This was also a holiday-shorted week.

As we write this, the big news comes from the election in France. The leading candidate is a banker named Emmanuel Macron, with about 24% of the vote in a 4-candidate race. The anti-euro Marine Le Pen came in second with just over 21%. From the sharp rally in the euro, which was up about 2% at one point, we assume that observers believe the odds of France leaving the euro have just gone down.

Of course, France (and the other European countries) faces a false alternative (well they ought to consider Keith’s gold bonds proposal, but that is not on the table). Staying with the euro means ongoing wealth destruction, and a downward slope that leads to nowhere good. However, that raises the question. What would happen if they were to try to leave?

We believe that no matter which theory prevails, and what measures are taken by les dirigistes (central planners), all roads lead to an accelerated default of trillions in bad credit. To understand why, consider the balance sheets of the banks and other financial intermediaries in France.

Suppose the new French franc goes down relative to the euro (we won’t address here whether it is likely to go up or down). This means that any French entity who had borrowed from a bank in Germany or Italy or Spain now sees its liabilities spike up relative to its assets which are now redenominated in francs. It would not take that much leverage or a very large decline in the franc to cause some major bankruptcies. The initial round of bankruptcies could cascade causing yet other bankruptcies in a highly interconnected financial system.

On the other hand, suppose the franc rises. Then the French banks get hit the other way. Their euro-denominated assets outside France are going down, but their domestic liabilities to depositors and bondholders are firm.

A regime of floating currencies sounds good in Milton Friedman’s argument about being an easy way to adjust wages downwards which are otherwise sticky. However, an actual currency revaluation means a wealth transfer from parties A, B, and C to parties X, Y, and Z. That may seem to be good for the latter, until you realize that they are creditors of the former. And the former were already leveraged, and already surviving on thin margins compressed after decades of falling interest rates. There is scant capital to absorb such a shock.