Après le Déluge, a case study: France’s debt crisis is exposing deeper cracks in the global economy

‘How can you govern a country which has 246 varieties of cheese?’ That was President Charles de Gaulle in 1962. He confronted staunch cultural diversity in domestic politics, and a world where Washington had sidelined France in the international monetary order. Irked by America’s post-war dominance, de Gaulle had challenged the dollar’s supremacy. Though the French franc had by then become a less significant currency, France was buoyed by economic growth.

Some things don’t change; some change dramatically. After six decades, the political landscape is as fractured, with vocal groups spanning the far-left to far-right spectrum — a feature that would test even a master statesman. What has vanished is the old economic confidence.

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Amid low growth, a high deficit and wary foreign investors dumping French government bonds, France today is stuck in an economic quagmire. As a common European currency, the euro — more relevant than what the franc was — may lend a semblance of protection, absorb some shock, and make the current crisis in French state bonds look less serious.

However, not only is it a far cry for France to question any economic hegemony, but it also finds itself in a world that has lost its bearings. It’s one thing for a proud nation to be at the wrong end of an international order. It’s altogether different for a slow, cash-strapped country to survive in a world that has no order.

The absence of a world order and the splintered politics of the old country have come together to trap France. Neither can it break out of the rut on its own, nor is it easy for the European Central Bank to freely buy French treasury papers with France slipping on macro parameters.

While a high deficit can be financed in different ways, it can only be fixed by either raising taxes or slashing government spending. France can do neither without leaving many unhappy — something the government won’t risk with presidential polls 6 mths away. Also, the numbers leave little wiggle room.

With the tax-GDP ratio at 43.5% — it’s 25.2% for the US, and below 20% for India — France doesn’t have the liberty, let alone the will, to raise taxes to battle a 5% fiscal deficit and below 1% growth. Its debt-GDP ratio is 116%, compared with 66% for Germany. The US, with 126%, is a different story, having still preserved the dollar’s ‘exorbitant privilege’, a term sarcastically coined by de Gaulle’s finance minister.

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While there’s no ideal debt-GDP ratio, sustaining high debts is easier when creditors are local. About 50% of French government lenders are foreign banks and funds that were attracted by high-yield pickups of French bonds (compared with lower returns on German gilts). Now, they are selling out due to the high deficit and the government’s reluctance to cut costs.

No one knows who holds how many bonds, who could step in, and when to offload and further hammer the market. Japanese asset manager Sumitomo Mitsui stunned all by selling its entire basket of French government bonds, fuelling rumours of hedge fund exits.

When fear spreads, second-round effects set in, as is seen in Spanish and Italian bonds, whose yields are up amid falling prices. This simply means these governments have to pay more to borrow.

Nasty geopolitics joins market forces to remind us of Ferguson’s law, which claims that any great power like the Ottoman Empire and Habsburg Spain was tipped over the brink when interest outgo on national debt outstripped military spending. For France, the former has surpassed the latter by over $10 bn.

It’s irrelevant whether history rhymes. What matters are 3 cold truths that France evokes.

u The turmoil is not an isolated calamity in a distant, seemingly unconnected bond market. It’s symptomatic of the woes of a world that has, in vain, thrown money at tough problems and used fiscal covers for years to suppress problems of low income and fewer jobs — where capital has received a larger and larger share of income than labour. It’s a festering problem brought to the fore by traders of French bonds and magnified by AI.

u The dollar will continue to hold its sway for years to come. Demand for the greenback is determined not by governments but by private parties, who would avoid the cost and hassle of shifting to the euro or any other currency — more so with Europe’s problems and US banks’ disproportionate influence over SWIFT, the payment messaging network.

u With liberalism on a long retreat, nations raising tariff barriers, states caving in to populism, and defence budgets bloated by geopolitics, other countries may, in future, be overwhelmed by troubles similar to what France faces today. It’s a reminder of how a lack of coordination among countries can manifest in curious ways.

The French connection is deeper than we all think.