Hollande Delivers A First Blow to the Economy

In his first major policy step, socialist French president Francois Hollande has announced that he will reverse the pension reform implemented by his predecessor and lower the retirement age from 62 years to 60 years.

There isn't a snowball's chance in hell that France can afford this – although its fertility rate is one of the highest in Europe at 2.01, it also sports one of the highest life expectancies (78.1 years for men, 84.8 years for women). A good overview of France's demographic data can be found here.

The Telegraph reports:

„Workers who entered employment aged 18 will be able to retire at 60 rather than 62, under the decree agreed at a cabinet meeting on Wednesday.

The decision follows pre-election promises from the new president Francois Hollande to reverse the rise in the retirement age introduced by his predecessor Nicolas Sarkozy in 2010.“

“We committed to put this measure in place quickly for social justice for those who started working early,” said Social Affairs Minister Marisol Touraine.

The reforms will cost the state billions of euros a year but can be afforded through higher worker and employer contributions, according to the government.

The €1.1bn (£890m) annual cost up to 2017 – €3bn thereafter – will be met by a 0.1 percentage point rise in payroll charges, amounting to an extra €2 a month on the average monthly French net salary of €1,600, it said.

Around 110,000 people are expected to benefit from the measure in the first full year.

Jean-Francois Cope, leader of France’s conservative UMP party, called the policy move “madness”.

“It risks the downgrade of France’s credit rating and at this rate tempts fate,” he said.

(emphasis added)

Yes, it is madness – not least because financing this extravaganza requires higher payroll charges, putting even more financial strain on both labor and business. One should not believe the back-of-the-envelope math of the government regarding the cost per worker for a single second. There is no government program on earth that has not turned out to cost far more than initially claimed, and so it will be with this one. Meanwhile, the French economy is sinking beneath the waves already. This measure should hasten the process.

In recent weeks, the market has treated France's government debt as a 'safe haven', mainly because the danger to France's big banks has been deemed  much diminished following the ECB's LTRO funding rounds.

Whether this view can be maintained remains to be seen – France's banks have the by far biggest exposure to Spanish, Italian and Greek debt in all of 'non-PIIGS' Europe. Their total assets comprise nearly 410% of France's GDP , with the three biggest banks holding assets worth 240% of GDP – the government would struggle to bail them out if things went wrong (note here that we continue to assume that all euro area banks are considered sacred cows and will therefore be bailed out).

As Margaret Thatcher once famously remarked, socialism works until you run out of other people's money. France needs the cooperation of the credit markets if it wants to finance its burgeoning deficit. One day soon, this cooperation may no longer be there.

10 year government bond yield of France – this bond may be an excellent short here - click chart for better resolution.

5 year CDS on France, Belgium, Ireland and Japan. CDS on France trrade at 221 basis points (the orange line) – the markets do not think that the country is a good credit risk. A few years ago it would have been considered outrageous for a highly rated sovereign issuer's CDS spreads to trade at this  - click chart for better resolution.

French Economic Data

Below are some recent French economic data that show the sorry state the economy finds itself in. In all likelihood all these data have in the meantime deteriorated even further, as the recent plunge in France's manufacturing PMI to the below the 45 level strongly suggests.

French manufacturing PMI at 44.7, the lowest level in three years and the sharpest one month plunge since mid 2009 - click chart for better resolution.

As might be expected, the slump is the worst in higher order goods production. Markit's senior economist Jack Kennedy remarked:

“Latest PMI data showed the French manufacturing sector in the grip of a deepening downturn in May. With new orders falling at the sharpest rate since April 2009, output slumped and employment was cut at a sharper rate.

“Detailed sector data showed a marked divergence; the intermediate and investment goods categories continued to suffer, in contrast to growth in the consumer goods area. This suggests that a lack of business confidence is a key factor weighing on the manufacturing sector’s performance at present, as companies put off spending and investment in the face of an increasingly uncertain economic outlook.”

Yesterday's release of the services and the composite PMI revealed similar sharp deterioration, with the composite PMI falling to a 37 month low:

France's composite PMI falls to a 37 month low - click chart for better resolution.

Jack Kennedy's comment on the services PMI release:

“The latest set of dismal PMI figures for the French service sector, combined with similarly downbeat manufacturing survey data, strongly suggests that GDP will contract in Q2 following stagnation in the first quarter. Economic uncertainty was again reported to have depressed new business inflows at service providers, with clients reluctant to commit to spending. Falling workloads led to renewed job cutting, ending the period of stability in staffing levels seen since the turn of the year, which bodes ill for unemployment.”

Below are more economic data from France, but as noted above, these are not reflective of the most recent developments yet. They look bad even so.

France, retail sales - click chart for better resolution.

France's current account deficit in billions of euros - click chart for better resolution.

French industrial production, year-on-year change - click chart for better resolution.

France's GDP, annual growth rate - click chart for better resolution.

French GDP growth, quarter on quarter (most recently at zero) - click chart for better resolution.

French budget deficit as a percentage of GDP – expect this to worsen in coming quarters - click chart for better resolution.

France's government debt as a percentage of GDP – this is far from the Maastricht treaty's limits and is set to grow further – click chart for better resolution.

France is a euro area 'core' country. If Hollande continues down his current path, he will make it all the more likely that the current crisis will worsen to the point where it can no longer be controlled by anyone. Already Europe is in a worsening recession – what is needed now are policies that keep deficit spending in check and allow the private sector to recover. Hollande is doing the exact opposite by heaping yet more obstacles in the path of recovery. He seems to be forgetting that the wealth he is redistributing so generously must first be created.

Francois Hollande, France's mad hatter – throwing around other people's money with both hands.

(Photo credit: Reuters / Gonzalo Fuentes)

Charts by: Bloomberg, bigcharts, Markit economics, tradingeconomics.com

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