The French EU Vote Is Not So Simple

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Updated from May 29

On Sunday, France rejected a referendum on the European Union constitution. Recent polls had indicated that those favoring a rejection had a slight lead. In order for the constitution to be adopted, all 25 EU members must approve it. The rejection by the French then threatens the entire process and, according to conventional wisdom, the value of the euro.

Coupled with the fact that the global capital markets are thin Monday due to holidays in the U.S. and U.K., there would seem to be potential for a volatile market reaction to a "no" vote.

Indeed, the euro fell against the dollar in European trading, recently fetching $1.2502 in London, down from $1.2584 late Friday in New York. Against the yen, it fell to 134.83, from 135.79.

Don't Panic

Yet I suspect that the situation is a bit more complicated than simply selling the euro, since the French rejected the constitution. In fact, a knee-jerk dollar bounce in response to the French rejection of the EU constitution might provide the savvy trader a good opportunity to either liquidate long positions or go short.

First, the market may not be so ill-prepared for a French rejection after all. The most recent Commitment of Traders Report from the Commodity Futures Trading Commission found that the speculative community has the largest long-U.S.-dollar exposure in several years. This, coupled with the euro's recent decline, may reflect some positioning for a no vote.

Second, the rejection of the constitution might not really be the earth-shattering event many partisans are claiming. The lack of a new constitution would mean the continuation of the status quo. It means that the EU lacks a strong executive and lacks a single voice for foreign policy. It means that the basic governing structure of the EU will be reformed, even though its membership increased markedly.

The defeat of the constitution could mean that further enlargement into Eastern Europe and Turkey becomes more difficult. Partly, a defeat of the constitution could reflect the fatigue of enlargement, as 10 new countries joined last year, and there is already concern that the new entrants are taking the job of "Old Europe," as U.S. Defense Secretary Donald Rumsfeld put it.

Local Politics

The euro itself is best understood as an economic solution to a political problem. That political problem was convincing Europe not to obstruct the unification of Germany when the Berlin Wall came down. The economic solution was to share the mark and the Bundesbank's anti-inflation credibility with Europe, integrating the German economy even more into Europe. Despite this fact, the French public accepted the euro with only the slimmest of margins.