Understanding the euro crisis
Last Thursday (15 September), Greek economist Yanis Varoufakis addressed a capacity audience in Dublin's Shelbourne Hotel on the roots of the crisis in the Eurozone, and offered his own proposals for solving it. The meeting was also addressed by Fintan O'Toole of the Irish Times and Sinn Féin's Pearse Doherty. Introducing Varoufakis, Doherty said: 'There is an urgent need to come up with new responses to a crisis that is both European in origin and systemic in effect. Tonight’s discussion and Sinn Féin's invitation to Yanis to address this meeting is part of an attempt by our party to provoke a debate on what these new responses should be."
Listen to an audio recording of the event here, or read an edited transcript of Varoufakis's presentation below.
I don’t know how many of you watched Jean Claude Trichet’s recent press conference. When I was watching him he gave me the impression of a battered man, a man who was in a kind of psychological meltdown. He was finding it impossible to keep it together, which is what heads of central banks ought to be doing at these press conferences. When you see our leaders getting together at some summit in the European Union, do you get the impression when they report on their deliberations that these are men and women who believe their own policies? Watching them reminded me of the story of Nils Bohr, the father of quantum mechanics. At some point he had a visitor in his country home, and the visitor, upon entering the house, noticed that there was a horseshoe pinned above the main door. He turned around to Nils and said: ‘Come on Nils, you don’t believe that the horseshoe is going to ward off evil spirits.’ And Nils turned said, ‘No, of course I don’t believe that, but my housekeeper says that it works even if you don’t believe in it.’
And this is the impression that our European leaders give me. They put together packages and policies and they come up with ideas on how to solve the Euro crisis, and they don’t believe in those ideas, but they hope that they might work even if they don’t believe in them.
When the whole thing blew up two years ago, three years ago, I enraged the media in Greece, but also the BBC and CNN by saying that this is not a debt crisis. This is what I want to talk about today, and to narrate my suggestion, jointly authored with Stuart Holland, in that context.
Let’s begin with debt. Debt has a very bad name these days, but debt and bankruptcy is to capitalism what hell is to Christianity: unpleasant, but absolutely essential. At the moment, yes, we have mountains of debt - in this country, in my country, in the United States, in Japan. Everywhere. But at the same time we have a glut of savings eagerly seeking ways of investing itself but not finding it. We never talk about this crisis as a crisis of too many savings. Yet it’s the other side of the same story.
Let’s go back a few centuries. Feudalism. Peasants worked. They produced the harvest - production. Then, the landlord would send in the sheriff and collect the landlord’s cut - distribution. The landlord’s cut would then be sold in rudimentary markets and money would be made for the landlord. The landlord would then use that money to buy luxury goods, to furnish his manor house, and possibly [he would] lend some of that. Financialisation. So in the mists of time we had production followed by distribution followed by finance. And then capitalism came. And this sequence was completely and utterly reversed.
How did this happen? The long and the short of it is that with the enclosures, especially in England and Wales, and parts of Scotland, the peasants were kicked off the land, and some ex-peasants took on the job of organising protection – they became entrepreneurs. Because the landlord didn’t want to do it himself, so effectively he rented the land. Suddenly land became…it was always a factor of production, but now it became a commodity. It was rented, and it was rented at a price which was commensurate to, effectively, the price of wool that could be grown on it.
So the entrepreneur, who was an ex-peasant, sometimes somebody who was very reluctant to be an entrepreneur but who had no choice, would have to borrow money – sometimes from a landlord, or from the money lender of the village nearby, in order to pay the rent to the landlord in order to pay subsistence wages to some of the ex-peasants who were starving outside the land from which they’d been evicted. What was happening? Before production starts you have distribution, which is based on finance, on the money lender. Then you have production, and then the poor entrepreneur is hoping that the harvest, when it is sold, will yield sufficient cash to repay the landlord, to repay the money lender, and the residual would be his profit.
"...debt is absolutely essential in a capitalist economy..."
So, capitalism, which was essential for the great leap forward of the Industrial Revolution, was based on finance. Finance suddenly came before production, and distribution came in between. This is why debt is absolutely essential in a capitalist economy. It’s a bit like – if you can imagine it figuratively – under capitalism what some do is, they put their arm into the future, and they grab value – future value, that has not been generated yet, and they bring it into the present, to finance the production process that will yield the value in the future.
This is how capitalism works. And when this works, and they make a nice little profit, then the tendency is to keep on doing this more and more and more. And the people who are responsible for this shifting of value from the future to the present – the financiers – suddenly find that as long as this recycling of value from the future to the present and then back to the future is working then they can make a nice little earner for themselves by helping themselves to some of that future value in the present. And when at some point this blows up because at some point you take so much value from the future that you cannot generate enough value in the future in order to justify what you took: then the whole thing breaks down. And then you have a crisis, usually. A debt crisis that leads to a production crisis. This has been happening from day one of capitalism.
This is how the United States of America came into being, we wouldn’t have had a United States if you hadn’t had a series of crises in the nineteenth century that caused what I call continental consolidation on the American continent. There was a significant crisis was in 1907, which led to the birth of the federal reserve system, and then the next in 1929, which led to President Roosevelt in 1932 to establish US treasury bills, federal bonds, and to create what we recognise today as the United States of America. That was a successful monetary union, because it addressed some of the problems that the bringing together many disparate economies has, and it did it in a way that was gradual. It was a result of a series of crises, but nevertheless it produced the dollar zone, which bound together different societies. Because, especially at that time, South Dakota, California, New York, were just as disparate as our European Union members are.
1929 was a very significant moment in human history. And it was a very significant moment because it was the first time we had a depression, and a depression that was long lasting. And my explanation for that is: when you have a combination of the increasing role of finance - which was already increasing from the 18th century - together with technological innovation, that leads to large corporations, which need a lot of financing. For example, when Edison created the first electricity grids, the financing that he needed in order to create that monopoly was enormous. And the stakes were enormous, and the profits were enormous. And when that thing collapsed we had 1929. And the market economies could not recover from this. And this is what the New Dealers recognised. Not so much because they read Keynes, but in conjunction with having read Keynes. And we exited the Second World War with a very simple concept in the mind of the New Dealers, who were still in power in the United States of America. They learnt the lesson of 1929 as follows: when such a debt crisis happens, and it leads to a recession in the real economy, two things go. The first victim is the common currency. In 1929 the world had a common currency - the gold standard. It collapsed. The second lesson is that once it collapses, then everybody turns against everybody else.
What happened after 1929 and the collapse of the gold standard was that a currency war emerged. It was followed by attempts to erect trade barriers so that America would protect its own industries from competition. It was the greatest loss of international income in the history of capitalism. So the New Dealers understood that we need a common currency, we need a set exchange rate mechanism that will create enough certainty regarding exchange rates – we need to fix that, as markets will not do it by themselves. If we don’t add shock absorbers within that system, then when a debt crisis happens - and it will happen, inevitably - then the lack of shock absorbers will lead that common currency to break. So, when they got out of the Second World War, the Americans were very keen to create a new fixed exchange system – almost a common currency, it was the Bretton Woods system – but to infuse in it shock absorbers. And the shock absorber was what I call a surplus recycling mechanism.
"The Japanese miracle and the German miracle would never have happened without those American investments"
What is the idea of a surplus recycling mechanism? Well, look at the United States, or Germany, or England, or Ireland: every economy is made up of a surplus and deficit ratio. So, California will always have a surplus viz a viz Arizona. Always did, always will. If you bind these economies together, as they are bound up in the US, something has to give, because you can’t have California having a surplus viz a viz Arizona constantly. At some point this imbalance will not be maintainable anymore. So you need a surplus recycling mechanism. In the US they have two. One is the social security system – fiscal transfers – so when unemployment increases in Arizona or Nevada or Ohio or Illinois, the federal system automatically uses taxes raised in New York or in California, and transfers them in the form of unemployment benefits to Nevada, to Arizona.
But this is not the main mechanism. The main mechanism in the US is the military industrial complex. So when Boeing goes to the Pentagon and says: ‘I want a trillion dollars to build the new F367 fighter aircraft,’ the Pentagon says ‘Yes, ok, but…’ - nudge nudge wink wink – ‘I want one factory in South Dakota, one in Illinois, one in Ohio’ - in other words in the deficit areas. Now this is not philanthropy. It’s rationality. Because that way jobs are created, investment is made in the deficit areas, so the deficit areas can maintain exports into them from the surplus areas. This how currency unions are made to work. The Americans understood that, and they understood that if they were going to bind together the dollar with the deutschmark, with the yen, the pound, the punt, the drachma, which is what they did after Bretton Woods, they would have to create a surplus recycling mechanism.
Keynes had suggested a formalised, institutionalised [version of] such a mechanism, but the Americans said no, we are going to do it as we please. And indeed they did. The Marshall Plan is an example. Effectively what they did was say, ‘Ok, we’ll dollarise Europe. We’ll give them money so that they can buy our stuff.’ And the post-war social contract, the international social contract if you want, was very simple from the American perspective: it was that America is going to have surpluses; it will sell more to the rest of the world than it imports from the rest of the world. But, and this is the social contract – they would take 70% of their surpluses and invest it in the other countries. The Japanese miracle and the German miracle would never have happened without those American investments.
Now, what were they, the Americans - philanthropists? No. They had a rational idea for how to maintain this global plan for Western capitalism that they had decided they needed to supervise, effectively. The problem was that for reasons that you all know - the Vietnam War was a major one as also was the Great Society programme of Lyndon Johnson - at some point the US lost its surpluses. This system could no longer go on. So it collapsed. In 1971 the Americans – because they were extremely astute in diagnosing the end of that plan – they themselves killed it off. Nixon, on the 15th of August 1971, declared Bretton Woods was no longer. Now, what would a German do if he or she got into deficit? They would take their belt and tighten it. They would say, ‘We need austerity, we need to cut back, etc.’ What did the Americans do? They said, ‘Ok, we have deficits: we’re going to increase them. And we’re going to go on a path of constantly increasing both deficits - the trade deficit and the US budget deficit.’ ‘Who’s going to pay for it?’ the Germans would say. And the answer is: the rest of the world. The importance of the US in the post-war world was that it was a surplus recycling mechanism. While it had surpluses it was recycling its own surpluses. Once it lost its own surpluses it started recycling other people’s surpluses. So the social contract changed after the 1970s. It’s what Paul Volcker, the Chairman of the Federal Reserve between 1978 and 1987, described as a ‘controlled disintegration of the world economy’. That’s a quotation from a speech he gave a month after he became chairman of the Fed. He said: ‘One would have thought that maintaining stability in the international economy would be beneficial for the world. But there is another argument: that it is in the interests of the US to pursue the controlled disintegration of the world economy.’ And what he meant by that was that the plan that I described, which was rational, regulated, balanced, with fixed exchange rates, the financial sector well under control, the Glass-Steagall Act in place: that was going to be thrown up into the air.
"Between the 1980s and 2008 two to five billion dollars was flowing every day into Wall Street"
For the first twenty years after the Second World War, what was happening was that America was working like a huge vacuum cleaner, sucking into the US the products of Japanese industry, of German industry. And who was paying for that? The Japanese, and the German employers and entrepreneurs sent their profits, in the form of ‘tribute’ – in inverted commas - to Wall Street. Voluntarily. Why? Because they thought they would get better returns there. And they did get better returns there. That was the brilliance of the Volcker plan: ensuring the magneticism of Wall Street; making sure that capital wanted, voluntarily, to flow across the Atlantic and Pacific oceans from Asia and from Europe towards Wall Street. And between the 1980s and 2008 something in the region of two to five billion dollars was flowing every day into Wall Street and immediately finding its way into the Stock Exchange. Think of this: a tsunami of capital is rushing constantly, every day, across the oceans towards Wall Street. Now, what do bankers do, if you give them billions of dollars a day? They find ways of making a nice little earner for themselves. This is what I call financialisation. All those wonderful financial engineering products, they are the result, in my mind at least, of this tsunami of capital. Financialisation and the rise of finance - from a meagre 15% of the American economy to almost 50% - was the result of that. It was not that suddenly greed overtook the psyche of human beings; it’s not that the character of entrepreneurs changed; it’s not even that governments suddenly became corrupt and allowed the regulators to be captured. It was the irresistible force of that tsunami of capital and the financialisation that was built upon it that led to, effectively, a new form of money.
Wall Street, and the City of London, and later on the European banks, discovered an amazing way of realising a dream that we all have, or at least I do: an ATM in our lounge that prints money. They started printing their own money. Because what’s money? It’s a means of exchange, it’s a store of value, these pieces of paper that they were producing – the toxic derivatives as we know them now – they were being used as money. And suddenly they realised that they could print as much of it as they wanted. So they printed a lot of it. By 2007, roughly speaking, for every dollar that the Federal Reserve had issued, Wall Street had issued a hundred. So at some point planet Earth was not big enough for all this private money, and that private money collapsed. This is the fate of all false gods: to be found out. And they were found out.
The tragedy is that this collapse was so big, that the USA ceased to be able to operate like a recycling mechanism. The capacity of the USA to absorb other people’s products, and to finance its deficits in a manner conducive to the recycling that is necessary to create demand for German goods, for Japanese goods, for Chinese goods – we lost that. The reason why our world is in disarray, why we have a crisis in the Eurozone, why we have a crisis in Japan, why there is a crisis in the USA.
"The moment this surplus recycling mechanism broke down, the euro was doomed"
Now, to Europe. What is the euro? It is the evolution of the deutschmark. What was the successful recipe of Germany? A strong currency, a Bundesbank that never accepted any Keynesian notions of reflating the economy, and aggressive exports. This is the German model. When the euro was built, Germany was convinced by President Mitterand that if the euro was created the Eurozone would become a larger Germany. So the Eurozone would operate along the same lines. It would have, effectively, the deutschmark – and this is why the ECB is in Frankfurt, alongside the Bundesbank, this is a symbolic gesture – and Germany could continue to export, not only to the rest of the world, but also be given a great deal of leeway to sell to the rest of the Eurozone at exchange rates which were fixed. And effectively they would not have to worry about those nasty Italians anymore, who carry on dividing the lira, and suddenly Fiat are competitive in Germany. So this is how Germany was convinced to create the Eurozone.
This vessel that they created – the Eurozone – it’s like a riverboat. A great, beautiful, Mississippi riverboat. It floats wonderfully; it’s majestic. If you take it and you put it in an ocean and the ocean is calm, it goes magnificently. And then there is a storm and it sinks. It was never designed to sustain a crisis. Back in the 1990s, when we were creating the Eurozone, we economists had provided ideological and mathematised superstitions in the form of cover for our policymakers to think that crisis is something that students of economic history will be learning, but not something that anybody will experience. There will be ups and downs, we said, there will be crises like the one in October 1987, or the savings and loan crisis, but Greenspan, the new doyenne of the Federal Reserve, will press the accelerator and release enough liquidity and it will be solved. Gordon Brown had, if you remember, exterminated boom and bust. They had bought their own rhetoric. As long as that tsunami of capital was financing American deficits it was working. But it broke down. The point I’m making is this: the euro, the moment this surplus recycling mechanism centred in the US broke down, was doomed. The way it was designed, it could not continue. It’s not a case of debt, it’s not a case of profligacy by the Greeks, or real estate deals that were shabby – although they were shabby here in Ireland. These are the reasons why Greece was the first domino to fall, and Ireland was the second domino to fall – but they are not an explanation of why the domino effect happened.
What you have here is an opponent of the euro, standing in front of you appealing to everyone to save the euro. Because it’s one thing to criticise its architecture. It’s one thing to say we should never have gotten ourselves into it. It’s quite another to say that we should get out. Because if we get out we’re not going to be where we would have been if we hadn’t gone in. We will simply jump off a cliff and all of us are going to perish. Not just the deficit countries, but the surplus countries.
"Every single bank in the Eurozone is bankrupt"
So what do we do to fix it? We are running out of time. I was very much more optimistic a year ago. This proposal that I am presenting to you today has, I think, a very small chance of being implemented. But I still believe in its rationality, and I still think it is important to put on the table proposals that one thinks may do the trick. But nevertheless I am very pessimistic about our world, our Europe, the euro, and our countries. I hope I’m wrong.
We have three related crises in Europe as a result of its false architecture. First, we have the banking sector, not just in Ireland, and I keep saying this - every single bank in the Eurozone is bankrupt. Every single bank. If the ECB stops providing them with liquidity they are dead in the water today. Their ATMs will stop functioning. So it’s not just your Irish banks – it’s all our banks. The second crisis is debt - state debt, sovereign debt. The third crisis is something that nobody talks about except some relics of the Left like myself: underinvestment. If you compare the investment ratio of the Eurozone with that of the US – which itself is not really going gangbusters investing at the moment – or with Japan, or Latin America, or especially China – you will see that Eurozone investment is running at around 30% of those other blocs. Now, if we keep doing this, we’re going to fall behind. Ms Merkel can keep talking about the importance of competitiveness, but what competitiveness? If you’re not investing you can’t become more competitive simply by accepting Bangladeshi wages. If you could do that then Bangladesh would now be Canada.
The euro has a few weeks, months left in it. So what I’m saying here is that whatever proposal we put on the table, it must not be a proposal that involves treaty changes. We must not create new institutions. We must fiddle and tinker with the institutions we have. This is a tall order. It’s not easy to change the architecture without changing the institutional framework. But I think we can do it. We have three crises – banks, debt, investment – and we have three institutions which, if suitably reassigned with a bit of an imaginative touch, can solve the problem within a year.
Here’s the proposal. We have created a European Financial Stability Fund, from which Portugal is drawing its bailout loans, and from which Greece is now going to get the second bailout. This is a toxic organisation. The way it is borrowing – its funding structure – and the way it is lending – its lending practice, turns it into the Lehman Brothers of Europe. So if we don’t give it enough money it’s useless, and if we give it too much money then it’s toxic. The EFSF is a problem, not a solution. But if we turn it into a European NAMA or a European TARP – that is, a European organisation that forcefully recapitalises the banks, and stops them from being in denial and pretending that they don’t have an insolvency problem it is a solution. If it uses the €440 billion that it has, that’s enough to infuse that capital into the whole of the Eurozone’s banks. Every single one of them needs it. Change the board of directors so that we can have transparency at long last; know exactly what the black holes in those banks are; fill those black holes and stop them sapping the economic energy from the European Union.
Then, the debt. The EFSF was meant to deal with state insolvencies. The simple idea here is that the ECB is given the tools it would need in order to do this job. At the moment the ECB is buying debt left right and centre. This is a losing battle. Instead of doing that, give them the tools to do the job properly. And what should the proper job entail? Stop treating this like a country-by-country problem. Treat it as a Eurozone debt crisis. Because when you try to squeeze it in Greece, it emerges in Ireland; you squeeze it in Ireland, it goes somewhere else. It’s a systemic crisis: deal with it systematically.
We split every Eurozone country’s debt into two parts. The part that you were allowed to have according to Maastricht – I call this Maastricht compliant debt, 60% of GDP – this is the good debt. And the rest is the bad debt. And the ECB should announce that it is going to be servicing the good debt of every single Eurozone country. Make no mistake: this is not a buy back of debt. It’s not buying it, it’s servicing it. That way, for all of us, a proportion of the debt, which is equal to 60% of GDP, is going to be serviced by the ECB. Where will the ECB find the money? From the Chinese. From the Norwegians. From private investors. It will borrow the money. It won’t print it, as it is doing now – now it’s printing all this money to buy back bonds, ineffectually. How will it borrow? It will issue its own bonds, ECB bonds. Not Eurobonds, but bonds by the ECB. It’s very simple. It simply issues bonds. It’s not rocket science.
The European Investment Bank, which is another arm of the Eurozone, and of the European Union, issues its own EIB bonds. It’s been doing this now for many many years, but nobody talks about that. They get interest rates of 2%. The ECB could do it too. And who pays for these bonds? We do. Not the ECB. Suppose that there is an Irish bond which matures in 2014. And it’s one of those bonds that the ECB has taken onto its books, according to this proposal. What has it cost the ECB? Nothing. Now, in 2014, it will have to pay the bondholder the face value. So will it print the money? No. It will borrow from a Chinese sovereign wealth fund by selling an ECB bond to them. And that will be a 20-year bond, at 2%. And then, it will immediately open a debit account for Ireland and say to the Irish government: ‘I’ve just opened a debit account, and within the next twenty years you have to put in this account the sum that will be necessary in order to repay this Chinese sovereign wealth fund.’ Ireland benefits enormously, because this bond, which is expiring in 2014, has been extended by twenty years at a ridiculously low interest rate.
And notice two things. Firstly, this happens not just for Ireland, it happens for Italy, Spain, Greece - everyone. What does this mean? It means that the debt crisis goes away. The money markets will see this, and they will clap. And the spreads will go down, so the bad debt will be much more serviceable too. And notice a second very important thing: when somebody talks about bonds that are joint, Barosso, Merkel, the Germans say: ‘Nein! Because this means that our interest rates, which are now 2%, are going to go up! Because they’re going to have to be pulled together with your bad debts!’ In this scheme, nobody guarantees these bonds except for the ECB. The German taxpayer doesn’t guarantee anything, unlike what they’re doing now; the ECB is not printing money. And the debt crisis goes away.
"Without growth we’re not going to plant the final nail in the coffin of the recession"
And the last part: investment. Because without growth we’re not going to plant the final nail in the coffin of the recession. Entrepreneurs will not invest until they see something happening which is going to inspire and motivate and re-energise what Keynes called their animal spirits. What we need is a new deal. Exactly what Roosevelt did in 1932. The concept behind the New Deal was that the federal government borrowed through treasury bills to invest in infrastructure. And not just in the deficit regions of the US: everywhere. So we need an investment led recovery programme for the whole of Europe, including Germany. Because Germany is experiencing a crisis as we speak. German workers are suffering. The working poor in Germany have doubled in number. And this is why they are turning towards the right and they are turning against the Irish, and soon they will turn against the Germans.
The European Investment Bank, if you go to their offices in Luxembourg, you’ll find that they have a long list of potentially profitable projects that they would like to fund - in Ireland, in Greece, in Germany, in France. Why don’t they do it? They want to. They don’t do it because in their charter there is a clause which says that 50% of the investment must come from the member state. Well, the member state here is bankrupt, it doesn’t have two pennies to rub together. But if we’ve created those debit accounts in the ECB, and the ECB has the capacity to issue its own bonds, why can’t the EIB go to the ECB and say, ‘Listen, I’ve got this very profitable project here that’s waiting to happen.’ I’m sure the ECB would say yes, it looks like it would work, and then they have a deal between them: the EIB issues half of the bonds, to raise half of the funding, the ECB issues additional ECB bonds to raise the other half, the ECB adds this debt to the Greek to the Irish debit accounts, and the Greek and the Irish governments don’t have to worry about repaying it, because this project pays for itself. And those bonds, the EIB and the ECB bonds, are repaid through the operation of the project. And that would create an infusion of investment in the Eurozone of between 8 and 8.5%. It would be the end of the crisis.
The recapitalisation of the banks would take about six months, and then they could be sold off, just like happened in Sweden in 1992. The transfer of the Maastricht compliant debt to the ECB could happen in 24 hours. It’s just an announcement. And then the investments of the EIB will take at least a year to come on stream. If this package were to be announced today, it would change the psychological climate worldwide. Private investors would start investing if they could see the light of rational thinking from Brussels, from Frankfurt, from Paris.