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France Is Going Down

There is a good bit of anticipatory gloating and schadenfreude about France in conservative anglosaxon circles.

We enjoy the spectacle of the French people electing a socialist government in the midst of a sovereign debt credit crisis. We are excited by the new government's array of taxes which will throttle any prospect of animal spirits in that lovely country. We are amused by the government's new law against plant closings. We await impatiently the inevitable "missed" fiscal targets, the "unexpected" decline in revenue and the "unexpected" rise in spending. We gnash our teeth at the bond market's dereliction, refusing to rise up and do to France what it is doing to Italy and Spain. But we know, in our heart of hearts, that France is going down.

No one wants to see Hollande fail more than I do. But I have to be honest: it isn't really his fault. Yes, of course raising taxes and cutting spending may help to keep the bond market happy, but it will not succeed; France is going down.

Thanks to the wonderful folks at the St. Louis Fed, we can readily access French financial and economic data in God's own language. The picture isn't pretty. Yes, debt/GDP is headed in the wrong direction, and yes, the public sector is gigantic. But that's not the problem. The problem is nominal growth (real growth plus inflation). Nominal money is the currency in which the world does business; "real" money isn't real.

France's nominal GDP growth is dangerously inadequate. Having fallen to -4% during the crisis, it crawled back to 2% and is now falling once again. Right now it's at 1.5%, and falling. No country can prosper and maintain fiscal balance without better growth than that. Since EMU, NGDP growth has ranged from 3% to -4%, with an average that is way too low.

NGDP growth of 1.5% necessarily limits government revenue growth to ~1.5%, and it is not possible to run a socialist economy on that level of growth. Yes, Northern Europe has done so. But Northern Europe has already reformed itself, and shed an awful lot of socialist dead weight in the process.

France has not reformed itself, and just voted for more left-wing utopianism. To live in a world of very low nominal growth requires heroic budget discipline and flat real wage growth. It requires docile labor unions and public-sector layoffs. It requires an efficient private sector that can restructure itself to compete despite a strong currency. That France doesn't have.

France needs at least 4% if not 5% NGDP growth to start digging out of its hole. Hollande could usher in his socialist paradise if he had that kind of growth. But he's not going to get it, the way things are headed. France is going down, but he is too dumb to know it. (Has he ever bothered to read an American economics textbook?)

France needs inflation now. There are only two ways to get it: eurozone exit or a change in the ECB's mandate. France is not going to leave the eurozone prior to its default, which leaves the ECB charter. The problem there is that the charter treaty can't be changed without a unanimous vote of the 17 eurozone members, and the North isn't buying it.

That means that France faces a future of anemic growth, continuing fiscal deficits, rising debt ratios, riots (of course) and, at some point, a bond market revolt. The ECB will do everything it can to prevent a sharp rise in French bond yields, but it is limited by its "no fiscal monetization" charter. That is why I expect France to go down, probably at the end of next year, when the fiscal targets are "missed".

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I have tried to minimize my exposure to the eurozone crisis.