France a ‘Time Bomb’? Hardly.

by Dan Burrows | November 19, 2012 1:42 pm

The French are furious about the latest indignity to their national honor, having been called the “time bomb at the heart of Europe” by no less an authority than The Economist[1].

As painful as it can be to side with the French, they do have a point.

Certainly a look at the French government’s borrowing costs make the publication’s claims seem rather bombastic. After all, Greece, Italy and Spain only became clear and present dangers to the future of the euro after the bond market sent their benchmark sovereign debt costs well above an unsustainable 7%. Once that happened, it was a no-brainer that those governments were facing insolvency at such usurious rates of interest.

France, meanwhile, enjoys the lowest rates it has seen … well, pretty much ever. A decade ago, the yield on France’s 10-year sovereign debt topped a whopping 8%. Today, it’s barely above 2%. See the chart, courtesy of[2], below:


The yield on the 10-year dropped decisively below 2.5% last summer and has been scraping record lows ever since. Indeed, the yield on France’s 10-year sovereign debt dropped 12 basis points (or 12/100ths of a percentage point) over the last month — and has plunged nearly 1.4% during the past year.

As TradingEconomics points out, from 1990 until 2012, the bond yield averaged 5.3%, with an all-time high of 10.7% in September 1990 and a record low of 2% notched just last month. By comparison, 10-year German bunds yield 1.36%, while the benchmark 10-year U.S. Treasury note stands at 1.61% and the U.K. 10-year gilt goes for 1.77%. At the other end of the sovereign-risk spectrum, Spain’s 10-year debt yields 5.89% and Italy stands at 4.9%.

That makes the timing of The Economist’s cover story a bit of a head-scratcher. Why call France a time bomb now when its debt has never been cheaper? Heck, yields across Europe are diving, thanks largely to moves by the European Central Bank that brought Spain and Italy back from the brink in July.

As sclerotic, uncompetitive and debt-laden as the French economy might be, the global flight to safety amid the shocks and aftershocks of the euro-quake are making it plenty easy for the bloated French state to borrow all the money it needs.

Yes, it’s true that sentiment in the debt market can shift quickly, as The Economist says. And certainly France offers would-be bond vigilantes ample ammunition.

The world’s fifth-largest economy is too big to bail out, and is dominated by public spending, which accounts for 57% of national output. Meanwhile, the country’s debt-to-GDP ratio stands at 90%. Reform — especially when it comes to government spending or powerful unions (which sap competitiveness) — means austerity for a sluggish economy already grappling with 10% unemployment.

But France is hardly on the same path as Italy, Greece, Spain or Portugal. For one thing, the government there actually does a decent job of collecting tax revenue. (If it didn’t, no French millionaire with a clever accountant would be crying foul over the new top income-tax rate of 75%.[4])

True, the nation suffers from overly rigid labor markets, high debt-to-GDP, a lack of innovation, chronically high unemployment and a long record of middling economic performance. But it also enjoys one of the highest standards of living in the world — and some of the lowest borrowing costs.

The bond market might — just might — become impatient with the government’s reform efforts. But that’s a huge “if” — and, importantly, it wouldn’t just blow up in an overnight spike in France’s sovereign debt costs.

If France is indeed a time bomb, why is the bond market so sanguine? Seems like either the fuse is very long, or the market is betting on a dud.

  1. The Economist:
  3. [Image]:
  4. the new top income-tax rate of 75%.:

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