Sinatra's 'My Way' for France and Italy

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On a cold Saturday night in November 2005, the German Army was paying in the Hanover city hall gardens its highest tribute to the retiring Chancellor Gerhard Schroeder. As the army band struck up "My Way" the proud and tearful chancellor, who reformed and rejuvenated an exhausted German economy in his Agenda 2010, wanted to tell the nation that he had no regrets for having done it his way.

Ol' Blue Eyes' (aka Frank Sinatra) incomparable rendition of his signature song could probably also stiffen the spines and concentrate the minds of French and Italian leaders.

And, who knows, the stiffer spines may lead them to abandon the humiliating habit they have developed since the onset of the financial crisis of having to ask Germany for permission to govern in accordance with the mandate they got from their own people.

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Some reflection may also make them realize that they just have to copy Germany. After all, Chancellor Merkel is a consummate and highly successful practitioner of what in another political context became known as Sinatra's "My Way" doctrine.

Trader shorts Germany, France; Buys euro
Trader shorts Germany, France; Buys euro   


Here is what an exasperated Jean-Claude Juncker, Luxembourg's former prime minister, EU Commission's next president and a long-serving president of the Eurogroup (a forum of euro area finance ministers) had to say about Chancellor Merkel's style of governing in an interview he gave to the French newspaper Le Monde on July 29, 2012: "How can Germany have the luxury of playing its domestic politics on the back of the euro? Is the euro area just a German branch office?"

"All politics is local"

Chancellor Merkel's message has been simple all along: "It's every man for himself." She ran her re-election campaign at the time of that interview on a firm promise that German taxpayers' money would not be used to rescue irresponsible and incompetent euro area partners.

And the political payoff for keeping German money away from euro area's fiscal miscreants was handsome indeed: Chancellor Merkel won a historic third term in office in September 2013 and an affectionate "Mutti" (Mamma) sobriquet from a grateful nation.

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Her warning to the crisis-ridden euro area partners is still the same: Raise taxes, cut public spending and keep pushing structural reforms. Never mind that all that has to be done under conditions of rising unemployment and sinking aggregate demand. Just do it.

As a result of all that, the euro area is again on the verge of recession. Italy was back in a recession in the second quarter and France continued to stagnate. Predictably, that did not leave Germany unscathed either: Its economy declined during the spring quarter at an annualized rate of 0.6 percent. And more bad news is on the way: Rising unemployment, sharply declining business confidence and flagging manufacturing exports could easily create a huge embarrassment for the euro area's economics lecturer.

What can France and Italy do to pull themselves out of their politically flammable downturn?

Little room for "growth-oriented" fiscal easing

To begin with, they could follow the hint of "growth-oriented fiscal policies" Mr. Mario Draghi, President of the European Central Bank (ECB), discreetly slipped into his speech at the U.S. Federal Reserve symposium in Jackson Hole, Wyoming, on August 22, 2014.

That general formula implies a preference for targeted tax cuts offset by lower public spending. Paris and Rome have been trying to do some of that already. But with the ECB's encouragement, they might now feel more secure to go further and more decisively in that direction. They also know that regulatory changes to enhance market efficiency are part of that mix.

Euro zone inflation is no 'game-changer': Pro
Euro zone inflation is no 'game-changer': Pro   

Political hackles raised in France about these "social liberal" economic policies (which in France means conservative – i.e., right-wing – economic policies) are a sure sign that the newly reshuffled French government may be on to something.

Whatever that might be, it won't be easy: Only a day after the new French government took office last Tuesday (August 26), an opinion poll showed that 75 percent of respondents did not trust the new cabinet.

By contrast, Italy's more popular government may be better positioned to see through a package of growth-supporting fiscal and regulatory measures.

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The question is: How much room do France and Italy have for such policies?

Italy may have a bit more space to work with. Its budget deficit of about 3 percent of gross domestic product (GDP) is close to balance on a cyclically-adjusted basis. Italy is also running a surplus of 4.5 percent of GDP on a budget before interest charges on public debt.

The big problem is Italy's huge public debt of 145 percent of GDP. That means that any fiscal stimulation would have to be roughly deficit neutral; tax cuts, for example, would have to be financed through lower spending and/or public asset sales. These measures would also have to be part of a credible fiscal consolidation program. Otherwise, there would be a danger of rising bond yields, which could blow up the whole exercise.

Euro performance all 'about the ECB': Pro
Euro performance all 'about the ECB': Pro   

France is having a problem of an unpopular government and serious deficit slippages. After a budget deficit of 4.3 percent of GDP last year, a similar deficit is expected this year, with no chance at all of bringing the deficit down to a promised 3 percent of GDP in 2015.

There is a big credibility problem here. And, unlike Italy, France is running cyclically-adjusted budget deficits of nearly 3 percent of GDP, with a primary budget deficit (excluding interest payments on public debt) of 1 percent of GDP. Also, France's public debt of 113 percent of GDP has risen sharply over the last three years.

Investment thoughts

France and Italy face tough political decisions. Tax cuts and reforms needed to support their economic growth will require deep and sustained declines in public spending and rising revenues from public asset sales. Nothing else will do.

Some help may come from public investment programs at the EU level (presumably a fund of about €300 billion), but the timing and the effectiveness of that spending is open to question.

The ECB has virtually exhausted its stimulus measures. It could still help "growth-oriented fiscal policies" by providing some backstop, within its mandate, to public funding programs. But Germany will make sure that the interpretation of the mandate remains as narrow as possible. Otherwise, Berlin will sue again.

France and Italy have to do something, though. And Germany has a novel idea. Commenting on the difficult French situation, Chancellor Merkel said last week on a German TV show that economic growth does not require money; it just needs intelligent policies. That got her a furious ad hominem attack from a French parliamentarian.

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Maybe Paris and Rome need alchemists and "my way" doers. Sounds impossible? Miracles do happen. "My Way" is a French song "Comme d'habitude," translated and brought to Sinatra's attention by a Canadian composer and singer Paul Anka.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

Follow the author on Twitter @msiglobal9