• A Modest Proposal for Resolving the Eurozone Crisis, Version 3.0

  • By Yanis Varoufakis , Stuart Holland | 05 Jun 13 | Posted under: Euro
  • 1. Prologue

    For two years now, caught up in a Crisis of its own making, Europe is fragmenting.

    A euro in a Greek bank has a lower expected value than a euro in a Spanish bank, which, in turn, trails the value of a euro in a German bank account. There can be no better sign of the common currency’s disintegration than this.

    And it is not just a matter for the Eurozone. The fallout from a Eurozone disintegration will be so severe, the rise of nationalisms so cataclysmic, that it is pure wishful thinking to believe that the European Union can be preserved, except perhaps in name, if the euro-system succumbs to the centrifugal forces it is now experiencing.

    Following a sequence of errors, delays and shenanigans, Europe’s leadership has stunned the world by its failure to take joint action. Most commentators lament the incapacity of Europe’s political and bureaucratic elites to act speedily and in a coordinated fashion. While there is truth in this, the recent double-edged ECB intervention vis-à-vis Europe’s banks3 shows that Europe can act decisively. The problem, however, is that, so far, its political leadership has pursued policies which it justifies on the basis of (a) a poor diagnosis of the Crisis’ nature and (b) two false dilemmas.

    In what follows, we begin by summing up the true nature of this Crisis. Then we present our Modest Proposal for overcoming the Crisis with three simple policies that can be implemented immediately and require none of the moves such as national guarantees or fiscal transfers to which many Europeans (and not only governments) are opposed, nor moves towards federation that entail Treaty changes which electorates are most likely to reject (e.g. fiscal transfers, federation) that Europeans currently find unfathomable.

    Finally, we juxtapose the logic behind our proposals against the false dilemmas that currently impede clear thinking and immobilise Europe’s policy makers.


    2. The Nature of the Eurozone Crisis

    The Eurozone Crisis is unfolding on three interrelated terrains.

    Banking crisis: While sparked off by events across the Atlantic, and the English Channel, the problem with the Eurozone’s banking crisis was never properly addressed. The reason was the terribly odd arrangement whereby governments, that lack the backing of a national Central Bank, maintain national control over global banks inhabiting within a trans-national currency union. At a time when forced recapitalisation of essentially insolvent banks is of the utmost importance, we end up with the unwholesome sight of fiscally stressed member-states (e.g. Spain) borrowing massively on behalf of the nation’ insolvent banks. And because this new public debt stresses their fiscal position further, they are abandoned by private creditors and have to rely on ECB liquidity that comes to them (to the states) via the very banks that the states are trying to save! It is abundantly clear that this madness cannot continue. For this purpose, our Modest Proposal suggests a very elegant, simple, instantly workable solution – see Policy 1 below.

    Sovereign debt crisis: Again as a result of a design fault, the sudden and catastrophic loss of liquidity that came to be known as the Credit Crunch of 2008, inevitably turned the eurozone’s most cherished principle (of perfectly separable public debts) into the ‘popcorn effect’ that drove three sovereigns into effective insolvency, before putting at least two large member-states in bankruptcy’s antechamber. Suddenly, reality bit back, reminding us that even though a common currency shields us from runs on individual currencies, our perfectly separable debts were bound to lead to a sequential run on member-state bonds, once panic set in the money markets following the financial sector’s implosion and the realisation of rating agencies that member-states would not act jointly to address the Crisis. While some of Europe’s leadership now understands this, and while Francois Holland has been elected on the basis of countering austerity by growth, there is an understandable reluctance of the surplus nations (mainly Germany) to become liable for the debts of the heavily indebted deficit nations gives rise to a certain paralysis. However, the problem caused by separate public debts can be addressed without asking of the surplus nations either to lend to or guarantee the loans of the deficit ones. For this purpose, our Modest Proposal puts forward another simple and elegant solution, one that violates neither the EU’s Treaties nor the charter of the ECB – see Policy 2 below.

    Under-investment and imbalances crisis: In addition to the banking and sovereign debt crises, Europe is facing (i) a dearth of aggregate investment (which threatens its long term international competitiveness) and, perhaps more significantly, (ii) an intra-Eurozone balance of payments’ crisis. The two are intimately linked. As the various regions within the Eurozone grew apart (in terms of competitiveness, investment, unit labour costs) during the period that led to the Crash of 2008, a well hidden (courtesy of open borders and a common currency) imbalance ensures that, when the global Crisis hit in 2008, the Eurozone risked disintegration. Following the massive loss of liquidity everywhere, the burden of adjustment fell on the regions with lower competitiveness and greater deficits, with swingeing cuts and painful austerity. Coupled with the impossibility of devaluations by these member-states, and the lack of new aggregate demand that would pull the deficit regions4 out the mire, the scene was set for a flight of capital and negative investment in the regions that needed it the most. Thus, Europe ended up with (A) low aggregate investment and (B) an even more uneven distribution of that investment among its surplus and deficit regions. To counter both problems at once, the Modest Proposal recommends that three of Europe’s existing institutions collaborate in order to stimulate investment in the regions of Europe in a manner that requires no tax-and-spend policies but which succeeds in mobilising idle savings and transforming them into profitable investments – see Policy 3 below.


    3. Three political constraints taken

    Designing the solution-concept for the current Euro Crisis resembles aconstrained optimisation problem.


    For the full text please refer to “Documentation” on the right or to: http://yanisvaroufakis.eu/euro-crisis/


    Yanis Varoufakis is Professor of Economics at the University of Athens and the Lyndon B. Johnson Graduate School.

    Stuart Holland is Visiting Professor of Economics, Coimbra University; formerly a Member of the House of Commons, UK, and advisor to Jacques Delors.

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