Sunday, July 21, 2013

Once Upon a Time There Was A Small Debt-Ridden State... Prof. Yanis Varoufakis

I came across this article (Google-translated) by Prof. Varoufakis. As provocative as the article sounds, I can agree with all of what Prof. Varoufakis says about EU-decisions back in 2010. Clearly, EU-leadership at the time was more worried about the Euro and the large European banks than about Greece's future. Thus, they decided to (eventually) send a couple hundred billions+ to Greece in order to save the Euro and the large European banks. Greece was an optimal target because the country's leadership had gotten their economy into such a mess over the previous 3 decades that it was easy to argue that not the Euro and certainly not the large banks were the cause of the problem but, instead, the corrupt and wasteful Greece. Thus, Greece offered all the excuses to enforce conditions which might otherwise have been considered as too harsh. After all, if one scared the living daylights out of Greece, that could serve as an effective deterrent for other countries.

There are some subtle points in the article which I could not subscribe to. When one talks about the idiotic lenders, one should also talk about the idiotic borrowers. When one claims that only because of the benevolent Frau Troika the Greek GDP collapsed, one should be honest and admit that the GDP collapsed because its prior artificial growth was the result of enormous net debt inflows and when that music stopped, there were not enough empty chairs left. Stating that the Greek GDP shrunk by over 20% since 2009 presupposes that the 2009 GDP reflected accurately Greece's domestic economic value creation. But what if the truth were that the Greek GDP, in 2009, was 30-40% overvalued because of all the recycling effects of foreign debt flows? Then GDP today would still be 10-20% higher than the 'true' GDP of 2009. To argue that the Greek GDP was shrunk by the benevolent Frau Troika is like arguing that the sub-prime market would still be a flourishing market today if no one had ever asked what these papers were really worth.

The real fast one which Prof. Varoufakis pulls is a genial fast one. Genial, because it sounds so convincing and 'fast' because it is so wrong. He says that if Greece had been forgiven all its debts at the outset, the benevolent Frau Troika would have saved 40 BEUR (because Greece's debt is now 40 BEUR higher today than it was then) and Greece would not owe a penny today. That makes me wonder how, in this scenario, Greece would have financed 40-50 BEUR operating expenses (without interest) during this period. In any restructuring, debt first goes up before it goes down (unless it is forgiven) because, as a general rule, the borrower has a negative cash flow and needs to finance that.

Still, I don't want to be nit-picky and I repeat that I agree with what Prof. Varoufakis says about EU-decisions of 2010. Instead, the article motivated me to write a little 'once-upon-a-time' story myself.

Once upon a time there was a small promising state...
One could argue that that promising state was a major success story for several decades. Its average rate of growth for half a century (1929–1980) was 5.2%; during the same period Japan grew at only 4.9%. These numbers are even more impressive when considering all the political and military turmoil which that promising state went through during these decades.

Still, that promising state has now become a symbol of economic and political bankruptcy, a natural experiment in institutional failure. It’s not easy for a single country to serve as a textbook example of so many institutional deficiencies, rigidities, and distortions, yet the government of our once promising state has managed it. The case of that once promising state is a precautionary tale for all others.

In the 1940s, Juan Domingo Peron emerged as Argentina's political hero because he had discovered the disenfranchised, the 'descamisados' as his electorate. Peron strengthened his power base by redistributing the enormous national wealth of Argentina to the disenfranchised. Our small promising state developed its own political hero who, like Peron, built his power base around the politically and economically disenfranchised. However, instead of redistributing national wealth to those disenfranchised, he redistributed the wealth of other nations to them. And whereas Peron did not have a real opposition because no one in the opposition wanted to be as irresponsible as he was, the opposition of the political hero of our small promising state promised to be as irresponsible should they ever come to power. And they were just that.

When reading the modern history of our small promising state, I am always overwhelmed by the enormous energies its people could marshal for a common purpose as long as that common purpose was against something: sometimes against foreigners; other times against one another. However, when it came to domestic objectives, there were only few leaders who could turn a domestic objective of national interest into a common purpose of all.

Now, notwithstanding the marvels of a pluralist democracy, when the choice of parties and leaders is rotten, the democratically elected leadership will be rotten, too. Yes, the democratic voters of our small and once promising state had a choice and they are responsible for their choices. But what if there are no good choices? Looking back at the last 30 years, it doesn't look like the voters ever had good choices.

One really has to feel sorry for the citizens of our small once promising state. First, they got a leadership which ran the economy into the ground (with the active assistance of foreign funders) and when it came to repair time, the leadership had no stomach for repairs. For quite a while, it looked like they meant by 'repair' that the process of redistributing the wealth of other nations could be jumpstarted again. 

Fortunately, our small and formerly promising state had a lot of capable economists. They understood that the only way to avoid the pains of repairs was to jumpstart again the process of redisributing the wealth of other nations. And these economists were very smart, indeed. They knew that asking for new loans would be a flop, so they came up with politically much more correct ideas. Offering other nations the opportunity to bail out its bankrupt domestic banks could only be interpreted as a grand act of continental solidarity. And channelling funds from official lenders into new domestic investments (regardless whether or not our small and formerly promising country offered profitable investment opportunities) could only be interpreted as an idea worthy of a Nobel Prize.

Our small country remained a small country and one way or another it survived. It may never have regained the 'promising' status but its people lived happily ever thereafter.


  1. The article by Pr. Hatzis is substandard. It is not completely wrong, in actual fact I quite agree with lots of it. THe mistakes though are bad enough to create the suspicion of intelle-ctual laziness. See for example:
    "(a) pasok’s economic policies were catastro-phic; they created a deadly mix of a bloated and inefficient welfare state with stifling in-tervention and overregulation of the private sector." Later on:
    "All the way back in 1974, Greek politicians forgot about economic realities. After the fall of the military dictatorship even the conserva-tive government nationalized banks and corpora-tions,subsidized firms, and increased the powers of the welfare state.Nonetheless, its policies were still limited in comparison with what the first socialist pasok government did during the 1980s. After 1981, state interven-tion increased, and regulation and cronyism became the rule. That....." Well it is either one or the other and qualifying the statement does not improve things.In actual fact the 1974-1981 ND was considered σοσιαλμανής (maniacal socialist). Unfortunately there are no refere-nces for this in English. Try to google it and see what happens. In actual fact the suffoca-ting laws started to be implemented in 1930 by the E. Venizelos government in response to the great depression.The process accelerated and reached its pinnacle during the Metaxas fascist regime. Most restrictions that are still tortu-ring Greece, like the trucking ones, were imple-mented then.During the 1929-1981 period Greece was a fascist economy with communist regime
    public ownership levels. In actual fact during the Nazi occupation most post war right wing Greek politicians belonged to something called the Socialist Union (my dad was the secreta-ry).This was a "well kept secret" but looking
    for references for this answer I came across the first public mention I have ever seen: It is in Greek but try to read it, it is very illumina-ting. It seems that Pr. Xatzis is ignoring all this and sticks to the internationally acce-pted "all is PAsok's fault" narrative.
    The trouble with articles like this, written by Greek academics to WSJ standards (this is an insult), is that they present a reality that suits the experience of bankers and politicians
    worldwide like Herr Kastner and, being a Greek analysis, they are accepted as truth. And when the country does something out of this limited analysis it is accused of being unreliable.
    Remember the question you posed: how come a group as homogeneous as the Greeks cannot get themselves to work together?This is a pertinent question with deep sociological implications and unless an article like Pr. Xatzis does not account for this in a rational manner is lazy. By the way I tried to answer your question about Greeks in a precise manner. I stopped after 5 pages of dense, difficult to follow argument.

  2. Varoufakis was fearing that Greece will exit euro. He didn't consider at all efforts of ECB and have the same projections with Prof Roubini in terms of foresight.
    The point here, we are always saying not what to change but how our small and pessimistic we are.

    However a question after 3 years, if all countries accept let say a haircut around 50%-60% in 2010 -in Greece- some French and German banks will face problems of solvency and their public opinion how will react?

    Here y make many mistakes, with all do respect. Varoufakis is right to his point.


    1. This was one of the poorest articles by Varoufakis so far and I have made two comments in his blog. It completely lacked objective discussion of what Sinn said (and Muenchau as well). Fortunately, Muenchau has now also commented Sinn's article (see below). I wish Varoufakis would have mangaged to conrol his emotions and prejudices and comment as objectively as Muenchau has done!

  3. However a question after 3 years, if all countries accept let say a haircut around 50%-60% in 2010 -in Greece- some French and German banks will face problems of solvency and their public opinion how will react?


    1. Just the fact that the expression 'haircut' has become quite a normal expression in the last years shows how mishandled the crisis was.

      Get this: a haircut of sovereign debt after only a few years of crisis should be out of the question in a country of the First World. There hasn't been any one-time catastrophe nor has there been poverty à la Bangladesh to justify such a thing. There is no way of telling today what the long-term consequences of such decisions will be, but they will not be good ones!

      What should have happened back in 2010, and I don't know how often I have meanwhile said this, is a rescheduling of debt. A debt rescheduling which, outside of Europe, has been standard for decades. Only, the Europeans didn't know about it.

      A debt rescheduling would have meant that existing creditors move the maturities of principal and interest way out into the future (possibly including even 99-year bonds). Risk takers should have remained risk carriers!

      Of course, many large banks couldn't have handled this and they would have had to be bailed-out by their governments. Tax payers would have been called upon to put up money for that. And that would have been good because then tax payers would have seen where their money went and that might have provoked legislation which really prevented banks from speculating. Also, tax payers would have received something in exchange for their money - bank equity. As it is today, tax payers got absolutely nothing for their money.

      Read the 6 comments to the Modest Proposal which Varoufakis published today. As you will see, not every economist agrees with the message of the messiah.

    2. Klaus> I agree completely that all that was required in the initial phase of the crisis was debt rescheduling and the inevitable failure of some (maybe quite a few) banks. With this analysis, we also posit a clear relationship between the State and banks located in its territory.

      However, let us not forget how we got into this mess. It could not have happened without the existence of the eurozone. With this structure, the national State and the central banks are sidelined and quasi-federal institutions have taken some powers, and left gaps in other areas. Those gaps, which are substantial, are then re-allocated back as the responsibility of the national governments.

      In such a catastrophic political mess -- because this is primarily a crisis of politics -- the position of the most powerful political actors becomes crucial. In 2008/9 these were Germany and France; now it is only Germany. The Troika is a political farce or charade; the IMF is regretting ever having touched the stinking mess of the eurozone, and we are left only with Germany. This is why there is so much hatred against the Germans, because they have abused their political power within Europe to damage other countries while protecting German interests, especially the interests of elites.

      My main point here, is that Varoufakis has tried to construct a political economy compromise that could save Europe. Nobody is interested. His compromise has some weak points, but is infinitely superior to the stupidities and arrogance of Schauble. Your criticisms of the Varoufakis approach neglect just how serious the political crisis is, and how trivial the economic problems actually should be. That is not to say that Europe is prospering, but it is to say that one could (ceteris paribus) expect it to survive. With the disaster that Germany is creating, even this basic expectation is under threat.

    3. I have never argued against the Modest Proposal. In fact, I consider the pillar of the ECBs emitting bonds genial because it would, instead of printing money, use available money to fund sovereign bonds. The only thing is, I have run this issue by the Governor of Austria's Central Bank, a long-time friend of the family, more than once and he has always short-cut it by saying that 'it is against the ECBs mandate'. There must be some reason why he keeps repeating that (and it certainly is not an aversion to people like Varoufakis because the Governor is a true Social Democrat).

      I am not sure that the MP would change much for Greece. Greece already borrows at extremely low rates (and some of them may even go to zero soon). The only pillar which could have some benefit for Greece would be the EIB pillar. That, of course, would require Greece to come up with new projects qualified for EIB financing.

      At the risk of repeating myself ad nauseum, I see the debt problem as the derivative. If the underlying is solved, the debt problem will go away by itself, and the underlying are the economic imbalances in the Eurozone; the widening gap between production and consumption. I really question whether the 4 'EU-freedoms' can or should be upheld. I guess Spain and Ireland were Maastricht-compliant before the crisis but even with that, there was no protection against markets throwing irresponsibly capital at those economies (and those economies misusing that capital). Even if Greece had retained the Drachma, I am sure that markets would still have thrown enormous sums at the country. Not as much as with the Euro but still very much. Look what's happening these days in Hungary where 80% of housing was financed with CHF loans.