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What happens if France leaves the EU

The German stock market closed today at its lowest level of the year. That may sound surprising, given that that the European economy is showing clear signs of improvement. ECB Chief Mario Draghi said the European recovery was "resilient." The Eurozone PMI rose to its highest level in 69 months.

Yet there it was: The German DAX down 1.2% to a new low for the year, with the rest of Europe down as well.

What gives? It's obvious that political fears are trumping economic optimism.

Why? Because the trading community knows they were wrong on Brexit, they know they were wrong on Donald Trump winning the White House.

Now they are beginning to realize that they could be wrong on the direction of European politics, and they are trying not to get surprised again.

No one is laughing anymore at the populist candidates who have been making provocative statements for years.

No one is laughing anymore when Marine Le Pen, the leader of France's populist National Front party and one of the front-runners in the upcoming French election, says she will pull France out of the eurozone.

If they leave, what does it do to the eurozone experiment? That is a clear negative for bond prices. Right now, sovereign debt is priced with an implicit backstop from the ECB. But under Le Pen's plan, the French government would be the sole backstop, with a bunch of Socialists in charge! How would you price the credit spread? I bet you'd cut the price of French bonds.

President of French far-right Front National (FN) party Marine Le Pen delivers a speech during a major rally to launch her presidential programme on February 5, 2017 in Lyon, France. Marine Le Pen is candidate for the Presidential elections in France this year.
Chesnot | Getty Images
President of French far-right Front National (FN) party Marine Le Pen delivers a speech during a major rally to launch her presidential programme on February 5, 2017 in Lyon, France. Marine Le Pen is candidate for the Presidential elections in France this year.

It gets even weirder: Le Pen would issue a new currency (she would presumably replace the euro with a new franc) and eventually devalue the new currency, a move that would boost exports and help the French economy, Le Pen's advisor Bernard Monot told Bloomberg in a recent interview.

Here's where it gets tricky: Government debt would be redenominated in the new French currency. The government, presumably, would continue to meet all its obligations, though with a new currency. Le Pen will then print money to reduce France's debt load.

If all of this sounds a bit, well, worrisome, particularly if you are a French bond holder, you're not alone. French 10-year bond yields hit an 18-month high today.

And remember, Italy is right behind them. They want the lira back. And the Germans? The old Deutsche Mark would be brought back, which would go through the roof.

This would be the final insult to whole grand European experiment with the euro: after a decade of relative stagnation, that a slowly improving economy should be derailed by the very centrifugal forces (populism, nationalism) that the euro and the European Union were designed to contain.