Who'll Take Charge in Frankfurt?

A leadership battle is eroding the ECB's credibility

Financial markets hate uncertainty. That's why choosing the head of an independent central bank is ostensibly a matter of grave deliberation, not vulgar political horse-trading. Unfortunately, in the European Central Bank's short life, horse-trading has been a driving force. From the three-year-old ECB's conception, France and Germany have waged open political war over the post. Small wonder: The unelected, all-but-unremovable ECB head holds the European economy's reins.

The current president, Wim Duisenberg, a Dutchman and the Germans' nominee, has been widely criticized for impolitic public comments and a too-tight monetary policy. But until recently, the world's currency and bond traders could take comfort that Duisenberg would be gone by next year. Respected Bank of France Governor Jean-Claude Trichet was to replace him in a Franco-German deal, they believed. Now it appears that deal is unraveling--if it ever existed--launching a new round of squabbling over the ECB leadership.

Neither the French nor German politicians, nor the ministries concerned would comment for the record. But privately officials say that the latest free-for-all shows a growing conviction that Trichet will be disqualified because of a year-long, ongoing judicial investigation. Magistrates are probing whether the former director general of the French Treasury was involved in some way in alleged falsification of then state-owned Crédit Lyonnais' accounts in the early 1990s. Unless he's cleared before Duisenberg goes, Trichet may well lose his chance to head the ECB. In a statement relayed by a spokeswoman, Trichet wouldn't comment on the investigation. He also said he "considers Duisenberg a formidable president who has the esteem and confidence of all."

Trichet's discomfort opens the door to other candidates, and everyone with a stake in the ECB has joined the fray. The issue even came up at the Apr. 21-22 European Union finance ministers meeting. "This is a hot political issue behind closed doors," says a Belgian official.

The seeds of the wrangling go back to May, 1998, when Duisenberg, 65, was named. French President Jacques Chirac claimed then that he had accepted him on condition that the former Dutch central bank chief retire midway through his eight-year term in 2002. Then Trichet--or another Frenchman--would step in.

Duisenberg denied the existence of such a deal right after his appointment. But markets still believed in it. Now, sensing an opportunity to keep their man in place, German officials say privately they never cut a binding deal with Chirac and that Duisenberg can stay. That has produced a bizarre twist in France, where both Chirac, a conservative, and Prime Minister Lionel Jospin, a socialist, are backing away from Trichet, who long enjoyed broad bipartisan support, and pushing rival candidates.

Confused? The markets are. "We want a definite date [for Duisenberg's retirement] and clarity," says Austin Hughes, chief economist at Dublin's IIB Bank. "But we're getting neither." None of this has helped the euro, which suffers from Duisenberg's poor image.

RATE-CUTTER RACE. Chirac's continued aggressiveness on the ECB leadership question has taken his EU partners aback, according to German and Italian officials. When European leaders were pondering who the first ECB chief should be, it was understood a German wouldn't get the job because the ECB was in Frankfurt: Having a German chief too would be overkill. Chirac, sensing an opportunity, pushed Trichet's candidacy, and only yielded, he says, when Duisenberg agreed to go early.

Now, with the world economy slowing, Chirac is desperate to get the hawkish Duisenberg out and install someone more likely to cut rates. And the legal problems of Trichet--a diehard supporter of the ECB's current policies--are an opportunity for him to seek a more dovish Frenchman. So Chirac has been quietly pushing the candidacy of Jean Lemierre, president of the London-based European Bank for Reconstruction & Development, according to German finance ministry officials. (Chirac's office won't comment.) In March, Lemierre told the Italian newspaper La Repubblica that Duisenberg had definitely agreed to step down early, an out-of-place comment for someone with no apparent role in the controversy. Hypersensitive EU finance veterans saw that as a pitch for the job.

The problem is that Lemierre, a former senior French Treasury official with no central bank experience, is an unknown quantity. Moreover, he's too conservative for French Premier Jospin, whose candidate is said to be Finance Minister Laurent Fabius. "The whole thing is a disgrace," says a senior official in one EU finance ministry. "They're making the presidency of the ECB into a French political football."

Adding to the French anguish is that the term of the ECB's French vice-president, Christian Noyer, ends in mid-2002. If that job goes to a Frenchman, France won't get the presidency. But if a citizen of another country gets it, and Duisenberg doesn't quit, France will have no one on the bank's executive committee.

The Germans are also irked. Whatever Duisenberg agreed with the French, they hope he will stay on at least until the investigation into Trichet is completed. If Trichet is exonerated, most European financiers would welcome him as the next ECB boss. They remember Trichet's deft handling of French monetary policy before monetary union in January, 1999. Also highly regarded is Italy's Tommaso Padoa-Schioppa, the ECB executive committee member in charge of international relations. An MIT economics grad, he's considered brilliant. But it's unlikely an Italian would get the job. "I can't imagine Padoa-Schioppa getting it given the shaky Italian environment," says Johannes Reich, head of strategy and research at Bank Metzler, a Frankfurt private bank.

Ironically, France's machinations have made its partners more willing to back Duisenberg. His clout in the governing council has increased--which, analysts say, explains why the ECB didn't cut rates on Apr. 26. "He has been bolstered and is now more firmly in control," says Kevin Muehring, European expert at Medley Global Advisors, a New York-based economic consultancy. Francesco Giavazzi, a research fellow at the Center for Economic Policy Research in London and noted commentator on the ECB, now thinks Duisenberg should stay to help ready the bank for EU expansion. "The whole thing seems to have backfired on the French," says an official from one EU finance ministry.

Whatever happens, the uncertainty hurts the ECB's efforts to build credibility. The consensus is that European politicians need to sacrifice their political interests for something really vital--putting the right person in the job.

By David Fairlamb in Frankfurt

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