Monday, August 26, 2013

Thoughts from the Frontline.....France: On the Edge of the Periphery

By John Mauldin

"The emotional side of me tends to imagine France, like the princess in the fairy stories or the Madonna in the frescoes, as dedicated to an exalted and exceptional destiny. Instinctively I have the feeling that Providence has created her either for complete successes or for exemplary misfortunes. Our country, as it is, surrounded by the others as they are, must aim high and hold itself straight, on pain of mortal danger. In short, to my mind, France cannot be France without greatness.
– Charles de Gaulle, from his memoirs

Recently there have been a spate of horrific train wrecks in the news. Almost inevitably we find out there was human error involved. Almost four years ago I began writing about the coming train wreck that was Europe and specifically Greece. It was clear from the numbers that Greece would have to default, and I thought at the time that Portugal would not be too far behind. Spain and Italy clearly needed massive restructuring. Part of the problem I highlighted was the significant imbalance between exports and imports in all of the above countries.

In the Eurozone there was no mechanism by which exchange rates could be used to balance the labor-cost differentials between the peripheral countries and those of the northern tier. And then there's France. I've been writing in this space for some time that France has the potential to become the next Greece. I've spent a good deal of time this past month reviewing the European situation, and I'm more convinced than ever that France is on its way to becoming the most significant economic train wreck in Europe within the next few years.

We shifted focus at the beginning of the year to Japan because of the real crisis that is brewing there. Over the next few months I will begin to refocus on Europe as that train threatens to go off the track again. And true to form, this wreck will be entirely due to human error, coupled with a large dollop of hubris. This week we will take a brief look at the problems developing in Europe and then do a series of in-depth dives between now and the beginning of winter. The coming European crisis will not show up next week but will start playing in a movie theater near you sometime next year. Today's letter will close with a little speculation on how the developing conflict between France and Germany and the rest of its euro neighbors will play out.

France: On the Edge of the Periphery


I think I need first to acknowledge that the market clearly doesn't agree with me. The market for French OATS (Obligations Assimilables du TrĂ©sor), their longer-term bonds, sees no risk. The following chart is a comparison of interest rates for much of the developed world, which I reproduce for those who are interested in comparative details. Notice that French rates are lower than those of the US, Canada, and the UK. Now I understand that interest rates are a function of monetary policy, inflation expectations, and the demand for money, which are all related to economic growth, but still….

France's neighbors, Italy and Spain, have rates that are roughly double France's. But as we will see, the underlying economics are not that much different for the three countries, and you can make a good case that France’s trajectory may be the worst.

"No: France Is Not Bankrupt" – Really?


We will start with a remarkable example of both hubris and economic ignorance published earlier this year in Le Monde. Under the headline "No: France Is Not Bankrupt," Bruno Moschetto, a professor of economics at the University of Paris I and HEC, made the following case. He apparently wrote this with a straight face. If you are not alone, please try not to giggle out loud and annoy people around you. (Hat tip to my good friend Mike Shedlock.)

No, France is not bankrupt .... The claim is untrue economically and financially. France is not and will not bankrupt because it would then be in a state of insolvency.

A state cannot be bankrupt, in its own currency, to foreigners and residents, since the latter would be invited to meet its debt by an immediate increase in taxation.

In abstract, the state is its citizens, and the citizens are the guarantors of obligations of the state. In the final analysis, "The state is us." To be in a state of suspension of payments, a state would have to be indebted in a foreign currency, unable to deal with foreign currency liabilities in that currency….

Ultimately our leaders have all the financial and political means, through the levying of taxes, to be facing our deadlines in euros. And besides, our lenders regularly renew their confidence, and rates have never been lower.

Four things leap to mind as I read this. First, Professor, saying a country is not bankrupt because it would then be insolvent is kind of like saying your daughter cannot be pregnant because she would then have a baby. Just because something is unthinkable doesn't mean it can't happen.

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