered last year to make loans to governments for the specific purpose of recapitalizing banks, with the conditions and payback terms focused largely on the financial sector and not the government’s fiscal autonomy.

In another concession to make the move more palatable to Madrid, the I.M.F. would not be called in to help oversee the program, according to one of the people close to the discussions. Instead, the European Banking Authority would take its place, this person said. That, too, would give a bailout more of a bank focus, rather than the sort of broader jurisdiction over government finances that the I.M.F. typically demands.

Nytimes

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Something’s Rotten in Athens

Just when you think Greece’s financial implosion can’t get any worse, a new wrinkle emerges to further frighten observers worried about the country’s prospects. On Tuesday, the New York Times warned that dwindling tax proceeds could quickly leave the country out of cash, and headlines continue to blare that Greece’s “agony” won’t end with new elections on June 17. Greek voters face a choice between harsh austerity measures being imposed in exchange for a financial bailout or facing the bleak possibility of leaving the eurozone entirely.  

Thirty percent of Athens shops have closed. On some streets, half the shops are shuttered. The commercial sector is in the grip of a closure epidemic which is spreading like a contagious disease. And in the heart of central Athens, a stone’s throw from the city’s glorious ancient sites, the tragic face of today’s Greece is on display. Here, we look at the human toll taken by the country’s shocking downturn in a series of photographs taken in Athens on May 22-25, 2012.

Above, heroin addicts inject drugs behind the Athens Cultural Center on Akademias Street in central Athens.ImageImageImage

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Home and dry – Europe’s weaker economies are in the grip of a worsening credit crunch

THE joke recounted by the boss of a large Italian bank is an old one, but it captures the moment. Two hikers are picnicking when a bear appears. When one laces up his boots to run, his friend scoffs that he can’t outrun a bear. The shod hiker retorts that it is not the bear he needs to outrun, merely his fellow hiker. “We’re sitting at the picnic with our boots still on,” says the bank boss.

As policymakers and pundits try to work out the effects of a Greek exit, banks and investors have already been taking precautions. One course of action has been to pull money out of more fragile markets. Never mind the weakest economies like Greece, Ireland and Portugal; Spain and Italy have also lost foreign bank deposits of about €45 billion ($56 billion) and €100 billion respectively from their peaks. Add in things like sales of government bonds by foreigners (see chart 1), and capital flight is probably equal to about 10% of GDP in those countries, say Citigroup analysts. Such outflows are hard to stop.

The European Central Bank (ECB) has filled this funding gap by providing liquidity to the banks. But that has in turn reinforced the second precautionary tactic: matching assets and liabilities within countries as much as possible. It is a common refrain from bankers that the euro area no longer functions as a single financial market, although that has the paradoxical advantage of making a break-up less destructive. Banks have used ECB loans to borrow from the national central banks of the countries in which they have assets; that should mean that both sides of the balance-sheet would get redenominated in the event of a euro exit.

Much of that ECB liquidity is meant to find its way into the real economy, of course. But the third precautionary technique, for both lenders and borrowers, is to hang fire while uncertainty is so high. The Economist has compiled a credit-crunch index, comprising a number of measures on everything from bank lending to the cost of buying insurance against default for banks, firms and sovereigns in the euro zone. A single index disguises big differences between weaker and stronger states, but it shows that credit is crunchier now than it was at the height of the banking crisis in 2008 (see chart 2).

Much economic activity is being strangled as a result. In Spain firms have put bond issues and asset sales on hold. Volatility makes it almost impossible to value an asset, bankers say. The Catalan government failed to sell 26 buildings in Barcelona earlier this year for about €450m because one of the bidders wanted to introduce a clause that said rents would be paid in dollars in the event of a euro break-up; the other bidder pulled out because it had been told by headquarters to hold off on deals in southern Europe.

The number of Spanish companies filing for bankruptcy climbed by 21.5% in the first quarter. Nearly a third of these were in the property or construction industries, but the rot is spreading. Alestis, an aeronautical supplier to aircraft manufacturers, filed for bankruptcy earlier this month after failing to reach an agreement with banks to refinance its debts.

The sound of credit crunching can also be heard next door in Portugal, where loans to non-financial companies fell by 5% in the first quarter compared with the same period last year, and credit to households by 3.6%. One of the conditions of the country’s bail-out programme is that banks should reduce their total loans to 120% of assets. The quickest way to do that is to avoid making loans.

Conditions are little better in Italy. The province of Varese, near Milan, is a manufacturing heartland: its factories make plastics, textiles and a range of engineering products. Once firms there griped about poor infrastructure and red tape; now the credit squeeze is their main complaint. The local bosses’ association says that 40% of firms were hit by lowered borrowing ceilings between January and March, and 15% were told to pay back loans. Banks turned down 45% of requests for new funding.

Those loans that are extended carry hefty interest rates, in part because higher sovereign-borrowing costs have a knock-on effect on banks’ funding costs. Differences in sovereign rates can be self-reinforcing, especially when German firms across the border are rivals. “A marginal northern Italian company competing against an equal company in Bavaria will go bust,” says the boss of one bank. “Then the cost of risk goes up and has to be shared by all the other small companies.”

If firms cannot borrow from banks they lengthen payment terms to their suppliers, exacerbating the credit problem, says Michele Tronconi of Sistema Moda Italia, a body representing textiles and clothing firms. Fashion is Italy’s second-largest export industry, but no sector has a higher level of non-performing loans.

This credit squeeze will have tightened since Greece’s inconclusive election this month. That further dents growth prospects: estimates by Now-Casting, a forecasting firm, suggests that euro-zone GDP will contract by 0.2% in the second quarter. That in turn risks worsening the debt dynamics of the zone’s peripheral countries at just the wrong time. Policymakers keep trying to buy time to solve the crisis, but they may be only speeding the end they are trying to avoid.

economist.com

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Europe’s biggest fear

It’s been a week since shares in Bankia plummeted on reports, later denied, that customers were pulling deposits out of the Spanish lender. Fears of a full-scale bank run in Greece have not yet materialised. But the possibility of a deposit run in Europe’s peripheral states is still very much alive. It is also the thing that policymakers are least prepared for. 

As with most aspects to the euro crisis, the usual answers are not much help. One tactic is to show customers the money. Old hands of emerging-market bank runs talk of how they used to pile cash up in full view of panicking customers so that they could see how well stocked the banks were with money. The equivalent now is to let the central bank provide enough liquidity that the ATMs always spit out cash. But if the idea is to get your hands on euros today in case of a currency redenomination tomorrow, then you will still want it out of the bank and under the mattress.

Another response to runs is to calm worries about the solvency of specific institutions by beefing up the scale of deposit guarantees. In the first phase of the crisis, which now seems almost innocent in its simplicity, that is what governments did. But that makes the problem worse, not better, if government solvency is at the root of the problem.

The logical solution, as we argue this week, is to set up a joint deposit-guarantee scheme, in which euro-zone states pool resources to provide credible reassurance that depositors across the zone will get their money back, up to a harmonised threshold of €100,000 ($125,000). To get around the redenomination risk, the guarantee would have to be a promise to repay the original value of the deposit in euros.

The problem, as analysts have noted this week, is that even if the political will to realise this end existed (which is highly questionable), it would take a long time to negotiate an agreement. There are all sorts of fiddly details for Eurocrats to get their teeth into. Should the scheme be prefunded? Should depositors be preferred creditors, or behind the ECB in the queue? What supervisory arrangements are needed to ensure that creditor nations have sufficient oversight of the deposit-taking institutions they now insure in peripheral countries? And that is before you get into the rigmarole of ratifying agreements.

The trouble with this is that there is a horrible, insoluble mismatch between the timescales to which Europe’s policymakers work and the timescale of a bank run. A run is most likely within the next few weeks. And if a run starts, Europe’s governments will have to reassure within a matter of hours. You might just about get a communiqué from Brussels in that timeframe, but could it really reassure when so many questions are unanswered?

If it does not, then the run will continue until such time as the banks close their doors to further withdrawals or the central banks have satisfied depositors’ demand for cash. The former means trapping depositors inside a system they do not trust. The latter means providing liquidity to a banking system that has been abandoned by its own citizens. It would be hard to come back from either position.

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In Rebuke to Merkel’s Party, Social Democrats Win German Vote

BERLIN — Chancellor Angela Merkel’s party suffered a stinging defeat in Germany’s most populous state, one likely to embolden her opposition both at home and abroad as the European debt crisisenters a critical new phase.

One week after Socialists seized the French presidency, the Social Democrats won the parliamentary election in North Rhine-Westphalia, early results and exit polls released Sunday showed. Norbert Röttgen, the lead candidate for Ms. Merkel’s Christian Democrats in the state, conceded defeat and said he would be stepping down as the head of the party there.

Exit polls for German public television showed the Social Democrats winning 38.9 percent of the vote, an increase of 4.4 percentage points from two years earlier. While the results were not official, the party was likely to achieve a double-digit margin of victory. The Christian Democrats won just 26.3 percent of the vote, 8.3 percentage points less than in the previous election.

“This is a bitter day for us,” Mr. Röttgen told supporters. “We have suffered a clear and decisive defeat.”

He attempted in his concession speech to shoulder the blame, calling it “my loss” as a result of “my campaign, my themes,” but the ramifications went far beyond the borders of the state.

With the Green Party’s 11.8 percent of the vote, analysts say Hannelore Kraft, the Social Democratic state premier, will be able to form a left-wing coalition to govern the state with ease.

Mr. Röttgen ran against the debt-financed spending supported by Ms. Kraft, and even described the vote as a referendum on Ms. Merkel’s Europe policies. Ms. Merkel has pressed debt-ridden European partners to pursue the path of harsh austerity policies even in the midst of recession.

The voters instead handed his opponent a significant victory. “We made people the central focus again,” Ms. Kraft told supporters Sunday evening.

The strong showing for Ms. Kraft and the Social Democrats, as well as what the German news media described as a “debacle” and a “disaster” for the conservatives, sends a clear signal that Ms. Merkel could face a difficult road to re-election.

With nearly 18 million inhabitants, the state is home to more than one of every five Germans. A major defeat here for the Social Democrats in 2005 helped pave the way for the defeat of Ms. Merkel’s predecessor, Gerhard Schröder, and her own rise to chancellor of Germany.

The result vaults Ms. Kraft, 50, a plain-spoken politician from the industrial Ruhr Valley, into the top rank of German politicians, prompting speculation that she might be the strongest candidate to lead the party against Ms. Merkel and potentially succeed her as chancellor.

“Queen of Hearts of the S.P.D.,” read a headline on the Web site of the newspaper Die Welt, referring to the Social Democrats by the party’s German acronym. Ms. Kraft is known as being down to earth and close to the people, still living in her hometown, Mülheim. Her party hopes she can help repeat the success on the national level, to Ms. Merkel’s detriment.

Ms. Merkel’s party has performed poorly in numerous recent state elections. Just one week ago the Christian Democrats were ousted from power in Germany’s northernmost state, Schleswig-Holstein. The next federal election is scheduled for September 2013, but the recent defeats have led commentators to ask whether Ms. Merkel could be forced into an early election.

Voters across Europe have expressed their displeasure with Ms. Merkel’s path, punishing the mainstream parties in Greece that signed the country’s loan agreement with foreign creditors, which required deep spending cuts. In France’s presidential election, François Hollande defeated President Nicolas Sarkozy, Ms. Merkel’s close ally, in part by rejecting the German focus on austerity and promising more pro-growth policies.

Ms. Merkel has ruled out any renegotiation of the fiscal compact signed in March. Mr. Hollande will travel to Berlin on Tuesday after his inauguration to meet with Ms. Merkel to discuss the path forward for the Continent in crisis. The success of the Social Democrats in Germany could well give Mr. Hollande confidence in the difficult negotiations.

“This will also strengthen us in Berlin,” said Andrea Nahles, general secretary of the Social Democratic Party, on German public television.

Peter Altmaier, the parliamentary leader of the Christian Democratic Union, also known as the C.D.U., called it “an extremely difficult day for the C.D.U. in North Rhine-Westphalia but also as a whole,” and a defeat that “surpasses our worst fears.”

Even as the Christian Democrats tried to come to terms with the magnitude of their defeat, their coalition partners in Berlin, the pro-business Free Democrats, celebrated a remarkable turnaround. Before last week’s election in Schleswig-Holstein the party was in the midst of a catastrophic slide, failing to reach even the 5 percent threshold for representation in five of the last six state elections. Analysts had begun to call the party’s very existence into question.

Building on a strong showing in Schleswig-Holstein, the party and its popular young leader in North Rhine-Westphalia, Christian Lindner, surpassed all expectations, winning 8.3 percent of the vote. “Staying true to your principles is a virtue and a sign of character,” Mr. Lindner said after the results were announced.

The Pirates, written off as a fringe party before their first success in Berlin last year, then as an urban phenomenon, won 7.8 percent on Sunday, enough to enter the state Parliament in Düsseldorf for the fourth election in a row. After it won the seats, there could be no denying that the party had established itself as a force in the political landscape in Germany.

Left-wing voters feared that the Pirates would draw so many votes that the Social Democrats and the Greens would be unable to form a government. For the past two years Ms. Kraft ruled with a minority government, forced to draw votes from left or right to pass every piece of legislation. But voters expressed their trust in Ms. Kraft, giving the Social Democrats and the Greens enough votes for an absolute majority.

Via NYtimes.com

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Auf Wiedersehen, Mon Ami – Foreign Policy (by Benjamin Weinthal)

If the results of the latest elections are any indication, Europeans will elect anyone from communists to fascists if they promise to fight German Chancellor Angela Merkel over the financial austerity measures she has imposed on the eurozone.

French Socialist François Hollande rode to victory on a wave of popular dissatisfaction on Sunday, May 6, defeating President Nicolas Sarkozy, a close ally of Merkel. “You did not resist Germany,” Hollande declared in a televised debate late last week, accusing Sarkozy of acquiescing to German economic measures that require France and other EU states to make deep, painful cuts to their social welfare spending.

Hollande now joins the collapsed Dutch government of Prime Minister Mark Rutte — which unraveled in late April over resistance to economic belt-tightening — to deliver a one-two austerity punch to Germany. Compounding Merkel’s political isolation on Sunday, May 6, voters knocked her Christian Democratic Union (CDU) out of a governing coalition in a regional election. Although the CDU secured the most votes in the northern state of Schleswig-Holstein, it was the party’s worst electoral performance since 1950.

In a shot across the Rhine, Hollande declared in his victory speech in the small southwestern French town of Tulle that “austerity is no longer inevitable.”

Yet for all his bluster, Hollande likely won’t be able to impose radical change on Europe’s core economics. The powerful German economy has kept the euro afloat as Greece, Italy, Spain, and other countries have drawn perilously close to the brink of collapse. Its manufacturing and exports businesses remain the engine of European prosperity.

Under the fiscal treaty Merkel advanced this year, EU member states are required to ensure that their “deficits do not exceed 3 percent of their gross domestic product at market prices” and must maintain strict limits on government debt. The treaty goes to great lengths — with corrective measures and potential legal action against member states — to prevent a repeat of a Greek-style economic meltdown.

On Sunday, however, Hollande promised a “new start for Europe,” spelling a possible wholesale revision of the fiscal treaty. All this has investors (and speculators) worried: His victory on Sunday, along with the weekend’s anti-austerity Greek election results, prompted the euro to sink to an eye-popping almost-five-month low of $1.2988.

All this helps explain Gideon Rachman’s recent Financial Timescommentary, “No Alternative to Austerity,” in which he notes that France is “a country where the state already consumes 56 per cent of gross domestic product, which has not balanced a budget since the mid-1970s, and which has some of the highest taxes in the world.”

Of course, this is all anathema to the rule-abiding Germans. In 2003, Merkel’s predecessor, Social Democratic Chancellor Gerhard Schröder, introduced his Agenda 2010, a sort of watered-down version of U.S. President Bill Clinton’s “welfare-to-work” program, which cut taxes, unemployment benefits, and other social welfare programs. The reforms brought German unemployment down from over 5 million in 2005 to 2.8 million today. Merkel has since led the way in imposing similar discipline across the eurozone, and Sarkozy has helped her.

“Europe must be pulled out of paralysis,” declared Sarkozy on his first presidential visit to Berlin after his May election victory nearly five years ago, urging the German leader to join him and “take the initiative.” Merkel reciprocated, culminating in a political alliance to retain EU unity and eventually impose robust fiscal discipline on the 17 eurozone countries. The unlikely and oft-quoted fusion of these two leaders — Merkozy — advanced an ambitious plan to prevent the European Union from fragmenting.

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Sarkozy fails to land the killer blow – The Economist

THIS was not a man who debated like a caramel pudding. For weeks, Nicolas Sarkozy’s people have been predicting that François Hollande, who once earned the nickname “Flanby” within his own party in reference to a wobbly dessert popular in France, would “self-destruct” when put face-to-face with the combative president.

It didn’t happen. During nearly three hours of live televised debate last night, covering wonkish detail on everything from European debt mutualisation to nuclear reactors, Mr Hollande kept his calm and held his own. This is unlikely to sway voters who are unconvinced by his arguments. But it did undermine the judgment that he does not have what it takes to be president.

With the two moderators sitting there mutely like table decorations, the candidates traded insults as well as statistics. Mr Sarkozy accused Mr Hollande of not sanctioning his Socialist friends who had compared the president to Pétain or Franco. Mr Hollande retorted that Mr Sarkozy’s camp had likened him to “beasts” and “animals in the zoo”.

Mr Sarkozy repeatedly accused Mr Hollande of “lying” and “slander”. Mr Hollande punched back with: “You are incapable of holding an argument without being unpleasant.” With reference to Mr Hollande’s effort to campaign as a “normal” would-be president, Mr Sarkozy declared: “Your normality does not measure up to what is at stake.”

On economic policy, Mr Sarkozy put in a feisty performance, and did a good job of exposing the contradictions in Mr Hollande’s programme. At one point, for example, the Socialist candidate declared that France had lost competitiveness to Germany, which he said now performs better “in every domain”. In that case, asked Mr Sarkozy, why do you embrace policies, such as the 35-hour working week, which run against everything Germany has done to reform its economy over the past ten years?

But even for a skilled debater like Mr Sarkozy this was not quite enough. His best catchphrases were batted back. “You want fewer rich people; I want fewer poor!” declared Mr Sarkozy. Without missing a beat, Mr Hollande replied: “And there are more poor people, and the rich have got richer!”

Mr Sarkozy’s real difficulty was that Mr Hollande kept turning the debate back to the incumbent’s own record. It was missing the point, he said, to declare that France was doing less badly than Spain or Italy: unemployment and debt have soared on Mr Sarkozy’s watch. “With you,” snapped Mr Hollande, “it’s very simple: it’s never your fault.”

For a voter who doesn’t share Mr Hollande’s logic, his performance last night won’t have made any difference. What it did, though, is show him to be more solid, and have a firmer grasp of detail and a tougher temperament than the image that even his own friends were once happy to spread—before he started to look like a winner.

There was no single killer strike, nor gaffe, last night; both contesters played hardball, and for once dealt with the issues. But my view is that, for Mr Sarkozy, this will not be enough. As Christophe Barbier, editor of L’Express magazine noted last night, he needed to dominate his opponent, not just to match him. And, on that score, he did not succeed.

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