16/12/2011: France’s latent power over the future of a common currency

The concept of any euro only makes sense if France participates. Thus, even in the unlikely scenario of a euro split and adapted to the economic strength of user countries, France plays a crucial role.
Every new European summit failing its chance to save the euro and finally resolve the European sovereign debt crisis raises the prospects of a possible breakup of the common currency. Don’t get me wrong: This is not our base case. We still assign only negligible probability to such a scenario. Nevertheless, we do consider that the consequences of such an event would be disastrous, so the risk, defined as likelihood times expected loss, is quite significant.
Numerous scenarios are currently discussed in the press about how such a breakup could proceed. They range from one or several countries exiting the euro to a full disentanglement of the common currency into seventeen new national ones. Often discussed is the split of the euro in two parts: a northern euro or “neuro,” and a southern euro or “seuro.” The neuro would take in all the strong countries of the Eurozone, and the seuro all the weak ones.
We see this among the least likely of scenarios. Why? Because the concept of any euro only makes sense with the participation of France. A neuro without France, including only Germany, the Netherlands, Austria and maybe Finland, would not differ at all from the good old Deutschmark. Before 1999, both the Netherlands and Austria were de facto pegged to the Deutschmark. Implicitly Switzerland also had such a peg, and Yugoslavia quite explicitly before it dissolved in the early 1990s. Therefore, the participation of France is crucial to make it something truly different.
A seuro with Spain, Italy, maybe Portugal and Greece, but without France, doesn’t make any sense either. Why would Spain and Italy want to share a common currency? The exports of Italy to Spain represent 6% of all Italian exports; Italy exports twice as much to both Germany and France. In comparison, Spain’s exports to Italy represent 9% of all Spanish exports, while those to Germany are 11% and to France a whopping 19%. Hence, again, only a participation of France in a seuro would grant lasting credibility to this new common currency.France is on the verge of losing its AAA rating. Top French politicians including President Nicolas Sarkozy, alluded to this recently. Once this has occurred, as we’ve discussed here previously, Mr. Sarkozy’s strategy to follow Germany on its gloomy austerity path may seriously jeopardize his chances for reelection next year. He will need to exert pressure on his German partners to ease their rigid stance, either by allowing Eurobonds or a greater involvement of the European Central Bank to mitigate the current contagion. In this respect, France has far more negotiation leverage than it realizes or has recently exercised. Because wherever France shall go, the euro will also follow.