Why France's debt crisis matters
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France is dealing with a major debt crisis and social unrest ahead of its presidential election next year.
Why it matters: Worries are rising about contagion in Europe and beyond, and the situation is drawing comparisons with the sovereign debt crisis that rocked the European Union in the 2010s.
- "Government bond yields in France are spiraling out of control. Contagion to the rest of high-debt Europe is unfolding rapidly," Brookings' Robin Brooks wrote recently.
Where it stands: Yields on government debt are rising across Europe and in the U.S., but the situation in France is worse.
- Investors are demanding higher yields to hold French debt, compared with bonds from Germany, which are seen as a safer alternative.
- On Friday, the difference, or spread, between the two countries' bond yields, was the widest it has been since the debt crisis.
- The spread is widening due to "higher sovereign default risk in France," Macquarie's Thierry Wizman wrote in a note Thursday titled: "Are the French Toast?"
State of play: France is dealing with challenges that should have a familiar ring to Americans: a ballooning deficit, an aging population driving up costs, and rising political polarization.
- Those pressures were building before the war in Iran. The conflict has made things worse by driving up energy costs and slowing economic growth.
- Last week, protests by high school students across France turned violent.
Threat level: It's getting higher. "Investors are apprehensive about a looming fiscal crisis that could undermine the European Union's legal framework," per a note from Evercore.
- "Emerging signs of contagion, particularly to Italy, are concerning as they signal a broader instability."
Zoom out: The French government is trying to cut its budget to reassure investors, but it is essentially in a holding pattern until next year's election. And that's what has investors antsy. "Political paralysis is the trigger," says Gianluca Benigno, an economics professor at University of Lausanne. The markets are pricing in France's ability to rein in its spending.
- France's far-right candidate Marine Le Pen is leading in the polls and has proposed writing a "golden rule" into the constitution, limiting the deficit, to constrain spending, as well as tax cuts.
- Far-left presidential candidate Jean-Luc Mélenchon, meanwhile, has suggested that the country's central bank should cancel the roughly 18% of French debt it holds: "Take it and burn it."
Between the lines: An action like that would be like setting fire to your house to fix the broken pipes.
- But as debt crises intensify, policymakers tend to grab for more extreme ideas, says Mitu Gulati, a professor at the University of Virginia School of Law, who studies sovereign debt and helped develop a restructuring plan for Greek debt in 2012.
- "Bad financial conditions give birth to loony solutions," he says.
Friction point: During the 2010s crisis, investors ran to the U.S. for safety — buying up U.S. Treasury debt, and yields here fell sharply.
- This time around, the U.S. status as a safe haven is less assured — it's unclear if that would happen again.
- In fact, the yield on U.S. 10-year government bonds is currently higher than on French debt.
Reality check: It's still early days and likely that the European Central Bank will step in to help.
- The causes of the current crisis are different from what happened more than a decade ago — now, developed countries have adjusted to a new era after years of being able to borrow money at ultra-low rates.
