Anybody investing in euro-denominated assets should know that the currency’s future, just as was the case with its origin, crucially depends on a French-German agreement — so far on Germany’s terms.
The latest such bargain is falling apart. An implied deal around French economic and political (i.e., structural) reforms, demanded by Germany, and France’s quest for eurozone institutional changes, was spurned by the EU Commission last Wednesday, Sept. 13, in a widely suspected, and highly probable, double act with Berlin.
Indeed, one could see a diligent rush by Germany’s pro-government center-right media to highlight Berlin’s full support of the EU Commission’s reform program.
That is a serious blow to French efforts to even out the playing field with Germany by establishing a legislative and executive control over the euro area, with common fiscal policy to run public debt, budget balances and the monetary union’s investment projects.
Paris could have seen that coming. As soon as the French euro area reform proposals were announced last spring, the German Chancellor Angela Merkel issued a statement that she would take a look at French ideas to see “whether the reforms were needed” and “what to do with them.”
France now has Germany’s answer, dutifully delivered, in German, by the president of the EU Commission so that Merkel does not have to bother with minutiae in the run-up to Sept. 24 elections.
How important is all this for people currently operating, or contemplating, euro area portfolios?
The short answer is this: If, as widely expected, Merkel remains the head of government and retains Wolfgang Schaeuble to serve as finance minister, Germany will be in no hurry to initiate euro area reforms. Germany’s only euro area problem at the moment is the expansionary monetary policy run by the governing board of the European Central Bank. Berlin’s big issue now is how to get a lock on the ECB by putting in a German, or a suitable (North European) surrogate, as the bank’s next president.
By contrast, France faces serious problems in its attempts to reform the economy and to set its public finances on a path consistent with the eurozone’s criteria.
Executive decrees to, as the French say, increase the “labor market fluidity” — essentially to make it easier and cheaper to fire people — are being met with street demonstrations and political warnings not to aggravate the country’s existing social tensions.
The first protest marches organized on Sept. 12 are estimated by the government to have gathered 220,000 people. The unions claim a much bigger participation. The next two events are announced for this week (Sept. 21 and 23), with larger crowds and broader political, economic and social agenda espoused by center-left parties.
The French government is putting up a brave face on all that, ready not to yield on labor market reforms and other politically flammable issues in the pipeline.
One of those will be public spending cuts to bring the budget deficit to 3 percent of GDP (from 3.4 percent last year), a borderline euro area requirement, and a far cry from the German proviso to get, with dispatch, balanced budgets throughout the monetary union. The French public debt of 96 percent of GDP (in 2016), compared with Germany’s 68.3 percent of GDP, is another problem Paris will be asked to deal with in the months to come.
All that is happening in a situation where the approval rating of the French President Emmanuel Macron went into a free fall during his first 100 days in office to 36 percent at the latest count — the lowest ever for any of his predecessors in the Fifth Republic at the same time of their tenure.
Still, Macron is a man in a hurry, sending his prime minister to Germany last week to convince the Germans: “Please, believe me, I can do cyclically inappropriate and politically destabilizing structural reforms you are asking for.”
That is absurd, but that’s the way it is: Macron is forgoing his large parliamentary majority to govern by executive decrees in order to make it easier to fire people in an economy where the unemployment rate rose, on his watch, to 9.8 percent in July from 9.5 percent in April, with a quarter of the French youth without jobs and a meaningful future.
All these entreaties to Berlin will come to naught. As in the past, Germany will take France’s economic problems and its militant body politic as a negotiating ploy to impose its views. That was the case with Macron’s immediate predecessors Nicolas Sarkozy and François Hollande.
The Germans are trying the same thing with Macron. Using their typical put-down zingers, German media called out Macron’s “pompous grandstanding” on Europe’s renewal during his excellent speech in Athens on September 5 from the hill of Pnyx, the birthplace of Western democracy, where ancient Greeks gathered to discuss public policies.
Macron is facing difficult options.
If he caves in to pressure from Berlin and Brussels and abandons his reform proposals, he will be mercilessly steamrolled by Germans, like his predecessors, and will expose himself as a weakling to ferocious attacks at home. Remember, in the first round of presidential elections last April, nearly half of French voters supported parties asking for more assertive French policies in defense of economic interests. They blamed the euro as an instrument of German austerity policies that led to rising poverty, soaring unemployment, deep recession and a sub-par economic recovery.
As the mass demonstrations are showing, these political forces have not disappeared; they are regrouping now and getting ready to pounce on what they see as a weak and disoriented government.
The second option for Macron, a man with deep sense of French history assailed by pressures from all sides, might be to get some guidance from the message Marshal Ferdinand Foch sent during the Battle of Marne in WWI: “My center is giving way, my right is retreating, situation excellent, I am attacking.”
Macron’s best bet could be to stand up and stick to his Eurozone reform proposals. Stand up indeed, because he got it right: An appropriate legislative and executive authority he is proposing is an absolute essential condition to frame sovereignty transfers for a common euro area fiscal policy. That would create a quasi-federal institutional environment to prevent policy domination by any single member country.
There is no need for French confrontation with Germany, although, true to form, Berlin seems to be pushing in that direction. Paris can easily demonstrate, and defend, that a rigorous institutional architecture must be put in place if key functions of a sovereign state are to be ceded and transferred to a supranational euro area entity.
The pending Eurozone reform issues won’t materially affect the short-term outlook — a one-year investment horizon — for euro-denominated assets. The ECB is firmly in charge as the main driver of the European economic growth, employment creation and price stability.
Further down the road, a tightly coordinated fiscal policy, or, ideally, a fiscal union will become necessary to run a cyclically appropriate policy mix for the Eurozone as a whole. That delicate and politically sensitive step toward European integration is inevitable. It will unfold as a gradual and contentious process of radical change.
The French plan looks to me well thought out to accommodate that next phase of the European project. Paris should have no trouble winning the day against the vague, inept and sloganeering integration rhetoric put forward by an apparently German-sponsored EU proposal presented last week.
People ready to sink their savings into euro assets should keep an eye on that, and think of this: The Europeans have put in place an infernal machine that is supposed to lead them to a united continent of peace and prosperity. Brexit is an example of how difficult it is to get off that wild ride.
And then keep this in mind, too: That machine gave Germans a captive European market that generates 62 percent of their massive trade surplus ($280 billion in 2016), with export sales that account for nearly one-third of Germany’s 3.1 trillion euro GDP.
Will Germans kill their golden goose? They aren’t crazy.
France has a chance to make a crucially important contribution — if it stands up firmly for itself and the rest of Europe.
Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.
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