May 15th, 2017

Euro news Fixed Income Note

When Macron met Merkel

  • In today’s Comment I will focus on Macron’s first meeting as President with Chancellor Merkel in Berlin. Macron’s pro-euro party program and the German’s warm reception of Macron suggests a quantum-leap of Eurozone integration must be in the cards. Or maybe not…
  • Macron has a clear view of what’s necessary to put the Eurozone on firmer foundations: a Eurozone parliament, a Eurozone Finance Minister and eurobonds. He also made clear to Berlin that if they continue to reject such governance changes, they will find Madame Le Pen in the Élysée in five years’ time. That was when Macron was still campaigning. Has anything changed since then? A Reuters article last week suggested that Macron and his close cohort of advisers are divided into three camps: one camp wants to aggressively confront Berlin to force through the governance reforms; the middle of the road camp, to which Macron himself belongs, wants to pursue the changes in a firm but friendly member; and the third camp would rather follow Berlin’s lead and emulate its policies.
  • And while Macron clearly acknowledges that the French economy – and especially its labor market – needs to be reformed, and that government finances need to be brought under control, he also has a wish list of policy changes that Berlin needs to undertake. That wish list addresses the usual criticism levied against Germany, namely that it needs to do more to boost domestic demand, preferably by raising investment and lowering the current account surplus.
  • Macron pleading with Germany to ditch its ‘lead by example’ policies and finally start acting as a benevolent hegemon invoked the predictably standard response: nein, nein, nein. Finance Minister Schäuble, who was also busy trying to defuse the IMF’s Article IV report on Germany, blamed the swollen current account surplus on the ECB’s loose policy, which resulted in an even more undervalued exchange rate from a German point of view. He showed no inclination of jettisoning Germany’s signature fiscal rigor, claiming that Europe isn’t helped by making the strong weaker.[1] Both Schäuble and Merkel flatly rejected Germany taking on other member states’ liabilities or meaningfully giving up sovereignty for the greater good of the Eurozone. Schäuble essentially stonewalled everything by saying that Macron’s proposals require treaty changes, and that now’s not the time for treaty changes as that there’s no popular support anyway (also a typical Schäuble jibe).
  • But Schäuble did offer something in return, namely a beefed-up ESM (‘European Monetary Fund’) overseen by a ‘Eurozone parliament’ and a ‘joint Eurozone budget’ (note the frequent use of the apostrophe). Don’t be fooled by Schäuble’s plans because they represent precisely what is wrong with the Eurozone/EU, and why I wholeheartedly support Brexit. Under the Schäuble plan each member state will delegate a few of its MP’s to sit in the ‘parliament’ that will only have consultative powers over the beefed-up ESM. Furthermore, member states will pool some of their financial resources in a Eurozone ‘budget’. Schäuble proposed to bundle defense and security budgets, precisely where Germany underspends. I think it’s all incredibly cynical, since Germany would give up (next to) nothing, while in return it would have an even greater say over economic policy. Furthermore, weak parliaments and backroom deals (the Eurogroup of Finance Ministers comes to mind) is precisely what unites eurosceptics and Europhiles (by that I mean the proper Europhiles) in their dislike of how Europe is run these days.
  • Assuming Macron has indeed a spine, Schäuble’s plans for closer ‘integration’ has no chance of succeeding. But make no mistake, Schäuble’s confederate vision of Europe is much, much more of a reality than Macron’s integrationist vision. Out of the Eurozone crisis came the banking union and the ESM, but both are just intergovernmental treaties, outside of the EU legal framework.
  • Berlin’s quid pro quo for anything that comes even close to true Eurozone integration is for Macron to show he has skin in the game. He will first have to address the rot in his own country with the familiar Germanic medicine of supply side reforms and austerity. Macron has praised the Nordic model of a flexible labor market and a generous social safety net, but I think the Germans will be skeptical. The difference could not be more stark with German government spending as a share of GDP at 44% versus 57% in France.
  • More importantly Macron (who still needs to win June’s legislative election, mind you!), like his erstwhile populist adversary Le Pen, will quickly find out that it’s difficult to radically change things when the sun is still shining. The economy of the Eurozone is in a relatively strong upswing. And almost all the debtor countries are running modest current account surpluses these days, given them a thin veil of debt sustainability. Furthermore, Merkel won’t win September’s election by supporting Eurozone integration – on the contrary: it would be a liability. If Macron were to ask Frau Merkel and Herr Schäuble when the Eurozone is in another existential crisis, then they would have to make a choice at last: between true integration or letting the whole thing collapse. In the meantime, expect to hear nice and kind words out of Berlin, but the answer will be a firm but polite nein.

[1] Schäuble tends to complain that it’s easy to talk about higher investment spending, but that in the real world the government can’t just drop billions to identify and start investment projects. This is of course an argument you can’t make year in year out.