'Too big to save': Krugman warns France could trigger European crisis

France’s debt problems could trigger a crisis across the euro zone and put European unity at risk, Nobel laureate in economics Paul Krugman wrote in a post on his Substack. He said even the European Central Bank might not be able to save France from a debt crisis. A bailout on the scale needed to prevent a default would be enormous, and other eurozone countries might refuse to provide it.

Markets currently put the probability of a French default in the next five years at 1.2%, Krugman noted. He personally considers that estimate too low. If a crisis does come, he wrote, it will follow the pattern of the 2009-2012 debt crisis that affected Greece, Portugal, Spain, and Italy.

“First, investors stop buying a euro-area nation’s bonds, raising the specter that the government will be forced into default because it simply doesn’t have the cash to pay interest and principal on its debt. Fear of default then leads to even more capital flight, which increases fears of default and the interest rate, and the vicious circle deepens,” the economist wrote.

The ECB managed to halt market panic during the 2009-2012 crisis, but Krugman doubts that the same approach could work for France. First, France is the eurozone’s second-largest economy, so supporting it would require enormous sums. Second, in the previous crisis, the countries in trouble sharply cut spending, while French politicians have yet to agree on similar measures. As a result, other eurozone countries, especially Germany, may oppose providing aid, he reckons.

In Krugman’s view, France may have crossed the line from “too big to fail” to “too big to save.” “France’s current situation is really worrisome. In particular, it’s not just a matter for France alone. France’s membership in the euro area creates the possibility of an explosive debt crisis – and such a crisis could be destructive to European unity,” he believes.

Krugman says high pension costs are one of the main causes of France’s budget problems. The country’s population is aging, and people there retire earlier than in other Western European countries, at 62 years and 9 months officially. Emmanuel Macron planned to raise the retirement age to 64, but opposition from right- and left-wing parties has put the reform on hold until after the 2027 presidential election. Krugman says the high cost of pensions is forcing the government to cut other spending, including on education.

“France is effectively handing over large subsidies to older French at the expense of everyone else. Mass national student demonstrations should come as no surprise,” he wrote.

Krugman’s comments came after several months of selling in French government bonds. Investors first worried about a new wave of inflation; then a widening budget deficit and political divisions became the focus of concern. As a result of the selloff, yields on 10-year French sovereigns reached their highest level since 2002, while the gap between their yields and those on comparable German government paper – a key indicator of investor confidence – widened to levels last seen during the 2011-2012 debt crisis.

France’s national debt has reached EUR3.6 trillion, or 119% of GDP, its highest level since the euro was introduced. Prime Minister Sébastien Lecornu’s government is trying to secure approval for a 2027 budget that calls for a EUR43 billion reduction in the deficit. But efforts to rein in the deficit are meeting with public discontent, as mass protests against spending cuts continue across France.