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jeudi 15 décembre 2011

SELECTED BLOGS: A.LILICO//Is it now OK for British politicians and central bankers to call for France to lose its AAA rating? When can we start?

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Andrew Lilico

Andrew Lilico is an Economist with Europe Economics, and a member of the Shadow Monetary Policy Committee. He was formerly the Chief Economist of Policy Exchange.

Is it now OK for British politicians and central bankers to call for France to lose its AAA rating? When can we start?

(Click here for large version of graph.)
Christian Noyer, head of the French central bank, thinks that, if any country should lose its AAA rating, it should be the UK. I would be most interested to ponder the French reaction, should such comments be made in reverse. Can we take it that it would now be OK for British politicians, civil servants, or members of the Monetary Policy Committee to call for France to lose its AAA rating? When can we start?
Here are the countries that Standard & Poor's still awards its highest, AAA, credit rating: Australia, Austria, Canada, Denmark, Finland, France, Germany, Guernsey, Isle of Man, Liechtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland, and the United Kingdom. If you focus upon European sovereigns, and set aside Luxembourg and the even smaller states, the relevant list becomes: Austria, Denmark, Finland, France, Germany, Netherlands, Norway, Sweden, Switzerland and the UK. The yields for the benchmark 10-year bonds for these countries over the past four years are shown above.
Now, over the past year, yields on all these bonds have fallen, except for two countries: Austria (where they've essentially stayed still); and France (where they've risen). We can think of these bonds yields as made up of four factors:
  1. expected growth across the relevant capital market
  2. expected inflation in the country
  3. expected depreciation in the currency in which bonds would be serviced / repaid
  4. the expected risk of the government defaulting.
The higher each of these factors, the higher the bond yield.
I've made the lines a bit thicker for France, the UK and Germany. The UK's yield has fallen markedly over the past year.  That is likely to be through a combination of growth expectations being downgraded and the risk of sovereign default falling (as the Coalition's deficit reduction plans bed in). While in early 2010, the UK had comfortably the highest yield on this graph, it has now converged to almost the German level. Yields in Germany fell until August 2011, then rose. The fall was probably driven mainly by the perception that the currency Germany would repay its debts in would appreciate relative to the current euro – e.g. if the euro broke up and there were a New Mark. The recent rise was probably driven mainly by increased risk of German default – e.g. if it took on responsibility for the debts of weaker eurozone members such as Italy.
French yields are amongst the least changed on the graph (together with Austrian). Now the French could claim that is because France is its own capital market and French growth prospects are better than those elsewhere. But no one would take that claim seriously. Note that French yields move almost in lock-step with Austrian yields.  The reason is that the banks in these two countries are believed to be particularly exposed to defaults in PIIGS states.  It is expected that the French and Austrian governments will bail out their banks, more, if those banks become distressed from, say, Greek default.
This renders Noyer's remarks about the French budget beside the point. French government budget plans are almost incidental. What places the French sovereign in particular distress is its commitments to the banks. Whereas in the UK the Coalition government has taken significant (albeit still inadequate) steps to disentangle the government from the banking sector, such as the Vickers proposals and the treatment of the Southsea Mortgage and Investment Bank, the French government is more entangled with the banks than ever. Furthermore, there is a material risk of the euro collapsing entirely, with the consequence that the French repay their debts in New Francs or something – a currency that might well be devalued relative to the euro (because of the loss of Germany). After all, the ERM crisis of 1992-3 eventually reached France, and the Franc was not able to hold its peg against the Mark. Is France really so immune this time?  Indeed, there is a material risk that France could be one of the first to withdraw from the euro. The Socialist candidate for the imminent French presidential election, who is well in the lead in opinion polls, says he will seek to renegotiate even the inadequate €+-26 Treaty agreed last week – an event that would presumably imply French withdrawal from the euro, since that Treaty is an absolute minimum necessary (though by no means sufficient) set of conditions for the euro to survive. Furthermore, if one looks back through history, France is the stand-out serial defaulter amongst the AAA-rated sovereigns.  That hasn't happened since the 1930s, but then France hasn't faced a situation like this since the 1930s. Total French societal debt (~340% of GDP), including private sector as well as public sector debt, is well above Italy's (about 310%).
The question France should be asking is not whether its credit rating can be justified as lower than the UK's. Instead it should be asking whether it's credit rating can really be justified as higher than Italy's.

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