Who will dic­tate Europe's fu­ture?

The Pak Banker - - Front Page -

WHICH coun­try holds the key to the euro's fate? Which of the 17 mem­bers will turn out to be the "pivot state" the coun­try around which the fu­ture of the eu­ro­zone will turn? I spent most of last week­end think­ing about the fu­ture of Europe with economists, politi­cians and se­nior pol­icy mak­ers at a two-day sem­i­nar or­gan­ised by Cen­tre for Euro­pean Re­form. (I know, I get all the fun.)

One way or an­other, this ques­tion kept on com­ing up - maybe be­cause it's a use­ful way to think about the dif­fer­ent paths which the euro could take from here.

Two years ago, you might have said Greece was the pivot state. Pol­icy mak­ers were con­vinced that a Greek exit from the euro would be the end of the whole thing. The ef­fort to save the euro boiled down to a mas­sive ef­fort to keep Greece in. Not any more. I don't speak to many City folk or Euro­pean pol­icy mak­ers who are con­fi­dent that Greece can stay in the sin­gle cur­rency. But I would say a ma­jor­ity are fairly con­vinced that the euro will sur­vive - even if some of them wish it were not so.

Ask the same ques­tion now, you might get "Spain" as the an­swer. The new con­fi­dence around the euro stems largely from the ECB's com­mit­ment to Out­right Mone­tary Transactions (OMT) - to act­ing as a back­stop for coun­tries in the mar­kets by buy­ing their gov­ern­ment debt. Spain is the coun­try that pro­gramme was de­signed to help. So how and when it gets that help might well de­ter­mine how this stage of the res­cue strat­egy works out.

Longer term, though, you have to won­der whether we will continue to be quite so fo­cussed on Spain. Af­ter all, it's not Spain that is re­spon­si­ble for 57% of the sov­er­eign debt of the trou­bled eu­ro­zone economies - it's Italy. And come the spring, Italy will be look­ing for a new prime min­is­ter.

In their punchy new book, Democri­sis, David Roche and Bob McKee say Italy is the "cir­cuit-breaker" that could make a lot of the cri­sis go away: "Italy rep­re­sents more than half of ev­ery form of mea­sur­able eco­nomic con­ta­gion of the eu­ro­zone sov­er­eign debt cri­sis... If the mar­kets be­lieve Italy is 'save­able', a vir­tu­ous out­come is pos­si­ble and con­ta­gion will go into re­verse." That makes Italy sound very much like the pivot state: the coun­try whose fu­ture could dic­tate ev­ery­one else's. The fact that an Ital­ian now runs the Euro­pean Cen­tral Bank is the ic­ing on the cake.

You might ask where Ger­many fits in all this. Af­ter all, we're used to think­ing Ger­many holds the euro's fu­ture in its hands. But the no­tion of a pivot state goes be­yond sheer power, or eco­nomic heft - the pivot state isn't nec­es­sar­ily or even usu­ally the big­gest coun­try. Rather, it's the ful­crum that helps to tip his­tory one di­rec­tion, or an­other. There is one large na­tion that I hear in­vestors and pol­icy mak­ers talk about more and more as the piv­otal state of Europe - but it's not Ger­many. It's France.

It's still pos­si­ble that events in Spain or Italy will de­ter­mine whether the euro sur­vives. But if it does last, France is most likely to de­ter­mine the kind of eu­ro­zone it is, and whether Ger­many and its peo­ple feel happy to play along. Al­most with­out any­one notic­ing, Fra ce has be­come an even more state-dom­i­nated econ­omy than it was 30 years ago, with gov­ern­ment spend­ing of nearly 60% of GDP and a ten­dency to raise taxes first, and talk about spend­ing cuts a lot later.

Many in France - in­clud­ing on the right - think that com­bi­na­tion is sus­tain- able, thanks to French com­pa­nies' world-beat­ing man­u­fac­tur­ers. In some key sec­tors, they are truly sec­ond to none. France also has much bet­ter de­mo­graph­ics, look­ing ahead, than ei­ther Ger­many or Italy.

But Chan­cel­lor Merkel does not take such a san­guine view. And nor do many in­ter­na­tional in­vestors.

That is why mar­ket watch­ers and not a few Ger­man of­fi­cials were pay­ing very close at­ten­tion to Pres­i­dent Hol­lande's big press con­fer­ence last Tues­day. They want to know whether he can com­bine con­crete eco­nomic re­form with his call for less aus­ter­ity. If he does not, then Ger­many knows that the harsh bud­get arith­metic in the new Sta­bil­ity and Growth Pact will not add up even for France - let alone the likes of Spain. For all these rea­sons, the so­cial­ist pres­i­dent of France may well be the Euro­pean politi­cian who has the most say in dic­tat­ing the fu­ture of the euro - es­pe­cially af­ter next year's Ger­man elec­tion. To be clear, I think the euro will prob­a­bly sur­vive. But his­tory may judge that it was Pres­i­dent Hol­lande who de­cided, in 2013, whether Europe was go­ing to have a squidgy, Latin kind of mone­tary union - or the aus­tere Ger­manic one de­scribed in the new fis­cal treaty.

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