Emmanuel Macron has done more damage than Liz Truss ever did

Emmanuel Macron
Emmanuel Macron's snap election undermines French hopes of a European fiscal union - Ludovic Marin/AFP

The director of the Bruegel think tank in Brussels once asked what would happen if a eurozone state ever attempted a variant of Trussonomics, without the protection of its own sovereign central bank and policy instruments. We may find out as soon as the first round of voting in the French elections this Sunday.

Jeromin Zettelmeyer said the Truss-Kwarteng accident was humiliating but was corrected quickly with no lasting damage. “The UK’s political and economic institutions absorbed the shock. Now think of something like this in the eurozone with, say, a populist Right-wing party in France trying to pull a Liz Truss. The consequences would be disastrous,” he said.

It is a pertinent question because the eurozone’s structure makes it almost impossible to react to a political train wreck with speed and clarity. The risk is equally great if the Left-wing Front Populaire wins with plans to roll back Emmanuel Macron’s reforms and push through the first radical spending programme ever attempted by a big eurozone state.

The European Central Bank (ECB) will step in to stabilise the French bond markets and stem contagion to the Club Med bloc before matters escape control, but legal constraints will prevent it from doing so until after the turmoil has festered long enough to endanger the faltering economic recovery.

This is not a repeat of the euro debt crisis of 2010-2012, which was the consequence of launching monetary union without a functioning lender-of-last resort. The ECB has since acquired powers to act as a backstop for the debt markets in an emergency. But that alone does not settle the matter.

The breathtaking events unfolding in France expose all the old deformities of the half-finished euro project. They revive the poisonous internal politics that have long bedevilled monetary union, pitting Teutonic creditors against Latin debtors with conflicting morality tales.

The ECB’s untested Transmission Protection Instrument (TPI) allows the governing council to buy distressed bonds on its own authority, but only for countries that pursue (a) “sound fiscal and macroeconomic policies”; (b) are not “subject to an excessive deficit procedure”; (c) do not have “severe macroeconomic imbalances”; (d) where the “trajectory of public debt is sustainable”; and (e) where stress is “not warranted by country-specific fundamentals”.

France fails on most counts, and is on course to fail on every single one under any of the scenarios likely to emerge on July 7, including the pre-insurrectional chaos of a state with no functioning government at all.

Markets have been strangely insouciant. The risk spread on 10-year French bonds has risen to an 11-year high of 71 points but you would hardly know that President Macron is talking openly of civil war if either extreme wins the vote, or that the venerable historian Michel Winock considers this the most perilous moment for the French republic since June 1940.

France had a deficit of 5.5pc of GDP last year. Unlike peers, it has failed to retrench since the spending blitz on Covid and energy bailouts. The International Monetary Fund forecasts 4pc deficits through the decade, with the debt ratio rising to 115pc if all goes perfectly.

“The Germans were aghast at Macron even before this snap election, and the situation is now dire,” said David Marsh, chairman of the Official Monetary and Financial Institutions Forum and author of books on the Bundesbank and the euro.

“They fear being caught in a pincer movement by the French and the Italians. They think the debtors are taking the creditor states to the cleaners,” he said.

The two Germans on the ECB council know that any decision to bail out a French government in open revolt against EU budget rules would be challenged in the German constitutional court. It would further crystallise a view in the German ordoliberal establishment that the euro project has gone off the rails. “The bar for ECB intervention is high,” said Davide Oneglia from TS Lombard.

Mr Oneglia said France is not facing a debt crisis as such. The growth rate of nominal GDP is well above debt interest rate costs, and therefore far short of the snowball effect in debt dynamics. But it has let matters slip badly, lulled by its “exorbitant privilege” as a core member of Economic and Monetary Union (EMU).

“Absent a catalyst, markets can find it convenient to ignore some facts for a long time. For years, France has managed to borrow at virtually the same cost as Germany, while running much larger deficits and piling up enormous leverage in the corporate sector,” he said.

What markets can no longer ignore is the drastic divergence in debt between two anchor economies of the euro. The public debt ratios of Germany and France were similar in the 1990s. Today Germany is at 64pc of GDP and falling: France is at 111pc and rising. This is untenable for monetary union.

French private and corporate debt is also extreme, and some of this is a contingent liability of the state. Data from the Bank for International Settlements show that total “core” debt is 320pc of GDP in France, 235pc in Italy, and 180pc in Germany.

“France has always been able to get away with it because it is France,” said Bernard Connolly, doyen of Wicksellian economists and author of You Always Hurt The One You Love: Central Banks and the Murder of Capitalism.

“But Germany is no longer inclined to let France get away with it. The differences are becoming too great to smooth over, and we are moving closer to the point where the Germans give up on monetary union,” he said.

Mr Macron first took power in 2017 touting a “grand bargain” with Berlin: he would reform France and make it fit for the euro; Germany would agree to fiscal union, the critical step needed to put the eurozone on stable foundations.

His gamble seemed to succeed when Angela Merkel accepted joint debt issuance for the EU’s €800bn (£676bn) Recovery Fund. But that was a one-off scheme, carefully ring-fenced in law. “People thought it was the start of eurobonds. It was really the death of eurobonds,” said Yanis Varoufakis, who had his own epiphany with Germany during the Athens Spring.

Berlin has since resisted all attempts to perpetuate the fund, or to issue joint debt for energy and defence. “Fiscal integration is a super-tough nut to crack in Europe because it is intrinsically linked to national sovereignty and democracy,” said Bruegel’s Mr Zettelmeyer.

“We thought for a moment that it was some kind of ‘Hamilton moment’ but clearly it was not. We will probably never get to the minimum economic constitution required for the euro to deliver stability and prosperity,” he said.

If there was any doubt a year ago, there is none now. Mr Macron’s snap election has guaranteed that Germany, Holland and the frugals will not share their credit card with the Latin bloc in any foreseeable future. They will not agree to an EU treasury with federal tax-raising powers. The euro will remain an orphan currency.

The euro may limp on for years because the trauma of breaking it up is too awful to contemplate. But what is the point of a monetary union that will never be placed on a viable footing?