Sarkozy, the European Central Bank and Gettysburg
By George Friedman
By George Friedman
Last week, French President Nicolas Sarkozy attacked the policies of the European Central Bank (ECB), saying that they are hurting France. He particularly criticized the ECB's interest rate policy, saying the bank has deliberately let the euro rise relative to the dollar. And he criticized the simultaneous injection of liquidity into the markets, saying it saves speculators but does not help business by lowering interest rates. As Sarkozy put it, the ECB policies mean that, as far as the French are concerned, "We sink."The sinking that Sarkozy is referring to is his own plan to liberalize the French economy, and thus make it more dynamic. In order to achieve his goal, he needs lower interest rates to facilitate entrepreneurial activity as well as general business expansion -- and he needs a cheaper euro to facilitate French exports. Sarkozy sees his vision for France under his presidency as being undermined by the ECB, whose policies are in many ways more important to the French economy than anything Sarkozy might plan. The ECB is simply pursuing a different policy.That is, of course, what central banks are supposed to do. Their independence from politics is supposed to guarantee that, rather than satisfy fleeting political passions, they follow policies that are in the best interest of the country from a strictly economic view. It is not a bad idea. It can be defended as part of the process of a republic, because the governors of the bank are appointed by representatives of the people. Even so, it places a great power in the hands of people whose wisdom must be assumed. As complicated as the idea of a central bank is in a democracy, it is further complicated in Europe by the question of exactly which country the ECB is supposed to be serving. Europe is not a country, but a federation of sovereign nations that are said to have a single economy. But while Europe is highly integrated, any one country -- its people and its elected government -- may be interested in pursuing divergent economic policies. Consider this case: Sarkozy wants lower interest rates and a cheaper euro. Germany does not. Unlike France, Germany is primarily concerned about inflation, particularly in the face of soaring energy prices. Since oil contracts are dollar-denominated, the stronger the euro, the cheaper the oil. Germany wants to maintain high interest rates because that attracts depositors to euro-denominated debt. The Germans are prepared to live with an increase in the price of their exports in return for an influx of foreign money and cheaper imports. In addition, German exports built around advanced capital goods are less susceptible to currency fluctuations than are French exports.Obviously, a central bank is supposed to pursue an independent policy. But Sarkozy's charge is that the ECB essentially is pursuing policies that benefit Germany and not France. This is not the first time the ECB has been charged with favoring some countries over others, but this is by far the most significant. The Franco-German bloc is the heart of the European Union and the eurozone. It has always been understood that, as the two major economies and major nations of the eurozone, their interests would be served by the ECB. But what has not yet occurred is a split between France and Germany over ECB policy. There is a tendency to minimize this as merely French politics incidentally intruding on a relatively harmonious relationship. We think that viewpoint underestimates the implicit seriousness of the situation. France elected Sarkozy to take it in a different direction. The Germans see little reason to sacrifice their monetary needs to help France go in a different direction. Which country, then, does the ECB serve?That is the fundamental question of the entire EU experiment. At its heart, the European Union is a confederation of independent countries pursuing their own foreign and defense policies, and free to craft their own social policies. They are independent nations that have entered an economic union. For some, this union is simply a free trade zone. For others, it is a free trade zone in which trade, and therefore economic and even social life, is regulated by a European bureaucracy. For yet others, the European Union is a monetary union.It is the latter that is the most confusing. A sovereign country has the right to craft its own social and economic policy. It has a central bank that is supposed to manage the currency -- particularly interest rates and liquidity -- on behalf of the country and in tandem with the broad social policies being pursued. The ECB serves multiple sovereign countries, many of which have divergent interests and desires and therefore need different monetary policies from the central bank. One size cannot fit all these sovereign countries. So when the interests of European countries diverge or conflict, whose interests will be served and whose will be harmed by ECB policy?No one can expect a central banker to sort this out. It is not an economic issue. It is a political issue that cuts right to the heart of Europe. The original plan was to create a European federation in which a great deal of the sovereignty of the individual European states would be transferred to the federation. That is unlikely to happen now because it would require a unified foreign and defense policy, as well as a unified social and economic vision. There is no such stable, unified vision. The questions, therefore, are simple. How do you have multiple sovereign states within a single central bank? How do you reconcile national sovereignty with a multinational monetary system when it is impossible to create a single monetary policy that satisfies the policies of multiple sovereign nations? Someone must always be hurt. What is of great significance is that Sarkozy has made it clear that it is France, one of Europe's founders, that is being hurt -- to the benefit of its partner, Germany. This leads to the more immediate question: If Germany and France undertake fundamentally different approaches to economic development, how can both of these strategies be contained in a single European structure? In a way, it would have been simpler had there not been a euro. Multiple economic strategies can be reconciled with a customs union, or even a multinational regulatory system. But reconciling multiple economic approaches with a single currency cannot happen. The United States confronted this question in the past. In the 1850s, some states wanted a radical revision of social, economic and monetary policy that would benefit them but leave other states at an enormous disadvantage. The industrializing part of the country wanted policies that would protect its interests. The agricultural part of the country, heavily dependent on exports, wanted a different policy. A conference was held in 1863 at Gettysburg. Both sides made compelling arguments over three days, but in the end it was decided that not only would the policies of the industrializing states be followed, but no one would be permitted to withdraw from the economic, political and social union of the United States. State sovereignty was to be limited and federal power was to be paramount. It was the Union Army that made the most convincing argument at Gettysburg. There is no Union Army in Europe. There is no sovereign center that can hold dissidents in the monetary or economic union. And there is, for that matter, no power on Earth that can keep France and Germany within a single system if they do not want to be there. Sovereignty, without the slightest shadow of doubt, rests with the nation-states of Europe -- and the European institutions will last only as long as they reflect the interests of all of these nations.The theory from the beginning has been that the European Union, whatever the underlying tensions, is of overriding importance to Europeans because it creates a single harmonized economic zone with a single large market. Thus far, that theory has been correct. The benefits far outweighed the costs -- and that is still the case. But there is one case in which that is not true: when the harmonization of regulations, markets and the central bank either hurt one nation disproportionately or make sovereign policies impossible to implement.For France, that moment has arrived. The structure of the European Union cannot easily support the policy changes that Sarkozy feels he must implement in order to maintain the French economy and French competitiveness. The issue could come down to his presidency versus EU institutions. The concerns that Sarkozy expressed are not trivial. The ECB's policies cannot support his stated intentions while supporting German needs. If Sarkozy has to choose between his presidency and the European Union -- which is not the case yet but is not an absurd possibility -- which will he choose? That has always been the underlying weakness of the union. It was designed to work superbly when interests are in harmony. It has few mechanisms for satisfying dramatically divergent interests. And politicians, choosing between re-election and institutions that are less than a generation old, tend to go with self-interest.The founding idea of the European Union was that Europe must never again fight a general war. In order to avoid such a scenario, France and Germany must be so deeply linked economically that conflict becomes unthinkable. The entire idea of the union was rooted in the understanding that national sovereignty in Europe had resulted in catastrophe. But the European Union has not solved the problem of national sovereignty. It is still very much alive, expressed in a muted anger at the European system. It shows up on the margins of the political system, or in the rejection of constitutions, in which Europe seems to be saying, "This far and no further." But Sarkozy said something very important last week. He said the ECB is hurting France. The concept of national self-interest is a religious principle in France, but no significant nation will accept long-term damage to its economy if it doesn't have to. The ECB must harmonize its policies, but it is not clear how it can harmonize the diverging policies and interests of Germany and France. Observers can minimize this, calling it a tempest in a teapot. Indeed, this particular affair might well turn out to be just that. But in the long run, this is no minor affair. It is the conceptual and practical weakness of the idea of Europe, of combining sovereign nations with multinational institutions and figuring they will work themselves out at some point. Europe will not have a Gettysburg. No one is passionately committed to Europe enough to wage war on behalf of the ECB. And without that passionate commitment, there is nothing to hold Europe together when the costs begin to outweigh the benefits. The European bet is that the loss of commitment will never happen, or at least not for a very long time. Sarkozy is a serious man and should not be dismissed. The logic of what he is saying leads somewhere -- if not to a Gettysburg then clearly toward a crisis that cuts to the heart and future of the European Union.
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