MR
17.10.10
First as History, Then as Farce:
The Euro Crisis Revisited

by Yanis Varoufakis

When the Crash of 2008 hit Wall Street, European capitalism was thrown into disarray.  With the demise of the export-absorbing monster that was the US consumer market, what in 2003 Joseph Halevi and I called "The Global Minotaur" (see Monthly Review, Vol. 55), Europe not only lost a critical source of aggregate demand but also discovered that its own banks were facing meltdown as the American collateralized debt obligations (CDOs) bursting the seams of their vaults turned to ash.  Despite the European gloating that this was an Anglo-Celtic crisis, and that its own banks had not been taken over by financialization's equivalent to a gold fever, the truth soon came out.  When it did, the European Central Bank, the European Commission (the European Union's effective 'government'), and the EU member states rushed in to do for the European banks what the US administration had done for Wall Street: they pumped them up with quantities of public money the size of the Alps, so as to replace the 'departed'private money (the troubled derivatives) by fresh public money borrowed by the member states.  So far, this seems identical to the US experience.  Only there were three profound differences.

The first difference is that the euro is nothing like the dollar.  While the dollar remains the world's reserve currency, the Fed and the US Treasury can write blank checks, knowing that it will make very little difference for the value of the dollar, at least while the crisis is unfolding.  The second difference is that Europe is lacking an internal surplus recycling mechanism (e.g. a federal budget or a military-industrial complex like what the US has) that would allow it to take accumulating monopoly profits from one country (e.g. Germany) and invest it in deficit regions (e.g. Greece).  Finally, the third difference concerns the way that the European banks succeeded in emulating Wall Street by using the post-2008 infusion of public money in order to start a new process of 'minting' fresh private money.  Wall Street did this by using the Geithner-Summers Plan which created from scratch a new type of financial instrument that allowed US banks to remove the toxic CDOs from their balance sheets at the taxpayers' expense.  The European banks did the same -- only without the direct cooperation, or even knowledge, of the government (either of the EU or of the EU member states).  This is how it happened:

At the same time that the European states were socializing the European banks' huge losses, and turning them into public debt, Europe's economies went into recession.  In one year (2008-9), Germany's GDP fell by 5%, France's by 2.6%, Holland's by 4%, Sweden's by 5.2%, Ireland's by 7.1%, Finland's by 7.8%, Denmark's by 4.9%, Spain's by 3.5%. . . .  Naturally, the states' tax receipts collapsed.  Suddenly, Europe's troubled hedge funds and banks had an epiphany: why not use some of the public money they were given to bet that, sooner or later, the strain on public finances would cause one or more of the eurozone (EZ) states to default?  The more they thought that thought, the gladder they became.  The fact that euro-membership prevented the most heavily indebted countries (Greece, Portugal, Spain, Italy, Ireland, Belgium) from devaluing their currencies meant that, sooner or later, one of the weak links in the EZ would break: i.e., it would default on its bonds.  So, they decided to start betting, small amounts initially, that the weakest link in that chain, Greece, would default.  As London's famous bookmakers could not handle multi-billion bets, they turned to the trusted credit default swaps (CDSs); insurance policies that pay out pre-specified amounts of money in the event of defaults.  Those banks that bought such bets in October and November 2009 made zillions.  Soon a roaring trade in these CDSs followed.

The reader will notice the subtle but important difference from the pre-2008 US-centered CDOs: whereas those CDOs constituted a bet that homeowners would pay back their debts, the post-2008 EU-centered CDSs were naked bets that some EU state would not be able to pay back its debt.  Thus emerged the new private money of the post-2008 world!  Of course, the greater the volume of trade in this newfangled private money, the more capital was siphoned off both from corporations seeking loans to invest in productive activities and from states trying to refinance their burgeoning debt.  In short, the European variant of the bank bailout gave the financial sector an opportunity to mint private money all over again at the expense of the real economy.  Once more, just as the private moneycreated by Wall Street before 2008 was unsustainable and bound to turn into thin ash, the onward march of the new private money was to lead, with mathematical precision, to another meltdown.  This time it was a sovereign debt crisis, whose first stirrings occurred at the beginning of 2010 in Greece.

The EU's response to the crisis took about six months longer than it would have had European capitalism featured a federal overlord similar to that in Washington.  By the time German industrial capital, the French banks, and the rest of Europe's various regional capitalist interests got their act together, the crisis had reached a crescendo that brought world capitalism to about three hours away from a new Crunch: this time, unlike September 2008, a Crunch sourced in the bond markets.  Faced with a complete breakdown of financial trading, and under the pressure from Washington and the IMF, Europe's leaders bowed to the inevitable and struck a deal to bail out bankrupt eurozone member states.  Tragically, the solution they arrived at, the so-called European Financial Stability Facility (EFSF), was an exercise in high order idiocy -- proof that, due to untamed centrifugal forces and mighty internal contradictions, political Europe is incapable of managing European capitalism at a time of crisis.

One may argue that my assessment is too harsh in that the euro crisis seems to have been contained, even Greece seems to have been stabilized, and betting against the euro and against Greek and Spanish bonds has eased.  Read on, dear reader, for the truth is less heroic.  Let us begin with a look at the EFSF.  It has a starting capital base of €60 billion made available from the EU's own budget and €250 from the IMF.  Additionally, it will be able to borrow up to €440 billion from the financial markets and institutions.  The idea is that the EFSF will lend at the behest of the EZ countries as a whole.  So far so good.  While the EFSFdoes not address the root causes of the crisis, the deep incongruities of European monopoly capital, at least it seems like a decent response to its symptoms.  Until, that is, one scratches the surface of the €440 billion part of the fund which the EFSF is meant to raise on the markets.  Conventional wisdom tells us that the trick to the EFSF's potential success is that it borrows by issuing its own bonds (let's call them EFSF bonds) which are supported by collateral provided by all the EZ countries in proportion to the size of their economy.  In other words, Germany and France put up most of the collateral.  This should encourage investors to buy the EFSF bonds at low interest rates.

The problem is that this bears an uncanny similarity to the circumstances that gave rise to the dodgy CDOs in the United States and, later, their European counterparts.  US-issued mortgage-backed CDOs were founded upon the trick of bundling together prime and subprime mortgages in the same CDO, and to do it in such a complicated manner that the whole thing looks to potential buyers like a sterling investment.  Something very similar occurred in Europe after the creation of the euro: CDOs were created that contained German, Dutch, Greek, Portuguese, and other bonds (i.e. debt), in such complex configurations that investors found it impossible to work out their true long-term value.  Lest we forget, the tidal wave of private money created on both sides of the Atlantic, on the basis of these two types of CDOs, was the root cause of the Crash of 2008.

Seen through this prism, the EFSF's brief begins to look worrisome.  Its 'bonds' will be bundling together different kinds of collateral (i.e. guarantees offered by each individual state) in ways that, at least till now, remain woefully opaque.  This is precisely how the CDOs came to life prior to 2008.  Banks and hedge funds will grasp with both hands the opportunity to turn this opacity into another betting spree, complete with CDSs taking out bets against the EFSF's bonds, etc.  In the end, either the EFSF bonds will flop, if banks and hedge funds stay clear of them; or they will sell well, thus occasioning a third round of unsustainable private money generation.  When that private money turns to ashes too, as it certainly will, what next for Europe?

A US-EU comparison is now in order: just as the Geithner-Summers Plan of 2009 sought to solve Wall Street's problem -- the toxic derivatives -- by issuing new state-sponsored derivatives, so too the EFSF creates new derivative-like bonds that will be sold to the banks and hedge funds in return for money that will be passed on to member states, which will then be returned to the banks holding the member states' debt and already profiting from issuing their own derivatives (CDSs) whose value depends on whether EZ member states (separately or together as the entire EZ) fail. . . .

The only conclusion that can be safely drawn from the above is that the EFSF has singularly failed to deal with the problem it was meant to address.  Already, struggling Ireland is coming to realize that to seek help from the EFSF would be suicidal (see this pertinent article in the Financial Times).  From our perspective, it is important to recall lessons that we once knew more confidently (largely due to the work of Paul Sweezy and Harry Magdoff) and which we now need to update.  One lesson that we learnt in the 30s was that, when oligopoly capitalism goes into a major crisis of demand, trying to engineer an escape in the realm of paper assets is not only doomed but likely to cause more damage as well.  A second lesson that is more pertinent to our era is that the rise of financial power has made it even harder politically to seek a realist solution which must involve: (a) the expropriation of failed bank assets; and (b) measures to directly boost demand.


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).
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