Mosler/Pilkington: Response to Yanis Varoufakis Regarding Our Eurozone Exit Plan

By Warren Mosler, an investment manager and creator of the mortgage swap and the current Eurofutures swap contract and Philip Pilkington, a journalist and writer based in Dublin, Ireland

Recently the Greek economist Yanis Varoufakis responded to the euro exit plan that we published on Naked Capitalism a few days ago. While Varoufakis was broadly supportive of the plan if an exit was absolutely necessary, he criticised some of the details therein.

Before we deal with some of the issues he raised – some of which are very important – we should first note as clearly as possible that neither one of us is advocating exit from the Eurozone for any countries therein. We both agree with Varoufakis that this would probably be a more painful option than simply staying in the currency union even with the current austerity programs in place.

In addition to this, both of us have published pieces arguing that the Eurozone will likely weather this crisis and the ECB, in some shape or form, will probably step in to backstop the debt of the peripheral governments in the coming months.

We merely published our sketch of an exit plan because both of us believe that it is always good to have a Plan B at the ready should any contingencies arise. We also think that having a viable plan in hand strengthens peripheral governments bargaining power vis-à-vis their neighbours.

But more on this in a moment. First, let us deal with some of the issues that Varoufakis raised. (All numbered points in italics are Varoufakis’, below is our response):

1. All contracts by the government to the private sector (abroad and domestically) will be renegotiated in the new currency after the initial depreciation of the latter. In other words, domestic suppliers will face a large haircut instantly. Many of them will declare bankruptcy, with another large lump sum loss of jobs.

First of all, there may not be any initial depreciation of the new currency if the government initiating the exit gets the exchange rate right. Since the new currency is required to pay taxes we anticipate that there should be a fairly consistent demand for it especially when it is first introduced.

Take the example of a domestic industry – say, a cement manufacturer that sells its goods to the government. It would be paid in the new currency and provided that the currency’s value remains somewhat constant the new currency can then be used to pay workers. In addition to this they will, as they do now, price their output relative to their costs so there would be no threat of bankruptcy.

Perhaps the key point here is that we do not anticipate a severe shortfall of demand for the new currency. Since it is released into the system slowly, and since it is required to extinguish tax liabilities, and finally since there will be an immediate need for cash in circulation, it should be widely sought after by economic actors.

If, on the other hand, a company has loans outstanding in euros they may need to convert some of their profits from the new currency into euros to service these obligations. Again, this has as much to do with how large the profits they accumulate are, as it does with the exchange rate between the two currencies. If their real income falls they might take a hit. But such is business.

Then there is the question of where these businesses get their inputs. If these inputs come from the domestic economy they will be able to pay for these in the new currency. If they come from abroad they will cost more money, if indeed the new currency does depreciate when introduced and even then the costs would be passed on to the consumer.

2. The banks will run dry and will not be kept open by the ECB. Which means that the only way Ireland or Greece or whoever adopts this plan can keep its banks open is if they are recapitalised in the new domestic currency by the Central Bank. But this means that bank account deposits will, de facto, be converted from euros to the new currency; thus annulling the beneficial measure of no compulsory conversions of bank holdings into the new currency.

This seems to us the most important point that Varoufakis raises. European banks do indeed have problems with both euro and dollar denominated liquidity and these problems will only worsen should there be a default and exit. Hence, we are back to the prospect of bank runs and other financial nasties.

In this case the government in question would, of course, only be able to provide liquidity in the new currency. The problems caused by this will only be as substantial as the amount by which the exchange rate between the new currency and the euro diverges. In the meantime, depositors will be exchanging euros for the new currency in order to meet ongoing payments (payrolls, taxes etc.). Once again, we underline the fact that we believe that the demand for the new currency would be quite strong and devaluation limited.

However, if a bank’s net worth (equity capital) falls below required minimums for any reason, the government will have to take it over and reorganise it. Options will then include: selling the bank as an ongoing business or selling the assets to other institutions. Both of these could lead to large losses for equity holders and, if the losses are severe enough, losses for depositors. It is not unheard of for depositors to suffer losses of the order of 25% during liquidation. We do advocate full deposit insurance be put in place to protect deposits denominated in the new currency, but deposits in euros will still be at risk and in this sense Varoufakis’ concerns have merit.

3. The authors claim that the above ill effects will be lessened by the government’s new found monetary independence which will enable it to discontinue austerity programs immediately and adopt counter-cyclical fiscal policy, as Argentina did after its default and discontinuation of the pesos-dollar peg. This may be so but all comparisons with Argentina must be taken with a large pinch of salt. For Argentina’s recovery, and associated fiscal policies, was far less due to its renewed independence and much more related to a serendipitous rise in demand for soya beans by China.

The extent to which soya bean price rises led to the Argentine recovery is subject to much debate. Certainly, it allowed Argentineans access to foreign reserves which they could use to extinguish foreign loans, but to what extent it was the cause of the recovery is a definite grey area. We hold that the fiscal policies initiated by the Kirchner government that removed substantial fiscal drag played a significant role in the recovery.

Varoufakis, by saying: “Argentina’s recovery, and associated fiscal policies, was far less due to its renewed independence and much more related to a serendipitous rise in demand for soya beans by China”, seems to imply that the fiscal policy expansion was somehow ‘allowed’ by the rising soya bean demand and the influx of foreign currency reserves. This is not the case. When Argentina ended the dollar peg they became able to extend government spending in as large quantities as they saw fit – that is, practically speaking: reducing fiscal drag by as much as the inflationary pressures created thereby were tolerated.

After depegging, Argentina’s fiscal position could be run into deficit without risking insolvency or causing interest rates to skyrocket, both of which were the key constraints on government spending throughout the dollar peg era. In this way, the Argentinean example is perfectly viable as a comparison to a Eurozone country undertaking an exit. If the exit is undertaken and a floating exchange rate adopted, fiscal policy can be run into deficit until political limits, devaluation or inflation allows it to run into deficit no more.

4. While it is true that the weaker currency will boost exports, it will also have a devastating effect: The creation of a two tier nation. One nation that has access to hoarded euros and another that does not. The former will acquire immense socio-economic power over the latter, thus forging a new form of inequality that is bound to operate as a break on development for a long while – just like the inequality that sprang up in the post 1970s period did enormous damage to our countries’ real development (as opposed to GDP growth numbers) in the second post-war phase.

Once again, the currency may not depreciate very significantly but even if it does, as the economy is brought back to full employment and output through reduced fiscal drag and increased exports, the government is then free to address distributional issues as it sees fit. The key point here would be to highlight these issues clearly prior to the exit taking place.

5. Last, but certainly not least, even if one country exits the eurozone in this manner, the eurozone will unwind within 24 hours. The European System of Central Banks will break instantly down, Italian spreads will hit Greek levels, France will turn instantly into a AA or AB rated country and, before we can whistle the 9th Symphony, Germany will have declared the re-constitution of the DM. A massive recession will then hit the countries that will make up the new DM zone (Austria, the Netherlands. possibly Finland, Poland and Slovakia) while the rest of the former eurozone will labour under significant stagflation. The new intra-European currency wars will suppress, in unison with the ongoing recession/stagflation, international and European trade and, therefore, the US will dive into a new Great Recession. The postmodern 1930s that I keep speaking of will be a tragic reality.

We should again reiterate that we are not actually calling for an exit. We simply believe that the governments should have a contingency plan and, most importantly, that this contingency plan would steer them away from the very real desire to peg their new currency to either the euro or to some other foreign currency in the case of default. As we wrote in the original plan, should this happen we expect another Argentinean/Russian style financial collapse within a few years of the new currency peg being adopted.

We should also point out that having a viable exit plan and having this exit plan and its possible results openly talked about gives the peripheral countries more bargaining power vis-à-vis their austerity loving neighbours. At the moment we should be focused on drafting any sort of national strategy that can give power back to sovereigns vis-à-vis the Eurozone. (In this, we know that Varoufakis sympathises as he has recently shown interest in our jobs program funded by tax-backed bonds which one of the authors [Pilkington] is currently trying to flog in Ireland).

We also think that it is unlikely that an exit will actually occur. We both think that the ECB will almost undoubtedly step in to backstop the unruly debt burdens of the periphery. However, this will probably mean that the periphery will be kept on ‘life support’ while austerity continues to be imposed upon it. Once again, it is imperative that countries within the periphery have as many bargaining chips as possible in their negotiations with their fellow Europeans.

Lastly, we should note that, should a nation exit the Eurozone in the manner we have outlined, a worldwide deflationary collapse might actually work to their advantage. Why? Because with their new currency they could undertake an Argentinean-style jobs guarantee program which would maintain full employment domestically while real terms of trade shifted dramatically in their favour as worldwide prices fell. Or, to put it another way: peripheral countries like Ireland would no longer have to rely on export-oriented growth in a world plagued by massive deflationary contraction. Instead they could run fiscal deficits to maintain full employment and high living standards while having little concern for the potential devaluation of the new currency caused thereby because worldwide prices would be falling at the same time.

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  1. Linus Huber

    “Argentinean example is perfectly viable as a comparison to a Eurozone country undertaking an exit”

    I have serious doubts that today a default will work similar to those prior to the start of the credit contraction. Well, the deflation is fought against by all Governments, still it will show its ugly head again and again until it finally wins out. In this environment, a defaulting country may face much higher interest rates from the very start, that is if free markets are allowed to operate. The dangers are considerably higher today for the risk on / risk off trades are producing increasingly extreme volatility and put systems to live threatening tests.

    1. Philip Pilkington

      “In this environment, a defaulting country may face much higher interest rates from the very start, that is if free markets are allowed to operate.”

      If a country issues its own currency and doesn’t have an exchange rate peg their central bank will have control over interest rates.

  2. Lafayette


    I’ve not been a big fan of the “greedy borrowers” theory of the mortgage crisis, particularly now, since the people who clearly bought too much house relative to their incomes defaulted quickly, in the 2007-2008 time frame, and are different than the people who are hitting the wall now.


    But the above does not defuse the argument that Greenspan had lowered the cost of money (interest rates) in the hopes, within a Credit Economy, of promoting Consumption and therefore Employment – thus keeping Republican Presidents in office. It is not a bad tactic, but one must be careful of the Demand side of the economy.

    Which reacts inordinately in our society because people fixates on spending ala “Shop till you drop”; meaning we live beyond our means. Moreover, there were those consumers who accepted the predatory lending of subprime loans because they thought they were “smarter than the market” in a asset-price bubble – by getting in a out of the market to make a quick-kill.

    Yes, most of those, now five years down the road since “flipping a condo” was in its heyday are now also being foreclosed due to long-term unemployment. But that does not negate the initial economic premises detailed above.

    We cannot escape this factual evidence, particularly in America. Because if we wish to push it aside and blame only the bankers – which 99.9% of the bloggers do – then we prepare the ground for the next SuperMess that will befall us. And I submit that it will not take another 80 years, the distance between the Great Recession and the Great Depression.

    And I need not quote Santayana again. It’s wisdom is evident to anybody with a respect for historical recurrence.


    Yes, the bankers were indeed part and parcel the instigators and manipulators of low-interest induced lending. The SubPrimes should never have existed as a financial credit product. They should never have been packages and assigned Triple-A ratings, then sold to debt-investors in the US and around the world.

    All that smells to high heaven of fraudulent commercial practice, and, yes, somebody should go to jail. And that somebody should be in a very high place so as to make a salutary lesson to the rest of the industry. Because apparently they have learned nothing. So the next time around a different group – but every bit as avaricious – will try making a megabuck a month by means of some sordid financial engineering machination.

    And the above are not the only ingredients of the Present Mess:
    * Reagan’s precipitous lowering of marginal income tax rates to ridiculously low levels primed the machination pump.
    * Our regulatory oversight agencies, which should have reacted to the realty asset-price bubble vigorously by means of auditing banks for the creditworthiness quality of their loans, were also asleep at the wheel. Why? Because the Bush Administration neutered their efficacy in the matter of market oversight, one of their primary responsibilities.


    What happened was no more nor any less than the same phenomenon rife in pre-1929 Wall Street – people trying to make a quick buck on asset-price appreciation. No one foresaw the calamity possible from their behavior.

    And so, in a helter-skelter, winner-take-all economy, the worst possible scenario possible did happen – the consequences of which took a full decade and a world war to repair.

    As well as much misery across America. Have we already forgot Steinbeck’s “The Grapes of Wrath”?

    Well, they are on the table again …

    1. Rex

      ‘Twould seem to me that Lafayette has posted this longish reply in the wrong thread. More appropriate for “Chase Banker Describes Predatory Mortgage Lending Practices “.

  3. Fiver

    Argentina has resources, but resources were NOT the sole driver for its recovery, as explained here in a piece that on completing I discovered originally appeared on NC:

    In any case, the REAL problem for Europe (and China, and Japan and the rest of the world that is already resource poor) IS the lack of cheap resources, a problem which will not be addressed any better by being bound to a an economy based on infinite debt-creation.

    We have hitched ourselves to a model that cannot slow down, even if we can see the wall approaching. By loosing the economy from any sense of “scarcity” by emitting ever more credit, ever more rapidly, our activity and consumption has expanded to occupy the “space” created. In fact, it MUST occupy that space, even if what we are doing is completely mad. The problem is that the REAL world is not configured that way. There ARE limits, there IS such a thing as scarcity, and it’s staring us right in the face.

    Here’s a talk by Chris Martenson. I’m well aware that he’s pitching gold and other PM. Please look past the investment stuff, which is to me completely irrelevant. It’s the issues and how badly we’ve mistaken the last few decades of debt-driven “growth” as a permanent condition that are vital. It isn’t the debt itself. It’s how very cheap debt over a long time has completely warped what we take to be “normal”, i.e., long enough so we cannot even perceive that a level of activity that constitutes hurtling down the road at every higher speed is anything other than insane.

  4. Robert Dudek

    From your analysis, it doesn’t seem like exiting the Eurozone is any worse (and might be better) than being forced into further austerity measures. In the former, at least the governments will have policy tools available to ameliorate the economic downturn.

  5. Maju

    Point 1: “First of all, there may not be any initial depreciation of the new currency if the government initiating the exit gets the exchange rate right”.

    Not realistic, sorry: (unless this refers to a strong economy state such as Germany) speculative movements will unavoidably sink the new currency into nothingness in a matter of days or weeks. That’s in fact a reason why leaving the euro (except maybe to adopt the US dollar instead – ???) is not an option.

    Exiting the euro is economically suicidal for a globally integrated economy, specially a small country like Greece or Portugal, lacking economical and political entity to support a new currency.

    For such countries kicking Germany out, and therefore weakening the euro and the extremist constraints on the ECB, is a much better option instead. But that’s a bad solution for Germany, which would lose an empire that way.

    Point 2: a “corralito” (automatic conversion of all accounts to the new currency) is unavoidable for any state exiting the euro. Your only opposition is that you believe certain things that are most unreal to others, including me. An economic plan should not be based on faith.

    Point 3: “the economy is brought back to full employment”

    No way! Full employment is gone for good. Unlike the USA, most European states have never really had anything close to full employment and notably not those with lowest social spending and less specialized productive economies. The ghost of creeping growing unemployment is here to stay and probably grow, no matter what the monetary policy is… eventually leading to a socialist solution unavoidably, via revolution most likely.

    Point 5: “We simply believe that the governments should have a contingency plan”…

    The contingency plan is to declare bankruptcy and keep printing euros. Who does not have a contingency plan is the Eurozone/ECB/IMF/Merkozy.

    Nobody is going to exit under pressure because it is even more suicidal than staying. It’s easier to threaten with bankruptcy and force Merkozy to do something even if in a negotiated way.

    In the end everybody knows that it is the overvaluing of euro the main cause of all these problems and that a depreciation will be the eventual result. This is for some reason unspoken but it is the only clear thing in all this mess: the euro is too high and that is damaging the southern European economies: inflation is the solution. If for that reason Germany must leave, let them do what they have to do.

    1. Jose

      @ Maju

      Overvaluation of the euro is not the main cause of the problems of the periphery.

      For example, a country like Portugal sends 75% of its exports to the eurozone – so, a depreciation of the euro vis a vis other currencies will be able to affect only about a quarter of its exports.

      1. Maju

        It is: Portugal (most Portuguese industries and services) can’t compete inside nor outside the Eurozone: outside is obvious why: they are comparatively too expensive. Inside may be less obvious but again they are comparatively too expensive: China or Brazil… or even other EU members like Britain or Poland, who are not in the Eurozone, are much more competitive.

        It is the main reason why Southern European economies have lost competitiveness: they are trying to compete at “German” and not “Polish” prices – but they have the “Polish” kind of products to sell, so nobody buys them: not in EU and much less outside.

  6. craazyman

    you dudes are right.

    anyone who studies Contemporary Analysis knows that money is a unique phenomenon that can’t really be modeld even by stock and flow metaphors. flow yes, but stock no.

    money is more like oxygen in the lungs or electricity. it can’t be “stored” as a stock any more than oxygen in the lung can be stored or electricity (which sort of can be stored in a battery, but let’s forget that for a second).

    the money is only real in relation to its flow value. if you have a stock of apples in your kitchen cabinet, they don’t depend for value on the flow of apples. they retain value in a stock state. but money does not. it’s only real if the flow is real.

    so the new drachma would facilitate the flow, which is now a stagnant euro pool in the Greek Lung, probably being hoarded in a lung sac and probly a Goldman Sac.

    so the flow is crucial, as you dudes point out, when it flows to facilitate the social cooperation that is now asphyxiated, it will realize a flow value and in so doing, it will illuminate and empower a stock value. since the flow value is only active in relation to social cooperation, which is its ultimate value createor.

    so the flow value of a new drachma will clearly depend on some manifestation of enhanced social cooperation among the populace, and so we have to look to group consciousness structures (i.e. social institutions in the public and private sphere) to evaluate flow potential.

    these are somewhat strained, but probably not totally dysfunctional.

    I’d say “let it rip”.

    1. mansoor h. khan


      It is the flow (proper velocity of money) which keeps the stock value somewhat stable and therefore useful and fulfills its social function (as you state).

      The flow has to be proper in space (geography – between various regions who use the same currency and across time – Germany is a surplus producer now – this should reverse over time and Greece should become the surplus producer and Germany surplus user — say in 10 years ).

      Fractional Reserve Banking (Debt base Currency Creation/Issuance) is becoming obsolete.

      The world economy is crying for fundamental money reform (money should be spent into existence and not lent into existence). ECB should print and give money to Greece/Spain/Portugal for social stability and peace (the most valuable assets in a society).

      The problem is that incentives are wrong. It is very simple:

      Money Supply = Gov Money (spend in existence) + Bank Money (lent into existence)

      Less bank money issuance means less income and power for the global bankers.

      Incentives are all wrong. Bankers would rather have a depression and re-start the lending cycle.

      Mansoor H. Khan

  7. pebird

    No one should expect an easy transition out of the Euro. But at least the country would regain its sovereignty and be able to push out the EU technocrats and take responsibility for its own economy.

    What that might do to the rest of the EZ is irrelevant, but why that should start a run on all the remaining EZ countries is not clear. Perhaps the rest of Europe would be inclined to build a democratic rather than austerian fiscal union.

  8. Pat

    A parallel, native currency will not work because inevitably that currency will be seen (rightly) as Monopoly Money and anyone who has it will immediately convert it to Euros.
    Everyone knows that the government intends to print as much as possible of Drachmas, Lira, Irish Pounds etc., for instance, to recapitalize the banks, which will be a huge amount. Euros are limited and backed by Germany, more or less. Native currency is potentially unlimited, and backed by nothing except the ability of governments to collect taxes in the future.
    So anyone paid in native script will try to convert everything except tax money to Euros. So if government pays government workers in native script, 30-40% goes to pay taxes, the rest (60-70%) gets converted to Euros.
    Who is going to supply the Euros for conversion, and to support the currency? Not the central governments, which do not have extra Euros to spare.
    And if governments collect taxes in native script, how are they going to service bond debts in Euros? They can’t.

    The only solution is for all countries to revert to native currencies at once, with realistic pegs to other currencies, and to institute emergency measures, including:
    – capital controls, limiting outflows to other countries
    – prohibition on citizens having accounts in foreign currencies (ie repatriation of offshore accounts)
    – forced conversion of bank and other deposits
    – recapitalization of banks with freshly-printed money
    – measures to stop currency speculation
    – redenomination of debts in native currency, and partial sovereign defaults and restructured debt
    – possibly price and wage controls, to stop inflation

    Obviously this will cause a depression in Europe, which is why everyone is trying to kick the can down the road. But this path is unavoidable.
    The depression would only last a year or two, and then things would return to normal, albeit with pre-Euro living standards for most of Europe. Countries would be forced to balance imports and exports, and would depreciate their currencies to do that.

    1. Philip Pilkington

      “The only solution is for all countries to revert to native currencies at once, with realistic pegs to other currencies…”

      That is EXACTLY what should not be done. Doing this will provoke another, much more severe financial crisis as the government that exits runs out of foreign currency reserves and interest rates hit the ceiling.

      1. Mr. Eclectic

        And in essence, that is what the euro is: 17 national currencies pegged to an exchange rate dictated by the ECB, without the fluctuations that were permitted under the ECU. In fact, euro is kind of a new gold standard for the EMU countries.

        And it would be a different instance of the paradox of thrift: Now we have everyone racing to the bottom via austerity, in the new paradigm everyone would be using just a different vehicle, that of currency devaluation. Screw gravity and terminal velocity, I’m hitting rock bottom first!

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