More than a decade after the financial crisis of 2008, the ECB’s accommodative monetary policy is being questioned. Many economists are critical of the low interest rates and asset buyback programmes, citing the limited impact of such an approach on credit growth, the collateral damage that it causes (i.e. lower profit margins for banks, the development of zombie companies (a fragile company only generating enough cash to pay interest on its debts) and the risk of a property bubble), and the unwarranted support for European states whose solvency is under threat, in other words every country except Germany and the Netherlands, according to these economists. The eternal debate between proponents of orthodox and Keynesian economics is therefore re-emerging, as the former repeat the basic rules of sound management, and the latter call for far-reaching fiscal stimulus supported by monetary policy.
The debate was already raging in the 30s, when the US and the UK opted for devaluation, combined with strong stimulus in the case of America, while France led a “gold block” made up of countries with currencies pegged to the gold standard and reiterated its concern for maintaining fiscal balances and the Franc’s strength. This makes it worth looking back on this period, from which many lessons may be learnt.
At the start of the 30s, the US was resolutely Keynesian, with its New Deal, whereas successive French governments expressed their wish to preserve the currency’s strength, an objective that was in line with public opinion in France. The devaluations in the US and the UK in 1933 therefore prompted a sharp fall in French exports (–50% between 1929 and 1935), as France became less competitive, which the government tried to remedy through a deflationary policy.
The minister Flandin embarked on this approach in 1934, but it failed to stabilise the Franc and, in May 1935, three interest rate hikes were needed to prevent the currency from depreciating. The deflationary measures were nevertheless ramped up by the Laval government of June 1935. These consisted of cuts to civil servants’ wages, state spending and electricity and gas prices. The consumer price index fell from 85 in 1933 to 72 in 1935, dropping by 15.3%, while the GDP (Gross Domestic Product) index fell from 93 in 1934 to 90 in 1935 (-3.2%). This deflationary policy failed to restore the fiscal deficit, as tax receipts decreased more quickly than spending and debt soared to 200% of GDP. The government was forced to turn to the Banque de France to finance the public deficit.
The Front Populaire gained power in 1936, again with a stated goal of avoiding devaluation. The steep wage rises resulting from the Matignon agreements of 1936 caused an abrupt return of inflation, however, and the government had to resign itself to devaluation of around 30%. This depreciation made the economy take off again starting from the autumn of 1936, but it came too late and France failed to benefit from the global recovery of 1933 to 1936. A downturn in the global economy in 1938 led to a second devaluation by around 25%, which boosted growth. Only these devaluations were able to compensate for the French economy’s low productivity.
So what lessons can be learnt from this historical sequence?
Firstly, note that devaluation stimulated the French economy in 1936 and 1938 more than economic stimulus measures. This is why the single currency’s exchange rate is important. The Eurozone makes significant exports to the rest of the world. From this viewpoint, the ECB’s policy seems likely to be effective as it keeps the euro at a reasonable level for exports. Abandoning the policy of low interest rates and monetary easing would drive up the currency’s value significantly, with major consequences for the zone’s export activity, its GDP and multinationals’ profits. This issue of the euro’s excessive value if the current policy were to be abandoned is often overlooked by the ECB’s denigrators.
Secondly, there is probably no need to fear fiscal stimulus, including for Southern Europe. The US made strong use of it in the 30s, whereas it wasn’t introduced in France until the arrival of the Front Populaire. The shrinking of public spending in France in 1934 to 1936 to make French exports more competitive again was an unsuccessful experiment.
Data taken from the work by Pierre Dockès, Le capitalisme et ses rythmes, quatre siècles en perspectives. Tome 1, Sous le regard des géants, Classiques Garnier.
Article by Florent Delorme, macroanalyst at M&G Investments.
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