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This will not end well, says the man who predicted the Euro crisis

Bernard Connolly’s predictions have been proved uncannily correct, writes The Motley Fool.

He worked in the heart of Europe, helping design the framework for the single currency, but he became disillusioned and turned against the European project, writing a polemical tome against monetary union called “The Rotten Heart of Europe: The Dirty War for Europe’s Money”. For his troubles he was sacked by the European Commission.

You could call him the Anakin Skywalker of the euro. Having left the Commission Bernard Connolly has been consistently eurosceptic for nearly two decades, but his views were usually ignored as extremist and irrelevant.

A man whose time has come
That is until now. Suddenly his prophecies of disaster in the eurozone have been proved uncannily right. And now traders and hedge funds hang on his every word as they search for clues about what will happen next as the sovereign debt crisis continues to unfold.

As you will see, he certainly doesn’t hold back in his views: “The structure of EMU flies in the face of all economic rationality. The project was politically motivated from the beginning.”

He is blunt; monetary union, implemented in the way it was, could only end in tears: “If the nominal exchange rate is abolished and national monetary policy eliminated through membership of a monetary union that is not also a political union, disaster is almost bound to strike.” When did Connolly write this? Way back in 2002!

Connolly foretells the Greek crisis, and more
He goes further, and his words seem to be an eerily familiar prediction of the Greek crisis. Without the mechanism of floating exchange rates and nationally-set interest rates, the imbalances in a currency union can become intolerable.

A poorer country will first boom, but over time the economy falls back, domestic demand declines and exports are needed to fill the gap. But the exchange rate cannot adjust to aid this process. As competitiveness worsens the economy goes into a tailspin. Unemployment rises, credit spreads widen, and government default becomes a real possibility.

In Connolly’s words: “The circle is vicious indeed. If nothing is done to break it, the outcome will be not just economic and financial collapse but social and political chaos.”

Indeed he names Ireland, Portugal and Greece as potential victims. All these countries, he forecasts, “will face depression… and potential default”.

He also predicts inflation, and that investors will go in search of an inflation-proof asset. What does that mean? Well gold, of course. Yes, Connolly also correctly predicted the gold boom.

So, what now?
Fast forward to today. The British-born and Oxford-educated Connolly now works as an independent analyst in New York. And, all of a sudden, his views are being listened to attentively by a wider audience.

In a presentation he recently gave at a Milken Institute conference, he said that to even up the imbalances the wealthiest nations of the eurozone (Germany, Austria, the Netherlands and Finland) would have to pay to the weakest nations a sum equivalent to 7% of GDP every year, forever — i.e. pretty much the same as the reparations demanded of Germany in the Versailles treaty!

His view is clear: this is not going to end well. “The current policy of lending plus austerity will lead to social unrest,” he said. To gasps in the audience, he talked about the countries at the centre of the storm — Greece, Italy, Portugal and Spain, “One should not forget that of the four countries we are talking about, all have had civil wars, fascist dictatorships and revolutions. That is history. And that is the future if this malignant lunacy of monetary union is pursued and crushes these countries into the ground.”

Ouch! Is Connolly exaggerating things? — I sincerely hope he is.

History is repeating itself, again

How could Connolly, pretty much all the way along, have been so accurate? Well, quite simply because the lessons in history are there to see, for anyone willing to take a look, whether you are talking about the end of the Gold Standard, the Argentinean crisis, or Britain’s exit from the ERM.

The politicians may not realise this, but history is repeating itself, again. As George Santayana once said, “Those who cannot remember the past are condemned to repeat it.” Just this once, could you politicians please listen?

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This article, written by Prabhat Sakya, was originally published on fool.co.uk. Authorised by Bruce Jackson.

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