Francois Hollande has ten weeks to avert a French bond crisis
There will be no speculative attack against French bonds on Monday morning because François Hollande has been elected president, the first socialist to take the Élysée since the Mitterrand debacle of 1981.
8:02PM BST 06 May 2012
The phantom army waiting to pounce is the cynical invention of the Sarkozy campaign. Any fears of a Leftist lurch have been in the price for weeks.
What is true is that the CAC-40 index of French stocks has underperformed Germany’s DAX by 20pc since last August, an ominous divergence for two countries yoked so tightly together. The yield spread of German 10-year Bunds over French OAT bonds has jumped 90 basis points.
This parting of the ways pre-dates the "Hollande scare". It goes beyond downgrade jitters, or fears of contagion from $710bn of French bank exposure to Italy, Spain, Greece, Ireland, and Portugal (IMF data). It reflects a gut feeling in global markets that France is sliding into deep trouble, clinging to a ruinously expensive social model in a Teutonic monetary union and a Chinese trading world.
French economists say the moment of danger will come later this summer - whoever is elected - as the full force of Europe’s contraction crisis hits France.
“They absolutely must cut public spending and control the debt,” said Marc Touati from Global Equities in Paris. “It will soon be clear that we are in deep recession. If they don’t act fast, interest rates will shoot up and we will have a catastrophe by September,” he said.
Fiscal tightening a l’outrance across Euroland is a grave policy error, he said, but ‘AA’ France nevertheless has to deal with reality.
The country lacks the credibility to go for growth alone under the constraints of monetary union. It is trapped.
Mr Touati blames the European Central Bank - BCE in French or “Banque Contre L‘Economie” as he calls it - for making matters far worse by needlessly pushing the whole Euro zone system into a slump out of “blind ideology”.
Star fund manager Edouard Carmignac makes much the same critique. His indictment of the pre-Draghi ECB is ferocious, but that does not alter the strategic dilemma for French leaders. Protracted slump makes it all the more imperative for each euro member to put its own house in order.
“If Hollande strays too far from virtue, French rates will go through the roof. France will not be able to borrow,” he said.
My own view is slightly different. The German deflation regime is - in the current circumstances - the greater threat to Greco-Latin societies, and to post-War comity in Europe. Sometimes you have to go through a cathartic trauma to break free.
But it is also true that Germany’s own democracy may turn fractious if policy strays too far from German needs and Grundgesetz. This is EMU’s curse. It destabilizes each nation state in turn, each in different ways - a “negative sum game”.
The worst of all worlds would be a nasty spat between Mr Hollande and Chancellor Angela Merkel that poisoned the atmosphere without bringing about any substantive change to Europe‘s “asphyxiation compact”.
Watch the French debt auctions on May 3 and May 16 carefully, says Sophie van Straelen from the French hedge fund consultancy Asterias.
If they go well, a President Hollande may start to think that bond vigilantes will stomach his big state romanticism.
“Our belief is that he has no choice. He must increase taxes and cut spending, otherwise markets could panic and we will have a disaster,” she said. The crucial deadline is the budget proposal in July.
Mr Hollande has already hinted at complacency, suggesting that market calm over the last two weeks is a vote of confidence in his policies. It is no such thing.
Paris has a strange atmosphere right now. It is hard to get a table at the bistros of Saint-Germain, yet people have a sense of foreboding.
They know austerity has hardly begun. The press is full of stories that the biggest property bubble ever known in France has begun to deflate. Yet the party goes on. Perhaps this is what it felt like in May 1931, avant le déluge.
Germany took its medicine with the Hartz IV labour reforms eight years ago - under a Social Democrat, nota bene - when the world was humming and EMU competitors were merrily inflating their way into varying degrees of fixed exchange rate Hell.
France will have to take its medicine in less propitious times, somehow clawing back 20pc in unit labour competitiveness against an austere Germany.
It is not easy to see how France can pull this off. Little has been done so far beyond repeal of the infamous 35-hour week. Labour rigidities - employment protection, high tax wedge and minimum wage (SMIC), etc - are among the most entrenched in the OECD club. The unreformed French state takes 55pc of GDP.
The current account has swung from a surplus of 3pc of GDP to a deficit of nearly 2pc in twelve years. France’s share of EMU exports has dropped from 17pc to 13pc. French trade data has become an “event risk”, keenly watched by traders.
Mr Hollande must know the dangers of “socialism in one country” under a currency peg. He was a Mitterrand aide when such an experiment blew up in 1983, leading to the `tournant de la rigueur’ or epic U-turn.
Markets won’t wait so long this time.
Yet he may be prisoner of events if he fails to win an outright majority in the legislative elections in June and has to rely on the fast-rising Front de Gauche -- the neo-Communist movement of Jean-Luc Melenchon with 11pc of the vote.
History buffs will remember the events of 1936 when Leon Blum’s Front Populaire came to power with “New Deal” rhetoric and Communist backing. Investors rushed for the exits, forcing the franc off the Gold Standard. The money crossed the Channel.
“Conversations in French became increasingly commonplace in the City of London, as French citizens made arrangements to open sterling bank accounts,” writes Barry Eichengreen in Golden Fetters, my favourite book on the Great Depression.
There are signs that it is happening again, says Louise Cooper from BGC Partners. If Italians were the biggest foreign buyers of top properties in London last year, the French are catching up this year in the £3m to £5m range.
“London property is like German Bunds - somewhere safe to park cash,” she said. Is it capital flight? Hard to tell.
Historian Nicolas Baverez said the French are in a natoinal sulk, idealizing a mythical past and retreating behind a new Maginot Line. Europe has become the great scapegoat.
“I am convinced that France will stand at the centre of the next Euro zone crisis,” he says.
Luckily for Mr Hollande, global markets have not yet reached their merciless verdict.