Communism is dead, socialism has been repudiated by the socialists themselves, fewer and fewer Europeans are believing Christians but it seems that a fanatical new religion – also practised in America – has replaced all of them: Central Bankism. Like all religions, it has both a supreme god – hard money – and a devil, inflation. Common sense suffices to oppose high inflation, and to fear hyper-inflation as the deadly disease of the currencies. But it takes the absolute faith of religion to refuse even very moderate inflation at the cost of immoderate unemployment and stagnation, as the Europeans have been doing, or to accept slow economic growth for years on end, as in the United States.

To be sure, the American version of central bankism is much more willing than its orthodox European counterpart to accommodate popular desires – the same is true of the other religions practised on both continents. Just as the Catholic Church is forced to allow more latitude in pragmatic America, where even devoted Jews drive on the Sabbath, the local version of central bankism has restraint imposed on it. The US Congress would legislate the Federal Reserve right out of existence rather than tolerate the horrendous levels of unemployment long prevalent in Europe. But the essential doctrine is identical. In the US, too, central bankism devalues labour rather than money, but instead of unemployment there are falling real wages – more than half of all jobs throughout the US economy pay less now than they did twenty years ago, in constant dollars. No wonder millions of new jobs keep being created, as Clinton keeps boasting: American labour is so cheap.

Like most religions, central bankism has its sanctuaries that inspire as much awe as any great cathedral: from the majestic Bank of England to the Greek temples of the US Federal Reserve, the massive modernity of the Bundesbank compound and the inevitable Umbertino of the Bank of Italy. The Nihon Ginko of Japan is housed in a solid but otherwise unremarkable office building on a side street, which is appropriate, given that until recently it was a servant of the powerful Okurasho, the ‘Treasury Ministry’, just as the Banque de France was a slave of the Ministry of Finance. As such, both were subject to the corrupting influence – dare one say it – of political decisions, though in truth both ministries are ultra-conservative élite strongholds, scarcely exposed to the vagaries of democracy.

Like many religions, central bankism has its high priests, constantly striving to assert their independence from secular parliaments, politicians and public opinion. Although, like any other public officials, they receive their salaries from the tax-payer, central bankers claim the right to ignore the public will by invoking their duty to a higher authority – the sacrosanctity of hard money. Central bankers in office – invariably for terms of Papal length, often prematurely renewed in fear of the fears of financial markets – are surrounded by an aura of sovereign power very properly denied to government ministers or even prime ministers and presidents, mere mortals voted in and out of office by the ignorant masses, or reshuffled at even shorter intervals. And when these high priests do at length retire, they are not uncommonly elevated to financial sainthood, their every fleeting opinion reverentially treasured, their candidacy for any position of special trust eagerly accepted, their very names talismanic, as with Paul Volcker in Wall Street and far beyond it, or Guido Carli in Italy, where the name of most past prime ministers evokes only opprobrium.

Because their own power derives largely from their supreme command of the crusade against the devil of inflation, central bankers naturally see His insidious presence everywhere. Very often, they detect ‘disturbing signs of incipient inflation’ or even ‘alarming warnings of mounting inflationary pressure’ in output, employment, and wage statistics that many respected economists view with equanimity, or find downright reassuring. Every time new statistical indicators are published, there are calls for slightly lower interest rates to achieve a bit more growth, but such outbreaks of heresy are easily squashed.

Simple, definitive proof of the doctrinal supremacy of central bankism can be found in the fact that any policy initiative that is branded as ‘inflationary’ is usually rejected out of hand. By contrast, the term ‘deflationary’ has no resonance at all. It is used as a purely technical expression, rather than a powerful condemnation of over-restrictive fiscal and monetary policies that strangle growth, and which in the Thirties brought about the Great Depression, political chaos, dictatorship and war. In the first instance it is the instrument of money that inflation hits, while deflation has an immediate impact on people, denying them the opportunity to work and earn, and to buy goods and services, which would allow others to work and earn.

It is perfectly true that real incomes and real wealth cannot be created by printing money, that inflation hurts the poor disproportionately as well as everyone who lives on a fixed income (‘the cruellest tax’) and wealthy rentiers who live on bond incomes. Inflation enriches all who are already rich enough to own real estate and other marketable assets, while disproportionately enriching smart speculators – but so does deflation. It is also true that, if unchecked, inflation naturally accelerates into hyper-inflation, which not only destroys currencies but also degrades economic efficiency – as people run to spend their suitcases of banknotes instead of working – and may even wreck the entire financial structure of a society. This being the worst manifestation of the devil, the ultimate Beelzebub, it is not surprising that in 1996, with inflation ultra-low at 1.5 per cent, the Bundesbank, when refusing to cut interest rates, still invokes the hyper-inflation of the early Twenties ‘that led to Hitler’ (it was followed by ten years of democracy, but never mind).

Inflation, then, is bad and hyper-inflation very bad indeed; but it is just as true that deflation is bad, and that hyper-deflation is disastrous. In economic theory deflation should have no consequences at all, because any upward movement in the value of money can be nullified by a compensating reduction in prices and wages. In practice, however, prices are downwardly sticky while very few employees anywhere at any time accept wage cuts without the most bitter resistance – even in the US with its mass immigration, increasingly unfavourable labour market and weak unions. Contrary to theory, deflation starves economies, even without taking into account the purely subjective mechanism that reduces real demand, and therefore real production and real employment, when people feel poorer just because the nominal value of their houses and other assets is falling. Inflation and deflation should therefore be viewed as equally objectionable by politicians and the public; they should resound in our ears as equivalent evils, like flood and drought, or theft and robbery. It is the greatest triumph of central bankism that only inflation is viewed as sinful.

Like all religions, finally, central bankism demands sacrifices from the faithful. Catholics, Jews and Muslims have it rather easy: central bankism resembles the Aztec faith in demanding human sacrifice. So far, we have yet to see Hans Tietmayer or any other European central banker climbing pyramids to cut out the palpitating hearts of young men and virgins with obsidian knives, but none of them hesitates to impose levels of unemployment that year after year after year deprive millions of young people of the opportunity even to start a career. Moreover, the central bankers have all the moral certitude of the Aztec priests. Gathered together last August with their host Alan Greenspan, chairman of the Federal Reserve, in Jackson, Wyoming (which instantly became the world’s premier resort), the central bankers congratulated themselves at length on their success in reducing inflation by keeping real interest rates high; they did not pause to deplore miserable growth rates, but engaged instead in a sort of reverse auction. As it is, the estimated 1996 growth rates for the G7 countries (US, Canada, Britain, France, Germany, Italy and Japan) average out at 1.8 per cent, which guarantees rising unemployment, simply because the labour force and labour productivity are conjointly increasing somewhat faster. Still, in Jackson the central bankers competed with each other in calling for even lower inflation rates.

Normally it is the chief of the Bundesbank who dominates such occasions. He can preach fiscal austerity and monetary discipline to errant foreigners everywhere, because Germany was for so long the perpetual winner of the deflation Olympics (except for the Japanese, who do not count – for those idiots, employment is always the priority). But this time around, France was the surprise winner. Untroubled by an economy not merely stagnant but in rigor mortis, with a level of unemployment (above 12 per cent) unseen since the Great Depression, the French were enormously proud of their amazingly low 1.3 per cent inflation rate (as of June 1996), a full 0.2 per cent below Germany’s! It was as if the defeats of 1870 and 1940 had been undone. The super-disciplined Dutch did not do quite so well with their 1.8 per cent, but that did not prevent Willem Duisenberg of the Netherlands Central Bank from sharing with confidants his fears that the Bundesbank was showing dangerous signs of laxity. After all, the German federal deficit stood at 3.6 per cent of the GNP, as opposed to the winning 2.7 per cent of the Dutch (which is only 2.7 percent away from reverting to a medieval gold-in, gold-out treasury, with no need of public finance at all).

The Italians, as befits real gentlemen, refrained from boasting – the Bank of Italy is the country’s only élite bureaucracy – in spite of their 2.9 per cent inflation rate, a brilliant achievement indeed given all the banknotes thrown into the economy by a 6.4 per cent budget deficit. The fact that low inflation drives up the lira, making Italian exports less competitive, thus cutting growth and employment in an economy already slowing down, was not the sort of thing the central bankers bothered to discuss.

Instead, with Duisenberg in the lead, there was heady talk of ascending to the paradise of central bankism, a zero inflation rate – it would only be a matter of eliminating budget deficits by scrapping more welfare programmes, and of interest-rate discipline, easily dispensed from the magnificent heights of Jackson, Wyoming, to the vulgar crowd of Europe’s 18 million unemployed. As for Alan Greenspan, he has nothing whatever to worry about, because slow growth, a 5 per cent unemployment rate and falling wages are all now accepted by Americans as perfectly normal, or even as good news. The stage has been reached at which any spurt of faster growth, any fall in unemployment, is very bad news indeed for Wall Street and all of us, because it will only lead the Federal Reserve to increase interest rates, in order to ‘cool down the economy’.

In fact, nobody knows the exact rate of unemployment below which wages start rising, pushing prices upwards. For one thing, every aspect of the US economy keeps changing, while the Government’s budget-starved statistical bureaux can only collect the same old increasingly outdated statistical series, in the same old way. Economists continue to debate the precise level of the Nairu (the non-accelerating-inflation rate of unemployment), but the Fed takes no chances. When in doubt, Greenspan invariably errs on the side of caution: a million people can lose their jobs because higher interest rates might, perhaps, keep inflation at one-tenth of 1 per cent below what it might have been.

How did this come about? How did the employees of one public institution among many assume a priestly status, becoming more powerful in many ways than prime ministers or Presidents? One heard very little about them in the three post-war decades of rapid economic growth, sharply rising incomes and widening prosperity. Only during the Thirties, not coincidentally the years of the Great Depression, were they as prominent as they are now. A world in crisis followed with bated breath every pronouncement from the lips of the Bank of England’s Montagu Norman, Germany’s Hjalmar Schacht and their lesser colleagues on both sides of the Atlantic. With tragic consequences for millions of American families, and far more terrible repercussions in Europe, governments almost everywhere accepted their remedy for the Depression, which was to deflate, deflate, deflate, by cutting public spending and restricting credit. One result was that Hitler’s rise to power was accelerated by mass unemployment.

We now know that the central bankers were totally wrong. The only way to refloat the sinking economies of the Thirties was to start off the chain-reaction of demand by sharply increasing government spending, and never mind a bit of inflation. Had the big boys of the world economy led the way, by inflating and importing first, to generate more demand for their own exports, everyone would have come out just fine. But only a few adventurous souls, and only one reputable economist, John Maynard Keynes, dared to contradict what seemed to be common sense, and even they were hesitant. The central bankers, by contrast, were utterly certain that they were right, just as they are now; and they gave exactly the same advice they are giving now; the only advice central bankers ever give: tighten credit, restrict spending, hold back demand. Old Sigmund had a term for that.

A simple explanation for the rise of central bankism as the prevailing wisdom of the age is institutional: while the value of money is protected with fierce determination by the central bankers, industry and labour have no such exalted defenders, only mere governments and parliaments now greatly inhibited by the caveats of central bankism. That is neatly mechanical but also circular and obviously begs the question. Perhaps there is a straightforward political explanation. In these post-socialist times, the Right everywhere is still unflinching in its allegiance to the bond-holding rentiers who oppose inflation above all things, while the Left, intellectually threadbare, is tired of complaining about unemployment, and frankly bored by the poor. In the US, the Presidential election rapidly became a contest between two right-wing candidates, except that on public finance Clinton managed to manoeuvre himself to the right of Dole. While Clinton tried to take the credit for the sharp cuts in all non-military public spending imposed by the Republican-dominated Congress (the Federal deficit is down to 1.7 per cent of GNP, a level unseen in two decades), it was Dole who proposed a tax cut, risking a deficit increase to stimulate growth.

In Europe, Tony Blair is only the most blatant among today’s party leaders of the left in his disdain for poor people and other losers, his overwhelming desire to sup at the table of financial success, and his contempt for the broad mass of working stiffs with small houses, big mortgages and ugly little cars. He is certainly ill-equipped to resist the plausibilities of central bankism. In France, Germany and Spain, the ex-socialist parties are not subject to the gravitational pull of fashionable society as the Labour Party is in Britain, but they can still do no more than march despairingly to electoral defeat. Such is the poverty of their ideas that they are now listening attentively to Blair’s mumblings about a ‘stakeholder’ society – not even bothering to go to the original source, Ryuzaburo Kaku, chairman of Japan’s Canon Inc.

In the absence of any intellectual counterweight to central bankism, an electoral victory of the Left can only yield right-wing policies poorly executed by ex-socialists who have no talent nor any natural affinity for commerce and finance. So it was in France under Mitterrand, and so it is in Italy, after the victory of the ex-Communist Party, now re-labelled PDS, the Democratic Party of the Left. The PDS, as exemplified by its leading government minister, the youngish, fashionable and ever-so-modern Walter Veltroni, far more at home on Madison Avenue than in the slums of the South, is using all its power to sustain Romano Prodi’s coalition government, which is entirely dedicated to central bankism. Its overriding goal is not to reduce Italy’s unemployment, terribly high in much of the South, nor to refashion decaying schools and antiquated universities on modern lines, nor to endow Italy with an adequate health-care system, nor to raise the Government’s bureaucracy to European standards, but to bring Italy into the European Monetary Union – the apotheosis of Europe’s particularly virulent form of central bankism.

The perfectly sound project of replacing Europe’s confusion of currencies with the ‘euro’ was born long before central bankism became today’s extremist religion, and did not originally imply the acceptance of deflation and unemployment for ever and ever. Even before the Bretton Woods system of fixed exchange rates pegged to the dollar, itself tied to gold at $35 an ounce, was undermined in 1971 by Nixon’s decision to end the convertibility of dollars into gold, the Common Market members had proclaimed their long-term goal of establishing a single currency. But so long as exchange rates were still fixed, barring infrequent devaluations and upvaluations, the multiplicity of European currencies was only a minor inconvenience. Commerce was not disrupted by currency gyrations nor inhibited by fear of possible shifts in exchange rates – at least, not until 1973, when exchange rates were unfixed, starting the up and down floating that has been going on ever since, to the great benefit of a new and thriving industry – currency speculation – and to the detriment of all others.

The project of a single European currency remained on the horizon as the ultimate aim, but in 1979 the European Monetary System was introduced as an interim arrangement, whereby member countries agreed to keep the relative value of their currencies within narrow limits. Under EMS rules, as soon as traders push up or mark down a currency anywhere near the limits, the country in question is compelled to react, chiefly by raising or lowering interest rates to attract or repel capital inflows, as the case may be. Central banks have also attempted to calm the waters by ‘open-market operations’, i.e. by out-trading the traders, dumping currencies much in demand, or buying up weak currencies, sometimes acting in concert specifically to ambush speculators. The central bankers, however, have never been very good at the game. Public and politicians may believe that they are geniuses, but speculators know better: they regularly leave the table with large winnings, at the expense of the central banks, sometimes with enough to keep their great-grandchildren in the pink on the basis of one night’s trading.

In any case, interest-rate jiggling and open-market operations could at best cope only with routine fluctuations. If a currency was sliding or ascending as a result of more enduring export and import trends, the only way of staying within the allowed EMS limits was to readjust the country’s taxation and spending structures as a whole, in order to raise or lower overall demand in its economy. In the old Bretton Woods days, currency problems could still be dealt with by currency solutions, leaving the domestic economy out of it and instead imposing, or relaxing, prohibitions on the purchase of foreign currency. But such ‘exchange controls’ have long since been abolished in the European Union – they are of course utterly incompatible with a unified market – so that there is no barrier between currencies and economies. Although the EMS is only an approximation to fixed exchange rates, let alone the euro, it already requires the currency tail to wag the economic dog, and all that goes with it: demand, employment, taxes, social programmes. In other words, the EMS can only work if its own priorities outrank all relevant political priorities, i.e. most of politics, and therefore most aspects of democracy. It is a foretaste of what the euro will require of its members.

Not everyone has been able to make the supreme sacrifice, as France is now heroically doing, raising its currency to majestic heights, depressing its people into a valley of despond. Having originally set the relative value of sterling much too high, Britain eventually had to withdraw from the EMS, but only after donating an immense fortune to speculators by trying and failing to out-trade them. The Germans could have saved the day by buying up the loose sterling clogging the market with their precious DMs. But that would have meant that parsimonious German savers would be paying for years of profligacy on Britain’s part in importing far more than it can export. The Bundesbank of a newly unified, far more self-confident Germany naturally did nothing and it may even have dumped some of its own stock of depreciating sterling. The British response was a cascade of press and Parliamentary insults of which ‘Nazi bastards’ is only the most printable – an episode worth recalling because it revealed how fragile is the ethos of European unity.

Italy, too, was forced out, though not because of any profligacy, being then as now a vigorously successful exporter. Instead the lira collapsed because of a loss of confidence in the Italian state itself, caused by the revelations of Tangentopoli and the resulting arrests, forced resignations and prudent withdrawals that wiped out most of the country’s political class. Both foreign and domestic foreign-currency traders, and many plain Italians with much or a little money in hand, calculated – very correctly – that the lira would go down, then sold it, thus ensuring that it would indeed go down. Some feared that the mountainous public debt accumulated during decades of waste, fraud, mismanagement and some investment, would be ‘monetised’ by whatever new rulers emerged, that is, be at least partially repudiated by inflating the currency. At a minimum, nobody could be certain that honest new politicians, if any could be found, would be up to the fiscal acrobatics and book-keeping stratagems needed to manage a public debt one-fifth larger than the GNP, not counting unfunded pension liabilities – calculators run out of zeros before that total is added up.

These episodes did not stop the onward advance towards the euro. Meeting in Hanover in June 1988, the European Union’s Council of Ministers agreed on the guidelines for the specialist negotiations leading to the Maastricht Treaty signed in February 1992, which laid down the criteria for admission into the European Monetary Union, future issuer of the euro currency. With that, the advance became a forced march because ‘Maastricht’, complemented by a December Council meeting in Madrid and another in Verona in April 1996, set a series of rigid timetables. As early as possible in 1998, each candidate’s 1997 statistics are to be examined, to determine which countries will be admitted into the EMU. On 1 January 1999, the successful applicants must irrevocably adopt fixed exchange rates. In practice that would already bring the euro into existence as Europe’s money, but national banknotes and coins would continue in circulation. At that point, DMs, francs, guilders or liras – if Italy is mad enough to join – would only differ in their colour and design, being entirely interchangeable at their respective, fixed, exchange rate. Finally, by January 2002 at the latest, national currencies are to be withdrawn, ceasing to be legal tender six months later.

It is not the euro itself, however, nor the compulsory, inflexible dates of its adoption (they simply disregard the business cycle) that have transformed Maastricht from being the name of one of Europe’s most pleasant minor cities into an evocation of fear, and a focus of scathing criticism from American economists, British politicians and, more to the point, European industrialists and trade unions. Currencies, after all, even the euro, can be managed in drastically different ways.

The value of sterling, for example, has often been ‘defended’ – i.e. forced upwards – from the Twenties onwards, to the greater glory of the British Empire, or the UK as the case may have been; to the great benefit of the City, which needed the prestige of a strong currency and/or high interest rates to attract depositors; and to the even greater benefit of wealthy Brits who could invest more advantageously abroad – and all at the expense of British industry, whose exports were systematically overpriced, while competing imports were correspondingly underpriced. In the process, X thousand City gents were kept happily rich with scant effort, Y hundreds of ultra-rich Brits cheaply accumulated many broad acres in Canada and Australia, real estate, bonds and shares in America, Europe and Japan, as well as villas on the Côte d’Azur, in Bermuda, the Bahamas etc, while Z millions of dis- or under- or never employed British industrial workers, their managers high and low, and all those foolish enough to invest in British industry paid for the fun.

That was what ‘the defence of sterling’, always much applauded by an innumerate press, has amounted to, from the disastrous 1920 decision to revert to the Gold Standard through to the Thatcher Government’s mad-dog decision to enter the EMS at a ‘prestige’ level, which guaranteed trade deficits and the further decline of British industry. Of late, with equally disastrous results for French industry, the French franc has been managed in the same way, and the DM, too, is greatly overvalued, leading to the emigration of German industry both eastwards into ex-Communist Europe, a new and better Ostmark, and westwards to the United States. Such are the fruits of central bankism – a currency that the unemployed can be proud of. The US dollar, by contrast, has mostly been allowed to float freely since fixed exchange rates were finally renounced in 1973. Far from defending the dollar, successive Administrations have intervened in earnest only to push it down, nakedly exploiting their geopolitical power over the hard-currency champions, but World War Two losers, Germany and Japan, to force them to upvalue their currencies, thereby devaluing the dollar. True, US officials have often promised to complaining foreigners that they would try to raise the dollar when it was too grossly undervalued, but they never promised that they would keep their promise. In any case, a very low and still declining propensity to save has ensured chronic US trade deficits, muting currency complaints.

Amid the total indifference of the public, in spite of some highly specialised Wall Street objections, successive US Governments have been gleefully happy to see the dollar fall, slide, plunge, plummet, collapse or even sink deep into the mud, for that means more exports, fewer imports, more work, more output and more profits – reckoned in dollars, and only dollars of course. At times, American tourists in Switzerland or France would be kicked out of their lodgings or denied a table by innkeepers afraid of being stuck with travellers’ cheques denominated in rapidly falling dollars. Such news always caused hilarity rather than shame back in the US of A, merely prompting suggestions that the unlucky tourists should try Florida next time. Central bankism is not quite so fanatical a faith in the US, and it has never been coupled with the sheer idiocy of currency nationalism.

It is not therefore the euro itself but rather its management that counts. Will it be kept as high as possible, as sterling has been and the French franc is now, or will it be allowed to slide merrily down in between upward jumps, as with the US dollar? Two things guarantee that the euro will be valued too high for the health of Europe’s already sickly economies: the specific Maastricht criteria for admission into the European Monetary Union, and the fact that from its inception its policy will be exclusively controlled by the European System of Central Banks.

The Maastricht criteria are utterly pervaded, inspissated and parboiled by the spirit of central bankism. Admission into the EMU requires that for 1997, the year of statistical ‘examination’, budget deficits be less than 3 per cent of the GNP (even Germany’s is now 4.1 percent); that the inflation rate be within 1.5 per cent of the three least sinful entrants (even Italy can make it); that long-term interest rates (a measure of the markets’ estimate of future inflation) be within 2 per cent of those of the three most virtuous entrants; that applicants be unblemished by the shame of any post-1995 devaluation; and finally, the most difficult of all criteria: that the public debt not exceed 60 per cent of the Gross Domestic Product, a condition that only France and Denmark could now satisfy. For the Netherlands at 78 per cent, or even Spain (79.8 per cent) and Portugal (70.7 per cent), let alone Germany (62.4 per cent), the permitted ratio of debt to GDP is definitely attainable by 1997 – all it takes is some stiff taxation to pay off some of the bond-holders at home or abroad. That will further depress demand, output and employment, but the newly disemployed will have plenty of company.

For Belgium at 130 percent and Italy at 123 per cent, on the other hand, the debt to GDP ratio could only be cut to 60 per cent between now and 1997 by the most extreme measures. In theory, it need not be so. Very little of Belgium’s or Italy’s public debt is held by foreigners. In theory, therefore, a simple two-step operation could do the trick: first impose a huge ‘patrimonial’ wealth tax to extract the money, then give it back more or less to the same people, to buy back their holdings of state bonds. Already advocated as a ‘simple’solution on election night 1996 by Italy’s Rifondazione Communista, the unreconstructed, pure red, hammer-and-sickle Communist Party on which Prodi’s Government depends for crucial Parliamentary votes, the two-step would not work out quite so well in practice. In fact, it would probably wreck the country for a couple of generations.

In the first place, assessment for the patrimonial tax would unleash a tidal wave of anonymous denunciations, which would no doubt improve the country’s mental health by venting all manner of long-festering animosities: Rossi has a villa under his wife’s sister’s maid’s name; Bianchi keeps gold in his mattress; Neri has money in a Jersey bank account ... But that would only add to the crushing burden of tax assessors trying to identify and add up each household’s listed and unlisted holdings of real estate, savings accounts, stocks and bonds, art works, automobiles, furniture, domestic appliances, jewellery, and perhaps clothes and toys as well. By which point, of course, all the country’s liquid assets, along with very many of its entrepreneurs and the more mobile among its professionals, would long since have flown the coop to watch the proceedings from afar. That would in turn make it somewhat difficult to sell off the real estate, which cannot be wired abroad in micro-seconds. Shares, too, would not be easily sold in a deserted stock-market with the index near zero. Finally, any attempt to collect the tax would trigger enough appeals and lawsuits to last a thousand years or so.

None of that, however, need happen. Just as the Maastricht meeting of the European Union’s Council of Ministers inscribed the 60 per cent criterion into the Treaty, another meeting can take it out. In that way, Italy as well as Belgium could join the others in the EMU, so long as they deflated their already deflating economy by cutting their deficit in half to the allowed 3 per cent, a perfectly achievable proposition if one does not mind a bit more unemployment. What cannot change is the governing principle of the EMU: the totality of monetary policy, from interest rates to credit norms, is to be controlled exclusively by the European System of Central Banks. Appropriately enough, it is the conclave of the European Central Bank, currently in creation, with the existing central banks of each country, which is to sit at the ECB’s feet to implement its every command. Its first act, as of the start of 1998, will be to conduct a statistical inquisition to determine each country’s fitness for admission. By that date too, all central banks not yet deemed ‘independent’ are to become so; in other words, laws must be passed to ensure their full independence from their own governments and parliaments, as the Bundesbank and Federal Reserve, among others, already have.

No independence, however, can be as magnificent and absolute as that of the ECB itself: it is to receive no instructions either from member countries or from any institution of the European Union. Such is the sovereign status of the institution, headed by a central banker selected by other central bankers, themselves recruited and trained by their predecessors from like-minded people, which is to assume total and exclusive control over the monetary policy of all member countries from the inception of the union on 1 January 1999. Itself free of any democratic interference, the ECB will be at liberty to interfere at will in everything that has anything to do with money in all member countries.

No institution has claimed such prerogatives since the heyday of the medieval Papacy. Beyond the enormous leverage of interest rates across the entire spectrum of economic life, beyond its control of credit in general, the ECB will be empowered to invigilate quite a few specific rules, including the three sacrosanct prohibitions: no financing of state deficits by central banks (back to gold-in, gold-out public treasuries); no loans on favourable terms to any public body or state-owned company by any private or public financial institution (au revoir Air France, arrivederci Alitalia); no guarantees by any member country of any other member country’s debt, the ‘no bail out’ rule. To a slight degree perhaps, it will matter who heads the ECB, for while all members of the fraternity are physiologically disposed to tighten credit, restrict spending, hold back demand (old Sigmund again), some are millimetrically more latitudinarian than others. At present, the leading candidate is Willem Duisenberg of the Netherlands Central Bank, the man who has allowed it to be known that he detects signs of laxity in the Bundesbank.

Still an obscure set of initials for the time being, the letters ECB deserve to acquire all the resonance of KGB or CIA, not to add, very indelicately, SS, because the European Central Bank is all set to be the King Kong of Europe’s institutional jungle. Yves-Thibault de Silguy, whose very name is redolent of the glories of absolute monarchy, a graduate of the Ecole Nationale d’ Administration, of course, now the European commissioner in charge of economic, financial and monetary affairs, and an enthusiastic advocate of the ECB, has recently raised and answered the Great Question to his own complete satisfaction: ‘Some people claim that the independence of the European System of Central Banks is anti-democratic. That criticism is baseless. The ECB will be subjected to the rules of transparency and open information already imposed on central banks in most industrialised countries.’ Who says that ENA graduate, French patrician Eurocrats lack a sense of humour? As I write, the Washington Post announces that the Federal Reserve is bringing in the FBI to investigate a leak of interest-rate recommendations. And the Fed is far more open in its dealings than any European central bank, i.e. almost as liberal with information as the North Korean Politburo.

What is much less funny is that under the ECB the euro will most certainly be managed like sterling in the Twenties rather than like the US dollar since 1974, as the very hardest of hard currencies, kept that way by the cruellest, most persistent deflation. What an outcome of all the hopes that European unity once evoked! With the economics of Western Europe stalled by a chronic lack of demand, with Russians lacking everything (except nuclear weapons), from surgical instruments in hospitals to space heaters at home, with other ex-Soviet states even worse off, generous printings of euros sent eastwards would immediately return to employ millions in Western Europe, relaunching investment and growth, engendering bright new hopes in its despondent youth, as well as some inflation no doubt. Now that would be a grand project, fit for a European Union worthy of its name, and it might even avoid the mega-disaster which could so very easily ensue if two or three things go wrong in Russia. All it would take is for the ECB to be governed by a board of industrialists and trade-unionists with no central bankers allowed on the premises, and headed by an accountant charged only with keeping hyperinflation at bay by stopping the printing presses churning out the euros now and then.

As it is of course, any real help for the Other Europeans is ruled out. Instead, they, along with the US and all other exporters to the EMU countries, will be incidentally damaged by their blind charge into the valley of hard-money deflation. It might mean the loss of as much as a third of US growth. But at least the ECB should be able to save on salaries. Certainly there is no need to hire the highly paid priests of central bankism to head the ECB. So very restrictive and mechanical are its intended monetary policies, so very narrow is the scope of its decisions, that almost any clerk armed with a cheap calculator would be up to the job.

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Vol. 18 No. 23 · 28 November 1996

I can scarcely believe that I have laboured through Edward Luttwak’s article (LRB, 14 November) on central bankism and find hardly a mention of the money markets. Surely, the principal reason why central banks and their religion of hard money have become tyrannical is that the money markets make them so. Thanks in part to round-the-clock trading made possible by new technology, flows of currency are far greater than they were even twenty years ago. The currency men and women can outgun governments. They like what they see of the Bundesbank, which painfully built up the Deutschmark’s credibility over decades and helped foster Germany’s economic success. They have a choice where to invest and now punish mercilessly any country which opts for a soft money policy.

Victor Smart

Vol. 18 No. 24 · 12 December 1996

In complaining that my article on central bankism ignored the influence of the money-markets, Victor Smart argues that they ‘punish mercilessly’ any country which opts for a soft money policy (Letters, 28 November). Very true – but how is that punishment inflicted? By marking down a country’s currency of course. And what consequences ensue in these deflationary times of chronic excess capacity? Cheapened exports rise, dearer imports fall, increasing employment at both ends, in import-substitution as well as export trades. That is exactly what happened in Italy in 1993-5, after the lira was forced down by the money-markets, alarmed that the country’s political turmoil would accentuate its fiscal and monetary laxity. As the lira fell the Italian economy enjoyed an export-led boom, while Germany and other EU countries of exemplary monetary discipline were suffering from increasing unemployment. With the lira then being much in demand to pay for all those Ferragamo shoes and everything else, it started a slow climb that still continues – even though only the more courageous fraction of investors and currency traders bought liras and lira-denominated bonds and stocks, adding their own capital demand to the trade-generated demand for liras. At the time, grave warnings were issued that Italy’s inflation would soon accelerate because of the rising cost of imports. That is what is written in textbooks – but then textbook-writers do not know much about Ferragamo shoes: when the cost of dollar-denominated ostrich skin increased, the import content of 300,000 lira shoes went up from 1000 liras to 1500 liras, i.e. to 0.005 per cent of their total value – and that was just about the extent of Italy’s import-induced inflation. Advanced economies are like that.

To be sure, in inflationary times with productive capacity already fully utilised, the down-valuation of the currency by money markets cannot result in increased exports, while rising import prices further accelerate inflation. My ‘central bankism’ critique is meant to apply to the present situation of chronic deflation and excess capacity. Everyone knows that inflation results from too much money chasing too few goods. Everyone knows that there is now an abundance of capacity, the equivalent of too many goods, so that much money can be printed without causing much inflation.

Edward Luttwak
Chevy Chase, Maryland

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