Carroll Quigley - Tragedy and Hope - A History of the World in Our Time

In this way, the strain on the gold reserves (which fell to 16 billion francs during 1935) was relieved at the cost of increased depression. By September, the franc was still overvalued (as far as cost of living was concerned) by about 34 percent as compared to the pound and by about 54 percent as compared to the dollar. The deflation necessary to bring French prices down to parity with the prices in the depreciated-currency countries could not be obtained. By the end of 1935, the government had abandoned the effort, and by borrowing to meet budgetary deficits had turned France toward inflation. Gold began to leave the country again, and this exit became a flood after a government of the Left led by Blum came to power in June 1936.

The Blum “Popular Front’’ government tried to follow an impossible program: “inflation on gold.” It sought inflation to relieve depression and unemployment and sought to remain on gold because this was insisted on by both the Communist and bourgeois supporters of the government. In an effort to restore confidence and slow the “flight from the franc,” it became necessary for Blum formally to disavow any intention of installing a Socialist program. The Right thus discovered that it could veto any actions of the Left government merely by exporting capital from France. The flight of such capital continued through the summer of 1936, while Blum negotiated with Britain and the United States regarding devaluation of the franc. On September 24, 1936, the bank rate was raised from 3 percent to 5 percent, and, on the following day, a Three-Power Currency Declaration announced that the franc would be “adjusted,” exchange stability would be maintained thereafter (through the stabilization funds), and trade restrictions would be relaxed.

The French devaluation (law of October 2, 1936) provided that the gold content of the franc would be reduced to an amount from 25.2 percent to 34.4 percent of the old figure of 65 1/2 milligrams. From the profits obtained by thus revaluing French gold reserves, an exchange stabilization fund of 10 billion francs was set up.

Although the French devaluation of September 1936 shattered the gold bloc and forced the other members of the bloc to follow suit, it did not end the period of deflation. The reasons for this were chiefly to be found in the complete mismanagement of the French devaluation. This decisive event was delayed too long—at least a year after it should have been done—a year during which gold steadily flowed from France. Moreover, when the devaluation came, it was insufficient and left the franc still overvalued in relation to price levels in the other Great Powers. Furthermore, the devaluation was shrouded with uncertainty, since the law permitted the government to devalue to any gold content between 43 and 49 milligrams. By stabilizing at about 46 milligrams, the government prevented any revival of confidence because of the danger of a further devaluation to 43 milligrams. By the time the government realized that a further devaluation was necessary, the situation had deteriorated so far that a devaluation to 43 milligrams was worthless. Finally, in the devaluation law the government took punitive measures against gold hoarders and speculators, seeking to prevent them from reaping the profits they would obtain by converting their gold back into francs at the new value. As a result, the exported and hoarded gold did not return but stayed in hiding. Thus the financial, budgetary, and economic difficulties in France continued. By the middle of 1937, they had become so bad that the only possible solutions were exchange control or a drastic devaluation. The former was rejected because of the pressure from Britain and the United States based on the Tripartite Agreement of 1936 and the support which their stabilization funds afforded the franc; the latter was rejected by all politicians likely to obtain power in France. As a result, the franc passed through a series of depreciations and partial devaluations which benefited no one except the speculators and left France for years torn by industrial unrest and class struggles. Unable to arm or give foreign affairs the attention they needed, the government was subjected to systematic blackmail by the well-to-do of the country because of the ability of these persons to prevent social reform, public spending, arming, or any policy of decision by selling francs. Only in May 1938 was a decisive step made. At that time the franc was drastically depreciated to 179 in the pound, and pegged at that figure. Its gold content (by a law of November 12, 1938) was fixed at about 27.5 milligrams nine-tenths fine. By that time France had suffered years of economic chaos and governmental weakness. These conditions had encouraged German aggression, and, when a decisive financial action was made in 1938, it was, because of the rising international crisis, too late to reap any important economic benefits.

We have said that the gold bloc was destroyed by the French devaluation of September 1936. This was accomplished almost immediately. Switzerland, the Netherlands, and Czechoslovakia devalued their currencies by about 30 percent and Italy by about 40 percent before the end of October. In each case, like Belgium rather than France, the devaluation was large enough in amount and abrupt enough in time to contribute to a noticeable reflation and improvement in business activity. Each country of the former gold bloc set up a stabilization fund to control exchange rates, and joined the Tripartite currency agreement of September 1936.

The historical importance of the banker-engendered deflationary crisis of 192 7-1940 can hardly be overestimated. It gave a blow to democracy and to the parliamentary system which the later triumphs of these in World War II and the postwar world were unable to repair fully. It gave an impetus to aggression by those nations where parliamentary government collapsed, and thus became a chief cause of World War II. It so hampered the Powers which remained democratic by its orthodox economic theories that these were unable to rearm for defense, with the consequence that World War II was unduly prolonged by the early defeats of the democratic states. It gave rise to a conflict between the theorists of orthodox and unorthodox financial methods which led to a sharp reduction in the power of the bankers. And, finally, it impelled the whole economic development of the West along the road from financial capitalism to monopoly capitalism and, shortly thereafter, toward the pluralist economy.

The controversy between the bankers and the theorists of unorthodox finance arose over the proper way to deal with an economic depression. We shall analyze this problem later, but here we should say that the bankers’ formula for treating a depression was by clinging to the gold standard, by raising interest rates and seeking deflation, and by insisting on a reduction of public spending, a fiscal surplus, or at least a balanced budget. These ideas were rejected totally, on a point-by-point basis, by the unorthodox economists (somewhat mistakenly called “Keynesian”). The bankers’ formula sought to encourage economic recovery by “restoring confidence in the value of money,” that is, their own confidence in what was the primary concern of bankers. This formula had worked in the past only when it had, more or less incidentally, reduced costs (especially wages) faster than wholesale prices so that businessmen regained confidence, not in the value of money but in the possibility of profits. The unorthodox theorists sought to achieve this latter more quickly and more directly by restoring purchasing power, and thus prices, by increasing, instead of reducing, the money supply and by placing it in the hands of potential consumers rather in the banks or in the hands of investors.

This change in the accepted theories after 1934 was a slow growth, and formed part of the eclipse of financial capitalism; in the long run it meant that banks would be reduced from the masters of the economy to become its servant in a situation where the major economic decisions would not be based on the supply of money but on the supply and organization of real resources. As a matter of fact the whole relationship of money and resources remained a puzzle to many and was still a subject of debate in the 1950’s, but at least a great victory had been won by man in his control of his own destiny when the myths of orthodox financial theory were finally challenged in the 1930’s.