A Le Pen-Led France May Be the Crisis That Draghi Can’t Fix

EghtesadOnline: If Marine Le Pen convinces France to embrace her anti-euro stance, Mario Draghi will likely be called on again to be savior of the single currency.

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03 April 2017

The trouble is that this time he might not be willing, or able, to do whatever it takes.

In fact, the European Central Bank president and his colleagues have given no signal at all that they’re preparing for the fallout from a potential National Front victory on May 7. Instead, officials privately point to an ad-hoc mixture of existing policy tools -- such as the emergency bank support that kept Greece just-about functioning during its 2015 referendum period -- that could be deployed until the future of France’s place in the euro became clear, Bloomberg reported.

Seven years of bailouts, bank rescues and stimulus programs show that the ECB’s theoretically limitless power to print money evaporates as soon as the consensus among political leaders cracks. And Le Pen’s promise to hold a referendum on pulling France out of the euro could see just such a situation arising, leaving the Frankfurt-based ECB sitting on the sidelines as politicians grapple with the currency’s fate.

“The ECB has unlimited firing power, as long as it has political backing,” said Guntram Wolff, director of the Brussels-based Bruegel Institute. “But if France and Germany are not on the same page anymore, it means that political backing is no longer there, and there’s not much the ECB can do.”

Cooperative Approach

While ECB officials hint that they’d continue to provide liquidity to French lenders, the duration of that support and the possibility of additional action would depend largely on whether the nation’s new president shifts to a cooperative approach.

A spokesman for the Frankfurt-based central bank declined to comment on the election.

“The recent good signals coming from the euro-area economy shouldn’t hide the fact that it remains an incomplete -- and therefore dysfunctional -- monetary union,” writes Bloomberg Intelligence economist Maxime Sbaihi in an analysis of the vote’s impact on the euro published Monday. “Le Pen wants to renegotiate France’s memberships and then hold an in-or-out referendum. She would face many high hurdles along the road to Frexit -- providing investors don’t derail her planssooner.”

Le Pen currently has the support of about a quarter of French voters, leaving her roughly tied with independent candidate Emmanuel Macron for the first-round of the election on April 23. While polls indicate that she is unlikely to defeat Macron in the runoff two weeks later, analysts warn that her chances will hinge on the level of abstention in a polarized political landscape.

“The situation is open and it’s a part of democracy that the end result is not known ahead of time,” ECB Governing Council member Erkki Liikanen said in Helsinki on March 30. “It’s our task to assess what the policy will be that follows from the election result.”

Available Tools

France has about 1.6 trillion euros ($1.7 trillion) in outstanding government debt, meaning a central bank effort to calm bond-market turmoil could potentially require massive intervention -- particularly because it’s unlikely France’s bonds would be the only asset that investors would seek to dispose of in a panic.

The uncertainty surrounding the election’s outcome has been one of the drivers behind the growing spreads between euro-area bond yields, according to ECB Executive Board member Benoit Coeure. In a speech in Paris on Monday, he said there’s reason to hope that this “perceived political uncertainty” will gradually dissipate and remove one of the factors behind flight-to-quality flows.

The 2015 chapter of Greece’s crisis -- where capital controls were imposed and cash machines ran dry as Alexis Tsipras’s government grappled with demands of euro area creditors -- provides a template for the ECB’s thinking.

In that case, the ECB decided as frequently as every day on the level of Emergency Liquidity Assistance granted to Greek banks, keeping Tsipras on a short leash. Then, on June 28, the governing council halted the increases because the political conditions required for the retail lenders to be considered solvent were no longer met.

With a balance sheet 25 times larger, a similar situation for France’s 8.7 trillion-euro banking system would put the survival of the currency at stake. The best-case scenario for survival could still involve months of market tension -- without collapse -- followed by a referendum in which French voters reject Le Pen’s plan to exit the currency.

Even though the anti-euro stance unites Le Pen’s party, public support for the currency is still strong. About 72 percent of voters want France to remain in, according to an Ifop poll published on March 25.

“If Le Pen calls a referendum on euro membership, the ECB would find itself in a dilemma: would it continue extending liquidity to French banks, even amid capital flight and with the possibility that France would default on its obligations after it left the euro zone?,” said Ben May, euro-area economist at Oxford Economics in London. “In the end, the ECB would have to hope for a couple of months of instability, followed by a resounding victory for the euro and some fallout in the economic outlook that it could handle with its unconventional policy tools.”