This is the another in a series of articles that makes a fundamental macroeconomic sectoral flow analysis of the economies of key countries across the globe.
The purpose of the review is to see if the local stock market is worth investing in via exchange traded funds (ETFs). These funds are available to all investors, even for non-residents or those not able to trade in the stock market of that country directly.
In this article, we examine France from a sectoral flow analysis perspective to see if the private sector, containing the local stock market, is getting the support it needs from the government and external sectors to continue its march upward.
Details of the methodology employed to analyze these opportunities are available in the sectoral analysis section found later in this article.
The magic formula for success is:
P = G + X
And you can read more about that below.
Which Countries Are Doing Well?
The first port of call is the ETF page at Seeking Alpha and a look at country ETFs and how they are performing.
The chart is from early December 2016. In that time positions have changed a little as the table below shows.
Most countries on the list are in the red and are of no further interest, though we could learn from them what to avoid, as could their governments and politicians. But, as investors, we will leave that to them.
Since the start of this series of articles, France has moved from 26 to 25 on the list. France is up 11% over the last 12 months.
We will start the analysis with the government sector.
The government of France focus is on "budget consolidation, " and this means spending less. This means tax increases and cuts to things such as welfare, education, security, health, and infrastructure. A deconstruction of the public realm.
The following slides taken from a Ministry of Finance presentation illustrate the fiscal aims for the future.
(Source: Government of France, Ministry of Finance)
With this sort of focus in the face of ten percent, unemployment one can see why the current French elections are hotly contested and why the Front Nationale, under Marine Le Penn, has moved from the periphery to center stage.
The chart below shows the long-term budget balance:
The chart shows the government is normally in deficit and is a net injector of funds into the private sector. This is a positive for the private sector.
One notices the familiar pattern of declining government spending and then a recessionary phase for the boom-bust cycle, early 1970's, the early 1990s, Dot-Com at the beginning of the 2000s and then more recently the GFC of 2007. Judging by the present rate of government spending decrease the next recession should arrive in 2020.
After 2020 there will be a return to an expansionary budget setting, after the boom-bust, as the automatic stabilizers deploy in the form of unemployment benefits for people made unemployed when jobs disappear in the recession.
France currently has a persistent and relatively high level of general unemployment and catastrophic levels of youth unemployment as the charts below show.
This clearly shows that the budget deficit is not nearly enough and that the government now has the opportunity to employ all that labor, that the private sector has no use for, on public infrastructure improvement. This idle labor resource has been available for almost ten years now.
The next chart shows the value of the budget and a measure of how much money is being added or drained from the private sector.
The chart shows that over the long term the government has been net adding to the private sector The net add is in planned decline if the current government remains in power. If history is any guide, the government will reduce its spending into the private sector for up to several years, and then a recession will result and a return to expansionary fiscal measures forced upon it. This is particularly so as France cannot fall back on a positive external sector and this is discussed further in the next section.
At the moment the government is injecting 80B Euros per quarter into the private sector.
France has some of the highest and most complicated taxes in the world:
(Source: Trading Economics)
It is not just the high rates but also the very complex bureaucratic impost that a value added tax (sales tax) creates. The administrative overhead smothers small business while larger companies are more able to carry the burden.
The French consumer pays a 50% income tax and also social security rates that also function as a tax. A consumption tax of 20% further erodes spending power. If the consumer is young, he most probably does not have a job as there are not enough to go around with youth unemployment at over 25%. Great Depression levels of unemployment for France's youth.
Your average French household is likely also to have its spending power further sapped by principal and interest charges on car, mortgage and consumer goods loans as shown in the high debt to income level in the chart below.
One notices from the chart that the average French household has doubled its debt load since 2000. 2000 was the time of the introduction of the Euro to France.
If the French household acquired their house in the last ten years, it is also likely to be underwater on its housing loan as the chart below shows.
The chart below shows that there are fewer house starts since the GFC but construction remains robust.
The chart below shows the long term balance of trade position.
The chart shows that France has a poor balance of trade that is draining the private sector of funds. The balance of trade appears to have had a change of trend after peaking in 2000, at the time of the introduction of the Euro. Since that time the balance has trade has steadily decelerated and turned negative in what appears to be a worsening trend.
The chart below shows the capital flow situation.
The chart shows a balanced flow of capital in and out of France. There is no strong trend in either direction, and this has been the case since the mid-1990's.
The chart below shows foreign direct investment.
Foreign direct investment has been mainly positive over time. There is no strong trend in either direction but does show that come boom or bust foreigners have been steadily investing in France and see it as a good place to make a profit and always have.
The chart below shows the current account situation.
The chart shows that the overall impact of the external sector is negative and a net drain on the private sector. This appears to be a new and sustained trend that began in 2000 with the introduction of the Euro.
Thus we have a private sector that is receiving a declining net inflow from the government sector and a net drain from the external sector, tendency worsening.
The external drain is about 20B Euros per year that is more than made up by government spending of 900B Euros per year.
One might ask why does one blame the introduction of the Euro for the change in France's fortunes? The answer is that the Euro is worth more than the former French Franc relative to other national currencies. This means that French export products are more expensive to purchase than when they were priced in Francs. Customers switch to alternate providers offering the same goods at a lower relative price.
One can see the total trend when one compares GDP with the amount of money in circulation, shown in the following two charts:
The charts show that GDP has fallen since the GFC and it now at the level it was over ten years ago. The money supply, on the other hand, has still grown.
There has to be roughly the same amount of money in circulation to enable the transactions that compose GDP to take place. If there is inflation, it is because more money than GDP is in circulation and vice versa.
GDP has fallen so one might expect that inflation might have increased because the same amount or a greater money supply exists and not matched by the same value of GDP transactions. The chart below shows that this is indeed the case, and inflation has ticked up. At less than 2%, inflation is by no means high and goes to show that if you want more inflation all your have to do is put more money into circulation or destroy productive capital or both. France has done both thanks to austerity imposed by the EU. One cannot grow and economy via austerity any more than a person can gain weight by eating less.
One can achieve inflation in two ways. One is positive in that the government puts too much money into circulation and the other is negative in that the economy shrinks and produces less while the money supply rises or stays the same. France is a good working example of the latter. France now has stagflation in that there is inflation and unemployment together.
The inflation rate is tolerable however general unemployment at ten percent and youth unemployment at twenty-five percent after ten years of austerity is intolerable. One can quite rightly understand political push-back against the ruling establishment after such mismanagement of the economy for such as long time.
In deflationary times a government can create more money and enhance the general level of education, health, and public infrastructure. This adds liquidity to the system and also long term productive capital into the economy.
France cannot do this as it is not the issuer of the local currency unit, "fresh water" can only enter the system through debt or an external surplus. Another method is to tax less and leave more money in the private sector to meet the saving and spending desires of the population and let the private sector save and invest. Considering the high and complex taxes and the private debt level, this would be a welcome and much-needed relief.
France is another country we have looked at that is no longer a sovereign nation in the true sense of the word. France has surrendered its sovereignty to Brussels and Frankfurt and functions now as a State in a Federation. A federation that has no treasury, just a central bank run by Germans.
Sectoral Analysis Methodology
Each nation state is composed of three essential components:
- The private sector
- The government sector
- The external sector
The private sector comprises the people, business and community, and, most importantly for investors, the stock market. For the stock market to move upward, this sector needs to be growing. This sector by itself is an engine for growth and innovation. However, it needs income from one or both of the other two sectors to grow in value.
The government sector comprises the government with its judicial, legislative and regulatory power. The key for the stock market is that this sector can be both a source of funds to the private sector through spending and also a drain on funds through taxes.
The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained, for a sovereign government with a freely floating exchange rate any financial constraint such as a matching bond issue is a self-imposed constraint as is a debt ceiling.
France does not enjoy this sovereign privilege as it is the user of a currency and no longer the monopoly issuer of its currency unit.
The external sector is trading with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.
One should note that a negative trade balance also means that a country has traded currency, that is in infinite supply, for real resources that have a finite supply.
For the stock market in the private sector to prosper and keep moving upward, income must enter the flow. Otherwise, the sector can only circulate existing funds, or is being drained of funds and is in decline.
The ideal situation is that the private sector has a net inflow of funds and is constantly growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.
The following formula expresses this simple relationship.
Private Sector [P] = Government Sector [G]+ External Sector [X]
P = G + X
For the best investing outcome, one looks for countries where the government sector and external sector are both net adding to the private sector and causing the local stock market index to rise with the receipt of additional funds.
France does not meet our assessment criteria and is not a buy at the moment, but there is hope. If France chooses to put Marine Le Penn and her Front Nationale party into power at this year's French election AND she can follow her stated plans for France to leave the Euro then the external trade situation can be turned around as can the internal government spending trend. This would lead one to invest in a France ETF.
If the political status quo remains, sectoral accounting shows that France is decelerating into a recession that it never really left. The government sector is adding less to the private sector and plans to add less going forward. The external sector has been draining the private sector of funds since 2000, and the rate appears to be accelerating. This means that the French private sector is being systematically shrunk and the falling rate of GDP and rising private debt levels show this.
To be able to move forward under present conditions the government sector needs to inject enough money into the private sector to match the external deficit PLUS meet the saving and investment desires of the private sector. France is hamstrung by its EU membership. Membership means France cannot devalue its currency, and it cannot spend more than 3% of its GDP on public purpose, and the result is great depression levels of unemployment ten years on from the beginning of the great recession.
France is one of the Southern European EU member country/states that are losers to their EU neighbors. For France, the Euro is too expensive, and for Germany and the Netherlands, it is too cheap. This confers a trading disadvantage on France and a trading advantage to Germany and the Netherlands that they would not otherwise have in a freely floating currency exchange market of national currencies.
If one wished to invest in France, and there does appear to be a glimmer of hope if there is change at the next election the following ETF can be used: the iShares MSCI France ETF (NYSEARCA:EWQ)
Some of the funds are hedged which is an important consideration given the weak prospects for the Euro. If and when the Euro breaks up, and replaced by various sovereign national currencies, a new French currency is likely to fall quite strongly. The fall in value due to its external sector weakness. This weakness is currently muted by the more strongly performing members of the Euro, such as Germany and the Netherlands, whose currency would rise.
That is about the only downside as a France free from EU shackles would be free to devalue its currency to attract export income and run government deficits large enough to stimulate enough employment to give more people a job. GDP would rise again; the economy would bloom and the stock market boom.
Our next article takes us to Switzerland.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.