27th November 2013
“Throughout the country we have come to the same conclusion – of a society rife with tension, exasperation and anger. There is a sense of despondency.” French regional prefects, in an unusually alarmist report to Paris
It’s notable how many notorious and dogmatic bears have capitulated in recent weeks, from hedge fund manager Hugh Hendry of Eclectica (a prominent proponent of the China hard landing thesis) to CNBC fixture Marc Faber (of Austrian school Fed hyperinflation/gold bug fame) and at the more credible and nuanced end of the guru spectrum, Jeremy Grantham of asset manager GMO. Having largely missed the huge rally in risk assets since 2009, all have more or less recanted on the basis that you can’t fight the flood of global central bank liquidity. Grantham for instance now sees global equities rising another 20-30% over the next year or two. So what could throw a rock in this pond of complacency? Political risk is rising globally as QE driven asset inflation exacerbates underlying inequality trends and drives social polarization from the US to Thailand. France is worth watching closely on this score; while long delayed spending cuts amounting to about €60bn are set to hit most public sector employees in coming months, we can safely assume that the overtime bill for the notorious CRS riot police will be well over budget as they attempt to suppress a growing backlash on the streets against perceived excessive immigration and deteriorating living standards.
The French are accustomed to an all-powerful and intrusive bureaucracy and almost monarchical executive, the broad structure of which hasn’t changed since Napoleonic times, but they expect their Presidents to at least project French flair and virility, not become a global laughing stock. Francois Hollande’s provincial mediocrity and innumerable political U-turns have earned him the moniker ‘Flanby,’ after a wobbly Nestle dessert brand, creating a political vacuum which the far-right National Front is seeking to fill amid growing talk of the end of the Gaullist Fifth Republic. While Italy has finally rid itself of Berlusconi and the New Dawn proto fascists have been sidelined in Greece, a febrile political mood is taking hold in France. The country has been in inexorable decline since the 1990s on just about every economic metric from productivity to government debt and trend growth has been a dire 1.2%, just above Italy’s; a tipping point may be looming in terms of investor perceptions in 2014.
The usual French ritual of noisy street protests by farmers, fishermen, teachers or some other interest group protecting their privileges until they force a government climb down simply can’t play out any longer, given the EU pressure on Paris to belatedly meet its 3% deficit target and we could well see a large portion of the lower middle classes in open revolt next year. The central bank asset reflation experiment since 2009 has exacerbated wealth inequalities globally, but it is a particularly contentious issue in a country with egalitarian pretensions as a key part of its identity, set against the backdrop of a sclerotic economy and the most centralized state administration aside from China and Russia.
Taxes have risen by about 3 percentage points of GDP in the past three years, taking the overall tax burden to 46% of national income and the spending cuts will antagonize a volatile national mood. A recent report by the OECD said there had been “no significant improvement” in France’s diminished competitive position since the financial crisis of 2008. France has swung from a trade surplus until 2004 to a deficit of about 2% of GDP (versus Germany’s 6% plus surplus). The EU and the OECD have called on the government to take more radical steps to cut the enormous public spending bill at almost 57% of GDP. Unemployment is over 11% versus just over 5% in Germany, but youth unemployment is on a par with Spain at almost 27%. Betting on a widening spread on OATS over Bunds hasn’t paid off this year, despite another credit downgrade and the government debt ratio exceeding 95% of GDP, but is a trade worth revisiting in early 2014.
The French economy unexpectedly contracted in Q3, there is no respite in Q4; the Markit composite PMI fell two points to a five-month low of 48.5 in November. Against that economic backdrop, the National Front’s populist mixture of anti-immigration, anti-EU and anti-austerity policies is gaining traction and echoes the platform of other far right wing parties emerging from the UK (UKIP) to the Netherlands (PVV),who may form a powerful ‘rejectionist’ bloc in the next European parliament, and thus resuscitate EMU sustainability fears among global investors.