The French economy has settled into a morose pattern of shedding jobs and shuttering companies. In 2012, economic growth was exactly 0%, in 2013 an imperceptible 0.3%. Government spending, which makes up a fat 56% of the economy, has grown 2.1% since the second quarter 2012. But the private sector, oh my! Private-sector GDP declined 0.2% during that time and remains 3.2% below the pre-financial-crisis peak.
And unlike its neighbors, France has a growing population, up 0.42% in 2013. So the low-to-no growth of the economy, as crummy as it is, turns decidedly negative on a per-capita basis. That’s what the French are experiencing.
And yet, France’s financial markets have soared.
After its financial-crisis low of 2,519 in May 2009, the stock-market index CAC 40 began soaring, though it was waylaid in 2011 by the gyrations of the Eurozone debt crisis. But in 2012, crisis fatigue set in, and investors began to ignore the French economy, the shakiness of its megabanks, the near-collapse of its now bailed-out auto sector, bankruptcies, rising unemployment, “negative growth” quarters, the tax policies of the new government, and they closed their eyes and held their noses and piled into stocks, driving the CAC 40 to 4,313, the highest close since August 2008.
And given France’s economic problems, you’d think government debt would show signs of stress. Ha! Those crappy 10-year government bonds? They yield 2.13%, vs 2.69% for 10-year US Treasuries. The yield spread between French and German 10-year bonds, after a nasty spike during the debt crisis, has stabilized in the range of 50 to 60 basis points. French debt is simply rock solid, allowing the government to borrow at record low cost. Foreigners love it: 63.2% of France’s tradable government debt is owned by non-resident holders.
“And it does not react to any announcement or shock,” confirms a new report by Natixis, the asset management and investment banking subsidiary of one of the largest megabanks in France, Groupe BPCE with over €1 trillion in assets and 20% of the retail banking market.
Natixis has its reason why France’s financial markets have performed so well, despite the economy, and why it has been spared the fate of Greece or Cyprus, which faced a market rebellion when they tried to fund bank bailouts and ballooning deficits. OK, Natixis doesn’t mention worldwide central-bank money printing that inflated most assets, no matter what, including those in France. Instead, it found that foreign investors had the hots for French assets “since there is no risk of a drastic crisis in France.”
Oh, not the teetering French megabanks
Note that Natixis is part of a French megabank and isn’t about to question the stability of French megabanks, whose bailouts, beyond those already engineered, would far exceed the means of the government. Hence its beautiful blanket of silence over that potential trigger of a “drastic crisis.”
The risk concerning France is different: it is one of weak growth over an extended period. Actually, everything points to this conclusion: taxation and depressed return on capital; poor cost competitiveness, problems related to labor force skills; low level of sophistication of corporate capital, sector structure of the economy. The pessimism about France’s situation will therefore take hold gradually and slowly.
Everything moves in the wrong direction, but slowly: Public debt of 93% of GDP isn’t jumping but rising at around 2 percentage points per year. Foreign trade is deteriorating, and the trade deficit in goods has reached 4% of GDP, but there is a surplus in services, and the broader current-account deficit is less than 2% of GDP. Unemployment, now around 11%, is inching up but is much lower than in Greece and Spain where it’s above 25%.
“France is not a very cyclical economy, and a drastic decline in activity is very unlikely,” the report finds. Two main reasons: Government spending makes up 56% of GDP (about 20 percentage points higher than in the US); and the rigid “non-competitive” labor market that makes layoffs difficult, stymies job creation, and “prevents real wages from falling during recessions like in other countries.”
So, growth or no growth, government and workers continue spending. France’s problem is “the prospect of very slow growth for an extended period due to persistent structural reasons.” In its optimistic manner, the government forecasts long-term growth to be 1.6% per year. Not exactly red-hot. But given the structural realities, it won’t be achievable. Natixis chops it to “1% at best.” With a population growth of 0.4%, per-capita GDP would grow 0.6% per year long-term, “at best.”
Structural realities are leading to this stagnation.
The return on physical capital is only 6%, down from 10% in 2007 (in the US, it’s nearly 16%). “This discourages investment in France, especially in industry, and is mainly due to the very heavy tax burden weighing on companies.”
Cost competitiveness is lousy, due to “the low level of sophistication of production” and the “very high” unit producer costs. This led to a collapse in profit margins in manufacturing, which now prevents industry from investing and “move more upmarket.” So resources are being diverted from industry to “sheltered services,” where productivity is low and not rising (retailing, construction, etc.).
Companies have been dogged by low productivity gains as investment in new technologies has fallen behind. In 1998, France invested 1.8% of GDP in new technologies, the US 2%. But then the gap widened like the open jaws of a crocodile: in 2013, France still invested 1.8% of GDP in new technologies, vs 3.3% for the US. For instance, companies in France purchased 2,900 industrial robots in 2013, dwarfed by Germany (16,500), the US (24,300), and Japan (27,200).
This “unsophisticated” capital and the inability to move upmarket leads to a “vicious cycle of falling prices and profitability,” and to a “lack of improvement in product sophistication, especially in the industrial sector.”
But unlike Cyprus, France is “not threatened by a drastic crisis….”
And that explains the glorious performance of the financial markets, and the “current lack of concern among investors.” Instead, France is “threatened by the inability to pull out of a situation of persistently weak growth.”
Which could sink France. The social welfare systems (healthcare, pensions, and unemployment benefits) have been seriously in deficit for much of the last ten years. In 2013, they were €15 billion in the hole. So Natixis offers this uplifting conclusion: “As the reduction in government spending required to correct the deficits is very difficult to achieve, public finances will continue to deteriorate on the whole. Investor concern will become more pronounced only slowly and over time.”
And the overleveraged megabanks that are chockfull with decomposing assets? Ah shucks, let’s not mention them.
While the dominant sector in the French economy, the government, is still growing, businesses are failing in record numbers. Read….No Crisis? France’s Private Sector In Deeper Trouble Than In 2009