March 01, 2017
The threat of Frexit
Le Monde asks on its front page what a euro exit would mean for France. Finally a newspaper addresses the proposals of Marine Le Pen and Jean-Luc Mélenchon, who both hold the euro responsible for high unemployment and low growth in France. So far in the campaign this question has been avoided, which is shocking given the importance of the issue for France and Europe. The Front National did their part in playing down the threat in conversations with investors, with suggestions of a parallel currency system linked to the euro. And yes, Frexit might not be the reason for voters to shift to either of the two candidates in the first round. But not taking the proposal seriously has its own risks in a campaign, even if we agree that a euro exit does not look very likely from today’s perspective. Last year taught us some lessons about how unlikely events can happen.
The Front National promised a referendum on EU membership if Marine Le Pen were to become president. They also promise a six-month negotiation with the EU about the modalities of a euro exit if this referendum produces a majority for Frexit. It is naive to think that an orderly process can be managed, let alone by an administration with no experience of government. Was this not the reason why Alexis Tsipras hesitated in the end to follow Yannis Varoufakis' parallel currency plan?
For all the benefits the FN promises in the medium term there are some painful costs in the short term they fail to mention. And no, this is not anything like Brexit. Once Frexit becomes a credible possibility, they need capital controls to avoid a capital flight out of France as it had to happen in Greece. This in turn is likely to push the low growth French economy into recession. And even if there is some competitiveness to be gained in the medium term through a lower exchange rate, the transition is likely to cost endanger smaller enterprises. Higher inflation certainly will not increase the purchasing power of French savers, and a higher risk premium will weigh on credits, life insurances and pensions.
What happens to public debt? The FN argued that since the bonds are under French law, it will be enough to redenominate through domestic legislation. This might be true, but misses the point. Rating agencies made it clear that such a move would be considered a default. This would trigger a financial crisis since 60% of French debt is held by international investors. The Banque de France recently calculated that the higher risk premium alone would imply more than €30bn extra costs to service the debt. And the idea that the central bank could simply help out by printing money has been tried in the past. Was it not one of the reasons why France went through a decade of painful disinflation to be able to join the euro? And this would all be for nothing?
Also the Frexit idea assumes that the euro continues to exist afterwards. But what if the French exit encourages others to go too? Would Italy want to be in the eurozone in this scenario? Given that the majority of Italian parties are today pro euro exit, this looks more like the beginning of the end of the eurozone.
Frexit is hardly a subject in this campaign so far, except for Le Pen and Mélenchon. The only outspoken pro-European candidate in the campaign is Emmanuel Macron. This is why he got the support of so many pro-Europeans, including Daniel Cohn-Bendit. Don’t expect any strong positioning on this issue from Benoit Hamon, or even Francois Fillon. The French elections are not about Europe, at least for now. This could soon change. If Le Pen and Macron end up in the second round, expect Frexit to be one of the mayor subjects in the campaign.