A Modest Proposal for Overcoming the Euro Crisis
by Yanis Varoufakis

It is now abundantly clear that each and every response by the eurozone (EZ) to the galloping sovereign debt crisis has been consistently underwhelming.  This includes the joint EZ-IMF operation, back in May, to "rescue" Greece and, in short order, the quite remarkable overnight formation of a so-called "special vehicle" (officially the European Financial Stability Facility, or EFSF), worth up to €750, for supporting the rest of the fiscally challenged EZ members (e.g. Ireland, Portugal, Spain).  More recently, European leaders announced their provisional agreement to create a permanent mechanism to replace the EFSF as well as a series of measures for, supposedly, attacking the crisis's causes, thus ensuring that it is not repeated.  Alas, no sooner were those measures announced than the crisis intensified.

The reason is simple.  The EZ is facing an escalating twin crisis but only acknowledges one of its two manifestations.  On the one hand we have the sovereign debt crisis which permeates the public sector in the majority of its member countries.  On the other hand we have Europe's private-sector banks, many of which find themselves on the brink.  Over-laden with paper assets (both publically and privately issued) which are worth next to nothing, they constitute black holes into which the European Central Bank (ECB) keeps pumping oceans of liquidity that, naturally, only occasion a tiny trickle of extra loans to business.  Meanwhile, the EZ leadership steadfastly refuses to discuss the private debt crisis, concentrating solely on the need to curtail public debt through a massive austerity drive.  In a never-ending cycle, these fiscal cuts constrain economic activity further and thus pull the rug from under the European bankers' already weakened legs.  So the crisis is reproducing itself.

Hard as it is to sympathize with the bankers, their failure to be reassured by Europe's response to the crisis is understandable.  Consider for a moment the "rescue" plan imposed upon Greece jointly by the EZ and the IMF.  The Greek state owes more than €320 billion, mostly to European banks, and is committed to repaying its loans with interest rates that are as high as 7%.  Last May, the banks became so worried about lending more money to the Greek government that they began demanding interest rates of more than 10%, during a lengthy period in which they themselves were borrowing from the ECB at between 0 and 1% interest rates.  It was at that point that the Greek government threw in the towel and exited the markets, accepting the EZ-IMF "rescue" package which, on condition of subjecting its economy to a most savage form of austerity, allowed Greece to borrow €110 billion over the next three years at interest rates of around 5%.

What did the bankers think of that "rescue" attempt?  On the one hand, they were reassured that, for a while at least, the Greek government would be meeting its periodic repayments by drawing on the EZ-IMF loans.  On the other hand, however, they became even more wary of longer-term dangers.  In their thinking, the certainty of repayments over the next three years has been bought at a much larger risk of a future default.  Banks understand that the austerity measures imposed upon Greece, at a time when its GDP is already shrinking at a dramatic 4% annually, will simply diminish the prospect that the Greek government will be able to repay both its old loans (to them) and the fresh ones (to the EZ-IMF).  Moreover, banks panic at the thought of what is called the EZ-IMF loans' super-seniority; that is, the Greek government's legally enforceable commitment that, in case it cannot meet all its repayment obligations, it will pay the EZ and the IMF first.  In other words, banks know that, if Greece cannot repay the whole mountain of debt that it will be under in 2013, when its GDP will have shrunk further, they will be the last to receive whatever payments the Greek government can make.

A Modest Proposal for Tackling the Present Crisis

What we have now is a textbook case of how not to run a bailout.  Is it any wonder that the banks are not reassured by Europe's long-term "resolution" of the Greek crisis?  And is it surprising that the markets are ready to speculate on which will be the next domino pieces to fall, once Greece and some banks (that have lent it large sums in the past) have toppled?  This is, in a nutshell, the essence of the euro crisis.  A crisis that is young and that has much energy left in it.  The question that naturally arises in view of the above is: Could Europe have responded differently?  And if so, why has it not?  In what follows I shall concentrate on these questions, starting with an outline of a modest proposal for an alternative rescue plan, one that does take into consideration the symbiotic link between the sovereign debt crisis and the crisis of the private sector (banks and businesses in general).

In the case of Greece, its "rescue" currently takes the form of a bilateral "negotiation" between the joint EZ-IMF delegation and the Greek government.  Reportedly, the idea is to strike a deal on what measures Greece is to take to increase its tax take and reduce its public expenditure in exchange for another installment of fresh loans from the EZ-IMF.  It is a "negotiation" that both entraps the Greek economy into an accelerating recession and, at once, sends shivers up the European bankers' spines (for reasons explained above).  Instead of that bilateral negotiation, my modest proposal is that the EZ should orchestrate a multilateral negotiation, one involving the following participants:

  1. Representatives of all high-deficit countries that will, potentially, require assistance during the next five years (e.g. not only Greece but also Spain, Ireland, Portugal, Italy);

  2. The heads of the EZ and the ECB, who will effectively be representing, as is their wont, the interests of the dominant, low-deficit countries (e.g. Germany, Finland, Holland);

  3. Representatives of all the main European banks holding the majority of the high-deficit countries' bonds.

The reason for bringing these three sides to the same table is simple: to tackle the debt problem in its entirety -- i.e. to avoid squeezing it in the domain of public debt only to see it balloon in the banking sector, or vice versa.  Here is an example of a possible rational agreement:

  1. Europe's banks agree to limit their demands over the debt of the high-deficit countries (i.e. to restructure the debt of Greece, etc.);

  2. High-deficit countries agree to implement reforms that reduce waste, corruption, and parts of their deficit whose reduction will have limited impact on poverty, social cohesion, and long-term productivity growth (e.g. defense procurement, tax breaks for wealthier citizens, subsidies on environmentally damaging agriculture);

  3. The EZ-ECB undertakes to come to the assistance of European financial institutions that are stressed by 1 above and, crucially, to utilize the European Investment Bank to increase productive investment throughout the continent, especially in its recession-hit regions.

Such a grand bargain would potentially produce a rational agreement on how to redistribute the burdens (private and public) of the unfolding crisis at the level of the eurozone as a whole and in a manner that steadies the nerves of markets, firms, consumers, and potential investors.  It would constitute, I submit, the kiss of life for the EZ as it would deal a mighty blow at the feedback mechanism which, presently, keeps reinforcing the vicious circle of (a) the banks' uncertainty about the states' ability to repay them and (b) the recessionary forces that prevent the states from paying these debts.

A Modest Proposal for Re-designing the Euro's Architecture

If the euro crisis reveals anything, it is the simple truth (once better understood -- see George Krimpas' excellent article here) that a currency union cannot bank on balanced trade within its regions.  Germany will, come what may, have a trade surplus with Portugal.  So, if the currencies of the two countries are to be locked up indefinitely, keeping the balance sheets balanced requires either a steady transfer of capital from Germany to Portugal or a constant diminution in Portuguese wages.  Though both phenomena are possible, and often observable, life has proved that neither the capital flows nor wage reductions are large enough to avert the ever-growing imbalances between deficit and surplus EZ countries.  In short, either the currency union will break up or a political-cum-institutional solution will be found.  What follows is a modest proposal of what that longer-term institutional solution might entail.  Why modest?  Because it does not call for the obvious solution to the problem: i.e. federation.

The gist of the proposal1 is that the current euro architecture is an edifice missing an important pillar and that this missing pillar is some mechanism for recycling surpluses between its core member states and peripheries.  My underlying assertion here is that the Crash of 2008 put the EZ in its current mess by exposing the imbalances that had been expanding during the boom years due to this missing mechanism but that didn't become apparent until a nasty shock.  So, here is the proposal:

  1. Transfer a tranche of around 60% of the sovereign debt of all member states to EU bonds.  This will immediately reduce borrowing costs for the most exposed member states, attract investments from the Central Banks of surplus countries (e.g. China) and from sovereign wealth funds (e.g. Norwegian, Russian, Chinese), stabilize the EZ in the long run, and turn the euro into a true global reserve currency.

  2. Empower the European Investment Bank to fund a pan-European, large-scale, eco-social investment-led program to serve as a permanent counterforce to the forces of recession, especially in peripheries which keep dragging the rest of the currency union toward stagnation.

  3. Put in place, as the German Chancellor is constantly requesting, mechanisms that enforce fiscal discipline among EZ member states, banning all attempts to use one member's tax system to undermine another member's investment policy.

Why This Modest Proposal Will Not Be Taken Up (for Now)

A myriad of objections will be urged against my modest proposal above.  However, the real reason for opposition is unlikely ever to be heard, at least from the mouths of officialdom or from embedded economists.2  All sorts of technical reasons will be laid out instead, but the true reason why the proposal here will be fought tooth and nail is terribly simple: it does not comply with the class interests of those in authority-- at least not as they perceive them.

The idea that the burdens of the crisis should be shared between capital and labor, between productive and financial sectors, between deficit and surplus regions is anathema to them.  The notion that interest rates paid by the German government will have to rise (even very modestly) so as to maintain a semblance of balance within the EU is abhorrent to the German elites.  For they are quite happy with the current situation where their profit rates are on the rise while the German workers are having to make do with declining real wages.  When confronted with the reality of the imbalances between Germany and Greece or Portugal, their response is to think: "Well, if our German workers, who are considerably more productive, take lying down constant diminutions of their living standards, then the lazy Greek and Portuguese ones should be walloped with huge wage and benefit cuts.  If not, our own workers may object to their lot."  Indeed, they are convinced of the moral case for such macroeconomic protectionism, unable to recognize that their insistence is incompatible with the maintenance of a common currency which boosts their own surpluses, viz. the maintenance of the deficit EZ countries and the rest of the world.

In conclusion, austerity may be the most irrational, destructive response to a major crisis like the one etching its mark on this generation.  However, it affords global capital an opportunity to regroup in its class war against labor and, thus, to snatch a major victory out of the jaws of a near catastrophe.  If austerity is being currently embraced enthusiastically almost everywhere (now that capitalists regained their poise following the state-funded bailouts of 2008-9), it is because it represents a strategy for shifting the burdens of private and public debt off their own backs and onto those who never benefitted from the debt-driven growth prior to the Fall.  It is nothing less than a class war by other means.  Moreover it is global in reach.

Puzzlingly, even as this class war against common sense is being waged on a global scale, the only people who even allude to it, albeit perversely, are . . . the Tea Party in the United States.  By targeting their enemies (including the Fed!) as "socialist," they at least evoke a project which, while currently dead in the water, used to be labor's rallying cry when attacked by capital.  All this would have been a delicious irony if it were not a real tragedy of real people suffering serious pain and desperately trying to find a narrative that delivers poetic justice.

Returning to Europe, one last time. . . .  Our very own tragicomedy appears in the form of elites whose strategic choices are made contradictory by the fact that, in their haste to wage their own class war against the peoples of Europe, they surreptitiously undermine the very currency union which was their own idea for facilitating capital accumulation on the continent.  It will be interesting to see which way they will jump when the crisis reaches a crescendo and demands that either the euro break up or a modest proposal like the one above be taken seriously.


1  The proposal emerged from lengthy discussions with Stuart Holland (currently a professor at Coimbra University in Portugal and formerly a leading Labour Party Member of Parliament in the UK).

2  I owe this term "embedded economists" to my colleague Thanassis Maniatis who coined it in order to allude to the vast number of our colleagues who have been co-opted by the powers that be and turned from independent thinkers to legitimizers of the illegitimate.

Yanis Varoufakis is Professor of Economic Theory and Director of the Department of Political Economy in the Faculty of Economic Sciences of the University of Athens. Varoufakis' books include: The Global Minotaur: The True Origins of the Financial Crisis and the Future of the World Economy (forthcoming); (with S. Hargreaves-Heap) Game Theory: A Critical Text (Routledge, 2004); Foundations of Economics: A Beginner's Companion (Routledge, 1998); and Rational Conflict (Blackwell Publishers, 1991).  The above article summarizes arguments made in Chapter 12 of Modern Political Economics: Making Sense of the Post-2008 World, authored by Yanis Varoufakis, Joseph Halevi, and Nicholas Theocarakis (to be published in March 2011 by Routledge).
| Print