Reflections on the nature & causes of global financial uncertainty – Amsterdam 4th DEC 2016

YV at RiskMinds Amsterdam conference 4 Dec 2016.jpg

On 4th December 2016 I delivered the keynote at the RiskMinds International risk management conference in Amsterdam. A summary of my talk, compiled by the organisers, follows.

What’s worse? Being a finance minister of a bankrupt state, or a risk manager in this environment?

Tuesday morning’s guest speaker at RiskMinds in Amsterdam, former finance minister of Greece Yanis Varoufakis, wasn’t sure.

“We seem to be having a perfect storm,” he began.

“A political class which is very rapidly losing the last remnants of legitimacy amongst voters, on both sides of Atlantic, and a very rare moment in the history of capitalism, where it seems impossible simultaneously to have an equilibrium in the money markets, a real rate of interest that equilibrates the demand and supply of investment funding, that at the same time is consistent with financial stability.

“The repercussions are being felt in our daily lives.”

The Eurozone was never designed to withstand a major banking crisis

Varoufakis used the recent Italian referendum to illustrate the state of European and global capitalism.

“It should be a social economy that is doing really well,” he argued. “It has a persistent current account surplus, a primary budget surplus at a healthy 2.3 -2.5%. It should not be facing a severe banking crisis or a debt to GDP ratio, which is increasing.”

“The only reason this is happening is because the Italian economy is embedded in a Eurozone, which was never designed to withstand the financial crisis of 2008.”

Moreover, he argued, European leaders are in denial of the fact.

“And whenever there is an economic systemic failure a political failure is close behind.”

Illusions are the order of the day

Indeed, the illusions that politicians labour under were the order of the day, he continued, explaining that Germany’s insistence that the problems in the EU are to do with competitiveness, was failing to recognise that it’s productivity that is key.

“Productivity is a variable sum game, I can increase my productivity while you can increase yours.

“Competitiveness is a zero sum game. It is this zero sum game that has harmed the EU, with some, during the good times, gaining at the expense of the rest.”

There were also the illusions harboured by Italy and France, Varoufakis contended, who think that the way out is to demand the right to violate the fiscal limits of the various successor Treaties to Maastricht: E.g. “The illusion that if only Italy was allowed to have 5 or 6% of budget deficit, then all things would be fine.”

“What we’re forgetting is that in Europe we have created a very interesting beast. A very large economy, featuring a supposedly independent central bank, but in reality we have created an economy where there is a central bank without a government to have its back, and governments without a central bank.”

“We ended up with a massive crisis without a central bank where we could park our bad assets, and the very quaint illusion that a banking crisis, yielding gigantic losses, could be overcome through austerity.

“Who would want to be in Mario Draghi’s shoes?” he asked. “No one.”

The problem with the ECB

“We have a central bank which is meant to be most independent central bank in the world but is actually the least independent,” he stated, going on to explain that the ECB, according to its own rules, couldn’t accept the (junk) collateral posted by most banks. But since refusing to would have shut down the banks, the banks were allowed to issue IOUs, go cap in hand to politicians to have the impecunious governments guarantee these IOUs, and then have the Eurogroup give the green light to the ECB to accept these worthless pieces of paper as collateral.”

“Thus the ECB is the central bank most dependent on politicians in the history of capitalism,” stated Varoufakis.

It was a similar case with the ECB’s quantitative easing, he said.

“The idea of purchasing government bonds was never imagined by those who set up the ECB, but of course Draghi had to do it. So they had to create a very quaint rule according to which, for every one Italian bond that he purchased he had to buy a lot more bunds… to maintain the illusion that there is no monetary financing of government debt, or discriminating between bonds – thus the system according to which purchases of government bonds where made in proportion to a country’s GDP, or ECB share holding. The result is the silliness we observe, the ECB purchasing scarce bunds in order to defeat deflation, a problem that Germany does not face!”

Italy compounded the problem by the way it has approached the EU:

“You have a young prime minister, Matteo Renzi, who, when he was appointed, had a lot of political capital. We were all hoping he would use it to do the grown up thing, to go to the EU summit and say these rules are not working, and then demand that Council discusses how to recalibrate the rules so that they can work. Instead he demanded Italy’s right to violate the existing rules.

And that’s when the conversation with German interlocutors ends.”

A working hypothesis for the perfect storm

“Allow me to put forward a working hypothesis,” he said, explaining that it has to do with the way in which surpluses and deficits are recycled.

“Between 1950 and 1971 it was a very boring time for bankers but an interesting time for humanity, the golden era for capitalism.

“The US took parts of its own surplus and recycled it in Europe and Japan.

“At the end of the US surplus, when it shifted to a deficit position, they blew up the system they had created because they realised it wasn’t working, unlike the Europeans, who will do anything to hang on to an unsustainable system.

“The US did something quite remarkable – they turned their deficit into a source of strength. They entered a deficit position but didn’t tighten belts; they hit the accelerator and increased their deficit. But that deficit was remarkably important for the rest of the global economy. It operated like a vacuum cleaner, sucking into US territory the net exports of Germany, Netherlands, Japan and later China.

“American policy ensured that the rest of the world not only sent their net exports to America but sent 70% of their excess money to Wall Street. They recycled other people’s capital. From 1950 to 2008 Europe did not have to perform macroeconomic stabilization, Washington was doing it for us.

“But Europeans never understood that we were lacking both the intellectual and economic expertise and the political mechanism by which to do that for ourselves. The tragedy of 2008 is that the breakdown led to the end of America’s capacity to recycle global surpluses.

“China played a significant role in slowing the crisis down through reflating and through boosting its investment ratio to an incredible 50%, but they knew it wasn’t sustainable. They inflated an investment bubble on purpose in order to give Europe and America the opportunity to get our act together.

“But we didn’t, because we are ungovernable. The US over the last ten years has proven ungovernable. As for Europe I don’t have to explain why we’re ungovernable, just watch every Eurogroup meeting. It’s like watching King Lear, the audience wonders how sensible people can behave so badly.

“If you see things from this perspective it all starts to make sense.”

It’s a political failure

“We made a monetary union before we made a political union,” he concluded.

“Brexit would never have happened if it weren’t for the inane handling of the Euro’s inevitable crisis. Wherever you start from, you reach that conclusion.

“This perfect storm that we find ourselves in today makes a lot more sense once we realise that a political failure lies at its heart.

“Technically speaking, the economic conundrum we find ourselves in can be overcome within a few weeks. It will not be overcome by increasing fiscal spending by governments that either have no central bank or refuse to tax the top earners. But it can be overcome by a combination of taxing those enjoying tax immunity and by having a large-scale investment programme in Europe, run by the EIB and supported by the ECB. Then we could discuss how to discuss fixing the political and institutional architecture of Europe.

“This takes a political decision,” he continued. “And yet, when I was trying to have this conversation in the Eurogroup, it was as if I was attempting to sing the Swedish national anthem. It was thought of as preposterous.

“All I was trying to do was to talk about how we could deal systematically with a systemic crisis, but there was and there is no interest in having that conversation. They insisted on treating it as a Greek crisis, an Italian banking crisis, an Irish banking crisis,” he revealed, before ending his presentation with a stark warning:

“Great incongruity between very high savings and very low investment, creates deflationary forces, and deflationary forces breed political monsters today, just like it did in the period between 1930-1933.

“Our perfect storm is due to a political failure. It is the establishment politicians’ fault. It’s our fault, for not forcing politics to shape up.”


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