Yanis Varoufakis: “‘A European New Deal for all of Europe”

The political economist and blogger thinks the Eurocrisis need a kind of a New Deal and not a Marshall Plan as some politicians suggested. He speaks for an alternative solution politically feasible regarding sceptical voters like the Germans. Not only for Euromenbers in debt sovereign crisis but for all of Europe including the surplus countries.

Yanis Varoufakis at Athens

Yanis Varoufakis at Athens

Varoufakis criticise the austerity policies in place, the ECB’s OMT (Outright Monetary Transactions program) tentative involvement in future precautionary lines for Ireland and Portugal, the Redemption Fund for debt conversions, and defaults as firsthand solutions. His political advice is not to press Germany to pay for the debts, but mobilise idle private savings, through the European Investment Bank and its sister organisation the European Investment Fund, and helping them find their way into productive investments that will both yield good returns for investors and, of course, help Europe recover.

The Redemption Fund (RD) was in the forefront recently in Portugal during the three-party meetings for the so-called “national salvation” agreement. The political difference between the RD and the “Modest Proposal” (MP) turns on the issues of moral hazard and potential deflationary effects: the RD mutualizes the debt above 60% of GDP (utilizing Eurobonds or other financial solutions and vehicles); the MP has the ECB service debt up to 60% of GDP through the issue of ECB bonds that member-states redeem.

Yanis Varoufakis, 52, is a Greek-Australian, author of “The Global Minotaur” (2011, 2013), professor of Economic Theory at the University of Athens, and since January 2013 teaches at Lyndon B. Johnson School of Public Affairs at University of Texas at Austin, US. His blog “Thoughts for the post-2008 world” is a reference. Recently published a “Modest Proposal for Resolving the Eurocrisis” with James K. Galbraith, professor at University of Texas, and Stuart Holland, a former Bristish Labour polititian and MP, that since 2003 is a visiting professor at the Faculty of Economics, University of Coimbra, in Portugal. The first version of the “Modest Proposal” was published in november 2010 by Varoufakis and Holland. Since then, it has undergone a number of revisions, in response to the crisis’ evolution. This month Version 4.0 was published, this time jointly with Galbraith.

Highlights

# The Redemption Fund proposal by the German Council of Economic Experts is based on the dangerous idea that its adoption be made conditional on a massive reduction of public debt down to Maastricht Compliant Debt (60% of GDP) levels.

# Having the ESM assist the bond yields of Portugal or Spain will accelerate the crisis. The ESM should not be giving any assistance to member-states. ESM must instead concentrate: (a) on direct bank recapitalizations and (b) providing insurance to the ECB’ limited public debt conversion program.

# A Marshall Plan requires a great power that is ready and willing to give away a very large sum of money to deficit countries or regions; just as the US did after the war. No one is prepared to do this now. Nor should they, really. It is a great error to believe that Germany should pay either for the debt or for the investments that our countries so desperately need.

# Our proposal for an Investment-led Convergence and Recovery Program is all about mobilising idle private savings, through the European Investment Bank and its sister organisation the European Investment Fund.

# Use the threat of default as leverage. Faced with such a determined position, I believe that Berlin and Frankfurt would see reason and avoid our unilateral defaults. If Berlin-Frankfurt refuse to listen to rational voices, insisting that our countries should be reduced to dust, so be it.

# But make no mistake. A large scale PSI would leave the Portuguese banks deeply insolvent whereas an OSI to our debts to the EFSF-ESM would probably bring down the EFSF-ESM.

# The ESM cannot handle an OSI (acronym for Official Sector Involvement in sovereign debt restructuring deals). At least not without a large cost. It would mean that the ESM’s own bonds will suddenly see their yields rise and, at the same time, so will Italy and Spain.

# These further cutbacks in Greece and Portugal are like petrol thrown onto a fire. It is to eat massively into our countries’ national income and, therefore, to enhance, idiotically, our debt-to-GDP ratio.

# One alternative would be for Ireland and Portugal to be placed formally under the umbrella of the ECB’s OMT. Of course, such a development would not change anything on the ground since a new Memorandum and fresh austerity will be part and parcel of the strategy.

# One only needs to think a little bit about why an ‘orderly exit’ from the Euro would entail to realise that it is an impossibility. For the moment it is announced, all hell will break loose. There’s no velvet divorce.

Interview by Jorge Nascimento Rodrigues, July 2013 © JNR

Q: Portuguese socialists suggested that: “The share of sovereign debt exceeding 60% of GDP should be managed at European level, each country assuming responsibility for payment of interest. This solution lowered the interest payable and the budget deficit. Notwithstanding this overall solution, based on a “Redemption Fund,” our country must defend the intervention of the ESM in protecting the debt issues of countries with difficulties.” Do you agree?
A: This is the German Council of Economic Advisers’ recommendation, known as the Redemption Fund. The German Council of Economic Experts proposed a European Redemption Pact in its Annual Economic Report 2011/12. It is misconstrued for two reasons.

Q: Why?
A: First, it plays to the critics of any central management of public debt because it appears to reward member-states in proportion to the extent to which they violated the Maastricht Treaty’s limit regarding public debt. By offering to convert (at lower rates) debt that exceeds the member-state’s Maastricht Compliant Debt (MDC – 60% of GDP) it sounds like a policy tailor-made to rewarding member-states that violated the Eurozone’s basic rules. In contrast, our “Modest Proposal” proposes a debt conversion plan that concerns only the (under the Treaties) ‘legitimate’ MDC of each member state, leaving the ‘illegitimate’ debt (which exceeds MCD) to the member-states. As such our recommendations answer decisively criticisms based on the notion of moral hazard. Secondly, the Redemption Fund proposal is based on the dangerous idea that its adoption be made conditional on a massive reduction of public debt down to MDC levels. This means that the public debt of, say, Italy, must be cut by 50% within twenty years or so. It would be suicidal for any Italian government to commit to such an idea as it would lock in expectations of massive deflation, courtesy of the gargantuan primary surpluses that it would necessitate.

Q: And about the intervention of the ESM?
A: The idea that Portugal “must defend the intervention of the ESM in protecting the debt issues of countries with difficulties” is seriously misguided in the sense that it shows no understanding that, in view of the CDO (Collateralized Debt Obligation)-like structure of the ESM’s own bonds (by which it finances ‘rescues’), having the ESM assist the bond yields of Portugal or Spain will accelerate the crisis. This is why our “Modest Proposal” suggests that the ESM should not be giving any assistance to member-states (leaving the limited public debt conversion program to the ECB) and instead concentrate: (a) on direct bank recapitalizations and (b) providing insurance to the ECB’ limited public debt conversion program.

Q: Is your Investment-led Convergence and Recovery Program-ICRP preferable to a full type Marshall Plan from the Eurozone surplus countries?
A: A Marshall Plan requires a great power that is ready and willing to give away a very large sum of money to deficit countries or regions; just as the US did after the war. No one is prepared to do this now. Nor should they, really. It is a great error to believe that Germany should pay either for the debt or for the investments that our countries so desperately need. No, what we need is closer to a European New Deal than a Marshall Plan for Europe’s periphery. And, this is precisely the essence and the strength of our proposed Investment-led Convergence and Recovery Program (ICRP). ICRP is all about mobilising idle private savings, through the European Investment Bank (EIB) and its sister organisation the European Investment Fund (EIF), and helping them find their way into productive investments that will both yield good returns for investors and, of course, help Europe recover.

Q: What are the strong points of your ICRP?
A: In short, the strong points of our ICRP are: (1) No need for governments to finance it, and thus no need to ask the taxpayers of the surplus countries to guarantee them, (2) No new institutions are necessary (since the EIB and the EIF are ready to take on this task), and (3) it helps Europe escape the false dilemmas of stability-vs-growth and austerity-vs-stimulus.

Q: How to convince German voters of any solution instead of punitive austerity if they have no historical memory of the Austerity Bruning period in Weimar Republic of the 1930s or about the details of the debate in Bretton Woods between the Americans and Maynard Keynes?
A: Through rational arguments. By pointing out to them that the current policies are (a) costing them dearly (e.g. the forthcoming Greek OSI) and (b) are failing. By explaining to them that policies like those in our “Modest Proposal” would solve the crisis without German taxpayers paying a cent, without any debt buybacks, without rewarding the profligate or causing inflationary pressures, without bending the rules of the Union.

Q: Why not a PSI or/and OSI debt hair cut? A Leftist party in Portugal proposed this month a haircut of 50% of the sovereign debt (overall €203 billion end of May in hands of official and private creditors) with a debt swap with a new maturity of 30 years.
A: Over the past few years, especially in 2010 when the Greek loan and associated memorandum were being hatched, my position was clear: Our governments should propose a rational Eurozone-wide solution like the one in our “Modest Proposal.” And, use the threat of default (along the lines suggested by the Portuguese leftist party that you mentioned) as leverage. If Germany and other surplus countries reject proposals like ours that would solve the crisis without making the surplus nations pay for our debts, then we have no alternative than to say «No» too. No to huge loans that are used to repay un-payable debts on condition of reducing our GDP massively (which is what austerity does). This remains my line.

Q: The Germans will accept the threat?
A: Faced with such a determined position, I believe that Berlin and Frankfurt would see reason and avoid our unilateral defaults. For we should make no mistake. While default is preferable to the current situation (of accepting huge new loans plus harsh austerity that destroys our economies), it would pose great problems for the Eurozone – and for our countries too. A large scale PSI would leave the Portuguese banks deeply insolvent whereas an OSI to our debts to the EFSF-ESM would probably bring down the EFSF-ESM. Then again, if Berlin-Frankfurt refuse to listen to rational voices, insisting that our countries should be reduced to dust, so be it. The task of our “Modest Proposal” is, at the very least, to silence those who argue that there is no alternative to the current policies.

Q: The Eurogroup and the Germans already accepted, although late as IMF recognized recently, a restructuring of Greek debt. Why not “extend” that procedure to Portugal for instance (that reached at the end of the 1st quarter of 2013 a debt to GDP ratio of 127.2%)?
A: They will probably have to do this. However, what is the logic of accepting a haircut for Greek and Portuguese debt, but not for Ireland’s or Spain’s or, indeed, Italy’s? There is no logic in dealing with this issue on a case-by-case basis. This is why our “Modest Proposal” offers a universal solution to the debt crisis that applies equally to any member-state that chooses to participate in our proposed limited debt conversion of the Maastricht Compliant Debt.

Q: In Greece the situation is presently different. Over 75% of the overall debt is in the hands of troika; in Portugal for example is 32%. Is an OSI unavoidable given that the Greek debt ratio to GDP over 168%? Are Merkel and Schauble opposing an OSI because of the German September elections or because it would be a huge precedent?
A: For both reasons. First, the German government is going to the polls by telling German voters that it has managed to defeat the Euro Crisis without any serious concessions on Eurobonds, OSI, etc. Mrs. Merkel does not want to agree to anything that will upset this electoral strategy. But there is another reason too. The ESM cannot handle an OSI. At least not without a large cost.

Q: Can you explain?
A: Think about it. The monies the ESM has provided to Greece, Ireland, Portugal and Spain are borrowed by the ESM which issues, for this purpose, its own bonds using guarantees by the rest of the member-states – including Italy and, yes, Spain. A large OSI would mean that the ESM’s own bonds will suddenly see their yields rise and, at the same time, so will Italy and Spain because (a) the chances of being helped in their hour of need, by the ESM, will have diminished (as the ESM’s borrowing costs increase) and (b) they stand to lose some of the money that they have guaranteed to the Greek bailout.

Q: So, it was a mistake?
A: I think it is now becoming increasingly clear that the ESM should never have got into the business of lending member-states. It is why we insist that the debt crisis should be dealt with by the ECB (as part of our limited debt conversion program) while the ESM should be re-deployed as, mainly, a bank recapitalisation fund.

Q: Troika imposed on the Greek government public sector workers’ layoffs (permanent and temporary – through a so-called ‘mobility scheme’) so as to provide Greece with the next tranche of €6.8 billion. In Portugal, the Public Expenditure Review imposed a permanent public expenditure cut of €4.7 billion (or 2.8% of GDP) for 2013 and 2014 as a pre condition to the follow-up of the bailout program until June 2014. What are the alternatives to these mandatory cuts?
A: The alternative is to wake up to the reality that these further cutbacks are like petrol thrown onto a fire; that, at a time of rapidly diminishing private sector expenditure, to introduce further cuts to public expenditure (especially through layoffs that cause the greatest negative multiplier possible) is to eat massively into our countries’ national income and, therefore, to enhance, idiotically, our debt-to-GDP ratio. So, the simple answer to your question is that the alternative to these policies is to … cease and desist. To embrace policies that transcend the toxic dilemma of austerity-vs-stimulus. How can this be done? Our answer is in the Modest Proposal 4.0.

Q: Are precautionary lines for Portugal and Ireland inevitable? Because those precautionary lines from European sources or IMF are temporary by nature, eventually to cover 2014-2015, what do you expect after 2015 for Portugal and Ireland?
A: Support is inevitable since neither Portugal nor Ireland is viable. But, there are many ways in which our leaders can provide more funding. One alternative to new official loans, or ‘precautionary lines’, would be for Ireland and Portugal to be placed formally under the umbrella of the ECB’s OMT. That way Europe can claim, disingenuously that the two countries have “returned to the markets” when, in reality, only the ECB’s threat against bond dealers will have allowed that. Of course, such a development would not change anything on the ground since a new Memorandum and fresh austerity will be part and parcel of the strategy.

Q: Suppose your proposal is not yet doable. If those two countries has also no “precautionary” temporary lines of financial help and little prospects for financing regularly from debt auctions or even syndicated ones, what could they do in the meanwhile?
A: Negotiate using as leverage the credible threat of a selective default, especially toward the ECB over the bonds that the ECB purchased during 2010-11 as part of its failed SMP program.

Q: Spain has already a leftover of €60bl from the €100bl package for Banks recapitalization. Do you think they will need to use these billions?
A: The greatest danger for Europe presently is that we will end up with zombie, undercapitalized banks forever and ever; that, so as to limit the states’ borrowing from ESM, on behalf of their banks, they will pretend that the banks have been adequately capitalised when that is as far from the truth as possible. Spanish banks need more than €100 billion. Settling for less sounds good in Madrid, but Spain will pay for that with a never-ending credit crunch.

Q: In more general terms what do you mean by the proposal for a direct recapitalization from ESM?
A: We propose that banks in need of recapitalization from the ESM be turned over to the ESM directly – instead of having the national government borrow on the bank’s behalf. Banks from Cyprus, Greece and Spain would likely fall under this proposal. The ESM, and not the national government, would then restructure, recapitalize and resolve the failing banks dedicating the bulk of its funding capacity to this purpose. Thus the umbilical cord between the banking crisis and the debt crisis will be severed. More precisely, our proposal is that a national government should have the option of waiving its right to supervise and resolve a failing bank. Shares equivalent to the needed capital injection will then pass to the ESM, and the ECB and ESM will appoint a new Board of Directors. The new board will conduct a full review of the bank’s position and will recommend to the ECB-ESM a course for reform of the bank. Reform may entail a merger, downsizing, even a full resolution of the bank, with the understanding that steps will be taken to avoid, above all, a haircut of deposits. Once the bank has been restructured and recapitalised, the ESM will sell its shares and recoup its costs.

Q: Without a Banking Union…
A: All this can be implemented today, without a Banking Union or any Treaty changes. The experience that the ECB and the ESM will acquire from this case-by-case process will help hone the formation of a proper banking union once the present crisis recedes.

Q: In his Financial Times column Wolfgang Munchau argues that Greece is getting closer to the moment when an exit becomes fiscally feasible as the country is about to achieve a primary surplus. Probably a Grexit will not happen, but its “technical” feasibility may change the debate about Greece and the discussions with the troika in Athens. Antonis Samaras government can use this argument?

A: Wolfgang’s ‘technical’ point is correct, in that, in theory, the Greek government is now living within its means and only borrows in order to meet its obligations to its creditors. His real point however, if I am allowed to interpret him, is that Greece should now use the ‘technical’ primary surplus position that it has achieved in order to bargain hard and even to default, within the Eurozone, unilaterally – the idea since it can now shrug its shoulders if Berlin threaten Athens with expulsion from the Eurozone. There are, however, three points to be added here. First, the primary surplus is tiny and predicated upon the state’s refusal to honour its obligations to its own citizens (e.g. delays in refunding VAT to exporters, non-payment of private firms for goods and services already supplied, etc.). Secondly, An exit from the Eurozone would have devastating effects that the current primary surplus, even if it were real, would not be able to cover for. The exodus of capital would necessitate an effective withdrawal from the EU. Thirdly, if the Greek government was truly interested in negotiating the very logic of its bailout loans with the troika it should be forging an alliance with the IMF to do so and, regardless of the actual size of the primary surplus, refuse to repay the ECB for the bonds that it foolishly purchased between 2010 and 2011. Alas, the Greek government is not interested in negotiating. It is only interested in being seen to be doing as it is told. In view of this last point, Wolfgang’s message to the Athens government is: Stop fearing your own shadow and demand a default within the Eurozone. The threat that you will be expelled is empty. And even if you are expelled, things will not be worse than being forced to stay under circumstances that guarantee non-recovery for ages and ages.

Q: Also in the Financial Times, Hans-Werner Sinn, president of the German Ifo Institute, proposes a Eurozone system similar to the old Bretton Woods currency structure under which member countries could exit, “clean” the situation outsider the euro, and an option to re-enter at a later date. An orderly exit – and he refers to Grexit – should be accompanied by debt haircuts and a conversion into national currencies, a debt re-denomination. Do you think this could be an alternative to the two main policies inside the Eurozone political parties, austerity deflation or debt mutualisation?

A: Herr Sinn has been trying his best, for a while now, to convince us that he is innocent of the meaning of a monetary union between surplus and deficit countries. The only explanation I have of his various positions so far, e.g. the OMT, TARGET2, Greece, etc., is that he is keen to see the end of the Eurozone. Take this latest display of innocent commentary. The Eurozone cannot possibly be made to resemble Bretton Woods for a simple reason a child can easily comprehend. Under Bretton Woods, we all had our currencies, but were committed to an exchange rate that could only be changed by negotiation (except for a +1% or -1% adjustment). In Euro Land we have a single currency that is not amenable to any differentiation. Period! As for an ‘orderly’ exit, there can be no such thing. One only needs to think a little bit about why that ‘orderly exit’ would entail to realise that it is an impossibility. For the moment it is announced, all hell will break loose. Greek ATMs will run out, immigration officers in airports and ports, not to mention land crossings into Bulgaria and Turkey, will have to search people for cash, the banks will be closed indefinitely, Soon, the ripples of these changes will hit Lisbon, as depositors will queue up to remove their euros from their bank account lest something similar happens there. And, so on and so forth. The kindest interpretation I have for Herr Sinn’s articles and speeches is that he has found a clever strategy for pushing for Germany’s return to the DM.

Q: Can you say something about your forthcoming book “Europe on the Road to Disintegration?”
A: I am writing my next book as a dramatic tale in which European decision makers feature as tragic characters not dissimilar to those in a Sophocles or Shakespearian tragedy. Powerful figures, ruling over a successful realm, who have nevertheless failed to notice that something rotten was eating into the foundations of their authority. Until, that is, a major tremor hit their dominion (here I refer to the 2008 financial crisis), at which point they embarked upon a colossal struggle to maintain the illusion that the edifice could be saved without questioning the creation myths on which their power was traditionally founded. But the more they strive to maintain these motivated, self-serving, illusions, the greater the crisis becomes and then, in a never-ending circle, the more authoritarian our Reverse Alchemists must be in order to implement the ‘Austerian’ policies which fuel the crisis. It is this impossible, negative, dynamic that connects traditional tragedy (e.g. Macbeth or Antigone) with Europe’s Reverse Alchemists today.

POLITICAL REASONS FOR A “MODEST PROPOSAL”

Varoufakis, Holland and Galbraith insist that any solution for the euro sovereign debt crises must respect real constrains in the present Eurozone political arena and structural differences between economies.

Proposals must be “realistic”. Grand schemes are enemies of the possible and defaults have important risks. That’s why they go for a “modest”, feasible proposal.

The constraints are four:

# The ECB will not be allowed to monetise sovereigns directly. There will be no ECB guarantees of debt issues by member-states, no ECB purchases of government bonds in the primary market, no ECB leveraging of the EFSF-ESM to buy sovereign debt from either the primary or secondary markets.

# The ECB’s OMT program has been tolerated insofar as no bonds are actually purchased. It is a “communication” tool. OMT is an open invitation to bond dealers to test the ECB’s resolve at a time of their choosing. That may happen when volatility returns to global bond markets once the Federal Reserve and the Bank of Japan begin to curtail their quantitative easing programs.

# Surplus countries like Germany will not consent to ‘jointly and severally’ guaranteed Eurobonds to mutualise debt and deficit countries will resist the loss of sovereignty that would be demanded of them without a properly functioning federal transfer union.

# Europe crisis cannot wait for federation. If crisis resolution is made to depend on federation, the Eurozone will fail first. The Treaty changes necessary to create a proper European Treasury, with the powers to tax, spend and borrow, cannot, and must not, be held to precede resolution of this crisis.

Due these constraints, the policies are also four:

# Case-by-Case Bank Program
For the time being, banks in need of recapitalisation from the ESM be turned over to the ESM directly – instead of having the national government borrow on the bank’s behalf. Banks from Cyprus, Greece and Spain would likely fall under this proposal.

# Limited Debt Conversion Program
The ECB offer member-states the opportunity of a debt conversion for their Maastricht Compliant Debt (up to 60% of GDP), while the national shares of the converted debt would continue to be serviced separately by each member-state. ECB would act as a go-between, mediating between investors and member-states. When a bond with face value of say €1 billion matures, two thirds of this will be paid (redeemed) by the ECB with monies raised (by the ECB itself) from money markets through the issue of ECB bonds.

# Investment-led Recovery and Convergence Program
This program will be co-financed by bonds issued jointly by the European Investment Bank and the European Investment Fund . The EIB has a remit to invest in health, education, urban renewal, urban environment, green technology and green power generation, while the EIF both can co-finance EIB investment projects and should finance a European Venture Capital Fund. Borrowing for such investments should not count on national debt. They should be Europeanised.

# Emergency Social Solidarity Program
Europe must embark immediately on an Emergency Social Solidarity Program that will guarantee access to nutrition and to basic energy needs for all Europeans, by means of a European Food Stamp Program modelled on its US equivalent and a European Minimum Energy Program. These programs would be funded by the European Commission. This program is not funded by fiscal transfers nor national taxes.

COMMENTS FROM INVITED ECONOMISTS

MAYBE AN EUROPEAN NEW DEAL, BUT NOT JUST QUITE THIS ONE — «I agree with the evaluation of the situation by Yanis Varoufakis, whose main points I would summarize as: (1) Austerity policies are counterproductive, self-defeating, and not grounded on sound economic analysis of data and alternatives (instead, these policies are based on ideology); (2) Unilateral transfers from euro-area surplus countries to deficit countries are not politically acceptable in surplus countries; and (3) The main EU policy makers are incompetent and stubborn: they failed to timely identify problems in the EMU architecture; and when the crisis stroke, they designed and implemented costly and irrational adjustment programs which aimed to keep the status quo going, i.e., to avoid any type of meaningful change to the architecture and functioning of the EMU. I also agree with the author’s argument that proposals must be “realistic”, not “grand schemes” and that crisis resolution cannot wait for federation. However, I see Varoufakis, Holland and Galbraith’s “Modest Proposal” as a grand scheme: it is too elaborate, complex, and requires changes to the EU Treaty, namely regarding the ECB role. While I like two of the policy measures proposed, I have the following criticisms:
(1) All of the 4 policy measures proposed have effects akin to fiscal transfers between surplus and deficit countries. It is only the case that the policies are too technical and convoluted to be perceived by the public opinion as outright fiscal transfers. But I think it is disingenuous to argue that fiscal transfers are not possible in the current environment and then propose policy measures that implement such transfers in an indirect form. EU policy making going forward has to change. It must be based on truth-telling, even if unpleasant. I do not think the “Modest Proposal” policies meet this treshold. The resolution of the euro crisis requires substantial transfers between surplus and deficit countries. The challenge is to design policies that are honest about this fact and that are still acceptable to the constituencies in surplus countries.
(2) The four “Modest Proposal” policies may be too small to be effective, and are to a large extent tweaks to the current architecture: (a) The eurozone currently faces the largest balance of payments and external debt peacetime crisis the World has ever seen. The author does not provide enough details about the 4 proposed policies. Nonetheless I infer from the text, perhaps incorrectly, that the policy with the largest macroeconomic impact is the “limited debt conversion program”. The macroeconomic savings from this program can be quantified, under some assumptions. If only medium and long term debt is converted to ECB bonds, achieving interest rate reductions of 3 p.p. on this debt, this would amount to fiscal transfers of 1,8% of GDP per year to the deficit countries governments’. But the overall effect would depend on whether the ECB would continue to provide low cost funding for these countries’ banking systems through TARGET2 lending. Note that national banks currently buy national public debt which they then offer as collateral to the ECB. Thus, the fiscal transfers already occur, but the difference is that currently fiscal transfers benefits private banks in the deficit countries, while the authors’ Modest Proposal sees these transfers benefiting the deficit countries’ governments directly. (b) An EU Investment Program led by the EIB and the EIF is a bad idea and is not sufficient given what is required. It is putting the lender in charge of the investment. The EIB has done that for a number of years, and their only worry is to make sure they can retreat graciously (without losses) if they make bad lending decisions, which they do far too often. They have shown little regard to the economic value of the project or the economic consequences of their lending decisions. In contrast, in my view, the investment program should be based on a budget, meaning that the EU investment program should based on projects that are only pure investment decisions and not joint investment- and lending-decisions.»

Ricardo Cabral, Assistant Professor at Economics and Management Department at the University of Madeira, Portugal

A KIND OF NEW DEAL MAKES SENSE — «Prof Varoufakis ideas on the economic consequences of the austerity imposed to the European peripheral countries are right. It doesn´t help to restore fiscal consolidation, on the contrary, Greece and Portugal are there to show that in spite of the austere fiscal measures implemented government debt has always increased. The problem is that the multiplier effects of spending cuts or rises in tax rates have been underestimated and the Greek and Portuguese economies came into a recession deeper and deeper. Quoting Paul Krugman, there is no reason for deflating the economy. Was there a locust invasion or so? I can assure (at least in Portugal) there wasn´t such a plague. Then all we need is a sound economic policy including some of an old-fashioned (for some economists) aggregate demand management. Neither Greece nor Portugal were devastated by the bombs of a terrible war so they don´t need a Marshall Plan. Of course, a kind of New Deal for all the Europe makes sense in light of the present weakness of aggregate demand. However, the financial and government debt issues should be, all of them, seen in the European monetary policy framework with the the role of ECB as central in this context. Never forget the basic principles of economics, as it stands now, the European Monetary Union is uniquely a fixed exchange regime for all the euro-zone countries. Think now about the consequences of such a regime for national economies with very different levels of competitiveness. Any solution for the crisis in Europe should address this inescapable economic issue.»

Emanuel Augusto dos Santos, economist, Bank of Portugal, author of the Portuguese book “Sem crescimento não há consolidação orçamental” (“No Fiscal Consolidation without Growth”), Lisbon, Portugal

A MINIMUM PLATFORM — «Inside that frame the admissible scenarios are so many Dantesque that we think preferable another route, a change within the euro area and therefore also a change in the European Union. And, here we are in complete agreement with Yanis Varoufakis, Stuart Holland and James K. Galbraith on the Investment-led Convergence and Recovery Program, a kind of New Deal for stricken European zone. And, we take this as an ideal platform to find a way to end this downtrend spiral. It should be noted that compared to the disaster, it is even a minimum platform and still within the framework in which this problem has arisen, within the framework of existing European leaders’ thought. So, full of limitations regarding the political context in Europe in general and Germany in particular.»

Júlio Marques Mota, Faculty of Economics, University of Coimbra, Portugal

THE SOLUTION IS TO FIND AN EXIT STRATEGY — «I agree with the analysis of the authors as to the shortfalls of efforts made by the troika in resolving this crisis. However, I disagree with the potential that they see in their proposal. Frankly, their proposal represents nothing else but to “re-arrange the deck chairs on the Titanic”. There will be no resolution to this crisis until European policy-makers come to grips with fundamental economics. The Eurozone never was and less and less is an optimum currency area. In theory the flaws in the construct are fixable, in reality there is not enough time or political will. It is the inescapable consequence that the Eurozone must be dissolved. In applying the lessons of German unification onto the Eurozone, it becomes unmistakably clear that even a willing Germany could never pay the price to make monetary union in the Eurozone work. The price tag for such exercise would be exponentially greater than the cost of German unification. Moreover, the ability to freely migrate in order to mitigate some of these problems simply does not exist in the Eurozone given cultural and language barriers. So, the solution is to find an exit strategy. Cyprus is a good test case. For all practical purposes Cyprus is no longer in the Eurozone. It no longer meets any convergence criteria and with capital controls in place a Cypriot euro does not carry the same value as a German euro. Even without capital controls the inherent value of the euro as determined by interest rates differs in every member state today. Now, Cyprus has made all the sacrifices of leaving the euro without any of the benefits, i.e. a devaluation of its “own” currency and the freedom of implementing monetary policy specifically suited to Cyprus. Monies will be required to finance an orderly dissolution of the Eurozone, capital controls will be necessary throughout much of Europe and there will be bank failures. Massive sovereign defaults will also – in the short term – weigh heavily on the region. But it is time to accept reality, stop experimenting and correct the mistakes of the past. Only then, will growth re-emerge and only then will young people in almost every country of the Eurozone begin to gather some hope in their own future. The authors’ proposals are well-intentioned, but it is just another patch doomed to fail in overcoming the insurmountable defects of the monetary union. »

Uwe Bott, founder and principal of Bott Consulting, located in New York and contributing Editor to The Globalist.

A STRONGER DOSE OF THE OFFENDING VIRUS — «Prof Varoufakis’ ideas are well-intentioned but misguided. Since the beginning of the crisis, European policy analysts have been seeking to find sources for more Government investment, more leveraging of private savings, and more debt mutualisation. Public capacity to borrow restricted by a temporary return to sanity in the markets pricing of European risks, Europe has now (in various countries) raided pension, insurance and investment funds, savings, and deposits. In reality, what Europe needs is a policy environment in which the Governments live within their means not in a hypothetical 20 years or 30 years time, but tomorrow, the electorates are not reliant on constant uplifts in public spending, and investment is based on a transparent, open and purely voluntary system of risk-return pricing. None of these are deliverable via Mr Varoufakis and his colleagues’ ‘modest proposals’. In effect, thus, the ‘modest proposals’ are a de facto replay of the road that has led Europe to the current crisis – a set of policy epicycles to perpetuate and vastly expand the corporatist system of economic and social governance, equivalent, on the one had to the indefatigable search for yet another credit card, and on the other hand to the tireless pursuit by the public sector of every private saving cent still left untouched. Good luck, Mr Varoufakis, in curing the disease by an application of the ever stronger doses of the offending virus.»

Constantin Gurdgiev, Russian economist, adjunct lecturer in Finance with Trinity College, Dublin, author of Trueeconomics blog.

SOUTHERN EUROPEAN COUNTRIES MUST TAKE COMMON ACTION — «The recent political developments in Portugal suggest that although no political consensus seems possible it is – in my point of view – urgent that the Southern European Countries take some common action and make their voice be heard in the European Union. Besides, it is of absolute necessity to revise – and eventually abandon – the the Public Expenditure Review imposed a permanent public expenditure cut of €4.7 billion (or 2.8% of GDP) for 2013 and 2014 as a pre condition to the follow-up of the bailout program in Portugal until June 2014. As Yannis Varoufakis suggests it is “like petrol thrown onto a fire” and the social situation in Portugal is at its limits. A final note on the social implications of the crisis: the Portuguese people are beginning to feel the troika measures as some kind of “neofeudalism” of the north towards the south and any steps taken make the situation more balanced will certainly be very welcomed.»

Paulo Pereira de Almeida, professor at ISCTE in the areas of Organization and Management of Business, Labor and Internationalization Business, Lisbon, Portugal

COMMENTS FROM YANIS VAROUFAKIS AND STUART HOLLAND

Follow Varoufakis’ blog here.

REPLIES TO THE REPLIES

Response from Ricardo Cabral to Professors Varoufakis and Holland’s replies:

My diagnosis of the euro crisis differs from that of the Modest Proposal’s authors. To me, the euro crisis is foremost a balance payments and external debt crisis. The four crises identified by the authors are, in my view, to a large extent, symptoms and consequences of this balance of payments crisis and of the misguided policies put in place by the EU and the IMF in response to the crisis.

If I am correct, the euro crisis arose because of large and systematic intra-eurozone external imbalances between member countries. These imbalances started building up in the run up to the euro launch but accumulated until 2010. This silent accumulation of intra-eurozone external imbalances was made possible by deficiencies in the EMU architecture, notably in the ECB monetary policy, instruments, and procedures.[1]

In my view, the response to the crisis should fulfill at least four criteria:
(i) it should address the symptoms and consequences of the crisis (this criteria is addressed by the Modest Proposal);
(ii) it should address the causes of the balance of payments crisis;
(iii) it should be of dimension comparable to the imbalances that underlie the current crisis, lest it be ineffective;
and (iv) some lessons should be learned – that is, ideally, one would like to see some changes to the architecture of the EMU so as to avoid the reocurrence of exactly the same crisis.

Regarding Professors Varoufakis and Holland’s replies to my comments, I have the following further comments:

On the fiscal effects issue:
All of the Modest Proposal policy measures have effects that are equivalent to fiscal transfers, redistributive in nature, which should be acknowledged as such.

For example, on the idea of using TARGET2 interest income to fund an Emergency Social Solidarity Programme. Right now this interest stream flows to the central banks of the surplus countries which then pass it on to the government in the form of dividends. The proposal would see these flows rerouted to the peripheral countries. Therefore flows that were until now accruing to the governments of Germany, Finland, The Netherlands would, under the Modest Proposal, flow to Greece, Ireland, Portugal, Spain and Italy. How can this not be a form of fiscal transfers?

If, for example, the Bundesbank pegged the domestic exchange rate (DM) to a foreign currency (fixed exchange rate regime), the Bundesbank would be forced to exchange the foreign currency to DM. Given that Germany has a Current and Capital account surplus it is likely that the Bundesbank would accumulate foreign currency over time. But the Bundesbank would in that case likely acquire some interest yielding assets with the foreign currency reserves. Thus, the Bundesbank would earn interest on the foreign exchange holdings in a fixed exchange regime.[2]

The limited debt conversion programme (LMCP) also has large fiscal effects. The LMCP would not work if the bonds were issued by any of the periphery countries’ central banks (and these countries had their own currency). The point of the programme is that the ECB is able to issue bonds at very low interest rates. If the periphereral countries’ Maastricht compliant debt was converted to ECB debt, the periphereral countries would attain significant yearly savings. The euro-area peripheral countries would see their balance of income improve. The surplus countries would see their balance of income worsen (not by the same amount). It is exactly as if large fiscal transfers were taking place from the surplus countries to the deficit countries. The size of the effect can be estimated.

Moreover, the peripheral countries’ governments would derive significant savings from the process. Assuming a 3 p.p reduction in average interest rates on the Maastricht compliant debt, this equates to a reduction in the peripheral countries’ government expenditure of 1.8% of GDP per year. Assuming a 4% discount rate, this flow has a net present value of 45% of GDP to the benefit of the governments in the peripheral countries. All of these flows would result from of this new ECB program of the Modest Proposal called limited debt conversion programme.

This is monetary financing of member countries by the ECB which is forbidden by the European Treaty and the Statutes of the ECB and the ESCB (Article 123 of the Treaty on the Functioning of the European Union and Article 21 of the Statutes). The LMCP would also see the ECB or Eurosystem balance sheet expand significantly. This is stark evidence of the would-be role of the ECB in the funding of euro area governments, under the LMCP. Now when the authors argue that the LMCP does not violate the Treaty, this seems a generous interpretation of the letter of the law.

It troubles me much that the response to the crisis designed by the current EU policy makers has been based on creative reading of the European Union Treaty. It seems to me that the key institutions and procedures of the EMU currently depend on the rule of (a few unelected) men and not on the rule of law. And this is the key problem with functioning of the European Union and of the EMU and the response to the crisis. But I cannot criticize the current policy makers and not criticize an alternative solution to the crisis that, in my view, adopts an approach similarly based on a generous interpretation of the EU Treaty.

On the size issue:
I claimed that the Modest Proposal does not seem big enough. My point is that the euro crisis is very large: it is the largest peacetime balance of payments and external debt crisis. Imbalances were allowed to accumulate for over a decade. In past balance of payments crises, the “sudden stop” in financial flows would have occurred much earlier. Therefore, the inbuilt imbalances are much larger than in prior crisis. For example, they are more than 2 times larger than observed in Argentinian’s 2001 crisis.

The net external debt of Greece, Spain, Ireland, and Portugal varied between 82% and 116% of GDP in 2010. Greece, Spain and Portugal’s combined balance of income deficit represented 2,4% of combined GDP in 2012.[3] Thus, to prevent the external debt of these countries from growing further and to avoid destructive “austerity” policies that turn countries with systematic trade deficits into countries with systematic trade surpluses, the policy response must foresee quite significant flows (transfers) between the surplus countries and deficit countries.

In my view, in Portugal’s case, they have to be equivalent to at the very least 3% of GDP per year, so that the country is able to slowly reduce its net external debt. But it may need to be around 5% of GDP initially, particularly if the country is forced to undertake measures without the agreement of its EU partners.

These transfers can take many forms: they can be based exclusively on debt restructuring; they can also arise from a banking union where a multilateral institution assumes the cost of bailing out banks.

On the EIB issue:
In Portugal, the EIB in the past lent to the bank consortia that underwrote several Public Private Partnerships in highway projects. Most of these projects are widely seen today as poor public investment choices.

The EIB included convenants in the loans that forced Portuguese banks to post cash, if their rating was downgraded. So at the height of the Portuguese crisis in 2011, the Portuguese banking system was forced to post between €1bn-€2bn in cash collateral to the EIB (according to this interview, from a former EIB manager, in Portuguese only), this at the time where Portuguese banks were cutting credit to families and SMEs due to the lack of liquidity.

I understand Professor Stuart Holland’s argument that EIB lending is a second best alternative given that EU policy makers are not willing to design and fund an infrastructure investment program. However, sometimes 2nd best alternatives are worse than no alternative, and this, in my view, happens to be the case with EIB loans to fund investments in the peripheral countries. The loans would simply replace the existing external debt or add to the existing external debt at perhaps a slightly lower interest rate. This would put the peripheral countries under continued pressure to service their external debt, interest on which can only be paid out of net export revenues, as pointed by Keynes in 1920.

If there were no EIB funded investment programme the peripheral countries will default on their external debt sooner than later, and thereby correct the external imbalances that presently cause so much damage to these countries’ economies.

In addition, as mentioned in my earlier comment there is a conflict of interest in using the EIB to promote an investment programme. The EIB is a bank, it finances projects that it feels give it the best chance to have its money back (namely by benefiting from state guarantees). It is very risk averse (see the above referred interview). It does not fund the best investment projects from the peripheral countries’ (macroeconomic) perspective.

NOTES:
[1] Cabral, R., “The roots of the euro crisis lie at the doorsteps of the ECB.” EconoMonitor, 1 Oct. 2012.
2 In my view, the low interest rate on TARGET2 balances (0.5% currently) is already a form of fiscal transfers from the central banks of the surplus countries to the private banking systems of the periphery countries.
3 I exclude Ireland due to the size of income flows in its financial center, largely for tax arbitrage reasons.

One Response to “Yanis Varoufakis: “‘A European New Deal for all of Europe””

  1. Hi! This post couldn’t be written any better!

    Reading through this post reminds me of my previous room mate!

    He always kept talking about this. I will forward this write-up to
    him. Pretty sure he will have a good read. Many thanks for sharing!

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