Nobel laureate warns: French debt crisis may be "too big to save," eurozone faces "explosive" crisis

Paul Krugman, winner of the 2008 Nobel Memorial Prize in Economic Sciences, has issued a warning that France's public finances are continuing to deteriorate, heading down a path of "fiscal unsustainability" and may have already transitioned from "too big to fail" to the dangerously precarious position of "too big to rescue". If a crisis erupts, it would pose a severe threat to the overall stability of the Eurozone.

In a Substack blog post published this week, Krugman wrote that France's debt issue is not merely a domestic matter; as a Eurozone member, it could spark an "explosive debt crisis," delivering a destructive shock to European integration.

Former ECB President Jean-Claude Trichet promptly called in an interview for all sides within the French political sphere to "take substantive action to prove that France, as a market participant, is responsible," in order to restore market confidence—which is also the prerequisite for activating the ECB’s relevant rescue mechanisms.

French government bonds have been under persistent pressure recently, with the 10-year OAT-Bund spread rising to its highest level since the 2011–2012 European debt crisis. French bonds saw a slight rebound on Friday, with the 10-year yield dropping 3 basis points to 4.86%.

Krugman pointed out that France is experiencing a confluence of multiple fiscal predicaments.

As of now, France’s debt has reached €3.6 trillion (about $4 trillion), constituting 119% of GDP, the highest level since the birth of the euro. However, the government has not only failed to effectively control its debt but has also continued to exacerbate its burden with large-scale budget deficits, all while facing rising debt interest pressures.

In Krugman’s view, the central issue for France lies in its retirement age policy. France’s pensionable age is among the lowest of Western Europe’s major economies, and next year’s presidential front-runner, Marine Le Pen, has even pledged to allow some workers to retire at 60.

Krugman wrote that France is, in effect, providing extensive subsidies to the older generation at the expense of other segments of society. At the same time, student protests are erupting across the country, triggered by teacher shortages, overcrowded classrooms, and dilapidated school buildings. “The emergence of large-scale national student demonstrations is hardly surprising,” he wrote.

Krugman provided a detailed account of how France could trigger a sovereign debt crisis in the Eurozone, drawing comparisons to the crisis of 2009–2012.

He explained the logic of this vicious cycle: once investors stop buying Eurozone country bonds, it raises fears that the government may be unable to repay its debts; the panic over default leads to larger-scale capital outflows, which then push up interest rates and further deepen the crisis.

Krugman noted that when then-ECB President Mario Draghi made his famous “whatever it takes” statement in 2012, its stabilizing effect was largely down to the fact that Southern European countries implemented “large-scale spending cuts.”

France’s current problem, however, is that with its ongoing deviation from fiscal responsibility, any rescue from the ECB would be “extremely costly” and politically highly contentious.

Citing Credit Default Swap (CDS) market data, he pointed out that the market-implied probability of French default is currently only 1.2%, but he considers this “too low,” and finds the recent spike in CDS prices itself “deeply concerning.”

In the face of external concerns, both the ECB and French officials have responded, though their positions differ markedly.

ECB President Lagarde told Eurozone finance ministers this week that the authority is closely monitoring financial market dynamics and possesses tools to address disorderly market conditions. French Finance Minister Roland Lescure, however, stated that France is still “a long way” from needing ECB intervention.

Trichet, in his interview, did not directly comment on Krugman’s assessment but stressed that the ECB possesses several responses, including the European Stability Mechanism (ESM) and the Transmission Protection Instrument (TPI).

The TPI was established in 2022 to provide stability in the event of market fragmentation within the Eurozone and has yet to be activated. He explicitly pointed out that activation of the TPI requires the French government to proactively seek assistance, which the current French official position does not consider necessary.

Trichet called on all sides of the French political spectrum: “I urge all political forces, regardless of their stance, to recognize that now is the time for France to prove—as a market participant—that it is responsible.” He emphasized that France’s primary task is “to convince itself that it is on the right track,” which is also the necessary prerequisite for activating the TPI.