The Free Market’s Unlikely Champion

In the dark hours of a collapse is when the free market tends to undergo its most radical depredations. Politicians never seem to grasp the complexities of what’s going on, but understand that SOMETHING needs to be done. Like FDR, they just start changing things and hope for the best. Later, a whole generation of economists would praise FDR for his decisive actions. “It’s not that his actions were particularly good,” they might say, “but something needed to be done.” A crisis can not go unanswered. To believe otherwise is sacrilege in macroeconomics. If one believes that an economy can be managed by comparing aggregate supply to aggregate demand, then one has not only the right, but the responsibility to correct the situation.

“With great power, comes great responsibility” were the fictionalized words of Spiderman’s Uncle Ben to Peter Parker, the main character. Peter resisted being called to the role of hero, but in the end, who else had the power to save the world. And this must be how politicians and macroeconomists must feel. They have been given the almost superhuman power to restore confidence in Capitalism by correcting some of the messier elements of the free market system.

And then there’s France. France has always been the butt of America’s jokes; the nation labeled by Homer Simpson as the land of “cheese eating surrender monkeys.” Americans fancy themselves as rugged individualists living by their wits in the dog eat dog world of free market capitalism.  We seem to feel that France is the sissy brother of our western allies: people speaking a strange language in a system so collectivist in their Socialism that it borders on Communist. Like most of America’s fantasies, we seem a bit off base; our system is far more collectivist (and socialist) than we would like to admit and our attitudes regarding France seem unduly harsh. Truthfully, I feel that those two nations have much more in common that either would like to admit. 

Lest we forget, it was France that enabled us to win our independence to begin with. While Americans seem to approach having an empire as a novel idea with grand appeal, France has already gone through their empire phase, complete with an attempt to take over the world through force. And when it comes to fiscal discipline, France seems to have a better understanding of when the game is up than we do. Experience is the best teacher and France has been burned before in the game of holding foreign currencies in the name of global stability. As Murray Rothbard recounted in A History of Money and Banking in the United States: The Colonial Era to World War II France was made a dutiful martyr early in the game of modern finance.

After the aftermath of the first world war, Britain made an attempt to return to the gold standard at their pre-war par. Normally this would have been a very contractionary move, as Britain had vastly inflated their money supply to fight the first world war and therefore there was a far greater ration of paper pounds to central bank gold to back it. One would expect that they would merely have taken the more conventional move of returning to the gold standard at a new par that reflected the vastly inflated quantity of paper notes in circulation. If Britain desired, for whatever reason, to return to valuing the pound at the old par, then one would then have expected for Britain to start contracting their money supply over the years as the United States did in retiring the greenback after the Civil War. But the master planners in Britain, now doubt influenced by the most prominent British economist of the time, John Maynard Keynes. Instead they desired to actually inflate their money supply while simultaneously revert to redeeming their pound in gold. While this scheme might seem absurd to the likes of ordinary mortals like you and I, the British economists felt they could do it.

Part of the plan was that they would not redeem the pound for gold with ordinary citizens, so it was not a true gold standard but rather what became to be called a gold exchange standard. Since the other nations of the world were also in shambles from the first world war (with the notable exception of the United States) Britain felt that no one else would be in a position to present large quantities of paper pounds for redemption as long as the Britain could get the United States to play along. The Federal Reserve, under the leadership of Benjamin Strong, supported this move by the British, for it required the Federal Reserve to expand its money supply even more than the British were doing. Both countries economies underwent a huge inflationary boom in “the roaring twenties”. We all know how that story ended.

What is often lost on those of us not familiar with Rothbard’s excellent history, is that the central bank of France began acquiring large quantities of British pounds as its industries revived and it ran a trade surplus with its British neighbor. The French became nervous as they watched the British and the United States continue their inflationary campaign. They understood that Britain might have a problem redeeming all of the pounds the French possessed should they be ever be presented. But the British central banker, Lord Montagu Norman, convinced the French that Great Britain would stand by their pledge to redeem their pound in gold, even if they had to start raising interest rates and end their inflationary campaign to do it.

So the French played along and held onto their British pounds. As the situation became increasingly untenable, the French began demanding that the British halt their inflationary ways and instead start contracting their money supply. The British were forced to either abandon their pledge to the world to redeem their pounds or they had to stop inflating. Instead of face the pain that might come with higher interest rates, they chose the abandon their gold standard.  France’s central bank had to take a huge loss on the paper pounds it held in it’s vaults.

Fast forward a few decades, and now the players are slightly different, but the story remains the same. Now it is the United States that is maintaining a gold exchange standard, and France is, once again, acquiring a large number of paper dollars. It received similar pledges from the United States that it would stand by its pledge to redeem the dollars in gold, but France once against watched as first LBJ and later Nixon expanded the money supply to increase government entitlements and fight a war in Southeast Asia. As they saying goes, “Fool me once, shame on you, fool me twice, shame on me.” Or, as President Bush shortened it, “You can’t get fooled again.” And so the French didn’t.

Having been burned by their previous experience with England no doubt colored the French decision to continue presenting their dollars to the United States for redemption. And again the leaders of the currency promising to redeem the dollar in gold, were so resistant to the idea of reigning in their spending, that they chose instead to simply make them irredeemable. Yet again, France and the other nations of the world took a loss on their dollar holdings, and today the loss has now spread over to the include debt instruments backed by the dollar as well. 

So now the French are lecturing the world on the benefits of fiscal discipline: Both French President Nicolar Sarkozy as well as Europe’s central banker Jean-Clause Trichet have recently announced a conference in mid-November that will be attended by all of the major western powers including the United States. The topic of this conference is to be a return to the Bretton Woods accord- the accord which Nixon abandoned by ceasing redemption of dollars for gold. 

It’s not hard to figure out the true motive here. Sarkozy and Trichet want to displace the US Dollar from the reserve currency of the world and instead put the Euro in its place. And why not? God has not ordained the US Dollar legal tender for all debts, the US government has; the history of the dollars reign as reserve currency of the world is one ripe with abuse as America has inflated its money supply and forced the other nations of the world to eat the cost. The nations of the world might be ready for a new currency, and Sarkozy and Trichet are certainly ready to make it the Euro. Odds are, this conference may produce little more than lip service, but there is also a chance that Europe may announce a coup by declaring a standard of redeem ability for the Euro in gold. If so, then I would image a stampede of the nations of the world out of the US Dollar and into this newly found hard money. I can only imagine what would happen to the value of the dollar.