A new eurozone economic policy "made in France"?

The appointment of Arnaud Montebourg - an outspoken critic of German and EU-mandated austerity and pro-competitivenesses policies - as the new French Economy Minister has not gone down well in Germany.

In a feature piece headlined, "He insults Germany and is promoted", Die Welt claims that "his appointment is controversial – he is known for his failures". The paper goes on to argue:

"He sees himself as the legitimate successor of Jean-Baptiste Colbert, the finance minister of the legendary French Sun King Louis XIV... In his previous post of Minister for Re-industrialisation, he above all others terrified foreign investors with class warfare slogans, and now has acquired even more powers in the government of President Francois Hollande".

The paper also claims that Montebourg secured his new position by threatening Hollande that, unless given the Economic Ministry, he would resign from the government - a move which would have been hugely destabilising given his position as a figurehead on the left of the Socialist Party. The paper has a round-up of some of Montebourg's more memorable quotes:

On globalisation, free trade and protectionism:

“The EU is the only one that does not protect itself against unfair competition. We have become the idiots of the global village...For 30 years, consumers have made the law in Europe and the result has been a disaster. Me, I defend the producers."

On the European Commission's application of competition and state aid laws:

"[These people] exercise law in the manner of the taliban, [they are] fundamentalists who apply the [legislative] texts blindly to the detriment of European interests".

On Angela Merkel and Germany's actions during the eurozone crisis (back when the French Socialist Party was still in opposition):

"The issue of German nationalism is resurfacing through the policy à la Bismarck [of Angela Merkel]."

And:

"Mrs Merkel is killing the euro, and it would be time to show the failure of the German model, rather than singing its praises."

Even allowing for the fact that Montebourg is playing to the gallery a fair bit, and that the new government's economic policy will remain more pragmatic overall, it is clear why his appointment will raise concerns in Berlin and beyond about France's already fragile economic situation. In the meantime, we're looking forward to new additions to his already impressive repertoire of memorable quotes.

The Spanish sovereign-banking loop

A heavy going blog post for a Friday afternoon, but you can digest it over the weekend (lucky you!). One of the key themes we highlighted in our recent briefing, comment pieces and general coverage on Spain is the importance of the sovereign banking loop.

The idea here is that the fate of the Spanish banks and the Spanish state are becoming increasingly intertwined. The two are always connected: if a state goes down normally its banks will too, while if banks fail the state often has to bail them out to support itself (or at least that is the prevailing logic).

As the eurozone crisis has progressed numerous states (PIIGS) have had significant trouble funding themselves (selling debt). In many cases the only people willing to buy a sovereign’s debt has been their domestic banks. In turn, a situation arises where banks pile more and more risky debt while the state becomes entirely reliant on them for financing. Far from ideal.

The unlimited ECB lending and the LTRO has only exacerbated this cycle and there is a strong correlation between increased reliance on ECB funding and the sovereign-bank loop – Spanish bank borrowing from the ECB jumped by €75bn in March, an increase of 50%.

An editorial in the FT today argues that the Spanish government has done well to avoid recapitalising its banks at cost to taxpayers, especially since many of the banks could fail without bringing down the state. This is undoubtedly a positive thing - taxpayers should be kept out of the equation as much as possible as taxpayer-backed bailouts invariably create the wrong incentives (i.e. moral hazard).

But for intellectual honesty, it's also vital to account for all sides of the sovereign-banking loop.

As we noted in our recent briefing the primary aim should be to force banks to recapitalise themselves and ensure they have sufficient provisions against bad loans. However, if they get into significant trouble the chance of a self-fulfilling bond run on Spain increases significantly as the domestic banks stop buying bonds. This could push the whole country into a bailout, which the eurozone could barely (if at all) afford.

This situation is a clear side effect of the failed policies taken on by the eurozone and the ECB, which we have long argued against – failing to tackle the underlying back solvency problems, loading them up with cheap liquidity and encouraging them to fund struggling states was always going to lead us here. Unfortunately, given the state of affairs now, suggesting that Spanish banks are too small to bring down the state misses how dependent the state is on cash from domestic banks.

A Spanish banking crisis and the ensuing bond run on Spain are very real threats to the eurozone. The Spanish government needs to push banks to increase provisions against losses and a thorough stress testing would go some way to highlighting just how much they need. We are loathe to suggest any cost be transferred to taxpayers, but realistically (given the eurozone's bail out policy) this option may what the Spanish government and eurozone leaders have to go for in the end, either through the FROB (Spanish bailout fund) or the ESM (eurozone bailout fund). If so, it's of course extremely important that any funds should come with strong conditionality including giving the government preferential shares and equity warrants as well as forcing banks to produce ‘living wills’.

But whatever happens, eurozone leaders must stop seeing a bail out as an end in itself. If it comes to that, unlike the ongoing ECB and bailout operations, any injection of funds should be part of a full assessment of the viability of the institution with fair consideration given to the prospect of winding those down that don't have a sound financial footing for the long term. Banks must simply be allowed to fail. Ultimately, purging the bad practices and poor management which helped fuel the boom and bust in Spain will be vital for the long term health of the banking sector and the economy.

The link between the health of the Spanish banks and the health of the Spanish state remains very strong - unfortunately neither is looking in a good position right now.

Some common sense from the Commission

Here's an encouraging proposal:

As we reported in our press summary yesterday, the European Commission has announced plans to revise its Byzantine state aid rules, potentially making life a bit easier for local and regional authorities. Currently, local bodies have to comply with the EU's jungle of rules, designed to ensure fair competition on the Single Market, even when subsidising or contracting out small projects such as swimming pools, playgrounds or crèches - which is just silly (and which adds unnecessary costs for taxpayers).

But, under the new rules, the Commission would lower the threshold on public procurement rules which - or so we hope - would let local authorities off the hook for public tenders for small-scale public services. As the competent EU Commissioner for Competition, Joaquin Almunia, put it.

"Our state aid rules currently apply also to local services organised by very small municipalities. It seems quite obvious to me that among these services, there are some that will have little impact on trade between member states and little potential to distort competition. I think that we need to adjust our scrutiny here and focus it on the cases that have a clear impact on the single market."

That makes sense. An official quoted over on Euractiv was even blunter:

"Most people [in DG Competition], they are not happy having to deal with a state aid complaint against a Dresden swimming pool. To be honest, it's more a pain in the ass than anything else, because they know very well that these matters should not be dealt with in Brussels."

The Commission says it wants to revise the regime in November (which it can do without asking member states or MEPs, since the EU has exclusive powers over this area). This is exactly the type of common sense that we want to see from Brussels.

But we need more of it - much, much more.

Incidentally, Open Europe will soon publish a list of examples of EU laws and measures that we feel should be revised on similar grounds. So watch this space.)