Wednesday, December 14, 2011

Charles de Gold

'Tis the season to be protesting. Day by day, as more countries are being sucked into the vortex of protest, it's opportune to reexamine another protest movement, this time the one that rocked France in 1968. The US had suffered from protests since 1965 supposedly arising from disaffection with the Vietnam war. Yet similar outbreaks in many European cities in 1968 had nothing to do with the Vietnam war. Of all such protests, the most violent was reserved for France.

It's also fitting that the French president then was Charles de Gaulle, its first president under the Fifth Republic. He led the writing of the Fifth Republic's constitution which transformed the parliamentary system of the Fourth Republic into a strong executive presidential system, one that fits De Gaulle's personality. De Gaulle once said, "A true leader always keeps an element of surprise up his sleeve, which others cannot grasp but which keeps his public excited and breathless." How true. Read the biographies of most strong leaders, you'll find that they relish in keeping their populace guessing as to their true intentions and actions. Except when it comes to economics, because in true poetic justice fashion, it is economics that keeps the leaders guessing for answers. And invariably the answers always elude them.

De Gaulle was soon to find out how easy it was to be outwitted by economics. On the last day of 1967, he addressed his countrymen, "It is impossible to see how France today could be paralysed by crises as she has been in the past." It was a bit premature. 1968 was to be the year of protest movements. Till today nobody knows why the wave of protests erupted in 1968. The stock answer has always been youth rebellion, a sort of culture issue that leaves more questions than answers.

We've seen how a similar movement in the United States had been triggered by slowing income growth that was addressed only through higher female labour force participation rate (LFPR) which impact was felt from the 1970s onwards. Without the high female LFPR, real income, instead of stabilising, might have been deteriorating. The benefit of the high female LFPR has now run its course. As the LFPR keeps drooping, real household income will surely follow suit. Those not participating in the labour force will be willing fodder for the barricades.

There was one common economic theme between the 1960s and our present times, to wit, the low inflationary environment. Everybody loves low inflation unaware that low inflation benefits creditors more than debtors. As the economy forges ahead over time, there'll be more debtors relative to creditors. If no structural changes arise, the ownership of wealth will be heavily skewed, favouring the creditors at the expense of debtors. It'll take a barrage of violent agitations to knock some sense into the politicians, prodding them to change course by tolerating high inflation and curtailing free trade and free capital movement.

Like the US, France enjoyed a prolonged period of economic prosperity right after World War II. That's why de Gaulle was blindsided by the protests. However he had been reelected for a second term in 1965 by a narrow margin. That should have signalled him that dangerous times were just around the corner. Money was becoming short in supply. It was still the era of Bretton Woods in which fixed exchange rates ruled.

Although the US was still notching current account surpluses then, its balance of payments were registering deficits because of the direct investment in European countries by its corporations. Nowadays the US current account is in heavy deficit but instead of the foreigners offsetting the deficits with long-term investment in the US, they are buying short-term bonds which give them the smug feeling of increased wealth. So either way, when the US current account was in surplus or is in deficit, the foreigners have been benefitting from US money.

Towards the late 1960s, the US were suffering from declining gold reserves. President Johnson attempted to limit the outflow of gold first by having a voluntary restriction on overseas investment in 1965 and when this didn't work, a mandatory one in 1968. Both had temporary effects as the overvalued US dollar was the cause of the gold outflow. The French franc was similarly overvalued. De Gaulle wrongheadedly believed in the gold standard and the benefits of a strong currency. In fact he had been calling for the price of gold to be increased to $70 per ounce to spite the US.

During the same period, both the British and French were also losing competitiveness as a result of slower productivity growth. Britain had been suffering from large current account deficits that made sustaining a strong pound untenable. To stem the loss of reserves, British Prime Minister, Harold Wilson devalued the pound by 14 percent on 18 November 1967 from $2.80 to $2.40. The Bank of England had earlier in the day spent ₤200m worth of gold and dollar reserves trying to shore up the pound. The devaluation did improve Britain's economy and reduce its current account deficits. By 1969, its balance of payment recorded a surplus although in the 1970s, Britain continued to fall back to deficits because of the oil crisis coupled with stubbornly low productivity.

De Gaulle however refused to countenance such a move. Being a prudent man, he was also stinting in public spending, refusing to invest on education, roads, telecommunication, housing and social services. In his private life, he took great pains to separate his official from personal expenses, which he paid out of his own pocket. As can be seen in the chart below (from Reinhart and Rogoff), in the 1960s, the French government was reducing its share of spending as a proportion of GDP. A more accurate measure would be total debt as a percentage of GDP but such a measure for France in the 1960s is not available on the web.

France was thus suffering from a shortage of currency. Its government was reducing its relative spending while at the same time, its corporations were having problems with their export markets as a result of the overvalued franc.

It is not surprising then that the protest started in May 1968 with students at the University of Nanterre. It then spread to workers who were demanding for higher wages. As the wages demand was met, the economy became more uncompetitive without a franc devaluation. Capital flight ensued. De Gaulle survived the 1968 riots but not a referendum the following year in which he had staked his presidency. He resigned from office in April 1969.

The currency shortage was eventually resolved by a 12% devaluation by his successor, Georges Pompidou in August 1969, four months after De Gaulle's resignation. De Gaulle may have foresight in political and military matters - he was one of the first among the French generals to appreciate the significance of the third generation mobile mechanised warfare that was eventually employed by the German army - but his weakness in grasping economic issues was to eventually lead to his downfall. Though he was an upright person who believed strongly in the virtue of savings, in politics, honesty and prudence don't make for a brilliant statesman.

Now more than 40 years have passed since the violent protests. Yet the current crop of EU leaders have learned nothing from the mistakes of De Gaulle. They are repeating the same errors and sharing the same perverted beliefs held by De Gaulle, that almost brought France to its knees in 1968. Only that this time it's not only France that will bear the brunt of the upheaval but the whole House of Europe, paving the way for its eventual collapse.

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