France’s Epoch-Making Choice

A month into his presidency, Francois Hollande faces a tantalizing choice: Does he want to pay interest rates on his nation’s bonds that are near Germany’s level — or near Italy’s? The answer to this question is obvious.

For all the alluring rhetoric of building a Franco-Italian-Spanish counterweight to Angela Merkel and Germany’s approach, the net result of all that talk is going to be very limited indeed. France’s President, if anything, is a pragmatist and a realist.

He therefore knows full well that, in whatever little room for fiscal maneuver he has to improve the mood of the French and France’s economy, the amount of interest he will have to pay on new bond issues will be a key factor in the political determinations he makes, both at home and abroad.

Hollande is also most acutely aware of what constitutes France’s ultimate treasure in the present, troubled times — that financial markets see his country, more or less, as a risk nearly as solid as Germany. Hence, he gets by with paying only a low spread over German rates, currently 2.67%, compared to Germany’s 1.54%.

If, in contrast, France were perceived as being in a camp with Italy or Spain, his country’s interest rates would soon creep up by three or more percentage points. That would completely eliminate what little financial wiggle room he has to spread some goodies among the electorate.

But isn’t it perhaps too crass, or at least too utilitarian, a thought to reduce a country’s policy preferences to the applicable interest rates on the public debt? For Hollande, that is far too abstract a question. Whatever the potential ethical or moral considerations, it is sheer political and economic self-interest that dictates what France is likely to do. The shirt, as they say, is closer than the pants.

At the EU summit on June 28-29, much ado will be made about a French-inspired European growth initiative, paired with somewhat softer fiscal cuts or extended timetables. However, it really doesn’t take much for France’s Socialists, newly invigorated after their win in parliamentary elections, to convince the German government to support a €100 billion growth initiative.

Spending more, in a very targeted fashion, on infrastructure investment, renewable energies and R&D — partly financed by the European Investment Bank and partly by EU Commission project bonds — is hardly likely to irritate the Germans.

What matters a great deal more is whether Paris will overcome centuries of sovereignty-mania and agree to financial inspections of national budgets? That is the key step for the future construction of Europe. And this is precisely what is foreseen by the European semester, and demanded by the German government, as the key condition to make any further moves on fiscal integration.

In that context, it is important to realize what Le Monde — not known to be a conservative newspaper — recently editorialized on its front page. It argued that conceding that bit of budgetary sovereignty — mind you, not to the Germans, but to Brussels and the common European cause — is not too much for Chancellor Merkel to ask (and, crucially, not too much for President Hollande to concede). That may turn out to have been quite an epoch-making moment.

One small step for “Europeankind”

National politicians pretty much everywhere benefit from oversight by a body or institution that provides at least a dampening on the spending impulse. Otherwise, the great collective unconscious — the constantly rising desire to spend yet more public money, regardless of whether funds are available or not — is almost impossible to resist. National parliaments, originally set up to do precisely that job, increasingly are incapable of fulfilling that role.

To paraphrase Neil Armstrong, if France takes this small step for “Europeankind,” but a great step for “Francedom,” then in many ways the battle for Europe has at least been pre-decided. For once there are binding commitments to be fiscally prudent, then the German inclination to play immovable will come to an end and the game toward a real European Union will be on.

Why might this happen? France’s leaders, and especially the ones from the Socialist Party, know that they have fallen behind their German brethren. This happened the moment they failed to do the fiscal consolidation-cum-labor market and structural reforms that the SPD in Germany undertook under Gerhard Schroeder.

The quite likely — and for many surprising — narrative that the Socialists in France are working on is that France failed to make the required modernizing moves under both Presidents Chirac and Sarkozy, conservative politicians both. If the PS can pull off this move, it would likely reshape the French political landscape.

There are some among the French Socialists who point to the danger that the extreme right-wing followers of Le Pen will only rise further. They fear that the next round of legislative elections could bring not just a conservative, but downright reactionary backlash, if the Front National and UMP make common cause.

I would not overrate those prospects. First, the French electoral system is set up in such a manner that it quite effectively hinders radical political forces from gaining too much power, as indicated by the actual number of the Front National’s seats in Parliament compared to its share of the vote.

But even if French conservatives were totally spineless (and heavily anti-bourgeois) the next time around and make common cause with Le Pen, two considerations prevail: First, with the right anchoring, a powerful European umbrella, including redemption bonds, will be spread over the currently creaky European edifice. That will provide time for national economies to heal and rebalance.

And second, political leaders sometimes heed the call to abandon their eternal inclination to think only in tactical terms. Sometimes, it actually matters to do the right thing. That’s precisely what Mr. Schroeder did in Germany when he made all those consolidation and restructuring moves.

True, he paid a heavy price — his party split and he lost the next elections. But that other party is now, just a decade later, on the ropes — and the country as a whole has certainly benefited from his well-timed moves.

The indications are that France’s Socialists could surprise the markets in just the same manner as Bill Clinton did in 1992, when he opted for fiscal consolidation against all expectations (but as this writer had predicted in his December 1992 book to howls of disbelief at the time).

If that comes to pass, then the British will feel particularly despondent and lonely. After all, the real core of their entente with France was never so much the bilateral defense relationship than the secure knowledge that France embraces sovereignty in any and all forms even more than the British. That crucial axis of European construction may soon come crashing down.

If anybody, then, it is the political and financial French elites who have a clear sense and deep appreciation of the multi-step road it will take to get to a true pan-European bond market. And they know that this would provide a true alternative in terms of depth and liquidity to U.S. Treasuries.

That may still seem some time off in the future, but the target is clear enough. In the meantime, doing a lot of carefully sequenced steps, all in the proper execution of a long-term plan, has never kept the French inspecteurs de finance and énarques from getting started. In fact, it’s what they do for a living.

And no doubt, they realize full well that the grand prize — a French balance sheet that over the long term will be very closely integrated with Germany’s — is a prize worth sacrificing for. Only then, as the énarques know, can France once again play in the big leagues.

Now over to the announcements by President Hollande…