Charlemagne

The driver and the passenger

How a skewed Franco-German partnership upsets the euro

Source: The Economist

WHEN Angela Merkel and Nicolas Sarkozy said last year that they wanted to change the European Union’s treaties to create a permanent financial-rescue system, their colleagues soon fell into line. And when the German and French leaders this month promised a “global” plan to resolve the euro-zone crisis, the rest delayed their summit so it could be drawn up.

The “Merkozy” duumvirate annoys some: the Italians say “a global situation cannot be solved by a bilateral axis.” Yet the Franco-German motor remains crucial. These days it would be more accurate to call it the Germano-French engine. Or better still, imagine a BMW motorcycle with a Peugeot sidecar; Mrs Merkel in leather trousers and Mr Sarkozy tagging along. As one senior Eurocrat puts it, the partnership serves “to hide the strength of Germany and the weakness of France.”

France’s fragility now directly affects the euro crisis. It has the biggest debt and deficit ratios among the euro zone’s AAA-rated countries, and its banks are dangerously exposed to southern Europe. At their recent summit in Berlin, a man from Le Monde asked Mrs Merkel whether she was in a partnership of equals with Mr Sarkozy, “given that France and its banks have been attacked by the markets.” There was no reply.

French policy in Europe has long been based on the quest for parity with Germany, politically if not economically. But the euro crisis has exposed the weakness of public finances in a country that has not run a budget surplus since 1974. Six months before a tight presidential election, Mr Sarkozy seems to be driven by one overriding objective: to preserve France’s top-tier credit rating.

Fear of a downgrade has pushed him into more effort to balance the books. But it has also led to a “hug her close” policy rather like Britain’s towards America: embrace the stronger partner in the hope of shaping its policies. Mr Sarkozy dare not disagree with Mrs Merkel in public, lest a row destabilises the euro and draws attention to France. This made the latest Merkozy show surreal, as Mr Sarkozy kept saying he was in “complete accord” with Mrs Merkel even though neither could say what they agreed about. A day later, Herman Van Rompuy, president of the European Council, delayed the next euro summit from October 17th to October 23rd, to “finalise our comprehensive strategy”.

Almost all the elements of a solution—resolving the Greek crisis, creating a firewall round solvent sovereigns, recapitalising wobbly banks and redesigning the euro zone’s rules—have run into French obstacles. In the end, though, France has usually had to yield to Germany. It refused to countenance a default by Greece, or even debt restructuring, for fear of market contagion. Greece will get its next tranche of loans in November, even though it is bust and will miss its deficit-reduction targets. But Germany now wants to impose much greater losses on Greece’s private creditors than those agreed under last July’s “voluntary” deal, and looks likely to get its way.

But before burning the Greek bondholders, Europe needs a proper firewall. In July leaders agreed to let the main bail-out fund, known as the EFSF, recapitalise banks and buy bonds. The Slovakian parliament has just voted this down, although it is likely to accept it in the end. It will be harder to win approval for the vital next step: a three-, four- or perhaps fivefold increase in the fund so that it can protect Spain and Italy. National guarantees for the fund cannot be increased much for fear of endangering the rating of France and others. The European Central Bank has rejected the idea that it should lend to the EFSF. So more esoteric leveraging ideas are being considered.

Meanwhile the collapse of a Franco-Belgian banking giant, Dexia, has brought home the pressing need to recapitalise Europe’s banks. France wanted to draw on the EFSF, both to present the problem as European and to share the cost with Germany. But, again, France has given in to Germany’s insistence that it is for governments, first and foremost, to stump up for their banks.

Mr Sarkozy has come around to the German belief that the euro zone must offer a “vision” of deeper integration, which will require a new treaty. On this front, at least, Mr Sarkozy has won some points by getting Mrs Merkel to accept his call for economic government. At the next summit the 27 EU leaders will talk of boosting growth; then ten will leave and the 17 from the euro zone will remain to discuss the crisis. This two-tier structure will become a regular event, under proposals by Mr Van Rompuy. He will preside over both sets of meetings, though the French do not want this to be a precedent: a future president of the European Council just might hail from a non-euro country, and, horror, preside over euro-zone business.

Mr Sarkozy will see all this as a great French victory. But would such a structure have averted the euro crisis? No. The true test will be the content of the reforms. Germany will want to replicate its federal system, with tough fiscal rules and more power for the European Parliament; the French will want a mirror of the Fifth Republic, with joint bonds issued by the euro zone and executive power (and much discretion) left in the hands of leaders.

Is it Mediterranean or northern?

Nobody should count France out. Yet its ability to get its way rests on economic credibility. Is it the weakest of the strong, or strongest of the weak? This matters: a downgrade of France could fatally damage the EFSF. French economists such as Jacques Delpla say fears over the AAA status are overblown: France’s perfumes will sell in emerging markets and its demography looks better than Germany’s. And the French are good at taxing their citizens. Yet all this assumes, crucially, that Italy or Spain do not implode. So the big doubt remains: if Germany decides to commit a lot more money to save the euro, can France afford to as well?