Timeo Danaos (et Romanos)

It is now largely overlooked, but the 19th century had its own precursor to EMU in the shape of the Latin Monetary Union, set up principally to try to solve the hoary problems of silver:gold bimetallism. But, if much of the Union’s history was dogged by the narrow technical issues of how, firstly, to structure its members’ own monetary system and, thereafter, to align it more closely with those of the non-members, there were other features, too, which are still very much germane today.

Unrealistic expectations, short-term politics, and – as ever – too much debt plagued both Greece and Italy in those days, too, with repercussions for the other LMU members as well as for their trading partners in the wider world.

[The following appears as Chapter II in my book ‘Santayana’s Curse’ available on Kindle]

Among the more germane of these is the extent to which the French government’s desire to broaden its diplomatic reach, to enhance its international prestige, and – let us be charitable – to facilitate the work of its wealth creators was stymied by the opposition of the Banque de France to any move to the unique gold standard which was adopted as a goal of the conferences, almost from the off, in recognition of the emergent consensus regarding the impossibility of maintaining a full bimetallic standard.

What was at the root of this stonewalling? Well, as the Swiss delegate to the conferences, Feer-Herzog, shrewdly observed, it may have been due to the hefty arbitrage profits enjoyed by the major shareholders of the Banque de France and the members of its governing council under the existing arrangements. ‘Regulatory capture’ and a stifling of reform by the too-big-to-fail crowd has a very contemporary ring, does it not? But even more pressing parallels lie in the inability of at least one of the early members, Italy, to live within the rules, and in the utter unsuitability of the inclusion of a second round entrant to the club – yes, Greece, of course.

Five years prior to the founding treaty, the infant Italy already had a public deficit amounting to some three-quarters of its tax receipts, partly as a result of its progenitive wars of independence, partly because those newly in charge of a backward and fragmented nation were rather more free with their promises to unite it in progress than they were endowed with the means to keep them.

As Henry Parker Willis (at one time, prominent in arguing the case for the founding of the US Federal Reserve but later one of its harshest critics) wrote of the nascent state:-

“For a long time, the deficit in the Italian budget had been developing into a chronic malady and the perturbed condition of the country rendered industrial enterprise well-nigh impossible. Hence, imports soon largely exceeded exports and trade became demoralized.”

As our author continues with his tale, the sense of weary familiarity is only heightened:-

“…taxes had been increased by 45%; immense loans had been contracted and it had been decided to confiscate… the property of the religious corporations. [But] toward the end of 1865… a final deficit of 210 million lire [~40% of receipts] was found to exist… taxes… proved unreliable and it was found necessary to float a new loan.”

 “All this was no new experience for Italy, nor does it seem likely that it would have overwhelmed her… had these events not been the climax of a long course of deficit financiering and depressed industrial conditions.”

 As the country rushed to take advantage of the looming Austro-Prussian War – by allying with Bismarck in exchange for the unconsolidated northern territory of Venetia – the prospect of a further deterioration in its finances saw a rush by foreign creditors to dump their holdings of its bonds in exchange for hard cash. The bonds, some of which had been launched at price of up to 85% of par, began to drop from the 65 of the last issue to a low of 40, shortly after hostilities commenced. Credit collapsed, swamping the ability of the National Bank to provide assistance, and so – barely a year after the inauguration of the Latin Monetary Union itself – Italy suspended convertibility and instituted a corso forzoso, or forced currency.

Here, it should be noted that Italy might not have become so deeply beholden to nervous foreigner investors, nor allowed its budget to fall into such disarray, had it not been for the exceptionally favourable terms on which it could fund itself abroad. This fatal temptation – not exactly unlike the one with whose malign consequences we are wrangling today – arose partly because of a boom in the formation of the new-fangled, limited-liability companies on one side of the Channel and the founding of three great deposit banks – CIC, Credit Lyonnais, and Societé Générale – on the other, as well as by the spread of the Pereire brothers’ Credit Mobilier model across the Continent and the countermoves they sparked on the part of the rival Rothschilds. A wild speculation ensued, much of which focused – sigh! – on sovereign lending, much of that on a syndicated basis in the form of so-called ‘omnia’. Nor was Italy’s incontinence lessened by the enthusiastic backing of that godfather of the infant state, the French emperor, Napoleon III – in a precedent followed today by that most enthusiastic supporter of the ‘PIIGS’, President Nicolas Sarkozy.

Once Italy took this drastic step of suspension, inevitably its silver coinage – both full-valued and subsidiary – rapidly drained out to the other LMU members where it was readily – and now legally – acceptable. In the short-run, this could only aggravate the growing problem of a silver glut within the Union and, indeed, soon led to the adoption of the étalon boiteux, or ‘limping standard’ whereby both metals circulated as full legal tender, but only the one – gold – could be freely coined at the mint. This decision was reinforced by the French desire either to mitigate the disruptive effects of the German monetary changeover (if one is being charitable) or actively to complicate them (if one is not). Indeed, monetary historian Marc Flandreau has dubbed this ‘The French Crime of ‘73’ on a facetious reference to the later sensationalization of the much better known American demonetization of that same year.

More ominously, the mass of lightweight Italian specie now circulating abroad also made its recipients especially solicitous of Italy’s financial well-being, lest the belief in ultimate redeemability of the influx at large within their borders be brought into question and a further systemic disruption ensue. Might we here note that the ongoing rigmarole involving ECB support for Irish state guarantees of domestic bank debt – whose aim is largely to avoid impairment of continental bank balance sheets – is not entirely dissimilar in nature?

Thus, the two sides – those whose budgets were maintained in good order and those with finances in disarray – became locked together in a Faustian pact; a kind of negative symbiosis of the kind practiced by certain viruses which discourage their extirpation by their host bacterium through filling its cytoplasm simultaneously with a short-lived antidote and a longer-lasting poison.

The growing awareness of what this dilemma entailed meant that, at the Conference of 1878, it was agreed to extend the Union beyond its original expiry date of 1879. Though differences were not absent – there was still a strong undercurrent of support for an outright gold standard – essentially the question to be settled was how to deal with Italy.

The latter was inevitably reluctant to suffer any serious retrenchment, only allowing that perhaps its smaller denomination of ‘forced’ paper could be replaced by new batches of Fr.5 pieces – despite the Union-wide problems to which their surfeit was already giving rise. After much horse trading a compromise was reached which offered only minor variations on the status quo ante while obliging Italy to retire its subsidiary coinage (in exchange for being allowed one last Fr.20 million emission of the troubled five-franc pieces) and to take steps aimed at a resumption of convertibility at some conveniently undetermined future date.

Even the redoubtable Swiss delegate, M. Feer-Herzog, was moved by the fleeting spirit of diplomatic concord to pronounce, at the final meeting, a wildly optimistic affirmation of the Union such as would not disgrace a Van Rompuy or a Barrosso in the status of the hostage it surrendered to fortune.

“The Latin Union is to be renewed and confirmed,” he ringingly declared. “Governments and people will learn, no doubt with satisfaction, that the five states are not to cease to be united by the bond of a common monetary circulation, and we may hope that this union, established between them with regard to their coinage, will continue to exercise a happy influence on their political and commercial relations.”

After launching a large stabilization loan in 1881 – whose employment was, with impeccable timing, almost frustrated by the period of prevailing monetary tightness brought on by a series of poor European grain harvests – an Italy now newly strong in gold rapidly began to cheat the rules by promulgating an intent to refuse all foreign silver after 1885 and by drastically limiting the proportion allowable in its domestic banks’ reserves in 1883, forcing the latter, in turn, drastically to restrict the metal’s deposit. The calculation – shared by the likes of Belgium – was that by keeping the coins circulating preferentially abroad – i.e., in France – rather than at home, while continuing to manoeuvre against a redemption at the Union’s councils, she could ignore the overhang rather than face the expense of having to deal with it.

The Grapes of Wrath

This was to be the high point of Italian finance – or perhaps the better geographical metaphor would be the saddle point that separates two deep valleys – for it coincided with the long political ascendancy of those champions of deficit finance and executive vote-buying, Prime Minister Depretis and his Finance Minister Magliani. From 1884 onwards, for each of the next thirteen years, the budget was unbalanced, the trade deficit grew, the exchange rate fell, and monetary disorders compounded the fiscal ones.

As John T Flynn put it, in “As We Go Marching”, the man his enemies soon dubbed the ‘incorruptible corrupter of all’

“…promised every sort of reform without regard to the contradictions among his promises. He promised to reduce taxation and increase public works. He promised greater social security and greater prosperity. When he came to power, he had no program and no settled notion of how he would redeem these pledges. His party was joined by recruits from every school of political thought. He found at his side the representatives of every kind of discontent and every organ of national salvation. The oppressed tenants along with the overworked and underpaid craftsmen of the towns crowded around him, beside the most reactionary landowners and employers, to demand, as one commentator said, the honouring of the many contradictory promissory notes he had issued on his way to office.”

 “Living from hand to mouth to keep himself in power, seeking to placate groups of every sort, Depretis used the public funds freely. Roads, new schools, canals, post offices, public works of every sort were built with public funds obtained by borrowing.“

“Depretis now discovered he had got hold of a powerful political weapon…. Deputies could be bought. But Depretis found that instead of buying the deputies he could buy their constituents. Every district wanted some kind of money grants for schools, post offices, roads, farm aid. The Premier found that he could buy the favour of the constituency by spending public money in the district. The deputy had to prove to his people that he was sufficiently in the favour of the Premier to bring such grants to them. The philanthropic state was now erected in Italy and it was never to be dismantled.”

The 1929 edition of the Encyclopaedia Britannica delivered this terse, yet damning verdict on a joint reign which showed the way for every New Deal, Great Society, Solidarity Fund, and stimulus package ever since:-

“In their anxiety to remain in office Depretis and the finance minister, Magliani, never hesitated to mortgage the financial future of their country. No concession could be denied to deputies, or groups of deputies, whose support was indispensable to the life of the cabinet, nor, under such conditions, was it possible to place any effective check upon administrative abuses in which politicians or their electors were interested.”

But if the infant Italy – already showing the way for a later dealer in men’s souls, Benito Mussolini – posed great problems to the LMU, let us not overlook the turmoil associated with Greece, either.

As Parker-Wills wrote of that nation’s inclusion in the scheme:-

“It is hard to see why the admission of Greece… should have been desired or allowed by that body. In no sense was she a desirable member of the league. Economically unsound, convulsed by political struggles, and financially rotten, her condition was pitiable. Struggling with a burden of debt, Greece was also endeavouring to maintain in circulation a large amount of inconvertible paper. She was not territorially a desirable adjunct to the Latin Union, and her commercial and financial importance was small. Nevertheless her nominal admission was secured, and we may credit the obscure political influences… with being able to effect what economic and financial considerations could not. Certainly it would be hard to understand on what other grounds her membership was attained.”

A century later, Sophia Lazaretou set out the background to the problem in her 2002 treatise, published by the Bank of Greece itself, entitled ‘Adventures of the Drachma’

“Beginning in the mid-1870s, political instability in Greece led to an increase of fiscal deficits. The segmentation of the Parliament into many small political parties and the short-lived governments caused a loss of revenues due to the laxity in tax collection and an increase in expenditure due to the numerous dismissals and transfers of civil servants that accompanied each change of government. None of the 19th century governments dared to undertake a budget reform, namely to improve the tax collection system and raise revenues from income taxes. Public expenditures – overwhelming government consumption – were financed by domestic borrowing… resulting in an excessive burdening of the budget during the second half of the 1870s.”

As she went on to relate, the analogy was further reinforced a decade later when all-too compliant foreign lenders became the primary source of funds and Prime Minister Harilaos Trikoupis took the opportunity to embark upon an ambitious programme of infrastructure-led modernisation, principally involving those old dirigiste favourites – railways, canals, and commercial real estate:-

“During this period, the Greek governments were able to raise foreign loans on favourable terms for the implementation of infrastructure projects…    From 1889 and onwards, foreign creditors willingly provided the Greek governments with long-term loans with small or no pledges and at a low interest rate… Nevertheless, the high level of primary expenditures and, more importantly, of expenditures for the repayment of the outstanding domestic debt, and their financing through foreign borrowing, created high interest payments, which perpetuated fiscal deficits.”

But alas, problems elsewhere in the world soon rudely interrupted this reverie as contagion spread from Portugal’s bankruptcy and the storm associated with the Argentina-related Baring’s Crisis. Faced with a cessation of the further flow of foreign finance and hit by the collapse of its surprisingly important export trade in Corinthian currants, Greece suspended external debt service in December 1893 with Trikoupis’ resonant announcement, “Regretfully, we are bankrupt.” In the aftermath of her military defeat by Turkey four years later, the exhausted country – its debt now quoted at today’s standard ‘distress level’ of 1,000 bps over the benchmark British Consols – was forced to submit to the indignity of allowing an International Committee for Greek Debt Management to dictate all aspects of economic policy.

However, far from being the sort of disaster we are so widely admonished against bringing about in our contemporary flounderers, the ensuing fiscal austerity and monetary deflation in fact marked a return to prosperity as competitiveness increased, entrepreneurial calculation was facilitated, savers were reassured, and foreign capital was encouraged to venture back. An export boom soon led to renewed domestic growth and the development of new industries (especially the shipping trade for which the country is still so renowned today).

One of the abiding themes here is that the tangled web woven by politicians when they choose to impose top-down solutions to their citizens’ need for a reliable medium of exchange opens up a field both fertile with honest error and fraught with conflicts of interest (such as the desire for seigniorage income and the recourse to manipulation of the currency either as a mercantilist tool, to force-feed industrial development, or to gull the state’s creditors). Another is the habitual intemperance of a populist executive when its spending habits are not severely trammelled about with meaningful financial, political, or moral restrictions. The road to office, too, is paved with good intentions and the bill for the tarmac and ballast which went into building it is all too often written on a posteriority – and, ideally for the office-holders, a posterity – to whom its presentation for payment can often be delayed but never indefinitely postponed.

Though it has done little to lessen the regulatory of the recurrence of such failings, the fact of their long-held appreciation can be demonstrated in the words of two former statesmen who, if hardly innocent themselves of all manner of enormities, at least understood the fatal juxtaposition of the temptations of power and the control of the purse.

After realising that he had been supplanted in the counsel of his master, Louis XIV, by the war minister Louvois, Colbert soon learned that the latter had persuaded the King to borrow the monies needed to meet his vast expenditures. The great finance minister fulminated at his rival, thus:

“You are triumphant! Do you not suppose that I knew as well as you that the King could raise money by borrowing? No, I advised him against it. Well, now we have started the game, just wait and see. The king will increase his extravagance and you will have to raise taxes to pay the interest. If the loans have no limit, neither will the taxes.”

More than 100 years later, seared in the holocaust unleashed by the hyperinflation of the Revolutionary assignats, the role model of the present occupant of the Élysée palace, Bonaparte himself, exclaimed at his first cabinet council:-

“National debt is immoral and destructive, silently undermining the basis of the state; it delivers the present generation to the execration of the next. I will pay cash, or I will pay nothing.”