A Debt-Fueled “Doom Loop”

When government debt gets out of hand, it’s a problem. In the run-up to the French Revolution, the French monarchy was heavily indebted and losing the ability to borrow from international bankers. Then the price of bread spiked, and the rest, as they say, is history.

What’s happening in France today is not a revolution. But the combination of weak government finances, investors worried about getting repaid and angry citizens is as explosive as ever — not just in France, but in many countries. Today my colleagues Eshe Nelson and Jim Tankersley write about something called the populism-bond market “doom loop.” Read on.

A vicious cycle of debt and populism

By Eshe Nelson and Jim Tankersley

When protests over high gas prices ripped through France in 2018, President Emmanuel Macron offered about $11 billion in tax cuts and wage increases to try to quell the unrest.

He can’t do that this time around.

Today, protests that initially began over education have turned violent. But Macron is no longer in a position to throw money at the problem.

That’s because the French government is also fighting the prospect of a crisis in its bond market. Investors have been dumping French debt, unsure of the government’s ability to manage its budget amid high interest rates and political uncertainty; announcing a big financial commitment to mollify protesters would most likely only rattle investors further.

Macron, in other words, is in a tight spot. Do nothing, and the protests could continue. Spend more, and he could ultimately leave France with even less money for areas like education, by making borrowing even more expensive. Both scenarios would most likely add to the momentum of the populist politicians running for his seat next year.

Trapped between angry citizens, and wary investors, Macron could wind up in an unhappy place — what researchers described to us as a populism-bond market “doom loop.”

Voters vs. investors

France is not the only country facing a debt trap. As borrowing has grown in many wealthy nations, including France, Britain and the United States, populist politics are surging. The combination makes for a combustible mix.

Market turmoil and political tumult can feed off each other, according to Michal Brzozowski and Joanna Siwinska-Gorzelak, researchers at the University of Warsaw in Poland, who published a paper on the relationship between populism and fiscal policy.

At the root of the problem is a considerable tension: Amid deep political and fiscal uncertainty, voters and investors appear to want different things.

Buyers of debt want to be adequately compensated for the risk of lending to governments. When they see governments unable to make difficult choices, such as cutting spending or increasing taxes, to reduce yawning budget deficits, what they see is a loan that’s getting riskier. As a result, they demand higher interest payments.

Voters, though, are increasingly turning to populist parties that largely reject the idea that budgets require these difficult choices. Instead, they promise to protect generous retirement programs and other spending, while often proposing to cut taxes, or to raise taxes only on the wealthy, which in most cases wouldn’t go far enough.

The resulting tensions could spiral like this: Economically anxious voters turn to populists, who promise a pain-free return to better days, and buyers of government debt recoil.

Catch-22

Some centrist politicians today are still pledging fiscal discipline — the kind of pledges that voters once rewarded. But today, such policies tend to leave the public with the impression that those politicians are largely powerless to improve conditions, said Ludovic Subran, the chief investment officer and chief economist at Allianz, the German insurance company.

“That’s really the Catch-22 of politics today,” Subran said. The politicians who have felt the disciplinary hand of the market are punished politically, while more populist parties “say whatever they want to say.”

Eventually these problems will come to a head, said Simon Radford, the director for policy and programming for the Milken Institute in Europe.

“If you’re not going to solve it with new growth, and if interest payments are outrunning growth, then eventually what can’t go on forever, won’t go on forever,” he said. Too much borrowing, and too little economic growth will eventually become unsustainable, regardless of who’s in power and what they say while they’re campaigning.

Though Marine Le Pen, the far-right front-runner in France’s presidential election, has vowed to reduce the deficit, economists question the credibility of her financial plan, which would lower the retirement age while slashing spending on state bodies and cutting the country’s contribution to the European Union. All those measures would be difficult to enact. Jean-Luc Mélenchon, France’s far-left candidate, has alarmed investors by proposing to effectively cancel some of the country’s debt instead of repaying it.

At this point, it’s looking increasingly possible that these two candidates could be facing off against one another in next year’s presidential elections. Investors are already grimacing.

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