France is next

I posted back in July that I thought France would be next after Italy in the contagion breakdown because of its macroeconomic metrics. High levels of public and private debt, a long running negative trade balance and current account deficit, stalling industrial production, GDP and employment along with significant banking sector exposure to the periphery all add up to a fairly risky predicament. This is certainly not a country that could take on a strict austerity regime without causing itself some significant short-to-medium term economic damage because it is obvious from the metrics that the private sector has been borrowing from both the external and government sectors for a long period of time.

I have mentioned a few times over the last 6 months that I have been surprised that a rating agency hasn’t already downgraded the country due to what appears to be an unsustainable economic model for a country inside the Eurozone, where there is obvious political and authoritative separation between the national government and the central bank.

Over the last month or so we have also seen Nicolas Sarkozy join Angela Merkel in building a new European economic treaty based on the premise of near-balanced government budgets. That being the case, France is almost guaranteed to under-perform over the next few years and, given its weak starting position, I would suggest there is significant downside economic risk for the nation.  Even if I am being a little bearish on those risks, this certainly isn’t a country that I believe deserves the highest marks you can get for credit default risk. When stacked up against a country like Finland or Germany it doesn’t really make much sense. The CDS markets appear to agree, with Indonesia, a BB+ rated country, outperforming France on 5yr CDS.

So with all that in mind I have been on the lookout for news that France was about to lose its top rating for some time. Not only because I have expected it to occur, but also because of the considerable flow-on effects this downgrade would trigger:

The European Financial Stability Facility may lose its top credit rating if any of the bailout fund’s six guarantors face a downgrade from AAA, Standard & Poor’s said.

“We could lower the long-term credit rating on EFSF by one or two notches if we were to lower the AAA sovereign ratings, which are currently on creditwatch, on one or more of EFSF’s guarantor members,” S&P said in a statement today.

At the same time, the ratings company said it “could affirm the AAA ratings on EFSF and its issues if we affirm the rating on all six of EFSF’s guarantor members currently rated AAA.” Germany, France, the Netherlands, Finland, Austria and Luxembourg are the top-rated nations backing the rescue fund.

Last night the markets appear to have been spooked by statements by Sarkozy’s finance minister, which backed up the president’s own comments from a day earlier and appeared to be softening up the citizens of France for a coming downgrade:

For France to lose its triple-A debt rating would be bad news but “not a cataclysm”, Foreign Minister Alain Juppe says, amid rumours a downgrade is imminent.

Since the weekend, French officials have been preparing the ground for a ratings agency to decide that the nation’s public finances no longer merit a perfect debt rating, a result once seen as a disaster.

“It wouldn’t be good news, but it wouldn’t be a cataclysm either,” Juppe told the financial daily Les Echos, in an interview conducted on Tuesday.

S&P appear to have rebuked the rumour for now, but I think it is fairly clear from these statements that the French government are expecting the worst. Given France’s economic circumstances, as I described above, so am I.

In other news, the Hungarian foreign currency home loan debacle is flaring up again, the Greek PSI+ is looking shakey , Italy paid a high price of its latest 5 yr offerings and finally, Merkel seems to be extending an olive branch to David Cameron.

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  1. I expect Belgium or Portugal before France, but it’s a house of cards so maybe France next.

    UBS yesterday said they don’t think the ECB will print, but after all the asset fire sales to occur in 2012 across the EU, no growth..etc. They print IMO.

    It’s started…
    EU Bank bailouts today:
    Greek Piraeus Bank – needs 400M small, but..
    Germany Commerzbank – need Eur5.3B by Jan 20

  2. Right, here is what might be happening:

    Behind the scenes of the recent summit a deal was done.

    The ECB will lend unlimited amounts to a select list of Euro banks who must on lend the money to their governments. So the three biggest German banks have unlimited funds to buy German bonds, the three biggest French banks have unlimited funds to buy French bonds, and so on for each Euro country. Any collateral will do, promissory notes from dead Uncle Herbert included.

    Thus the solvency and future profitability of the chosen few is assured (Europe is all about insider deals behind closed doors – they are not like us).

    How does this work out? The favoured banks sell down their foreign assets but buy more of their own government bonds on the guaranteed carry trade this gives them. So the chosen Italian banks borrow at 1% and on lend at 6.5%. Nice if you can get it, but there is a catch.

    Yes there is always a catch. This is the perfect mechanism to set up a sytem of Euro dissolution (which the Bundesbank demand – do not be fooled by the rhetoric).

    Is there a secret agreement that these loans from the ECB will automatically redenominate into local currency should the Euro dissolve?

    • Sorry that should read

      Is there a secret agreement that these loans from the ECB will automatically redenominate into local currency when the Euro dissolves?

      Have they already set a date?

    • @RTD – …..(Europe is all about insider deals behind closed doors – they are exactly like us).


    • Interesting if the Euro breaks up can the countries maintain a banking system structure separately or will it all dwindle into a depression. The debt is something like 2.9 trillion that rolls into the Eurozone next year and he is saying there are no buyers for this debt.

  3. DE, if you insist on phonetic spelling, why don’t you go all the way and spell it “looz”.

      • Lol. BTW, Lorax, you suggested on another thread that I was coming from a hard core libertarian perspective. I thought I would check myself out again on that score, since I had not visited for a while. Maybe my political views had changed.

        My score this time was -1.25,-3.74. Somewhat left of centre, more libertarian than authoritarian, but not extreme by any means.

        Interested to know what your score is, and those of other MB readers who might like to take the test.

          • Hmm, I came in mildly bottom left too. Birds of a feather flock together perhaps.

            Not sure about their basic premise though, usually these things correlate most heavily with IQ, so thick people tend to be more authoritarian.

            Did they administer the test to the famous people they plot as examples? I suspect not.

          • Forgot to add, people get more conservative with age.

            Personally I see that as a good thing. Capital is so valuable it should be allocated by the wiser members of society.

          • @RTD “Did they administer the test to the famous people they plot as examples?”

            No. On the Analysis page, under the heading International Chart:

            ” A diverse professional team has assessed the words and actions of internationally known contemporary leaders to give you an idea of how they relate to each other on the political compass.”

            Interesting that all modern politicians they analyse are in the upper right quadrant. No careers in politics for MB readers, then!

          • Economic Left/Right: -2.62
            Social Libertarian/Authoritarian: -4.82

            seasonal adjustment…yup…south west corner is flavour of the day.

        • My test returned (-4.5,-4.1), which bothers me quite a bit, since I usually find myself in violent disagreement with most Libertarians, and consider Utilitarianism (which always seems to go hand in hand with Libertarians) to be simply an attempt to layer a veneer of philosophical respectability around psychopathy.

          • Wouldn’t worry too much about it, drsmithy. People who self label as libertarians tend to score -9.0 or lower. Often they are extreme right wing politically as well, so 9.0,-9.0 would not be untypical.

        • Gandhi. I wonder if I was hypocritical with my answers as I ended up with -5 / -2.51. I’ve always been centre right in real life, but I’d struggle voting republicans in the US. It depends on the surrounding society how you look at things.

        • I’m close to center, I think there is at least a grain of truth in all views,

          Economic Left/Right: 0.62

          Social Libertarian/Authoritarian: -1.33

        • dumb_non_economist

          Well, blow me down I’m a saint or near enough to it, I’m between Nelson Mandela and Dalai Lama!!

          L/R -5.50
          L/A – 5.23

          I’ll accept donations of any worthwhile currency or if you’re short on cash I’ll begrudgingly accept gold/silver!

          • Hehe, As Gandhi, I volunteer to peacefully negotiate the form and amounts of donations you receive, and I am grateful for whatever reward or lack thereof you may consider appropriate for my participation.

      • Hmm, interesting result. Easy to do whilst having my cup of coffee. I’m definitely a fuselage, politically, although I think I’ve moved over to the left aisle since blogging at MB.

        Economic Left/Right: -2.12
        Social Libertarian/Authoritarian: -4.82

  4. “Forgot to add, people get more conservative with age.

    Personally I see that as a good thing. Capital is so valuable it should be allocated by the wiser members of society.”

    I have my own adage on these things, which is that youth is wasted on the young and money is wasted on the old…..:)