Why France will fall nextft

A French family tale

This summer I met a French couple who work amicably together in their vineyard. They are raising their two boys good-humouredly. They socialise harmoniously. But when under a Provencal sun she grabbed a piece of baguette from his plate, he erupted. Unjustifiable behaviour? Perhaps. But a Frenchman and his food are not to be separated.

What is truly unjustifiable are the negative real interest rates being paid on some French government bonds, while Spain and Italy’s are only being kept from record highs by the promise of action by the European Central Bank.

This situation is coming to an end. France is going to have to pay a risk-adjusted return on its bonds, at which point its precarious balancing act will collapse. There are three reasons why this looks likely to happen sooner rather than later.

The first is that the eurozone’s newly launched rescue fund, the European Stability Mechanism (ESM), will have to borrow money in the continental bond markets to fund countries in need of help. Goldman Sachs believes it could crowd out other borrowers like France, the so-called “soft core”, which have benefited from investors fleeing the periphery countries. Meanwhile, the continued existence of the European Financial Stability Facility, its predecessor, which still has to fund programmes for Ireland, Portugal and Greece, will add to the supply of lower risk bonds in the euro market competing with French sovereign ones.

The French couple, Herve and Claudine Bizeul, run Clos des Fees, a vineyard named after the fairies. It produces magical wine .

France’s fairy godmother has been Switzerland, but it may be stepping down from that role, the second reason for France to fall.

Switzerland has been one of the main buyers of bonds issued by the core eurozone economies as it battles to keep the Swiss franc at a ceiling of SF1.20 against the single currency. This costly policy has been a blessing to France. It began in September 2011 and has resulted in the tiny Alpine state becoming the fifth largest holder of foreign exchange reserves in the world, with 60% of its SF418bn held in euros, according to Standard & Poor’s. France’s abysmal economic fundamentals have been brushed aside by the Swiss National Bank’s largesse and resulted in untenably low or negative yields. However, domestic opposition to an already controversial Swiss policy is rising and the central bank is under pressure to decelerate its euro bond buying programme.

Thirdly, assuming Spain asks for a rescue in the next couple of months and the ESM takes action to buy its bonds, the market’s attention will shift away from the periphery and onto France, whose borrowing requirements are rising steadily while its ability to pay debt back is declining just as steadily.

(Some market participants and executives argue that the reason the French central bank has been so hard on Italy and Spain is to distract from its own country’s abysmal state. Others accuse Frenchman Michel Barnier, the Internal Market Commissioner, of being soft on reform of the rating agencies in an unspoken pact to ensure downgrades of his country’s debt are not as severe as they should be. Conspiracy theories abound, some more credible than others).

In 2013 France will need to borrow €171bn. At 56% of GDP, it already has the highest annual public spending in the eurozone. Germany spends €163bn less on its population which is 17m larger than that of France. Public and private debt in France is 160% of GDP (125% in Italy, 128% in Germany). In fact, according to a US fund, if you add in all the off balance sheet items – saving Dexia, the TGV, pensions, healthcare, and the like – the number escalates to around 600%.

The last few governments, of whatever persuasion, have refused to confront reality – as evidenced by nearly 40 years of accumulated annual budget deficits and an anti-private sector bias which has led to an avalanche of social security costs, taxes and regulation. The result is a stymied private sector.

At the creation of the euro in 1999, France’s exports as a percentage of world trade were 6.5%. They have since plummeted to 3%. Its manufacturing margins have followed the same downward plunge to 5% from 12%. Germany’s have increased from 12% to 14%. The majority of the companies in the CAC-40, France’s main stock market index, post losses in their domestic businesses which are somewhat camouflaged by their profits abroad, notes outspoken economist Nicolas Baverez in his latest salvo to save France*.

France’s disinclination to change is disheartening. “The will to erect Maginot lines against Europe and globalisation is both dangerous and a chimera,” writes Baverez, referring to the defences put in place against the German army in the 1930s. Considered impregnable, they were proved useless. France is an accident waiting to happen, and paradoxically, a borrowing crisis may well force the country to reform, not unlike what has happened to its southern neighbours.

Herve and Claudine have chosen to stay in France and defy a state which batters entrepreneurs and SMEs. Meanwhile, 50,000 of the best and brightest graduates emigrate annually. Whether in the future the two Bizeul boys stay or go may will be a telling indicator of the health of the nation.

*“Reveillez-vous!” (Wake up!) by Nicolas Baverez, an outstanding call to arms.

The Bank of England’s Tucker time

Asian crisis lessons for Spain and Italy

Knees to chest in the womb position, I bounced in the harness attaching me to the two- inch thick, descending cable. Picking up speed, I accelerated to more than 70 kilometres per hour over the Costa Rican valley open before me.

The finish, 750 metres away, was lost amidst faraway trees, as was the tiny body of the fool who had zip lined across before me.

“I am a widow with an 11-year old child and a thirst for life. WHY AM I DOING THIS?!” I screamed. Perhaps I only imagined the scream as my lips were frozen in petrification. I was powerless to stop the horrific experience. There is no rational reason to be separated from the earth by 200 metres.*

The lookout point from which we started the zip lining faced a colossal volcano. El Arenal is known as Costa Rica’s most active volcano, spewing large amounts of ash, lava and gas. However from 2010 it entered an indeterminate resting phase. An erupting volcano was not the issue. Thus the obvious risk in our zip lining was not the most important one.

Likewise, Spain and Italy are residual risks for the euro. Banks from other countries have had enough time to lower their exposure to the two countries. Wholesale financial markets have been inaccessible to the Mediterranean nations for some time. They are relying on the ECB.

In Spain, a full bail-out is needed, not least to take over from a government whose economic and financial chiefs (Minister Luis de Guindos and Minister Cristobal Montoro) are apparently too intent on throwing poisoned darts at each other to focus on the crisis. Prime Minister Mariano Rajoy cannot bear the humiliation of asking for help. Every day that passes the debt burden on Spaniards becomes heavier. For this he will be judged.

Meanwhile, neighbouring technocratic Prime Minister Mario Monti, who started with a bang, now has his hands tied by a squabbling Italian parliament.

They both need an authority from outside the domestic and European political mess, which can only be the International Monetary Fund.

During the Asian crisis, the IMF stepped in with a heavy tread. With hindsight, it would undoubtedly do some things differently. But all in all, its presence was sufficient to remove the political obstacles to structural reforms while its resources were put to use in Thailand, Indonesia, the Philippines and others.

The complexity of the factors and players involved in the solution to the Asian disaster defies a short column like this one. Still, the need for an authority separate from the crisis-ridden countries is paramount. The European Central Bank is too involved and too political a body: it should play a junior role to that of the IMF, like the central banks in the Asian countries being rescued at the time.

There are those who dismiss Western Europe’s future as that of a Disneyland for tourists from the Bric and other nations in Asia. Beware facile judgments. Many voices were heard being equally contemptuous of Asian nations during their crises. Within only a few years, the Asian tigers rose even stronger.

Only two months ago, the Philippines extended a $1 billion loan to the IMF to help in stabilising the developed world economies.

Transparency has become the sacred cow of our days. Justifiably so. Shining a torch into the hidden recesses of financial institutions has revealed the murkiness of Mexican money laundering, risk exposures being fudged and clients being consistently ripped off.

But there are times when obscurity is necessary, as in the following case. Until the spring of 2012, Paul Tucker, Deputy Governor of the Bank of England, was a strong contender to inherit the governorship from Mervyn King, whose second term finishes in June 2013.

As part of the recent scandal over LIBOR, the ever-more-powerful Treasury select committee called on Paul Tucker to give evidence. They quizzed him over a 2008 email from Bob Diamond, where the (now former) ceo of Barclays alleges that the Deputy Governor told him over the phone that “it did not always need to be the case that we [Barclays] appeared as high as we have recently”.

This was understandably interpreted by Barclays Capital, as an instruction to lower the bank’s Libor submissions.

Now, there is a big difference between the unethical manipulation of the Libor rate for profit – which had been going on for awhile at Barclays and other banks – and the example in question.

The phone call took place a few weeks after the fall of Lehman Brothers, when the world was zip lining with an untested harness. The biggest fear for the central bank and the government was a bank run, which would probably have spread, leading to panic on the streets. There were already rumours about Barclays’s shaky finances in the markets. These could not be allowed to spread to retail depositors. The central bank was simply doing its job in nudging Mr Diamond, via an innuendo-laden sentence, to lower Barclays’s Libor rates so as to shore up its shaken credibility.

There may well be reasons Mr Tucker is not the right person to take over at the Bank of England. But it is incorrect to judge him negatively for doing his job as he did in that now-famous telephone call. Shadows are just as necessary as light in economic management.

A short week in Costa Rica was followed by a leisurely ten days in France. Our summer holidays moved from zip lining, monkey tribe attacks and white water rafting, to Provencal pools surrounded by the smell of lavender. Appearances to the contrary, the risk increased. France is the real risk to the euro, as will be explained in next month’s column.

*For those foolhardy enough to replicate the Costa Rican adventure www.skyadventures.travel.com.*

Robinson Hambro letter in the FT

More candidates for the bloodbath

I’d like to draw your attention to a letter Robinson Hambro published in the Financial Times on the 9th July 2012. It was in response to an article from an outstanding FT columnist who, in an access of Robespierre-like rage, had called for the heads of investment bankers to roll. Robespierre’s reign of terror during the French Revolution was regrettable. So was columnist John Gapper’s suggestion.

Dear Sir,
I was struck with awe at the bloodthirsty implications of John Gapper’s article calling for the heads of former investment bankers who now run universal banks because “they may be honourable individuals but, as a group, they symbolise the relentless ascendancy of the securities trading floor.”

Following Gapper’s logic, I look forward to seeing many more heads roll, not least his. For as a member of the press he may have been individually honourable but, as part of a group, he symbolises the relentless ascendancy of hacking and exploitative journalism. I would join him in having mine chopped off, for as the principal of a board search firm I may be an honourable individual but, as a group, head-hunters symbolise a failure to people boards with directors capable of stopping the rot.

The same treatment should surely be meted out to policemen, politicians, royalty and members of any group or institution that has failed to uphold moral standards.

Surely, though, shouting like the Queen of Hearts in Alice in Wonderland, “Off with their heads!” and ending up with a blood bath is not quite the FT way?

Karina Robinson
Robinson Hambro Ltd

Reputation loss: Rato, Mervyn and Dimon

The growth myth

If raw capitalism is about creative destruction, we have undoubtedly seen a lot of destruction. It is not yet clear how creative it will be.

On the back of the financial crisis there was a first wave of people such as Dick Fuld of Lehman Brothers and Sir Fred Goodwin of Royal Bank of Scotland.

We are now seeing the second wave. Mervyn King has lost his reputation as a competent governor, although he won’t lose his job. The Governor’s consistent refusal to commission a study of what went wrong at the Bank of England; a series of in-depth articles detailing his rejection of dissenting opinions; his antipathy towards the City; his obsession with monetary policy at a time when financial stability should have been high on the list; these have all massively eroded his credibility.

The much-criticised independent Court of Directors has now countenanced three separate studies on the issue, surely an embarasse de richesse. Those who argue the Governor ensured each study has a very limited brief are right, but the fact that they are taking place is itself a most vehement slap in the face.

The destruction of the stellar career of Rodrigo Rato, Spain’s much-lauded Finance Minister in better times and subsequently Managing Director of the International Monetary Fund, is further advanced. It has now imploded with Bankia’s effective bankruptcy. The third largest Spanish bank by deposits was effectively nationalised and its chairman fired. The bank spent many months without a ceo as no banker of note was willing to serve under a man who had never been a banker yet whose views reigned supreme.

Jamie Dimon, the embattled head of JP Morgan Chase, is still in his post following $2bn of declared trading losses at the chief investment office. Market and press estimates put the loss at a probable $7bn. More importantly, this raises doubts about the bank’s risk assessment. Dimon’s fate has yet to be decided, but calling the trades “an isolated event” is surely tempting fate.

Is there a common theme linking these three personalities? None of them have been felled by personal scandals. They are all intelligent and all acted and are acting with the best intentions. They have been justifiably acclaimed for years. But we are living in exceptional times. What they perhaps all lack is the capability to allow strong characters around them, the capacity to accept criticism and the flexibility to change behavior accordingly.

At least what happens to those who fall from grace these days is less violent than in ancient times. Julius Caesar, whose dictatorial tendencies were upsetting his peers in the Roman Republic, was assassinated by Brutus and others. He needed a jester, much beloved of later European monarchs, who was armed with permission to mock and thus keep the ego and ambitions of royalty and others within bounds.

According to Roman historian Suetonius, Caesar’s final words were not the famous “Et tu, Brute?” (And you, Brutus?); rather, he spoke his last words in Greek, the language he used for family and intimates: “Kai su, teknon?”(Even you, my son?).

Caesar was rumoured to be Brutus’s father as his long affair with Brutus’s mother was well-known.

The Financial Services Authority will exist for only a bit longer in its current form. It is now a source of destruction, liberally doling out fines and reputational damage as it seeks to cover its former laissez-faire sins with a tsunami of action.

At Robinson Hambro we quacked with fear at the return address on the envelope that came through the office door: “Unauthorised Business Department, Financial Services Authority”.

Our Board Search boutique looked set to bite the dust. All the hard work – be it finding Chairmen for companies, to hosting high-powered dinner parties, to dealing with Ambassadors and family offices – was to be in vain.

We quacked as we opened the letter. Had we mistakenly told a retailing Chairman that a few more women on his board would be a good thing? Had our Ambassador turned out to be a much-married fraudster with children scattered all over the world? Had the blue of our corporate logo infringed a new regulation?

Once the shaking of the hand that held the letter stopped, it turned out to be a warning that we were being targeted by fraudsters. As the FSA warned, in bold, “Remember: if it sounds too good to be true, it probably is!”

The new conventional wisdom, that growth can be easily combined with austerity is just that: too good to be true. There is worthy growth, based on structural reforms and investment and moderate spending, and bad growth.

Far be it from me to question the wisdom of the International Monetary Fund, which in this week’s report on the UK suggested a further lowering of interest rates from the base rate’s 0.5%. Nevertheless, when you are bumping along the bottom, shaving off half a percentage point makes little difference. Take a look at Japan.

As for its suggestion of infrastructure spending, anyone who has tried to move around London, where traffic is paralysed by road and building works, would think enough is being done. For future spending, with no money in state coffers, it will be tempting to finance increased infrastructure investment via private finance initiatives (PFI) or public private partnerships (PPP). These are often accounting gimmicks to keep government liabilities off-balance sheet. The UK has merrily exported these to the rest of the world.

Additionally, infrastructure spending takes quite a bit of time to make its way through the system.

There is, of course, a more radical solution. As proposed by the Institute of Directors and the Taxpayers’ Alliance, a single income tax rate of 30% would put money in consumer’s pockets. It would lead to a surge of spending. Combine that with another radical measure, the raising of interest rates, and savers would be rewarded after years of being the losers compared to borrowers. This would create enough confidence at a micro level for increased spending.

Simplistic, you say, gentle reader, with no thought for the other implications of such policies? Right you may be, but the IMF prescriptions are no less so. Pushing a cut in interest rates and more quantitative easing, when there is no evidence of what the medium term effects are, leaves a lot to be desired.

Perhaps, though, a new “growth” strategy from the government will be enough to boost confidence, just as perceived austerity took it away. Headlines on new spending are perfectly timed for mid-term. The coalition government’s management of public relations is looking good.I have my own jester, keeping my feet on the ground. My son’s Norfolk terrier, Sasha, a small golden bundle of fun, pines to be a source of destruction – with no creativity thrown in. He has now taken to dementedly barking at all and sundry, especially larger dogs who could eat him in two easy gulps.

Having tried everything from rolled up newspapers to shouting, it was suggested I try spraying his nose. Armed with a spray bought in Avignon a few summers ago, we set off on our walk. Encountering a German Shepherd, I maniacally spritzed Sasha’s button nose with lavender spray. The smell of many a Provencal summer wafted tranquillity onto me. The little dog continued his snarling and baying for blood. The German Shepherd disdainfully walked on by.