The 10-year interest rate spread between France and Germany now exceeds 140 basis points, and the French rate is approaching 5%. France is acting alone: it is entering a crisis of its own making.
Why investors doubt
Investors will not change their minds on their own. Two questions are on their minds. First: will the government manage to pass the 2027 budget? Second: why is France the only comparable country whose public debt, relative to GDP, has increased since the pandemic? Since 2020, this ratio has fallen by 15 points in Italy and by 20 points in Spain.
The presidential election is doing little to reassure investors in Singapore, London, or New York: none of the frontrunners considers the budget issue a constraint. Why, under these circumstances, take the risk of investing in France? The situation appears deadlocked until next May, and the downward spiral could continue. Volatility will therefore remain the primary concern.
What are the solutions?
Recourse to the ECB
The ECB is the first point of reference. It has two procedures.
The TPI (Transmission Protection Instrument) allows it to purchase securities of a country targeted by speculation that is not based on proven macroeconomic imbalances. It serves to mitigate market risk. France does not fall into this category.
Outright Monetary Transactions (OMT) allows the ECB to purchase bonds from a given country with the agreement of the other eurozone countries, in exchange for a commitment to rebalance public finances. For France, this would mean at least stabilizing public debt, representing €150 billion in savings: a veritable austerity plan. During the sovereign debt crisis, Spain, Portugal, and several other countries experienced similar plans, with sharp declines in the purchasing power of civil servants, job cuts, and massive adjustments to pensions.
Neither the ECB nor France, its citizens and businesses, have reached that point yet. Should it happen, France would become a new member of the PIIGS club in the sovereign debt crisis.
Two illuminating precedents
1. Getting out of hyperinflation.
Thomas Sargent studied episodes of hyperinflation in Germany and Central Europe during the 1920s and 1930s. In Germany, in 1923, the situation was intractable. The turning point came with a credible commitment from the government and the central bank to a policy to be pursued—a very restrictive policy that was maintained over time. International institutions and investors took note of this break, and both the government and the central bank adhered to the chosen course. The economic cost varied from country to country, but hyperinflation was halted. This long-term commitment resembles the one France could, or should, make to the ECB in the event of an Outright Monetary Transactions (OMT) program.
2. The turning point of 1983.
In early 1983, the franc had just been devalued for the third time. Should France leave the European Monetary System (EMS), or even the European Economic Community, or remain in the EMS while making the necessary efforts to avoid being its weakest link? The choice to remain resulted in the austerity measures of March 1983 and the abandonment of inflation as a macroeconomic adjustment tool. France had to align itself with German inflation to avoid the risk of a fourth devaluation, which would have been devastating. A decision by one man at the Élysée Palace led to a radical change in approach and, ultimately, the stabilization of inflation, to the benefit of the French economy. France has never again resorted to inflation for economic adjustment.
At the root of the problem
France is going through a period of political uncertainty, at the end of a very long cycle, which began in 1975, during which public debt was the preferred means of adjustment. No sudden break in the system justified this increase in debt: it stems from a social model whose needs exceeded what the economy could provide. The immediate uncertainty arises from the fact that these social needs remain high while French growth is faltering.
The divergence with the rest of Europe on the debt trajectory, coupled with political uncertainty, makes it impossible to take the necessary adjustment for granted. The perception of France has changed: it is now singled out as the country that has not made the necessary budgetary efforts to adapt to a changing world.
A double adjustment
Regardless of the current crisis, the difficulty lies in the dual adjustment that needs to be implemented.
The first is budgetary.
To stabilize public debt as a percentage of GDP, approximately €150 billion in savings are needed in the primary budget (i.e., excluding debt interest payments). This effort could be spread over several years, but it would already represent a significant shift, requiring a reallocation of budgetary resources. Historically, spending cuts have proven more effective in the long run than tax increases.
The second concerns growth.
Mario Draghi reiterated this point in his recent Zurich speech: Europe must relearn how to generate growth on its own and become more self-reliant in what it is capable of doing, producing, and achieving. It must therefore align itself with a global economy marked by two technological revolutions: artificial intelligence and electrification coupled with the energy transition. In a centralized country like France, the impetus often comes from the incentives put in place. Here too, resources will need to be reallocated: replacing outdated spending with new, more growth-oriented approaches for the future.
Conclusion
Today, the world has changed, and adjusting supply matters more than adjusting demand. France must clarify its priorities to avoid a prolonged period of austerity and social instability. It must enter the 21st century and accept an era of power struggles. It is up to France to learn how to enter the fray to protect its well-being.
