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Analysis
President Hollande sets the stage

President Hollande sets the stage

All central banks are equal, but some are more independent than others
Currency wars, Franco-German style

by David Marsh

Mon 18 Feb 2013

The threat of worldwide currency hostilities has receded for the time being, after the Japanese government escaped international censure last week over prime minister Shinzo Abe’s go-for-growth strategy built around looser credit policy and a weaker yen.

The risk that world finance ministers really would reprimand the new Japanese government was rather low.
 
Given the pumping up of central bank balance sheets in the US and Europe, any campaign to castigate the Japanese for over-enthusiastic monetary loosening would have been more than a tad hypocritical.

If a currency war does break out, it is most likely to be between two countries that have officially abolished the exchange rate between each other: France and Germany.

With a Gallic mix of pragmatism, panache and provocation, French President François Hollande has set the stage. He has admitted what most people knew anyway: there is little chance that France will meet its growth and budget deficit targets this year.

At the same time, he has made clear – in a move soundly rebuffed by the Berlin government, the European Central Bank and the Bundesbank – that the euro’s heady rise on the foreign exchange market needs to be brought under control.

The issues of growth and the exchange rate are linked. Germany is projected to exceed France’s economic growth rate in 2013 for what will be the seventh year out of the last eight. It ran a current account surplus of 6% of GDP last year against a deficit of 2% for France. So the Germans can live with a euro above $1.30 (or maybe even $1.40) much easier than their western neighbours.


On the budgetary front, Jörg Asmussen, the former German finance ministry state secretary who is now Germany’s man on the ECB’s six-member executive board, fired a warning shot last week by calling on France to stick to its plan to bring the deficit down to 3% of GDP.

France needn't fear direct European repercussions. Paris faces merely a polite rap across the knuckles. Olli Rehn, the EU’s monetary commissioner, carefully signalled last week that countries such as France and Spain may be given an extra year – until 2014 – to meet their deficit targets if they can prove that they are making efforts in structural reforms.

Psychologically and politically, the implications are more severe. The episode badly weakens France’s negotiating hand as the euro area heads for a choppy period. The period of financial market stability wrought by the ECB’s bond-buying pledge last summer may be coming to an end. Optimists such as Jacek Rostowski, the Polish finance minister, who bravely said in London last week that the euro crisis is ‘effectively over’, are in the minority.

If Greece, Cyprus, Italy and Spain again make negative headlines in the next few months, it will be much more difficult for France and Germany to muster a common position on economic rigour in all these countries, now that Paris and Berlin are far apart in other elements of policy.


The French government is likely to draw encouragement from Abe’s early successes in his campaign to clip the wings of the Bank of Japan and steer the Japanese economy out of years of deflation.

Yet Germany’s euro negotiating line may get tougher, not more generous, as we approach the federal elections in September. Chancellor Angela Merkel’s personal lead in the opinion polls looks far less likely than earlier predicted to give her Christian Democrat party the power to lead a new government this autumn.

If the Social Democrats and their Green former coalition partners do return to power after September, they may be slightly more accommodative on Europe than the present Berlin government. But Merkel’s Christian Democrats and their current coalition partner, the Free Democrats, will be far more rigorous on euro bail-outs than the present SPD-led opposition.

In its almost ritualistically uncompromising stance on the euro, the Frankfurt-based Bundesbank has been a lonely voice on the European stage in the past two years. But now, just as other central banks like the Bank of Japan are starting to lose their autonomy, the Bundesbank may be coming back into vogue.

It was probably a mistake to think that more than one big central bank in the world could ever be properly independent. As George Orwell might have put it, all central banks are equal, but some are more independent than others. The Bundesbank, as ever, will be the last institution standing firm.

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