France Will Be the Next Eurozone Victim

In my Money Week column this week, I argue that France may be the next country to fall to the euro crisis. Here is a taster.


The euro debt crisis increasingly resembles a teen horror movie. As soon as you think it is all over, the monster springs back to life. There is an unlimited number of sequels. And it usually ends up with a bloodbath.
This week it was the turn of Italy to be in the spotlight. The country’s bond yields started to spike upwards, a serious issue for a nation that has vast debts to pay the interest on. After flying under the radar for much of the crisis, the Italian debt market looks close to unravelling. Spain is coming under increasing scrutiny as well. It might well be next.
But in fact the markets are looking in the wrong place. True, there is plenty to worry about in both Italy and Spain. But the real testing ground for the euro is going to be their northern neighbour, France. It too is struggling to stay in the euro – and it, far more than Italy or Spain, has the potential to trigger a financial meltdown. France matters to the global financial markets far more than any of the other euro countries in trouble.
Monetary union was, of course, largely a French idea. The country’s industrial and financial establishment had long been unhappy with floating exchange rates. As one of the major exporters within the European Union, they could see that constantly shifting currencies made life very difficult for their companies. While Germany primarily exports to the rest of the world, France is a euro-zone manufacturing hub. A fixed currency system was very much in its interests. Indeed, one interpretation of the creation of the euro was that it was a deal between the French and the Germans: the Germans accepted merging their currency with France’s in exchange for French support for the re-unification of Germany after the fall of the Berlin Wall. It is ironic, therefore, that it isn’t working out the way France planned.
Could France seriously have a problem staying in the euro? After all, it is a big, successful economy. It is not a peripheral nation like Greece or Portugal, neither of which ever really industrialised, or a chronically financially chaotic country like Italy. Then again, Ireland was a successful, wealthy economy, and that didn’t stop the country going bust as a result of monetary union.
In reality, France is steadily losing competitiveness within the euro. That was confirmed last week with the latest trade data, which showed a widening deficit. The April trade gap rose to 7.42 billion euros. The UK, by contrast ran a deficit of £2.8 billion or 3.1 billion euros in April. The French deficit now amounts to 3% of GDP, and has been hitting fresh records month-by-month. France’s trade deficit with Germany, its main trading partner, is now one billion euros a month. “Within euroland, France is losing competitiveness to Germany, and it has no option for devaluation to help itself out,” noted Hi-Frequency Economics in an analysis of the figures. “A potential rift between France and Germany on trade would be a far more serious challenge to EMU’s political fabric than a disagreement over how to restructure loans to euroland’s second-smallest economy [Greece].”
Indeed so. There is no great mystery about what is happening. French wages have been rising at a faster rate than German wages, and their productivity is not as good. The country is steadily becoming a less attractive place to make things.
The important point is that persistent and rising trade deficits are clear evidence that France is struggling within the single currency in precisely the same way as the Greeks – it’s the same explosion, just with a much longer fuse. As it runs bigger and bigger deficits, the money will have to be re-cycled through the banking system. Eventually that will lead to a financial crisis.
It may happen sooner than anyone thinks. While a country such as Italy has a greater stock of out-standing debt, France is racking up new debts at a far faster rate. Last year it ran a deficit of 7% of GDP. French debt will total 90% of GDP this year and 95% in 2012 according to estimates by Capital Economics. That isn’t exactly running out of control – but it is getting very close.
There are other problems on the horizon. A Presidential election is due next year. That may turn into a competition for who can make the most extravagant promises. And the far-right National Front leader Marine Le Pen is pledged to bring back the franc. If she continues to do well in the polls, then pulling out of the euro will be on the agenda. That is not true of any other euro area country, not even Greece.
At any point, the bond markets may well take fright. They will start pricing in the possibility of France pulling out of the euro, or defaulting on some of its debt. Yields on French debt will start to spike upwards. And that will be the point at which the crisis turns scary.
While Greece, Portugal and Ireland don’t matter very much to the global capital markets, France does. In fact, it matters much more than Italy and Spain. It has $1.7 trillion of outstanding public debt, making it the fourth largest debtor in the world, according to data from the Bank for International Settlements. (The US, Japan and Italy are ahead of it). That debt is widely traded – 37% of French debt is held internationally, which is a lot more than Italy (24%), the US (19%) or Japan (1%), again on BIS figures. In truth, French bonds are held by institutions right around the world and have always been regarded as rock solid.
On current trends, that will have to change. France can no more survive in the euro-zone than Italy or Spain can. At some point, the bond markets are going to wake up to the problems in France. They are going to get very nervous about French debt, the same way they did about Greek and Portuguese and Spanish debt. They will start marking down the bonds, and factoring in potential default. But if that happens the losses to the financial system will be very nasty indeed. The euro was created in France. It may well be in France that it starts to finally unravel as well.