How Democratic Is the Euro?

Dani Rodrik

Mario Draghi presents ECB report at EU Parliament

SAN SERVOLO, ITALY – When Italy’s president recently vetoed the appointment of the Euroskeptic Paolo Savona as finance minister in the government proposed by the Five Star Movement-League party alliance, did he safeguard or undermine his country’s democracy? Beyond constitutional strictures specific to the Italian context, the question goes to the heart of democratic legitimacy. The difficult issues it raises need to be addressed in a principled and appropriate manner if our liberal democracies are to be restored to their health.

The euro represents a treaty commitment from which there is no clear exit within prevailing rules of the game. President Sergio Mattarella and his defenders point out that an exit from the euro had not been subject to debate in the election campaign that brought the populist coalition to power, and that Savona’s appointment threatened a financial market meltdown and economic chaos. Mattarella’s detractors argue that he overstepped his authority and has allowed financial markets to veto the selection of a minister by a popularly elected government.

By joining the euro, Italy surrendered monetary sovereignty to an external, independent decision-maker, the European Central Bank. It also undertook specific commitments with respect to the conduct of its fiscal policy, though these constraints are not as “hard” as those framing monetary policy. These obligations place real limits on the Italian authorities’ macroeconomic policy choices. In particular, the absence of a domestic currency means Italians cannot choose their own inflation target or devalue their currency vis-à-vis foreign currencies. They also have to keep their fiscal deficits below certain ceilings.

Such external restraints on policy action need not conflict with democracy. Sometimes it makes sense for the electorate to tie its hands when doing so helps it achieve better outcomes. Hence the principle of “democratic delegation”: Democracies can enhance their performance by delegating aspects of decision-making to independent agencies.

The canonical case for democratic delegation arises when there is a paramount need for credible commitment to a particular course of action. Monetary policy is perhaps the clearest instance of this. Many economists subscribe to the view that central banks can generate output and employment gains through expansionary monetary policy only if they are able to produce surprise inflation in the short run. But, because expectations adjust to central bank behavior, discretionary monetary policy is futile: it yields higher inflation but no output or employment increases. Accordingly, it is far better to insulate monetary policy from political pressures by delegating it to technocratic, independent central banks that are charged with the singular objective of price stability.

Superficially, the euro and the ECB can be seen as the solution to this inflationary conundrum in the European context. They protect the Italian electorate from their politicians’ counterproductive inflationary tendencies. But there are peculiarities to the European situation that make the democratic delegation argument more suspect.

For one thing, the ECB is an international institution, bearing responsibility for monetary policy for the eurozone as a whole rather than Italy alone. As a result, it will be generally less responsive to Italian economic circumstances than a purely Italian, but equally independent central bank would have been. This problem is aggravated by the fact that the ECB chooses its own inflation target, which was last defined in 2003 as “below, but close to, 2% over the medium term.”

It is difficult to justify the delegation of the inflation target itself to unelected technocrats. When some countries in the eurozone are hit by adverse demand shocks, the target determines the extent of painful wage and price deflation these countries must undergo to readjust. The lower the target, the more deflation they must bear. There was a good economic argument for the ECB to have lifted its inflation target following the euro crisis to facilitate competitiveness adjustments in Southern Europe. Insulation from political accountability was probably a bad thing in this case.

As Paul Tucker, a former deputy governor of the Bank of England, discusses in his masterful recent book Unelected Power: The Quest for Legitimacy in Central Banking and the Administrative State, the argument for democratic delegation is a subtle one. The distinction between policy goals and how they are implemented needs to be clear. Insofar as they entail distributional consequences or tradeoffs between contending goals (employment versus price stability, for example), policy objectives have to be determined through politics. Delegation is warranted at best in the conduct of policy that serves politically determined objectives. Tucker argues, correctly, that few independent agencies are based on a careful application of principles that would pass the test of democratic legitimacy.

This shortcoming is far worse in the case of delegation to international agencies or treaties. Too often, international economic commitments serve not to fix democratic failures at home, but to privilege corporate or financial interests and undermine domestic social bargains. The European Union’s legitimacy deficit derives from the popular suspicion that its institutional arrangements have veered too far from the former to the latter. When Mattarella cited the reaction of financial markets in justifying his veto of Savona, he reinforced those suspicions.

If the euro – and indeed the EU itself – is to remain viable and democratic at the same time, policymakers will have to pay closer attention to the demanding requirements of delegating decisions to unelected bodies. This does not mean that they should resist surrendering sovereignty to supranational agencies at all costs. But they should recognize that economists’ and other technocrats’ policy preferences rarely endow policies with sufficient democratic legitimacy on their own. They should promote such a delegation of sovereignty only when it truly enhances the long-term performance of their democracies, not when it merely advances the interests of globalist elites.

Dani Rodrik is Professor of International Political Economy at Harvard University’s John F. Kennedy School of Government. He is the author of The Globalization Paradox: Democracy and the Future of the World Economy, Economics Rules: The Rights and Wrongs of the Dismal Science, and, most recently, Straight Talk on Trade: Ideas for a Sane World Economy.

Political tale-telling is splitting the eurozone apart

The biggest threat to the bloc is the toxic combination of mistrust and untruths

Wolfgang Münchau

Matteo Salvini, left, and Luigi Di Maio. Italy's populist government is not an electoral accident, as the country's moderate political commentators want us to believe © AFP

Narratives matter. A friend once warned me not to use the word “narrative” because it was a convoluted way of saying “stories”. But narratives are special kinds of stories. They are the tales we keep telling each other, until we believe them.

I have been following narratives on European integration in the largest member states of the EU with mounting disbelief. One of the causes of the vote for Brexit was the language of Euroscepticism and the lack of an intelligent counter-message. Similar stories are now driving the eurozone apart.

A well-known political columnist at Der Spiegel recently referred to Italians as beggars lacking the decency to say thank you. Behind this disgraceful insult stirs an all-too-widespread belief among Germans that they are bankrolling the EU — and Italy, in particular. But the truth is that Italy is a net contributor to the EU budget, runs surpluses in its primary fiscal balance and its current account, and has never been a recipient of German bailouts.

Another common line in Germany, but also in many English-speaking countries, is that France is an economic basket case. Few proponents of this idea seem aware of the fact that France’s economic performance has been similar to that of Germany since the creation of the eurozone almost 20 years ago.

What is particularly shocking about these spurious narratives is not only the contempt and ignorance they reflect, but the casual way in which they are cobbled together. They are part of common folklore and judged to be true because everybody has been saying the same kind of stuff for years.

This tendency could be seen in the UK during the run-up to the Brexit referendum. If people are told to associate the word “Brussels” with “bureaucrat” for two decades, why should we be shocked when they vote to cut loose from the hated bureaucracy?

The lesson I draw from Brexit is that narratives shape politics. Italy’s populist government is not an electoral accident, as moderate Italian political commentators want us to believe. It is what happens when a prolonged economic downturn drives the electorate against the establishment. Italy used to be one of the most pro-European countries. According to the latest Eurobarometer survey, it is now the most Eurosceptic.

Narratives also matter in policy analysis. Here we face a different crisis — one of self-censorship. At the height of the eurozone crisis, I was briefly drafted into an expert group to help come up with ideas. I remember well the opening statement by a German economist, who announced that the group should not even consider proposals which the German government had already rejected. This was a reference to a mutualised eurozone bond— the “He-Who-Must-Not-Be-Named” of discussions about eurozone policy. Reading a recent report by 14 French and German economists on the eurozone, which was astonishing for its lack of ambition, I had a sense of déjà vu.

I know many economists who agree privately with the assertion that the eurozone requires a mutualised safe asset. But when they put their names to reports on the subject, they begin to talk like politicians.

If realism is your guide, as it should be, then the reality of the eurozone should be all that matters. The argument in favour of mutualised bonds is that, without them, the eurozone’s financial system can never be stabilised. The eurozone is a monetary union in a semi-permanent state of crisis.

I understand the argument that political boundaries must be respected. Eurozone crisis resolution is about compromise and adopting second or third-best alternatives. But I shuddered when I heard political commentators gushing that Angela Merkel was to be congratulated when she finally gave her response to Emmanuel Macron on eurozone reform.

The German chancellor said no to almost everything the French president has proposed. The only meaningful concession is a short-term lending facility for countries in trouble — but on conditions likely to be unacceptable to Italy in particular. I have not heard anyone even trying to explain how this could help reduce instability.

The same goes for the idea by the 14 economists to create a synthetic eurobond through debt securitisation. This is the same method used to create the toxic financial instruments in the previous decade. The narrative is similar to what it was then. The risks are apparently not correlated, we are told. Except that the strong co-movement of Italian and Greek bond yields would suggest otherwise.

The only known antidote to misleading narratives such as these is truth-telling. The biggest threat to the eurozone now is the toxic combination of the preachers of hatred and those who dare not speak truth to power.

Inflation: Your Role as a Milk Cow

by Jeff Thomas

Traditionally, inflation has been defined as “an increase in the amount of currency in circulation.”

Such an increase almost always causes an increase in the cost of goods and services, since, more plentiful currency units lowers their rarity, as compared to the supply of goods and services, which remains roughly the same. Therefore, it shouldn’t be surprising if a 20% increase in the amount of currency units translates into a 20% increase in the price of goods and services.

Unfortunately, in recent decades, even dictionaries have been offering a revised definition of inflation, as “an increase in the price of goods and services.” This is a pity, as it makes an already confusing subject even more difficult to understand.

This is especially true for the average guy who has a minimal understanding of economics, but does realise that, even if his wages increase (which he regards as a good thing), he never seems to get ahead. In the end, he always seems to be worse off.

So, let’s see how simply we can break this down. And, let’s do it from the layman’s personal point of view.

Let’s say that you’re paid $4000 per month. You budget for housing, food, clothing, transportation, etc. Let’s say that that adds up to $3800 per month, and you’re hoping to put $200 per month into savings. Often that doesn’t happen, as unplanned expenses “pop up,” and must be paid for. So, in the end, you save little or nothing.

In the meantime, you’re daydreaming about buying a new car, but it can’t be bought, because you don’t have any money to allocate to it.

Then, your boss says that the recent prosperity has resulted in a big new contract for the company that allows him to give you a raise of $200 a month.

This is your big chance. You go to the car dealership, buy the car, and arrange for time payments of $200 per month to pay for it.

However, what’s rarely understood is that the theoretical “prosperity” is the result of governmentally induced inflation. What appears to be prosperity is merely a rise in costs and, along with it, a rise in your wages.

You appear to be “getting ahead,” but here’s what really happens…

The inflation that resulted in your pay rise also raises the prices on most or all other goods and services. So, instead of spending $3800 on expenses every month, your costs have risen to, say, $4200.

So, only months after your pay rise, you become aware that, not only are all your expenses higher (which you didn’t figure on when you bought the car), you now have the extra monthly obligation of the $200 car payment.

A year later, you look back and say to yourself, “Just when I was finally getting ahead, just when I was realizing my dream to have a new car, all those greedy businesspeople raised their prices because they just want to be rich, and I ended up a loser.”

Not so. The businesspeople raised their prices for the same reason everyone does during inflation—because their costs are also higher and they must either raise prices or go out of business.

So, in effect… no one got ahead.

But, worse, you got behind. Because, now, in addition to your monthly expenses, you have debt obligations, and buying on time is always more costly than paying as you go.

As time goes on, you run into emergencies of one type or another that dip into your meagre savings.

You must renegotiate your debt with the bank in order to keep your car and, of course, the bank demands a greater percentage than before, assuring that your economic situation will only get worse.

Ergo, inflation has not been a boon, but a curse.

And that, in fact, is exactly the idea. Banks figured out ages ago that, although people will only tolerate so much taxation, they’ll not only tolerate, but welcome the hidden tax of inflation. The illusion that they’re “getting ahead” gives them the false confidence to take on debt, which will, over time, cripple them.

The purpose of bank-created inflation is to extract wealth from the populace.

By regularly increasing the amount of currency in circulation, banks create an environment in which the concept of debt appears to be beneficial. As a result, virtually everyone in today’s society not only has debt; he actually believes that he couldn’t improve his life except through debt.

So, that’s essentially how inflation works. However, there’s a further knock-on effect from inflation that comes with retirement.

When retirement arrives, almost no one who is caught up in the system described above has found a way to get out of debt. Inflation always gobbles up whatever advances he feels he’s made, because inflation itself created those imagined advances.

Just before retirement, most people have their most expensive houses, cars, etc., and appear to have prospered, but they also have the greatest level of debt that they’ve ever carried.

If they’ve been careful, they may have savings and/or investments that they hope will carry them through their twilight years. But they quickly find that inflation continues after they retire. Savings in banks no longer earn money. In fact, they do the opposite. Inflation takes more than the paltry interest savings received, resulting in an annual loss on any money held in banks.

But, inflation continues to march on, assuring that the retiree’s costs will continue to rise, even as his savings decline.

In essence, the inflation concept was invented by banks as an invisible tax—a means by which they could extract wealth from the populace.

And, here we get back to the original complaint of the individual. As he tries to balance his chequebook or to plan for his retirement, he scratches his head and wonders, “How is it that no matter how much more money I make, I never seem to get ahead?”

In effect, the individual is used by the banking system as a milk cow. For his entire working life, inflation is carefully adjusted to extract as much monetary value from his labours as possible, whilst still leaving him capable of continued production.

Pretty grim… So, is that it, or is there a way out?

Well, to begin, it would be very helpful to exit any country where the dual monetary drains of taxation and inflation are prominent. (By leaving, you may take an initial step down, but, over the long haul, you’re more likely to prosper.)

An additional move would be to refuse to borrow money for any situation. Yes, it will mean that, as your friends show off their new cars, you’ll be driving an older model. They’ll also live in nicer houses than you and they’ll “own” their own house before you do. But, at some point, since you’re free from debt, you’ll pass them by and eventually retire well.

By understanding inflation, and acting on that understanding, the odds of living your life as a milk cow can be greatly diminished.

The Rhetorical Battle Over China’s Rise

By Phillip Orchard


Defense chiefs from more than 40 countries gathered at the annual Shangri-La Dialogue in Singapore last weekend. Such high-profile gatherings usually come and go without producing any meaningful outcomes, but two emerging realities were on display at this year’s event. The first: Beijing is losing the rhetorical battle over the nature of its rise. A dominant theme in Singapore was that China has little interest in preserving the established order, and it’s becoming less and less useful to pretend otherwise. The second: Indo-Pacific states aren’t waiting around for the U.S. to contain China on their behalf, but uncertainty about the U.S. is breeding reluctance to form a cohesive front.

In his keynote speech, for example, Indian Prime Minister Narendra Modi obliquely criticized China’s disregard for the rules-based order and said the U.S.-India relationship is becoming a pillar of regional stability, but he also decried the U.S. retreat into protectionism and warned against a return to great power competition. The U.S., Japan and Australia agreed on the need for greater international cooperation in the South China Sea but didn’t hint at a plan of action. France and the U.K. announced plans to conduct new freedom of navigation operations in the South China Sea, but these patrols do nothing to slow the Chinese advance in the disputed waters. Singapore said China’s military buildup and the U.S. retreat into protectionism were equal threats to the status quo. The recently revived Quadrilateral Security Dialogue – intended to lay the groundwork for a coalition between Japan, India, Australia and the U.S. – was barely mentioned. U.S. Defense Secretary James Mattis said China’s recent installations of missiles and bombers on its man-made islands would be met with consequences and insisted that the U.S. was in the region to stay, but he declined to elaborate on what any of that means in practice.

For China, which sent only a midlevel delegation to face the fire, this heralds a deeper retreat into diplomatic isolation from its Indo-Pacific counterparts. It has little choice but to double down on the strategy that got it to this point, however alienating it may prove to be. For everyone else, well, talk is cheap. Forging a consensus on the nature of the Chinese challenge is one thing. Forging a coherent response is quite another – though there are hints that the U.S. may be preparing to match word to deed.
The Tide Begins to Turn
Since the beginning of the year, the hints of a backlash against Beijing’s narrative – that its rise will be mutually beneficial to its neighbors – have been bubbling up across the Indo-Pacific. For example, there’s been a growing drumbeat of warnings that China’s One Belt, One Road initiative is luring poorer countries into “debt traps,” which Beijing could exploit to, say, secure naval access to the far-flung deep-water ports it is funding. Strategically important China-backed infrastructure projects in Malaysia, Myanmar, Indonesia, Nepal and elsewhere have since been put up for review by host governments. In Australia, China is fending off a backlash over purported influence operations targeting Australian civil society groups, universities and, according to Australia’s spy chief, “every level of government.” Recently, U.S. and Canadian intelligence warned that Chinese infiltration in both Australia and New Zealand is putting the intelligence-sharing pact among those countries (plus the U.K.) at risk.

Europe, meanwhile, has largely rebuffed China’s attempts to portray itself as a champion of free trade while the U.S. targets friends and foes alike with protectionist grenades. Europe has instead echoed U.S. warnings about nefarious Chinese investments and technology theft. Even the Philippine government, whose rhetoric about Chinese power has become markedly fatalistic, has begun to harden its position. Last week, Manila laid out three “red lines” in the South China Sea and warned of war if China crossed them. The Philippines also recently resumed construction on its largest holding in the Spratlys and, in April, finally broke ground on projects, implementing a landmark 2014 deal giving the U.S. rotational access to Philippine bases.

China’s boilerplate defenses – that suspicions about its infrastructure investments are unfounded and cynical, that the blowback to its efforts to win friends in Australia is hysterical, and that any country with its experience with foreign exploitation would build a protective buffer on its periphery – aren’t entirely groundless. It rightfully fears a Japan-U.S.-India-Australia coalition that could sever its access to critical trade routes through the first island chain or the Strait of Malacca. One Belt, One Road is more about keeping the Chinese economy humming and opening new trade outlets than bullying smaller states into serving as a network of naval bases. It is encircled by powers capable of bringing the economy to its knees. The Communist Party of China has staked its legitimacy with the public on a pledge to make the country a great power against even greater odds.

In other words, China’s behavior is largely a symptom of its enduring weakness. But this doesn’t change the reality that China’s historical memory and persistent vulnerabilities are compelling a degree of assertiveness that makes it difficult for its neighbors to put much faith in Beijing’s intentions.
A More Robust Response
Regional states certainly aren’t sitting on their hands. At the Shangri-La Dialogue, India announced new trilateral exercises with Singapore as well as plans to involve Association of Southeast Asian Nations members. This comes less than a week after India struck a deal with Indonesia that could give the Indian navy access to a deep-water port at the mouth of the Malacca, and two weeks after it launched its first-ever maritime drills with Vietnam. Australia, too, has begun poking around in the South China Sea and deepening defense ties with regional states. Japan has been the most active, ramping up security assistance and strategic aid in Southeast Asia, shedding internal constraints on its military, and spearheading efforts to revive the Quad and the Trans-Pacific Partnership.

To an extent, the mounting sense of urgency in Tokyo, New Delhi and Canberra to contain Chinese assertiveness stems from their shared anxieties about U.S. commitments. But only the U.S. can fill in the gaps in each of these states’ naval capabilities and transform the grouping from a loose coalition to a dynamic alliance in a conflict. This extends to the economic realm as well. Coordinated efforts to counter Chinese coercion in One Belt, One Road target states and shield each other from retaliation would be much more robust with the world’s largest consumer market and investment source on board. Mattis acknowledged as much in Singapore and in January’s National Defense Strategy.

More than anything, states fear committing to something that exposes them to Chinese retaliation and then being hung out to dry by the United States. This problem is particularly evident among Southeast Asian states, whose participation would be invaluable in an effort to contain China, but who have the most to lose to China and the least ability to do anything about it. Philippine President Rodrigo Duterte has a point when he says that U.S. disinterest in a war over Chinese-occupied reefs off the Philippine coast has given Manila – a U.S. treaty ally – little choice but to comply when Beijing dictates terms on fishing, resource extraction and so forth. Vietnam’s recent cancellation of two foreign-backed drilling projects on the fringes of China’s territorial claims, reportedly under threat from Beijing, spoke louder than words. The White House’s threats to sanction states for purchasing Russian arms – critical to military modernization among weaker Indo-Pacific states – certainly doesn’t build faith in U.S. motivations.

The U.S. is hinting that a more robust response is forthcoming. In mid-May, the U.S. pulled China’s invitation to the Rim of the Pacific exercise, the world’s largest annual multilateral naval exercise – a move Mattis called merely a small consequence for Chinese actions. Notably, Vietnam (which agreed to ramp up maritime cooperation with the U.S. on May 25), Malaysia and potentially Taiwan will participate for the first time in China’s stead. Last week, a top U.S. general talked openly about the U.S. ability to destroy Chinese military installations in the South China Sea, and Mattis said the U.S. is planning a “steady drumbeat” of naval exercises near Chinese holdings in the disputed waters. On June 5, Reuters reported that the U.S. is mulling sailing a carrier group through the Taiwan Strait for the first time since 2007. Also this week, the U.S. conducted a freedom of navigation operation involving two warships for the first time, sailing near Chinese holdings in the Paracels, and then flew two B-52s over the Spratlys. The Quad finally held its second meeting on June 7.

Chinese weapons on South China Sea islands may not threaten core U.S. interests, and they may be useless in a war with the U.S., but they are certainly undermining U.S. partnerships with littoral states. If the U.S. thinks preserving credibility is important enough to roll back Chinese encroachment in the South China Sea, it would be a lot easier to do so sooner rather than later. And if the North Korea standoff is soon settled in a manner the U.S. can live with, the U.S. would be better positioned to stomach a major collapse in relations with China.

This may be what’s behind the newfound willingness in exceedingly cautious countries like the Philippines, Vietnam and Indonesia to stick their necks out. Similarly, per new satellite imagery obtained by Fox News, China has at least temporarily removed some surface-to-air missile systems from Woody Island in the Paracels – suggesting it may think the U.S. is serious about giving its South China Sea policy some teeth. But as always, the devil will be in the details. Freedom of navigation operations are good PR, but they are not an actual deterrent and never were intended to be. The same goes for winning a rhetorical battle without any appetite for a risky fight over the facts on the ground.