The EMU: An Endangered Specie? David Roche in The Wall Street Journal 97-06-12

- "I am not saying I want to renegotiate the pact, butI am not saying I can accept it," said French Finance Minister Dominique Strauss-Kahn on the stability pact, Monday, So now we're all thoroughly confused.

... Meanwhile, investors stare like paralyzed deer into the blinding confusion of the Franco-German headlights and do nothing -- so reinforcing politicians' confidence that the wise, political Euro-mind will prevail over unruly markets.

Nothing could be further from the truth. This crisis substantially reduces the chances of EMU happening on time, and may well prove to be a watershed in European politics.

... Indeed, rather than torpedoing the stability pact, the French government had other options. It could have signed the stability pact and then blown out the 1998 budget deficit, which hardly counts for EMU participation, while fudging the all-important 1997 budget deficit to below 3% of GDP. After all, France's 1997 deficit will be only marginally affected by expansionary fiscal measures that, even if enacted this autumn, will only bite for a few months.

The truth is more awkward. French Prime Minister Lionel Jospin is a politician who will not sign deals he thinks are economic nonsense and socially unjust. He thinks the harsh financial constraints imposed by the stability pact and the Maastricht Treaty are both likely to lead to European disintegration. He has said as much. And we had better start reading his lips and believing.

Mr. Jospin's convictions may be the antithesis of Margaret Thatcher's. But the political consequences of his convictions will be just as difficult to deal with, and at a more critical time for Europe. There is nothing more awkward for EMU than the entry on the European stage of an honest and unbending politician.

So what does Mr. Jospin believe in? For a start he does believe in European integration. But he does not believe that l'Europe can be achieved with rising unemployment and disappearing social cohesion. That puts cutting joblessness ahead of cutting budget deficits. It also puts achieving this social aim ahead of EMU timetables.

And he also believes the French economy is suffering from a lack of demand, which is the same as saving too much. The country's current-account surplus -- 1.5% of GDP -- is symptomatic of this excess of savings over investment and is a measure of foregone growth.

... For those of us who learned economics in the 1960s, this /Jospin's plans/ all resembles the Keynesian plumbing models of macroeconomies, with the state controlling a spigot to top up the level of demand whenever it sinks below full employment. Surely this view has been shown to be unworkable over the last several decades. Two other elements complete the jigsaw.

Mr. Jospin has exactly one year to show results. If not, the president can call another election. That is a strong motivation to do things differently and to make a dash for growth and jobs. And the French people have a strong belief that there are alternative economic models to the harsh and savage world of Anglo-Saxon market economics, which Mr. Jospin has highlighted as a threat to European civilization.

What has happened in France is an abrupt change in political and economic thinking. The issue is not whether Mr. Jospin's vision will work, but how Germany will accommodate it in the run-up to EMU. The answer is badly. The German government has just lost a major battle with the Bundesbank -- Germany's most popular political institution -- after being caught red-handed trying to fudge its own compliance with the Maastricht criteria by revaluing its gold holdings. Its credibility as defender of its own people's economic interests is in tatters.

And the Bundesbank waits in the wings to savage any other attempts to fudge EMU. Of course, Chancellor Helmut Kohl madly wants to reach some agreement with the French on the stability pact to get EMU back on track. But if he does, it will be by "softening" EMU yet again.

No Room to Fudge

There will be plenty of opportunities for the Bundesbank to stop this: as an expert witness in cases brought against EMU in the German Constitutional Court, as adviser to both houses of parliament at the final EMU vote in 1998, or by simply calling a press conference and condemning the whole thing.

None of this leaves Chancellor Kohl with any room to ditch the stability pact or to fudge conditions for the abandonment of the mark. It suggests an EMU outcome quite different from the one entertained by financial markets today. The Bundesbank now has the power to ensure that there will be a "hard core" EMU or none at all. The choice is stark. Either the French back down and a meaningless compromise is found to salve wounded Gallic pride, or EMU is going to be postponed.

If Chancellor Kohl's political future is carried out feet first along with EMU's, that would mark a generational change in European politics. The new leadership, irrespective of party, would be distinctly less wedded to this generation's vision of Germany as an economic giant but a political pygmy, with all national identity and sovereignty diluted in the greater Euro-mass.

But there is another possibility. Chancellor Kohl may himself decide that EMU needs another term of his good offices to be completed, and so dump EMU in time to re-establish his credibility with the German people, blaming French irresponsibility for postponement. Either way, the French assumption that they continue winning concessions from Germany is dead wrong.

Before long, the volatility of European politics will find its match in European markets.

Mr. Roche is chief strategist at London-based Independent Strategy.