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So why have elections become of such high prominence to financial markets? In the wake of the ongoing crisis, government intervention in financial markets has reached unprecedented levels.

04 Aug 2012

By Chirag Mehta
Elections have recently been of utmost importance to financial markets then anytime in history. Elections and not fundamentals seem to be the prime driving force at the moment. Last month, people were glued to their television sets waiting for Greek election results and that too over a weekend. Elections in a small country like Greece had such an impact as an alternative outcome would have paved way for a Greek exit from Eurozone and thereby adding more uncertainty and risk to financial markets.

So why have elections become of such high prominence to financial markets? In the wake of the ongoing crisis, government intervention in financial markets has reached unprecedented levels. The health of the global economy is arguably as dependent on government as it has ever been. The era of bailouts, stimulus and interventionist policymakers that aim to resolve all economic issues by unlimited money creation have completely altered market dynamics. So when the governments are driving markets, you really care about whom the government is and who is in power.

It impacts the real economy as well..
A major drawback of a government-steered economy is that high uncertainty prevails about what rules, regulations and policies will be enacted thereby making it more difficult for businesses and consumers to ascertain what the future might look like. The resulting lack of clarity, can indeed be disastrous.

In such an environment, businesses turn cautious and are less likely to hire new workers or invest in new factories. Similarly, cautious consumers are more likely to save money than to spend on optional items. With public debt reaching such high levels and governments showing signs of no return, people are increasingly worried on the promises in terms of benefits and entitlements that should be the right of the citizens. People are realizing the possibility of these promises be broken and are preparing for the worse. This type of policy uncertainty is on the rise and near historically high levels.

Who gets elected will have a big say in what happens. Part of what investors are dealing with is that they don't know what policies will actually be put in place. Complicating matters is the fact that the weak economic situation, policymakers now face has never happened in their lifetime, which means there is no precedence to provide them with a course of action. We are in unchartered territory.

This time is different
Historically, elections have usually been bullish for financial markets as the party in power seeks to boost its chances of winning by pushing through policies that stimulate the economy ahead of the polls. It is indeed different this year. The debt crisis has highlighted the unsustainable course of running deficits and ballooned debt levels. This has taken off the ability from policy makers of creating money out of thin air and increase spending in order to garner votes.

It is indeed clear that the current path to spending beyond means cannot continue forever. At some point, elected officials will have to call it a day and follow the path to more rational order. It may also involve back out on the promises as it will be difficult for the government to fulfill all given the extent of their unfunded liabilities. Therefore, the personal finances are increasingly being influenced by politicians and policymakers around the globe.

But, Austerity is not an acceptable policy…
The stakes have never been higher. Election outcomes will shape economic outcomes. In many ways, the immediate fate of the Eurozone was at stake when Greek voters went to the polls. Irate citizens unhappy with their economic plight have already toppled European leaders whose policies they disliked. In May, French President Nicolas Sarkozy, who viewed fiscal austerity as the best way to reduce rising debt loads, lost to socialist Francois Hollande, who favors pro-growth policies. Last year, Italy's Prime Minister Silvio Berlusconi resigned amid questions about his economic stewardship. And what happens in Greece or Spain or China could affect what happens on world stock markets.

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