How Russia Decides to Go Nuclear
Deciphering the Way Moscow Handles Its Ultimate Weapon
RAYMOND POINCARÉ formed his National Union Ministry on July 22, 1926. In the twelve-month since he became Premier and Minister of Finance he has brought the financial problem with which France was then faced within sight of final solution. The nature of the problem which confronted him was stated with admirable clarity in the report made public on July 3, 1926, by the French Committee of Experts, and need not be re-stated here in detail. However, it is perhaps useful to outline briefly certain of the main events which preceded M. Poincaré's assumption of office.
Following the Armistice the French people were faced with the choice of restoring the nine devastated Departments of France or of applying themselves to prompt fiscal rehabilitation. To have undertaken both tasks simultaneously might have risked double failure. At all events, successive French Governments addressed themselves primarily to the solution of the problem of physical reconstruction in the hope that with the aid of Reparation Payments they could maintain the fiscal situation in status quo. It soon became apparent that no important sums would be received from Germany in the years immediately following the war. But reconstruction was already in full course and it proved necessary to finish the work unaided rather than abandon it half completed. It is not necessary to analyze at length the effect of this decision on French public finance. Suffice it to say that successive Finance Ministers, hampered as they were by recalcitrant Chambers, were unable to raise the funds necessary for reconstruction and at the same time balance the Budget and avoid currency inflation.
When M. Poincaré took office matters had definitely come to a head, the Budget was not balanced, the floating debt had become unmanageable and had ceased to float, the State was without current funds, the franc was at 248 to the pound sterling, and it was obvious that the State soon must either have further recourse to the issue of paper money in order to avoid openly repudiating its obligations or undertake promptly some such comprehensive program of fiscal reconstruction as had been recommended by the Committee of Experts.
Physical reconstruction had meanwhile been approximately 90 percent completed, and the remaining task in this respect was not great. It was the fiscal situation which was so bad as to seem hopeless to many observers both in France and abroad, and it was to the solution of this problem that M. Poincaré at once addressed himself.
He had not been long in office when he realized that the cornerstone of any program of fiscal rehabilitation was a balanced budget. French budgets had previously been divided first into three categories -- Ordinary, Extraordinary and Recoverable -- and later into two -- Ordinary and Recoverable. This multiplicity of budgets designed to distinguish between recurrent, special and non-recurrent expenditures and receipts served simply as a thin disguise for the fact that the State's current expenditure exceeded its current revenue. In his report of June 10, 1927, the Agent General for Reparation Payments commenting upon the similar German practice of presenting the Reich's accounts in separate budgets states the fundamental objection to such budgetary method in the following terms: "The effect of all this procedure is to present the financial position of the Reich in a most artificial light. . . . This system of accounting, in other words, permits budget surpluses to be shown which do not actually exist and which will only come into existence in the future to the extent that loans are actually placed."
Such criticism can no longer be applied to France. On August 3, 1926, M. Poincaré required Parliament to vote increased taxation of 9,300,000,000 francs in order to balance the State's expenditure and revenues. At the same time budgetary accounting was so simplified that it is now possible to obtain a complete and accurate view of the State's accounts without expert knowledge and months of hard work.
The Budget for 1926 was the first since 1913 to be balanced in the fullest sense of the word. Indeed the fiscal year 1926 ended with a real surplus of current receipts over current expenditures in excess of one 1,592,000,000 francs -- a sum which has since been devoted to a retroactive increase in the pay of civil servants in the lower grades. Furthermore, M. Poincaré presented to the Chamber and had voted before the beginning of the year a fully balanced budget for the calendar year 1927, which to date shows a real surplus of receipts over all expenditures of slightly over 700,000,000 francs. The 1927 Budget, it should be noted, provides about 4,300,000,000 francs for Debt Amortization in addition to 3,500,000,000 francs with which the Caisse d'Amortissement is endowed for the purpose of retiring Bons de la Défense Nationale. The year 1927, therefore, should close with a net reduction of the public debt, the best of all proofs of budgetary equilibrium.
Assured that current expenditures would be met from current revenue, M. Poincaré next turned to the question of the floating debt. His primary aim was to avoid forced consolidation such as had been found necessary in neighboring states. To this end he created by Constitutional Act, a Sinking Fund Commission (Caisse d'Amortissement) under independent management to care for the renewal and retirement of Bons de la Défense Nationale. To this Commission the product of the Tobacco Monopoly and certain tax revenues were assigned. Its operations from the start have been attended with uniform success. In order to assure itself a reasonable working capital it began last autumn by offering a long-term amortizable loan which was attractively priced and hence was considerably over-subscribed. This was the first government or semi-government long-term internal loan which had been successfully sold in nearly four years. With its cash position thus assured, the Commission has gradually converted some twelve billion francs of one, three and six month bills into one and two year bills. Its position is now so strong that it no longer even offers one year bills for sale or renewal, the holders of these having no option but to accept payment for their bills as they fall due or to convert their holdings into two year bills. In addition, it progressively reduced the interest rate on one year bills from six to three percent and pays only four and one half percent on two year bills. This difference in interest rate has been a factor in driving investors away from the one year notes to the two year notes at a pace of about 2,000,000,000 francs per month. As no two year notes were issued until December 16, 1926, it will be noted that so much of the floating debt as is included in the two year note class does not present itself for payment until December, 1928.
Through the above operations the Commission has reduced the average monthly maturity of bills from nearly seven billion francs to under three billion francs. With the return of the investor's confidence in the Government's will and ability to meet its obligations, the Commission has found it difficult, however, to reduce the actual total of the Bons de la Défense Nationale under its control. In spite of the consolidation in May of over 7,300,000,000 francs, or approximately 15 percent of the total bills outstanding as of April 30 last, the issue of such "bons" remains somewhat above the level of a year ago.
Early in the current year M. Poincaré, as part of his program of floating and short term debt consolidation, offered a loan designed to consolidate short term debt maturities for 1927. This issue paid an adequate interest rate and was successful. Provision thus has been made to care for short term debt maturing this year. Between April 25 and May 25 last, a further consolidation loan designed to fund short term debt maturing (in some cases at the option of the holder) in 1928 and 1929 was sold. These maturities totaled 18,450,000,000 francs. This issue also attracted heavy subscriptions, and debt maturities for the next two years have been reduced to 7,500,000,000 francs, a sum fully within the Treasury's capacity to handle.
The effect of the above operations has been to reduce heavily the total short term debt and in addition to change the floating debt into longer and longer maturities.
In the meanwhile M. Poincaré did not neglect the purely monetary aspects of his problem. By the law of August 6, 1926, the Bank of France was authorized to purchase gold, silver and valuta (foreign exchange) and to issue francs for this purpose in excess of the amount authorized by law, such excess issue, if any, to be shown in the circulation figures. The Bank is required to hold the gold and silver or valuta so purchased as reserve against the excess notes issued. Under this law the Bank of France has purchased whatever valuta offerings have been made in excess of those which the exchange market in the ordinary course of business would absorb. In addition, the Bank has purchased gold and silver coin in France at prices somewhat below the world prices of such metal. The inauguration of this policy in the late summer of last year was one of the causes of the rapid recovery of the franc to 124.2 per pound sterling, at which price it has been held by the Bank of France since December 20, 1926. The return of confidence on the part of the French public in the solidity of its Government's financial position, of course played some part in the swift rise of the franc last fall as did in a certain measure the borrowing abroad by various French railroads, et cetera, of approximately one hundred million dollars. This sum, however, was not held by France but served to obviate exchange purchases in order to pay off certain indebtedness due to Holland, Switzerland, and other countries, and to meet normal interest and sinking fund payments on the Government's foreign commercial debt.
Subsequent to the decision to hold the franc at 124.2 francs per pound sterling, the Bank of France and the French Treasury have come into possession of very important valuta reserves. These reserves are freely estimated by the French press to be now in excess of one thousand million dollars. This sum apparently represents a net gain of valuta, since early in the current year the French Treasury and Bank of France together made a heavy payment in liquidation of the debt to the Bank of England and the Treasury has further met payments on war debts to the British and American Treasuries in addition to meeting the normal charges on its foreign commercial indebtedness.
The process by which this great valuta reserve was accumulated seems to have been somewhat as follows:
Purchases of valuta were made in the first place not because the Bank particularly desired to accumulate additional foreign exchange reserves but in order to keep the franc from rising above the selected level. The francs issued to purchase such valuta have not, however, in fact increased the bank note circulation. The seller of valuta has apparently been taking the francs which he received in return for his sale of foreign exchange to a deposit bank. The Bank of France does not pay interest on deposits with it, and there are no longer any short term bills in which the banks of deposit can readily invest their funds. These banks, because of the slight commercial demand for funds, have been at a loss to know what to do with their money. The result has been that the banks of deposit have been driven to place their excess funds on demand deposit with the Treasury, which for some time paid interest thereon at the rate of 1.6 percent per annum free of tax. At the end of July of this year, however, the interest rate paid on such deposits was reduced by the Treasury to approximately 1.25 percent.
These abnormally low interest rates are of course due to the plethora of ready funds. The funds deposited with the Treasury in the process described above have been used by it to reduce its indebtedness to the Bank of France and thus increase its borrowing margin with that institution. The result of the whole process has been that since July 22, 1926, the debt of the Bank to the Treasury has been reduced from 38,550,000,000 francs to 26,250, 000,000 francs on July 21, 1927. The bank note circulation, on the other hand, during the same period fell from 55,000,000,000 francs to 53,131,000,000 francs.
Some part of the money which has been attracted to France with the return of confidence in her credit has come from foreigners who have become interested in investing in French securities. Not only American investors, but Dutch, British, German and Swiss have been heavy buyers of French internal securities. There is perhaps some element of peril in such investments, because funds may be repatriated after profit-taking, the law which prohibits the export of French capital not being applicable to foreigners. But a considerable portion of the foreign investments in France are thought to be there to stay. While it is of course impossible to determine to what degree foreigners have taken part in the recent flow of foreign funds to France, there seems to be a tendency in some quarters to overestimate their share in the movement. In France it is believed that perhaps one-half of the French funds which went abroad during the flight from the franc in 1924, 1925 and 1926, estimated in the French Economic Year Book for 1927 at $1,500,000,000, has now returned.
The demand deposit account which is being carried at the Treasury has caused some concern. The amount of these demand obligations on July 22, 1927, was over 10,000,000,000 francs. Late in June the Government issued a long term internal loan for the purpose of funding such portion of this indebtedness as was not really required in the form of liquid funds. According to semi-official reports this loan produced some 4,700,000,000 francs in cash. It must be remembered in connection with these Treasury deposits that the short time floating debt has practically disappeared and that no one, three or six month obligations are now being issued. It should also be noted that the deposits with the Treasury at 1.25 percent interest represent almost exclusively the funds of banks, insurance companies and large corporations. The minimum amount that may so be deposited is 500,000 francs. On the other hand the larger part of the floating debt as formerly constituted was held by small investors.
Perhaps it is necessary to draw attention to the fact that the large foreign exchange balances now held by the Treasury and the Bank of France do not represent the acquisition of new wealth either by French citizens, the Bank of France or the French Government. They represent largely the assets of individual Frenchmen or foreigners which were formerly held outside of France. When the Government inaugurated its comprehensive program of fiscal reform and it became apparent that the Budget was really balanced, that the danger of unlimited currency inflation had been removed, and that a forced consolidation of the floating debt need no longer be feared, owners of capital, as has been said, regained confidence in the State's integrity and moved their funds into France for investment. What has taken place, therefore, is the transfer of rights to foreign balances from a great number of individuals, French or otherwise, to the Bank of France and the Government.
The amazing transformation of the fiscal situation of France which has been outlined above has not been without effect on the industrial condition of the country. The French franc after a period of rapid appreciation has now been held at a fixed price for seven months. The result, as nearly as such things can be measured, appears to have been to force the rise of French prices to fairly close to the world level. On the whole, the industry and commerce of the country have withstood this rise of prices fairly well. Trade is of course not as active as it was during the inflation period, but the slackening which followed the appreciation and de facto stabilization of the franc did not cause unemployment in excess of some eighty thousand at the peak and there has been a subsequent reduction to approximately fifteen thousand. Furthermore, foreign trade and tax figures for the first six months of the current year do not indicate any considerable decline of activity. Indeed, recently published foreign trade figures indicate an increased volume of trade, both in exports and imports. French industry has shown surprising capacity for adjusting itself to de facto stabilization at the current level.
The return of Alsace-Lorraine and the prompt reconstruction of the northern industrial section have had a profound effect on the French national economy. France seems to have entered definitely into the ranks of those countries whose balance of trade is in equilibrium, or nearly so. This fact is important, as it would seem to confirm the fact that the balance of payments is and seems likely to remain in France's favor.
Certain observers have contended that the success which M. Poincaré has had in handling the problem of French fiscal reform has been almost wholly due to the confidence of the average Frenchman in his personal integrity and capacity. To such confidence is certainly attributable the halt in the flight from the franc immediately after he took office last year. But confidence would not have been maintained had not his actions proved it well founded. In the space of one year he has balanced the Budget, consolidated the greater part of the short term debt maturing in the next three years, reduced monthly maturities of floating debt by over one-half, put an end to all talk of forced consolidation, and paid off a portion of the short term foreign indebtedness of the State. These measures have been the basis for the return of capital to France, for the maintenance of the franc at the selected level since December last, and for the acquisition by the Bank of France of valuta reserves for its protection. M. Poincaré may thus be said to have fully justified by his choice of means and by his energy in applying them the confidence of those who held that his accession to office meant the inauguration of a period of thorough-going fiscal reform.
France is of course still faced with many serious problems. But the past year has proven beyond doubt that under competent leadership the French people have the capacity to meet the problems of peace as they so well proved their capacity to stand the shock of war.