Skip to main content

Rescue Deal Won’t Be Too Easy This Time

Irwin M. Stelzer

Fear not. Tuesday French President Nicolas Sarkozy and German Chancellor Angela Merkel will meet to solve still another crisis.

No two national leaders are better qualified for such a meeting, for neither doubts the necessity of saving the euroland currency, and not merely for financial reasons. Mr. Sarkozy is on record as believing “Euro spells Europe, the euro is Europe. Europe has meant 60 years of peace on our continent. We’ll by no means abandon that.”

Ms. Merkel, despite running a bluff last year at a dinner meeting of the 27 EU heads of state—“Perhaps Germany should leave” euroland—remains convinced that Germany’s national interest is best served by the survival of the euro and membership in the euro zone.

So a deal will be struck. But it won’t be easy. They will not be dealing with the problem of a tiny economy. The crisis has moved from Greece and Portugal to Italy and, dare we say it, France. Nor will they have the certainty that they once had that austerity is the solution to the problems of troubled euro-zone countries.

The Greek economy contracted at an annual rate of 6.9% (5% if seasonally adjusted say some economists) in the second quarter of the year, largely as a result of the tax rises and spending cuts the Greek government promised in return for it bailout. The 10% increase in tourism could not offset the reduction in spending by consumers and the government. Spain, another patient that has taken the austerity medicine prescribed by Dr. Merkel, saw its economy contract, unemployment rise to even higher levels, its banks unwilling or unable to lend.

The president and the chancellor’s job will be made even more difficult by three additional hard facts. First, the euro-zone economy is not in the best of shape. In June, industrial production in the 17-nation area declined at the sharpest rate since the end of last year, and it is likely that the zone’s economy is now in a zero-growth state. Markit sums it up best: “Euro zone drifts nearer to stagnation in July, as Germany and France slow further and Spain falls back into contraction.”

Second, France joined Italy in the no-growth club just as Mr. Sarkozy was convening his cabinet in an effort to tighten spending and reduce the deficit to help preserve his country’s triple-A rating. Consumer spending plummeted at an annual rate of 3% in the second quarter as a cash-for-clunkers scheme that had stimulated auto sales expired. Exports unhelpfully fell.

Mr. Sarkozy’s problem is that slow-to-no growth will reduce the government’s tax take and raise outlays for unemployment benefits, making it less likely that France, which ran a deficit of 7.1% of GDP last year, will hit its deficit target of 5.7% this year.

The presidential election is only eight months away, and polls show that Mr. Sarkozy would lose in a second round to socialist Francois Hollande by a 14-point margin. That should dim the president’s enthusiasm for adopting the sort of unpopular austerity measures he has so enthusiastically favored for Greece, Portugal, Spain, Ireland and Italy. In France’s case austerity would include a 3 billion ($4.3 billion) tax increase, layoffs in an economy with an unemployment rate already in excess of 9%, and structural reforms of labor market rigidities.

Worse still, if Standard & Poor’s raters, who reaffirmed their faith in France last week, eventually decide that sauce for the American goose is sauce for the French gander, Mr. Sarkozy will have to add a downgrade to his electoral burdens—and become a diminished figure in the euro-zone political hierarchy.

Third, a French downgrading would have severe consequences for the euro zone’s plan to have the European Financial Stability Facility become the über bailout mechanism by selling its own triple-A rated bonds. Only the guarantees of triple-A rated countries (Germany, France, the Netherlands, Austria, Finland and Luxembourg) count when computing what the ESFS can borrow, with France accounting for 158 billion out of 450 billion of guarantees. If France drops out of that group, points out David Gauthier-Villars, this newspaper’s Paris reporter, the remaining five would find their guarantee-burden jumping 54%, in Germany’s case to 325 billion, 13% of the nation’s GDP, from 211 billion.

Whether Ms. Merkel could sell that to her coalition partners and her already-angry voters is doubtful. She has promised to oppose the European Commission’s request to expand the EFSF’s 440 billion lending capacity (figures of 1.5 trillion and more are being tossed about), and an increase in Germany’s share of the current guarantees would come to much the same thing.

So Tuesday will be no easy day for France’s president and Germany’s chancellor. But one guess is that any temporary fix—and there will be one—will not necessarily derail France’s long-run goal for Europe—a zone funded by Germany and managed by a French-dominated bureaucracy.

The French have step-by-painful-step brought Germany to the point where it can no longer deny its euroland partners access to its balance sheet. Consolidated finances inevitably require central management of economic policy, a skill honed in the Polytechnique.

But France’s dream might turn into a nightmare. Germany might just insist that he who pays the piper calls the tune. In return for becoming the payer of last resort for Europe, for being forced to pay higher interest rates when it borrows because of the contingent liabilities it is taking on, Ms. Merkel might insist that Frankfurt and Berlin dominate the institutions that will henceforth monitor national budgets, France’s included.

The irony would not be lost on any student of history.

Related Articles

Trump Is Betting Everything on the Economy

Irwin M. Stelzer

Because if a recession hits before 2020, the government will have no tools to fight it...

Continue Reading

Europe’s AI delusion

Bruno Maçães

Brussels is failing to grasp threats and opportunities of artificial intelligence...

Continue Reading

How Is Larry Kudlow Going to Get Along with Trump?

Irwin M. Stelzer

The free trader will have to move carefully with the president...

Continue Reading