France’s Threat to the World’s Government Bond Market | American Enterprise Institute– www.aei.org
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EXCERPT:
Mark Twain is said to have observed that while history may not repeat itself, it certainly rhymes. We would do well to bear this in mind as we watch France’s government bond-market crisis unfold. As with the 1997–98 Asian financial crisis and the 2010 eurozone sovereign debt crisis, the turmoil in France’s bond market could quickly spread to other countries that share some of its basic weaknesses. That risk looks especially acute at a time when Italy, Japan, the United Kingdom, and the United States all appear to have unsustainable public finances.
In 1997, the Thai currency devaluation triggered a wave of devaluations across Asia, including in Indonesia, Malaysia, the Philippines, and South Korea. Similarly, the 2010 Greek debt crisis set off sovereign debt crises in Ireland, Italy, Portugal, and Spain. In both cases, contagion spread for two reasons: The initial crisis put a spotlight on other countries with similar weaknesses, and traders who lost money on positions in the first country were forced to liquidate positions elsewhere.
Today, France, Europe’s second-largest economy, appears to be on the cusp of a full-blown government bond crisis. Its $4 trillion government bond market is roughly eight times the size of Greece’s. Since the start of the year, French 10-year government bond yields have soared from around 3.5 percent to almost 5 percent. That is the largest increase among the G7 countries, and it has pushed the spread between French and German bonds to its widest since the 2010 eurozone crisis.
There are at least three reasons to believe that France’s crisis will deepen in the months ahead. First, the country’s public finances are unsustainable. Second, its dysfunctional politics prevent it from addressing its budget deficit. Third, its sclerotic economy is being hit by several external shocks that could tip it into recession.
Years of budget profligacy have pushed public spending to a staggering 57 percent of GDP, while the public debt-to-GDP ratio has climbed from 80 percent in 2010 to almost 120 percent today. Meanwhile, a French Ministry of Finance study suggests that, on present policies, the budget deficit will rise from 5.4 percent of GDP in 2026 to 6.8 percent by 2030, worsening an already troubling debt sustainability problem.
