by Murray Rothbard
(Contents by Publication Date)
"Attacking" The Franc
An all-too-familiar melodrama was played out in full on the stage of the world media. It was the same phony story, with the same Heroes and Villains.
The French franc, a supposed noble currency, was "under attack." Previously in September, it was the British pound, and before that the Swedish krona. The "attack" is as fierce and mysterious as a shark attack in the coastal waters. The Hero is the Prime Minister or Finance Minister of the country, who tries desperately to "defend the value" of the currency.
Prime Minister Eduard Balladur of France, pledged himself to defend the "strong franc" (the franc fort) or go under (that is resign) in the attempt. The "defense" was waged, not with guns and planes, but with hard-currency reserves spent by the Bank of France, as well as many billions of dollars expended in the same cause by the German central bank, the Bundesbank. In many cases, international institutions and the Federal Reserve lend a hand in trying to support the value of the "threatened" currency.
If national and international statesmen and governments are the Heroes, the Villains are speculators whose "attack" consists simply of selling the currency, the franc or pound, in exchange for currencies they consider "harder" and sounder, in this case the German mark, in other cases the U.S. dollar.
The upshot is always the same. After weeks of hysteria and denunciation, the speculators win, even after repeated pledges by the prime minister or finance minister that such devaluations would never ever occur. The krona, the pound, or the franc is, one way or another, devalued. Its old official value is no more. The government loses a lot of money, but the promised resignations never take place. Prime Minister Balladur is still there, having saved face by widening the "permitted bands" of movement of the franc.
And, as usual, after the hysteria passes, and the franc or pound or krona is finally lowered in value, everyone begins to realize, as if in a wonder of new insight, that the economy is really in better or at least more promising shape now than it was before the "attack" succeeded in its wicked work.
Why the repeated subjection of currencies to attack? And why do the villains always win? And why do things always seem better after the "defeat" than before?
It's really fairly simple. A currency's value is determined like any commodity: the greater the supply, the lower the value; the greater the demand, the higher the value. Before the 20th century, national currencies were not independent commodities but definitions of weight of either gold or silver (sometimes, unfortunately, both). In the 20th century, and especially since the last vestige of the gold standard was eliminated in 1971, each currency has been an independent commodity. The supply of francs or dollars consist in whatever francs or dollars are in existence. The "demand" to hold these currencies depends largely on people's expectations of what will happen to price, or to the value of the currency.
The more a government inflates its currency, then, the lower will be the "value" of that currency in two ways: its purchasing power in terms of goods and services, and its value in other currencies. Inflationary currencies, therefore, will tend to suffer from rising prices domestically and from falling exchange rates in terms of other, less inflated currencies. A severely inflated currency will lead to a "flight" from that currency, since people expect greater inflation, and a flight into harder currencies.
The best and least inflated form of money is a world-wide gold currency. But absent gold redeemability, and given our existing fiat national currencies, by far the best course is to allow exchange rates to float freely in the foreign exchange markets, where they at least clear the market and insure no shortage or oversupply of currencies. At least, the values reflect supply and demand.
Governments like to pretend that the value of their currency is greater than it really is. If France really wants a "franc fort," the central bank should stop increasing the supply of francs on the market. Instead, governments habitually want to enjoy the goodies of inflation (higher prices, high government spending, subsidies, and cheap loans to friends and allies of the government), without suffering any loss of prestige. As a result, governments habitually set a value of their currency higher than the free-market rate.
Fixing the exchange rate amounts to an artificial overvaluation (minimum price floor) of their own currency, and an artificial undervaluation (maximum price ceilings) of such harder currencies as dollars and marks. The result is a "surplus" of francs or krona and a "shortage" of the harder currencies.
To maintain this artificially high rate, the government and its allies have to pour in (waste) many billions of dollars in what is equivalent to price supports, which eventually must run down as the government runs out of money and patience. And since the overvalued currency under attack has only one way to go--down--speculators can move in for a handsome and sure profit.
Blaming speculators for these crises is as absurd as blaming "black marketeers" for higher prices under price controls. The true villains are the supposed "heroes," those government officials trying, like King Canute, to command the tides, and to maintain artificial and unsound valuations.
The alleged Heroes are even more villainous these days than usual. Since 1979, the European governments have been trying to maintain a fixed exchange rate system among themselves; in the last few years, they have been trying to close the allowed bands of fluctuation 2.25 % plus or minus the official rate--in preparation for a single European Currency Unit (ECU) that was supposed to begin at the end of 1993 and would be issued by a single European central bank.
A single European currency and central bank was sold to the world public as a giant "free trade unit," but it actually was a giant step toward centralized government in Brussels. It was a step toward the old Keynesian dream of a world paper unit by a World Reserve Bank administered by a world government.
Fortunately, with the resistance to Maastricht, and then with the pullout of Britain from the European Currency System and the face-saving new system of very wide exchange rate bands, the ECU and the Keynesian dream lie all but dead. The world market has once against triumphed over Keynesian statism, even though the power seemed to be in the Establishment's hands.
In the French case, there was another villain condemned by all. The German Bundesbank, worried about German inflation as a result of the mammoth subsidies to East Germany, has not been as inflationary as France would have liked. One way for France or Britain to be able to enjoy the goodies of inflation without the embarrassment of a falling currency is to try to muscle harder currencies to inflate, dragging them down to the level of the weaker currencies.
Fortunately, the Germans, even though they inflated a bit and wasted billions supporting the franc, did not inflate nearly as much as the French or British would have liked. Yet for pursuing a relatively sound monetary course, the Germans were condemned as "selfish," for they had not sacrificed their all for "Europe"--that is, for Keynesian inflationists and centralizing collectivists.
It is all too easy to despair as we look around and see the world's governments and opinion organs in the hands of power-seeking collectivists. But there is mighty force in our favor. Free markets, not only the long run but often in the short run, will triumph over government power. The market proved mightier than communism and the gulag. Even in the much despised form of shadowy speculators, it has once again triumphed over unworkable and malevolent plans of statesmen and international Keynesians.