Will France be the first domino to fall?
The British should resist the temptation to gloat over the difficulties faced by neighbours across the Channel. The political and economic implosion of the second largest economy in the Eurozone will have far reaching consequences for all of Europe and beyond. So how did the unshakeable pillar of European stability, the co-founder of the EU and the world’s sixth largest economy crumble - and could it be that the next global financial shockwave emanates not from a market crash but from a political collapse in Paris?
Following Emmanuel Macron’s disastrous decision to call a snap election in July 2024, in less than two years France has been through five prime ministers - a political feat unsurpassed even in Rome's times of post-war political turbulence. The French parliament is currently split into three hostile blocks on the left, far right and centre, and as a result the legislative body cannot pass a budget. No single group can hope to form a functioning government because the other two would always unite against it. Making the situation even more intractable is the timing: the pending departure of Macron makes it all the more unlikely that either side will make concessions. There are important municipal elections in March and then the presidential elections in May 2027.
The fiscal situation is deteriorating rapidly, with the cost of servicing France’s massive deficits now exceeding countries such as Italy, Spain and Portugal. National debt has exploded, and investors are losing faith in France’s ability to stabilise either its finances or its politics. Economic commentators are now seriously contemplating the possibility and potential consequences of an IMF or European Central Bank bailout.
To understand the true gravity of this situation, we must first examine the staggering economic realities lying at the heart of the French malaise. France’s national debt has passed three trillion euros, and while other countries carry similar debt loads, the trajectory of France’s deficits is uniquely alarming. It has been over half a century since France has had a balanced budget, and the consequences of fifty-one consecutive years of profligacy have now arrived with a vengeance. Post the Pandemic, the cost of servicing France’s debt rose along with global interest rates, and as cheaper debt raised during the zero-interest rate era matures, the cost of refinancing maturing debt has multiplied.
The cost of servicing French national debt this year is estimated to be €67 billion - it now consumes more money than all government departments except education and defence. Forecasts suggest that by the end of the decade it will outstrip even them, reaching €100 billion a year. This financial black hole is crowding out fiscal space in every other segment of public spending. Last month the ratings agency Fitch downgraded France’s debt, reflecting growing doubts about the country's stability and ability to service that debt. The country will as a result be paying even higher rates of interest on its borrowings, causing a vicious circle of higher rates leading to more borrowing and further downgrades. French borrowing costs have reached parity or even exceed those of Italy and Greece, the countries that were at the epicentre of the 2011 debt crisis.
For France, a country that used to lecture countries in southern Europe on fiscal responsibility, to be viewed as more unstable than Greece is a humiliation of historic proportions. The French annual deficit has ballooned to nearly 6% of GDP, double the European Union’s limit. France has failed to meet its spending projections in every year since the Pandemic and is not expected to do so anytime soon. Business failures have reached a historic high with over 67,000 bankruptcies recorded in a twelve-month period. Unemployment has settled at 7.5% but youth unemployment remains in excess of double this figure. Without effective government, this does not provide a promising background from which to address France’s deteriorating fiscal backdrop. However, the most serious impediment to progress is the French electorate’s unwillingness to accept any of the medicine required.
France’s ageing population results in a current ratio of a little over three workers for each pensioner. This ratio is destined to fall to 1.7 workers per pensioner. An increase in the retirement age from 62 to 64 has been met with violent protest and, if successful in the forthcoming election, opposition parties promise to reverse this rise. The fact that average earnings have fallen behind the generous state pension is causing an exodus of talent to financial centres such as London, New York and Dubai. France’s public sector constitutes 58% of the economy and central government’s total tax take now exceeds 45%. Threats to reintroduce a tax on wealth will only hasten the flight of capital. Therefore, notwithstanding a lack of effective government, the inability to extract significant additional taxation and both popular resistance and lack of political will to push through cutbacks in welfare spending are squeezing other areas of public expenditure.
One possibility is that the country's inherent strengths - its wealth, infrastructure, institutional resilience - will see it through what many feel is a historic turning-point. But there is another scenario: that it emerges permanently weakened, prey to extremists of left and right, a new sick man of Europe. No one is suggesting that France’s mounting problems are unique to that country, but what is unique is the total absence of political leadership or mandate for change, let alone the acquiescence of the generation shouldering the current burden of an unrealistic pension regime, who will in all likelihood be forced to forego these rights themselves.
This situation is likely to continue until France’s inability to finance rising deficits requires a rescue by the IMF and the European Central Bank. If the experience of Greece, following the previous Euro debt crisis, provides a reliable guide, public sector unemployment will spiral, public sector workers will remain unpaid, rubbish will pile up uncollected in the streets and French living standards will fall sharply. France was previously considered among those EU members that were too big to fail, but perhaps it has become too large to rescue. Alternatively, if the size of the required rescue package is considered too large, the only obvious alternative is for the French Franc to return to replace the Euro and allow France’s currency to fall and interest rates to rise to levels that will attract support from international investors.
Given the nature of the interwoven supply chains and economic activity within the EU and beyond, the resulting contagion would in all probability precipitate a domino effect throughout Europe that could be the catalyst for a global monetary reset. Although post Brexit, UK will not be in the direct firing line to take part in a French rescue, there should be no schadenfreude from this side of the Channel. The demise of our close neighbour will greatly affect us all, and so we must hope that French politicians can agree a solution that restores the country’s financial credibility. Elections might not await their scheduled date in 2027, but there are worryingly few signs that the French parliament will find an administration that promises the required spending cuts around which they can coalesce.
In the words of veteran political commentator Nicolas Baverez: "At this critical moment, when the very sovereignty and freedom of France and Europe are at stake, France finds itself paralysed by chaos, impotence and debt.” According to Françoise Fressoz of Le Monde newspaper, "We have all become totally addicted to public spending. It's been the method used by every government for half a century - of left and right - to put out the fires of discontent and buy social peace. Everyone can sense now that this system has run its course. We are at the end of the old welfare state. But no one wants to pay the price or face up to the reforms which need to be made.”
France and Japan could be the first dominos in the queue - but the UK’s fiscal dynamics are worryingly similar.
About the author
Jo Welman had a career in the City spanning 45 years and worked in a wide variety of financial sectors. After graduating from Exeter University in 1979 with a degree in economics, Jo spent ten years at Baring Asset Management where he managed a range of UK and US pension funds and unit trusts, investing across multiple sectors including bonds, international equities, commercial and residential property and private equity.
In 1989 Jo became Managing Director of merchant bank Rea Brothers’ institutional and private wealth investment management division. Over the following decade Jo launched a series of specialist investment trusts and funds in a variety of industry and property sectors, before forming a joint venture with reinsurance broker Benfields (now Aon Benfield) and raising one of the first limited liability corporate capital vehicles for the Lloyds insurance market in 1993. As part of his long-standing involvement in the insurance industry, Jo co-founded the Benfield Re-Insurance Investment Trust plc (Brit) in 1995. Following the sale of Rea to Close Brothers in 1999 Jo became Chairman of Brit Insurance Holdings Plc and in 2001, in partnership with Brit and Benfields, he co- founded specialist asset management firm, EPIC Investment Partners (EPIC).
Jo continues to provide corporate finance and investment advice to entrepreneurs and private investors. He sits on the board as a non- executive director of ARK Syndicate Underwriting
“Feet up by the pool”
Jo does not receive any remuneration for his EPIC commentary. Instead, EPIC is pleased to promote the latest edition of his book “Feet up by the pool”.
Profits from sales of the book go to The Money Charity, a charity that shares Jo’s objective to help fill in some of the worrying gaps in the school curriculum. These omissions leave many young adults lacking in the financial awareness that they need to survive in a world where they will rely on their own savings if they are ever to stop working. Even if they earn the right to a full State Pension, today this amount hardly covers council tax and utility bills, and so they need to save and build up a sum of capital amounting to around twenty times their desired retirement income. A frightening number.
As Jo eloquently says, “If we can do our bit to raise awareness of the impending UK saving and pensions crisis, the exercise will have been worthwhile.”