Hutchinson Lilley Investments LLP
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April
The FTSE Index fell by 1.62% but European shares rose by 1.68%. The oil price fell by 3.35%
UK Bonds rose by 0.44%, Gold rose by 1.52% and US shares rose by 0.91%.
In March’s report I wrote that I believed the worst was over for the Pound, at least for now. The Pound
subsequently rose in April against most currencies, helped along by the surprise announcement of a
snap UK general election – which was not the reason for my call. The rationale behind the rise was that
Theresa May’s position in the Brexit negotiations would be strengthened by virtue of having secured a
large parliamentary majority, which looks very likely. The Pound’s strength caused the FTSE to drop (it
contains many exporting companies) which was the mirror image of the reaction immediately post the
Brexit referendum result. Both the Pound and the FTSE have a long way to go before they return to
their pre June levels, however.
© 2017 Robert Hutchinson. All rights reserved
www.hlinv.com
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French Elections and International Negotiations- April 2017
As at the start of the month we had already more or less reduced the net exposure to foreign
currencies to zero which was helpful given the Pound’s rise. Our shares performed satisfactorily with
many of them paying out sizeable dividends. We did not suffer from any bad failures but neither did we
hold the big winners for the month, several of which were from Germany and France (see below) which
rallied after the first round result of the French election. Turnover in the fund was low during the
month.
Pound Euro Exchange Rate
France
A few days after the announcement of the UK election, the Euro got a boost too when Macron
won the first round of the French presidential race. The rationale here was that, while Le Pen
had pledged to pull France out of the Euro and restore the French Franc, Macron is a profederalist who is supportive of more power for the EU. The federalist won round 1 and the
Euro rose. The French bond market breathed a sigh of relief (more below) on the result and
French shares were lifted by about 5%. Macron is heavily favoured to win the second round on
May 7th.
© 2017 Robert Hutchinson. All rights reserved.
www.hlinv.com
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French Elections and International Negotiations- April 2017
L’Etat. C’est la UE
France is a stalwart of the European unification programme. The EU suits France well for it is totally
aligned with the national psyche. Its architect and founder, Jean Monnet was French after all. The
French love the State - bigger is better, they invented ”Le Dirigisme” (whereby the state determines
where investment is made) and they love codification and regulation. The EU needs France too;
without it, there can be no federal Europe. The EU could theoretically lose all of its members bar 2 and
still survive, as long as the 2 were France and Germany.
The EU suits Germany nicely too. Some say that the Germans have expansionary tendencies of their
own. Germany is in the driving seat politically and economically within Europe and its population has
prospered in past years. It is not surprising that the German electorate supports the status quo with a
large majority.
Germany is the number one exporter to the rest of the EU which means that good profits are earned by
its excellent businesses. Porsches, Mercedes and Siemens tram systems are in high demand throughout
the other member states.
As we have seen, though, there is a downside for Germany in that it is the country most on the hook
for bailing out those other member states once the latter realise that they couldn’t really afford the
Porsches etc in the first place. The pattern in recent years (much more of which is still to come) has
been that the buying country borrows Euros, buys the German product and then defaults on the loan,
causing trouble for the bank which lent the money and leading to rescue, either by
the German
taxpayer or with special assistance from the European Central Bank (ECB).
We have often referred to the ECB’s money printing activity which it does in order to buy up the debt
of the weaker country. The orange section of the chart below represents the volume of EU member
country debts - among other things - “bought” by the ECB with newly printed money. (Bank of Japan is
grey, Federal Reserve is blue, Bank of England is green and Swiss National Bank is red. So much for QE
being a temporary response to the banking crisis of 2008.) Many of these loans will never be repaid
back to the ECB and so the money will never be cancelled back out of the system. We have often
written about this in the past.
© 2017 Robert Hutchinson. All rights reserved.
www.hlinv.com
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French Elections and International Negotiations- April 2017
Actions have consequences and what can’t go on won’t go on. ie you can’t print money to buy Porsches
and trams for ever without something giving eventually. But for as long as this particular type of
alchemy lasts, there is a calmness and even a type of equilibrium. For Germany, it is a positive
equilibrium because the important economic indicators are favourable. German companies operate
profitably, the country has full employment and there has been wage growth. Taxes are high enough to
cover government spending – the budget is balanced. Germany does not need to borrow but if it did, it
can do so extremely cheaply. In fact, thanks to the European Central Bank it can borrow for less than
nothing since interest rates are zero out to 8 years. Like a perfect summer, the Germans would like it
to continue this way forever.
We mention this because we are looking at possible existential threats to the EU and from Germany’s
camp, we see none whatsoever. France is a different story, though. There, things are less positive and
in particular, the French have lost ground to the Germans ever since the Euro was introduced. GDP per
capita relative to Germany has fallen (and in the peripheral countries of Europe it has fallen even
further) which people instinctively know and if they didn’t then Marine Le Pen has been pointing it out
to them of late.
© 2017 Robert Hutchinson. All rights reserved.
www.hlinv.com
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French Elections and International Negotiations- April 2017
In other ways, France lags behind Germany too. Unemployment rates, for example, differ widely
between the countries.
© 2017 Robert Hutchinson. All rights reserved.
www.hlinv.com
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French Elections and International Negotiations- April 2017
In France, therefore, there is not the same equilibrium. While they love big government, they do not
like losing out in the wealth stakes to their main rival/partner and this has caused dissatisfaction. The
extent of the dissatisfaction can be measured by the size of the pink areas on the map of France below
which represents the regions coming out in support of the anti-Euro Le Pen camp. It is a far larger area
than at any time in the past.
© 2017 Robert Hutchinson. All rights reserved.
www.hlinv.com
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French Elections and International Negotiations- April 2017
As mentioned, without France, there is no EU and so the pink area on the above map is the biggest
(and only real knockout) existential challenge to the EU. If the European project of unification does
one day collapse, it will be because of this. And while it is theoretically possible to imagine a France
which is out of the Euro but somehow still in the EU, in practice the EU would be dead if France
abandoned the Euro.
However, despite all this pink, France is not about to vote to overturn the established order and to
disembark the EU train. The forces of “revolution” are still far too weak and one way to see this is with
the help of one or two fear gauges in the markets. Although we have just witnessed relief rallies in the
Euro, French bonds and French equities on the victory of establishment/federalist/former investment
banker Macron after the first round of the election, in reality the markets never really feared a Le Pen
victory.
The best way to see this is to compare the yields on 10 year French and German government bonds.
The difference between the two rates of interest is the bond spread or the risk premium and it
measures in money terms the perceived extra riskiness of France over Germany. Throughout the 1970s
and for much of the 80s and 90s this premium was large ie the price the French government had to pay
to borrow funds was meaningfully higher than for Germany. The risk of not getting your loan repaid was
considered higher in France because its economic fundamentals were worse than Germany’s throughout
most of this period. Mainly there was lower growth, higher indebtedness, a worse budget and worse
trade figures.
However, following the passing of the Maastricht treaty in 1992 and leading up to the introduction of
the Euro in 2002, the risk premium fell quite a long way. Even though the economic performances of
the two countries continued to differ, the markets were saying that under a common currency the risk
of not being repaid by the French government was more or less the same as for Germany. For a brief
period, astonishingly, France was even considered less risky than Germany (in the lead up to the Euro
in 1997 the interest differential was negative ie in France’s favour), but that aside, the difference
between the two was nearly zero for several years once the Euro was in place (2002 to 2007). From the
bond markets’ point of view, Germany and France were now the same place.
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French Elections and International Negotiations- April 2017
10 Year Government Bond Spread France minus Germany in Basis Points ie hundredths of a
percent pa (The right hand scale is between 0 and 150 basis points)
The first sign of trouble after 2002 was during the financial crisis of 2008. Germany and France were
not the same place, after all. French bonds began yielding half a percent pa more than German bonds –
not a huge amount, agreed, but more than in the previous 10 years. French financial companies were
indeed in trouble during the crisis but so were German ones. Nevertheless, in the midst of the storm,
investors wanted the least risky thing they knew and that was German bonds, not French ones.
The next challenge to the narrative of parity with Germany came during the Euro crisis of 2011. France
was swept along with the tide which was mainly afflicting Greece, Spain, Italy and Portugal. Faith in
France was challenged at this time as represented by the larger spike in borrowing costs over
Germany’s in that year.
Most recently the support for anti-federalist Marine le Pen in the French election – and her pledge to do
away with the Euro - caused the fear index to rise again although not really by very much, and by
nowhere near as far as in 2011. The markets seemed to be only very slightly worried by the outcome as
opposed to really fearful of it. After the first round election the differential closed back up a little.
To conclude, even before the first round victory for Macron, markets were pricing in a Le Pen defeat.
This means that, despite the loss of economic ground to Germany, high unemployment in France and
the deceptively large pink area on the above map, the European project is alive and well. No
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www.hlinv.com
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French Elections and International Negotiations- April 2017
existential threat exists from Le Pen’s camp right now. The markets believe that it will be nearly
impossible for her to win the second round next Sunday.
Brexit Negotiations
There are no guarantees of any sort of deal being struck and after this week’s hostile Downing Street
meeting between May and Juncker, even more doubt has been cast. Last month we wrote that no deal
would be better than a bad deal and that the UK should be prepared to offer concessions regarding
trade and residency on a unilateral basis. We stand by this view. But it is still possible that deals will
be struck.
I am not a French historian and might be doing that fine country an injustice but it strikes me that the
French do not have a good history of negotiating. They are either too hard (eg German reparations post
WW1 in 1919) or too soft (eg Louisiana purchase in 1804 under which they sold one third of the
landmass of the US >800,000 sq miles for around $15.0m equivalent to $250m today). They will be
aiming for a better outcome during their discussions with Theresa May in the coming 1 and three
quarter years.
The chief negotiator, Michael Barnier, is French so Theresa May would do well to brush up on the
excellent work by Richard D Lewis, author of the Lewis Model for Cross Cultural Communication. His
website is here.
About 2 years before the EU referendum he wrote a piece specifically aimed at negotiating with the
French. It could useful for Ms May. Even the layman reading today’s tabloids will be able to recognise
certain national characteristics from the negotiation updates provided by those papers.
Lewis writes as follows:
“Here’s The Trick To Negotiating With The French
In both politics and business, the French like to be independent (at times maverick) and can appear
frustrating to Americans, Japanese and Europeans alike.
They are immersed in their own history and tend to believe that France has set the norms for such
things as democracy, justice, government and legal systems, military strategy, philosophy, science,
agriculture, viniculture, haute cuisine and savoir vivre in general. Other nations vary from these
norms and, according to the French, have a lot to learn before they get things right.
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French Elections and International Negotiations- April 2017
Their general attitude toward foreigners is pleasant enough, neither positive nor negative. They will
do business with you if you have a good product, or if you buy, but their initial posture will be
somewhat condescending. If you don’t speak French, you appear to be an Anglophile. That is not a
good start in their eyes.
You are not seen as an equal. You may be better or worse, but you are different. The French, like the
Japanese, believe they are unique and do not really expect you will ever be able to conform
completely to their standards. What approach should you adopt when dealing with the French? Should
you gallicize yourself to some degree, becoming more talkative, imaginative and intense? Or should
you maintain stolid, honest manners at the risk of seeming wooden or failing to communicate?
In order to get the best of your dealings with the French, you have to study their psychology and
tactics when they enter commercial transactions. They approach negotiation in a very French manner,
which includes the following characteristics:

Surnames and formal introductions are used, and seating will be hierarchical.

Politeness and formal style will be maintained throughout negotiations managed by the
French.

Logic will dominate their arguments and lead them to extensive analysis of all matters under
discussion. They will pounce on anything illogical said by the opposition.

Meetings will be long and wordy.

They do not present their demands at the beginning, but lead up to them with a carefully
constructed rationale.

They reveal their hand only late in the negotiations.

The French try to determine the other side’s aims and demands at the beginning.

The French are suspicious of early friendliness in the discussion and dislike first names,
removal of jackets, and disclosure of personal or family details.

They pride themselves on quickness of mind but dislike being rushed into decisions. For them,
negotiation is not a quick procedure.

They rarely make important decisions inside a meeting.

They will prolong discussion, as they regard it as an intellectual exercise during which they
are familiarizing themselves with the other party and perhaps discovering their weaknesses.
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French Elections and International Negotiations- April 2017

Their objectives are long-term; they try to establish firm personal relationships.

They will not make concessions in negotiations unless their logic has been defeated, which
often makes them look stubborn to some.

During deadlock they remain intransigent but without rudeness, simply restating their
position.

They try to be precise at all times. The French language facilitates this.

They believe they are intellectually superior to any other nationality.

They often depart from the agenda and talk at length on a number of issues in random order.

British and Americans often complain that the French talk for hours but make no decisions.
(The French clarify their own thoughts through extensive discussion before arriving at any
decisions or taking action.)

They arrive at the negotiation well informed in advance, but seeing things through French
“spectacles” often blinds them to international implications. Sometimes they are hampered
by their lack of language skills.
How to Empathize with the French
When dealing with the French, you should behave much more formally than usual, using only surnames
and showing almost exaggerated politeness to French senior executives.
Stick to logic at all times, avoiding American-style hunches or British-style “feel for situations.” If you
contradict anything you said, even months earlier, a French person will pounce on the contradiction.
You should be willing to appear “more human” than usual, as the French are, after all, Latins in spite
of their logic and exactness. They like a good discussion and observe few time limits for this. If you
don’t talk enough, they will label you as monosyllabic afterward.
If you want to gain points, you can score by criticizing the English — a favorite French pastime. You
need not be unfair to anyone, just show that you are not entirely in the Anglo-Saxon camp. The
French do not mind if you have a go at their other neighbours — the Italians and the Spaniards —
either.
Do not criticize Napoleon — he has a kind of lasting identity with the French soul. You can say what
you want about Charles De Gaulle, Francois Mitterrand or any current French prime minister. They
probably won’t know who your president or prime minister is, so they can’t crucify him or her.
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French Elections and International Negotiations- April 2017
The French are often criticized by people of other nationalities, and it is not difficult to see why.
Essentially argumentative and opinionated, they frequently find themselves out on a limb at
international meetings, isolated in their intransigence when all the others have settled for
compromise. This naturally leaves them open to charges of arrogance.
And yet one must have some sympathy for them; they are clear-sighted, perceptive thinkers who feel
that they have a better historical perspective than most of us. They would rather be right than
popular. Are they usually right? Like all others, they are fallible in their judgment and subject to bias,
but they have great experience in politics, warfare, domestic and overseas organization and
administration, and the humanities.
Like the Germans, they cannot be accused of taking things lightly. Their long and significant
involvement in European and world affairs gives the French the conviction that their voice should be
heard loud and clear in international forums. Their political, military and economic strengths may no
longer predominate as they once did, but the French perceive no diminishment in their moral and
didactic authority.
Like the Americans, British and Russians, they have a strong messianic streak. They would not be
human if they did not resent the rise of the British after the fall of Napoleon, the decline of the
French language as a world tongue, the incursions of the Japanese on the European economic scene,
and, most of all, the pernicious Americanization of large parts of the world, including once-Frenchdominated Europe and even French culture itself.
Though often seen as selfish defenders of their own territory, it is not inconceivable that with their
old-fashioned doggedness and resistance to precipitated globalization, they might one day emerge as
the champions of the age-old values and philosophies that Europeans subconsciously cherish. The
maverick of Europe may well turn out to be its moral bedrock. At all events, the French merit a closer
examination of their apparent obstinacies and negative features.”
Richard D Lewis
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French Elections and International Negotiations- April 2017
For reference, according to Lewis, this is our style.
Charts for other countries, here.
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