Source: Barrons
Author: Desmond Lachman
Desmond Lachman wrote in a guest commentary that France's debt crisis could disrupt global markets.
The economist Herbert Stein once said, "If something cannot go on forever, it will stop."
If there is a time when his statement is most applicable, it is certainly the current public finance situation in the United States and France. Stein did not specify when or how this unsustainable situation would come to an end. However, it appears that we may need to prepare mentally for significant fluctuations in the bond markets of France and the United States over the next year.
Long before President Trump took office, the U.S. government's debt was already on an unsustainable trajectory. Now, the "Great and Beautiful Act" could potentially worsen the nation's public finance outlook. The nonpartisan Committee for a Responsible Federal Budget estimates that the tax cuts in this act will increase the budget deficit by approximately $5 trillion over the next decade. This will result in the budget deficit remaining above 6.5% of GDP for an extended period and push public debt to 128% of GDP by 2034, comparable to Greece's levels.
One advantage of the U.S. economy is that its government borrows in its own currency. This makes it virtually impossible for the U.S. government to default on its debt, as it can always rely on the Federal Reserve to print money to repay its obligations.
However, its weakness lies in its heavy reliance on foreigners to finance its budget deficit. In fact, foreigners hold about 30% of the U.S. outstanding public debt. If they become concerned that the U.S. will diminish its debt burden through printing money, thereby escaping from the mountain of debt, these foreign investors will be reluctant to continue financing the U.S. government at the current bond yields.
President Trump continues to pressure Federal Reserve Chairman Jerome Powell to implement significant interest rate cuts, and has recently dismissed Federal Reserve Governor Lisa Cook. These actions undermine the independence of the Federal Reserve and suggest that the unsustainable fiscal situation in the United States may reach its tipping point sooner than anticipated. As evidenced by the 10% decline of the dollar and the nearly 38% increase in gold prices this year, foreign bondholders are likely to refuse to finance the ever-expanding U.S. budget deficit at current yields; it is merely a matter of time.
If the United States is on an unsustainable debt path, France is similarly positioned.
According to data from the International Monetary Fund, without corrective measures, France's government budget deficit is expected to remain around 6% of GDP for the foreseeable future. This would cause France's public debt-to-GDP ratio to reach 128% by 2030, four years earlier than the same level projected for the United States.
Two factors increase the likelihood of a bond crisis in France occurring before that in the United States. First, unlike the United States, France borrows in euros rather than in its own currency. This compels France to rely on the European Central Bank's willingness to continue supporting France through large-scale purchases of French government bonds.
Given the magnitude of these purchases, it is expected that the European Central Bank will tie its purchasing actions to France's commitment to implement stringent fiscal austerity and rectify public finances. However, this is no easy task. France is trapped in the 'straitjacket' of the Eurozone, unable to offset the contractionary effects of fiscal tightening through independent monetary or exchange rate policies.
Secondly, France is currently experiencing significant political instability. Over the past 20 months, France has changed Prime Ministers four times. The current Prime Minister, François Borne, has been in office for less than nine months and has called for a confidence vote next week following the rejection of his budget proposal by representatives from both the left and right in the National Assembly. This budget proposal includes measures to raise the retirement age and cut two public holidays.
If his government collapses due to the failure to pass the budget proposal, the far-right 'National Rally' led by Marine Le Pen may gain more seats in the parliament in a new election.
This momentum-driven party is advocating for large-scale tax cuts, which would make budget austerity nearly impossible. Meanwhile, France's debt-to-GDP ratio is soaring to levels comparable to those in the United States. The interest rates on French debt have already surpassed those of other EU member states with heavier debt burdens, including Italy and Greece.
This is not a good omen for the United States. The size of the French economy is far greater than that of Greece, and if a bond crisis erupts in France, the impact on the global financial markets could be even more severe than the 2010 Greek sovereign debt crisis. This could also serve as a catalyst for bond market watchers to shift their attention to the precarious state of U.S. public finances.
The combination of slowing economic growth and rising long-term interest rates is not good news for maintaining the currently extremely high stock market valuations. In contrast, the unsustainable public finance situations in the United States and France are likely to support the extraordinary rise in the gold market this year, as investors have increasing reasons to question the fundamentals of the U.S. dollar and the euro.
Editor/Rocky