Right before Easter, a historical debate between the 11 candidates to the presidency of the French Republic took place, with over 6 million viewers. The event was expected to reduce the volume of undecided voters (latest polls indicate they represent a 40% of the voters) offering variety with other small candidates, among them Jean Luc Melanchon. The leader of the French extreme left (an acknowledged euro-skeptical) was the ultimate beneficiary of the debate, now placed third in the election polls and adding more uncertainty to the election’s outcome.
Surprisingly, Marine Le Pen was not the only candidate to criticize the European Union. Others like Benoît Hamon, François Fillon, Jéan-Luc Melenchon or Nicolas Dupont-Aignan showed themselves euro-skeptical, calling into question the real advantages that belonging to the Union may imply France. Emmanuel Macron was one of the main defenders of the common project, urging his colleagues to change the wronged mechanisms in the Union from within.
Recent polls showed that, so far, a great part of the French people (around 60%) would not wish to exit the Union (see sondage CSA). Nonetheless, and being aware of how complex it would be to recreate an accurate estimate of the real impact of a Frexit due to the lack of precedents, we want to present a likely scenario for this under economic terms.
Brexit: comparisons are odious
Those defending the feasibility of a hypothetical “Frexit” take UK’s Brexit as an example, which was officially triggered a couple of weeks ago. Although it is true the pound has lost value since then (17% against dollar and 11% against euro), the British economy weathered the storm and FTSE100 reached record values during the last weeks (that is, under a context of favorable inflation and currency depreciation). No massive outflow of capital has been recorded, nor a significant decrease in foreign investment in their economy as others predicted. Finally, last quarter of 2016 registered a GDP growth percentage of 0.7% (+0.6% on the previous quarter).
FTSE100 share price evolution. source: telegraph.co.ukThat being said, it is important to underline how it is not the same to get out of the Union with your own structured currency, than also getting out of the euro and having to restore your old currency. And all this, with a weaker economy than the British.
One of the main drawbacks of exiting the Euro is related to foreign debt. Re-denominating national debt in francs would imply a reimbursement of that debt in a different currency than the €. Foreign creditors would not be willing to receive such payment, which could trigger a default chain-effect. Not to mention the interest rates, that would rise exponentially in front of risk and growing uncertainty from political events and instability.
This is important, if we consider that close to 59% of French debt (2100 billion €) is held by foreign creditors. As for the UK, the risk is way lower given the fact that a greatest part of their debt (close to 75%) is financed internally by banks, assurances and other funds.
For the calendar of 2017, there is a public debt emission estimate that goes up to 180 billion €. What would happen if foreign investors were not willing to finance that debt anymore? The government is counting on these foreign creditors to balance its budget, and the in-flow of capital into the country might suffer under this perspective.
Illusory Monetary Sovereignty
Achieving monetary sovereignty for your currency is not equivalent to do as you please with its the value and fluctuation. Just as it happened with the pound in 1992 (see George Soros and the BOE), a hypothetical “new franc” would undoubtedly be attacked by traders and hedge funds as the markets start to lose confidence in a weakened French economy struck by the consequences of Frexit. Thus, it is not unreasonable to speak of a 25-35% devaluation for this currency, once it replaces the € after a referendum victory for the Frexit. For its part, the Euro would also suffer a noticeable depreciation, but not as severe.
Monetary sovereignty makes no sense at all if a country is not not financially solid and do not possess a certain degree of autonomy when it comes to financing your public expenses, as we mentioned above. And furthermore, and as Le Pen said several times, if the point of achieveing such sovereignty is to be able to devaluate the currency at will, let us see why this would be no clear solution.
Devaluing a currency does not improve competitiveness, but dresses it up.
The “blame it on the unfair neighbor, who devalues his currency” moto is no longer a valid excuse to justify a lack of competitiveness and efficiency in your own industry.
Helping sectors in a state of decay by devaluing your currency and artificially lessening their production costs is shooting yourself into your own foot. It just draws away the attention from the real solution: increase productivity, more innovation, efficiency, better product quality and added value.
Devaluing can also be used as a tool to dress up a country’s indebtedness as your debt loses value with the generated inflation, which would also be very convenient for Le Pen’s scenario.
In an economy that relies heavily on foreign trade to receive an important part of its resources and goods, franc depreciation would certainly not be of much help. In addition, 7 out of the top 10 commercial partners of France are members of the European Union, which would add extra pressure in their imports and exports relations abroad. To make imports more expensive (via depreciation and extra-taxes on imports to fight “unfair trade policies”) would cause the PCI to shoot up and it would be the citizens paying in the end.
As exposed in the recent data of France’s trade balance, France drags a significant deficit since long ago (in 2016 it amounted to 47,9 billion €). In January 2017, we observe a negative balance of -7.9 billion €.
An autarchic model would never work in open and globalized economies as in the French case. Adding taxes to protect your own products would result in even higher prices and further trouble for French companies abroad, that would find themselves in the middle of a commercial war.
Le Pen’s populist speech is filled with promises or estimations that will hardly come to see the light someday, if we consider all the mentioned above. Among them, a GDP growth of around 2-2.5% by the end of the five-year presidency, a significant increase in public expense and to lower the interest rates to companies and households.
With interventionist measures and bureaucracy in excess foreign investment will see no attractive market there, so access to financing is clearly limited. Exiting the euro means the risk prime to skyrocket, hence the cost of national debt will be more elevated (in an economy with a high degree of private debt, this is determinant).
Javier Palazón Nadal | Energy Consultant