New French president insists on more inflation in European Union


By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, July 10, 2007

French President Nicolas Sarkozy threw down the gauntlet in Brussels last night, vowing to press ahead with his plans for a "fiscal shock" regardless of European Union rules on budget policy.

Softening his tone slightly after a blizzard of criticism, he told eurozone finance ministers that his government would "aim" for a balanced budget by 2010, but refused to give real ground.

Mr Sarkozy's E11 billion (L7.4 billion) fiscal blitz will widen France's budget deficit from 1.7 percent to 2.4 percent of GDP -- or nearer 3 percent, say private economists -- and spells the end of any serious attempt to abide by the terms of the revamped Stability and Growth Pact. Few were convinced by Mr Sarkozy's assurance that he "believed in the pact."

Holland's finance minister Wouter Bos captured the mood of irritation: "France should stick to the same agreements that all the other countries agreed to stick to."

As a general principle, EU governments are obliged by treaty law to bring their budgets into balance during fat years to create a fiscal cushion for downturns.

France is now launching a "dash for growth" at the top of the cycle, threatening to push up inflation for the whole eurozone bloc and tempt others to follow suit.

Mr Sarkozy's gambit risks a dangerous clash with German Chancellor Angela Merkel, who has cut Berlin's budget deficit to 0.6 percent of GDP after a long stint of belt-tightening. Germany's debt burden is now falling fast.

Although Mr Sarkozy swept into Brussels with an air of Napoleonic confidence yesterday, his position is desperately weak. The global bond "vigilantes" are the ultimate enforcers of budget discipline in the eurozone -- even if slow to act at first -- and they are growing restless.

Goldman Sachs has advised investors to shun French bonds, warning that France would soon have to pay a higher premium to offset "strains on underlying sovereign credit-worthiness."

It predicted the interest rate "spread" between German and French 10-year bonds would widen from four basis points to nearer 10 -- the first time since the launch of the euro that the markets have begun to separate the destinies of Europe's two dominant economies.

While this would not in itself have much economic significance, the symbolism could be very powerful. EU veterans have long feared that this how the eurozone could start to unravel.

France has slipped down the rankings to become the sick man of Europe, with a growth rate of 1.8 percent since 1991 compared with 2.8 percent for OECD peers. It's share of eurozone exports has fallen 18 percent since the launch of the euro, leading to an unprecedented trade deficit of E29.2 billion in 2006.

Germany has reclaimed her place as the world's biggest exporter. By holding down wages through a relentless squeeze, German has gained 22 percent in cost competitiveness against France since the launch of EMU.

Mr Sarkozy's strategy is to use his spending blitz as a "sweetener" to ease through root-and-branch structural reforms, but most free-market economists doubt if there is any real "Thatcherite" content to his plan. One proposal is to index wages to inflation, a 1970s measure abandoned long ago by the Left. His trade policy is "Community Preference," a euphemism for a closed tariff bloc. The "fiscal shock" is mostly a hodge-podge of measures that boost demand -- by making mortgages tax-deductable, for example. But France's root problem is the bloated state, which still consumes 54 percent of GDP. Mr Sarkozy backed away from any serious attempt to cut the number of public officials during the electoral campaign earlier this year, deeming it too sensitive.

France's slipping competitiveness is the reason why he repeats calls for activist measures to force down the value of the euro, a move that would effectively strip the European Central Bank of its independence. This too risks a bitter dispute with Germany.

Der Spiegel magazine reports that Berlin has warned Mr Sarkozy in recent days that "should he seriously attack the ECB's independence or the aim of price stability, then he had better brace for strong German resistance".

Mr Sarkozy deflected the issue yesterday, joking he and ECB chief Jean-Claude Trichet were not "exactly on the same wavelength."

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