THE French financial situation is a cause of deep anxiety not only to Frenchmen but to their neighbors and friends. What, exactly, are the difficulties in which France finds herself? What are their origins? What are the solutions?

Everybody knows that the present situation cannot continue indefinitely. But very few have the courage to face the fact that a crisis will inevitably occur unless remedial steps are taken. Politicians always have the vague hope that something unforeseen -- economic recovery or the revival of international trade -- will intervene to render painful decisions unnecessary. Self-styled financial writers, with more imagination than experience, offer all kinds of fantastic plans which obscure the stern realities. To be sure, France has known other periods in the recent past which were at least as difficult. In 1925 the task of balancing the budget appeared Herculean; the flight of capital out of the country seemed irresistible; the most absurd proposals received public credence. Yet at that time a firm determination to balance the budget was enough to restore confidence. Confidence, in the words of John Law, is merely "the certainty of being paid."


Two fundamental phenomena characterize the French financial situation of 1938: the flight of capital and the unbalanced budget. Any unprejudiced observer would regard the flight of capital as the result of the unbalanced budget. But not the French public or French statesmen. They are extremely loath to treat the matter so simply. Yet one has only to trace the development of each factor to realize how closely they are related.

The flight of capital from France did not begin yesterday, nor with the rise of the Popular Front to power in June 1936. It began much earlier. Ever since 1933 the Bank of France has been confronted with an outflow of gold. Measured in terms of the Poincaré franc, the Bank's gold reserves were 81.1 billion francs in 1933, 78.9 billion in 1934, 75.3 billion in 1935, 57 billion at the end of May 1936 and 50.1 billion on the eve of devaluation in September 1936. The gold reserve had fallen to 38.7 billion francs on January 20, 1938, although this figure does not include the small amount of gold earmarked for the Exchange Stabilization Fund. These flights of capital originated in the conviction that sooner or later the franc would have to be devalued. They occurred during the ministry of Daladier in 1933 just as they did under Doumergue in 1934 or Flandin and Laval in 1935. But in August and September 1936 the flow was accentuated and ended in the first devaluation, that of September 1936. Immediately the pound sterling jumped from 75 to 105 francs, touched 110 in March 1937 and reached 150 in July, after the decision was made to let the franc seek its own level.

Since early in 1936 the Bank of France has lost 37.3 billion francs in gold (figuring the gold content of the franc at 48.5 milligrams). Curiously enough, this loss of gold is practically equal to the increase of advances made during the same period by the Bank to the Government -- 32 billion francs. The coincidence is the more startling if one considers only gold lost by the Bank due to export of capital, excluding for the moment gold exports for settling the balance of payments.

Incidentally, from the day in September 1931 when the British went off gold, sterling exchange declined gradually until from being worth 125 Poincaré francs it was worth only 75 Poincaré francs. As there was no proportionate increase in British commodity prices, the benefit of the relative cheapness of the franc established by M. Poincaré was lost to that extent.

But the French public persist in comparing the current gold content of the franc with what it was before the war and consider the reduction in gold content to mean that they have lost 90 percent of their wealth. This, of course, is absurd. National wealth has not diminished in this proportion; indeed, it has probably increased. To identify shrinkage of the gold content of the franc with shrinkage of the country's wealth is as ridiculous as it would have been during the war years to believe that the wealth of the country increased in proportion as the Bank of France issued more and more franc notes and prices skyrocketed. What is true is simply that there was a cut in the claims of one part of the nation -- the creditors -- on the national wealth. Their income, expressed in gold, has decreased because of the successive devaluations. To a certain point this cut is justified, for the rest of the nation at present could not, without going into bankruptcy, repay the creditors in the gold values at which the obligations were originally contracted.

The fall of the pound sterling between 1931 and 1934 cancelled some of the advantages which Poincaré had obtained in stabilizing the franc. And when as a consequence of the fall of the pound the franc was again devalued to reëstablish the old ratio of 125 to the pound, the effect was only to readjust the price levels of the two countries to their previous relationship. But many things had happened in the five years between the British and French devaluations. Most important, the depression had caused the French national income to fall from 250 billion francs to 190 billions annually.

The decrease in national income resulting from the fall in prices at once manifested itself in budget deficits. As a matter of fact, deficits had begun five or six years earlier and had increased steadily. The budget of 1930-31 showed a deficit of 4.9 billion francs; it grew to 5.5 billion in 1931-32, 6.5 billion in 1933, 8.8 billion in 1934, 10.4 billion in 1935, 7.8 billion in 1936, and reached from 7 to 8 billion in 1937. We are speaking here only of the ordinary budget. To these amounts should be added the expenses which are called in France "les charges de la Trésorerie," and which constitute an extraordinary budget for which no revenue is provided. These additional expenses are estimated at 30 billion francs for 1938. M. Blum estimated that they might reach even 40 billion francs. I shall explain in a moment the nature of these extraordinary expenses.

These deficits have been met by borrowing. Since 1931 the Government has borrowed about 126 billion francs, of which 32 billion (as of March 1938) were advances made by the Bank of France. The British and American Governments were also borrowing during this period, but at very low rates, thanks to the fact that in both countries there was a surplus of capital seeking investment, and to the banks' habit of using their deposits to buy government issues in the open market. The French Government had difficulty in borrowing even at an interest rate of 7 percent or better. Thus no funds were available at reasonable rates for the needs of industry, and the depression was thereby intensified. The financing of short-term Treasury notes became increasingly difficult because of the decrease of bank deposits, caused by the flight of capital.

While the Government's income was falling as a result of the causes mentioned, its expenses increased because of the intensification of rearmament, relief for the unemployed, and the growth of the railroad deficit, which is met by the Government. Let me give a few figures to show the financial effects of increased rearmament to keep pace with German rearmament, and of the unprecedented economic depression. The following table considers the French Government's expenditures for 1938 under two heads: those covered in the ordinary budget; and the total expenditure anticipated, including sums in excess of expected receipts.

Ordinary Budget Total Expenditures Percentage of Total
(in billions of francs) (in billions of francs) Expenditure
Public Debt 11.6 11.6 16.9
Civil Pensions 5.9 5.9 8.5
War Pensions 5.0 5.0 7.3
National Defense 10.8 22.0 32.1
General Administration 19.2 19.2 27.7
Railroads 2.2 2.2 3.2
Public Works 2.4 3.4
Recoverable Outlays 0.6 1.0
---- ----
  Total 54.7 68.9

Three general observations can be drawn from these figures. (1) The cost of administration is less than one-third of the total expenditure; national defense represents another third; while interest on the national debt and pensions account for the remaining third. (2) The difference between expenditure foreseen in the ordinary budget and the total expenditure really expected is made up, essentially, of two items: increased appropriations for rearmament (12 billion), and the cost of public works to deal with unemployment. If these two items -- totalling about 14 billion francs -- were eliminated, the budget apparently could be balanced. (3) However, the difference between income and outgo is actually greater than indicated, for the state must make good the railroad deficit and assume certain communal and departmental liabilities, while military expenses are always greater than anticipated. Thus it probably is spending 30 billion francs a year more than it is taking in.

The parallel between the continuation of budgetary deficits and the export of capital is striking. Evidently the basic and causal phenomenon is the deficit; but, oddly enough, it receives less attention than the flight of capital. The latter is what the public observes and tries to explain.

The explanations found are generally political. Some people blame the character of the present parliamentary majority. They point out that the Socialists are the dominant political party and the Communists one of the majority parties, which fact is alleged to frighten the moneyed groups into sending their funds to other countries. The explanation would be more convincing if the flight of capital had not begun before the advent of the Popular Front Government of 1936. It occurred even under a conservative government, e.g. in 1922, when M. Poincaré was in office and the strength of the Socialists and Communists was insignificant. It is true that the rise of the Popular Front Government may have given many people the idea that very severe tax measures would be adopted; and these may for that reason have sent their funds abroad for safekeeping. But such exports are only a drop in the bucket compared to the steady outflow of gold that has been going on for years.

Others blame recent social trends -- disputes between employers and employees, the increase of strikes -- and allege that capital will hurry back as soon as laws are enacted determining the respective rights of employers and employees and establishing peaceful methods of arbitrating labor disputes. Labor troubles certainly have accelerated the outflow of capital. But it would be quite illusory to imagine that the elimination of labor disputes would put an end to doubts as to the stability of the currency.

Still other observers discover the cause of our woes not in political or social trends but in the unfavorable trade balance. But this is not so significant as is generally believed. The unfavorable trade balance of 16 billion francs in 1937 is only part of the story, for it was to some extent counterbalanced by invisible items due among other things to the influx of tourists visiting the Paris Exposition. A group of experts has recently estimated that for the year 1937 France really had an unfavorable balance of payments amounting to not more than 5 billion francs. Moreover, in any consideration of imports, one must take account of forward buying, i.e., purchases for future delivery, by means of which Frenchmen hope to cover themselves against losses due to a possible devaluation. The unfavorable trade balance, though not a negligible factor, is much more the result of the monetary crisis than its cause.

All these explanations of the flight of capital are secondary compared to the persistence of budget deficits and the attendant fear of renewed inflation. Everyone knows that while the Government spends more than it receives and while the French money market is unable to extend loans of 30 billion francs to meet the difference, the Government has but one recourse: to borrow from the Bank of France. They also know that this alternative, if in the least prolonged, must unavoidably result in a new devaluation. The fears which spring from this fact affect all classes of French society. Quite irrespective of political philosophy, and disregarding whatever social uneasiness may prevail, Frenchmen of all classes agree in wanting to put their savings in a safe place. This is true whether the savings are small or large. In the case of exporters, they are keeping cash which they receive from sales abroad in foreign currencies. But there is not a single Frenchman who has funds which he cannot immediately use who does not reflect whether it might not be safer to send them abroad than to keep them at home.

Hence the vigor and persistence of the capital outflow. And hence its interruption whenever the French public discerns the beginnings of a more intelligent financial policy. Twice during 1937 a considerable repatriation of capital occurred: in March, when the Blum Government announced a breathing spell, and in the autumn when measures taken by Georges Bonnet seemed to point to a new financial policy. With the advent of Daladier in the spring of 1938, the same hope led to the same repatriation. In a word, the same cause which brought about the export of capital in the years 1922 to 1924, before the Poincaré reforms, still produces the same result; and the factors which then caused the flight to cease still have that effect.

If there were no fear of an unbalanced budget, the technical conditions for a return of capital to France would be suitable. For one thing, the rise of prices necessitates putting more francs in circulation. Industry is so short of funds that it would be virtually obliged to repatriate a part of its capital funds. In the second place, conditions would be such as to encourage foreign-owned capital to seek investment in France. For it must be remembered that the movement of capital in and out of France is not determined by French buyers and sellers of francs alone, but also by the demand for francs in world markets. Given the very high money rate in France as compared to the low rate elsewhere, it would be reasonable and natural to expect foreign capital -- short-term capital at any rate -- to seek investment in France.

Now what is it that has stopped foreign capital from seeking investment in France? The fear, even of short-term capital, that there will be a devaluation of the franc and hence a loss when the investment is ultimately re-converted into the original pounds or dollars. Just as a rise in the value of the franc attracts foreign capital, so whenever the outlook is for a continued or even an irregular decline in the franc no one is attracted by the French investment market. An examination of French security prices shows that most of them are unduly low. With a minimum return of confidence, they ought to rise substantially. Thus the prolongation of the budget deficit and the fear of fresh demands on the Bank of France not only cause Frenchmen to export their capital but dissuade foreigners from sending their funds to France and lead them to seek investment elsewhere.

Many people attribute our financial woes to the enactment of the law for a 40-hour week, with a consequent decrease in production and an increase in operating expenses. I have no intention, certainly, of trying to defend a law which is indefensible, one which has resulted only in stepping up production costs in a country where the demand for unskilled labor is always greater than the supply. But although I strongly hope that the law will be modified, I cannot admit that to do so would be enough to affect the exchange situation. So long as budget deficits continue on their present scale, there will be no return of confidence in the franc.

From whatever side one approaches the problem, one always comes back to the fact of the unbalanced budget. If so many statesmen refuse to face the issue squarely, that probably is because the problem of balancing the budget is so difficult to solve, because the fiscal and political obstacles along the road are real. I should like to discuss these obstacles briefly and indicate to what extent they might be lessened if not eliminated.


Here is the problem in a nutshell: How can France, whose total national income does not exceed 250 billion francs per year, support a budget of 85 billion, when only 55 billion of that sum is provided by taxes and when the remaining 30 billion must be raised in some other way? The problem is insoluble if the budget is required to provide for the enormous costs incurred by the last war and the even greater cost of preparing for defense against new international dangers. The costs of the previous war can be lightened in only one way: ending the process of amortizing the debt and reducing the interest rate on it. Both steps naturally will encounter serious political resistance. It is so easy for any political party, whatever its hue, to assume the rôle of defender of established contracts! But in this particular case any such position would be hypocritical. If the budget is not balanced, the holders of rentes will certainly suffer from a decline in the purchasing power of their income. The restoration of a balanced budget, on the other hand, will carry definite assurance of payment of interest and will thereby increase the market value of government bonds. It is better to sacrifice form to substance than substance to form.

Economically it is absurd for the Government to borrow at 7 percent in order to amortize obligations contracted at 5 percent. It is equally absurd to continue to drain the money market by loans at practically usurious rates. France has not been able to create the abundance of capital which in London and New York permits interest rates of 3 and 4 percent. But it must be achieved either by the procedure adopted in Belgium or else by making Government rentes subject to the income tax. The sacrifice demanded of rentiers is the same in either case although it is obtained in a different way. The result would be a saving of about 8 billion francs; and two billion more could be gained by other reductions and by a readjustment of taxes.

A second measure, equally important, is the necessity of giving the money market a breathing spell, so that interest rates can gradually fall. Perhaps this can be achieved earlier than we expect if the Government will guarantee that no more than the 12 billion francs in the extraordinary military budget will be asked for this purpose. We must have no illusions about the permanence of the extraordinary military budget. For a long time to come -- unless the international situation improves rapidly -- the Government must continue to borrow to meet a part of its military expenses. But it cannot afford to prolong the economic crisis by borrowing at such a high rate that industry is unable to compete in finding new capital. State borrowings must be allowed to take only a part of the annual national savings.

The repatriation of capital will make the lowering of the interest rate easier. And repatriation will begin just as soon as the Government announces a reasonable financial program that will give the public confidence in the future of the franc. Under such conditions the money market will gain a reassurance which today it lacks, and the Government can finance many of its needs by Treasury notes rather than by advances from the Bank of France. Increasing confidence will justify the Government in expecting that the same taxes will yield greater returns, which ought, in a year or two, to balance the budget for all items except the extraordinary military expenses.

As early as next year we can expect a real decrease of expenditure which will greatly facilitate the finance minister's task. The fact that the railroads have been put in a healthier condition has already resulted in a reduction in their operating deficit, and this will be reduced still more if general economic conditions improve even slightly. Relief for the unemployed ought also to diminish as business picks up. Finally, the curtailment of public works and of unwarranted loans by the national government to the cities and departments ought to help in getting the budget in balance.

It is not outside the bounds of reason to suppose that a financial program based on the simple principles here set forth should, within two years, restore an equilibrium which, though perhaps not perfect, will nevertheless be adequate to dispel fears of a new devaluation.

It will have become evident in the preceding pages that for the last three or four years French finance has been dominated by the requirements of rearmament. In the early postwar years the dominant factor was the need of reconstructing the devastated areas. This need produced the budget item which caused the principal difficulties of the early 1920's. Hardly had reconstruction been completed and hardly had Poincaré stabilized French finances, when the country encountered the depression of 1931. The successive devaluations of the pound and the dollar placed the French budget in jeopardy. Then came the intensified rearmament of Germany and the openly expansionist policy of Chancellor Hitler. The spectre of war, which we thought had been banished for decades, reappeared. As a result, during the last five years France has had to double its military expenses. We could have borne even the cost of unemployment relief had it not been for the rearmament burden. But the coincidence of the depression and of intensified rearmament was fatal to budget balance so brilliantly achieved from 1926 to 1930.

For this reason it really is most unjust to attribute the cause of our woes to the errors of French statesmen or their lack of vision. These men have had to cope with international events not of their making and not within their power to control. What one can rightfully ask of our statesmen, however, is to demand sacrifices from the French people, and to do it promptly. Given assurance regarding the future, I think that Frenchmen will rise to the demands of today. Shortly after the war one of my American friends remarked: "The only criticism I can make of French statesmen is that often they underestimate the great sacrifices their fellow citizens will make." Now as then, the French are ready to give what must be given to restore monetary stability. But their statesmen must have the courage to ask it of them.


During the early weeks of May, two events confirmed this view: an 8 percent increase in existing taxes, which ought to add 4 billion francs to the Government's revenues; and a new devaluation, which resulted in an exchange rate of 176 francs to the pound. At once there occurred a considerable repatriation of French capital and an influx of foreign short-term capital seeking investment. The banks immediately made use of these funds by subscribing on an extremely large scale to short-term Treasury notes. The result was a lowering of short-term interest rates as well as of the discount rate of the Bank of France; and the Treasury was placed in a position where it can face the expenses of the next few months without worry. The Government has given assurance that it will not permit the pound to rise above 179 francs.

All this confirms the belief of those of us who looked on the flight of capital as being primarily motivated by fear of a new devaluation. Also confirmed is the argument that a return of capital is the only way of lowering the interest rate. A Government loan can now be issued at a much lower rate than was possible with preceding loans.[i] The events of early May are extremely fortunate not only in themselves but for the immediate justification they gave to opponents of the policy of exchange control.

But we must not exaggerate their significance. Monetary stability cannot be achieved by Government decree. As in the past, it can only be maintained by the reëstablishment of a balanced budget and by an increase in national income. The level of French prices expressed in gold has fallen below that of foreign countries. France therefore is in an excellent position to increase its exports of merchandise. No danger to the currency can arise from this kind of price disequilibrium. The only danger comes from financial uncertainty and the lack of balance between the Government's income and outgo.

Recent events strengthen the contention put forward in these pages regarding the necessity of including in the ordinary budget all expenditures with the exception of those for increased armament. More than ever the Government must set its financial house in order and not appeal to the Bank of France to meet a budget deficit. The increase of general taxes, which has just been voted, will only just balance the ordinary budget. The tremendous extraordinary expenditures will be only slightly affected. I am convinced, therefore, that the only way of balancing the over-all budget is to suspend, purely and simply, part of the service of the national debt -- in particular, to suspend amortization and to levy a tax of 2 to 3 billion francs on income derived from Government bonds. The holders of the bonds will largely be compensated by the increased market value of the bonds themselves.

I do not make such suggestions lightheartedly. But I hope that in making them I shall be able to do something to help the American reader understand the great problem that confronts us. The World War forced the French Government to make unprecedented appeals for the savings of its citizens, first to carry on the war to victory and then to rebuild the devastated areas. It is not easy for the Government to break faith with those who responded to its appeal in the hour of need. But the reason why the step is necessary is obvious: the fresh menace of a general war which, if it occurs, will destroy material wealth and mankind's intellectual heritage the world over on so gigantic a scale that even the vast destruction of the last war will pale into insignificance.

[i]Editor's Note. The May 16 issue of 5 billion francs was on the following terms: coupon, 5 percent; issue price, 98; repayable at 120, by drawing by lot from 1941 to 1968; repayable at par, at option of holder, every three years beginning May 15, 1941. Yield to first optional redemption date, approximately 5.7 percent.

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  • CHARLES RIST, Professor of Political Economy at the University of Paris; member of the Committee of Experts, 1926; chief French financial adviser at the World Economic Conference
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