Greece, Spain, Italy and now France

Thomas Pascoe

Thomas Pascoe worked in both the Lloyd's of London insurance market and in corporate finance before joining the Telegraph. He writes about the financial markets. His email is thomas.pascoe@telegraph.co.uk

Why France is on the road to becoming the new Greece

By Thomas Pascoe Economics Last updated: July 23rd, 2012

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This is France, not Greece

The euro is headed south today against all comers except The Great British Krona (as FT Alphaville calls sterling) which is engaged in a nosedive of its own. The reason this time? Spanish 10 year debt is yielding 7.5pc, half of what it ought to yield but enough to spook markets not yet ready to face the inevitable deflation of what has long been a bond super-bubble.

This bubble is particularly evident in France. The debt levels which the country has are as unsustainable as Britain’s, yet its policies are more irresponsible and its remedies more restricted. Although it is considered a core country in the eurozone, France’s economic profile now bears more resemblance to Greece’s the Germany’s.

Public debt in France is at 86.1pc of GDP (146pc if ECB liabilities and bank guarantees are included). The projected budget deficit this year is 4.5pc, with France having exempted itself from the EU’s instruction to bring deficits down to 3pct by the end of the year.

These numbers are not unusual in the context of eurozone economies in general. What distinguishes France is the lack of political will to address them and, as a consequence, a projected debt to GDP ratio which would place it firmly amongst the PIIGS grouping,

A 2010 paper by the Bank of International Settlements – cited by economist John Mauldin in his brilliant recent dispatch on ‘hidden lions’ – sought to model the likely effects of three separate policy paths by European governments. These range in severity from governments essentially carrying on as they are, to the most extreme austerity the authors believe to be politically possible, a gradual downwards movement in government spending while age related entitlements are frozen.

The results are captured in the graphs below, which show public debt/GDP projections:

At first glance you would be forgiven for thinking that the authors had simply copied and pasted the French graph into the Greek column:

Even under the most savage of these austerity models, French public debt reached 200pc of GDP within 30 years. Using the baseline scenario, debt reaches 400pc of GDP in the same time frame thanks to an aging population, relatively high structural unemployment and perpetual over-spend in government.

The worst case scenario is not unique to France. Of the eurozone countries both the Dutch and Greece would fare as badly as France were the base case to turn out to be correct. Unlike France, the Dutch are able to exert significant control on their own destiny through austerity measures. The best case scenario sees Dutch debt under 100pc of GDP.

The figures also outline the extent of the British problem. Not only will current spending and demographic patters leave Britain facing a similar debt to GDP ratio to the French 30 years down the line, but interest payments alone would reach 26pc of GDP.

That said, the British and the Americans both have two options not open to eurozone France. Firstly, they can continue to print paper to honour their debts and thus sustain otherwise impractical debt payments. I suspect both will do this, although it will devalue the savings and wages of their citizens.

Secondly, both have the option of cancelling the bond issues purchased by their central banks using Quantitative Easing. In a stroke, this would reduce public debt back to less than 50pc of GDP. This is politically impossible for the eurozone given that costs and benefits would be felt very differently across the different sovereigns.

Japan, the other vitally important debtor state in the global economy, also has a get out which is closed to France. While its debt levels are out of control, its borrowing costs are low thanks to Japanese pensioners investing their life savings in government bonds. Irrespective of global demand, domestic appetite for debt will keep rates low.

France has access to none of these remedies – it must therefore rely on making cuts domestically. This is why the euro arrangement is so difficult for many eurozone countries – Germany will not allow them to 'cheat' in the way that Britain and the US are doing by debasing their currencies.

Enter stage left Monsieur François Hollande. At a time when France is in dire need of a plan to re-invigorate private industry, reduce spending and encourage the return of capital, the French have elected a man committed to driving capital from the country and increasing government spending still more.

Mr Hollande’s attempts to rectify the French problem have so far involved the following:

• Lowering the pension age from 62 to 60.
• Increasing the minimum wage above inflation (albeit not much above inflation).
• Demanding that the EU take even more money from the national governments than was planned, violating a prior agreement and potentially adding £3bn to Britain’s annual tribute.
• Introducing a top rate of income tax at 75pc for those earning €1m or more – a move which gives a marginal rate of tax of 90.5pct on certain types of income.
• Introducing a tax on anyone owning assets in France but living abroad which will see 15.5pc of the rent or capital gain onproperty transferred to the state.
• Introducing a one off wealth tax at double the rate which had been previously trailed.

These reforms may have had some chance of working in the 1960s, when there were sufficient exchange rate and immigration controls in Europe to prevent the mass exodus of people and capital overseas. They have not the slightest prospect of working now.

Britain discovered, when it raised taxes on what it termed the ‘super-rich’, that these do not raise any additional income. The very wealthy now are too footloose to submit to any taxation regime they decide in iniquitous. Those who get hammered tend to be the mid-level operatives nearing the end of their career. The really big catch often gets away.

As it is, Hollande’s policies rely on the political view that Orwell believed he discerned in Dickens, the notion that rich people should be nicer and more amenable to taxation, and that were this the case all would turn out for the best.

This is not likely to happen soon. France’s economic course makes bankruptcy under the present system likely, her political course makes it inevitable. She is too large to be bailed out, but will eventually need to print currency to honour her debts. To do that she will need to leave the euro.

France's economy can and will survive for some time yet in its present form. The sharks are circling other bodies in the water, and until the bond markets make borrowing costs today's problem and not tomorrow's, the issue can be deferred. The time will come, however, when France's domestic inaction will translate into a break-up of the currency as a whole. The hour is not yet known, but the course seems set.