Signal Berlaymont: France’s fiscal incontinence may subject it to ECB bureaucratic despotism 

The agendas of both Marine Le Pen’s National Rally and the left-wing populist bloc were “dangerous for the economy”, leading French business federation MEDEF warned ahead of France's elections.

Both blocs' plans would drive the annual budget deficit higher than 6 per cent, even worse than the expected 4 per cent deficit, said projections by Insee and Allianz. Last month, S&P Global Ratings downgraded France's debt rating, warning "France's public debt ratio is now the third-highest in the eurozone, behind Greece and Italy." The lower rating is particularly worrying with the interest burden on French debt  projected to increase to 5 per cent of GDP in 2027, from 3.3 per cent in 2023.

The success of the far Left and its allies in the second round of France’s parliamentary elections only adds to these worries, even if the far Left is unlikely to actually enter power.

Rarely is the role of the European Central Bank mentioned in all of this. The ECB has a crucial influence on the long-term interest rates eurozone governments pay to refinance their often gigantic debt mountain. In the case of France, that’s 112 per cent of GDP, pretty much twice the level two decades ago.

Those sceptical about the eurozone's survival have always closely watched the “spread” or difference in interest rates investors charge to eurozone governments. Last month, France had to pay 0.8 percentage points more for its 10-year lending than Germany. This is the largest “spread” between the two core eurozone economies since 2012. It is quite something, even if the spread dropped following the election. Probably that is because of relief that neither the left-wing alliance nor the National Rally will have a majority, as market analysts consider Macron’s plans still the least dangerous for France’s public finances, despite his poor track record.

In any case, Société Générale now thinks the spread has entered a new, higher range, especially given the left-wing alliance's strong showing. On top of that, none of the three big blocs in French politics are willing to fundamentally deal with the French state's oversized role in the economy.

ECB to the rescue

Does this mean we will see France struggling to refinance its debt, ultimately endangering the eurozone? This is unlikely. Ever since ECB President Mario Draghi uttered the words – not coincidentally also in 2012 – his institution would do “whatever it takes” to save the euro, investors have refrained from dumping eurozone government debt to test the ECB.

What’s more? Even in the highly unlikely scenario Germany's government openly revolts against the ECB bailing out France, people would hear soon enough hear again about “Target2”. That's the settlement system in the “eurosystem” whereby some countries have massive claims on the system, whereas others have massive debts towards it.

It may probably not surprise Germany has a whopping €1000 billion claim, and Italy a massive debt. In practice, this means if Germany decides to end the euro, it would not only face the cost of the financial instability resulting from the changeover, but it would also be unlikely to recover this Target2 claim. Add in political tensions and sovereign defaults that could very well cause the breakup of the EU and the single market.

The European Central Bank is very able to come up with yet another bailout of a struggling eurozone country. It has form in creating acronym-named programmes that ultimately all amount to excessive money printing aimed at keeping interest rates down. Still, it comes at a steep cost. Over the years, easy money policies – meant to prop up ever more unsustainable spending by Europe’s sleepy welfare states – have been badly hurting savers. 

Yes, savers can opt to invest into real estate or stocks instead, but they come with risks, taxes, and complications, which is why many savers do not.

If the ECB would bail out France, by for example activating its “Transmission Protection Instrument” (TPI), which allows it to buy French state debt, this is unlikely to go down well in Germany, which is under pressure to reign in spending as a result of a ruling by its top court ordering it to respect the “debt brake”. None of this will improve the Franco-German relationship.

In theory, TPI can only be used against “unwarranted, disorderly market dynamics”. This means the ECB cannot use it to lower borrowing costs of governments that have just implemented a change in policy, making markets demand a higher risk premium to lend to them. As the Wall Street Journal’s Paul Hannon however notes, “it is difficult to distinguish between a move in bond yields that is a valid response to policy changes, and a move that is ‘disorderly’ and ‘unwarranted'.”

In sum, the ECB will find an excuse to activate TPI, if it wants to.

Bureaucratic despotism  

Actually, we have been here before. At the start of the 1980s, a radical left-wing government led by François Mitterrand entered power in France. Its large spending programmes quickly had to be revised, as markets exerted discipline following attacks on the franc.

Spend-drunk eurozone governments no longer face the same disciplinary force unfortunately. However, they are more vulnerable to intervention by the European Central Bank – at the instigation of other eurozone governments. For example, Silvio Berlusconi claimed his ousting in 2011 was due to the ECB simply slowing down on the money printing until Italy’s interest rates were so high the Italian political class would get away with chasing him from office.

No hard evidence exists to prove this, but what is clear is that eurocrats are not above acting in this way. Timothy Geithner, US treasury secretary at the time, wrote in his memoirs, "At one point that fall, a few European officials approached us with a scheme to try to force Italian Prime Minister Silvio Berlusconi out of power; they wanted us to refuse to support IMF loans to Italy until he was gone." He added, “as helpful as it would have been to have better leadership in Europe, we couldn't get involved in a scheme like that."

Just before the second round of the French parliamentary election, German Finance Minister Christian Lindner warned he hoped the European Central Bank would not have to take action to stem France's borrowing costs as this would raise "economic and...  constitutional questions". He also stressed he did not see a "risk of contagion" to financial institutions in France. We can safely translate these kinds of denials, actually, as expressions of worry.

The problem is with bond vigilantes out of the picture, the only option left for Germany to oppose the ECB depreciating German savings for the sake of the French Treasury is to lobby the ECB to intervene into French domestic politics. In this way, the euro deeply undermines democracy.

Last month, leading British political scientist Larry Siedentop died. About the EU, he warned “bureaucratic despotism” was now the danger, noting it acts more and more as a “government of strangers” breeding “fear, sycophancy and resentment”. He disagreed with many in Britain fearing the power of a reunified Germany within the EU, arguing instead the EU had been especially shaped by French interests. In particular, it was the single currency, created in anxious response to German reunification and Mitterand’s humiliation by the markets, that reinforced this pattern. That left Europe, he thought, “in the hands of bricklayers, not master builders”.

With France nearing a confrontation with the ECB and Germany, it may well get a taste of the “bureaucratic despotism” it has always promoted.