Thursday, January 05, 2017

Why Le Pen is wrong to say the French wouldn’t feel any consequences of a return to the ECU

French far right leader Marine Le Pen yesterday shed some light on how she would see France’s monetary arrangement after it would have left the euro and reintroduced the franc. Apart from her suggestion to reinstate a basket of currencies, similar to the ECU, she claimed that “a national currency co-existing with a common currency would not have any consequences on the French's daily life”. 

This is incorrect, apart from the fact that I think it’s a good idea to get rid of the euro, given how it enables more unsustainable debt than national currencies (private currencies would be even better in this regard). The ECU was nothing more than an advanced form of currency pegging. If currency pegs appear unsustainable, they break up anyway. To reinstate the French franc would be a major event, for the following three reasons:

- The end of easy money: 

French banks would no longer enjoy easy money from the ECB, as they would now be dependent on the French Central Bank for their funding. The more a currency is used, the more a Central Bank can get away with uncontrolled monetary expansion. The more monetary expansion, the lower the interest rate – given how the latter constitutes the price of money. As a result, the interest rates French banks pay to borrow from their Central Bank would go up considerably, which would result in higher interest rates for French public borrowing. In short: savers would win (as they’d enjoy higher yield), politicians would lose. The French state would need to cut back its spending considerably. 

- A possible French state default:

A French euro exit may well lead to a French state default, given how the French State’s external debt would increase relative to the performance of the new French franc. 

- Depreciation of the new currency:

French savers will enjoy higher interest rates, but on the other hand their purchasing power will suffer from the likely depreciation of the French franc. However, as opposed to countries like Greece, the euro’s valuation isn’t dramatically out of lockstep with France’s economic performance, so we shouldn’t overplay this third reason.

If Marine Le Pen would be elected French President – unlikely, given how opinion polls surely can’t be that wrong – and if she would then hold a referendum on the euro, I think the French are very likely to vote to stay in the Eurozone, precisely for the three reasons listed above. Would people keep their deposits in French banks, in the run-up to the euro - referendum? They surely will be afraid, but in any case the argument that their deposits would be endangered in case they vote against the euro will convince. 

If the euro collapses, it’s likely to be as a result of a financial event, not a political one, when Germany will be unwilling to destroy the German savings base to save the euro after a major financial crash. That moment may take a long time to happen or it may happen tomorrow, but at some point Germany’s willingness to bail out the euro will end – at least that’s what I suspect.

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