France's crisis seems familiar... Is America next?

France is witnessing massive turmoil, and faces political and economic challenges that seem familiar to Americans. The country is approaching a financial crisis after spending more than it can repay.

With bond interest rates rising in recent months, driven by rising energy costs, the repayment date for these obligations is much closer than expected. Although raising taxes and reducing government spending may constitute part of the solution, making such decisions will face widespread political rejection, and may lead to increased anger in the street, which is already suffering from a severe state of congestion.

Any viable solution will face difficult obstacles amid an uncertain budget battle and a deeply divided government. An increasing number of countries are facing challenges similar to those experienced by France, especially the United Kingdom, where the current features of the Western economic landscape are a rapid increase in public debt, a sharp rise in the costs of financing this borrowing, and the absence of sufficient political will to take the difficult decisions necessary to address this problem.

The financial pressures facing France are very acute, while the risk of infection spreading to the rest of Europe remains small. Moreover, France's massive social safety net constitutes a much larger share of government spending than it does in the United States.

The unique dynamics of the American economy also mean that the United States faces no imminent risk of becoming “the next France.” The problem: These are not new problems; Europe's social safety net has been on an unsustainable path for decades, and economists and some politicians have warned for years that the bill for these policies will eventually come due.

But the situation is getting worse; The war in Iran exacerbated the financial problems facing Western countries. The International Monetary Fund stated in a report last week that the average yield on 10-year government bonds in the Group of Seven (G7) economies has risen since February by more than one percentage point, reaching its highest level in about 20 years.

The Fund expects that by the end of the decade, the total public debt of these seven countries will exceed the size of their economic output. This is the first time this has happened since World War II. In France, public debt amounts to about 119% of GDP - twice the percentage targeted by the European Union - while the annual budget deficit reaches 5.4% of GDP.

“In Europe, people are increasingly fearful of the bond market and the interest rates that governments have to pay to borrow,” said Peter Taylor-Guppy, professor of social policy at the University of Kent. He added: "We have reached a stage where this matter can no longer be ignored. If we ignore it, we will face a serious crisis."

On paper, the situation in America does not seem much different; The US public debt, at $32 trillion, is roughly equivalent to the US GDP, and the budget deficit - which just reached $2 trillion - represents more than 6% of GDP. The cost of financing the US public debt has exceeded $1 trillion annually, which is equivalent to a staggering 14% of the total federal budget.

In other words, $1 out of every $7 of tax revenue goes toward paying interest on money the United States borrows. But the serious discussions about cutting spending and raising taxes, which are taking place in Europe, seem much less serious in the United States.

Why does the United States not have the same problems as France? Why won't this happen in the United States?

The great advantage of the United States is that it is the one that prints the world's reserve currency. The majority of commercial transactions globally are conducted in US dollars, including the trading of commodities such as oil and gold.

Demand for the dollar remains strong, in large part because it is viewed as a safe haven. US transparency and commitment to the rule of law make the dollar a cornerstone of the global financial system, even if its luster has faded slightly over the past decade. This also boosts demand for US Treasuries, widely considered the most safe-haven asset.

Even in light of a global sell-off in government bonds, interest rates on US bonds remain lower than in other Western economies. When stock markets witnessed a sharp decline last week, investors did not hesitate to resort to their traditional safe haven, which in turn led to a sharp decline in Treasury bond yields.

But the difference between France and the United States lies essentially in one thing: As James Carville said: “It's the economy, stupid.” The United States also has a uniquely large and diversified economy, making it less vulnerable to shocks than many smaller economies.

Artificial intelligence, in particular, is the driver of an investment boom in the United States, giving a boost to the economy at a time when other sectors appear to be stagnating or declining. One of the main ways to reduce the importance of fiscal deficits is to maintain strong economic growth; This makes the amount of debt appear small in comparison.

So, countries need to ask themselves: What is the interest cost we pay? Is it sustainable to continue paying it in light of our expected economic growth rates?

“France and the United Kingdom are in a fairly close position,” notes Mark Zandi, chief economist at Moody’s Analytics. “In the United States, the contributions of artificial intelligence to economic growth make it likely that the country will be able to manage its debt and deal with this challenge much more smoothly.”

Economists warn against confusing the absence of an imminent debt crisis in the United States with the presence of “fiscal responsibility.” It is simply that the United States has a better ability to deal with this problem than France or the United Kingdom. “This does not mean that we should feel comfortable,” Zandi adds. “It is just that we are in a different situation.”

Every time a European country faces a financial problem, there are fears of a contagion that could spread across the continent. But economists widely believe that the problems facing France remain confined to its borders.

The European Central Bank has indicated that it will not have to intervene in France's financial situation. However, Andrew Kenningham, chief economist for Europe at Capital Economics, explained that the bank has the ability to intervene if necessary, and is well placed to buy large amounts of member state bonds to limit any potential repercussions that may spread to other countries.

In comparison, the budget deficits of other European countries are much smaller; Some of them even expect to achieve financial surpluses this year. Moreover, French political parties - with their various orientations, whether from the left or the right - have confirmed their desire to remain within the European Union.

This includes Marine Le Pen, the far-right candidate and the most likely candidate in the French presidential race, who previously called for her country to leave the European Union (Frexit), but later retreated from this position. As for the Alternative for Germany (AfD) party, it has also called for leaving the European Union, but Kenningham points out that the party is still far from forming a government at the present time.

However, there is an unknown factor that could lead to a debt crisis outside of France. At some point next year, the United States will once again reach its debt ceiling, and the new Congress will have to negotiate with President Donald Trump to raise this ceiling. This political issue may become more complicated with a president in his final term and a Congress that may be controlled by Democrats, making them less willing to make concessions.

If the parties fail to reach an agreement to raise the debt ceiling, the United States may find itself forced to default on its debt, even though it actually has the ability to repay. “You could imagine a scenario where we hit the debt ceiling by Halloween next year, and then other problems will arise,” Zandi says.