By Professor Richard Roberts, King’s College London
France and Germany have been entwined at the heart of the European project for 60 years, with the closeness of the relationship reflected in the narrow spread between French and German government bonds since the mid-1990s, after the financial dislocation of German unification.
The spread widened in 2011, reflecting investors’ preference for Berlin’s bonds over anywhere else during the eurozone debt crisis, but reconverged a couple of years later. Now the gap is back, waxing and waning with the poll numbers for presidential candidates Marine Le Pen and Jean-Luc Mélenchon in this year’s election.
The driver is Le Pen’s declared ambition to withdraw France from the euro and re-establish the franc.
That would be followed by the redenomination of €1.7tr of French public debt — the part of the €2.1tr total issued under French law — in a new national currency amounting, according to rating agencies, to the world’s largest ever sovereign default.
That would be a reversion to a historic, though long outgrown, tradition of French public finance.
Between 1300-1800, France defaulted 10 times on its external debt, the record for the era, well ahead of runners-up Spain, at six times, and England’s four.
Ancien régime monarchs were also frequent defaulters on domestic debt, a tried and tested method being the arrest and execution of major domestic creditors. French kings were fiscally challenged because of heavy expenditure on wars, combined with a ramshackle, ineffective and inequitable revenue collection effort.
Sinking Sun King
Louis XIV’s serial wars plus the Sun King’s other extravagances, notably the Palace of Versailles, resulted, despite periodic culls of creditors, in a debt to GDP ratio in excess of 100% by the time he died 1715.
France’s fiscal stress provided an opening for John Law, an enterprising Scot, who won the confidence of a desperate regime which allowed him to undertake some radical experiments in public finance.
In 1716 Law was allowed to create a monopoly bank to issue paper money, replacing the multiplicity of silver and gold coins, arguing that a standard currency would stabilise prices, lower interest rates and stimulate the economy.
He also took on a trading company to develop the vast French colonial territory of Louisiana (rather more of the Americas than the US state which bears the name today) and to conduct all French trade outside Europe.
The Mississippi Company diversified into tax collection and then launched a scheme to refinance the whole of the national debt at a favourable interest rate.
To fund this operation it issued large amounts of equity — the essence of the operation was a debt-for-equity swap on a grand scale, investors exchanging public debt for equity in a private company.
Brilliant in conception but flawed in execution, the value of both the paper currency and Mississippi Company shares crashed in 1720. France defaulted and John Law fled for his life.
France’s costly involvement in the Seven Years’ War (1756-1763) and the American War of Independence (1776-1783) resulted in another debt mountain. The regime hiked taxes, but still defaulted yet again in 1788. The backlash to this default a year later is known today as the French Revolution.
But tax receipts collapsed after the revolution, leading to a further resort to paper money — the assignat — issued by the National Assembly. Such was the volume of issuance that by 1796 the notes had become worthless; the government ceremoniously burnt the banknote printing plates in the Place Vendôme.
Napoleon stabilised matters by the introduction of the 20 franc gold coin in 1803, helped by an infusion of $27m into state coffers from the sale of the Louisiana territory to the US that year.
The gold “Napoleon” served as a prized store of value and was the benchmark for the coinage of members of the Latin Monetary Union, something of a proto-eurozone, that circulated until 1914. The scarring hyperinflation of 1720 and 1796, and another bout during the First World War, led to a deeply-ingrained French preference for gold and gold-backed currency that lasted through to General De Gaulle and into the 1970s.
At the end of the 1970s, France’s debt to GDP ratio was around 20%. Since then it has risen steadily to almost 100% — so back at the level that John Law wrestled with.
Leaving the euro, should it ever came to pass, might well prove as radical an experiment for France as John Law’s schemes of 1716-1720. But Marine Le Pen would doubtless prefer to look to a more illustrious role model — Napoleon Bonaparte and his sound money scheme.
