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A liberal case for a preemptive and orderly default on French sovereign debt

    Gaspard Koenig is a French liberal author and politician. The first meeting of his French think tank 'Génération Libre', took place at the Centre for Policy Studies late last year. In this guest post, Gaspard writes on the conclusions and recommendations of GL's first report. You can follow him on Twitter @gaspard2012.

    The issue of public debt goes back as far as the emergence of centralized nation-states. Towards the end of the 18th century, the founding fathers of modern Liberalism were quite radical in the remedies they proposed. “When it becomes necessary for a state to declare itself bankrupt, writes Adam Smith in The Wealth of Nations, a fair, open, and avowed bankruptcy is always the measure which is both least dishonourable to the debtor, and least hurtful to the creditor”. Default was not the taboo it has become nowadays.

    In the view of Smith, debt restructuring is not intended to punish the creditor (as in the leftist “repudiation” argument), but represents a pragmatic tool to minimize damages for both parties in the bond contract when public finances are getting out of control. It humbles the State and, if properly carried out and accompanied by the necessary reforms, reassures the markets. As David Hume, another Enlightened Scotsman, put it, anticipating the Bulow-Rogoff argument of debt-forgiveness: “A prudent man, in reality, would rather lend to the public immediately after we had taken a spunge to our debts, than at present”.

    This reasoning seems relevant in today’s French context. The French State has not had a balanced budget since 1974 and interest payments are becoming the nation’s number one expenditure. According to the IMF, debt could exceed 100% of GDP in 2016 if no major reforms are undertaken. The Government’s original deficit-reduction forecasts have already been dropped.

    The typical responses no longer seem relevant. Inflation is not on the order of the day under the current mandate of the ECB. Fiscal pressure will represent an unprecedented level of 46.5% of GDP in 2013, reaching its socially acceptable ceiling. It was even officially acknowledged a few days ago that 8,000 households paid more than 100% of their revenues to the Treasury last year! As for spending cuts, they are (i) doubtful as a debt-management tool, as Christine Lagarde, the IMF Chief, has been warning for some time, (ii) out of proportion with what is required to balance the books, and (iii) not to be expected in the current political context.

    Rejecting the alternative between ‘stimulus packages’ and ‘austerity’, we therefore propose a third route – an orderly and preemptive restructuring of French debt.This option has not been explored in France since the “banqueroute des deux tiers” in 1797, but deserves serious consideration today: although interest rates remain historically low given the quantitative easing frenzy the world over, major investors (including investment funds and international banks) are quietly starting to sell their stock of French bonds, and the prospect of a debt crisis is likely to emerge abruptly once the tide of cheap money will have ebbed.

    According to our calculations, a limited but efficient restructuring could consist in a 3-year moratorium on interest rates, which would put public finances back on a positive trend with a primary surplus by 2017 and a the debt ratio falling below 90% of GDP by 2017. Technically, such a restructuring could be carried out by the retroactive introduction of Collective Action Clauses into French bond contracts, which would then allow for a negotiation with France’s creditors (the majority of which belong to the Eurozone). Creditors’ losses in net present value (NPV) would not exceed 10%. Basic projections show that the banking system could very well absorb the losses. Life insurers would probably be the most exposed, but they pose little systemic risk.

    The new working-age generation would thus be freed from the burden of an ever-rising debt, while those who should bear most of the cost, ie the savers from the ‘68 generation, are precisely those who let the debt rise in order to finance unreasonable standards of living.

    Of course, restructuring the debt would not represent a solution in itself. It would only make sense – and be acceptable to the markets - if it is comes with major structural reforms. Interest expenses ‘saved’, circa €209 billion, should therefore be entirely devoted to buying off the rents of overprotected sectors and professions, and liberalizing the French economy in a fair and smooth manner.

    The prospect of a French “default” inevitably raises the question of a joint restructuring of European sovereign debt, at least for the most endangered countries such as Portugal, Belgium, Italy, Spain, Portugal or Ireland. This idea is gaining ground among towering figures of European politics: Michel Rocard, a former French Prime Minister, has been arguing for years for a cross European default, while Mario Soares, the father of Portuguese democracy, called last April for a default on Portugal’s sovereign debt.

    Is it time to put in place a ‘European Sinking Fund’? In any case, the Old Continent, beset with unsustainable debt, should grasp the nettle before it is forced to do so by its creditors. 

    Gaspard Koenig is a French liberal author and politician.

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