Wednesday, July 15, 2015

The Rotten Heart of Europe

Bernard Connolly's The Rotten Heart of Europe: Dirty War for Money is a jeremiad against European monetary union first published in 1995. Its publication led to the author's sacking from the European Commission, where he had been senior monetary and foreign exchange economist. This is not, as Connolly a matter of saying the "Emperor has no clothes" but that, in his words, the Emperor is "ugly and sickeningly malodorous".

It is entirely within keeping with the book's analysis that the European Court of Justice referred to the book as:
aggressive, derogatory and insulting.
Apparently the Court took, in the words of the above news report:
particular umbrage at the author's suggestion that Economic and Monetary Union was a threat to democracy, freedom and "ultimately peace".
While the Court did not ultimately go there, the Court had been invited to consider the book analogous to blasphemy. (No, I'm not making this up.) Europe, with a capital EU, really is a substitute religion, a secular Faith.

A new of edition of The Rotten Heart of Europe was issued in 2011, with a new introduction. The ongoing Eurozone crisis puts Connolly in the position of Robert Conquest (at least as suggested by Conquest's friend Kingsley Amis): I told you so, you fucking fools. The author notes in said introduction:
That no-one dared to attack the book's economic analysis but that the book's author was subjected to a concerted campaign of vilification says much about the nature and purpose of monetary union.
The book reads very much as an insider expose, because Connolly was very much an insider. It is fairly obvious he can describe various meetings and events so vividly because he was there (or worked with people who were: as a former policy bureaucrat, I can testify such folk are incurable gossips).

The book is an enlightening, if depressing, read. Depressing for an outsider living in an economy which has avoided so much of this nonsense; if you and yours actually had to live through the ill-effects, it might make you as angry as the author.

The book does lurch into hyperbole at points (particularly in the introduction written for the 2011 re-issue). But hyperbole is the vice of the impassioned, and the author has plenty to be angry about. Since it is about monetary policy and the effects thereof, the book could have done with an introductory primer--following the balance of payments, interest rates, etc interactions is a bit of an ask for a lay reader, even though Connolly is a clear writer and, if you persevere, explanations are generally forthcoming.

ERM as Euro precursor
The book covers the rise, operation and collapse of the European Exchange Rate Mechanism (ERM) and the use of the ERM as a springboard to Monetary Union--i.e. the Euro. It is a "how did we get here?" book, for the ERM, in its creation, reason for existence and operation was completely the precursor to the Euro: monetary union was always the aim. The ERM was the Euro, mark 1: the Euro is the ERM, mark 2. All the problems, failures and difficulties of the Euro were already on display with the ERM; but not as bad, because the Euro is far more constraining and the democratic deficit now bites even deeper.

The Euro is far more constraining because, while one could leave the ERM with a press release, leaving a common currency is much harder, as the Greeks are wrestling with. But that made the Euro more attractive to the Europeanising networks, not less, for it insulated their power-and-connection games against external disturbance.

A floating exchange rate is an economic shock absorber, a fixed exchange rate an economic shock transmitter. The stability of the Australian economy since the Reserve Bank of Australia (RBA) adopted a broad inflation target in 1992-93 has been based on the ability of (changes in) the exchange rate to absorb economic shocks, making it much easier for the RBA to keep total spending on goods and services in the economy on a fairly even path.

That is why Optimum Currency Area (OCA) theory considers what alternative shock absorbers economies have (specifically factor mobility and fiscal coverage) in examining how suitable territories are to share a common currency. That is why economist Paul Krugman entitled his paper on the Euro debacle Revenge of the Optimum Currency Area (and added financial integration to needed shock absorbers). As Connolly writes in his 2011 introduction:
The great ... mistake ... was that monetary union simply converted currency risk (the risk that a certain government's bonds might be devalued, in terms of another currency) into credit risk (the risk that a government might simply be unable to pay its creditors).
Hence the Greek tragedy.

The European Faith
The "coordinated" exchange rates of the ERM again and again magnified economic shocks, to the detriment of participating economies. Rather than the failure of the ERM leading to a rethinking of the project, the European elite "doubled down", going all the way to the Euro. Creating, if somewhat delayed, a much worse set of difficulties, problems and failures. Fairly clearly, they will not willingly abandon the Euro project, but want to "double down" again, using the ongoing crises to create an even higher level of policy, financial and political integration.

All of which is based on a deep interweaving of faith and interest. The faith is A Single Europe; the interest is the status, career paths, financial handouts and poorly (or simply un)accountable power the EU system provides. What Connolly refers to, in his 2011 Introduction, as:
a self-serving transnational nomenklatura made up of interlocking political, bureaucratic, business, financial, academic and media elites.
The book makes it clear, as it had long been to those with eyes to see, that the European Union's democratic deficit is not a bug, but a feature.

Connection uber alles
One of the perennial questions amongst folk who prefer their economic policy to be of the liberalising kind is how does France manage it? It seems to continually "break the rules" yet create a successful society and economy (well, mostly successful; let's ignore the suppurating social sores of the les banlieue). Reading The Rotten Heart provides useful basis for understanding how it is managed; through technical excellence, insider meritocracy, and corporate life operated as one vast insider trading exercise.
  • If the French builds something, it works.  This simple technical capacity provides a pervasive advantage and support for the broader system.
  • Their grande ecole system produces extremely well-trained, skilled and self-confident (indeed, somewhat ruthless) bureaucrats. Bureaucrats embued with a deep belief in, even reverence for, the State.  A reverence that easily translates into faith in Europe and the European superstate being built.
  • Networks and connections are keys to corporate life. The return to information (particularly regarding policy action) and certification comes from connection. As does ability to affect policy decisions in advance. 
Which is why the masters of the system tend to loath the "Anglo Saxons": not merely their success but their "casino markets" and excessive democracy.

It is not merely, as Connolly rather savagely puts it, that:
the French Establishment has never forgiven the Anglo-Saxon world for liberating the homeland from the Nazi occupation their incompetence and decadence had permitted (Ch.9).
(Just as, as their moral pretensions swell, the European elite cannot forgive Israel for the Holocaust.)

The 2005 riots: many local unpleasantnesses.
The combination of "Anglo-Saxon" economics (accepting the dynamism of open markets) and of "Anglo-Saxon" politics (governments as seriously responsible--British version--or accountable--Washington version--to their voters) is doubly subversive to the French elite's entire modus operandi. The "Anglo-Saxons" provide an identity to define oneself against and, in the case of the US, a counterpoint to seek to surpass. (One cannot really say "rival" because the US fails to feel threatened by European unity--indeed, actively promotes it; which is, if anything, even more infuriating.)

Open markets tend to dissipate the advantages of connection. Closed or restricted markets can accentuate it. For example, the difficulty in dismissing employees under French law raises the risks of employing new people and thus increases the advantage of certification and being in the correct networks. As Connolly writes of the French technocratic elite:
For them, economics is not only a subject invented and developed by Anglo-Saxons, it is a subject fit only for Anglo-Saxons and their decadent liberal democratic societies. The servants of the enarque state have no need of economics: they possess power instead (Ch.12).
I wonder if an Anglo-Saxon economist of working class origins found dealing with the such folk a bit wearing. On the other hand, he is talking of folk he dealt with professionally, for years. His is an informed antipathy.

Admirers of the Bundesbank might also profit from reading his informed, but jaundiced, view of its operations and performance. Having read Richard Hetzel's two (pdf) articles (pdf) on the history of German monetary policy in the C20th, I found Connolly's critique plausible but not surprising, though his observations on how much the Bundesbank relied on essentially managing (and stunting) the Frankfurt financial market were striking. (Which would make it somewhat similar to--but not, on Connolly's description, as bad as--the way the Japanese Finance Ministry does the same to the Tokyo financial market.)

Continental European corporations more generally have a level of state support and political cushioning that American corporations strive to achieve but ultimately fall short of. In Europe, particularly continental Europe, connection trumps, and generates, money. A game the French technocratic elite plays better than anyone else because they are so well trained to play it and believe in it so passionately.

EU as French state multiplier
The pattern of connection trumps, and generating money, is extended and reinforced by the EU; partly because said elite labours so mightily to make sure it does. As Connolly notes:
For France (as for Germany), a "level playing field" in the Single Market had always meant a slope steeply in their favour -- the result of the ERM and the Social Charter impositions, both intended to keep the 'peripheral' countries of the Community in a state of economic weakness and political dependency (Ch.13).
Flexible exchange rates allowed countries to evade the anti-competitive effects of the Social Charter and other EU regulations by devaluation. The ERM, and even better Monetary Union, cut that option off. As Connolly writes:
For the French elite, money is not the lubricant of the economy but the most important level of power (Ch.1).
Moreover, the less say the general public has over important matters of policy, the higher the return to connection and insider status is. So, elections are managed so both sides of politics (with the occasional backsliding) play the key games the same way.

(One of Syriza's fundamental flaws is that they actually want to play the same game too--that even more be done via state networks is not subversive, it is the pretence of it--yet the massive Greek indebtedness which brought them to power also casts them as supplicants; they get the attention of the Top Table folk, but not in a good way. Margaret Thatcher was more threateningly subversive of the EU than Alexis Tsipras could ever hope to be.)

Hence we get 'Corporatism in One Continent' as Connolly nicely labels it (Ch.2). Something which favours the established but provides no avenues for the up and coming (Ch.3). Hence also the attraction of monetary union:
Fix the exchange rate, neuter monetary policy, and then use the fear of macroeconomic instability as an excuse to stifle the dynamism of the capitalist process (Ch.3). 
Thus the effort invested in the ERM then and the Euro now. If reversion to independent floating currencies occurred:
... more than just 'monetary Europe' could be lost to France's corporatist, fonctionnaire, industrialist and financier class: 'Europe' itself, with its promise of 'Corporatism in One Continent' in which bureaucrats, indigenous multinationals and trade unions could hold at bay the tide of the Anglo-Saxon market economy could be at risk (Ch.9) 
The creation of a remarkably unaccountable central bank, as the European Central Bank (ECB) is, was very much not a defect of Monetary Union: despite differing conceptions of final outcomes between German and French EU-elites, they both found that highly desirable.

First the French manage the Germans (and vice versa) and then they manage everyone else, for:
The Franco-German axis is the Community, and the role of other members of the European Council is to give a ceremonial benediction to what the French and German leaders want to do (Ch1.).
One of the themes of the book is other countries trying to be "core" and not "periphery". But that is a status decided by the Franco-German connection, according to the interests thereof.

Accountability (or, rather, the lack of it) is at the heart of the problem. Particularly when one gives such power to an unaccountable central bank:
... politicians have at some point to confront the consequences of their mistakes; their unaccountable central bankers do not (Ch.10).
While the ECB embraced inflation targeting originally pioneered by New Zealand, the full New Zealand model of an explicit (indeed, performance-based) contract between central bank and elected government horrified European central bankers. Connolly warned:
... the trend toward greater interference by central bankers in explicitly political affairs, set in train by Maastricht, will be hard to arrest as long as the fools' paradise of EMU beckons (Ch.10, fn10).
The fools' paradise has arrived, and so has the predicted pattern. A pattern that has not fully run its course, and which Connolly feared, for:
an ECB would be a totally anti-democratic institution that hastened the decaying of political life in 'Europe' and a probably precursor to an authoritarian reaction to mounting chaos (Ch.13).
We are not there yet, but nor has the working out of the implications ended. Connolly summarises the ERM thusly:
The rules of the system were, from the outset, more important than its results, for the framing and interpretation of the rules determined the distribution of power between and within -- perhaps even over -- the Community countries (Ch.11).
As with the ERM, so also with the Euro.

Another theme of the book is that Britain can never really be at "the heart of Europe", in part because of a seriously divergent political culture:
For most people in Britain, politics is seen as providing a framework within which the constant balancing of the interests of different groups, or for that matter of different regions or countries, can proceed in legitimacy and reasonable harmony ... That idea of politics is, literally, foreign to French technocrats. What they are interested in is power -- first imposing their will on France and then imposing their conception of France's will on everyone else (Ch. 14).

The Church of EUrope
Reading this analysis of how the EU works, one is reminded of late medieval ("Renaissance") Catholic Europe and its interplay of doctrine and interest. Now the doctrine Is Ever Greater Union, and heretics (such as Connolly) are to be hunted down, denounced, and thrown into the outer darkness. (Actually, in Connolly's case, he seems to have had a nice post-Eurocrat career as a exchange rate analyst.) As Connolly puts it in his 2011 Introduction, the EU has no demos but
'Europe' has a right to arise because of its supposedly superior ethos and supposedly necessary telos.  
Nor has his righteous anger abated:
the absence of a European demos implies, given the strains produced by the efforts to create and maintain a monetary union, a ruthless, deceitful, malignant anarchy-imperial ethos reflecting a telos devoted to destroying law, democracy, accountability, legitimacy and to emerging victorious in a 'clash of civilisations'.
Go on, tell us what you really think.

Meanwhile, in counterpoint to the Church of EUrope, the Eurosceptics and enraged nationalists are the oikish Protestants, daring to want to decide things for themselves. Of course, those damned Protestants actually did rather well for themselves; as, in the long run, the combination of more open cognitive systems, nakedness before God and personal sovereignty created increasingly more dynamic societies.

It was a bit of a revelation to discover that "growth-positive fiscal austerity" was originally ERMonomics, just as it has now become Euronomics. As an aside, countries such as Australia, Norway, Denmark, the UK have unusually downwardly redistributive (pdf) welfare states: fiscal "austerity" implies something rather different in such societies than it does in the upwardly distributive Mediterranean states. (The share of GDP spent by government on welfare is actually a very poor measure of how redistributive a welfare system is.)

Though the blogosphere metaphor of Calvinism (i.e. rigid theologising) to describe those who insist that everyone is to blame, and everything is to be done, except examine the role of the ECB and the entire Euro project, comes across as even more appropriate. Connolly argues that an underlying notion of the ongoing General Will is used to trump mere elections. Hence the response to the (narrow) rejection of the Treaty of Maastricht by Danish voters in June 1992:
The Treaty of Rome be damned, they said in effect, a few thousand Danish votes one way or another could not be allowed to stop the March of History, to frustrate the General Will as decided by the political bosses in the countries that really mattered (Ch.6).
Framings for ignorance
Reading Connolly's book, I am struck by the power of Scott Sumner's point that so many people--including policy makers--simply do not understand monetary economics:
... monetary policy failures are not about special interest politics. There is an almost mindboggling lack of understanding of monetary theory at the top levels of government. The entire world economy is resting on the hope that a few sane people like Haruhiko Kuroda can keep their head and keep NGDP chugging along while the rest of the political establishment careens recklessly from one extreme to the other.
But policy makers do have framings through which they view the world, so they just apply the framing to matters of monetary policy that makes sense to them on other grounds. 

So, in the absence of genuine understanding, those who worship at the altar of the state apply those framings to monetary policy. Those who get wrapped up in signalling Virtue apply that framing to monetary policy. Supporting the ERM and Monetary Union was the way, par excellence, to signal what a Good European you were.

Hence also conservatives tend to instinctively go for hard money policies, because it fits in with their social order concerns--they naturally think that devaluing money (so undermining proper order) is the worst thing you can do to it. (Not even close to true, but then you would have to understand monetary economics to realise that hard money and sound money are very much not the same.) There is quite a history of economically liberalising (or at least liberal) right-of-centre governments being brought down by hard money obsessions.

Which is part of the story Connolly has to tell--how Thatcher's otherwise very able Chancellor of the Exchequer (1983-89) Nigel Lawson's obsession with having the Pound Sterling shadow the Deutschmark stoked the boom-and-bust that helped fatally weaken Thatcher's Premiership. Connolly clearly admires Lawson, who comes across as the tragic hero of the story.

Margaret Thatcher, who proved to be entirely correct about the problems of the ERM and of the proposed Monetary Union, is the book's fallen hero and martyr, since her fall made the path to disaster all but inevitable (and, Connolly argues, was at least partly engineered by Europeanising networks). Bundesbank President (1991-93) Helmut Schlesinger is admired for his commitment to German national interests, sense for German public opinion, and his strategic skill (particularly as he used it to effectively destroy the ERM).

The book has too many villains to count. Though Banque de France chief Jean-Claude Trichet is treated with thinly veiled contempt and Thatcher's successor John Major with open contempt.

As an Australian reader, the constant political and policy dramas, the twists, distortions (and at times outright lies) engaged in to "defend" some particular exchange rate just seems mad. Which, if your goal is good economic policy for people in your society, it is. But the combination of portentous ignorance, faith and self-interest operating in a milieu of sabotaged accountability produced this madness, fed on it, and spiralled it up to even grander madness. Leading to the Eurozone having to beware of Greeks bearing debts and forcing deals which not only won't work, but can't, even in theory. But what is elementary economic and fiscal logic to Faith in Europe?

Though some mordant humour is to be had:
The Bonn summit was a classic example of international economic 'coordination': one country agrees to something that is bad for it on condition that another country does something equally bad for it (Ch.2).
Or, on the Major Government's ultimately failed attempt to be in the ERM:
Instead, the government resorted to the tried, tested and failed methods of the 1960s and 1970s: bravado, declarations of undying and irrevocable commitment to the parity, insinuations that sterling would soon enter narrow bands, sneering denunciations of anyone who suggested a change in policy on the exchange rate (Ch.6).
Needless to say, the final outcome was--a change in policy on the exchange rate (ejection from the ERM and a floating exchange rate).

But, as Connolly notes of international coordination:
'The masters of the world' inevitably prefer 'coordination' to competition as a way of arriving at the desired result, simply because the processes of international 'coordination' increased their own influence, prestige and insulation from political accountability (Ch.7).
Not that Connolly was a perfect predictor. The ECB proved to be much tougher on inflation than he expected, and much more independent of the French politicians than he (or, for that matter, folk such as Mitterand) expected. But that was the outcome of French and German elites managing each other.

Cognitive closure
What comes across strongly in the book (and the history of the Euro since) is what a disastrous engine of cognitive closure signalling Virtue can be. Conservatism is prone to its own forms of cognitive closure: in recent decades, they have tended to matter much less since conservatives have so little role or influence over educational, academic, cultural, literary and intellectual life. In the case of the ERM and the Euro, many conservatives were very much wrapped up in signalling being Good Europeans, so ended up helping to build bricks in the wall of cognitive closure.

A wall of cognitive closure from which a constant public barrage was mounted, leading Connolly, in his introduction to the 1995 edition, to quote political scientist Leonard Schapiro's famous analysis of propaganda:
the true object of propaganda is neither to convince nor even to persuade, but to produce a uniform pattern of public utterance in which the first trace of unorthodox thought reveals itself as a jarring dissonance.
And dissent against Virtue is wicked, so need not be engaged with, merely denounced as signs of a deformity of moral character. As Connolly writes in the final sentences of his book:
On this question, as on every other question about the ERM and monetary union, the propaganda steamroller attempts to flatten analysis. For analysis can only mean dissent. And dissent cannot be tolerated.
Cognitive closure indeed. And yet, all those Virtuous Europeans were so wrong, and Margaret Thatcher was so right.

But only if you care about economic consequences; particularly the way mass unemployment blights lives.* But the Good Europeans clearly don't (or they care about others things a whole lot more). The have their Faith and their Connections and that is clearly more than enough for them.

If you want to see their ugly and shockingly malodorous world in operation, then The Rotten Heart of Europe is a guided tour therein.  The book is 20 years old, but still explains so much of what is happening in Europe now.

*A lot of which is caused by supply-side restrictions, but they are also part of the EU game, as played variously in different countries. And post-2008, by the policies of the ECB.

[Cross-posted at Skepticlawyer.]  

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