Europe’s giants are sinking

I’ve mentioned France a couple of times over the last year. When I talked about it last I stated:

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.

As I mentioned in the case Spain, once the economy begins to slow, government sector revenues fall. If deficit cutting is a priority over growth then this inevitably leads to calls for further cuts in government spending and increases in taxation which, in the absence expanding private sector credit or offsetting growth in the external sector, leads to a further deterioration in economic growth. It is far too early in the case of France to suggest such a dynamic has taken hold but growth has certainly become a problem:

The French economy will shrink in the third quarter after stagnating for nine months, the country’s central bank said Monday, indicating the slowdown of the euro zone’s second-largest economy is intensifying.

The 2 trillion euro ($2.56 trillion) economy will shrink 0.1% in the three months to September, Bank of France said.

The forecast suggests France faces its first quarter of contraction since the country pulled out of recession at the start of 2009.

This puts further pressure on President Francois Hollande, who has vowed to kickstart the economy in an effort to make necessary budget adjustments less painful. In a televised interview last night, Mr. Hollande said the government had significantly cut its economic forecasts for next year–with growth now expected to be barely above zero this year, and reaching just 0.8% in 2013, much less than the 1.2% expansion forecast previously.

And in response to the lagging economy and with deficit reduction in mind it isn’t hard to guess what comes next:

Mr. Hollande said his government would propose a budget this month packed with as much as €20 billion ($25.6 billion) in new taxes and €10 billion in spending cuts. He confirmed that the budget will include a special 75% tax for people earning more than €1 million a year that has fanned fears of an exodus of France’s wealthiest citizens.

The painful measures are necessary to fulfill pledges to lower the country’s budget deficit to 3% of gross domestic product next year from 4.5% in 2012 and reassure investors, who have been more lenient with France than with other highly indebted euro-zone countries such as Italy and Spain.

Mr. Hollande was elected in May with a pledge to shift the burden of economic hardship onto the rich and to resolve the protracted euro sovereign-debt crisis by softening the German-inspired prescription of austerity. Stimulating economic growth, Mr. Hollande said, would make restoring the health of public finances easier.

With France’s major export partners being Germany, Italy, Spain , Belgium and the UK it’s very difficult to see the external sector as a source of renewed growth so it will be very interesting to watch exactly what happens to the French economy over the next 12 months. But let’s just say I am more than a little sceptical about those 2013 growth figures.

Mr Hollande, however, isn’t the only leader I think is being overly optimistic given the circumstances. Last week Italy’s Mario Monti was quoted as saying:

Italy has averted the worst case scenario of the debt crisis, and economic recovery in the eurozone’s third largest economy is within reach, Italian Prime Minister Mario Monti said on Wednesday.

“Although recovery is not visible in numbers yet, … it is now within our country’s reach and I think it will come soon,” Monti told local television Norba 24.

I have to say I am struggling to see what Mr Monti is referring to. Unemployment has climbed to 10.7% up 2.4% in a year, the PMIs look woeful, the current account is still over 3% of GDP, industrial production is shrinking rapidly, business and consumer confidence are trending towards GFC lows and yesterday the nation’s GDP was revised downwards again:

Italy’s economy shrank by 2.6% compared with a year earlier, compared with the previous estimate of 2.5%, the national statistics institute Istat said. Compared with the previous quarter, domestic consumption fell by 0.7%, while investment dropped by 2.3%.

“It’s worse than we expected and the size of the contraction in consumer spending is a particularly nasty surprise,” said Unicredit economist Loredana Federico.

The Italian economy – the eurozone’s third largest – has contracted for the past four quarters as the government has implemented a series of drastic spending cuts designed to cut its debt levels, which currently stand at more than the country’s annual economic output.

It must be remembered these are the 5th and 8th largest economies in the world by GDP (nominal) and together have a GDP 35% larger than Germany. Both countries are major trading partners with each other along with Spain, Germany, Belgium and The Netherlands and over 25% of Spain’s exports go to one of these two countries.

Just how periphery euro nations are expected to evolve into export driven powerhouses when their major trading partners are both shrinking and attempting similar policies remains one of those unanswered European economic mysteries. Some may even call it delusional.

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  1. “Some may even call it delusional.”

    Nice one 🙂

    But…but…Hollande opted for growth!!!!How can this all possibly be?

    • Hollande SAID he would opt for growth. His idea of growth seems to be to eat the rich.

      I don’t envy him the job, however. Wasn’t it de Gaulle who bemoaned the impossibility of governing a nation with 146 different kinds of cheese?

      • “How can anyone govern a nation that has two hundred and forty-six different kinds of cheese?”
        Charles De Gaulle

        • or this one?
          “Only peril can bring the French together. One can’t impose unity out of the blue on a country that has 265 different kinds of cheese.”
          Charles de Gaulle

  2. Yep. Delusional. As I’ve said before I share the concern re France which I suspect, for a multiple of demographic reasons, poses a threat to social fabric if the economy deteriorates significantly. Kyle Bass has long forewarned re France.

  3. A couple of French-related tidbits:

    – mate wants to buy a European car, decides on a Peugeot. Been back to the dealers 3 times in 12 months for serious work.

    – French mate goes back to France after work in the NW for 10 years, only jobs on offer are paying less than when he left, despite a decade of international experience. The interviewer asked how little he’d be prepared to work for, it was basically an auction for the job, lowest bidder wins.

    Sell ’em cheese.

  4. Some of these comments, however, have to be seen as positive. France has a highly diverse economy and has pretty high levels of education. There are more global firms than Britain or Italy, for example – in pharmaceuticals, fashion, make-up, wine, power companies, banks, agriculture, tourism, automobiles (which, despite what was said above are far better than they used to be! Particularly Renault – also, the same can be said about most European cars, the thing about Australia is that if you have a small problem with your European car here in Australia you pay through the nose – the same problem with the Japanese/Korean car is fixed cheaply and so nobody complains). If the euro devalues and wages are low, France will be competitive with the likes of many countries around the world.

    • But still likely lack the work ethc of Asian countries for the next 25 yrs until they run out of money?

      • Maybe not. But it sure is a far more attractive place to live (if you can find a job!). As Asia pollutes itself to death, Europe, like Australia will probably remain a very attractive place to migrate to
        from the likes of China and India. Particularly France, with its excellent infrastructure, world class skiing, food and architecture.