This CESifo group Munich seminar took place on June 11, 2018 in Ludwig-Maximilian University, in Munich. The euro crisis has highlighted the urgent need for reform in the Eurozone. However, approaches to a solution can be divided into two camps. The disagreement, primarily between France and Germany, is reflected very clearly in their different attitudes towards fiscal union. While the French strongly support a fiscal union, which necessarily implies fiscal transfers by Germany and other donor countries, Germany absolutely rejects a fiscal union and favours a post-crisis write-off of bad loans instead. In his speech Yanis Varoufakis argues that both visions are flawed and potentially dangerous, going on to differentiate between the solution to the Eurozone’s structural problems and the zeal and ambitions of its political class.
In these trying times for Europe, our common home, opportunities like tonight’s to discuss honestly and frankly Europe’s crisis are priceless.
When the title of my talk was announced, many of my critics were puzzled. Having portrayed me as a Greek politician who, back in 2015, came to Germany cap-in-hand demanding more money, they had difficulty explaining why I would be standing in front of you to argue that Germany neither can nor should pay more to save the eurozone.
The puzzle of course disappears after a close look at what I was saying since 2010. Let me give you an example. On July 24, 2013 I published an article in Handelsblatt entitled ‘Europe needs a hegemonic Germany’. In that article I had, again, surprised many by arguing in favour of a strong Germany as the best way of leading Europe out of its difficulties. My criticism of the German government, and its attitudes towards the eurozone more broadly and Greece more specifically, was not that Berlin was not paying enough but that, in a sense, it was paying too much – except that it was wasting the German people’s money in perpetuating what I termed a gigantic exercise in fraudulent bankruptcy concealment. Germany was paying too much… in perpetuating a gigantic exercise at fraudulent bankruptcy concealment.
I added that Europe needs a robust Germany, an energised Germany, to lead the way, to use its money wisely – in other words to be genuinely hegemonic, as opposed to spending too many resources on concealing impossible bankruptcies. Indeed, back then, in 2013, I had warned that continuing to insist on hiding serial bankruptcies would cost all of us more and more and would require increasing degrees of authoritarianism to perpetuate and reproduce the policies of denial.
In short, I wanted a Germany that was hegemonic and efficient, not authoritarian and caught up in a European Ponzi scheme. That was in 2013. Two years later, in March 2015, I wrote an article, while Greece’s finance minister, referring to the first and second bailout loans, of 2010 and 2012. Allow me to quote from it:
“The fact is that Greece had no right to borrow from German – or any other European – taxpayers at a time when its public debt was unsustainable. Before Greece took on any loans, it should have initiated debt restructuring and undergone a partial default on debt owed to its private-sector creditors.
But this “radical” argument was largely ignored at the time. Similarly, European citizens should have demanded that their governments refuse even to consider transferring private losses to them. But they failed to do so, and the transfer was effected soon after. The result was the largest taxpayer-backed loan in history, provided on the condition that Greece pursue such strict austerity that its citizens have lost one-quarter of their incomes, making it impossible to repay private or public debts.
The ensueing – and ongoing – humanitarian crisis has been tragic... Animosity among Europeans is at an all-time high, with Greeks and Germans, in particular, having descended to the point of moral grandstanding, mutual finger-pointing, and open antagonism. This toxic blame game benefits only Europe’s enemies.”
A personal note here, if you permit it: For me, nothing hurt more than my unfair portrayal as an anti-Europeanist Greek politician demanding more money from Germany, or arguing that Germany must pay more for Greece and for Europe. In fact the reason I resigned the ministry is simple: I was refusing to sign the third bailout, to take more of your money, because I was convinced that, when you are bankrupt you have no right to borrow more. What should we have done? Declare bankruptcy, suffer the pain together with the lenders that should not have lent to the previous governments, reform the country and move on. What happened instead?
Italy and Greece
A few weeks after my resignation, Mrs Merkel, Mr Tsipras and others agreed on another 85 billion euros loan to the Greek state. On that day I rose in Greece’s Parliament to denounce this as another extend-and-pretend loan – another mountain of money given to the bankrupt Greek state in order to pretend for a few more years that it is repaying its debts – and granted under conditions that guarantee that the Greek economy and our society would continue to shrink, that the debt would not be repaid, and that Europe would move on to repeat the same mistakes in Italy – a country whose public debts and banking losses are just too large for Germany and other countries to sustain via Greek-like bailout loans.
That is what I said in the summer of 2015. Today, I painfully observe the realisation of those fears. Italy has fallen to the forces of xenophobia and Europhobia that welcome the European Union’s breakup. How did that happen? It happened because the failed policies first tried on Greece were also implemented in Italy.
Just like Greece, Italy had been ruled for decades by a corrupt oligarchy enriching itself from EU transfers and relying on a kind of ‘establishment-populism ’ that traded on the impossible promise that everyone would become better off as long everyone pretended to adhere to the EU, Maastricht & Fiscal Compact rules – rules that could not be adhered to even if the government wanted to.
When this promise was proven false, and the doom loop of bankrupt state and zombie banks caused per capita income to shrink and prospects for most Italians to wither, the electorate voted for a new government representing two opposing anti-establishment populisms (that of the xenophobic Lega and of the Five Star movement). The crucial difference, ladies and gentlemen, between this Italian government and the Greek one I served in is that we were committed Europeanists – we did not want to leave the euro even though we had, realistically, to consider a Grexit – especially when constantly threatened with it by the creditors. The main movers behind the new Italian government, however dream of being threatened with Italexit, a fact that guarantees a clash of gigantic enormity with Berlin, Brussels and Frankfurt.
A badly designed monetary union
These developments, ladies and gentlemen, are not the result of bad choices, of human frailty. They are the result of a badly designed monetary union. Germany is simply not rich enough to support this faulty architecture. The EU cannot, backed by Germany, extend and pretend Italy’s 2.6 trillion debt, as well as the losses of their zombie banks. At the very same time, Italy will continue to stagnate within this faulty architecture until some political event will cause its uncontrolled, very costly breakdown. It is the fate of an unsustainable system not to be sustained. The longer it is sustained by political stealth and authoritarianism, the more catastrophic its collapse will be, when it comes.
What should we do?
So, what should we do? What should Germany do? Some argue that we need the German treasury, and the treasuries of other surplus countries, to support the treasuries of the deficit countries. This is both infeasible and undesirable. Infeasible because the fiscal surpluses of the Germanies are dwarfed by the banking losses and debts of the Greeces and the Italies. Then there are those who propose the liquidationist approach – let public debt default if it must. While I sympathise with the logic, and I wish we had followed that approach with Greece’s public debt, liquidationism is inconsistent with the euro architecture: following such government bond automatic restructuring, our weak banks that rely on these bonds for collateral and repo operations will go under, demanding of the weakened states to refinance them – which defeats the purpose of liquidating part of their debt.
Back to square one then: What should we do? I shall be arguing that:
- The current rules cannot be applied, even if we were all desperate to apply them
- Those who seek a fiscal union with the German federal government footing the bill of other governments are wrong: the German government cannot afford to finance the eurozone’s necessary reforms and, indeed, it should not have to
- Those who propose the liquidationist route – e.g. that the ESM extends loans to states at the price of restructuring of their debt – are also wrong, because they do not take into consideration the doom loop binding together the insolvency of our states with the insolvency of our banks (e.g. Italy’s)
- Proposing a new Treaty as a solution to the eurozone’s immediate problems only deepens the sense of pessimism in the heart of those who, correctly, estimate that the current political climate makes New Treaties impossible
- In this eventuality, there are two courses of action that we must consider: One is the controlled dismantling of the current eurozone. The other is a simulation of a federation using existing institutions and new policies based on a re-interpretation of the letter of the charters and treaties.
So, let me begin by explaining why the current rules cannot work within our asymmetrical monetary union (MU). Sure, the Maastricht rules and the ECB charter could have worked fine in a symmetrical MU, as long as governments wanted/were forced to stick to the rules: a symmetrical MU is one in which countries differ on productivity and endowments but every market in every country comprises exclusively pricetaking firms, customers and workers (in other words, no one has the capacity to influence prices). In such a symmetrical, perfectively competitive union trade surpluses and deficits, as well as different productivity growth paths, are auto-corrected through a process of devaluation in the country whose productivity growth lags behind and of internal revaluation in the ‘stronger’ country. Whether this devaluation is external or internal makes no difference. Whether we have the euro or separate currencies does not matter, except perhaps that under the euro we would have enjoyed lower transaction costs.
However, things are very different in an asymmetrical MU. In a positively asymmetrical MU like our eurozone, financial markets are bound to destabilise our economy and cause a crisis that makes impossible the implementation of our rules.
What exactly is an asymmetrical MU? It is a monetary union between:
1. National economies that comprise large oligopolistic manufacturing sectors, replete with economies of scale (as well as of economies of networks and of scope), with production units operating at excess capacity (that reflects their market power and their capacity to deter competitors), and concentrating much economic activity on the production of capital goods; and
- 2. National economies where the capital goods sector is atrophic, where production is much less capital intensive, and where economic rents are not due to economies of scale but due to corrupt practices and socio-political impediments to competition (e.g. restrictive practices, crony relations between authorities and particular business interests).
When one nation, or region, is more industrialised than another; when it produces most of the high value added tradable goods while the other concentrates on low yield, low value-added non-tradables; the asymmetry is entrenched. Think not just Greece in relation to Germany. Think also East Germany in relation to West Germany, Missouri in relation to neighbouring Texas, North England in relation to the Greater London area – all cases of trade imbalances with impressive staying power.
A freely moving exchange rate, as that between Japan and Brazil, helps keep the imbalances in check, at the expense of volatility. But when we fix the exchange rate or, even more ambitiously, introduce a common currency, something else happens: banks begin to magnify the surpluses and the deficits.
They inflate the imbalances and make them more dangerous. Automatically. Without asking voters or Parliaments. Without even the government of the land taking notice. It is what I refer to as toxic debt and surplus recycling. By the banks.
It is easy to see how this happens: A German trade surplus over Greece generates a transfer of euros from Greece to Germany. By definition! This is precisely what was happening during the good ol’ times – before the crisis. Euros earned by German companies in Greece, and elsewhere in the Periphery, amassed in the Frankfurt banks. This money increased Germany’s money supply lowering the price of money. And what is the price of money? The interest rate! This is why interest rates in Germany were so low relative to other Eurozone member-states. Suddenly, the Northern banks had a reason to lend their reserves back to the Greeks, to the Irish, to the Spanish – to nations where the interest rate was considerably higher as capital is always scarcer in a monetary union’s deficit regions.
And so it was that a tsunami of debt flowed from Frankfurt, from the Netherlands, from Paris – to Athens, to Dublin, to Madrid, unconcerned by the prospect of a drachma or lira devaluation, as we all share the euro, and lured by the fantasy of riskless risk; a fantasy that had been sown in Wall Street where financialisation reared its ugly head.
Crucially, the private capital inflows from a country like Germany to a country like Greece, alter the structure of B’s economy. A large, inefficient service sector develops in the Greece’s while periphery’s manufacturing wanes under the inexorable pressure of the surplus countries exports. While manufacturing wages collapse in absolute and per worker terms, the portion of the wage bill that comes from this parasitic, import-and-debt financed sector rises. And so does the corrupt oligarchy in the Periphery, house prices and a false sense of wealth. To sum this up in a vulgar but accurate manner, this is similar to buying a car from a dealer who also provides you with a loan so that you can afford the car. Vendor-finance, is the term used. Only in Europe we practised it at a macroeconomic level. This is similar to buying a car from a dealer who also provides you with a loan so that you can afford the car.
Irresponsible borrowers and irresponsible lenders
I think you can see the problem? To maintain a nation’s trade surpluses within a monetary union the banking system must pile up increasing debts upon the deficit nations. Yes, the Greek state was an irresponsible borrower. But, ladies and gentlemen, for every irresponsible borrower there corresponds an irresponsible lender. Take Ireland or Spain. Their governments, unlike Greek ones, were not irresponsible. But then the Irish and the Spanish private sectors ended up taking up the extra debt that their government did not. Total debt in the Periphery was the reflection of the surpluses of the Northern, surplus nations.
This is why there is no profit to be had from thinking about debt or surplus in moral terms. And this is why my message to my German friends is simple: before the crash, we Greeks invested our loans and transfers unwisely. But you invested your savings, your surpluses, unwisely.
Let’s take a dispassionate look at Germany’s current account: it is large, persistent, and extraordinary in international and historical comparison for a large country that is not focused on exporting raw materials. This means that your savings are increasingly entrusted to the hands of foreigners who do not have the capacity to look after them. Germany's net international investment position is over 50% of GDP, after discounting past investments that have lost about 15% of GDP worth in the crisis. Moreover, the German surpluses are mostly due to the non-financial corporate sector, followed by government, with only a modest contribution by households and financial corporations having actually turned to a net borrowing position. So, it is not the demographics that drive the CA surplus in this country. It is the euro’s architecture.
When σ>0 everywhere, and we push τ to zero, we are forced to a large trade surplus – which pushes the euro up and strengthens… Trump.
Will σ not equilibrate in the periphery if wages and prices fall? Will internal devaluation – austerity not do the trick? No, because private and public debts and losses do not devalue – and investment is deterred by this loop of doom, by this recycling of state and private bankruptcies. Even in countries like Spain and Ireland, the growth we have been celebrating recently is due to another unsustainable rise of private debt.
And this is where the rules become impossible and the EU's attempt to pretend that they still hold ridiculous.
An example of Europe’s Ponzi schemes by which to pretend that the rules were adhered to:
For the full lecture including the last 20 minutes, not on the wrong question, “How can we pretend that the rules still hold?’, but “the right question” which is, ‘ What must we do to stop this crisis from destroying us?’ – see the video above. In argument 5, Varoufakis outlines two stark options, the controlled dismantling of the current Eurozone or a simulation of a federation. ( Video 58 minutes in all).
For the subsequent Q & A ( 23 minutes), see here: