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France, Germany coming unhinged

France, Germany coming unhinged

Election setback for Hollande bodes ill for European alignment 

by David Marsh

Tue 25 Mar 2014

Forget the peripheral countries in the euro area. The real schism opening up in the single currency bloc is between Germany and France. The most extreme danger of a euro break-up has dissipated over the past two years, thanks to some inspired brinkmanship by Mario Draghi, president of the European Central Bank (ECB). It could easily come back to haunt us. If this happens, the place of crisis re-emergence is likely to be not Athens, Lisbon or Madrid. Instead, we would see the re-entry of an archetypal focal point of all great post-war tensions in Europe – Paris.

The weekend municipal election setback for French president François Hollande is one more step towards further Parisian discomfiture and weaker Franco-German political and economic alignment. Hollande's Socialists lost ground across large swathes of France to the main centre-right Opposition party, the UMP, as well as to the far-Right Front National, as voters sanctioned the government over high unemployment and low growth.

The goal behind the establishment of the single currency in 1999 was to rebalance Europe through the incorporation of post-unification Germany into a network of continental cooperation that would be more integrated, more equitable and more sustainable than anything seen before.

The historical power of the D-Mark and the Bundesbank would be subsumed into a European currency under multinational control. Unfortunately, that is not how it has worked out. The ECB under Draghi's presidency is more market-savvy than under his predecessor, the French political technocrat Jean-Claude Trichet. But it is also more obdurate about the need to turn up the heat on governments as an instrument for pushing through economic reforms.

Draghi’s promise in summer 2012 to carry out unlimited bond market intervention to guard against break-up risk, since enshrined in the (unused) 'Outright Monetary Transactions' (OMT) programme, has worked almost too well.

For it has dissipated pressure on governments, above all Chancellor Angela Merkel’s administration in Berlin, to take further steps towards fiscal integration that would be highly unpopular with electorates (especially the Germans, who are gloomily aware that they will have to pay if things go awry). Merkel’s awareness that the ECB had saved her from the unpleasant task of taking real measures towards political union was the main reason why, unscripted, she gave the OMT a warm welcome shortly after the ECB boss had revealed his hand.

Draghi is not so far removed from the leading Italian monetary officials of the 1960s and 1970s, who were always close to the German-led 'economists' school of European thought that held that monetary union should come about as part of a gradual process of economic convergence. These leading Italians were traditionally sceptical about the French-inspired doctrine espousing a 'big bang' approach to freezing exchange rates, under which a single currency, by its very establishment, would create the right conditions for economic unity and provide a self-perpetuating force for positive change.

We can now see where this approach has taken us, with a significant growth gap opening up between France and Germany. In sharp contrast to the pattern for 30 years after the first oil shock in 1973, Germany since 2006 has shown an annual 1 to 1.5 percentage point advance over France in GDP growth every year (with the exception of the recession of 2009) – and the trend looks set to continue.

France’s economic weakness is the main reason for the surge in support for the Front National on Sunday. The FN under Marine Le Pen, viscerally opposed to monetary union, won outright its first mayoral seat since 1995 and looks likely to take control of other towns in the second round of votes next Sunday. A similar outcome is near certain in the May European parliamentary elections. None of this will derail monetary union on the short term. But the divergence bodes ill for the political and economic rapprochement between Germany and France that has been at the heart of successive European grand designs stretching back 60 years.

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