Traumatised by the new reality

Pity poor France! A Gallic conspiracy theorist, pondering the state of the nation, might ruefully imagine that France had been brought to its current low ebb by sleight of foreign hand. While nuclear test blasts echo fruitlessly around the south Pacific, at home the currency is languishing, economic growth declining, social divisiveness widening and confidence in political leadership crumbling. Could this be a product of a cunning plot to destabilise France by feeding it the illusion that the country could ignore the disagreeable realities of the post-Cold War world? By seeking to tie the franc to the mark in a bid to hold down a unified Germany - a policy now coming more unstuck by the day - has France been lured into a position of economic and political infirmity by its neighbour east of the Rhine?

The truth is more prosaic. France is in a mess because of its own failure to make internal reforms to adjust to the collapse of the Berlin Wall and the ending of the US-Soviet superpower system. External circumstances have changed, but France still wants to play the game of "Carry On as a Grande Nation" - exerting pivotal international influence without the pivot. Promising a colourful mix of nationalism, Europeanism, socialism, corporatism and liberalism, President Jacques Chirac took office in April either unaware or uncaring of the contradictions in his policies. Six months and a string of broken promises later, the full extent of the crisis facing France's society and its decision-making structures has been laid bare. Chirac has been hoist with the petard of his own hubris.

France's economic malaise is just one element of its troubles. They include the spillover into France of terrorist attacks emanating from the bloody unrest in Algeria - a problem that both feeds and feeds off the growing alienation of the country's new-generation immigrants from the Maghreb. The economic crisis is, however, the most serious manifestation of France's ills, not least because it exposes the country's full vulnerability in the all-important bilateral comparison with Germany.

The sheer ponderous continuity of German political leadership has exacerbated France's task of maintaining economic credibility. Since 1983, when France shifted away from devaluations to keeping the franc steady against the mark, France has had eight prime ministers, none of them achieving the full confidence of the financial markets - while Germany has had Chancellor Helmut Kohl.

Over the past five years the power of French-style capitalism, epitomised by the omnipresence of grande ecole-educated functionaries in industry, banking and the civil service, has been weakened beyond measure. Since German unification in 1990, top French industrial companies and banks have been much less successful than German ones in restructuring their operations to meet international competition.

The decaying influence of the French governmental elite has been evident, too, in budgetary policy. Well-meaning statements of intent have not been turned into action. Unlike Germany, which has recently been more adept than expected in cutting its budget deficit to match the European targets for economic and monetary union, France's fiscal stance has been irresolute. Its public sector indebtedness, like that of Germany, has doubled during the past five years. France, though, has nothing to show for it - in contrast to the Federal Republic, which has taken on the extra debt to absorb and rehabilitate the former East Germany.

Edouard Balladur, the Gaullist prime minister between 1993 and 1995 and Chirac's opponent in the presidential election earlier this year, launched a piously worded crusade two-and-a-half years ago to head off what he called the "fatal trap of spiralling indebtedness". Balladur's rhetoric far outstripped his capacity to deliver, and the deficit rose last year to 6 per cent of gross domestic product, double the Maastricht target.

Balladur's successor, Alain Juppe, warned three weeks ago that high public spending, particularly on social security, placed France in "national peril". Juppe has faced anger within his own party over his illegitimate use of a chic subsidised Paris apartment (which he is now being forced to vacate), a one-day general strike from public service workers protesting about a planned pay freeze, and increased attacks on the franc fort from right- and left-wing politicians. The latest came last week from Juppe's Gaullist rival Philippe Seguin, who criticised the "devastating" consequences of high French interest rates.

High short-term interest rates no longer support the franc. They depress it because the triple effect of lowering economic growth, pushing up government spending on unemployment and further weakening the capital base of France's badly overstretched banking system makes the franc fort policy increasingly unsustainable in the eyes of the currency markets.

France will be able to avoid a formal devaluation against the mark thanks to the wider currency fluctuation bands that were brought in during the 1993 summer flare-up in the European exchange-rate mechanism. But the next few weeks are likely to show that France is willing to trade a weaker franc - and (inevitably) the postponement of its plans for European monetary union - in return for lower interest rates and hopes of economic recovery.

As Le Monde delicately put it in an editorial on Friday, Britain, by lowering sterling's value against the mark in September 1992, provided an "example" that could "enrich" the French economic debate. Britain's devaluation, Le Monde pointed out, is one reason why the UK has 1 million fewer unemployed people than France. Unlike Britain in 1992, France has a low inflation rate and a current account surplus, but the overriding need to reduce interest rates indicates that the franc's link with the mark will shortly be "temporarily loosened" (as any Paris governmental euphemism would no doubt describe it).

Unfortunately for Mr Chirac and Mr Juppe, France's troubles cannot be resolved simply by Houdini-like unravelling of the mark knot. Reflecting shortages in skills, flexibility and capital in much of French industry, as well as the sluggishness of European export markets, France's immediate corporate prospects would receive only a modest boost from a franc depreciation. Further, a looser monetary policy would require France to toughen further budgetary rigour - a move already demanded by the Patronat employers' federation, which is likely to cause more pain all round.

France is in the uncomfortable position of knowing that, whatever action it takes on the economic front, the short-term consequences will be dire. This will be grist to the mill of Parisian conspiracy theorists. Anglo-Saxon foreign-exchange dealers taking an autumn break around the Champs-Elysees in the next few weeks should take out extra insurance cover.

The author is director of European strategy at Robert Fleming, the London- based investment bank.