By James Mackintosh
The French have a traditional approach to revolting peasants: Let them eat cake. It didn't work for Marie Antoinette, but the European elite has since found that fiscal expansion works better at buying off the populace than handouts of sweetened baked goods.
Investors are increasingly concerned that the populist uprising that toppled the U.S. establishment and led Britons to vote for Brexit is about to upset elections in three of the eurozone's biggest economies.
They need not be so gloomy. Sure, far-right candidates in France, the Netherlands and Germany will do far better in elections next year than imagined a few years ago. But they arevery unlikely to win.
Instead of worrying about the end of the euro and a new reign of terror over financial assets, investors should be cheering the prospect of mainstream politicians pandering to populists. So long as the far right doesn't actually win, their voters can push the elite to embrace share-price-friendly spending increases and a move away from austerity.
The purse strings are already being loosened in Europe, and the closer populists get to power, the looser fiscal policy is likely to become.
The populist threat isn't imaginary. The number of votes gathered by far-right groups once on the fringe will dominate coverage of the French, Dutch and German elections next year. But these groups are all far from winning, and the widespread questioning of polls' reliability in the wake of the surprise wins by U.S. President-elect Donald Trump and the Brexit campaign goes too far.
Take Marine Le Pen, of France's National Front. She told the BBC that Mr. Trump "made possible what had previously been presented as impossible." She's polling more than a quarter of the votes and is the front-runner to win the first round of the presidential elections in May.
That is as close to the office of the president as she's likely to get next year. Polling shows her lagging by double-digit percentages against any of the center-right Républicains, one of whom is almost sure to be her competitor for the presidency in the second round of voting.
This is starkly different to the situation in the U.S. or U.K. If the U.S. used the same system as the French, Hillary Clinton would have won, while in the U.K., the polls showed the outcome was close -- even if they mostly called it the wrong way.
Bruno Jeanbart, deputy managing director of pollster OpinionWay, points out that, last December, Ms. Le Pen's FN failed to win the regions where its support is strongest, thanks in part to a big turnout against it in the second round.
"If they can't be elected in their favorite region, I don't see how they can win the national election," he said. He sees little effect from Mr. Trump's win, as the FN was already normalized in political discourse.
All this suggests is that the risk for investors is taking Ms. Le Pen too seriously by watching the sharp rise in the probability bookies put on her winning, which has doubled to almost a third since just before Mr. Trump's election.
Still, the threat is serious enough that mainstream politicians are sure to respond, shifting further away from postcrisis austerity.
In a way, the handouts of cake are already happening. The new government in the U.K. has ditched plans to balance the budget by 2020. In the U.S., both Mr. Trump and Mrs. Clinton promised heavy infrastructure spending. In Europe, fiscal rules are supposed to prevent governments buying offtheir voters, but the rules were relaxed ahead of the summer's Spanish elections for fear of encouraging the populists.
On Wednesday, the European Commission -- enforcer of the rules -- joined in, calling for a "significantly more positive" fiscal stance for the eurozone and saying countries need only be "broadly" compliant. Rather than a slight tightening of fiscal policy, it now wants policy looser by 0.5% of the economy.
"It's not desperately stimulative or transformative but it is keeping the show on the road," said Huw Pill, chief European economist at Goldman Sachs.
Politicians in the troubled southern states are bound to push for more loosening. Germany is sure to resist. How the balance of forces plays out both in fiscal and monetary policy has for years been key to investing in the eurozone. The spread of the populist backlash strengthens the political case for higher spending and lower taxes, which usually means higher bond yields.
With finances stretched, weak countries can only go fiscal if the European Central Bank keeps buying their bonds to hold yields down. For now, that looks like a reasonable bet.
But the political risks will remain elevated, even with the far right in opposition. There is a distinct possibility that the forces supporting austerity, largely in Germany, could prevail. In that case, it will be small reassurance to investors that, unlike in 1789, they will lose their shirts, not their heads.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
November 17, 2016 16:26 ET (21:26 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.