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Euro Split On The Cards

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July 24 (Bloomberg) -- Interest rates are ``far too high, and there is room to cut them significantly,'' the French president said.

Nicolas Sarkozy in 2007? No, Jacques Chirac in 1996.

The central banker in the presidential sights then was Jean-Claude Trichet, who rebuffed the interest-rate plea and refused to let the French franc weaken. Now head of the European Central Bank, Trichet, 64, is up against another French leader, Sarkozy, determined to assert political control over monetary policy.

This time the fate of Europe's economy, not only France's, hangs in the balance. ``The stakes of the game have been raised,'' said Holger Schmieding, chief European economist at Bank of America Corp. in London. ``It has the added complication that Sarkozy can claim a popular mandate because he has just been elected.''

As the ECB prepares the ground for the ninth interest-rate increase since late 2005, it confronts a French president at the height of his powers and popularity. Two months into his term, Sarkozy is using divide-and-conquer tactics to sideline the Socialist opposition at home and pouring on the charm to make France's points abroad.

Sarkozy, 52, already rolled over European finance ministers, disarming their criticism of France's planned budget- deficit overruns when he became the first head of state to intrude on one of their meetings, on July 9 in Brussels.

The Euro's Gain

The euro's appreciation since the French presidential campaign strengthens Sarkozy's hand, potentially pressuring the ECB to delay the next increase in lending rates to prevent an even higher euro from sapping European exports.

The 13-nation currency rose to a record $1.3845 on July 23, up from $1.3366 on April 2 when candidate Sarkozy demanded a ``real conversation'' with the ECB over the handling of the economy and the euro.

So far, the economy has weathered the upward drift of the currency, with the European Commission forecasting growth of 2.6 percent in 2007, topping the U.S. for the first time since 2001.

Trichet thus faces a more formidable opponent than the Chirac of 1996, who made the interest-rate plea against the backdrop of sliding popularity that would cost his party control of the government in elections a year later.

As a Frenchman, Trichet has to be tougher on governments than central bankers from Germany or the Netherlands where central-bank independence is firmly anchored, said Paul de Grauwe, a professor at the Catholic University of Leuven in Belgium.

`More Catholic'

Trichet has to be ``more Catholic than the pope,'' said De Grauwe, who was twice the Belgian government's nominee for the ECB's Executive Board. This ``forces him to be very outspoken.''

Central-bank independence came late to France, in 1994, almost four decades after Germany's Bundesbank was freed from political constraints and given the mission of fighting inflation. And the French were reluctant converts, accepting the notion of an apolitical central bank as Germany's price for moving toward a common European currency.

As French central-bank chief during the transition to independence, Trichet went through a sort of basic training in how to fend off politicians, running a domestic gauntlet that the ECB's first president, Wim Duisenberg of the Netherlands, didn't have to face.

Nemesis Sarkozy

One of Trichet's political nemeses at the time was Sarkozy, who was budget minister from 1993 to 1995 as France struggled to emerge from the recession of the early 1990s. As the 1995 budget was in preparation, Trichet warned that ``new efforts on both spending and revenues are probably required'' to meet the government's deficit-reduction target.

Trichet turned out to be right. What Sarkozy planned as a deficit of 3.6 percent of gross domestic product for 1995 ended up at 5.5 percent, well above the 3 percent limit for countries striving to adopt the euro, then still on the drawing board.

France's establishment quickly learned the politically correct way of treating the central bank, with Chirac saying in his 1996 Bastille Day interview that ``I don't want to intrude on the business of the Bank of France, which, as you know, is independent.''

While railing against the euro's appreciation and calling for more ``dialogue'' between the ECB and governments on interest rates, Sarkozy and his aides make the same disclaimer.

No `Attack'

Such a dialogue ``in no way represents an attack on the independence of the European Central Bank,'' Jean-Pierre Jouyet, France's European affairs minister, told the European Policy Centre in Brussels on July 17.

The call for a check on the ECB is an old French demand. Intent on building a ``counterweight,'' France in the late 1990s pressed for a new panel of finance ministers to steer the economy. Under German pressure, the panel was given no formal powers; Trichet sits in on every meeting.

Chairmen of the panel have periodically locked horns with the ECB, as when Belgium's Didier Reynders hounded it over interest rates in 2001. Last year, the current chairman, Luxembourg Prime and Finance Minister Jean-Claude Juncker, called for more regular meetings with Trichet, to no avail.

``It's hard really to see what more meetings will achieve,'' said Julian Callow, chief European economist at Barclays Capital in London. ``If Sarkozy thinks more dialogue means Trichet will roll over, he's going to be disappointed.''

To contact the reporter on this story: James G. Neuger in Brussels at jneuger@bloomberg.net

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The Euro has enjoyed stability during a period of low interest rates but it is only a matter of time before it breaks up.

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The Euro has enjoyed stability during a period of low interest rates but it is only a matter of time before it breaks up.

What would interest rates be like in Spain and Ireland if that happened ?

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It seems that the Euro is just no replacement for the dollar as a de facto.

The dollar is all we have for the time being and that means the thesis of James Turk and John Rubino remains the most likely to my mind. The other countries will be forced (to continue) this policy of propping up the dollar by debasing their own. The so called death spiral in The Coming Collapse of the Dollar, by the same two folk I mentioned.

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