Speculators Saved France from the Curse of the Strong Franc

STEVE H. HANKE

August 10, 1993|By STEVE H. HANKE

Ever since France ceded its economic policy to the European Community, debate about French economic matters has been taboo.

Indeed, President Francois Mitterrand on the left and Prime Minister Edouard Balladur on the right march to the drumbeat from Brussels of the European Community's executive commission president, Jacques Delors.

Alas, the French politicos' embrace of EC policy mandates has pushed France into a nasty recession coupled with the worst asset price deflation since the 1930s.

Fortunately for the suffering French, the international speculators have been watching the Mitterrand-Balladur spectacle with utmost attention.

Contrary to what the French politicos say, the speculators know that France's so-called strong fundamentals are a mirage. Indeed, they know that, since 1973, France's unemployment record has been the worst of any large OECD country.

That's no surprise, since France, in the spirit of the EC's social charter, has adopted more job-destroying laws than any other European country. The surging unemployment rolls, which don't include almost a half-million workers ''employed'' in phony jobs under the contrats emploi-solidarite, are well known.

In addition to the sclerotic labor market, speculators know that France's fiscal house is in disorder and that the budget deficit has soared to new heights. They also know that the portion of enterprises reporting poor profits exceeds the share reporting good results by 50 percentage points, the largest margin in 10 years.

Although the French finance minister stated as recently as Aug. 3 that the economy had stabilized in the second quarter and was emerging from recession, currency traders knew this was a false claim. Indeed, with all projections pointing toward a worsening economic slump, the shadow of gloom that prevails in France doesn't surprise anyone.

Faced with these horrendous fundamentals, the speculators knew that the monetary squeeze and relatively high short-term interest rates imposed by the embrace of the ''franc fort,'' (''stong franc,'' a link between the French franc and the German D-mark) represented an irrational policy stance.

Ignoring the long-standing political demonization of the financial markets, the speculators rescued the French economy from the hangman's noose. Unlike the French voters, the voices of currency traders can be heard. Indeed, speculators are empowered to force governments to recognize the inconsistencies in their policies.

During the last week of July, the currency traders voted in a massive way with their money, not their mouths. Their message was received loud and clear.

In consequence and in an attempt to save face, European officials widened the fluctuation bands of the Exchange Rate Mechanism (ERM) to 15 percent for all member currencies, except the D-mark and the Dutch guilder. Now the perverse ERM lies in tatters and the French franc is allowed to float freely in a de facto floating exchange rate regime.

The French should be praising the speculators' sagacity. Now the Bank of France, which lost all of its foreign exchange reserves in a futile attempt to maintain the franc's parity with the D-mark, can relax its monetary squeeze by allowing short-term interest rates to fall below long-term rates.

Usually, that interest rate profile jump-starts an economy. Indeed, since the British threw off the ERM's chains and allowed the pound to float, short-term British rates have fallen below long-term rates and the economy has begun to show signs of life.

Will lower rates provide the French with relief and stimulate the economy? Alas, even though lower interest rates will spell relief for the French, lower rates will not jump-start the economy.

That sobering conclusion follows from the fact that the ''franc fort'' has left the much-touted French fundamentals in ruins. To appreciate that, we must look no further than the balance sheets of French banks and businesses.

The recent chaos in the currency markets has accomplished something the politicians could never have pulled off directly: At taxpayers' expense, banks have made huge profits on their currency trading operations. That has allowed them to restore, to some degree, their sagging capital.

However, the banks' balance sheets are still weak. Consequently, as short-term interest rates fall below long-term rates, the banks will borrow short-term funds and purchase high-quality, long-term government bonds. That will allow the banks to reliquify and improve the quality of their balance sheets.

But those operations will not increase the supply of credit available to the private sector. The credit crunch will continue until the banks have sufficiently strengthened their balance sheets.

The ''franc fort'' policy has wreaked havoc on the balance sheets of French businesses, too. Since 1988, businesses have been piling up high-cost debt at an alarming rate. Consequently, interest payments eat up about 11 percent of French businesses' cash flows.

As interest rates fall and cash flows improve, corporations will aggressively attempt to repair their balance sheets. They will direct free cash flows toward debt reduction rather than new investments. Consequently, interest rate reductions will not stimulate an investment boom.

To their credit, the speculators cut the ''franc fort's'' noose from the French economy. Consequently, the healing process, namely the repair of banks' and businesses' battered balance sheets, can begin.

Contrary to Mr. Balladur's assertions, however, economic growth will have to wait for another day. This, alas, spells trouble. After the French return from their paid August holidays, the unruly elements will probably take to the streets of Paris.

Steve H. Hanke is professor of applied economics at the Johns Hopkins University.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.