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Would 'Frexit' mean economic disaster?

Two of France's presidential election candidates want the country to abandon the euro currency. But some economists say 'Frexit' could lead to economic disaster because France is heavily indebted in euros.

For some candidates in this year's presidential election in France, the euro is to blame for major problems plaguing country - for high unemployment and slow economic growth. They propose a withdrawal from the single currency. But what would happen to import-dependent and heavily indebted France if they really did withdraw? Let's conduct a thought experiment.

Front National leader Marine le Pen is particularly vociferous in proposing France's exit from the euro. She proposes a referendum on it. At the moment, she's ranked first in pre-election polls - with about 26 percent support, according to a survey by "The Economist" from early this week.

But France has a 'run-off' election system: Unless someone wins over 50 percent of the vote in the first round, there's a second-round vote in which voters choose between the top two candidates from the first round. She's widely expected to lose the second round, regardless of whom she faces as her opponent.

On the other side of the political spectrum, Jean-Luc Mélenchon, candidate of the Left party, hews to a slightly softer euroskeptic line. He's in favor of a renegotiation of the EU treaties and, if that does not get results, he would back France's withdrawal from the euro.

Marine le Pen, Lyon, Feb. 5, 2017 (Reuters/R. Prata)

Marine le Pen launched her renewed Presidential candidacy in Lyon, France, with verbal attacks against the European Union

The other three most important candidates all favor France staying within the euro currency union. They are Benoît Hamon, who became the new leader of the moderate-left Socialist Party just a few weeks ago, at the end of January; François Fillon, leader of the conservative Republican Party, who has landed in hot water on accusations that he had previously employed close relatives in government jobs they did not actually carry out; and Emmanuel Macron, a former investment banker and senior civil servant, who was Minister of Economy, Industry and Digital Affairs from 2014 to 2016. In April 2016, Macron founded a new 'social liberal' political organisation called 'En Marche' with which to contest the presidential election. He lately has been wooing French expats in Britain to return to France post-Brexit.

Outside the euro, France would become more competitive

For Le Pen, the main argument for a euro exit is national sovereignty. But economic arguments are important too. If France were to return to using the Franc, and therefore able to devalue its own currency, French products would become automatically more competitive, because they'd be cheaper for foreign customers paying with other currencies, she argues. Lower wages would then no longer be the only variable that could be adjusted in order to compete on international markets.

And without the Brussels 'diktat' on state deficit limits, the state would also have more room to help French industry through subsidies. Traditionally, French governments have used subsidies to maintain strategic sectors, such as shipbuilding.

Infografik G20 - Nominal GDP per capita in US dollars, 2015 figures

Comparative nominal GDP per capita of G20 nations in US dollars, 2015 figures. France lags Germany, but not by much

It is to be expected that French exports would in fact become cheaper on global markets if France were to abandon the euro, according to Anne-Laure Delatte, deputy director of CEPII, a French research institute on the global economy.

"When the euro was introduced, 6.50 francs were worth one euro. Today, we would have to pay at least eight francs per euro," the economist told DW. "This means that foreigners would have to spend less of their currency to buy goods priced in francs."

Disadvantages especially for low-income people

The problem is that a weak French currency would also mean imports would become more expensive. Last year, France imported 48.1 billion euros more in goods and services than it exported. The country imports many basic foodstuffs, and also oil, gas and clothing. All that would get more expensive.

"If the French currency were to be devalued, the poorer sections of the population and small and medium-sized enterprises would be hit hardest - and those are, ironically, the very people the Euroskeptic candidates are appealing to," Olivier Pastré, an economics professor at the University of Paris VIII, told DW. That's because low-income earners spend a relatively high share of their income on imported goods, such as basic foodstuffs.

Another effect of the euro exit, according to Pastré, would be higher interest rates. Poorer population strata are particularly dependent on loans - since they own few assets - and they would have to pay more for them.

Rennes Citroen factory (picture-alliance/dpa/P. Renault)

France's Citroen builds the e-Mehari, a small electric car, at a factory in Rennes. Would its car industry benefit from Frexit? Hard to say - automotive supply chains are heavily integrated across European borders

Higher interest rates, more inflation

Interest rates would rise because, even after France had re-adopted the French franc, the government would still have to make payments on its huge sovereign debts in the currency in which it borrowed - i.e. the euro.

A repayment of sovereign debts denominated in euros was a condition recently set by the head of the European Central Bank, Mario Draghi, if a country wanted to withdraw from the currency union - a possibility which may grow acute for Spain or Italy in the next few years. France's debt now amounts to more than 2000 billion euros, which is almost as much as the annual economic output (Gross Domestic Product) of the country.

In order to be able service its debts, the state would then have to exchange francs against the euro on a very large scale. The state would borrow most of those francs from the population - from people with savings. The strong demand for borrowing francs would drive the price of borrowing - i.e. the interest rate - upward.

Alternatively, the state could simply print money - after all, it would have its own currency. But that would also hit low-income French citizens hardest, because it would tend to drive consumer price inflation - since after all, the larger amount of money in circulation would not automatically be offset by an equal increase in the volume of French-produced goods and services.

Emmanuel Macron at a campaign rally (picture alliance/abaca/B. Eliot)

Emmanuel Macron at a campaign rally, Palais des Sports, Lyon, February 4, 2017. Macron is pro-European Union and anti-Frexit

"A French exit from the euro would lead to economic disaster"

However, according to Philippe Crevel, macroeconomist and head of the research group Cercle de l’Epargne, these wouldn't be the only negative consequences of Frexit. He thinks the departure of France from the currency union would immediately lead to a major economic downturn - and that the European Union, as an institution, could not survive without its second-largest economic power.

"France would go bankrupt, because we simply would not be able to repay our debts in euros. Nobody would want to trade euros for our Francs - nobody wants Francs!," he said.  And it would not only be the state that would go bankrupt - so would many banks and insurance companies, whose debts are largely in euros and dollars, both of which would be foreign currencies.

"BNP Paribas is the second-largest bank in Europe after HSBC. It if collapses, it would be ten times worse than the collapse of Lehman Brothers, which in 2008 contributed to the outbreak of the global economic crisis," warns Crevel. Compared to Germany, France's banks are much more vulnerable - because the French economy is highly centralized. The French banking world is also very centralized - unlike in Germany, where there are several regional central banks that are independent of each other.

In addition, the economist said, Frexit would lead to the bankruptcy of major insurance companies, such as Axa: "It would be a systemic shock and would lead to complete anarchy in Europe's financial world. Nothing would be like it was before."

 

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