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Words of a Euro Doomsayer Have New Resonance

The euro zone was crumbling, just as he had long predicted, yet Bernard Connolly, Europe’s most persistent prophet of doom, still faced a skeptical audience.

Euros & Downward Graph
Steven Hunt
Euros & Downward Graph

“The current policy of lending plus austerity will lead to social unrest,” Mr. Connolly told investors and policy makers at a conference held this spring in Los Angeles by the Milken Institute, arguing the case that Greece, Italy, Portugal and Spain could not simply cut their way to recovery.

“And 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,” he concluded, his voice rising above the chortles and gasps coming from the audience and the Europeans on his panel. “And that is the future if this malignant lunacy of monetary union is pursued and crushes these countries into the ground.”

Mr. Connolly has been warning for years that Europe was heading for disaster. As a European Union economist in the early 1990s, he helped design the common currency’s framework, but then he was dismissed after he expressed turncoat views. In 1998, just months before the euro’s introduction, he predicted that at least one of Europe’s weakest countries would face a rising budget deficit, a shrinking economy and a “downward spiral from which there is no escape unaided. When that happens, the country concerned will be faced with a risk of sovereign default.”

Now, as the European debt crisis that began in Greece threatens to engulf even France along with Italy and Spain, Mr. Connolly’s longstanding proposition that the foisting of a common currency upon so many disparate nations would end in ruin is getting a much wider hearing. Hedge funds looking to bet on a euro zone breakup scour his research reports for insights.

Longer-term investors who listened to his decade-long recommendations to steer clear of the bonds of Greece, Italy, Portugal and Spain are congratulating themselves for not falling into the trap that bankrupted MF Global, the investment firm run until recently by Jon S. Corzine, the former Goldman Sachs executive and New Jersey governor.

And central bankers outside the euro zone are among his most faithful readers.

In 2008, Mark Carney, the governor of the Canadian central bank, cited the British-born Mr. Connolly, along with the far more prominent Nouriel Roubini of New York University and the Harvard economist Kenneth S. Rogoff, as having been among the few who foresaw the global financial crisis. Mervyn A. King, the governor of the Bank of England, has become more vocal about the euro zone’s problems and is also a longtime follower.

Nicolas Carn, an independent research analyst and money manager who worked previously as chief investment strategist for the London-based hedge fund Odey Asset Management, is one of Mr. Connolly’s biggest fans. “Bernard has influenced me a great deal,” Mr. Carn said. “He has shaped my views on Europe and contributed significantly to my investment performance.”

To be sure, Mr. Connolly was not the only analyst who raised early warning flags about the euro project. Economists like Martin Feldstein of Harvard and Paul Krugman, a Princeton economist who writes an Op-Ed page column for The New York Times, have been longtime critics, as were many experts in Britain, which has long been skeptical of the euro. But few have gone on to devote more or less their entire professional career to exposing Europe’s monetary fault lines.

Unlike many critics of the euro, Mr. Connolly, 61, plies his trade mostly in private, eschewing cable television programs, opinion pages and policy journals.

He represents a new breed of independent analyst that has come increasingly to the fore since the financial crisis broke in 2008.

As investment banks have cut down on staff and remain constrained by their banking and government relationships, independent analysts like Mr. Connolly, who are mostly pessimistic in outlook, have become highly popular for hedge fund investors who wager large sums of money betting against the currencies, bonds and banks of countries headed for trouble.

Mr. Connolly worked for AIG Financial Products, the banking arm of the insurance company American International Group, until it went into government receivership. He now operates out of a nondescript office in New York, where he is said to pound out as much as 20,000 words of analysis a week.

Insights Don't Come Cheap

His insights, like those of other such analysts scattered around the globe, do not come cheap. While the price Mr. Connolly charges is not public, analysts of his stature command, in some cases, as much as $100,000 for a full array of services, including regular meetings and phone calls along with written reports.

And like many of them, Mr. Connolly — the Oxford-educated son of a bus driver from Manchester — guards his privacy zealously.

He declined numerous requests to comment for this article. People who know him say that his public reticence is also fed by a lingering anxiety that officials in power will exact some form of revenge.

The origins of that fear, as well as the anger and passion that drive him, date to 1995, when he took a leave from his job with the European Commission to write “The Rotten Heart of Europe.” The book was an excoriating history of the failure of the euro’s predecessor, the European exchange rate mechanism.

In Britain, where suspicions of common European economic policy ran very high, the book was a hit for its attacks on the architects of the European common currency, including Jacques Delors, the former head of the European Commission, and Jean-Claude Trichet, the French finance official who would go on to run the European Central Bank for eight years.

The book was greeted less enthusiastically in Brussels; Mr. Connolly was told not to return from leave to reclaim his position.

Moreover, the European Commission investigated whether he had disclosed any proprietary information in his book. Investigators found that he had not.

In 2005, when Greek, Portuguese and Irish bonds were trading at rates barely higher than Germany’s, Mr. Connolly’s work at AIG Financial Products persuaded a small group of hedge funds and independent investors to bet on a euro zone crackup.

They did so by buying the credit-default swaps of what he saw as the most vulnerable European countries.

When fears that those countries would default took off in 2008 and 2009, sending the values of those swaps skyward, they were able to sell — reaping large profits.

“It took a while, but we finally were able to monetize Bernard’s views on Europe,” said James Aitken, who worked with him at AIG Financial Products and describes his job at the time as translating Mr. Connolly’s arcane musings into actual investment strategies.

While other investors have also profited from following Mr. Connolly’s advice, Mr. Aitken says that the analyst’s true passion is to try to prevent the social and political train wreck he fears is just around the corner.

“He is anguished,” said Mr. Aitken, who runs his own research service for investors, Aitken Advisors, from his home in London. “He sees where this is going and is warning against the human tragedy.”

Yra Harris, a trader on the Chicago Mercantile Exchange, is another of Mr. Connolly’s supporters in the investment world. “Bernard is like no one I have ever met,” he said, citing his work as inspiration for some recent profits he made selling Italian bond futures.

Mr. Harris concedes that Mr. Connolly’s reports can be hard going. Indeed, some exceed 70 pages, cite Hegel and John Stuart Mill and include footnotes that can run on for more than a page.

But Mr. Harris is so convinced that Mr. Connolly’s views should find a wider audience that he and a colleague have offered to pay Mr. Connolly’s publisher $75,000 to reissue 25,000 paperback copies of “Rotten Heart,” now out of print.

“I will pay out of my pocket because he has meant so much to me,” Mr. Harris said. “Each time I talk to him, it’s like I’ve been to Harvard for four years.”

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