Sacre bleu! Francophiles call for country to drop the single currency

Published on Wednesday 13 December 2006 01:36

HERE is a strange phenomenon: just as the euro is coming into its own with the slide in the US dollar, the French are starting to think about the nuclear option of abandoning the European currency for the old franc.

This is actually good news for the world economy as it starts to unwind the endemic American trade and capital deficits before they implode in some dangerous, uncontrolled fashion. A cheaper dollar will boost US exports and stop Americans buying expensive petrol from abroad.

The downside, as far as America is concerned, is that a cheap dollar boosts domestic inflation as import prices rise. That is a headache for Ben Bernanke, the head of the Federal Reserve, as he has to decide between raising interest rates to curb that inflation, or cut rates to boost economic growth. There are a lot of American commentators worried that Bernanke is dithering between the two.

Elsewhere in the world, the falling dollar is a bit more problematic. Many Asia economies keep their currencies tied to the sinking dollar - notably China. This is good for stability in trading relationships, which is good for world peace. Where it causes a problem is in Europe, where the euro is obviously rising as the dollar falls. Most commentators expect this trend to continue into the first half of 2007.

The eurozone economies are thus left taking the brunt of the US currency adjustment, especially as the markets think the European Central Bank will raise interest rates in the coming period while they assume Bernanke will get off the fence and lower his. Thus the hot money will head to Europe, taking the even euro higher.

All things being equal, a strong euro will hurt European exports, which is precisely what is upsetting the French. For instance, the euro has risen nearly 70 per cent in six years against the Japanese yen. This has provoked PSA Peugeot-Citroen to build its 4x4 sportif models in Japan itself. Then there is the troubled Airbus company, Europe's flagship builder of passenger airliners, which is being beaten hands down by Boeing, partly because the euro exchange rate is above $1.30.

Enter the silver-coiffeured Dominique de Villepin. He is still the prime minister of France - though most folk have forgotten he exists since his bid to be a candidate in next year's presidential elections went up in smoke, after his cowardly retreat before the Paris mob over the issue of reforming youth employment contracts.

De Villepin is seeking a return to popularity by denouncing the European Central Bank as being complicit in the strong euro and ability of those pesky Asian economies to keep their trading currencies cheap. "We must clarify matters in exchange rate policy, which means taking back our sovereignty and our margin for action", thunders this author of a best-selling book on Napoleon.

By this he means invoking Article 111-2 of the Maastricht Treaty, which gives EU governments the power to override the ECB and set exchange rate policy for Europe. This includes physically controlling the flow of capital in and out of the eurozone economies, which could be done by a qualified majority of EU finance ministers, leaving Gordon Brown with no veto.

Doubtless the German civil servants of the ECB, never mind global financial markets, would be outraged by such overt political intervention, which why this is referred to as the "nuclear option". But then, France is a nuclear power.

Are the French serious, or is sabre rattling to get the ECB to hold off raising interest rates? For the moment, the answer is probably the latter. Sgolne Royal, the French Socialist presidential candidate, has been prominent in accusing the ECB of "shattering growth", suggesting the whole French political establishment is crowding the ECB.

However, some traditional Gaullists, such as Nicolas Dupont-Aignan, are deadly serious about getting back the franc. The French are not alone: a poll conducted by Stern magazine last year found that 56 per cent of Germans wished to see the return of the Deutschmark.

The danger in all this political rhetoric is that it might force the ECB to raise rates just to show off its independence. Besides, when politicians are silly enough to deliberately undermine the independence of the central bank, markets become unsettled and business confidence gets rattled. Fortunately, British politicians have largely been sensible enough to avoid such dangerous bravado.

Which raises the interesting question: whither sterling? Once upon a time, a falling dollar would have taken the pound with it. But these days sterling is staying firmly hitched to the euro. Partly this is because the pound is now a safer hedge than the US currency, but with higher interest rates than the euro.

The UK economy is also on an upswing, while the American economy is going down. This means we in the UK are enjoying unusual (for us) exchange rate stability, but don't have to put up with the likes of De Villepin trying to mix politics and economics in a way Britain escaped years ago.