Europe's FDR? How France's New President Could Save Europe

Is the new French president a "dangerous man"? Let's hope so, for the continent's sake.


The only thing Europe has to fear is fear of 3 percent inflation. That's the truth the Old Continent desperately needs to hear. Unfortunately, Franklin Roosevelt figures are in short supply nowadays. But this weekend's seismic anti-austerity votes in France and Greece -- the latter for other, darker reasons -- have given Europe one last, best chance to come to terms with this reality. Nothing less than the future of the half-century European Project is at stake.

Newly-elected French president François Hollande has already inspired an impressive amount of hand-wringing on the part of the commentariat. His proposal to raise the top marginal tax rate to 75 percent has drawn ire from conservatives. So too has his emphasis of growth over so-called structural reforms. More broadly, his proclaimed opposition to German-led austerity and tight money has created uncertainty about the future of the euro. It's all been enough for The Economist to editorialize that Hollande is "a rather dangerous man."

Let's hope so. If he's not, the euro is certainly doomed.


Before moving on to the economic consequences of Mr. Hollande, let's recap the euro crisis in two easy steps. First, southern Europe is too uncompetitive. Second, it has too much debt. The former is the legacy of the boom; the latter of the bust. During the good years, capital poured into southern Europe. Wages shot up relative to Germany's. And then the money spigot turned off. Southern European economies crashed, deficits swelled, and so did public debts.

Eurocrats have failed to solve these dual problems. The German solution of simultaneously cutting wages and slashing budgets is no solution. It's self-defeating. Smaller paychecks make it harder to pay back debts that aren't smaller. It's true of households and it's true of countries. Austerity has perversely made southern Europe's debt problems worse because they've saved less than they've lost. That's why laments over Hollande potentially sidetracking structural reforms are so misguided. Southern Europe undoubtedly needs to fix its labor markets, but doing so won't bring back needed growth anytime soon. At least as long as wages are being cut.

What's the alternative? Germany could meet the periphery halfway. Southern Europe's competitiveness problems wouldn't look quite so bad if German wages went up a good bit, nor would southern Europe's debt problems look quite so bad if their economies grew a good bit. In other words, Germany needs to allow more inflation and/or more spending.

Hollande's "dangerous" agenda has centered on pressuring Germany to do exactly this. The French president-elect has said that he wants to challenge Angela Merkel's Fiscal Compact. But that's really a bit of a sideshow. Even if Hollande wins a bit more fiscal flexibility, German-financed eurobonds are not coming anytime soon. The real battle is over the ECB.

Which means the real battle is over the Bundesbank. The German national central bank is the real power behind the ECB. The past few years it's maintained its traditional hardline anti-inflation stance, despite the absence of much inflation. It's gotten so bad that The Economist recently asked the Bundesbank to allow higher inflation in Germany just so that the ECB can hit its overall 2 percent inflation target. Keep in mind: it would probably take a much higher overall inflation target for the euro to survive -- and the debate is whether the Bundesbank will even let inflation hit an already too low level.

It gets worse. The Bundesbank thinks about its hard-money policy in more Machiavellian terms too. Bundesbank president Jens Weidmann has openly said that he thinks that "higher interest rates [in southern Europe] are also a spur to reform." Translated from central banker speak: the Bundesbank opposes bringing down borrowing costs for southern Europe, because those countries might then ignore Germany's demands. The Bundesbank doesn't see the eurocrisis as an existential crisis for the single currency. The Bundesbank sees the eurocrisis as an opportunity to remake Europe in Germany's image.


Hollande must either break the Bundesbank, or the Bundesbank will break Hollande. To his credit, Hollande has made this a core part of his platform. He wants the ECB to cut interest rates (which somewhat inexplicably remain at 1 percent) and to lend directly to governments, if necessary. The Bundesbank is loath to deviate so far from financial orthodoxy -- but they do look increasingly isolated politically. The continent-wide backlash against austerity gives Merkel less room to back the Bundesbank. There's an albeit slim chance that Hollande could jolt the ECB into doing more.

Still, Weidmann et. al. likely won't give up without a fight. Slate's Matthew Yglesias has already outlined what seems like a plausible scenario: the ECB will passively let French bond yields and banks come under pressure in order to get Hollande to toe the German line. It's what they did to Greece. It's what they did to Italy. And if they do it to France -- and Hollande relents -- then Europe can look to Greece for its future.

When mainstream political parties offer nothing but failed policies, the public turns to extremists. That's what happened in Greece over the weekend. Support for the mainstream, pro-austerity New Democracy and PASOK parties collapsed. The far left and far right were the big winners -- including an explicitly neo-Nazi party. Now, neither New Democracy nor PASOK have had much choice when it comes to austerity: if Greece left the euro it would be left with an equally unpalatable choice between hyperausterity and hyperinflation. But that hasn't absolved them of blame in the public's eye.

Europe -- read: Germany -- needs to come up with a plan that doesn't require southern Europe to suffer through a depression. (Remember when Germany was going to launch a "Marshall Plan for Greece"?). Otherwise, more anti-euro, anti-bailout, anti-immigrant parties will rise. The rest of southern Europe is still a few years behind Greece -- but the political earthquake is coming. Most of them have already kicked out one of their mainstream parties. If the the other one fails too, then the fanatics will be waiting. That's the real threat to the survival of the euro.

IT'S 1933, AGAIN

Make no mistake: the German/Bundesbank policy of long-termism has failed. Austerity and too tight money are strangling southern Europe. More austerity and tighter money aren't the answer. Granted, structural reforms and low inflation are normally ingredients for long-term growth, but the euro will die long before it gets to the long-term. Europe needs to worry much less about the next five years and much more about the next five months.

This is Europe's 1933 moment. When he came into office, FDR thankfully ignored the high priests of financial orthodoxy of his time who warned in apocalyptic terms against abandoning failed policies. Hollande needs to do the same now. I'm not optimistic Hollande is radical enough for the moment, but there's nobody else.

As another French leader might have told Hollande: Europe is worth 3 percent inflation -- or more.