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Karina's Column

An insider’s view on the City of London and beyond

Why France will fall nextft


A French family tale

This summer I met a French couple who work amicably together in their vineyard. They are raising their two boys good-humouredly. They socialise harmoniously. But when under a Provencal sun she grabbed a piece of baguette from his plate, he erupted. Unjustifiable behaviour? Perhaps. But a Frenchman and his food are not to be separated.

What is truly unjustifiable are the negative real interest rates being paid on some French government bonds, while Spain and Italy’s are only being kept from record highs by the promise of action by the European Central Bank.

This situation is coming to an end. France is going to have to pay a risk-adjusted return on its bonds, at which point its precarious balancing act will collapse. There are three reasons why this looks likely to happen sooner rather than later.

The first is that the eurozone’s newly launched rescue fund, the European Stability Mechanism (ESM), will have to borrow money in the continental bond markets to fund countries in need of help. Goldman Sachs believes it could crowd out other borrowers like France, the so-called “soft core”, which have benefited from investors fleeing the periphery countries. Meanwhile, the continued existence of the European Financial Stability Facility, its predecessor, which still has to fund programmes for Ireland, Portugal and Greece, will add to the supply of lower risk bonds in the euro market competing with French sovereign ones.

The French couple, Herve and Claudine Bizeul, run Clos des Fees, a vineyard named after the fairies. It produces magical wine .

France’s fairy godmother has been Switzerland, but it may be stepping down from that role, the second reason for France to fall.

Switzerland has been one of the main buyers of bonds issued by the core eurozone economies as it battles to keep the Swiss franc at a ceiling of SF1.20 against the single currency. This costly policy has been a blessing to France. It began in September 2011 and has resulted in the tiny Alpine state becoming the fifth largest holder of foreign exchange reserves in the world, with 60% of its SF418bn held in euros, according to Standard & Poor’s. France’s abysmal economic fundamentals have been brushed aside by the Swiss National Bank’s largesse and resulted in untenably low or negative yields. However, domestic opposition to an already controversial Swiss policy is rising and the central bank is under pressure to decelerate its euro bond buying programme.

Thirdly, assuming Spain asks for a rescue in the next couple of months and the ESM takes action to buy its bonds, the market’s attention will shift away from the periphery and onto France, whose borrowing requirements are rising steadily while its ability to pay debt back is declining just as steadily.

(Some market participants and executives argue that the reason the French central bank has been so hard on Italy and Spain is to distract from its own country’s abysmal state. Others accuse Frenchman Michel Barnier, the Internal Market Commissioner, of being soft on reform of the rating agencies in an unspoken pact to ensure downgrades of his country’s debt are not as severe as they should be. Conspiracy theories abound, some more credible than others).

In 2013 France will need to borrow €171bn. At 56% of GDP, it already has the highest annual public spending in the eurozone. Germany spends €163bn less on its population which is 17m larger than that of France. Public and private debt in France is 160% of GDP (125% in Italy, 128% in Germany). In fact, according to a US fund, if you add in all the off balance sheet items – saving Dexia, the TGV, pensions, healthcare, and the like – the number escalates to around 600%.

The last few governments, of whatever persuasion, have refused to confront reality – as evidenced by nearly 40 years of accumulated annual budget deficits and an anti-private sector bias which has led to an avalanche of social security costs, taxes and regulation. The result is a stymied private sector.

At the creation of the euro in 1999, France’s exports as a percentage of world trade were 6.5%. They have since plummeted to 3%. Its manufacturing margins have followed the same downward plunge to 5% from 12%. Germany’s have increased from 12% to 14%. The majority of the companies in the CAC-40, France’s main stock market index, post losses in their domestic businesses which are somewhat camouflaged by their profits abroad, notes outspoken economist Nicolas Baverez in his latest salvo to save France*.

France’s disinclination to change is disheartening. “The will to erect Maginot lines against Europe and globalisation is both dangerous and a chimera,” writes Baverez, referring to the defences put in place against the German army in the 1930s. Considered impregnable, they were proved useless. France is an accident waiting to happen, and paradoxically, a borrowing crisis may well force the country to reform, not unlike what has happened to its southern neighbours.

Herve and Claudine have chosen to stay in France and defy a state which batters entrepreneurs and SMEs. Meanwhile, 50,000 of the best and brightest graduates emigrate annually. Whether in the future the two Bizeul boys stay or go may will be a telling indicator of the health of the nation.

*“Reveillez-vous!” (Wake up!) by Nicolas Baverez, an outstanding call to arms.