Q+A with Christine Lagarde, French Finance Minister

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Question: Are you looking forward to visiting Iqaluit?

Answer: Yes, absolutely… with trepidation!

President Chirac was totally infatuated with the Inuit - he knew the Inuit civilization inside out, and he collected the art. So I am very much looking forward to seeing it, because I heard him talk about it.

Q: There seems to be an agreement in G7 countries that there needs to be more robust bank regulation, but a divergence in views over what kind of regulation is best. Jim Flaherty, Canada's finance minister, will be using the Iqaluit summit to push for stronger capital reserves. President Barack Obama is proposing a system where commercial and investment banking are kept separate and proprietary trading by banks is outlawed. Do you endorse any of those approaches?

A: My big concern is with a level playing field.

Stability and security are the overarching principles that should inspire any work that we do, because we don't want a relapse of the collapse. And I'm sure we share that view - we need stability, we need security.

But obviously we're all starting from different angles, because we have our respective field regulations, systems of law, business models for banks, numbers of players, and so on and so forth. There is a great diversity, and I think we have to be careful with one-size-fits-all solutions, but at the same time we need to secure a level playing field.

So what I see right now is a lot of good intentions on everybody's part, with a serious concern about one's domestic market and how to best offer that stability and security and respond to public opinion.

And we all share the same view, I'm sure, and we're all people of good will, but we need to be very careful with this level playing-field issue. Because what works with one set of banks or one country does not necessarily work with another set of banks or another country.

And we have to be attentive to all angles, because the way we set, for instance, capital requirements can be skewed by differences in the accounting systems, for example.

We need to preserve a level playing field because it's an industry that's by all means mobile; money can move around in next to no time. And that's where it's going to be difficult and sensitive, because you stand where you sit, and you predict what's going to work for your market without having necessarily the same level of concern for others.

Q: Are there areas where French banks need to change their structure or their level of regulation or their reserves?

A: All banks need to have a sufficient level of capital and a sufficient level of liquidity to avoid what happened. I think that's happening now in the Basel II system and in the revisions to Basel II - it's OK from the French bankers' perspective. That was checked and validated by our central bank, which is the ultimate banking supervisor for France.

So at this point of time, under present rules, they don't need to recapitalize.

Q: So the Basel II standards are adequate for bank regulation?

A: At the moment, they are. The problem is, as you know, that hey are not applied across the board. For instance, the United States is not applying Basel II principles. And I think they're quite resistant, and I hope we can understand why and understand what their timetable is.

I'll tell you one thing I hope we can achieve in Canada during the G7 meeting. It is a better understanding of the process and methods. I'm not pointing fingers or blaming anybody, but proposals are coming up here and there, back and forth, now and again, repeatedly, and investors, taxpayers, are losing a sense of the direction, in my view. We as members of government are here to try to coordinate and bring better coordination about.

So that would be my goal number one: better coordination and agreement on the principles and methods and processes we adopt, if we want to restore stability and security and avoid the collapse happening again.

Q: Do you think that President Obama's banking reforms are applicable beyond the United States banking system?

I think directionally they are good. Because he is indicating that more regulation and better regulation is needed, and there are issues that need to be addressed, so that in and of itself is a good signal.

Some of his proposals just would not work for us. When he is suggesting, for instance, to dissociate between commercial banks and investment banks, for us it wouldn't make any sense. All our banks have a universal model, so to speak - they have a mixed model, being predominantly commercial and marginally investment banks, and it's a business model that has really helped them resist the crisis.

Point number two, in and of itself I'm not sure if that's the adequate response. Because if you look at what initially started the process, Lehmann was not a commercial bank, it was an investment bank, so you could argue that effectively it complied with the Glass-Steagall Act in a way - it didn't have access to liquidity; it was not a mixed model.

Q: But there has been a crisis in France attributable in part to proprietary trading.

A: But that crisis was essentially attributable to the lack of compliance and the failure of the control system, if you're referring to Société Générale. That's also what the Commission Bancaire, the supervisor, concluded: A clear breakdown in the system, failure to comply, and sanctions were imposed. But I would not put that particular failure in the same category as the Lehman collapse - it's different. It could have happened, notwithstanding, anyway.

Q: On the problem of currency imbalances, President Sarkozy suggested a reregulation of exchange rates, as occurred during the Bretton Woods period, and a revaluation of the Chinese currency - is there any consensus among ministers in how to confront this problem? And given that this has come up over the past decade over and over, is there any way to make this work?

A: The consensus we have is that we all want stability of the currency system, and we all want to avoid by any means volatility and particularly excessive volatility - you will find the same wording and the same jargon over and over in every communiqué of the G7 in the last 10 years - so there is no question that there is a historical consensus, because it has travelled through crises and ups and downs and the rest of it.

So we want that. Clearly we are not having it at the moment. And there is a changed relationship between the US dollar which used to be a very dominant currency, and the renminbi or yuan, which is clearly gaining strength and power, to the extent to which you believe that a currency reflects the strength of an economy…

So, given that, and the fact that the system has changed, we need to talk about it, and we need to address the issues. I am not suggesting that we have a consensus, and there may be some of my colleagues who are not particularly keen or concerned about it. But I think it's worth raising it, because if we don't, then we will continue to have a situation with volatility, with clear over- and under-valuation of one currency relative to where it should be according to IMF and other experts, and it doesn't hurt to think about it, frankly.

Q: President Sarkozy's other big idea was to return to a regime of managed exchange rates, as during the initial Bretton Woods period…

A: He said we need a second Bretton Woods. Which means, back at the time of Bretton Woods, there was an agreement, there was the setting up of international institutions, there were mechanisms in place, the IMF being one - we need to give it a second look, and decide whether it can sustain the current situation and the rise of china and the rebalancing we all hope for, and we need to put a new system in place.

Q: And how would such a system work?

A: With a bit of brain, first. No, seriously, it's not going to happen overnight, and I am sure there are chapters of books which have been rewritten and revisited on the issue, but we need to concentrate on what we want and what we're prepared to do, whether it's the SDR [a turn to the International Monetary Fund's Strategic Drawing Rights as an international reserve currency]or a special reserve or a rebalancing.

Q: Do you think there should be a move away from US dollars as the reserve currency?

A: It's happening anyway. Gradually, little by little, when you look at the reserves held by central banks around the world, there is very slightly a change. It's not a massive change, granted.

Q: Central bankers say the problem is that the Euro doesn't have any equivalent to the Treasury bill, and the SDR is insufficiently liquid.

A: That's a good point.

Q: So do you think there's a way forward, perhaps by pressuring China.

A: I don't honestly believe that pressuring anybody is going to give us any tangible, satisfactory result.

Q: So what happens then? This is a crisis we've been facing since the beginning of the last decade, and balance-of-payments imbalances were at the heart of the crisis.

A: I think that out of crisis, there are major difficulties and misery, but there are also opportunities, and now is the time, actually, post-crisis, after we mended the system so that it did not completely collapse, now is the time to give it a good thought, and a collective thought.

We have never been so much together - both at the G7 level and more importantly at the G20 level. Even though we don't talk currency at G20 - which is why I think G7 is not such a bad thing to have.

Q: So you think there is a consensus on the currency?

A: No, I don't think so, I think it's a question of trying to work on a consensus. On the one hand, the United States is saying 'our rescue plan is to export massively, and to restore employment' - well, if you want to export massively and restore employment, you need to manufacture at home, which means that you need to use the currency as your competitive advantage. So if the dollar is down relative to others, it's probably ok with respect to President Obama's economic policy. On the other hand, China is rebalancing its model a bit by better organizing its domestic market and trying to encourage consumption, yet it strongly relies on exports - and therefore there is no reason in the world why they should resume the movement they had started a little bit, up to a year ago, to revalue the yuan. That's why we need to talk about it - it's a big issue.

Q: Speaking of stimulating consumption , this is another area where consensus is being sought: When, and how much, to roll back the stimulus or begin paying back the fiscal debts for it. The United States has begun cutting, and some parties in Britain want to: Is there any hope of coordinating the withdrawal from stimulus?

A: We [in France]have a very simple policy, which rotates around three Rs: Recovery, Reform, and Restore public finance.

Recovery means we are going to continue spending, under the stimulus package that was voted last year, because we have organized it so that about 80 per cent of it was spent in 2009, and we still have 20 per cent to go. So we're not going to cut that 20 per cent. But we're not either looking at expanding the stimulus package or having another one. We believe that if we maintain the 20 per cent investment that is left under the stimulus package plus to not raise tax on consumers, this combination on one hand and stimulation of public/private investment should suffice.

On the reform front, we should just keep at it to make the French economy more flexible, more agile, more prone to picking up the wind of growth when it comes from the outside and there is demand addressed to the French economy.

And on restoring public finance, we just have to do it, because we have more than doubled our deficit in 2009, and we need to go back to business as usual from a public-finance perspective.

Q: Do you see real domestic demand returning?

A: The production numbers are good, they're certainly on the upward side. Consumption has always increased from one quarter to another, we've never had a negative number as far as consumption is concerned. The area where we need to work hard is private investment, because that has dropped massively, by about 7.9 per cent in 2009, and our forecast is a slight improvement but not a major improvement. Because companies have started rebuilding inventories; temporary jobs is up; advertising budgets are up. Those are sort of anticipatory signals, but actual investment in capital expenditures or equipment is actually going to take a while. But the tax reform that is now in effect, the removal of the business tax, will help.

Certainly as far as Europe is concerned, we're all determined to do the two things: to continue to support the fragile growth we have at the moment with the tail of the stimulus packages, tiptoe out of that, and come back to sound public-finance management. That's the goal toward which we are all working.

Q: When the Germans are forced to withdraw their part-time employment support program, there could be trouble.

A: That will be interesting to see. The major success of Germany, as I see it at the moment, is that they had a big drop of growth in 2009, and yet they've managed to maintain the level of employment, and that's because of this program you're talking about. But they're going to have to decide, now, do we extend it by more than 24 months, which is the timeline against which they're running, or do they drop it, at which point I think the unemployment rate in Germany might shoot up and skyrocket - I really hope not, for them. As well as for us, because we're all in this together.

Q: Is France's high unemployment going to become a larger problem?

A: There will be a lag between the pickup of growth and the creation of jobs. We're sort of working against the clock in that respect - how to fine-tune the extended part-time employment-support scheme while encouraging the creation of jobs.

Q: France has the interesting program of lending mediation committees [government-appointed bodies which instruct banks to make loans to business] Has that worked?

A: Not only has it been a success, but I think it will be a survivor… my recollection is that about 180,000 jobs were secured and maintained because of the involvement of the mediator… it's been very efficient… the beauty of it was we appointed one person who relied on existing networks, the branches of the central bank in the regions, so he could multiply his effects - it was a matter of having a good team around him and good knowledge of local conditions.

Q: It sounded to some people like a government agency telling banks to make loans they wouldn't have otherwise wanted to make.

That was perfectly legitimate, because we were participating in the system at the banks' request. If it had been my choice, I would have much preferred using our money for other things than what we had to do. We had to kick-start the system of interbank lending, we had to reinforce equity by quasi-equity funds, we had to get in the [banking]business. And it was only legitimate if we actually made sure that at the other end, the output end, there were actual results.

Q: When you began this job, you could not possibly have foreseen this - that you would be increasing the government's role in the economy.

A: That's true. Very true. But it was necessary. Whether it is temporary or not is going to be the question for tomorrow. Is it actually needed, that the state is so involved? Or are we going to be sufficiently efficient and quick to the ball to put in place a set of regulations and gatekeepers so that economic actors actually go about their business respecting the principles of stability and security for their society?

I would hope so, because I am, economically speaking, a liberally-minded person. I'm not a state interventionist, if you take my point.

Q: After some sustainable recovery, would you like to see the French economy having less state ownership, less state involvement?

A: Yeah. Less state ownership, less direct involvement in the economy, less actual pushing and pulling economic players. But less regulation? No, I don't think so. More efficient regulations and a stricter set of rules - yes, for sure.

It is certainly my understanding, and my belief in economic liberalism, that a free market does not mean a market without rules. And the free market can actually survive and be sustainable if it has a proper set of rules, and the rules are respected and enforced, and if not, the players sanctioned. Which is why I believe that anti-trust councils, stock-market authorities and banking supervisors are absolutely key tot the functioning of the free market.

Q: A transaction tax, or Tobin Tax - a couple years ago if I mentioned it, this would have been obscure. Now Gordon Brown has proposed it at the last G20 meeting, Angela Merkel has spoken in its favour, and you would like to see it happen. Can the idea grow beyond Europe?

A: Gordon Brown sort of interrupted the G20 meeting and said, what about the Tobin Tax? It was not a spur-of-the-moment thing. And Chancellor Merkel actually had it inserted in the last G20 heads of government communiqué, that there should be something like this thought of for the financing of global warming.

The use of the fund is going to be the second big issue. The first big issue is how do you make it work - and we are all pulling out our hair and struggling to see how it would work and on which basis it would be built. And number two, what are we going to do with it? Because we've got people who want it for development, others who want it for global warming and with a strong environmental focus, and others are saying, wait a minute, we want a big insurance pool that will help us against any recurrence of the systemic risk.

Q: So we're spending the paycheque before we've got the job!

A: That's exactly right - it's like the lovely story by Jean de la Fontaine, which you may know [The Milkmaid and the Pot of Milk]- the farmer walks to the market with big jar of milk on her head, and she thinks, once I sell my milk, I will buy a cow and I will buy this and that, and she gets so excited by all this that she starts dancing, and this makes the milk fall off her head and spill, and all the dreams are gone.

So we don't even have the pot of milk at the moment!

Q: That's the thing - I don't exactly hear the United States government talking about transaction taxes.

A: No, I think Tim [Geithner, U.S. Treasury Secretary]was very bluntly sceptical about it, to put it politely. But, you know, consensuses are formed in funny ways. The Brits were not talking about it, either, until Gordon Brown suddenly comes up with it.

Q: Do you think there's a chance of progress on it?

A: At this meeting, I don't know, but a chance of progress, yes, I should think so.

Q: Some economists say this is the wrong time to be raising the cost of debt and capital.

A: The beauty of that tax as initially thought of by Tobin is that it is infinitesimal, but on a huge basis.

I think it's far more important that we set up a good clearing system and that we have a little less of that OTC business [over-the-counter trading]where no one knows what is going on. Once we have a good clearing system, then we know where and how the transactions are made and concluded. But until we do that, I don't know how we can control the flow.