Santayana’s Curse – Timeo Danaos (et Romanos)

The second of three excerpts from Chapter 2 of Santayana’s Curse, which is now available for Kindle.

Continued from Union Victory, Union Defeat.

… 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 them more closely with those of the non-members, there were other features, too, which are still germane today.

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, and 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 a 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 counter moves 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.

Of the impact of the Pereires we shall have more to say below.

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 Americande monetization 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.