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French Finance Minister Christine Lagarde 'We Europeans Are All Being Put to the Test'

In a SPIEGEL interview, French Finance Minister Christine Lagarde, 55, discusses Germany's plans for reforming the euro zone, whether the euro rescue fund should be allowed to buy bonds and what a new global monetary order involving China could look like.

SPIEGEL: Madame Lagarde, at the recent EU summit, there was a heated debate  over a "pact for competitiveness," which is intended to harmonize the economic policies of different European countries. The strategy was developed at the Chancellery in Berlin. Are the plans the beginning of a "German" Europe?

Christine Lagarde: Fortunately, the days of dictates and hegemonies in Europe are over. I'm pleased that German Chancellor Angela Merkel and French President Nicolas Sarkozy have jointly reached the conclusion that in order to keep the euro, we will have to go a step further than tightening the Stability and Growth Pact. We must coordinate our economic policies more effectively. We have no other choice.

SPIEGEL: France has repeatedly raised the issue of a European economic government, intended as a political counterweight to the European Central Bank (ECB). Will a French idea now be implemented with German content?

Lagarde: Let's put it this way: Angela Merkel is lending new clout to Nicolas Sarkozy's idea. The point is to close the gap between competitive member states like Germany and those that are less competitive, such as Greece. It's not about everyone becoming like Germany or France. What we expect is that everyone should seriously ask themselves what they can learn from the best in Europe. For example, German industry is certainly the most competitive in the euro zone at the moment. We should use it as a yardstick for our own efforts.

SPIEGEL: What can Germany learn from the others in return?

Lagarde: From France, it can learn a few things about how to better integrate women into professional life, and how to combine family and career more effectively. Your family minister, Kristina Schröder, has already discussed the issue with me. That's the way the competitiveness pact is supposed to work.

SPIEGEL: Nevertheless, we have the impression that the core of the intended pact is very German: balanced budget acts modeled after Germany's "debt brake," a retirement age of 67, wage restraint. It all sounds like austerity measures imposed by Berlin.

Lagarde: The pact combines German virtues with a proper dose of realism. The issue of the retirement age is a good example. No one is aiming for a situation where every European would in the future only be able to retire at the age of 67. Chancellor Merkel also knows that the retirement age in each country has to be brought into line with demographic developments in that country. But one basic rule applies to all countries, namely that if people are living longer, the pension system has to be adjusted. We have to work longer because we are living longer. It's simple mathematics.

SPIEGEL: Under the pact, wages would also no longer rise automatically with inflation, as is customary in Spain and Belgium, for example. These countries sense an attack on their social systems.

Lagarde: Of course we have to be careful that we don't antagonize people too much. But if tying wages to inflation results in certain countries being less competitive, they should ask themselves: Is this wage policy really the best approach? The French government, like the German government, believes that wages should not rise in lockstep with inflation.

SPIEGEL: The pact is supposed to be implemented within a year. That's quite ambitious, given the snail's pace at which the EU usually makes decisions.

Lagarde: We want to pick up the pace a bit.

SPIEGEL: The head of the Euro Group, Luxembourg Prime Minister Jean-Claude Juncker, has warned against massive social cutbacks within the euro zone. The Irish are up in arms about the notion of a uniform rate of corporate tax. How do you intend to bring all the opponents into line?

Lagarde: It's a question of the basic principle of give and take. The right to receive assistance from the community in a time of need is justified. But so is the right to expect the recipients of this assistance to improve their situation. Solidarity is not a one-way street. This has nothing to do with social cutbacks.

SPIEGEL: The goal of the competitiveness pact is to curb economic imbalances in the euro zone. This also applies to the German trade surplus, which many see as one of the key causes of the euro crisis. You yourself sharply criticized the German trade surplus a year ago, but then you changed your mind.

Lagarde: And I can tell you why. What has really changed fundamentally in the last few months is the source of German growth. Unlike the way it was a few months ago, growth in your country is no longer being driven solely by exports, but also by domestic demand. This is a development that I, like all Europeans, very much welcome. Germany retains its competitiveness and is still a major exporter. But it has also found another source of growth: consumption and investment.

SPIEGEL: Nevertheless, your old opinion has found a new advocate. Marco Buti, the director-general for economic and financial affairs at the European Commission, wants to see a cap on trade surpluses included in a competitiveness pact.

Lagarde: It isn't possible to simply tell a competitive country to stop being competitive. Nevertheless, it is a good thing for the countries with surpluses to be putting their economic models to the test. If the domestic economy in Germany heats up, it's good for Germany and for all of Europe.

SPIEGEL: A reform of the European euro rescue fund, the European Financial Stability Facility (EFSF), is also in the works. Until now, only about half of the available €440 billion ($595 billion) could be distributed, because the fund can only keep its top rating if it maintains large cash reserves.

Lagarde: That is a problem indeed. We want to organize the bailout fund in such a way that it can actually distribute the €440 billion in aid. Therefore we need to say what is necessary to achieve this.

SPIEGEL: But additional guarantees are needed for that purpose. Is this just a job for the six euro-zone countries with the highest credit ratings, including Germany and France?

Lagarde: No, not at all. The stability of the euro affects all 17 euro-zone member states, which means that everyone has to contribute to it and provide additional funds.

SPIEGEL: You have to admit that you want to distribute the burden onto as many shoulders as possible, because you're afraid that your country will soon no longer belong to the exclusive club with the highest credit ratings. How much longer will France keep its AAA rating?

Lagarde: You're completely on the wrong track there. As long as I occupy this office, France will not give up this status. We are also doing a lot to keep it that way. We are sorting out our finances and reducing our new debt. We are pursuing tough reform policies that will increase our growth.

'Europe's Financial Institutions Urgently Need More Capital'

SPIEGEL: There is also the idea that the bailout fund could buy up government bonds itself in the future.

Lagarde: First of all, the EFSF is powerful and is operating successfully. The first issue of its bonds was over-subscribed and exceeded all of our expectations. However, the EFSF has to become more flexible and be able to react quickly in an emergency. There are many roads to more flexibility. For example, we are now discussing whether the bailout fund should be allowed to buy up government bonds or whether it should provide funds to a highly indebted country so that it can buy back its own bonds at a discount. It isn't clear yet which approach is best.

SPIEGEL: Many economists believe that certain countries will need a debt restructuring with the involvement of private lenders, a so-called haircut.

Lagarde: I don't like the word. I prefer to talk in concrete terms. In the case of Greece, we are talking about extending the terms of Greek bonds. This amounts to the involvement of private investors. The same applies if the bailout fund takes bonds off the market at market prices or provides the Greek government with funds to buy back its own bonds. All of the alternatives amount to creditors waiving portions of their claims.

SPIEGEL: These are all ideas for the time up until 2013, when the EFSF is scheduled to close down. What happens after that, if Greece's debt still amounts to 150 percent of the country's gross domestic product? Will the markets ever have confidence in Athens' efforts?

Lagarde: That will depend on whether Greece, as well as Ireland, live up to the commitments they have made to us, the ECB and the IMF. The credibility of these countries depends heavily on whether they keep their word. So far, it's looking good.

SPIEGEL: If private investors also have to suffer, this could lead to more bank failures. Many banks could hardly cope with write-offs of their claims against Greece or Ireland.

Lagarde: This shows that Europe's financial institutions urgently need more capital so that they can withstand such failures. We are on the right track with the new regulations contained in the Basel III accord, which force banks to back risky business activities with more capital.

SPIEGEL: The new stress tests for the banks are about to begin. Will they be more meaningful than those that were carried out last year, which were criticized at the time for not being rigorous enough?

Lagarde: They were indeed not credible. Some member states did not stick to the shared assumptions that we wanted to test. There was no European regulatory authority that could have made sure that the procedures were applied with the same degree of rigor by all national regulatory agencies. This isn't the right approach. We have to realize that not just the banks, but we Europeans are all being put to the test.

SPIEGEL: Euro Group Chairman Juncker proposes euro bonds as an instrument to combat the crisis. How do you feel about this?

Lagarde: Slow down! We shouldn't put the cart before the horse. In my opinion, the four important priorities at the moment are stability, growth, competitiveness and harmonization. Those who don't observe these priorities face the threat of sanctions. If we make progress in this regard, we can talk about euro bonds as a next step.

SPIEGEL: In other words, euro bonds would be a kind of culmination of European economic integration?

Lagarde: Yes, if you want to put it like that. It would then be safeguarded that no country could dilute the joint bond through its own weaknesses. If you put together the six euro-zone members with AAA ratings and those with poor ratings today, the weaker countries would benefit from it while the stronger ones would be at a disadvantage. That's not the cocktail I want. I want a really well mixed drink.

SPIEGEL: Does that mean we'll only have euro bonds once all countries receive the highest ratings from the rating agencies?

Lagarde: What's important is that we all pursue the right policies, policies that ensure that budget deficits, debt levels and competitiveness develop in the same direction. If that succeeds, we can also talk about euro bonds.

SPIEGEL: The G-20 nations are also addressing currency issues. President Sarkozy has declared the reform of the global monetary system to be one of the main objectives of the French G-20 presidency in 2011.

Lagarde: The G-20 is the only forum in which it makes sense to discuss these issues, because it's the only framework where China and the other large emerging economies are also sitting at the table. If you look at the amount of capital currently flowing to Brazil, South Korea and Mexico, you don't need a lot of imagination to picture the shocks that this triggers in the economic systems of these countries. If we want to protect trade and the emerging economies, we need a system that monitors capital movements more effectively.

SPIEGEL: Couldn't this be achieved with target zones for exchange rates?

Lagarde: Every idea is welcome, including target zones for exchange rates, particularly as stability is threatened from another side. The central banks' reserves still consist primarily of dollars. It is very clear that this situation will change, because the euro is playing a bigger role, as is the Chinese renminbi. We have to organize this transition. This is in the interest of the United States and China, which has a large volume of dollar reserves and certainly doesn't want these reserves to suddenly lose their value. If this approach produces a Chinese currency that is internationally convertible, all the better.

SPIEGEL: That sounds like a new global monetary order, like the one that was agreed to in Bretton Woods in 1944.

Lagarde: I am always cautious about overly ambitious goals. But if we do manage to develop such a system, and it's referred to as Bretton Woods II in the future, that's okay with me.

SPIEGEL: Madame Lagarde, thank you for this interview.

Interview conducted by Christian Reiermann and Peter Müller
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