07 April 2015

The danger posed by the National Front may lie where it is not expected!

The electoral debacle of the French left in the recent departmental elections has reignited the debate surrounding the likelihood of a “democratic” access to power by the National Front through the ballot box.

Accordingly, some consider with relative equanimity the presidential elections of 2017 the outcome of which would be a classical left/right rotation, masking further progress by the Front, before the decisive confrontation in 2022; others, more pessimistic, envisage the possibility of a right wing victory as early as 2017.
 
Recently, I listened very carefully to an interview of Marine Le Pen on the French TV channel LCP in which she accused all her critics indiscriminately of bad faith or incompetence while making, as usual, a masterful display of those same “qualities”!
 
Thus she “demonstrated” that the fear over devaluation of the currency (which is part of her program to restore competitiveness) is pure scaremongering as proven by the devaluation by 25% of the € which has created no problems – quite to the contrary. What she omits to say is: 

• That Peugeot will not sell one additional in Germany (whose currency has also devalued by the same amount)  and that there has been no competitive gain within the Eurozone which is the largest French export market;
• That the –so far – painless perception of this devaluation is due to the near zero inflation with hardly any impact on prices. That has allowed the fall in oil prices (50%) to have a favourable impact on household’s purchasing power, though only to half the extent that it has improved American competitivity because oil is paid for in Dollars.

 I have therefore three straight forward questions to put to Marine Le Pen: 

• As the € has devalued by 25%, is exiting the Euro still necessary to restore French competitiveness?
• If, as is likely, the answer is affirmative, does she think that the consequences of a devaluation in relation to the € would be equally painless?
• Is an exit from the € conceivable without imposing exchange controls and, possibly price controls, reminiscent of the period following WWII?

Marine Le Pen dismisses with equal scorn the question of indebtedness. She asserts that the “Lex Monetae” automatically converts obligations denominated in the “national currency” (today the €) into obligations denominated in the new “national currency (presumably the New Franc (“NF”)) when a change in the monetary regime is sanctioned by law. Adding to her bluster in an attempt to prove her competence, she conceded that some 3% of the French national debt, issued under foreign law, would indeed remain denominated in €. Thus, she asserts that France would have no problem in servicing its debts in NF!
 
Additional questions to Marine Le Pen: 

• How does France finance the repayment/rollover of the national debt? Through issuance of new obligations or the printing press? It is , indeed, highly unlikely that foreign investors who collectively hold in excess of 50% of the French sovereign debt will be willing to subscribe having just suffered major losses on their holdings they believed in good faith to be denominated in €. International markets would be closed to France, necessitating recourse to the Banque de France with – very schematically – the following consequences: inflationary pressures, increased level of interest rates, increased budgetary deficits, etc. It follows that French citizens will also shy away from purchasing the new debt issues, accelerating the pressure on public finances in a vicious circle recalling the worst inflationary years of the 1970/80’s; such souvenirs escape the grasp of Marine Le Pen who was too young and allows her to share her ignorance with her fan club.


• Even if one admits that the Lex Monetae would allow the State to pretend it was fulfilling its undertakings, would that extend to “private” contracts between French and foreign parties? Will importers be able to pay their bills? How many will be driven to the wall with what incidence on the economy and on employment? This situation cannot be compared to the effects of a “classical” devaluation of old when contracts were clearly expressed in a reference currency (national or foreign) and each monetary realignment had its share of “winners and “losers”; the parties were thus able to evaluate currency risks at the time of contracting. In case of “Euroexit” essential conditions that validate the mutual obligations of contracting parties would have been unilaterally modified by the “Fait du Prince”; this will necessarily lead to many long and expensive legal proceedings, paralysing a significant part of economic activity.

Turning now to Marine Le Pen’s proposal to impose a 3% import tax (in violation to the EU Treaty) - aimed at financing a reduction of € 200 in charges withheld on all monthly salaries below €1500 - she asserts that it would hardly affect the purchasing power of the French. Miracle! In this particular context she completely overlooks euroexit, forgetting that this manna from heaven (as well as all base salaries) will now be expressed in NF and that the impact of its devaluation (be it only in relation to the price of oil, fuel or gas) would swallow all if not more than the relief the measure is supposed to bring.
 
All this rubbish makes absolutely no sense, as is the case for most of the remaining “economic program” of the Front! Marine Le Pen is perfectly justified in holding the successive “UMPS” governments responsible for the dire straits in which France fins itself; it is, however, no excuse for attempting the mad adventurous policies advocated by the FN.
 
The real danger may lie elsewhere than resulting from the accession of the Front to power followed by the implementation of its crazy program. It is potentially far more imminent because, contrary to its citizen’s belief, France does not live in an ivory tower, immune to the influences of the outside world. These can have two separate origins:
 
The first concerns events over which France – acting alone – has only a minor capacity of influence: the situation in the Middle East, North Africa or Ukraine, fluctuations in world economic activity, foreign exchange parities and raw material prices or political developments, be it within the EU or elsewhere. We will leave such contingencies aside because it is not the vote of French citizens that will carry any weight in these matters, any more than the vote of Greeks for Syriza allowed their government to impose on its European partners solutions to Greece’s internal problems. One should, nevertheless bear in mind that any of these events might ignite a crisis that no French government can be sure of controlling.
 
The second relates to events directly related to developments with France. Among these, the absence of any visible results of government policies and the growing public distrust in the body politic rank very high. If this situation lasts, one can only expect that the FN will make further progress in the December regional elections. From its results it will be easier to evaluate the danger of an FN in the 2017 presidential elections, and in particular the likelihood (already very strong) that it will qualify for the second round. It is on the reaction of financial markets to such events that I wish to focus.

Madame Le Pen may well hate and hold in contempt financial markets but when foreign investors hold more than 50% of the French sovereign debt, they cannot be ignored. Operators will certainly not await meekly the ex post consequences of the application of the Lex Monetae but rather will act in anticipation in order to limit the damage. As the likelihood of a FN win increases, investors will either withdraw or, for the most adventurous, seek to force on the issuer higher interest rates to compensate for the additional risk. Capital flight (which the wealthier French have long since undertaken due to the excessive tax burden) will only amplify as the process gathers momentum.
 
In an initial period, the effects of the capital flight might remain hidden due to the quantitative easing policy of the ECB which could accumulate several hundreds of billions of French debt between now and September 2016 directly and through the Banque de France. Thus, the ECB is assuming the role of lender of last resort (as many claim it should) up until – as it is now being questioned in the case of Greece – it might limit its interventions both in light of its mandate and its role as Supervisor. The intention expressed by Mrs. Noüy to impose risk weightings as well as absolute limits on the sovereign debt holdings by Eurozone banks could have significant consequences.Such measures seem aimed at strengthening the independence of the ECB when taking decisions that could bring it into open conflict with EMU Members.
 
This situation should allow interest rates (in €) to remain artificially low, underpinning the French government’s pretence that the credit standing of the country remains unblemished while it burns candles in the hope that a world economic revival rescues the country before the debacle. Indeed, if it more generally thought that “Grexit” could be handled, Mrs Le Pen is correct when she states that an exit by France means the end of the single currency.
 
A scenario in which the growing strength of the FN would impact decisively the reactions of financial markets ahead of the elections is by far more likely; it would force the government in power to assume alone the consequences of the drastic as well as unpopular necessary measures. It would, however, be prevented from taking the austerity measures that normally accompany a rescue package by its European partners in light of both their dubious efficiency at this late stage of the crisis as of the exacerbated “anti European” mood of public opinion making an exit of the euro and its implosion inevitable.
 
Cynically, one should wonder whether this is not precisely what Marine Le Pen is hoping for, calculating that she can eschew any responsibility – despite the fact that the FN popularity and the fears of its policies would be the main cause of the capital flight – hoping to pick up the pieces by promising to restore the country on the ruins of the Vth. Republic.

Such a bet is far from being won. Indeed, being subjected to the devastating consequences of the €’s implosion, it is likely that the adventurous policies advocated by the FN will lose any remaining credibility, inciting the mobilisation of cohorts of disgruntled voters and sending the FN packing. For that to happen, a new generation of political leaders must emerge, capable of galvanising public opinion, just as General de Gaulle was able to do in his time.
 
This apocalyptic scenario can, nevertheless, be avoided if, with the support of all “republican” parties, the government (or better still a broad coalition) undertakes a “change in its orientation.” Such a change should not aim at accentuating stale left or right wing policies which are at the centre of the political debate and have no chance of bringing effective solutions. Rather one should attack the root of the problem and concentrate all efforts on the urgent completion of EMU in partnership with the other members, in particular Germany. This implies painful choices (mainly for the body politic), namely making concessions relative to the aspirations of French supremacy/exceptionalism as well as significant transfers of sovereignty. The creation of a “European Federal Authority”, endowed with sufficient resources to ensure that it can simultaneously enforce the discipline and guaranteethe solidarity among its members, is the precondition to protect the Euro and underpin France’s development.
 
The strengthening of the FN is not irreversible. The fact that many “republican” politicians share the euro scepticism of the FN is one of the main factors of the latter’s credibility.The best way to fight it is to propose an alternative that must necessarily encompass the acceleration of European integration, which alone has the capacity of defending our common interests and protecting our social model in a globalised and dangerous world.
 
The omens are not favourable, strong adverse currents are blowing but the situation is still far from desperate… Bet che!

© Paul Goldschmidt