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The European leaders add oil to the Greek fire instead of putting it out

06 April 2011 / 14:04:50  GRReporter
20736 reads

Victoria Mindova

Yanis Varoufakis is Professor of Economic Theory at the Athens University. He shares for the readers of GRReporter his views on the developments in the rapidly developing economy of Greece and assesses the achievements so far in the context of financial crisis. Varoufakis supports the idea that lower taxes will bring more revenue into the Treasury as well as the reduction of the corporate tax to 15%. He believes that the Memorandum of the financial aid is the wrong way for the government of George Papandreou, but he is certain that the Mediterranean country has to remain within the Euro zone in any case.

Two major proposals concerning Greece were adopted after the Summit in late March this year – to resort to the European permanent mechanism for stability in case of need and the payment term of the financial aid of 110 billion euros to be extended and at lower interest rates. Many economists agree that this is not a great victory for Greece, but an expected development. What is your assessment for those decisions?

It was a sensational failure of the European Union. Generally, those decisions are nothing more than a mistake that has been repeated more than a year now.

What do you mean?

Imagine that the Euro zone is a building that was hit by a major earthquake to define the global economic crisis in 2008. The building or the Euro zone was not built in a way to endure this disaster and begins to fall. The weaker parts like Greece were affected first, but then the problems passed on to other parts. This is a growing crisis that begins to migrate from one sector to another. It started in the banking sector of Europe, transferred to the foreign debt of Greece, and then got to the banking system of Ireland and to the foreign debt of Ireland subsequently.

Excuse me, but Ireland had its own problems with the real estate market.

Look, the problem of Ireland is that it belongs to the Euro zone. The crisis in the Euro zone takes different forms in the different countries. If Ireland was outside it would not have a problem. The same is true for Spain. When the currency is locked, but there is no common economic policy and there is no, as I call it a surplus recycling mechanism within this system, the organisation begins to crumble. We have witnessed this for already a year.

If we look at how Europe has been trying to cope with this problem a whole year, we are going to see no logic at all. On the one hand, we have banking systems that are on the brink of bankruptcy.

Do you mean Greece?

No, I mean the whole of Europe.

But let’s get back to the results of the Summit. There were adopted decisions for a meaningless policy. This is a policy that disregards the real causes of the problem. The crisis was perceived as an ordinary debt crisis and, therefore, they gave the financial aid in return for fiscal consolidation and very stringent economic measures.

As far as I understand you oppose the whole logic of the Memorandum and the financial aid, is that right?

I believe that Europe did not have to push for that decision. Mainly, because it did itself wrong. Europe is currently in crisis that is only growing due to the Memorandum of Greece.

A major problem is that we have a banking system that is like a black hole. The banks in Europe are in panic, mainly because their portfolios are full of toxic derivatives from the private sector and government bonds of countries from the periphery of the Euro zone, which are actually useless.

If a serious stress test is made now similar to the one applied by Treasury Secretary Timothy Geithner in the USA, rather than the one that is currently held in Europe, almost all European banks will go bankrupt. The problem is that they have assets of no real value. If they enter the market to sell them - they will not be able to do it. This leads to fear and if a bank has to give a larger loan to another bank, it will not do it. So, there is no reliable interbank lending. All live from the European Central Bank. Actually, all banks should offer collaterals to be lent by it. However, the banks avail no collaterals and offer what they find and the ECB has nothing to do but to accept them. Take, for example, Ireland. The European Central Bank has given aid in the amount of 140 billion euros to the Irish banking system so far, and their Memorandum of aid is in the amount of 100 billion euros.

That is why I say that the European banking system is a black hole. This hole is the result of the toxic derivatives of the crisis in 2008. There stems the problem of Ireland, Spain and Germany. We should note that Spain and Ireland had problems with the real estate market, because they had given huge loans for major projects and the bubble burst.

Let’s go back to Greece.

The problem in Greece is known. The banks had no toxic investments, but they had plenty of government bonds. When liquidity disappeared after the last global financial crisis, many of the toxic financial products got lost, the prices of real estate dropped and a substantial part of the capital went to New York. The capital always migrates to the dollar when there is a global crisis. Therefore, the value of the dollar increased in 2008, although the crisis began in the USA. Europe found itself in the middle of the liquidity crisis and the European Central Bank tried to hide this problem somehow. When the crisis hit Dubai, then the credit rating agencies panicked. They had forecasted neither the toxic bonds, nor the real estate crisis in Spain and Ireland, etc.

In the case of Dubai, however, the problem immediately transformed from a problem of the real estate market to a crisis of the state credit. Then, they started looking much deeper and tried to find out which foreign debt could be a problem later. So, they found Greece, which has always been of the verge of the rates. They started finger pointing it and because they had panicked already, and to show that they do something. As a result, the spreads of the Greek government bonds reached fantastic levels; the country can not be funded and failed. And we return to the main question – a country in the Euro zone starts burning, figuratively. What do the European leaders do to put this fire out? They add oil instead of water.

What do you mean?

They go to a bankrupt country and give it more loans. They want money from German taxpayers to give it to Greece, Ireland, etc. And instead of allocating the funds to warm the economic climate and to increase the budget revenues from taxes, they oblige them to give the money to the banks or to pay off old debts. At the same time, in order to get this "assistance" these countries are required to impose such stringent measures so that to reduce their GDP, which makes them even more ruined than before.

In other words, all the money given as aid, similar to the Greek one, were given in vain because they fall into the black holes which we mentioned above. Banks, however, do not solve their problems with this aid and the crisis spreads from country to country. That is why I think that this type of lending is like extinguishing fire with oil.

I understand your logic, but what would it mean the state to allow a Greek bank to fail? What would be the consequences in your opinion and what are the alternatives before us?

They would be disastrous and for the whole European banking system. Alternatives exist, but there is no political will. This puzzle ranging requires a few steps. The first is that when we have two problems like the foreign debt crisis and the survival of banks, they must be hit simultaneously. Currently, this is not happening. The rulers want to solve the foreign debt problem by ignoring the failed banks and lending to countries, thus only shifting the problem.

We should know what results we want to achieve to start from somewhere. Do we want to reduce the foreign debt? This will not happen if we are lent more money. It will not reduce through redundancies in the public sector, because these redundancies reduce the tax revenues due to the recession. We will reduce the credit if we turn to the European Central Bank, which is credited at much lower levels than those of the government bonds.

I will give you an example from life to make it clearer. If a young couple decides to borrow money today, but the bank does not know them, it would credit them at 10% interest rate. However, if the parents of either of them have been customers of this bank for many years and it trusts them because of the good cooperation the bank will grant a loan at a much lower interest rate, for example, 3%. Then, the young couple can enjoy the low interest loan and takes the obligation to pay the installments.

So, imagine that the European Central Bank plays the role of the parents and it is credited at very good prices. It could sell Eurobonds on the international markets, which will earn interest of not more than 2.5%. Thus, the legal foreign debt of Greece, which is 60% of the GDP for the Euro zone, could be transferred to the European Central Bank. The remaining amount of the debt remains in Greece to cope with it alone, but it has the option of cheaper credit within those 60%. When it comes to the maturity, Greece and ECB themselves settle the accounts.

At the same time, here comes the issue of the European Financial Stability Fund, which instead of giving money to troubled countries should begin to support the banking system in Europe. To check, for example, Deutsche Bank or any other European bank, what capital it needs in order to fill its black hole. This amount is not more than one trillion euros in total. There is no need to give them free of charge but in exchange for shares and to sell them when the crisis is over. In this way, the stability fund will be worth nothing to the community.

What prevents the EU leaders from discussing such a funding system for the Euro zone countries?

One of the reasons is political. If any of the European leaders or bankers makes a similar proposal in public and alone, then the spreads of the country concerned will reach the sky or the shares of the bank will fall significantly. Such a decision may be taken only by consensus. Currently, this is not possible because the necessary leadership will is lacking.

The second reason is also important. If such a decision is taken, Germany loses its right to leave the Euro zone. Greece, which has a deficit, can not leave the currency union even if it wants to but Germany can do it.

Germany has sacrificed a lot for the euro. Why do you think it would like to leave the union?

I do not think it wants but that does not mean that it can not. If Spain gets into a financial collapse, I believe that Germany will seriously consider leaving the Euro zone. And while all the other countries know that Germany has this option, no matter how unacceptable it could be, it gives a big trump in the hands of Chancellor Merkel. Countries with stable economies such as Austria, Germany, Holland and Denmark have the option to withdraw if they consider that the situation is getting worse. Germany can not leave the union any longer if the plan for the Eurobonds and the European Central Bank, which we discussed, is enforced. As if California to decide to leave the United States. Whether it wants it or not, it can not leave the USA, because the federal debt is common and the proportion of that particular state in the total debt can not be calculated.

Do you think the reforms in the public sector are correct, given that the private sector took the burden of unemployment and of many of the difficulties?

The Greek State is extremely inefficient compared with other countries. Another problem is the revenues. They are less than expected. If, however, costs are referred to as a percentage of the GDP, we will see that there is no big difference compared to the same indicator in the UK or France.

So, I think that the main problem in Greece is related to the revenues and the poor management of the public sector rather than to the government expenditure. Another factor that contributes to this gap in the revenues is that the richest in Greece do not pay taxes or at least a substantial part of them. If we look at the tax returns of the Greeks to see how many the rich in the country are it will come out that there are almost none. However, if we look around us, we will see many wealthy people. So, they find a way not to pay their taxes - something that ordinary people on the payroll can not do. These people always pay their taxes whether they want it or not.

Regarding the public sector, I want to emphasize that the civil servants are permanently appointed in all countries in the world. Whenever there is a crisis the private sector is the one that suffers the heavy blow of unemployment.

There are over 800,000 civil servants in the narrow public sector. Isn’t this a large number for a country like Greece? And given that their wages are not low.

No, I do not think so. If you look at the statistics on the workforce in other European countries involved in the public sector, you will see that it is in the range of 20% -28% of the total number of workers in each country. In terms of salaries, I can say that, in fact, they are lower than the average value for the Euro zone countries. Of course, this is associated with the productivity of the public sector. In other words, the problem of the Greek public sector is not its volume, but that it has low revenues and that it is not productive.

The decision to dismiss civil servants to reduce the costs in the budget is wrong because the crisis is a free fall. The rule that if the one loses the other will gain, or if the state sector loses the private sector will gain, does not work in this case. Now the more the one loses the more the others lose.

Thus, if 200,000 people in the public sector are dismissed today this will have no positive impact on the private sector. Quite the opposite since the countries are not like the companies. The GDP is a product created by public and private spending. It is disastrous in times of recession when private investment is reduced to reduce the government one too. The time to reduce the state sector is not the time of recession but the time of economic growth. First, we have to deal with the crisis and then, to look at the reforms in the public sector.

At the last press conference the Troika of the International Monetary Fund, the European Central Bank and the European Commission announced that the government will carry out mass privatization, which will accumulate 50 billion euros by 2015 and will be able to cover part of its foreign debt. Do you think this plan is realistic and feasible?

I think that to collect as much money from privatization is more wishful thinking than reality. I do not think Greece avails so attractive assets so as to collect 50 billion euros. Moreover, there will be debt restructuring soon which is like we to haircut ourselves. I mean that if we end up selling any property in order to prepay part of the foreign debt and then to announce its haircut by 30% is just silly. I do not think that privatization should be carried out when there are talks about some kind of debt restructuring. Moreover, the crisis pushes the prices and we are at risk to sell for mere song assets that can be privatized under better conditions later.

Tags: EconomyMarketsForeign debtBank crisisYanis VaroufakisEuropean union
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