France’s political crisis has moved out of parliament and into the bond market. That matters to Ireland because when investors begin questioning the finances of one of the euro zone’s largest members, the consequences rarely remain within its borders.
The premium demanded to hold French 10-year bonds rather than German debt has risen above 150 basis points, its highest level since late 2011. French borrowing costs are approaching 5 per cent. The country’s credit-default swaps, a measure of the cost of insuring against financial trouble, have reached their highest level since 2013.
These are not the numbers of an imminent default. France remains a large, wealthy country with deep capital markets and an economy capable of supporting substantial public borrowing.
But that is precisely why the warning should be taken seriously.
The last euro zone debt crisis began in smaller economies that could be treated as exceptions. France cannot be ring-fenced in the same way. It sits at the center of the European banking system, the bond market and the political project itself.
France’s problem is not simply that it has too much debt. It is that the political system appears increasingly incapable of deciding who must pay for it.
Public debt has reached approximately 119 per cent of gross domestic product. The budget deficit remains well above the European Union’s 3 per cent limit. The government is seeking €54 billion in savings, including freezes affecting public-sector pay and pensions, while preparing to issue a record €340 billion of debt next year.
Bond investors want credible spending restraint. Voters want public services protected. Political parties are approaching a presidential election in which promising sacrifice is unlikely to be rewarded.
The result is paralysis.
The government’s proposed budget has failed to reassure investors and has helped ignite wider unrest. Schools have closed, students have clashed with police and thousands have been arrested. The immediate grievances concern classroom conditions, staffing and public funding, but the deeper conflict is about the distribution of scarcity. France can no longer provide every service, protect every benefit and borrow at yesterday’s interest rates.
This is often presented as a uniquely French failure. It is not.
Across Europe, governments built their finances during an extraordinary period in which interest rates were suppressed, central banks bought sovereign bonds, and investors treated public debt as almost costless. Programs could be expanded, taxes cut and difficult trade-offs postponed because refinancing remained cheap.
That period has ended.
Higher energy prices, persistent inflation and the retreat of central-bank bond purchases have returned price discovery to sovereign debt. Private investors must now absorb more issuance, and they are demanding greater compensation for inflation, political instability and fiscal risk.
France is discovering that the bond market does not vote, negotiate or accept promises of reform at some unspecified future date. It simply raises the price.
The obvious reassurance is that the European Central Bank will intervene if the pressure becomes dangerous. It has the capacity to purchase bonds and prevent a disorderly divergence in borrowing costs between member states.
That protection is neither automatic nor unlimited.
The ECB’s Transmission Protection Instrument was designed to counter market moves judged to be unwarranted and disorderly. France’s deterioration has so far been gradual, and its fiscal weakness is real rather than the product of an irrational speculative attack. France is also subject to the EU’s excessive-deficit procedure, complicating any argument that it deserves unconditional support.
The ECB faces another constraint: euro zone inflation has risen to 3.8 per cent, driven in part by higher energy and food prices. Buying French bonds to suppress borrowing costs while simultaneously trying to restrain inflation would expose the contradiction at the center of European monetary policy.
The central bank can provide liquidity. It cannot make an unsustainable political settlement sustainable.
Ireland enters this period from a stronger fiscal position than France. Government finances are healthier, public debt is lower relative to national income, and recent tax revenues have provided a substantial cushion.
That should not encourage complacency.
Ireland is deeply integrated into the euro zone’s financial system. Stress in French sovereign debt can affect European banks, corporate borrowing costs, investment flows and the value of bonds held across the system. A broad repricing of European risk would eventually reach Irish businesses and households through mortgages, commercial lending and weaker demand from major trading partners.
There is also a political lesson.
Headline fiscal strength can disappear quickly when temporary revenues are mistaken for permanent income. Ireland’s corporation-tax receipts are unusually concentrated among a small number of multinational companies. That windfall should be used to strengthen the State’s balance sheet and finance productive long-term investment, not to create permanent spending commitments that assume exceptional receipts will continue indefinitely.
France is demonstrating what happens when public expectations become rigid but the financing environment changes.
The choice facing European governments is not between austerity and endless generosity. It is between making difficult decisions deliberately and having the bond market impose them later at a much higher cost.
Ireland still has the advantage of time, credibility and favorable finances. Those advantages should be protected while they exist.
France’s crisis is not yet another 2011. But the bond market is issuing the same warning it gave Europe in 2011: political promises do not become affordable merely because reversing them is unpopular.
The lesson for Ireland is straightforward.
Fiscal sovereignty lasts only as long as someone is willing to finance it.