In early September, I warned that France’s politics could ignite Europe’s financial powder keg. The fuse, I suggested, might be lit when Prime Minister François Bayrou faced an inevitable confidence vote, which he would lose.
That prediction proved correct. On 8 September, the National Assembly rejected Bayrou by 364 votes to 194. His successor’s cabinet, Sébastien Lecornu, lasted just fourteen hours – the shortest-lived administration in modern French history.
Never mind, President Emmanuel Macron reinstated Lecornu as Prime Minister just days later. We shall see how long he lasts this time.
But France’s predicament runs deeper than even this extraordinary political turbulence. The National Assembly splits three ways: the NFP alliance with 182 seats, Macron’s Ensemble with 168 and Le Pen’s National Rally with 143. None can govern alone. Any two can unite to destroy the third. And they do.
The Fifth Republic was designed by Charles de Gaulle to ensure decisive leadership through a strong presidency and a compliant parliament. But it is that mechanism that was meant to ensure stability which now prevents it. France has become ungovernable under its constitutional rules.
While France’s politicians will somehow have to muddle along with this paralysis, financial markets have less patience.
Ten-year French bonds yield about 3.5 to 3.6 per cent. That is around 85 basis points higher than what Germany must pay. That is a multi-year high, and a sign of just how serious the situation is for France.
Another is that L’Oréal recently borrowed more cheaply than the French state on similar maturities. When a cosmetics company gets better rates than the Republic, something is not quite right.
What spooks markets is not just France’s €3.3 trillion debt pile or even its gargantuan 5.6 per cent of GDP budget deficit. It is the political dysfunction that is the real concern. Because it means there is a risk France may struggle to service its debt obligations for political reasons.
For the first time since the Eurozone crisis, therefore, it is not Greece or Italy that defines the currency union’s risk premium, but France.
That shift can already be seen in T2, the claims and liabilities between Euro-area central banks. T2 replaced TARGET2 in March 2023, a system readers of this column may be familiar with. I have long considered this system the best indicator of Eurozone troubles.
T2 is the Euro’s hidden balance sheet, tracking money movements between national central banks. When there is confidence in the system, the balances in T2 run close to zero. When confidence falters, things look very different, though. Then negative T2 balances mark the places that capital flees from – and positive balances the safe harbours it flees to.
The numbers from T2 paint a clear picture. Germany sits at over €1 trillion in credit. Italy presides over around €400 billion in liabilities. Spain owes roughly €390 to €440 billion. France now also runs negative, around €150 to €210 billion across 2024-2025, and this is expected to rise.
T2 matters because it tracks what Europeans actually do with their money, not what politicians say they should. When money flows from, say, Italy or France to Germany, it shows where people think their euros are safer.
The balances today dwarf those from the 2012 crisis, when markets feared the Euro might fall apart. Back then, at least, there was clarity: Germany was safe, Greece was not. Today, with France paralysed and Germany stagnant, the old certainties no longer hold.
The European Central Bank (ECB) has tools for such moments. Its Transmission Protection Instrument permits unlimited bond purchases to support member states facing “unwarranted” market pressure (whatever that means).
Yet to qualify for such assistance, countries must comply with EU fiscal rules. They must demonstrate debt sustainability. They must cooperate with Brussels on economic reforms.
Today, France fails every fiscal test the EU has devised. The deficit is nearly double the EU’s 3 percent limit. Debt exceeds 110 percent of GDP, which is above the 60 percent threshold. No wonder the Commission placed France under an Excessive Deficit Procedure (not that it has made any difference).
Should markets force the ECB to defend France, any intervention would invite immediate legal challenge. Germany’s Constitutional Court has long questioned the central bank’s mandate-stretching.
Still, in a genuine crisis, the ECB would almost certainly act anyway. It simply could not leave the Eurozone’s second-largest member exposed to attacks.
But doing so would then also expose the Euro’s central contradiction. It is a monetary union which may be forced to suspend its own rules to survive. This demonstrates that the Eurozone still suffers from fatal design flaws, even after more than a quarter century in existence.
Incidentally, the French crisis also highlights the inadequacy of Europe’s financial tools. This year, France needs to finance €307 billion. But the European Stability Mechanism, introduced to prevent a repeat of the Greek debt crisis, has a maximum lending capacity of €500 billion.
After Greece’s crisis, a half-trillion-dollar safety mechanism sounded impressive. But it would not keep France alive for longer than one and a half years.
To be clear, Europe’s monetary union is not on the brink of collapse (yet). However, with France heading in the direction it is, it could soon be testing the limits of the Eurozone’s crisis framework.
The most likely outcome, for now at least, is a long period of muddling through. That means we will neither see a resolution nor a disaster. Instead, we will witness a gradual erosion of confidence. Markets will demand even higher returns; growth will slow a bit more, and France’s politics will become even more chaotic.
In a way, that would make it business as usual because Europe has perfected the art of postponing any reckonings. In each crisis, the EU rolls out another stopgap to preserve the system without ever tackling its underlying contradictions, let alone sorting out the root causes of the crisis.
For the time being, thus, the Euro remains the world’s second reserve currency, accounting for 20 percent of global holdings. The French crisis will probably fade from the headlines soon enough. The ECB will find a way to bend its rules without quite breaking them.
And still, it is worth remembering the truism coined by American economist Herb Stein: “If something cannot go on forever, it will stop.”
France may not be the point where Europe’s monetary union stops working. However, it is equally clear that it cannot continue like that forever, either.
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