(The following was first published on Cumberland Advisors’ website and via LISTSERV. For details, visit https://www.cumber.com/.)

The political disruption in France has implications for the euro and for world financial markets. France is the second largest economy in Europe; Germany is first. 

It was one of the original six countries that participated in the Maastricht Treaty and the creation of the euro. (See “Maastricht Treaty: Definition, Purpose, History, and Significance,” https://www.investopedia.com/terms/m/maastricht-treaty.asp; “The euro: the birth of a new currency, ”https://www.ecb.europa.eu/press/key/date/1999/html/sp990521.en.html). Now, political forces are a disruptive rather than a creative catalyst. Here’s what is happening to the credit default swap pricing on French government debt.

Here’s what is happening to the Target balances for France in the ECB system. Readers are advised that Target balances are complex subjects for most Americans. The “T” system is the way the various countries in the eurozone clear their payments with each other through their national central banks while complying with the single-currency structure. Essentially, Germany is now the only significant country supporting the entire credit structure of the euro. Germany holds claims measured in the trillions of euros within the T system. The other countries have the liabilities. References for details about the T system are in the reading list below. France has joined the other negative T-balance countries like Italy and most of the others.

There is no way to forecast the outcome of European political events when there is such turmoil. Coincidentally we are witnesses to a growing Russian (Putin) threat to Europe. Witness the recent Russian-piloted Chinese ship attack on internet cables (“Chinese Ship’s Crew Suspected of Deliberately Dragging Anchor for 100 Miles to Cut Baltic Cables,” https://www.wsj.com/world/europe/chinese-ship-suspected-of-deliberately-dragging-anchor-for-100-miles-to-cut-baltic-cables-395f65d1). Witness Putin’s recent use (with loud fanfare) of a ballistic missile against Ukraine (“What we know about Russia’s Oreshnik missile,” https://www.bbc.com/news/articles/cvg07zw9vj1o).

While America tries to find its new foreign policy, a defense budget (not completed), and a financial structure involving debt, deficits, and tax policy, bad actors are working hard to undermine the Western alliance.

We now see it in the credit markets.   The spread between the 10-year French govt. bond and the 10-year German govt. bond has widened from about 50 basis points in the summer of 2023 (see reference below) to about 80 basis points last week.   Also note that the spread between the German 10-year govt. bond and the 10-year US Treasury note has widened to over 200 basis points last week.  In the summer of 2023, it was about 150 basis points.  

France is the latest casualty of unfolding global political events. 

Reading list below.

“French Premier Warns of Market ‘Storm’ If Budget Voted Down,” https://www.bloomberg.com/news/articles/2024-11-26/french-premier-warns-of-market-storm-if-budget-voted-down

“France’s Barnier caves to far right’s electricity tax demands as budget crisis looms,” https://www.politico.eu/article/french-pm-michel-barnier-far-right-demands-electricity-tax-budget-negotiations/

“There Is No Normalization of Target Balances, Despite the Normalization of Monetary Policy,” https://austrian-institute.org/en/blog/there-is-no-normalization-of-target-balances-despite-the-normalization-of-monetary-policy/  (Note that this paper was published in the summer of 2023.)

Excerpt:

Deutsche Bundesbank claims on the ECB totaling around 1.1 trillion euros are offset by liabilities of the Banca d’Italia to the ECB totaling around 700 billion euros. The total volume of Target imbalances is around 1.8 trillion euros. Hans-Werner Sinn (2020) has called the Target balances a trap. The Deutsche Bundesbank cannot simply collect its claims on the ECB. According to Sinn (2018), these claims would be worthless if the euro project were terminated. There could then be a huge gap in the Bundesbank’s balance sheet, as the Target claims are far larger than the Bundesbank’s share of capital and reserves (€5.5 billion). A reduction in Target imbalances would be desirable from this perspective, but that is not expected any time soon. “TARGET balances of participating NCBs,” https://data.ecb.europa.eu/data/data-categories/ecbeurosystem-policy-and-exchange-rates/target-balances-participating-ncbs