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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. 

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March 01, 2017

Fear and loathing of a referendum in Spain

There is a broad consensus that the Spanish constitution needs some minor reforms - opinions on major reforms are more divided. But there is also a feeling that the national consensus that allowed the democratic constitution to be drafted to get away from Franco's regime 40 years ago is no longer there. As a result, long-awaited constitutional reforms have been delayed for years. The most visible manifestation of this lack of national consensus is the Catalan independence movement. And according to this story in El Independiente, the People's Party is not keen on allowing even minor constitutional reforms for fear that a referendum might be called that might give the Catalan voters a chance to overwhelmingly vote against.

The context of the story is the agreement signed between the PP and Ciudadanos last Summer. In exchange for Ciudadanos' support for Rajoy's PM bid, the PP agreed to introduce PM term limits, and also to eliminate the condition that some public officials be tried in the Supreme court instead of the ordinary courts. None of these two reforms are controversial, but any constitutional reform must be submitted to a referendum if one tenth of the deputies or senators so request. In the current parliament, avoiding a referendum would require an agreement by all of PP, PSOE, Ciudadanos, and Podemos. Under these conditions, the PP would seem to prefer to use its blocking minority in both houses of the parliament to prevent a constitutional reform in the first place. 

Another condition that Ciudadanos set last summer was that the PP agrees to a parliamentary committee of inquiry on its own illegal financing allegations - the so-called Bárcenas case. In case the PP does not follow through, Ciudadanos is minded to get the parliamentary committee going with the support of the rest of the opposition.

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March 01, 2017

How to get around Theresa May’s little ECJ issue

There are quite a number of straw men issues in the Brexit debate. One of them is the role of the ECJ. The Brexiteers are saying that they want to extricate themselves from the ECJ symbolically and factually with Brexit, while the Remainers argue that the ECJ will be the ultimate adjudicator of the extended customs union. 

Andrew Duff notes that this conflict is not as difficult to solve as some people might think. What is needed is a robust dispute settlement procedure. Where it is not possible for the EU and the UK to reach political compromise in a dispute, they could then go to to a judicial tribunal that passes binding arbitration. One model could be the Efta court, which adjudicates on disputes between EEA members and the EU. The Efta court is not truly independent of the ECJ - Duff calls it a sister court - but they are not the same either. Duff notes that one could use the actual Efta court - thus extending its responsibilities - or create a new one. He suggests a tribunal of three judges, one from each side plus a neutral third party. The tribunal would not have the power to impose legislation on either the UK or the EU. If the ruling does not solve the dispute, the parties could take the case either to the WTO or the International Court in the Hague.

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March 01, 2017

Solve the problem

The best response to Donald Trump, Brexit and all the stuff we don’t like is not to propagate conspiracy theories, but to solve the actual problems - raising stagnating median incomes, and managing economic shocks that arise through sudden shifts in trade and migration, constraining the financial sector.  

We were delighted to read that Massimo Franco is taking this position in his latest commentary in Corriere della Sera, which marks a refreshing break from the tendendency of Italian commentators to focus too much on the short term. He makes the point that the best action now would be for the Gentiloni government to use its majority and take action on economic and social reforms. This would be the best way to silence the critics, and to reduce the probability of a surge in the support of the extremist parties, which are benefitting from the current political statemate. The best strategy for the government to adopt is to govern. Franco did not go into details of the economic debate in particular. We would welcome it if the debate extended beyond the Maastricht deficit criteria to the conditions for lasting sustainability inside the eurozone. What reforms are needed to happen in Italy and in the eurozone itself to achieve a stable position? We see very little of that in Italy itself.

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