Reply No. 2 (YV2) to Kantoos Economics on the merits of the Modest Proposal

Kantoos Economics (KE) just posted the first installment of a reply to my long rejoinder to his original comment on our Modest Proposal.[1] Two are the main point raised by KE, and to which I respond below: One concerns the tradeoff between (a) maintaining market pressure on member-states to keep their public debt under wraps while (b) alleviating the crushing effect of unsustainable interest rates on their public finances (see Spain, for instance). The second point addresses the question of what to do with member-states for which the Modest Proposal’s Policy 2 (ECB-mediated debt conversion of their Maastricht-compliant debt) will simply not be enough. Should there be some grace period? Should the IMF be engaged? Both are excellent points, to which I shall now turn.

Point 1: Interest rate signals versus fiscal waterboarding

KE rightly interprets the Modest Proposal’s key aim vis-à-vis interest rates: On the one hand to reduce massively the average interest rates that the Eurozone as a whole pays to borrow in the money markets (as a currency block, that is) while, on the other hand, creating a new type of interest spread that is the best ally of the Maastricht criteria: a spread between the interest rate a member-state must pay to service its ‘good’ (Maastricht-compliant) debt and interest rate it must pay on the remaining ‘bad’ debt.

Presently, the Eurozone is typified by one type of interest rate spread only: that between the few surplus countries, like Germany, and the rest. Having Spain pay 6.5% on all its debt (‘good’ and ‘bad’ alike) while Germany pays net to nothing to borrow again on all its debt (‘good’ and ‘bad’ alike) is highly distortionary. It really reflects a macroeconomy, sporting a common currency, that has got all its signals confused. Our ECB-mediated Maastricht-compliant debt conversion scheme will accomplish two things:

First, it will push down to less than 2% the cost of servicing the Maastricht-compliant debt of every member-state within the Eurozone. Thus average interest rates in the Eurozone will fall very, very significantly and, as a result, all interest rates (including those Spain and Ireland, to mention two, are paying for their ‘bad’ debt) will fall, reducing the mountain of interest that needs to be paid by the Eurozone in aggregate over the next, say, twenty years. This will bring excellent effects on market sentiment towards the prospects of the Eurozone as a whole.

Secondly, interest rate spreads between Germany and the rest will diminish (let’s call this ‘across-country spread’, or ACS) with their ‘place’ being taken by the interest rate spread that each member-state will be facing between its ‘good’ and its ‘bad’ debt (and call this Intra-country spread, of ICS). ICS will, of course, depend entirely on market sentiment regarding the extent to which the member-state has kept its debt on a leash. But, unlike the burgeoning ACS today, it will no longer burgeon as a result of the capital flight from countries like Spain to Germany. Put differently, today, the bloated ACS reflects more the state of the Eurozone’s disintegration than emitting any useful signal about Germany’s and Spain’s relative efforts in reining in their debt.

In summary, we commend Policy 2 of the Modest Proposal as a means of steering a clever course between the competing demands of (A) not just maintaining market discipline for member states, but in fact reinforcing it; and of (B) eliminating interest rate spreads that make life within the Eurozone simply impossible for the majority of member-states.

Point 2: And what if this ECB-mediated conversion of Maastricht-compliant debt is not enough to get countries like Spain (and of course Greece) out of the woods? What do we do? Bring in IMF-like programs and conditionalities?

KE and I agree that, even if our policy regarding debt (as discussed above) is adopted, there will be a lot of mopping up to do afterwards. That, while the Crisis will become far less acute, it will not go away. However, this is precisely why the Modest Proposal has three pillars; why it is founded on three policies. Policy 1, let me remind the reader, concerns the complete and immediate unification of the banking system. Suppose, for a moment, that it were implemented tomorrow. Suddenly, neither Madrid nor Dublin would have to labour under impossible burden of re-capitalising their insolvent banks. Remember: the money for these recapitalisations come from the centre of the Eurozone anyway; from the EFSF (or will do so in the case of Spain, once Rajoy’s idiotic resistance to the inevitable ends). What we are suggesting is that this capital infusion bypasses the state governments altogether. The benefits from this are enormous. First, it means that Americans, the Chinese, the Japanese will no longer have to fear that to transact with a Spanish firm may mean that the Spanish cheque they will receive may bounce as a result of Madrid’s fiscal implosion. The benefits to European trade from this will be enormous. Secondly, by taking the bank recapitalisation away from the national governments (and shifting it to the centre of Europe; to the ESM-EBA-ECB nexus) we sever once and for all the cosy, hopelessly corrupt, unedifying relationship between local bankers and local (or national) policitians. Thirdly, national budgets get a chance to breathe and national governments (especially the Dublin one) an opportunity to balance its books without the nightmare of discovering around the corner some new black hole in one of the nation’s idiotic banks.

Then there is Policy 3, which effectively calls for the Europeanisation (via the EIB-EIF) of investment. This is a central plank of the Modest Proposal. Taken together with Policies 1 and 2 (i.e. the debt conversion operation, to which we dedicated most of our discussion, and the unification of the banking systems), the Modest Proposal effectively suggests the Europeanisation (without Federation, which is neither necessary nor desirable – at least for now) of banking, public debt (the Maastricht-compliant part of it) and investment. This three-pronged Decentralised Europeanisation project (as I like to call it) will not only make the Crisis go away but also allow us to impose a simple conditionality on member-states: a balanced budget provision, just like the one that applies in the United States. No need for grace periods, for IMF-like programs, for economic czars etc. In this manner, the peoples of Europe will recover their sovereignty over things that matter to them (e.g. health, education, culture, internal solidarity), they will have an opportunity to elect governments that balance the nation’s books and, of course, will be living in the shared prosperity of a Eurozone that, centrally, and rationally, manages banks, a ‘legal’ common debt and investment flows.

[1] Since this useful debate is, most likely, to go on and on, it is perhaps sensible to number the replies, so as to keep track of them. So, allow me to apply the following numbering:

KE1 = KE’s original critique of our Modest Proposal (ModProp hereafter)

YV1 = My long rejoinder to KE1

KE2 = KE’s first reply to YV1

YV2 =  the present reply to KE2


  • The central MP aims is to get more credit on cheap interest rates for Greece. Which is of course: sort of eurobonds. However, between 2003 and 2008 there were de facto ‘good Maastricht’ conditions for Greece (and the other GIPSIF countries) already, not just for 60% but for 100% of the new debt, see here

    The history undeniably proved that Greece didn’t use the extremely good refinancing conditions (or the steady inflow of cash via the EU) for strengthening of her economy. Quite the contrary.

    So, question is, what reason should one have to be optimistic that Greece will act more responsibly the next time she gets socialised refinancing conditions which are better than what Greece alone justifies for?

    Aside from that: the MP seems to be tackling the monetary issue only? At least I can’t find the whole bunch of restructuring which is inevitable to bring Greece in a position where she can become free from the dependance on transfers from other nations taxpayer’s money. Maybe I just missed this part, if so, can you pls. show me where to find it?

    • But if Greek state would be restructured and got rid of corruption, how would all the macho German Firms like Siemens bribe the Greek politicians in order get most of the publicly funded construction (and other) projects?
      So the plan was nicely structured, give loans to the South and find the “means” to get most of the money back by utilizng corrupt leaders or by forcing nations of the South to buy flawed weapons (case of Greece being forced to buy broken submarines from Germany!)…
      So make this favor to the rest of the Europe and maybe the World, get out of Eurozone close down your borders and cut communications with the rest of us… You are not wellcome and we do want you to “play” with the rest of us anymore. You are a “good race” and you have proven it so you’ll not have any problems alone…bye bye

    • Yanis, is

      “In your mother’s ass maybe? That’s where I saw it last time…”

      the language you want to have on your blog? Do you have any idea what it says about you and your credibility that you allow such comments?

    • You are right. I must confess I just lack the time to read every line in every comment. Who was this by?

    • VSM:

      I would like you to read carefully verse 2 of the British National Anthem – circa minute 1:09 – which specifically references Merkel.

      In it the British people, in their ageless wisdom, prey to God to:

      1, To scatter Merkel and make her fall
      2. Confound her politics and frustrate her knavish tricks

    • Yanis, just here in this subthread:

      AnteGamisouEpitelousSERIUS-SAM June 2, 2012 at 16:31 #

      In your mother’s ass maybe? That’s where I saw it last time…
      Oh and if you don’t find it there, just post your home address and somebody could visit and help you with the issue…

  • The minute there is a Eurowide investment vehicle (bond equivalent or otherwise – the nature of the vehicle is secondary) there will be a massive inflow of capital from US, Chinese, Japanese, Russian and similar sources.

    All the outsiders are looking for is a sign the Europeans have gotten it together and that the Euroland represents an inseparable entity.

    Germany’s misgivings ought to be irrelevant in such endeavor. This ought be a case of a simple majority vote where any German objections could be quickly and decisively overruled.

    • yeah sure…and who’s gonna pay then? you urself or your fellow “we-r-treated-like-slaves-we-poor-victims”-fellows? because you dont expect germany to pay when you ask her for, do you…if you do you still have no idea whats going on

    • Dean, I think you are talking about the Eurobonds.

      This is a stupid idea put forth by socialist politicians who want to control Europe from the centre.

      The Eurobond idea has already been tried, it was called the Euro and it allowed Greece to borrow at the same rates as Germany.

      This has been shown to be completely nuts. Investors have now realised their stupid mistake and are now pricing Greek debt differently from German debt like they did before the Euro. This is normal and how it should be.

      I dont want to labour the point but…

      Eurobonds are simply a way for the Greek government to borrow at the same rates as Germany which is nuts. It has been shown to be a completely crazy state of affairs and his has led directly to the crisis in Greece.

      It gave enormous spending power to a corrupt government system. Which is bad.

      If Greeks want their corrupt and inefficient government to continue as is, without reforms, then yes, Eurobonds will allow things to continue as is.

      About Germany. In my opinion they are the only sane person in the room and they are the only party that is on the side of Greeks working in the private sector. And yet I hear Greeks vilifying Merkel which shows what an excellent propaganda job has be done by the ECB and its subsidiaries. Again, my opinion.

    • Richard:

      Obviously what you say is not supported by facts.

      If the whole purpose of this exercise was to prevent Greece from borrowing at rates close to Germany’s, then why Greece today has all of its cost of debt repriced at 2%? Which happens to be 350% better than the cost of borrowing on the Spanish debt and close to 300% better than the Italian cost of debt?

      If that was the purpose i.e. to deny Greece low cost of borrowing then I’d say this whole exercise has been a giant waste of time because what will happen next is that Greece will get close to 0% financing and all of its debt forgiven.

      No, the flaw is with the design of the euro and Germany playing for time when in fact everything is getting worse and stacking up against Germany in a monumental fashion.

      I strongly urge you to read my first post on Yianis’ next topic below which is the most accurate picture of the euro crisis yet written courtesy of George Soros. There you will find that the current problem of Germany’s making and of no one else. There is no escape for Germany and the final bill will be enormous and well deserved I might add.

    • Germany is everything but sane. If it were it would never have joined this Versailles II operation called Euro.

    • No it is not. Germany used to have a sound currency, not one that needs to be “rescued”. It also never had a currency that other countries could just print…

    • Dean, I dont think I was clear

      1.The Euro allowed Greece to borrow at unrealistic rates ie similar to Germany through the misunderstanding of investors
      2. Rates are now realistic given the situation whether that be 100% or 30%
      3. Eurobonds are intended to allow Greece to borrow similar levels to Germany (see point 1)

      2%? You must be talking about the debt that has already been taken out. Greece cannot even borrow on the open market at the moment, forget about 2%. Because investors know the debt is not serviceable and that the government should/has to default.

    • Richard:

      You get tangled in details.

      The proposal is for Greece to use low cost of debt for its existing debt. Not future debt.

      Just give Greece, for example the same rate of close to 0%. which germany gets today on its existing debt and see how fast Greece can achieve a primary surplus.

      You need to get off this “sin and redemption” mentality. Economics is a practical science not a morality nonsense a la Germania.

  • Dear professor, I have a few questions:

    1) How does the so called “ECB-mediated Maastricht-compliant debt conversion” get along with the ECB’s mandate, especially with the ECB’s credibility as a fighter for price stability, inflation expectations and the clear separation between monetary and fiscal politics? Being liable for such an amount of debts is “something” to say it mildly. The entire proposel reminds me of turning the ECB into a huge imaginary bad bank for junk bonds.

    2) How should the ECB (in her role of a debt guarantor) make sure that souvereign (!) loan recipients do indeed balance their books if there is no constraint to comply like in an IMF-program? The fiscal compact is nothing but teethless paper tiger with insufficient sanction mechanisms and doesn’t guarantee anything. This question has of course something to do with question 1)

    3) How does anyone make sure that the balance of payments becomes balanced if there is no constraint to comply like in an IMF-program? This question has also something to do with question 1) Due to Greece’s current imbalance of payments, Greece still requires an internal devaluation. And the EC’s monitoring efficiency and strength hasn’t been properly tested yet.

    4) If there is a “Europeanisation of investments”, how do you make sure that there is no moral hazard either, e.g. that the same countries profit from the biggest share of commonly financed investments always and forever if there is no constraint to comply and no central watch dog like a central European government? That question has of course something to do with question 2) & 3) since the bigger the trade and budget deficits, the more investments are required.

    All this sounds like a big and intransparent back door transfer mechanism which lacks any democratic legitimization and which suffers from huge moral hazard risks and there is not even a monitoring mechanism involved.

    I thank you in advance for your answers.

  • BTW, here is Krugman’s BBC HardTalk Part Deux.

    And I am happy to report that now I know what’s bugging him about Greece. A Greek economist at NYU challenged him (circa minute 7). Look how he responds; he does not even acknowledge that the poor man exists and goes one to talk about Bernanke.

    Anyway, I will state it again for the record. I have a tremendous difficulty reconciling the rationality Krugman displays about his country and the irrationality he exhibits about mine. This by all means is a serious character flaw in my book.

    And given his near panic about Obama’s fate, under no circumstances I will allow him to use my Greece as a sacrificial lamb.

  • Sounds good to me – I am curious what Kantoos has to say. It would be almost too good to be true if there was some way out of this mess.

  • O.k. I admit it! I have a love-hate relationship with Krugman. I just don’t understand how a brilliant mind like his which so correctly (circa minute 12) says that we are spending erroneously time Hellenising our crisis whereas the true crisis is in Spain, could have so unjustly adopted such hostile attitude lately towards Greece.

    Of course the video also is telling of who is influencing his thinking in the “sin & redemption” propaganda originating from Berlin. The broken accent of the guy who introduces him speaks directly of the bad company poor Krugman has fallen into.Yani can you remind us of the name of this unfortunate fellow(introducer) from your Berlin conference? I just remember the guy turning my stomach with his German mechanic’s “figures” on how Europeans should securitize the Maastricht Treaty compliant 60% debt (what a genius !) and thus provide a tiny incremental step towards some financial Teutonic “Auftrag für Deutschland und Satelliten-Staaten”.

    • This is my opinion. Krugman is a spokesperson for hire to the highest bidder. I put zero credibility in what he says. My opinion.

  • Hi Yanis.
    We read in the news these days, the IMF would advocate the unification of banks in Europe.
    This sounds very much like one of your proposals, is it, what you are proposing on the matter?

    • “Ever closer union” was exactly what led us in the mess we are in: Abolishment of democracy an freedom with a currency crisis on top!

    • It would seem that the ECB is also calling for something similar. Mr. Draghi’s call “for a banking union entailing a euro zone-level fund for resolving failed banks, a euro zone-level deposit insurance guarantee system, and banking sector supervision that is more centralized on a European level” seems to be in line with—if not borrowed directly from—points 1 and 2 of the Modest Proposal.

      Yanis, do you have any notion of whether this is coincidental, or if the Proposal is starting to attract “official” attention within the EU?

    • When I presented it in Berlin in April, this is the one aspect of it most ‘officials’ (including ECB folkds) present said they found interesting.

    • Yanis, with all due respect, unifying the banking system will lead Europe into complete and utter fascism. The last thing Europe needs is more power concentrated in fewer hands. That is a recipe for complete and utter corruption.

      You talk about the cosy relationship between local banks and governments. Okay, the system is not perfect but having less politicians involved is again a recipe for even cosier and even more corrupt relationships as less people will need to be bought off to keep schtum.

      I am not going to pretend to understand the intricacies of what you are proposing but looking at it from a human nature point of view it is a bad idea.

      Can you imagine for example that the EU were to combine together all the car makers under one brand. I am confident that this would lead to worse cars, less customer choice and less innovation.

      I would propose letting the banks go through the same bankruptcy procedure as any other business. Sure it may be chaotic but given human nature I think this will lead to a sounder banking system in the future because it will be more fragmented.

      The more banks governments have to deal with to borrow money the better.

      My opinion

      Also, you talk about cutting local governments out of the loop, this sounds highly undemocratic.

      The only money that the ECB has belongs to the taxpayer, for the taxpayer’s representatives to be taken out of the loop sounds bad to me, no matter how corrupt the representatives are, unfortunately they are the only voice the people have.

  • o.k. Let me wallow in my own shame. Yesterday I brutally attacked the man and then I come across this and I am 100% in agreement with what he says.

    So, maybe (just maybe with the highest of hesitations) there is something wrong with me. 🙂

  • I am happy that what happens in Eurozone (Spanish wise, IMF wise, President Holland wise) is a gradual acceptance of the facts and assumptions that MP’ s versions have set. But
    1) I am afraid that -if and when its interconnected necessary and sufficient pillars will be fully endorsed and implemented by the Eurozone ‘ s clergy, then at least for some countries will be too late.
    -eg.for Greece till now due to the fact that almost all of borrowed, after the crisis, money flew either to banking system’s black hole or to transforming its total owed debt from private to either a high superiority IMF or between the country and Germany et all. Thus high rocketing its ‘bad’ debt only by the fact that Greece signed and adopted all the austerity measures. Thus leaving not enough room for Investment actions effects.
    2) I am afraid also that although for the peoples of Europe ‘things like health, education, culture, internal solidarity ‘ matter to them, the same exact things’ expenses are the ones condemned by all European governments to be first in line for butcher’s ax.

    • Out of topic but, nice coincidence seeing you here.Ive attended your classes in Operational Research I and Administration Econ.II

    • “then at least for some countries will be too late”

      Exactly. I havetransfered most of my liquid assets outside the Eurozone. I will not pay one cent for countries in the South. even if this means I will stop working!

  • Goldman Sachs P.R. Chief’s Accidental Exit Interview

    The Greek transaction, risk of swaps

    Use of derivatives, Goldman Sachs as a ‘bogeyman,’ ‘too big to fail’

    Deregulation, interest and involvement in regulation of investment banks

    Conflict of interest: the “culture of greed”; cause of Greek debt

    Overregulation Risks


    Aftermath of a crisis

    Quants. The alchemists of Wall Street

    Debt and Redemption

  • Dear Mr. Varufakis
    At “Point 2” , para 1 of your reply, where you explain the expected benefits of “Policy 1” of your “Modest Proposal”, I would humbly add : ” Fourthly by ameliorating the danger of bank runs, national banks will return to what they were supposed to do i.e. make plain vanilla business loans to private enterprises, thereby mobilizing idle savings complementing and reenforcing “Policy 3”. Fifthly recapitalization as in Policy 1, in contrast to the LTRO style of indirect handouts, will stop the cash hoarding and delevelaging phenomenon which plights the banking industry at the moment. (see Bill Gross “The ugly side of ultra-cheap money. FT 19/12/2011)”
    I would also like to see in your proposal Mr. Varoufakis, a super low pan-european flat tax for holders of the ECB bond issue under Policy 2 and Policy 3.

  • Hello Yanis. While confessing to no formal economic training for myself, but certainly being an avid amateur observer of the financial markets, the events of the last week strongly suggest to me a scenario that has been previously widely proposed as a possible outcome, including by yourself.

    That the Euro will split into the Northerners and the Southerners, and all the consequences that entails.

    With the interest rates on Spanish and Italian bonds starting to escalate, and France still hiding their issues under the carpet, I really can’t see why the Northerners would agree to be dragged further into that mess. Whatever rational solution may exist (e.g. Modest Proposal) will be overcome by the lack of political will and fear of being caught in a considerable quagmire.

    Oliver March Hartwich, provides an informed perspective on the conflicting views at play in Germany:

  • I find it rather academic (in a bad sense) to distinguish between good and ba debt. Which basic principle is the foundation of the Maastricht debt criteria? It is just a silly number that in reality says nothing. It does no account for aff balance sheet debt, regional debt etc.

    So the concept is too technical and focused on the details while missing the big picture.

    The second point is “reduce massively the average interest rates that the Eurozone as a whole pays to borrow in the money markets”. Did we just invite a perpetuum mobile? Can we use this concept to create a structured product and become infinitely rich?

    • Unfortunately you have to blame the EU for that.The MP talks about good and bad debt in order to extinguish fears of violating the treaty.The Maastrich Treaty itself created these 2 types of debt,and it would look like the EU “legalises” debt to gdp ratios above 60% if they ever decided to adopt the MP and covered 100% of gvt debt.

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