France could be about to crash the global economy
Unsustainable debt and a lavish welfare system risk triggering a run on banks
Matthew Lynn
31 August 2025 4:00pm BST
C’est normal, as they would put it on the other side of the Channel. The Government is teetering on the edge of collapse, the budget is out of control, there are emergency tax rises on the way and the rioters are gearing up for protests on the streets.
For France, it is all pretty much business as usual.
Yet this could turn into far more than just a political drama in Paris. With worries about government debt and the affordability of lavish welfare systems rising all the time, France could be about to trigger a full-blown market crash.
It will be a month of high drama in Paris. François Bayrou, the prime minister appointed earlier this year by Emmanuel Macron to pass a budget that at least makes some attempt to bring the deficit under control, has called a vote of confidence for Sept 8.
It may well prove a brave but foolish decision. In fairness, Bayrou has been admirably gutsy. He has spent the last week lecturing voters that the country can’t carry on living beyond its means – it would be a refreshing change if a British politician tried that for once – and sacrifices will have to be made.
His proposals, such as scrapping a couple of bank holidays and slowing the rate at which state spending increases, are modest. But they are at least a start. Even so, they are too much for France’s parliament, and unless he can come up with a miracle next week, Bayrou, like his predecessor Michel Barnier, will be sent packing.
France certainly needs to do something. If some of us are starting to feel Britain is overtaxed, our neighbour has taken it to a whole new level.
State spending has hit 58pc of GDP, while the tax burden on workers has hit 47pc, one of the highest levels in the OECD. And yet despite that, the deficit is forecast to hit 5.7pc of GDP this year and will probably punch through 6pc, while its debt-to-GDP ratio is over 113pc, and higher if you take its share of the EU’s debts into account.
It is hardly surprising that investors are starting to feel nervous about lending the country even more money. Yields have already spiked above Greece and Portugal, two countries at the epicentre of the last eurozone crisis, and that is hardly reassuring, while the finance minister, Eric Lombard, has started warning about an IMF bailout. It is not, to put it politely, an encouraging outlook.
To most of us, that may look like a purely French matter and one for the politicians and bankers in Paris to resolve. Here’s the problem, however. The crisis in France could easily turn into the trigger for a wider market meltdown. There are three ways it could crash the global economy.
First, keep an eye on the banks. Shares in Societe Generale were down 10pc over the last five days, while BNP Paribas was down by 8pc. What’s up? It is clear that the hedge funds have worked out that “shorting” the major banks is the easiest way to play the “France is bust” trade.
According to the latest data from the Banque de France, French government debt accounts for 3pc of the banking sector’s total assets and 71pc of “tier 1 capital”. If there are substantial losses on those holdings, one or more of the major banks may face a collapse.
Even if there are worries about that, it could trigger a run on the banks, and, as we learnt in 2008 and 2009, that can quickly escalate out of control. In Greece, it was the “doom loop” from sovereign debt to the banks that turned the drama into a global crisis, and something much larger could easily start to play out in Paris.
Next, watch out for contagion. When Greece crashed, it quickly spread to Ireland, Portugal, Italy and Spain. The reason was simple: they were all very similar, even if their debts were not quite so completely out of control. True, France is the most fiscally irresponsible of all the major developed global economies.
But if it crashes, then other countries – most notably the UK – will very quickly get caught up in the storm as well, just as Ireland and Portugal were after Greece crashed. The markets will be looking for the next domino to fall, and it won’t be long before they find it.
Finally, we should be worrying about the solution. Even Marine Le Pen’s Front National has reconciled itself to the euro, at least in public. And yet a simple truth remains. The easiest way for France to get out of the fiscal mess it finds itself in is for it to leave the euro and restore the franc.
There would be a massive devaluation, of course, but when you owe €3.35tn (£2.9tn), much of it to foreigners who have lent you the money in euros, that might not be such a bad thing. Sure, you get a bout of inflation, but your exports get a big boost, and more importantly, the debt effectively gets cut in half at a single stroke.
It is tempting. And yet it would prove chaotic for what remains the world’s second-largest currency, while what would amount to a partial default would leave banks, fund managers and investment firms around the world facing huge losses.
The French budget crisis may look like a purely domestic matter. But let’s keep this point in mind. The country’s debts are now the third largest in the world, after the US and Japan, and both of those are far larger economies.
We will see what happens to the prime minister next week and whether he can muddle his way through the month. But one point is surely clear. This is not just a French drama – it could easily turn into the trigger for a wider market crash.
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