3. The French Franc

(i) An open letter to the French Minister of Finance (whoever he is or may be) (Jan. 1926)

Monsieur,—When I read in my daily paper the daily projects of yourself and your predecessors to draft new budgets and to fund old debts, I get the impression that Paris discusses very little what seems to me in London to be the technical analysis of your problem. May I, therefore, divert your attention for a moment from your Sisyphean task of rolling budgets up Parliament Hill back to certain fundamental calculations?

I have written about the French franc many times in recent years, and I do not find that I have changed my mind. More than two years ago I wrote: "The level of the franc is going to be settled in the long run, not by speculation or the balance of trade, or even the outcome of the Ruhr adventure, but by the proportion of his earned income which the French taxpayer will permit to be taken from him to pay the claims of the French rentier." I still think that this is the root idea from which your plans ought to develop.

Now it is obvious that there are two methods of attaining the desired equilibrium. You can increase the burdens on the taxpayer, or you can diminish the claims of the rentier. If you choose the first alternative, taxation will absorb nearly a quarter of the national income of France. Is this feasible? If it is ever safe to speak about the political atmosphere of another country, I should judge from recent indications that the French public will certainly refuse to submit to the imposition of a burden of additional taxation sufficient to satisfy the claims of the rentier at their present level. And even if such taxation were politically possible, it would probably break down administratively. The pressing task of the French Treasury is not to devise additional taxes, but to construct an administrative machine capable of collecting those which exist. If, therefore, I were in your place, I should not, as a politician, give another minute's thought to new taxes, but would concentrate, so far as concerned the fiscal part of my office, on consolidating and administering the taxes already voted.

Since this by itself is not enough, your next business—provided you accept my conclusion as to the mind of the French public—is to consider coolly how best to reduce the claims of the rentier. Three methods offer themselves: first, a general capital levy; second, a forced reduction of the rate of interest on the public debt; third, a rise of prices which would reduce the real value of the rentier's money claims. Unquestionably, the first is preferable on grounds of virtue, justice, and theory. For Britain in a similar fix I should advocate it. But I think it so probable that such a project would be defeated in France to-day by the same political and administrative difficulties which stand in the way of further taxation, that I should not lose my time on it. The second method is attractive, if only because it offers no administrative difficulties. I believe that some authorities in France have favoured it. Nevertheless, I should decline this expedient also, if I were in your place, because, unlike a general capital levy or a depreciation of money, this species of discrimination is truly named Repudiation, and Repudiation of the National Debt is a departure from financial virtue so extreme and so dangerous as not to be undertaken but in the last emergency.

We are left, therefore, by a process of the exclusion of alternatives, with one Exit only—a rise of internal prices; which leads us away from the fiscal field to the price level, the foreign exchanges, the gold in the Bank of France, the volume of foreign investment, and the balance of trade. Here I must invite your particular attention to an interesting paradox.

Successive Finance Ministers have, in fact, done their utmost to find an escape through the Exit I indicate. They have inflated magnificently, and they have brought down the gold value of the franc by progressive stages with only temporary set-backs. What more could they have done?

I will tell you. The great army of your predecessors have failed, in spite of all their efforts, to depreciate adequately the internal purchasing power of the franc. Your present difficulties are due, not to the inflation of the notes or to the fall of the exchange (for these events are tending all the time to help you out of your troubles), but to the failure of these factors to diminish proportionately the internal purchasing power of the rentier's money claims.

The following figures present the essence of your problem. In December 1925, the gold value of the franc on the foreign exchanges was 19 per cent of its pre-war parity; world gold prices were about 158 per cent of their pre-war level; therefore on the pre-war basis a note circulation and a franc price level amounting to 830 per cent (for 158 ÷ 19 = 8·3) of their pre-war figures would be justified. Now the note circulation, being about 1000 per cent of its pre-war figure, roughly corresponds to the level of the foreign exchange—though, allowing for increased territory and the loss of gold and silver coin from the circulation, it is probably still too low in relation to the exchange, rather than too high, on a pre-war comparison.

When we come to the internal franc price level, on the other hand, we find an entirely different story. Imported raw materials have inevitably risen to their international parity. But the classes of goods such as food and other articles entering into the cost-of-living index number, which are dominated by home production, are far below their equilibrium value. Wholesale food prices in November 1925 were 490 per cent of pre-war, retail prices in Paris (thirteen items) were 433 per cent, and in the third quarter of 1925 the cost-of-living index for Paris stood at 401 per cent. These figures may understate the real rise of prices, but it certainly seems that French domestic costs are not above five times their pre-war figure. This means that the prices of purely home produce, converted at the present rate of exchange, are not much more than half world prices, and are actually below their pre-war level in terms of gold. Thus the Inflation of the currency has produced its full effect on the exchanges, and consequently on the prices of imported commodities, but has largely failed to do so on the prices of home produce.

Now the burden of the rentier on the taxpayer is measured by the internal purchasing power of the francs which have to be taken from the latter to be handed to the former. Thus if internal prices had risen as fast as the exchange has fallen, the real burden of the national debt service would be reduced by at least a third. I suggest to you, therefore, that, whilst the solution of your fiscal difficulties can come about in no other way than by a rise in the internal price level, it is not so clear that this need be accompanied either by further Inflation or by a further fall in the exchange.

It is for you to decide in your own mind at what level of internal prices you can hope to balance your budget. Your next step must be to bring about this rise in as orderly and scientific a way as you are able. Looking from outside, it appears to me that an internal price level between eight and nine times pre-war might be high enough. In this case there is no justification for any considerable further Inflation or fall in the franc exchange. All you have to do is to stabilise the note circulation and the franc exchange at near their present level and to allow time for internal prices to rise correspondingly.

What are the explanations of the present low level of franc prices? I think that they are: (1) the time element—internal prices move slowly, but will move as they should in time; (2) the hoarding of bank-notes on an even greater scale than formerly, leading to a sluggish circulation of the available currency; (3) excessive foreign investment by Frenchmen, due to lack of confidence, which drives the exchange down below the figure appropriate to the trading position; and (4) the legal restrictions on rents, etc.

These influences should be remediable as regards (1) by the mere lapse of time, and as regards (2) and (3) by the restoration of internal confidence. The right strategy, therefore, is to restore confidence and then just wait. And the way to restore confidence is, surely, not to heap up taxes, but to stabilise the franc exchange beyond doubt or criticism near its present level.

How to stabilise the franc exchange? Not so difficult as it is supposed to be. The balance of trade is strongly in favour of France. The present level of internal prices encourages exports and discourages imports. The metallic reserve of the Bank of France is worth (at the present exchange) nearly 40 per cent of the note issue. Nothing is required, I expect, but that the Bank of France should declare that for two years at least it will furnish dollar exchange against francs in unlimited amounts on terms not worse than some stated rate between dollars and francs, and that the Bank should be prepared, if necessary, to use its gold for the purpose. The rate selected should probably lie somewhere between 1 dollar for 25 francs and 1 dollar for 30 francs, and it would be safer to choose the latter ratio at first, with just a hope that the former might be achieved in the end.[1] The success of the scheme requires no more than that the Bank's undertaking should be believed. With this background of stability you will be able to borrow enough to carry you through the transitional period without further Inflation.

For the rest you can trust time. As the internal price level gradually rises to an equilibrium with the exchange and as the machinery for collecting the taxes is gradually improved, your budget receipts will grow month by month until they balance the expenses. Those taxes which are fixed in francs and are not ad valorem should, of course, be raised pari passu with the rise in prices.

There are two matters on which the Government of France needs to exercise an iron resolve—to fix the franc exchange at a minimum figure even if it costs gold to do so, and to collect the taxes in full. These are the indispensable measures. Heroic efforts to increase the rates of taxation are, at this stage, efforts in a wrong direction, and will not be successful.

What are the arguments against these courses? They are entirely political. A policy which will not be successful unless it raises prices by a heavy percentage will be open to the universal unpopularity of la vie chère. A policy of bringing about an equilibrium between internal and external prices must be injurious to the export interests which flourish on their disequilibrium. It may not be sufficient to reply that the first must happen in any case unless the taxpayer will sacrifice himself to the rentier, and that the second must happen some day unless the franc is to fall for ever.

But there are political considerations of some weight to set on the other side. A rise in the prices of agricultural produce will not be unpopular with farmers and peasant producers who have been selling their output much too cheap. Further, the Government must make it clear that wage-earners and officials are not intended to suffer, and will, if it is wise, pass a law providing for automatic quarterly increases of all wages and salaries throughout the next two years corresponding to every increase in the cost of living.

Well, I offer these reflections for what they are worth. Whether or not they commend themselves to your judgement, I am sure that the following questions are those which you need to ponder:—

  1. Would a rise in the level of internal prices solve your difficulties?
  2. Can you solve your difficulties without a rise of prices?
  3. Is it not impossible anyhow to prevent a rise in the long run?
  4. If so, will you not be judicious to facilitate an orderly rise and to play for time meanwhile?
  5. Whether you choose this course or another, is there any sufficient objection to using the gold in the Bank of France to anchor the franc exchange?

Your obedient servant,

J. M. Keynes

  1. [This was a happy guess, since the actual figure adopted two and a half years later was 25.5 francs to the dollar.]

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