France is a lot like Greece

Πηγή: FT

By Lisa Pollack
July 27 2012

That is, if you ignore the difference in their government bond yields and just use debt-to-GDP projections made in a working paper from 2010. But we’ll get to that later. For now, it’s over to John Mauldin of Mauldin Economics in his weekly newsletterwho’s going to tell us why France is a ticking time bomb run for your lives:

Don’t look now, but the lion that lies hidden in the grass is France. Yes, the France that is supposedly a big part of the solution to eurozone woes and Germany’s stalwart partner in guaranteeing all that debt. AAA France. Rated that way by the same people who turned the nuclear waste of subprime CDO squareds, composed 100% of the worst sort of BBB junk, into gold.

Now, the rating agencies are using the same alchemical Philosopher’s Stone to transmute French debt into … fool’s gold.

As a reminder, France was downgraded to AA+ by S&P in January and has been onMoody’s negative watchlist since February.

FT Alphaville has written quite extensively about France effectively being in the “senior tranche” of the eurozone bailout funds. And also how its credit default swap spreads have consequently ended up as a bellwether for the state of the currency union because of this. So we get where some of Mauldin’s thoughts are coming from.

Moving on (emphasis ours):

First, let’s look at this chart from the IMF, examining the debt prospects of six countries (The entire study was of 18 countries.) The dotted lines are three paths that the debt-to-GDP ratio can follow. The top line is the trajectory without any actions by the individual governments. The middle dotted line is what the debt trajectory would look like with mild reforms to entitlements, and the bottom line is the debt trajectory if very draconian measures are taken. See if you can spot the hidden lion by guessing which country’s debt situation looks most like France’s.

At this point in the newsletter come the charts referred to in the above quote.

We went hunting for the exact study they came from, but we couldn’t find it. Then we found a blog post by “Humble Student of the Markets” that appears to have successfully identified the source: a March 2010 working paper from the Bank of International Settlements. Here’s the full table from that paper:


(Click on picture to enlarge)

For context, Mauldin just has the first two rows of charts in his newsletter. He then goes on to write:

Yes, the country most like France is Greece. Yes, THAT Greece.The one that just defaulted. The one that everyone agrees is dysfunctional. Also notice that if Greece were to follow the suggested draconian path, it could stabilize its debt. And then notice that if France were to make the same level of draconian cuts, its debt-to-GDP ratio would merely rise to almost 200% within 25 years. Oops.

Looking at all of the charts though, France is also projected to do better than Japan and the UK, and is neck and neck with the United States, even though France lacks their printing presses. Asides from which, it strikes us as a bit mental to show charts that have forecasts that go out this far, especially in the world of European politics that we live in.

But go on, tell us about the irresponsible Frenchies…


So, what has been the response of the new French government? It has decided to double down on what was already an irresponsible path. Do you think the average German understands just how bad off their “partner” is? For that matter, do you think the average French politician understands how bad off France is? Certainly not the majority of them, and it is doubtful that their counterparts in Germany do, either. This is going to be a train wreck of truely biblical proportions. Think 12 plagues, not the run of the mill 10.

Oh my, plagues? We’re supposed to think about plagues?

Well, here’s an idea, let’s look at what the IMF is definitely on the record for, as of April 2012 (click to expand):


(Click on picture to enlarge)

Less terrifying, isn’t it? (Admittedly this is also because the IMF’s projections don’t go out nearly as far as those of the academics in the BIS paper did.)

What of the United States? Here we go:


(Click on picture to enlarge)

That’s worse than France! Lion in the grass, you say?

OK, enough being silly. Let’s go over to our Humble Student, who had some thoughts on Mauldin’s letter:

"I have two reactions to that analysis. My inner investor says, wow that’s terrible. France is an accident waiting to happen. French debt costs will surely blow up and investors need to re-examine the credit risks of any debt paper that they consider. If French yields were to surge because of some event, then risk premiums will also blow sky high and that won’t be good at all for the risk-on trade, i.e. stocks, commodities, etc.

My inner trader tells me that, under the current circumstances, French real interest rates are negative and the France is actually making a profit by running these deficits. It has zero incentive given market conditions to rein in its deficits. In fact, it should be taking advantage of current conitions [sic] to extend the maturity of its debt structure in order to lock in low rates.

It’s important to be aware of the long-term risks of the French fiscal path, these kinds of things have a way of not mattering to the market until it matters. As a trader who is measured by the bottom line in his portfolio, he has to be aware of the risk but not hide in the bunker and act on this “lion in the grass” until the lions starts to move.

You have to watch for the inflection point. These differing viewpoints certainly put the Merkel/austerity vs. Hollande/stimulus debate into a fresh perspective".

Well put, Sir.