Michael Pettis: Syriza and the French Indemnity of 1871-73

Yves here. Get a cup of coffee. This is a fabulous, readable but nevertheless carefully argued and therefore long post on the drivers of the Eurzone crisis and what the parameters for a sensible resolutions are. Or you can read an FT Alphaville post (hat tip Jeffrey C) that hits some of the high points from this insightful article and adds some data and news tidbits.

By Michael Pettis, a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management. Cross posted from China Financial Markets

European nationalists have successfully convinced us, against all logic, that the European crisis is a conflict among nations, and not among economic sectors. Today’s Financial Times has an article discussing the travails of Greece’s new Finance Minister, Yanis Varoufakis as he takes on Germany:

In a small but telling sign of the frosty relations between Berlin and the new Greek government, the German finance ministry last week criticised Mr Varoufakis for failing to follow through with a customary courtesy call following his appointment. Mr Schäuble, meanwhile, has warned Greece not to attempt to “blackmail” Berlin with demands for debt relief.

This is absurd. The European debt crisis is not a conflict among nations. All economic systems— and certainly an entity as large and diverse as Europe— generate volatility whose balance sheet impacts are mediated through different political and economic institutions, among which usually are domestic monetary policy and the currency regime. With the creation of the euro as the common currency among a group of European countries, monetary policy and the currency regime could no longer play their traditional roles in absorbing economic volatility. As a result, for much of the euro’s first decade, a series of deep imbalances developed among various sectors of the European economy. Because Europe’s existing economic and political institutions had largely evolved around the national sovereignty of individual countries, and also because the inflation and monetary histories of individual countries varied tremendously before the creation of the euro, it was probably almost inevitable that these imbalances would manifest themselves in the form of trade and capital flow imbalances between countries.(1)

We have a great deal of experience in modern history with the kinds of imbalances from which Europe suffered and continues to suffer, and from the historical precedents three things are clear. First, the imbalances that led eventually to the current crisis had their roots in hidden transfers between different economic sectors within Europe, and not between countries. It is only because of deep institutional differences among the member countries that these imbalances manifested themselves largely in the form of trade imbalances between the different countries in Europe. These hidden transfers artificially forced up the savings rates in some countries and, for reasons that I have discussed elsewhere, it is a matter of necessity, well understood in economics (although too often forgotten by economists), that artificially high savings rates in one part of an economic system must result in higher productive or non-productive investment (in advanced countries usually the latter) or artificially low savings in another part of that system.

Second, deep distortions in savings and investment historically have almost always led to an unsustainable increase in debt, and Europe was no exception. For many years European debt has risen faster than European debt-servicing capacity, but the gap between the two has not been recognized and written down, and instead manifests itself in the form of excessively high and rising debt burdens whose costs have eventually to be assigned.

Third, and most worryingly, it has always been easy for extremists and nationalists to exploit the grievances of the various economic groups to distort the meaning of the crisis. One way is to transform it into a class conflict and another way is to transform it into a conflict among member states. Resolving a debt crisis involves nothing more than assigning the losses. In the current crisis these costs have to be assigned to different economic sectors within Europe, but to the extent that the assignation of costs can be characterized as exercises in national cost allocation, it is easy to turn an economic conflict into a national conflict.

Most currency and sovereign debt crises in modern history ultimately represent a conflict over how the costs are to be assigned among two different groups. On the one hand are creditors, owners of real estate and other assets, and the businesses who benefit from the existing currency distortions. One the other hand are workers who pay in the form of low wages and unemployment and, eventually, middle class household savers and taxpayers who pay in the form of a gradual erosion of their income or of the value of their savings. Historically during currency and sovereign debt crises political parties have come to represent one or the other of these groups, and whether they are of the left or the right, they are able to capture the allegiance of these groups.

Except for Greece, in Europe the main political parties on both sides of the political spectrum have until now chosen to maintain the value of the currency and protect the interests of the creditors. It has been the extremist parties, either on the right or the left, who have attacked the currency union and the interests of the creditors. In many cases these parties are extreme nationalists and oppose the existence of the European Union. If they succeed in taking control of the debate, the European experiment will almost certainly collapse, and it will take decades, if ever, for a European union to revive.

But while distortions in the savings rate are at the root of the European crisis, many if not most analysts have failed to understand why. Until now, an awful lot of Europeans have understood the crisis primarily in terms of differences in national character, economic virtue, and as a moral struggle between prudence and irresponsibility. This interpretation is intuitively appealing but it is almost wholly incorrect, and because the cost of saving Europe is debt forgiveness, and Europe must decide if this is a cost worth paying (I think it is), to the extent that the European crisis is seen as a struggle between the prudent countries and the irresponsible countries, it is extremely unlikely that Europeans will be willing to pay the cost. As my regular readers know, I generally refer to the two different groups of creditor and debtor countries as “Germany” and “Spain”, the former for obvious reasons and the latter because I was born and grew up there, and it is the country I know best. I will continue to do so in this blog entry.

It is a horrible irony that while the view that the European crisis is a conflict between prudent Germany and irresponsible Spain could easily tear apart the European experiment, it terribly muddles Europe’s actual experience and may create a false impression of irresponsibility. To see why, it is useful to start with a little history. Nearly 150 years ago Spain’s “Glorious Revolution” of 1868 saw the deposition of Isabella II and the collapse of the first Spanish Republic. More importantly for our purposes it also unleashed within continental Europe a conflict over the succession to the Spanish throne which ultimately, through a series of circuitous events, resulted in France’s declaration of war on Prussia in July 1870. This was widely seen in France as a chance partially to even the score over Prussia’s victory during the Napoleonic wars, but in the end France’s revanchist fantasies were frustrated. By early 1871, the French army was roundly defeated by Prussia, which during that time had unified the various German states as the German Empire under the Prussian king.

There were at least two important results of France’s military defeat. Of minor importance for the purpose of my blog entry, but interesting nonetheless for those obsessed with modernism and with France’s late 19th Century cultural history, like me, the Franco-Prussian War will always be remembered for its role in the subsequent creation and collapse of the Paris Commune. This event left its mark on the thinking of many cherished artists and intellectuals, from Manet and Rimbaud to Proudhon and Haussman.

But the other, to me, very interesting and far more relevant consequence was the French indemnity. As part of the privilege of conquest and as a condition for ending the occupation of much of northern France, Berlin demanded war reparation payments originally proposed at 1 billion gold francs but which eventually grew to an astonishing 5 billion, at least in part because of an explicit decision by Berlin to impose a high enough burden permanently to cripple any possible French economic recovery.

To give a sense of the sheer size of this payment, usually referred to in the literature as the French indemnity, this was equal to nearly 23% of France’s 1870 GDP.(2) Germany’s economy at the time, according to Angus Maddison, was only a little larger than that of France, so Germany was the beneficiary of a transfer over three years equal to around 20% of its annual GDP. This is an extraordinarily large transfer. I believe the French indemnity was the largest reparations payment in history — German reparations after WWI were in principle larger but I don’t think Germany actually paid an amount close to this size, and certainly not relative to its GDP.

Transfer Beneficiary

Astonishingly enough France was able to raise the money very quickly, mostly in the form of two domestic bond issues in 1871 and 1872, which were heavily over-subscribed. One of the most complete studies of the French indemnity, I think, is a booklet by Arthur Monroe published in 1919.(3) According to Monroe, the first issue of 2 billion in perpetual rentes was issued in June 1871, a mere 48 days after the treaty was signed, and was heavily oversubscribed. The second issue was even more successful:

Thirteen months after announcing the first loan the government opened subscriptions for a second, this time for three billions, again in 5 per cent rentes, but issued at 842. The response to this was astounding, for more than twelve times the amount desired was subscribed, more than half of the offers coming from foreign countries.

Monroe goes on to note that “it is no small compliment to the credit of France at this time to note that about one-third of the foreign subscriptions were from Germany,” so when we think about the net transfer to Germany, it was less than 5 billion francs. Although Monroe says that more than half the subscriptions came from outside France, and one-third of those were German, with twelve times oversubscription there is no way for me to estimate how much was actually allocated to German purchasers so I have no estimate for the amount by which the 5 billion should be adjusted.

The payments were made in the form of bills of exchange and to a lesser extent gold, silver, and bank notes, and Berlin received the full payment in 1873, two years before schedule. It was during this time that Germany went fully onto the gold standard, and obviously enough the massive indemnity made this not only possible but even easy. It also guaranteed currency credibility almost from the start, and it may jolt modern readers to know that at the time monetary credibility was not assumed to be part of the German DNA, so the additional credibility was welcome.

What does all of this have to do with Syriza? A few weeks ago I was discussing with a group of my Peking University students Charles Kindleberger’s idea of a “displacement”, and I proposed, as does Kindleberger, that the 1871-73 French indemnity is an especially useful example of a displacement from which we can learn a great deal about how financial crises can be generated.(4) It then occurred to me that the French reparations and their impact on Europe could also tell us a great deal about the euro crisis and, more specifically, why by distorting the savings rate wage policies in Germany in the first half of the last decade would have led almost inexorably to the balance of payments distortions that may eventually wreck the euro.

It is a nice accident that the French indemnity accelerated Germany’s adoption of the gold standard, because massive transfer payments from Germany to peripheral Europe were probably necessary for many of these countries to adopt the euro, in some ways their own version of the gold standard. Before jumping into why I think the French indemnity is relevant to the Greek crisis, I want to make three quick points:

1. I went into more detail on how France raised the money than might at first seem necessary for the purpose of this blog entry because it actually illustrates a potentially useful point. In the first third of my 2001 book,(5) I discussed extensively the historical role of global liquidity on the evolution of national balance sheets and sovereign debt crises. One important point is to distinguish between financial crises that occur within a globalization cycle and those that end a globalization cycle. Whereas the latter are often devastating and mark the end for many years of economic growth, the former — like the 1994 Tequila crisis or the 1997 Asian crisis, or even the 1866 Overend Gurney crisis — may seem overwhelming at first, but markets always recover far more quickly than most participants expect. When markets are very liquid, and in their leveraging-up stage, they can absorb large debt obligations easily, and because they can even turn these obligations into “money”, they almost seem to be self-financing.

The 1858-73 period was one such “globalization period”, with typical “globalization” characteristics: explosive growth in high-tech communications and transportation (mainly railways), soaring domestic stock and real estate markets, booming international trade, and a surge in outflows of capital from the UK, France, the Netherlands and other parts of Europe to the United States, Latin America, the Far East, the Ottoman Empire, and other financial “frontiers”. I would argue that this is why, despite Berlin’s expectation that the indemnity would cripple the French economy, it was surprisingly easy for France to raise the money and for its economy to continue functioning. Germany, similarly, struggled over many aspects of the WWI reparations, but after 1921-22, when global markets began their decade-long globalization boom, driven by extraordinarily high US savings (and characterized by the familiar globalization sequence: electrification of American industry, the spread of telephones, automobiles, radios, cinema, and other communications and transportation technologies, booming international trade and capital flows, the Florida real estate mania, stock market booms, and, of course, the rise to fame of one Charles Ponzi), Germany found it relatively easy to raise the money that famously became part of the reparations recycling process — until, of course, the 1930-31 global banking crisis, after which Germany was forced into default. This may be relevant as we think about any possible future European sovereign bond restructuring. Any attempts to assess their impacts based on historical precedents must distinguish between periods of ample liquidity and the radically different periods of capital scarcity. Once the liquidity contraction begins, every debt restructuring will be brutally painful, unlike now when they are absorbed almost without a thought.

2. I explain in my book that the French indemnity actually increased global liquidity by expanding the global supply of highly liquid “money-like” assets. Of course Germany’s money supply increased by the amount of the transfer (not the full amount, because part of the subscriptions actually came from Germany), but this was not offset by an equal reduction in France’s money supply. The creation of a huge, highly liquid, and highly credible instrument, the two French bond issues, involved the creation of “money” in the Mundellian sense. While the transfer of money from France to Germany might have seemed systemically neutral, in fact it resulted in a systemic increase in global “money”.

3. From an “asset-side” analysis, as I discuss in my January 21 blog entry, the transfer of capital over three years from France to Germany equal to more than 20% of either country’s annual GDP would have had very predictable impacts — they should have been very negative for France, as Berlin expected, and very positive for German. In fact the actual results were very different. This is because there are monetary and economic conditions under which liability structure matters much more, and conditions under which it matters much less. Economists and the policymakers they advise are too quick to ignore these differences, perhaps because there is not as well-formulated an understanding of balance sheets in economics theory as in finance theory, so that when someone like Yanis Varoufakis proposes that there are ways in which partial debt forgiveness increases overall economic value, instead of merely creating moral hazard, worried economists often recoil in horror, while finance or bankruptcy specialists (and an awful lot of hedge fund managers) shrug their shoulders at such an obvious statement.

It is mainly the third of the above three points that is relevant for the current discussion about European sovereign obligations. One might at first think that France’s indemnity, at nearly 23% of GDP over three years, might have been devastating to the economy. It certainly left France with a heavy debt burden, but its immediate economic impact was not nearly as bad as might have been expected. Wikipedia’s assessment is pretty close to the consensus among historians:

It was generally assumed at the time that the indemnity would cripple France for thirty or fifty years. However the Third Republic that emerged after the war embarked on an ambitious programme of reforms, introduced banks, built schools (reducing illiteracy), improved roads, spreading railways into rural areas, encouraged industry and promoted French national identity rather than regional identities. France also reformed the army, adopting conscription.

Far more interesting to me is the impact of the indemnity on Germany. From 1871 to 1873 huge amounts of capital flowed from France to Germany. The inflow of course drove the obverse current account deficits for Germany, and Germany’s manufacturing sector struggled somewhat as an increasing share of rising domestic demand was supplied by French, British and American manufacturers. But there was a lot more to it than mild unpleasantness for the tradable goods sector. The overall impact in Germany was very negative. In fact economists have long argued that the German economy was badly affected by the indemnity payment both because of its impact on the terms of trade, which undermined German’s manufacturing industry, and its role in setting off the speculative stock market bubble of 1871-73, which among other things unleashed an unproductive investment boom and a surge in debt.

Do Capital Inflows Cause Speculative Frenzies?

As money poured into German, its current account surplus of course reversed into deficits, which by definition means that there was a large and growing excess of investment over savings. Part of this was caused by rising German consumption, but much of it was caused by surging investment. Unlike in peripheral Europe 135 years later, the capital inflows were not mediated through commercial banks into the pockets of households, businesses, and local governments but rather ended up wholly in the hands of Berlin. Germany in the 1870s had an opportunity denied to peripheral Europe in the 2000s, in other words, to control the use of the massive transfer. I will get back to this point a little later.

As money poured into Germany the German economy boomed, along with German consumption, investment (a growing share of which went into projects at home and abroad that turned out in retrospect to be overly optimistic), and into the Berlin and Viennese stock markets. By early 1873 more experienced German, Austrian and British bankers were quietly warning each other of a speculative mania, and they were right. The stock market frenzy culminated in the 1873 global stock market crisis, which began in Vienna in May, shortly after the beginning of the 1873 World Fair, and rapidly spread throughout a world brimming with liquidity (a large part of the first French indemnity payments went directly to London to pay outstanding German obligations). By September the crisis reached the United States with the collapse of Jay Cooke and Company, one of the leading US private banks, and for the first time in history the New York Stock Exchange was forced to close, for ten days. The subsequent global “Long Depression”, which lasted until 1896, was felt especially severely in Germany, one of whose first reactions was the collapse of the railway empire of Bethel Henry Strousberg, a major industrialist at the time whose prehistory included a stint in jail for absconding from a previous job as financial agent with other people’s money (petty criminals who become industrial magnates seem to be another characteristic of globalization periods).

Within a few years of the beginning of the crisis attitudes towards the French indemnity had shifted dramatically, with economists and politicians throughout Germany and the world blaming it for the country’s economic collapse. In fact so badly was Germany affected by the indemnity inflows that it was widely believed at the time, especially in France, that Berlin was seriously contemplating their full return. The great beneficiary of French “largesse” turned out not to have benefitted any more than Spain had benefitted from German largesse 135 years later.

This is interesting. The German economy responded to French capital inflows in almost the same way that several peripheral European economies responded to large German capital inflows 135 years later. It might seem an unfair comparison at first because the 1871-73 transfer to Germany was huge, but it turns out that the magnitude of the French transfer into Germany was broadly similar, in fact probably smaller, to the inflows into peripheral Europe. By the way I should point out that I use Spain to represent peripheral Europe not just, as I stated earlier, because I was born and grew up there, and so know it well, but also because Spanish government polices were in many ways among the most “responsible” in Europe, and so cannot really be blamed for the aftereffects. Spain’s debt and its fiscal accounts were far stronger than the European average and stronger than those of Germany in most respects.

It is hard to imagine that the amount of inflows into Germany from 1871 to 1873 could have been comparable to the inflows Spain experienced, but if anything they were actually smaller. Here is why I think they were. From 2000-04 Spain ran stable current account deficits of roughly 3-4% of GDP, more or less double the average of the previous decade. Germany, after a decade of current account deficits of roughly 1% of GDP, began the century with slightly larger deficits, but this balanced to zero by 2002, after which Germany ran steady surpluses of 2% for the next two years.

Everything changed around 2005. Germany’s surplus jumped sharply to nearly 5% of GDP and averaged 6% for the next four years. The opposite happened to Spain. From 2005 until 2009 Spain’s current account deficit roughly doubled again from its 3-4% average during the previous five years. The numbers are not directly comparable, of course, but during those four years Spain effectively ran a cumulative current account deficit above its previous 3-4% average of roughly 21-22% of GDP. Seen over a longer time frame, during the decade it ran a cumulative current account deficit above its earlier average of roughly 31-32% of GDP.

These are huge numbers, and substantially exceed the French indemnity in relative terms. Of course the current account deficit is the obverse of the capital account surplus, so this means that Spain absorbed capital inflows above its “normal” absorption rate equal to an astonishing 21-22% of GDP from 2005 to 2009, and of 31-32% of GDP from 2000 to 2009. However you look at it, in other words, Spain absorbed an amount of net capital inflow equal to or substantially larger than Germany’s absorption of French reparations during 1871-73. It is not just Spain. In the 2005-09 period a number of peripheral European countries experienced net inflows of similar magnitude, according to an IMF study, including Portugal, Greece and several smaller east European countries.

By the way in principle it isn’t obvious which way causality ran between capital account inflows and current account deficits (the two must always balance to zero). In 1871-73 it is obvious that German capital inflows drove current account deficits. In 2005-09 European countries might similarly have run large current account deficits because of the capital inflows imposed upon them, but it is also possible that they had to import capital by eagerly borrowing German money in order to finance their large current account deficits. To put it differently, German money might have been “pushed” into these countries, as the “blame Germany” crew has it, or it might have been “pulled” in, by the need to finance their spending orgies, as the “blame anyone but Germany” crew insist. For those who prefer to think in more precise terms, Germany either created or accommodated the collapse in Spanish savings relative to Spanish investment. For those — including, distressingly enough, most economists — who believe a country’s savings rate must be driven only, or mainly, by domestic household preferences, please refer to “Why a savings glut does not increase savings“.

The structure of the balance of payments itself does not tell us conclusively which caused which, German outflows or Spanish inflows, and no one doubts that there was a strong element of self-reinforcement that was an almost automatic consequence of the payments process, as I have discussed in the January 21 entry on this blog. If it were the latter case, however, it would be an astonishing coincidence that so many countries decided to embark on consumption sprees at exactly the same time. It would be even more remarkable, had they done so, that they could have all sucked money out of a reluctant Germany while driving interest rates down. It is very hard to believe, in other words, that the enormous shift in the internal European balance of payments was driven by anything other than a domestic shift in the German economy that suddenly saw total savings soar relative to total investment. I have discussed many times before what happened in Germany that resulted in the savings distortion that convinces me that the flows originated in Germany, as it has many others.

What is interesting is how similar the consequence of the inflows were even though Berlin was able to control the disbursement of the inflows in a way of which Madrid could only dream. And yet from 1871 to 1873 the German economy experienced one of the most dramatic stock market and real estate booms in German history, and although the flow of funds into government coffers rather than through banks to businesses and households ensured that the subsequent rise in German consumption was not early as extreme as it was in Spain, Germany did engage in a frenzy of investment at home and abroad in which a substantial share of the inflows was effectively wasted in foolish investment. Of course unlike Spain today, there never was any question about Germany’s obligation to repay the transfer. It had come, after all, in the form of reparations demanded by a victorious army, and not in the form of loans. In fact it took the massive US lending to Germany in the 1920s for German investment misallocation to lead to wholesale default on external debt.

Syriza’s Challenge

It is useful to remember this history when we confront the consequences of Greece’s recent elections. Syriza’s victory in Greece has reignited the name-calling and moralizing that has characterized much of the discussion on peripheral Europe’s unsustainable debt burden. I think it is pretty clear, and obvious to almost everyone, that Greece simply cannot repay its external obligations, and one way or another it is going to receive substantial debt forgiveness. There isn’t even much pretence at this point. This morning financial advisor Mish Shedlock, sent me (as a joke? as a sign of despair?) German newspaper Zeit‘s interview with Yanis Varoufakis entitled “I’m the Finance Minister of a Bankrupt Country”.

Even if the question of who is to “blame”, Greece or Germany, were an important one, the answer would not change the debt dynamics. It would take the equivalent of Ceausescu’s brutal austerity policies in Romania, which were imposed during the 1980s in order for the country fully to repay its external debt, to resolve the Greek debt burden without a write-down. Given that Ceausescu’s policies led directly to the 1989 revolution, which culminated in both Ceausescu and his wife being executed by firing squad, the reluctance in Athens to imitate Romania in the 1980s is probably not surprising.

But to say Greece simply cannot repay isn’t the end of the story. As Europe moves towards a more rational debt policy with Greece, I would say that there are three important things to remember:

1. There is an enormous economic cost, not to mention social and perhaps political, to any delay. I worry about the terrifyingly low level of sophistication among policymakers and the economists who advise them when it comes to understanding balance sheet dynamics and debt restructuring. Greece’s debt overhang imposes rising financial distress costs and increasingly deep distortions in the institutional structure of the economy over time, and the longer it takes to resolve, the greater the cost.

I think most analysts understand that costs will rise during the restructuring process. I am not sure they understand, however, that delays will impose even heavier costs during the many years of subsequent adjustment. There is a lot of bad blood and recrimination among the various parties. I suspect that some of those who oppose Syriza are probably revolted by the thought that a rapid resolution of the Greek crisis would rebound to Syriza’s credit, but they must understand that dragging out the restructuring process will impose far greater long-term costs on the Greek people than they think.

My friend Hans Humes, from Greylock Capital, has been involved in more sovereign debt restructurings than I can remember, and he once told me with weary disgust that while it is usually pretty easy to guess what the ultimate deal will look like within the first few days of negotiation, it still takes months or even years of squabbling and bitter arguing before getting there. We cannot forget however that each month of delay will be far more costly to Greece and her people than we might at first assume.

2. From what I read, much of the focus of the restructuring will be aimed at determining an acceptable and manageable debt-servicing cashflow for Greece. There is a mistaken belief that this is the only “real” variable that matters, and the rest is cosmetics. I don’t agree. Greece’s nominal debt structure will not just affect the debt-servicing cashflows but will also determine future behavior of economic agents.

There are at least two important functions of an economic entity’s liability structure. One is to determine the way operating profits or economic growth is distributed among the various stakeholders, or, put differently, to determine economic incentive structures. The other is to determine the way external shocks are absorbed. This is why the restructuring process is so important and can determine subsequent economic growth. The face value and structure of outstanding debt matters, and for more than cosmetic reasons. They determine to a significant extent how producers, workers, policymakers, savers and creditors, alter their behavior in ways that either revive growth sharply or slowly bleed away value. Incentives must be correctly aligned, in other words, so that it is in the best interest of stakeholders collectively to maximize value (this rather obvious point is almost never implemented because economists have difficulty in conceptualizing and modelling reflexive behavior in dynamic systems). Rather than let economists work out the arithmetic of the restructuring based on linear estimates of highly uncertain future cashfllows, whose values are themselves affected by the way debt payments are indexed to these cashflows, Greece and her creditors may want to unleash a couple of options experts onto the repayment formulas and allow them to calculate how volatility affects the value of these payments and what impact this might have on incentives and economic behavior.

3. In fact the overall restructuring must be designed so that the interests of Greece, the producers who create Greek GDP, and the creditors are correctly aligned. To date sovereign debt restructurings have almost never included the instruments that reflect the instruments in corporate debt restructurings that accomplish this alignment of interests, largely becausse these instruments have not been “invented”. Among other things the negotiating committee might want to dust off the GDP warrants that were included in Argentina’s last debt restructuring.

If the restructuring is well designed, within a year of the restructuring I think we could easily see Greek growth surprise us with its vigor. I was delighted to see that Greece’s new Finance minister agrees. An article in Monday’s Financial Times starts with the claim that “Greece’s radical new government revealed proposals on Monday for ending the confrontation with its creditors by swapping outstanding debt for new growth-linked bonds, running a permanent budget surplus and targeting wealthy tax-evaders.” Today’s Financial Times has an article by Martin Wolf that mentions the benefits of “a growth linked bond”. In The Volatility Machine I spend chapters explaining how to create liability structures that minimize external shocks, align the interests of creditors and citizens, and improve the quality of payments for creditors, and I show why these make a restructuring much more successful for all parties concerned. This is just basic finance theory. Yanis Varoufakis should really take the lead in designing an entirely new form of sovereign debt restructuring, not just for Greece but for the many countries, in Europe and elsewhere, that will soon follow it into default.

Enough people seem to hate or fear Syriza that there will be little attempt to approach Greece’s problems with enough imagination to give either party what it needs, but in fact with the right cooperation, imagination, and intuitive understanding of how balance sheet structures change overall value creation, a greek debt restructuring could leave both sides far better off than either side might imagine. Of course if done right this matters far more than for just its impact on the Greek economy. While everyone probably agrees that Greece simply cannot proceed without debt forgiveness, less widely agreed, but no less obvious in my opinion, is that there are a number of other European countries that also need debt forgiveness if they are to grow. Because I was born and grew up in Spain, and my French mother founded and ran a successful business there which my family and I still own, I am confident that I know the country well enough to say that even with some impressive reforms having been implemented under Mariano Rajoy, Spain is nonetheless one of these countries. I suspect that many other countries including Portugal, Italy, and maybe even France are too.

I also know, however, that Spanish debt prospects are an extremely sensitive and emotional topic, and I will be roundly condemned for saying this. Today’s Financial Times has a very worrying article explaining why Madrid wants to be seen among the hardliners in opposing a rational treatment for Greece: “when it comes to helping Greece, there will be no such thing as southern solidarity or peripheral patronage.” This is the reverse of what it should be doing. In an article for Politica Exterior in January 2012, I actually proposed, albeit without much hope, that Spain take the lead and organize the debtor countries to negotiate a sustainable agreement, but in its fear of Podemos, the Spanish equivalent of Syriza, and its determination to be one of the “virtuous” countries, it strikes me that Madrid is probably moving in the wrong direction economically. Ultimately, by tying itself even more tightly to the interests of the creditors, Rajoy and his associates are only making the electoral prospects for Podemos all the brighter.

As it is, and for reasons that may have to do with recent history, Francisco Franco, and the psychological scars he left among those of my generation, any discussion in Spain is likely to be subsumed under non-economic considerations, especially angry denunciations of moral virtue and moral turpitude. These non-economic considerations are irrelevant. In fact some of them are very important and even admirable. But they must be understood within a more neutral context.

As far as I can tell there are at least four important reasons that opponents of debt forgiveness, not just in Germany but also in Spain, have proposed as to why demands for debt forgiveness would be a long-term disaster for Spain:

1. Spain’s economic future depends on its remaining a member of Europe in good standing. To demand debt forgiveness (let alone a renegotiation of the currency union) would cause a financial crisis and relegate Spain to backward country status.

2. If Spain fails to honor its debt commitments it will be considered forever an unreliable prospect and will be frozen out of future investment and trade.

3. More importantly, it would be morally wrong. The German people provided Spain with real, hard-earned resources which Spaniards misused. It is not fair or honorable that Spain punish the German people for its generosity.

4. Spain had a real choice, and it chose to spend money wantonly on consumer frivolities and worthless invest projects. It got itself into this mess only because of the very poor economic policies a corrupt Madrid implemented. Had Spaniards acted more like Germans and refrained from excessive consumption — the result of a flawed national character trait — it would not have suffered from speculative stock and real estate market bubbles, wasted investment and, above all, an unsustainable consumption boom and a collapse in savings. It is unfortunate that ordinary Spaniards must suffer for the venality of tis leaders, but ultimately they are responsible.

These four arguments, which are the same arguments made about other highly indebted European countries, have been made not just by the greedy Germans of caricature, but also, more importantly, by indignant locals. They genuinely believe that their country behaved stupidly and must pay the price, and it is hard not to respect their sincerity.

Blaming Nations

The last of the four points is I think the most powerful of the arguments and among the most confused, and it is the one I hope I have at least partly addressed with my discussion of the French indemnity, and that I will discuss more below, but I should briefly address the first three, and of course while I refer to Spain, in fact much of what follows is as true of Greece and other heavily indebted European borrowers as it is of Spain:

1. There is no question that a renegotiation of Spanish debt or of its status within the currency union would be accompanied by economic hardship and perhaps even a crisis. But compared to what? The Spanish economy is already in disastrous shape and there is compelling historical evidence that countries suffering under excessive debt burdens can never grow their way out of their debt no matter how radical and forceful the reforms.

This means that by refusing to negotiate debt forgiveness, not only must Spain be prepared to live with unbearably high unemployment and slow growth for many years, which would undermine the social, political and financial institutions that are the real determinants of whether a country is economically advanced or economically backwards, but in the end after many years of suffering Spain would be forced into debt forgiveness anyway, only now with an economy in far worse shape. Historical precedents also suggest that while the real reforms Madrid has implemented seem to have failed, in fact it is the debt constraint that has prevented their impacts on productivity from showing up as economic growth. I suspect that many of these reforms have actually been very positive for Spain’s long-term productivity. In that sense I think Mariano Rajoy and his government have put in an impressive performance. Unless Madrid waits too long, they may very well even unleash tremendous growth once debt is written down, but until the debt is resolved, they will not seem to have worked. Throughout modern history even “good” reforms have failed to generate growth in nearly every previous case of overly indebted countries, unless of course those reforms sharply reduce outstanding debt.

Some economists argue the facts on the ground already contradict my pessimism. Last week Madrid announced excitedly that GDP grew by 1.7% last year, its fastest pace in seven years. The Financial Times pointed out that Spain was well-positioned in 2015 to continue to take advantage of lower energy costs, a weaker euro, and a cut in personal and corporate taxes, to which I would add lower metal prices, massive QE, and stronger than expected consumption. But even if these tailwinds are permanent, and they clearly are not, nominal GDP growth is still much lower than the growth in the debt burden. This is as good as it gets, in other words, and it is not good enough. As the debt burden continues to climb, and as social and political frustrations mount, Spain will slide inexorably backwards into the backward-country status it wants so badly to avoid.

2. There is overwhelming evidence — the US during the 19th Century most obviously — that trade and investment flow to countries with good future prospects, and not to countries with good track records. The main investment Spain is likely to see over the next few years is foreign purchases of existing apartments along the country’s beautiful beaches. Once its growth prospects improve, however, with among other things a manageable debt burden, foreign businesses and investors will fall over each other to regain the Spanish market regardless of its debt repayment history. This is one of those things about which the historical track record is quite unambiguous.

3. It was not the German people who lent money to the Spanish people. The policies implemented by Berlin that resulted in the huge swing in Germany’s current account from deficit in the 1990s to surplus in the 2000s were imposed at a cost to German workers, and have been at least partly responsible for Germany’s extremely low productivity growth — most of Germany’s growth before the crisis can be explained by the change in its current account — rather than by rising productivity.

Moreover because German capital flows to Spain ensured that Spanish inflation exceeded German inflation, lending rates that may have been “reasonable” in Germany were extremely low in Spain, perhaps even negative in real terms. With German, Spanish, and other banks offering nearly unlimited amounts of extremely cheap credit to all takers in Spain, the fact that some of these borrowers were terribly irresponsible was not a Spanish “choice.” I am hesitant to introduce what may seem like class warfare, but if you separate those who benefitted the most from European policies before the crisis from those who befitted the least, and are now expected to pay the bulk of the adjustment costs, rather than posit a conflict between Germans and Spaniards, it might be far more accurate to posit a conflict between the business and financial elite on one side (along with EU officials) and workers and middle class savers on the other. This is a conflict among economic groups, in other words, and not a national conflict, although it is increasingly hard to prevent it from becoming a national conflict.

But didn’t Spain have a choice? After all it seems that Spain could have refused to accept the cheap credit, and so would not have suffered from speculative market excesses, poor investment, and the collapse in the savings rate. This might be true, of course, if there were such a decision-maker as “Spain”. There wasn’t. As long as a country has a large number of individuals, households, and business entities, it does not require uniform irresponsibility, or even majority irresponsibility, for the economy to misuse unlimited credit at excessively low interest rates. Every country under those conditions has done the same. What is more, even if the decision about the disbursement of the inflows could have been concentrated in the hands of a single, responsible entity, the experience of Germany after 1871 suggests that it is nearly impossible to prevent a massive capital inflow form destabilizing domestic markets. Germany, after all, was much better placed than Spain later was for two important reasons. First, unlike Spain today, Germany was not saddled with an enormous debt obligation which it had to repay. Second, in 1871-73 the transfers went straight to Berlin, which was able fully to control the disbursements. In 2005-09, on the other hand, the transfers to Spain left behind an enormous debt burden and were discrete and widely dispersed in ways that were almost certainly biased in favor of the most optimistic or foolish lenders and the most optimistic or foolish borrowers.

And this is a point that’s often missed in the popular debate. Over and over we hear — often, ironically, from those most committed to the idea of a Europe that transcends national boundaries — that Spain must bear responsibility for its actions and must repay what it owes to Germany. But there is no “Spain” and there is no “Germany” in this story. At the turn of the century Berlin, with the agreement of businesses and labor unions, put into place agreements to restrain wage growth relative to GDP growth. By holding back consumption, those policies forced up German savings rate. Because Germany was unable to invest these savings domestically, and in fact even lowered its investment rate, German banks exported the excess of savings over investment abroad to countries like Spain.

Why didn’t Germans, rather than Spaniards, take advantage of the excess savings to fund a consumption boom. The standard response is to point to German prudence and Spanish irresponsibility, but it must be remembered that as German and Spanish interest rates converged (driven in large part by German capital flows into Spain), because they adopted a common currency at a time when Spanish inflation had been higher than German, the real interest rate in Spain was lower than that of Germany. As German money poured into Spain — with Spain importing capital equal to 10% of GDP at its peak — the massive capital inflows and declining interest rates ignited asset price bubbles, and even more inflation, setting off in Spain what Charles Kindleberger called a “displacement”. This locked Spain into a classic self-reinforcing cycle of rising asset prices and declining interest rates.

What is more, under normal (i.e. pre-euro) conditions the Spanish peseta would have dropped and Spanish interest rates risen, but the conditions of the euro prevented both adjustment mechanisms, and to make things worse this gave Berlin’s policies far more traction than anyone expected, locking Germany into an over-reliance on capital exports to Spain, the obverse of Germany’s current account surplus. German workers gave up wage growth in order to eke out employment growth, which itself depended on an ever rising surplus. Throughout it all there was little productivity growth as German companies reduced their investment share in the economy.

Meanwhile German banks, flush with the higher savings that low wage growth, rising surpluses and growing corporate profits all but guaranteed, continued eagerly to export into Spain the savings they simply could not invest at home. So why didn’t ”Spain” step in and put an end to this process by refusing to borrow German money? Because, again, there was no “Spain”. There were millions of households and business entities all of whom were offered unlimited amounts of lending at very low or even negative interest rates, and under the conditions of euro membership Madrid could not intervene. If German and Spanish banks blanketed the country with lending proposals, Madrid could do nothing to stop it (at least not without raising domestic unemployment and igniting the the ire of Brussels and Berlin). As long as there were some greedy, overly optimistic or foolish borrowers (and in a country of 45-50 million people how could there not be?), German and Spanish banks fell over themselves to make loans. The money had to be absorbed by Spain and there was no mechanism to ensure the quality of its absorption.

Above all this is not a story about nations. Before the crisis German workers were forced to pay to inflate the Spanish bubble by accepting very low wage growth, even as the European economy boomed. After the crisis Spanish workers were forced to absorb the cost of deflating the bubble in the form of soaring unemployment. But the story doesn’t end there. Before the crisis, German and Spanish lenders eagerly sought out Spanish borrowers and offered them unlimited amounts of extremely cheap loans — somewhere in the fine print I suppose the lenders suggested that it would be better if these loans were used to fund only highly productive investments.

But many of them didn’t, and because they didn’t, German and Spanish banks — mainly the German banks who originally exported excess German savings — must take very large losses as these foolish investments, funded by foolish loans, fail to generate the necessary returns. It is no great secret that banking systems resolve losses with the cooperation of their governments by passing them on to middle class savers, either directly, in the form of failed deposits or higher taxes, or indirectly, in the form of financial repression. Both German and Spanish banks must be recapitalized in order that they can eventually recognize the inevitable losses, and this means either many years of artificially boosted profits on the back of middle class savers, or the direct transfer of losses onto the government balance sheets, with German and Spanish household taxpayers covering the debt repayments.

Who is Fighting Whom?

I am not rejecting the claim that “Spain” acted irresponsibly, in other words, only to place the blame on “German” irresponsibility. But it is absolutely wrong for Volker Kauder, the parliamentary caucus leader of German Chancellor Angela Merkel’s Christian Democrats, to say, according to an article in last week’s Bloomberg, that “Germany bears no responsibility for what happened in Greece. The new prime minister must recognize that.” There was indeed plenty of irresponsible behavior on both sides, during which time wealth was transferred from workers of both countries to create the boom and to absorb the subsequent bust, and wealth will be transferred again from middle class households of both countries to clean up the resulting debt debacle.

Put differently, there is no national virtue or national vice here, and there is no reason for the European crisis to devolve into right-wing, nationalist extremism. The financial crisis in Europe, like all financial crises, is ultimately a struggle about how the costs of the adjustment will be allocated, either to workers and middle class savers or to bankers, owners of real and financial assets, and the business elite. Because the major parties have refused to acknowledge the nature of this allocation process, and have turned it into a fight between a creditor Germany, on the one hand, and indebted peripheral European countries on the other, I was able to make in 2010-11 one of the easiest predictions I have ever made in my career — whichever extremist parties, whether of the right or of the left, who first went on the offensive against Germany, the bankers and the currency bureaucrats, I predicted, would surge in electoral popularity and would eventually reformulate the debate.

That is why the question of debt forgiveness must be reformulated by the centrist parties first. Fundamental to the argument that Spain (or Greece, or anyone else) has a moral obligation to repay in full its debt to Germany are two assumptions. The first assumption is that “Spain” borrowed the money from “Germany”, and that there is a collective obligation on the part of Spain to repay the German collective. The second assumption is that Spain had a choice in what it could do with the German money that poured into the country, and so it must be held responsible for its having mis-used hard-earned german funds.

The first assumption is, I think, easily dismissed. Germany exported capital because by repressing wage growth, Berlin ensured the high profits and low consumption that forced up its national savings rates. Instead of employing these savings to invest in raising the productivity of German workers (in fact domestic investment actually declined) it offered them either to fund German consumption at high real interest rates (and there were few takers), or through German and Spanish banks this capital was offered to other European households for consumption or to other European businesses for investment. The offers were taken up in different ways by different countries. In countries where the offered interest rates were very low or negative, the loans were more widely taken up than in countries where real interest rates were much higher. To ascribe this difference to cultural preferences rather than to market dynamics doesn’t make much sense.

What started slowly quickly accelerated, again for reasons of market dynamics. As the huge inflow into Spain set off stock market and real estate booms, some Spanish households, feeling wealthier, borrowed to increase their consumption, and many Spanish households and businesses borrowed to buy real estate. In the subsequent frenzy, credit standards collapsed as Spanish and German banks fought to gain market share, and as optimism soared, consumption grew to unsustainable levels, until eventually Spain was so overextended that it collapsed. The same story can be told elsewhere. In fact this is what happened in Germany after the French indemnity.

As for the second assumption, that Spain had a choice, this too should be quickly dismissed. Clearly Spanish households and businesses in the aggregate behaved, in retrospect, with astonishing abandon. But could they have done otherwise — did they have a choice? Almost certainly not. Germany did not when it received the French indemnity, and I don’t think there are many, if any, cases of countries that were able to absorb productively such massive inflows. In every case I can think of, massive capital inflows were accompanied by speculative bubbles and financial crises. Even the US in 19th century — urgently needing foreign capital to finance a massive amount of productive investment that could not be financed out of domestic savings, making it the best candidate possible to receive massive foreign inflows — was not able to absorb surges in inflows without seeing the creation of bubbles, investment scandals, and financial crises. Is it reasonable to insist that Spain’s failure to choose a path that no other country in history seems ever to have chosen indicates greater irresponsibility on the part of the borrowers than of the lenders? As long as there is a widely diverse range of views among Spanish individuals and businesses about prospects for the future, as long as there is a mix of optimists and pessimists, or as long as there are varying levels of financial sophistication, I think it would have been historically unprecedented if at least some Spanish entities did not respond foolishly to aggressive offers of extremely cheap credit, especially once this cheap credit had set off a real estate boom.

In summary, I think there are several points that those of us who want “Europe” to survive should be making.

1. The euro crisis is a crisis of Europe, not of European countries. It is not a conflict between Germany and Spain (and I use these two countries to represent every European country on one side or the other of the boom) about who should be deemed irresponsible, and so should absorb the enormous costs of nearly a decade of mismanagement. There was plenty of irresponsible behavior in every country, and it is absurd to think that if German and Spanish banks were pouring nearly unlimited amounts of money into countries at extremely low or even negative real interest rates, especially once these initial inflows had set off stock market and real estate booms, that there was any chance that these countries would not respond in the way every country in history, including Germany in the 1870s and in the 1920s, had responded under similar conditions.

2. The “losers” in this system have been German and Spanish workers, until now, and German and Spanish middle class savers and taxpayers in the future as European banks are directly or indirectly bailed out. The winners have been banks, owners of assets, and business owners, mainly in Germany, whose profits were much higher during the last decade than they could possibly have been otherwise

3. In fact, the current European crisis is boringly similar to nearly every currency and sovereign debt crisis in modern history, in that it pits the interests of workers and small producers against the interests of bankers. The former want higher wages and rapid economic growth. The latter want to protect the value of the currency and the sanctity of debt.

4. I am not smart enough to say with any confidence that one side or the other is right. There have been cases in history in which the bankers were probably right, and cases in which the workers were probably right. I can say, however, that the historical precedents suggest two very obvious things. First, as long as Spain suffers from its current debt burden, it does not matter how intelligently and forcefully it implements economic reforms. It will not be able to grow out of its debt burden and must choose between two paths. One path involves many, many more years of economic hell, as ordinary households are slowly forced to absorb the costs of debt — sometimes explicitly but usually implicitly in the form of financial repression, unemployment, and debt monetization. The other path is a swift resolution of the debt as it is restructured and partially forgiven in a disruptive but short process, after which growth will return and almost certainly with vigor

5. Second, it is the responsibility of the leading centrist parties to recognize the options explicitly. If they do not, extremist parties either of the right or the left will take control of the debate, and convert what is a conflict between different economic sectors into a nationalist conflict or a class conflict. If the former win, it will spell the end of the grand European experiment.


I leave my readers with three questions that I hope we can discuss in the comments section:

1. If a huge amount of capital, equal say to 10-30% of a country’s annual GDP, is forcibly distributed to an enormous group of entities within that country in a short time period, and if the only way in which to distribute this capital is through a wide variety of banks, with biases such that the more optimistic and irresponsible the bank, the more it profits, and the more optimistic and irresponsible the borrower, the more it receives, is it meaningful to refer to either side as behaving “irresponsibly”, and if so, which side? Does this sound like a loaded question? If it is, can it be rephrased in a less loaded way?

2. There have been many cases of large capital recycling in history — just in the last 100 years I can think of the recycling of the US trade surplus to Germany and other countries in the 1920s, the petrodollar recycling to Latin America in the 1970s, and the recycling to the US of the Japanese trade surplus in the 1980s and the Chinese trade surplus in the 2000s. These were all accompanied in the recipient country by stock, bond and real estate bubbles and by overconsumption and wasted investment. Have there been cases of large capital recycling that did not end in tears for the recipients? If so, how were they different?

3. What about the other side of the recycling? In most cases the recycling country also experienced bubbles and rising debt. Have there been cases that did not also end in tears and if so, how were they different?


(1) The imbalances themselves occurred in forms that are widely understood and for which we have many historical precedents. I discussed these in my book, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy (Princeton University Press, 2013). I am far from the only one to have done so. Martin Wolf’s excellent The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis (Penguin Press, 2014) presents a schematic account of the causes of the crisis, and in The Leaderless Economy: Why the World Economic System Fell Apart and How to Fix It (Princeton University Press, 2013) Peter Temin and David Vine set out with great clarity the framework within which Europe’s internal imbalances had inexorably to lead to the current outcome.

(2) Michael B. Devereux and Gregor W. Smith, “Transfer Problem Dynamics: Macroeconomics of the Franco-Prussian War Indemnity”, August, 2005, Queen’s University, Department of Economics Working Papers 1025

(3) Arthur E. Monroe, The French Indemnity of 1871 and its Effect (The MIT Press, 1919)

(4) Charles Kindleberger, A Financial History of Western Europe, (Routledge 2006)

(5) Michael Pettis, The Volatility Machine: Emerging Economics and the Threat of Financial Collapse (Oxford University Press, 2001)

Print Friendly, PDF & Email


  1. Swedish Lex

    I read both yesterday. Start with the Alphaville summary which is really good (and for free).

    The war in 1870 was sought by the Germans to create a new European hegemon and and carried out by Bismarck who fooled the French into a trap:

    Wiki: “Bismarck adroitly created a diplomatic crisis over the succession to the Spanish throne, then rewrote a dispatch about a meeting between king William of Prussia and the French foreign minister, to make it appear that the French had been insulted. The French press and parliament demanded a war, which the generals of Napoleon III assured him that France would win. Napoleon and his Prime Minister, Émile Ollivier, for their parts sought war to solve political disunity in France. On 16 July 1870, the French parliament voted to declare war on the German Kingdom of Prussia and hostilities began three days later. The German coalition mobilised its troops much more quickly than the French and rapidly invaded northeastern France. The German forces were superior in numbers, had better training and leadership and made more effective use of modern technology, particularly railroads and artillery.”

    Mitterand wanted the euro in order to be able to influence and control Germany through the combined strength of the other EU States (lead by France, of course) and by the EU Institutions. Successive French leaders, and pretty much all other European leaders, have since totally abdicated their responsibilities with regard to what Mitterand and Kohl started, which have transformed the euro into a kind of Frankenstein’s monster, impossible to control in pursuit of the entirely illusory and wacky aim of a greater D-mark über alles.

    Germany, and other euro states like the Dutch, all seem to have read and apply the philosophy of Nixon’s entourage; “If you have them by the balls, their minds and hearts will follow”. I would not rule out that the Germans, and perhaps the Dutch, truly believe that they not only can, but also would benefit from, kicking out Greece since that would create a precedent that would create such fear within the other Club Meds that they would continue to comply with any future instructions from Berlin.

    This logic however disregards the fact that extreme parties and not so extreme parties but very euro-hostile (understandably) are growing everywhere. Where it matters most is in France where the Front National in my view has a good chance of winning the élections (presidential and for parliament) in 2017. A France dominated by le Front National would mean the imminent collapse of the euro and of the European Union. No discussion.

    Germany would then have brought us all back to square one. Again.

    If this is how things will play out, then Greece had better leave the sinking ship pronto. Get a head’s start with their new currency a couple of years before the total implosion.

    There was about 1 million casaulties in the Franco-Prussian war 1870-71.

    Political leaders continue to be oblivious to the suffering they inflict.

    1. Ulysses

      “Political leaders continue to be oblivious to the suffering they inflict.”

      Yes, and part of the reason for that is because political leaders are rewarded by the super-wealthy, who they serve, for developing a deliberate obliviousness to the suffering of the non-wealthy.

      Michael Pettis hits the nail on the head here:

      if you separate those who benefitted the most from European policies before the crisis from those who befitted the least, and are now expected to pay the bulk of the adjustment costs, rather than posit a conflict between Germans and Spaniards, it might be far more accurate to posit a conflict between the business and financial elite on one side (along with EU officials) and workers and middle class savers on the other. This is a conflict among economic groups, in other words, and not a national conflict, although it is increasingly hard to prevent it from becoming a national conflict.

      The intensity of the crisis in Europe today stems from the massive downward social mobility among formerly prosperous groups. A situation, as Yves described so poignantly the other day, where medical doctors are forced to turn to prostitution for survival is an inherently unsustainable one. The ideal would be for the working and middle classes throughout the Eurozone to recognize their mutual interests– in kicking out the parasitical, kleptocrat-enabling political classes, and replacing them with people willing to represent their interests. The rise of Syriza, and Podemos, reflect the potential for this to actually happen, and this has the political servants of the kleptocracy desperate to put out this leftist brushfire before it spreads.

      The most dangerous possibility at this moment is that the kleptocrat-enablers will be tempted to welcome the ignition of hard-rightist brushfires as the quickest way to do this. This is clearly insane, but we must remember most of the European elites in power today were not even born by 1945, and even those who were, were only infants in the 1930s and 1940s.

      1. blub

        ” I would not rule out that the Germans, and perhaps the Dutch, truly believe that they not only can, but also would benefit from, kicking out Greece since that would create a precedent that would create such fear within the other Club Meds that they would continue to comply with any future instructions from Berlin.”

        As a German I can only second this. They are some problems with corruption and the US-type corporate influencing of political decisions but for a large part it is actually worse:
        German (center-left) politicians and especially high-level bureaucrats to a large extent believe that austerity does work and do not understand that their decisions are rebelled against because they are seen as economically wrong and not only because people refuse to suffer short-term pain for long-term gain.

        There are many reasons for this, e.g. the example of Germany in the early 2000s seems to “prove” that it has worked and, I think more importantly, an economic tradition which refuses activist monetary or fiscal strategies to macroeconomic management (ordoliberalism). (Btw. Finland seems to be the country which believes even more strongly in this than Germany and the Netherlands).
        They do not understand that this nonsensical strategy, even if it would be followed perfectly by southern Europe, would lead to >5% net exports of the eurozone which the world simply cannot absorb (the famous “Martians problem” described by Martin Wolf).

        I would also like to mention some aspects which are typically overlooked in the US or the UK:
        1.) “Pacta sunt servanda” is one of the key values of German societies. Rules must kept by both parties even if both are worse if they are kept.
        I listened to leading politicians telling me that the economic strategy is bullshit but because there is a formal agreement they are pursued and, even more extreme, that if there had been an agreement about fiscal transfers before the crisis, they would happen, but rules should not be changed halfway so they do not happen.
        This is very different from the utilitarian thinking in southern Europe or the Anglophile world.
        2.) For key political players of the center-left in Europe the experience in the 90s has been: “If we copy the center-right, we will win elections, otherwise we’ll lose”, which is something they never forgot. They do not understand that times may have changed.
        3.) There is a real problem in high-level German bureaucracies with an overrepresentation of people with a background in law. They really believe that they can change several hundred year old societies/countries by having them follow some treaties (see 1.)).
        4.) The German media is actually a really large problem and has become a real disgrace. I know George Packer is seen as part of the establishment on this blog but his profile on Angela Merkel and Germany more general is worth reading when it comes to the German media. The cohesion in the press from the center-left (Sueddeutsche, ARD, Zeit) to the center-right (ZDF, FAZ, Welt, Bild) when it comes to the euro crisis is mind-blowing.

        1. Carla

          Wow. I really appreciate this insight into Germanic culture and politics. Thank you so much.

          P.S. We all have just WAY too many lawyers. This is a huge problem in the U.S., and apparently in Germany as well. Here, it seems a law degree is the new MBA. The legal profession is poisoning everything. Tragic, really.

        2. Marko

          ” For key political players of the center-left in Europe the experience in the 90s has been: “If we copy the center-right, we will win elections, otherwise we’ll lose”, which is something they never forgot. They do not understand that times may have changed….”

          That’s a familiar pattern to those of us in the US. It was probably first evident with the election of Jimmy Carter , then blossomed fully with Clinton’s “triangulation”.

          That’s why , to so many of us , Syriza is like the first breath of air after a decades-long waterboarding session. I guess it remains to be seen whether that air contains any oxygen.

    2. Barry Fay

      @ Lex The idea that Bismarck “fooled the French into a trap”, thereby becoming themselves the aggressors in the Franco-Prussian War, is obvious anti-German propaganda – post WWII´s favourite pasttime! You then go on to say: “The French press and parliament demanded a war, which the generals of Napoleon III assured him that France would win. Napoleon and his Prime Minister, Émile Ollivier, for their parts sought war to solve political disunity in France.” – Oh, THOSE could be the reasons the French DECLARED WAR. That and swatting down the newcomers on the world scene. Try to see past the anti-German propaganda that continues to be rife in the media if you really want to understand what is going on. For instance, as the article makes perfectly clear, the situation is not between nations but between “economic groups”! And if you believe the BS about the Germans and the Dutch “believing” that they would benefit by kicking Greece out of the Euro, then let me please invite you to my next poker game!

  2. Brooklin Bridge

    As Mr. Pettis notes, this is not an easy process, not even in the assignment of blame.

    These four arguments, [to be a member of Europe in good standing, honor debt commitments, moral integrity of debtror, irresponsible spending spree on easy credit = flawed national character trait ] which are the same arguments made about other highly indebted European countries, have been made not just by the greedy Germans of caricature, but also, more importantly, by indignant locals. They genuinely believe that their country behaved stupidly and must pay the price, and it is hard not to respect their sincerity.

    One of the things I would be interested in is the negative influence the United States, or perhaps more accurately international capital, has had over these events unfolding in the manner Mr Pettis describes in Europe. It would appear that TPTB – the international fat cats – actually understand the process Mr. Pettis describes, albeit in a rudimentary lizard like way of hot and cold, and have been ruthlessly exacerbating it for the sole purpose of short term profit and exploitation. Ukraine and ultimately the prospect of WWIII is intrinsic to this discussion.

    1. juliania

      And under ‘negative influence’ please bookmark the 2008 election. A new New Deal was on the cards with that election and the massive support we gave Barack Obama, and he completely blew it. Mr. Pettis makes the point that sooner is better than later, and instead we have had interminable cankicking from the ptb whilst enormous profits have been made for the .01% It’s very hard to see that as anything but immoral.

      1. Carla

        Barack Obama certainly did not “blow it.” He decided early in life that he would be one of them, and not one of us. Toeing the line with big money while lying to the public is par for the course. It remains to be seen whether he will win the world championship in this contest, but he appears to be at the top of his game.

        1. ex-PFC Chuck

          The “Audacity of Hope” turned out to be the unprecedented, breath-taking scope of the bait-and-switch scam he was pulling off on the American public.

        2. JerryDenim

          I think he decided in 1995, when he watched his saintly, lover of the third-world, bleeding-heart liberal mother die penniless, almost alone, and without health insurance at 52 of ovarian cancer. Instead of being an inspiration, I think his mother was some sort of anti-inspiration. A reverse allegory for how not to live your life for young Barack Obama. Ayn Rand looked at communism as the supreme evil and decided a photo-negative opposite of socialism would be the key to life. I believe a young Barack Obama looked at the liberal, naive idealism of his mother and decided quietly, and in a very Machiavellian way, he would be her polar opposite while adopting the walk and talk of the left in order to mobilize political followers and benefactors. Barack Obama is a bit like the sociopathic Martian invaders in the 90’s sci-fi comedy, “Mars Attacks”. ‘We come in peace, we come in peace’ – right before he bails out Wall Street, ratifies the TPP, builds the Keystone pipeline and incinerates your face with his death ray. I believe he is a case study in cold, cruel effectiveness. Sasha and Malia will not have any worries in life, because their daddy is going to die an extremely rich man with very powerful, important friends. R.I.P. Ann Dunham.

      2. Brooklin Bridge

        I was unclear above, though I agree that Obama screwed us Royally (Haaavad you know), and I completely agree with Carla that he didn’t blow it; it’s intentional.

        What I was trying to say, however, is that Mr. Pettis describes the European experience as something taking place largely between the haves and have nots of Europe. That’s true, but international powers both political and economic, particularly from the US, have had a considerable, if not always visible, role or influence on the behavior of the Troika and of Germany, particularly of Merkel, and while the effects are to exacerbate and reinforce the intransigence of the Northern European elite, the intent has been simple American style short term profit and political hegemony with contempt for social cost and little regard to long term viability – as per usual. Note how closely our own brutish ideology produced for similar occasions in the US follows the four points mentioned above to come up with a fictitious class of moochers whose only purpose in life is to rob all law abiding decent ladies and gents of their hard earned inheritances, and to provide the middle class with a rich and hollowly satisfying experience of moral indignation that seems to elevate being robbed blind to the status of a human right. Note the insanity of insisting the Europeans levy draconian sanctions on Russia that have brought us to the brink of war while at the same time installing Biden’s son and a host of other Americans in positions of power and profit in Ukraine.

        Also, I think you hit on something, Juliania, when you mention, [the] interminable cankicking [I would say, “theft”] from the ptb whilst enormous profits have been made for the .01% It’s very hard to see that as anything but immoral.. Mr. Pettis at least seems almost too careful not to assign moral responsibility where it is due, and I’m left hoping that what ever his reasons, they prove fruitful, since it is clear where his intentions lie.

  3. Jim Haygood

    ‘If a huge amount of capital … is forcibly distributed to an enormous group of entities within that country in a short time period, and if the only way in which to distribute this capital is through a wide variety of banks, is it meaningful to refer to either side as behaving “irresponsibly”, and if so, which side?’

    Michael Pettis poses this question in a stylized ‘Germany-Spain’ context. But consider the same question in relation to the last twelve years (‘la docena trágica’) of the Greenspan Fed (1994-2005).

    With little fanfare, and no observable due process, the Greenspan Fed authorized commercial banks to engage in the shady subterfuge of ‘overnight sweeps,’ arbitrarily treating demand deposits (with reserve requirements) as saving deposits (with virtually no reserve requirements) for reserve accounting purposes. De facto larger reserves, along with transformative technological change (the rollout of internet service to households) set off what is retrospectively called the Super Bubble, driving US stocks to their highest valuation ever in early 2000. Bubble I expanded despite tightening fiscal policy, which briefly created cash surpluses in US fiscal accounts.

    Even as Bubble I was collapsing, the foundations of Bubble II were being laid with securitized mortgage-backed securities. A massive real estate bubble began launching in 2002, fully funded with freshly-created, ‘money good’ AAA debt securities (including CDOs) which US and European banks took up in unlimited quantities. Greenspan famously egged on Bubble II in 2004 by urging homeowners to refi with ARM loans, taking advantage of his ‘low, low’ 1% teaser rates. Predictably, Bubble II ended in tears in the 2008 crisis.

    So who behaved irresponsibly? Let’s not mince words: it was the purblind charlatan Greenspan.

    Michael Pettis accurately points out the cost of delaying a real resolution. Quantitative easing, seeking to paper over collapsed bubbles with fresh bubbles, is ante omnia a delaying device. As such, the cost of continuing Greenspandian monetary policy carries on metastasizing. Whereas bubbles once were local, involving single countries adopting John Law-inspired fiat-currency Ponzi scheming, now we have planetary bubbles. When Bubble III blows (I have it penciled in for 2016-2017), we may be collectively cast back to Cro-Magnon living standards.

    But for now, the QE pipers are blowing a beguiling tune, and we are obliged to dance to it, despite an obvious shortage of chairs when the music’s over (turn out the lights).

    1. DCR

      You are wildly optimistic in your expectation of 2016-2017. If the Greeks don’t cave in ten days we may be looking at March of 2015.

    2. DCR

      Jim, you are one of the limited number of folks who understand that Greenspan’s gutting of reserve requirements in the mid-90s launched us into the mess that is our current financial system. That was followed by profound indifference as the derivatives explosion began in earnest in 2000, followed by negative real interest rates, and now QE to the stars. Twenty short years to wreck a middle class.

  4. Uahsenaa

    Perhaps because I am left-ish myself, I feel the need to lob an objection against the characterization of Syriza or Podemos or Greens or what have you as “radical” or “extreme.” I haven’t seen any of these parties advocate for, say, the transfer of the ownership of the means of production to workers or state ownership of industries or a 100% estate tax or any of the planks of the Communist parties in the 19th century. Rather, the label of super duper extreme is applied to a party that dares to suggest that maybe, just maybe, debts involve contracts and contracts can be negotiated. Capitalist logic is never thrown to the side; in fact, it’s assumed in all these discussions, so maybe we can dispense with the never terribly subtle suggestions that Syriza are one step short of lobbing molotov cocktails and abolishing all parliamentary procedure for a dictatorship of the proletariat.

    I do appreciate, though, the level-headedness that comes of recalling historical analogues. Perhaps we might also recall that Argentina was allowed to renegotiate its debts in 2005 without being characterized as a slightly more reasonable alternative to Hitler. In all his interviews, Yanis appears perfectly calm and rational, insisting that we can all speak like adults, rather than raving like children.

    1. Yves Smith Post author

      I’ve repeatedly pointed out that Syriza is a middle of the road Social Democratic party at most. However, I gather its name in Greek really does translate as “radical left” so the media can pin them with that with abandon.

      1. uahsenaa

        It was a comment more on the Pettis piece and others in which those who seek to appear centrist construct a false equivalence between mild Socialists (Syriza) and very real fascists (Golden Dawn). I do, however, appreciate your efforts to evaluate things as there are, Yves.

  5. MartyH

    It was striking, to me, that Pettis reframes what’s going on not as a National problem but an “Economic Sectory” (gasp “Class Problem, even). If you adopt that frame rather then the “Nation as Person” rhetoric, what’s going on with “Globlization” is much clearer. Pettis’s clarity is much appreciated as it cuts through a lot of chauvinistic nonsense.

    A troubling thought is that if we adopt Pettis’s line of thinking and admit that “they” are winning the Grand Universal Cash Heist (GrUNCH, a Bucky Fuller-ism from a book on economics) where cash is Property of all classes.

    1. MartyH

      <sighs> … that’s what I get for only reading once. Yes, but Pettis is much deeper than that. But his discussion of Europe, brilliant as it is, begs the question of suppression of wages in other economies (the US in particular) and the impacts on imbalances like this of capital flows (hot money) seeking yield and causing/amplifying “problems” like Greece and Spain. It strikes me that the history lesson of The French Indemnity may be misunderstood as “be careful what you wish for.” My reading is tha the lesson intended is “people in fragile economies (glass houses) shouldn’t throw rocks.”

  6. Jim Haygood

    ‘The policies implemented by Berlin that resulted in the huge swing in Germany’s current account from deficit in the 1990s to surplus in the 2000s were imposed at a cost to German workers.’ — Michael Pettis

    If I recall correctly, this policy had its genesis in the question of how to finance German reunification in 1991. It was decided, effectively, to take the cost out of the hides of German workers on a ‘pay as you go’ basis, rather than resorting to debt financing.

    Apparently German wage repression continued well after the exigencies of reunification were over, for obvious reasons — owners of capital loved it. But what did they do with the capital raised by wage repression? Lent it out to Spain! And now their collective refrain is l’Espingouin paiera!

    1. susan the other

      Yes. I wondered how Michael Pettis left this detail out. Germany paid zillions for reunification. When they could no longer throw a big construction and infrastructure party they loaned out their rewards to Club Med. German workers have been screwed for decades. We never hear the stories of how unhappy they are that the money they are taxed is used in a headfake so that it doesn’t ever go to the Greek people at all. But Greeks are billed for it nonetheless.

  7. hemeantwell

    to take the cost out of the hides of German workers on a ‘pay as you go’ basis

    Jim, would you elaborate on how that flow went? How would lower wages lead to more funds available to the state to address reunification costs? My — likely shallow — impression was that the Bargain was at least touted as lowering product costs via wage restraint in order to make German commodities more competitive. Does increased market share eventually lead to more tax revenue to handle reunification costs?

    1. Benedict@Large

      You’re making the mistake of assuming honest brokers. Germany was to be reunited as one of the great goals of defeating communism. People pretty much believed that was a good thing. At that point, German businesses pulled their perennial rabbit out of the hat that they pull for everything, “Oh, we can’t do that without wage cuts.”. That didn’t mean it was true, But it was their excuse for doing it this time. Whether anything then led to anything … blah, blah, blah … reunification, was irrelevant. The one-trick ponies got their wage cuts.

      1. hemeantwell

        I never assume an honest broker when it comes to capital. I was asking whether there is a connection between lowered wages and increased state expenditures. As an aside, it does seem that German workers did much better than American workers after agreeing to wage restraint. German workers tended to retain their jobs, American workers ended up having to reinvent themselves.

    2. Jim Haygood

      At the time of reunification, inflation was a concern owing to East German marks having been generously converted to West German marks at one-to-one, despite the East having nowhere near the productivity to justify such an exchange rate. Suddenly the East had fresh buying power conferred upon it, and West Germany experienced a temporary reunification boom.

      Wage restraint was intended less to finance reunification directly, than to finance it indirectly by keeping German exports competitive despite inflationary boom conditions domestically. When the reunification boom tapered off in 1994, wage restraint policies remained. This report (by Joerg Bibow, who grew up in Hamburg) records (pp. 15, 16) that ‘starting [in] 1996, Germany shifted a gear down and henceforth established its own new lower norm of zero nominal unit labor cost inflation.’


      1. guest

        Wage restraint was intended less to finance reunification directly

        Let us not forget that supplementary income taxes — the Solidaritätsbeitrag or contribution of solidarity — were raised in the Western part of Germany specifically to finance reunification; this repressed purchasing power of wage earners further.

    3. Jim Haygood

      Bibow wrote quite accurately last August that,

      ‘Contrary to German chancellor Angela Merkel’s recent claim, the euro crisis is not nearly over but remains unresolved, leaving the eurozone extraordinarily vulnerable to renewed stresses. In fact, as the reforms agreed to so far have failed to turn the flawed and dysfunctional euro regime into a viable one, the current calm in financial markets is deceiving, and unlikely to last.

      ‘The euro regime’s essential flaw and ultimate source of vulnerability is the decoupling of central bank and treasury institutions in the euro currency union.’


  8. Benedict@Large

    The shorter Pettis: This is a class conflict; not a national conflict.

    (1) Well of course. But didn’t we all know that from the start before these battle lines got drawn up? Perhaps in Europe because of the broken currency this got papered over pretty quickly, but here in the US it’s been from the start and remains pretty obvious.

    (2) Doesn’t that place Angela Merkel in the role of senior business partner, and not as a national leader? Or does she retain the title simply because if all else fails, she’s the one who gets to decide which of her clients to dump the costs on (German bankers or German depositors)?

    1. James Levy

      Actually I thought Pettis too squeamish about the fact that this is absolutely class conflict and he missed the fact that these things can and do involve States because states make the decisions how to structure their economies and can eventually turn to armed force if they think their end of the deal stinks badly enough to fight over it (Japan 1937-41 jumps to mind). What complicates things is that German workers don’t understand how they fit into this picture–that they were the original patsies in this process of extracting surplus value to then be dumped in the periphery for high returns. They are stuck in a Germany where they can bet their bottom dollar that if they were to side with the Greeks and the German banks took a hair cut, it would be them who paid the price, not German financiers or German industrialists. If I’m a German worker it’s hard for me, even if I can get past my ignorance of the true situation and my deep attachment to my own country, to imagine that a deal good for the Greeks is not going to turn out bad for me and my family. In this way nations count, big-time. I think the author misses a lot of this reality by thinking too structurally and abstractly. His analysis is excellent, but limited.

      1. Marko

        I think Pettis made a wise strategic move by framing the argument using Spain and Germany as the examples to represent the opposing sides in the capital flow mismatch. He makes clear in the text that this isn’t really the way we should view the problem , but if he’d set it up from the start as a 1% vs 99% issue , many readers would have been turned off after a paragraph or two , dismissing the piece as another “class envy rant “. As it is , he’s been receiving praise from all quarters for this piece. It’s up to the readership to make the connections , which are pretty obvious in the end , I think.

    2. washunate

      On 1, yep, I think that’s what’s interesting in Europe. In the US, we are only dealing with the looting. Our intellectual class has a common identity across our various states and regions.

      But in Europe, you have those class issues and then national/regional identity issues on top of them. The lack of a strong, central government across the continent is ironically making it harder for the authoritarians to continue the looting now that open socialization of the losses is required.

      1. Left in Wisconsin

        There is one point that needs to be made over and over again. The agent of the working class – unions – is organized everywhere (to the extent it is organized at all) into national (or subnational) units. To the extents unions have actual institutionalized power anywhere – and Germany along with a few other properous European countries are where unions probably have more power than anywhere else – it is power to act at the national level. This is an institutional fact and it also naturally leads working people to see economic events through a national lens, and thus to more naturally identify with the class opponents with whom they share a national identity rather than with class comrades of different nationalities.

        It seems clear that Europe and the EU need a real European labor movement ASAP. But when there is no political institutional mechanism for unions to influence events at the European level (i.e. no real European political state), and still some (rapidly declining) union influence at the national level, it is perfectly understandable that no one in Europe has succeeded in recasting the crisis as a class crisis rather than a national one.

        I find it very interesting, and troubling, that the “radical” solution is Grexit, and perhaps the dissolution of the EU, rather than the creation of a true European political entity in which working people could again achieve political power. If there is one thing Europeans should learn from the US experience of the last 40 years, it is that even in the most “powerful” nation-states, a globalized economy makes is extremely difficult (to say the least) for working people to exercise real political power.

        1. washunate

          To me what stands out is the irrelevance of unionization on this front. Rates vary widely among the major western nations, yet we are all dealing with the same problem in political economy. The western world still pretends that the individual is the building block of society, that is still the broadly shared value amongst the general population, but in practice unaccountable authoritarianism has replaced that concept. It is hard to find a powerful union or intellectual figure that seriously challenges the paternalism and secrecy and oppression of our times anywhere, from DC and NY to London and Berlin. Professors and police chiefs and judges and prosecutors and defense contractors and all the other highly paid public workers in the US don’t live in working class neighborhoods. They live in their own world separate from how most Americans live.

          Don’t worry your pretty little head, the PhDs have it all under control. And the JDs, everything is legal of course. Now just run along and do what we say…oh, and pay lots of money to cover up the war crimes and financial fraud. It’s for your own good, after all.

          If we’re really evaluating what is happening without the faux optimism goggles that seem to be required to be taken Seriously in the US, people are getting fed up with being talked down to, treated as idiots being so foolish as to believe their own lying eyes. I think there’s an increasing sense that it is better to be independent outside the group than a subordinate inside it.

          That’s the fundamental danger of authoritarianism – the loss of trust in institutions becomes catastrophic and systemic, sending people off haphazardly into little groups instead of being willing to cooperate on the large scale necessary for a wealthy and complex society to be stable over the long term.

          Just to give a specific example in the US context, these are some unions that endorsed Barack Obama for President in 2012:


          Perhaps no one was more eloquent than Richard Trumka, at AFL-CIO:


  9. William Neil

    Wasn’t the official line in Germany the rationale for the wage restraint that the savings from such went into further sophisticated capital equipment invention and deployment, and in the sectors that Germany exports so heavily with: chemical plants, energy equipment, medical equipment, optics, autos and so forth? Virtuous in other words into their balance sheet strength. Well maybe not then, it went via their banks into real estate lending in the sunny temptation countries…where Germans like to sun themselves in the winter?

  10. Alistair Nicholls

    The problem is that calm, balanced, logic is not what politicians practice. They are inherently prejudiced. Hence the inability to resolve conflicts both rationally and quickly.

    And politicians reflect populations and individuals, most of whom are very rarely able to look at an issue from another person’s perspective. When crisis happens, much better to quickly come to a mutual “minimise collective losses” agreement, than to keep fighting and maximise those collective losses. How many divorces destroy wealth (or pass it to lawyers) by endless fighting?

    It is that rather depressing human condition, which makes this Euro crisis extremely difficult to resolve. Even if the politicians could see and agree a “minimise collective losses” agreement (with massive debt forgiveness for Greece), would the voting public in all the European countries accept it?

    The underlying problems are that:
    – the European politicians have not understood what they have been doing
    – the European politicians still do not understand what they need to change for the “European project” to work
    – the European public have not been educated or prepared for the compromises necessary
    – the European public have not been asked to support, or otherwise, the “European project”
    – a radical, revolutionary change to the “European project” is required within 1 month before it all falls apart

    All problems are opportunities! May Varoufakis and others have the charisma, persuasiveness and eloquence to convince the European governing elites, and the German, Dutch, French, Spanish, Italian people that a revolutionary change is in the best interests of ALL of Europe (even the bankers, long-term).

    1. Left in Wisconsin

      It was perhaps BS but I heard from several very knowledgeable left-ish Europeans thoughout the 1990s that the history of European integration, from the Iron and Steel Community onward, was that economic integration comes first, and then political integration follows when economic events demand a political solution. That is clearly the case now, and yet further political integration, particularly political integration in which the agents of working people have any influence, is nowhere to be seen, or even called for.

      1. Yves Smith Post author

        I have not verified it either, but that’s consistent with some things I’ve read, that economic integration would lead to the perception that more interests were shared and would simplify the political part of the equation. But instead, economic issues are sharpening the divisions.

        1. Matt Pappalardo

          Perhaps unsurprisingly, Yanis Varoufakis has already laid out his thoughts on this particular topic:


          In contrast, the European Union’s bureaucracy was always built as a democracy-free, even a politics-free, zone. Its founding fathers, men like Jean Monnet, harboured a deep distaste for democratic politics and aspired to creating a technocracy in Brussels that would direct Europe’s macro-economy in a corporatist manner in the interests of the Central European heavy industry cartel. Many of the Central European corporations that were dominant inside that cartel in the 1950s are still dominant within it today. In contrast to the fluidity of the United States spectrum of corporate power, the Central European industrial terrain is remarkably stable and in a stable relationship of co-dependence with Brussels; i.e. with the European Union institutions that were created to administer the legal and institutional framework functional to the interests of the ubiquitous Central European cartel. In this context, it seems natural that the European Common Market was an attempt at de-politicising the European integration project and subjecting it to the guidance and administration of unelected technocrats who would consistently reduce politics to management and democracy to consultation.

          Mrs Thatcher’s error was to mistake the Central European, traditionalist, corporatist, and highly conservative notion of a ‘Europe of Nations’ for a penchant for a Federal Europe. There was never any political project, backed by powerful European interests, to create a federal, democratically elected government. The idea was always to erect a mighty bureaucracy that would work together with, and on behalf of national governments, in a manner that makes democratic accountability utterly impossible. How? Whenever an elected minister, or Prime Minister for that matter, returns home with a European deal that her or his own Members of Parliament find unfathomable, the retort is simple: “It was the best I could achieve.” Clearly, the ‘Europe of Nations’ is a super-state decision-making process lacking any mechanism by which electorates, and their elected representatives, can scrutinise its decisions.[1]

          The ‘Europe of Nations’, seen from this perspective, was utterly consistent with and functional to the dominance of the capital goods, heavy industry cartel that was the foundation and motivating force of our, supposedly, United Europe. The notion of a Federal Republic where the sans culottes of France, of Spain, heavens forbid of Greece, would elect a common, a federal government on a one-person-one-vote basis, and have real influence on how United Europe would be administered, was and remains anathema to our elites and leaders. It simply did not, and does not, compute.

          Thus, the EU’s radical reluctance to move in a federal direction following the Euro Crisis is not a mystery, after all. No cartel that controls the administration of its vital space directly wants to concede this exorbitant privilege to some democratically elected central government. Especially when a huge, expensive bureaucracy has been set up in Brussels precisely to preclude this. A bureaucracy that includes some very skilled technocrats who harbour a deep, Platonic, contempt for both history and democracy.

          1. Left in Wisconsin

            This seems right, but working people (i.e. most everybody) have never been able to rely on technocrats or existing institutional structures to protect or promote their interests without constantly applying political pressure when economic crises emerge. They only respond to demands backed by power, not intelligent argument or pleading. Where are the German unions on this? Or the French? Or the Greek? Even if the unions have no European power now, it’s high time they get to work on building it.

            1. Matt Pappalardo

              One of Germany’s main trade union leaders recently presented his views on the subject:

              So, the DGB (German Trade Union Federation) is demanding an overall solution for debtor countries. We want fresh negotiations within the framework of a European conference on debt for all countries in crisis in order to restore debt sustainability and, thereby, stabilize the Eurozone. We reject this false chatter about Grexit; it would be damaging if Greece quit the monetary union. That, too, wouldn’t be a lasting solution but would simply aggravate problems because of a potential domino effect…

              First, we have to state baldly: The policy of spending cuts has never got close to overcoming the crisis in the Eurozone. Since Mario Draghi’s famous “whatever it takes” of 2012 the crisis has simply paused for breath. But the old Barroso-Commission and member state governments didn’t use this pause to correct the design faults in their crisis strategy. They carried on acting according to the principle of shifting the burden onto the shoulders of the ECB. But, with the Zero Lower Bound in effect, there’s a limit to what monetary policy can achieve. That’s why we’re pretty sceptical about the real impact of the new quantitative easing measures. Monetary policy now urgently requires an assist from fiscal policy. Without any boost to aggregate demand nobody will invest a single Euro. At the end of the day, it’s investments that pay off; when everybody saves nothing is invested.

              So, we’re asking the EU for a clear departure from the current anti-social politics of austerity which simply ratchets up the crisis. Unions in Europe have made investments in the EU’s real economy a priority issue. Europe needs a master plan for a pan-European campaign of investment. Jean-Claude Juncker’s investment plan is a first step in the right direction. It sends an important political signal: for the first time in a long while we’re talking in Europe about investment-led growth. Juncker has also thereby taken up the drive of the ETUC and DGB for a European Marshall Plan. Of course, Juncker’s plan is not ambitious enough given its volume, funding and the restrictions built into it. So, we’re demanding improvements and extra funding via the member states in order to ensure it has a genuine impact.

              A European investment programme should also be meshed into the industrial strategy of the previous Commission and the climate change summit in Paris this year. If we can succeed in raising the added value of manufacturing back over 20% of GDP then we’ll be better able to face the future and to increase our resilience. The basic lesson for us must be: you cannot save your way out of a crisis, you can only grow your way out.

              Reiner Hoffmann is a member of the SPD (Social Democratic Party of Germany), which is currently part of the coalition government. I assume you’re aware of Gerhard Schröder’s reputation as a ‘reformer’, and it seems Sigmar Gabriel’s tenure as chairman hasn’t represented a sharp break from this philosophy. As a result, I’m not sure how assertive the German unions will be.

              1. Left in Wisconsin

                I met Hoffmann once and his heart seemed like it was it the right place. Same for officials in ETUC. But talk is cheap. My guess is that the German unions don’t feel like they can go to the mat for Greek workers because they don’t think a majority of the German voters would support that. That’s where the nationalism gets in the way.

          2. Jeff W

            Greg Palast says this (as mentioned in the Links 1/22/15):

            …The horror of austerity is not the consequence of Greek profligacy: it was designed into the euro’s plan from the beginning.

            This was explained to me by the father of the euro himself, economist Robert Mundell of Columbia University. (I studied economics with Mundell’s buddy, Milton Friedman.) Mundell not only invented the euro, he also fathered the misery-making policies of Thatcher and Reagan, known as “supply-side economics” – or, as George Bush Sr. called it, “voodoo economics.”…

            The euro is simply the other side of the supply-side coin. As Mundell explained it, the euro is the way in which congresses and parliaments can be stripped of all power over monetary and fiscal policy. Bothersome democracy is removed from the economic system. “Without fiscal policy,” Mundell told me, “the only way nations can keep jobs is by the competitive reduction of rules on business.”

            [emphasis added]

            1. financial matters

              It seems to be a prerequisite to remove social/political aspects to achieve labor as a commodity. Communities tend to take care of each other.

              ‘But the final stage was reached with the application of “nature’s penalty,” hunger. In order to release it, it was necessary to liquidate organic society, which refused to let the individual starve.’ (Polanyi 1944)

              ‘That’s not only because a minimum income, as discussed, makes it possible for workers to say no to dirty energy jobs but also because the very process of arguing for a universal social safety net opens up a space for a full-throated debate about values – about what we owe to one another based on our shared humanity, and what it is that we collectively value more than economic growth and corporate profits.’ (Klein 2014)

              In the spirit of a job guarantee she also brings up that things such as child care, elder care etc are deserving of renumeration.

              ‘The Agenda is rooted into a long run planned deficits commitment of which the counterpart is the planned growth of public investments creating tangible and non tangible real wealth.’ (Parguez 2012)

              This implies that there can be real growth in services such as providing basic medical. legal and educational services. Public expenditures such as NIH can often do a better job to support private sector growth than short sighted private equity funds. This is well discussed by Mazzucato. (The Entrepreneurial State)

  11. washunate

    Very enjoyable read. I think a lot of us Americans across the pond could do with more listening, less advice giving for our European friends.

    The euro crisis is a crisis of Europe, not of European countries.

    That’s the trick, isn’t it? Whether people inhabiting the continent of Europe desire to view themselves as Europeans or not for political identity? If anything, the current trend seems to be for smaller regional governance rather than transcontinental governance. Belgium had difficulty forming a government. Italy, Spain, and the UK have significant issues of regional identity. Etc.

    To us Americans, the costs of non-Europe seem obvious. Even Texans love being part of a United S of A. But it’s been fascinating watching the rollout of the EU generally and the EMU specifically, because a desire for a United S of E doesn’t seem to really exist. The UK and Denmark don’t even use the Euro.

    Sometimes I wonder if the more sensible thing to do is go back to the core ECSC states, do a real unified federal government, and then add member states only when they want to be fully integrated. Clearly the elites have moved faster than their local populations wanted to move, and now we’re in a quandary because the debt from financial fraud has been socialized onto national government balance sheets rather than the balance sheet of ‘Europe’.

  12. financial matters

    Interestingly, some of this has been thought out by Alain Parguez with respect to Italy


    Out of the Euro strait-jacket
    The economics of a Man-made catastrophe
    The true nature of the Euro zone crisis and how to escape from the race to the abyss

    (To be published in ROKE the review of Keynesian economics) 2012-2013

    Anyway, only bold people could generate those courageous politicians wishing to save their country from destruction.

    Would there be a catastrophe like the wrath of god against the unfaithful daring to escape from their fate ? My answer is a strong No, for the following compelling reasons :

    A. As soon as the Italian State is free, it shall solemnly take the oath of restoring the law of value by targeting true zero effective unemployment out of carefully studied program of productive investments. Priority being given to investment in labour.

    B. Taxes should be cut for middle-size and small firms and household.

    C. Thereby, there will be a planned increased deficit, a good one. Private banks will no more finance expenditures out of loans at the rate of interest they will. State money creation will be undertaken, directly or indirectly by the central bank having lost any sovereignty . The State will no more be obliged to issue bonds to meet banks desired growth of their worth.

    D. All outstanding debts will be converted into the new currency. In a first stage the rate of conversion could be 1 to 1.

    E. What about imports ? The exchange rate between Lira and the Euro, Dollar, etc… should be floating.

    Would there be an unbearable depreciation of the new currency leading to a collapse of purchasing power ? The sensible answer should again be NO ! The inverse is to happen ! The Euro will soon strongly depreciate relative to the new engine of growth currency.

    This proposition stems from the theory of exchange -rates. According to the general theory of the monetary circuit (Parguez and Seccareccia 2013 ) the real value of a currency is the amount of real wealth created by productive expenditures in this currency. To be simple it is positively related to the rate of effective employment. Thereby the real or natural exchange-rates is equal to the ratio of effective rates of unemployment.

    Now the effective exchange-rate is determined by “speculation” bets on the relative market value of the currencies. The effective exchange-rate should converge towards the normal rate and stabilize at this level, or at least gravitate around it. This theory is supported by second empirical data for Argentina (Forstater 2012 ).

  13. Jesper

    Is the current ‘wage-restraint’ in the US voluntary or is it due to the very real threat of outsourcing to other countries? Are any workers in any country in the wealthy parts of the world immune to the threat of globalisation? Why is one country repeatedly singled out?

    Globalisation weakens the negotiation-power of workers everywhere, the gains of globalisation flows to the wealthy and the concentration of wealth/capital makes it possible for capital to quickly flow between countries or withing countries.

    Banks are the facilitators of capital flows, they need to be regulated tighter or they’ll continue to make bad decisions forever. Lower leverage of banks, lower leverage to be allowed by borrowers and enforce the regulation.

    1. hemeantwell

      Re common interests of workers, just now I was searching for the rationale for 90s wage restraint in Germany and came across a number of links to stories about German unions currently pushing for wage increases. Some of the reasons were more or less “It’s time we got our share of the gains,” but there was also the idea of supporting demand within the Eurosystem. It would be great if unions would seize the time and, drawing on arguments like Varoufakis’ and Pettis’, assert a claim against Troika hegemony and offer a Grand Alternative that might serve to ground a new, yes, International. I saw that, in an otherwise superb article, Pettis wants the center parties to smarten up so that the left doesn’t build a counterclaim to bourgeois hegemony in its austerian form. I hope that the left can use his arguments to its own ends.

      1. blub

        The threat of outsourcing was definitely behind the acceptance of “wage restraints” by German unions in the late 90s.

  14. JEHR

    I can’t believe that I just read both articles and found them highly readable. I’m so glad to know that Yanis V is on the right track.

    One really wonders about the abilities of those “technocrats” in Europe.

    1. Mel

      Pettis’ whole blog is very educational. Serious, topical, and easy to understand. Has a lot about China, if you’re interested in China, but good general articles (like this one) as well. Just added it to my daily surf list.

    1. JEHR

      I had been for some time contributing to a blog based on GS fraudulent behaviour. I have a vast arsenal of articles on my computer about all the ugly things they have done since they became an investment bank a long time ago. I can always use another article to add to my misdemeanor file on GS.

      See: http://www.goldmansachs666.com/

  15. Gaylord

    This insane greed with all the bickering about the Euro crisis PALES in comparison to the issue we should all be focused on: industrial civilization is destroying the ecosystem. We humans are so self centered that we are blind to the accelerating extinction of species and the disruption of the climate, which inevitably will destroy our own (and only) habitat. Scientists have given us fair warning. These brilliant economic and political thinkers should be putting their heads together to organize a global effort to radically change course in order to deal with this URGENT situation, because the longer we continue along this path, the more costly and dire the consequences will become and nobody will escape them. Some may think this to be off topic, but as many visionaries have pointed out, the capitalist growth imperative is the root cause of the ecocide and its incentives must be ABOLISHED; tweaking around the fringes will not work. Please check out Natural Law Resource Based Economy.

    1. hemeantwell

      As you seem to bring out at the end of your post, I don’t think it’s a matter of being self-centered, it’s a matter of locking ourselves into a system that relies so centrally on profit accumulation to motivate and guide production, i.e. capitalism. I’m aware that nominally socialist countries have not performed well as guardians of the environment. But the political competition with capitalism imposed a productionist rationale on their economies. Doesn’t have to be that way.

      1. an.on.

        not necessarily “capitalism” per se, but pursuit of an artificial growth model required to pay off debt that expands exponentially due to front-loaded compounded interest.

        until incentives & costs are altered to better reflect ecological realities, the damage will continue to spread.

        1. Yves Smith Post author

          I suggest you real Kaly Polanyi. He argues that the commidification of labor (human beings) and the environment is an inherent feature of a market system, and efforts to ameliorate that wreak havoc with the operation of the market system. So per Polyanyi, efforts to deal with ecological realities will cause a breakdown of the market system.

          See our overview of Polanyi here:


          1. susan the other

            Michael Pettis is always so good and this didn’t disappoint me except for the environment factor. I feel like when economix gets lost in its own world (even as complex as his is) the environment will never recover. We are already so far gone that Obama put out a statement to the fact that we would focus our efforts on “adapting” to global warming. Good luck. Especially when we really have to admit that the world which we so happily exploit is not longer our oyster – it is closer to starfish goo. So Varoufakis, who calls for debt repayment linked to GDP and therefore growth going forward, and who also calls for sufficient investment to promote growth, would win big if he put his talents to just what kind of growth. If reclamation were part of economics we might not get such troublesome imbalances.

            1. an.on

              i agree once again with you susan.
              in this day & age, it’s the quality of growth, not quantity, that matters.

          2. an.on

            thanks for the suggestion — i took you up on it and read the post and all the comments.

            your comment about how ownership predated capitalism was particularly insightful. been noodling on that from both sides — reflecting how capitalism appropriated the feudalist model, but also how, through that, ownership began to decentralize for a bit, but is now back in the process of consolidation.

            btw, not arguing for capitalism or any ‘isms’ for that matter. even discussing that nature & humans can be owned at all seems quite bizarre. i agree with susan’s comment from the Polanyi link — we should be continually striving for higher levels of understanding.


    2. Gusets

      Your ‘capitalism as eco-axis of evil’ premise is entirely personal anecdote at best, and scientifically contrived rot at worst, to benefit the same Mil.Gov.Sci.Edu sycophants to power and wealth that got us into this mess.

      Sure, I miss an Appalachian Spring as much as anyone; strip mining is a terrible waste, and even if done ‘correctly’, lands won’t heal for two generations and waters most likely will never heal, although it should be pointed out, they are drinkable. Fracking is more of an economic danger than an ecological one, creating a false allusion of surfeit, when in facts, its just licking the bottom of the cake pan. Other that that, the glaciers have been melting for as long as mankind has migrated out of Africa, and the seas have risen, although only the width of a pencil lead every year, if that, and the earth is warming, what, some hundredths of a degree?

      More at risk than the ‘ecosystem’ is the human food chain. We live on a very thin layer of tilth, and that is being squandered away by BigAgra. Now comes the GMO grains, and the massive pesticide and herbicide blight with them, that will literally wipe out all life in the farming regions, and, if you understand mechanical agriculture, will leave us all exposed to pesticide and herbicide soaked ‘food substances’ that will reduce our genetic health and vigor, resulting, inevitably, in a population crash which has nothing to do with ‘capitalism’. Look at what kibble ration has done to your pets, just in the short time you’ve been alive.

      To claim then, that by somehow putting the oil genie back in the bottle through usurious central government restrictions on access to energy, then to housing, then to jobs, then to savings, then to food itself, is just another ethnic cleansing argument from the same supremacists who pushed eugenics, a ‘superior race’, ‘survival of the fittest (sic)’, the ‘herd immunity’, and all those other fascisms that litter our modern world, of which Al Gore’s Inconvenient Truth was just a poor 21st Century knockoff.

      In fact, oil and gas showered gold dust across the world for the last 80 years, and everything you see around you came from that hidden source of wealth. To shut in those flows, to cap the flow of wealth, is just a recipe for mass suicide, a lemming solution proffered by the same Mil.Gov.Sci.Edu who bleed us of its benefits now, and who would hold a perfumed lace to their nose as they rode past the stacked up bodies.

      The problem isn’t capitalism. The problem is Pernicious Stage 5 Metastasizing Central Government.

      1. skippy

        Best central government that a few nimrods… with a passel of wealth and a few screws lose… could cobble together a philosophy…. with the help of some extremely lower bound ethical standards policy wonks… and call it freedom and liberty thingy….

      2. Barry Fay

        @Gussets – Boy are you confused! Take a little of this and a little of that and stitch it all together to come up with, what?, Libertarianism?. Where no concerted actions are possible? Then, how about this muddle: you say “More at risk than the ‘ecosystem’ is the human food chain. We live on a very thin layer of tilth, and that is being squandered away by BigAgra” and then go on to say “capitalism” isn´t the problem. Big Agra, my friend, is Capitalism in its purest form!!!!

  16. Grizziz

    I really enjoyed the article. The light which came on was to reimagine categories from political or class to economic sectors. My preference for a term might be industrial sector in place of economic sector for industrial seems to be a tighter fit for the institutions where the money or credit flows in or out. Regardless, to change the terms of the argument and refocus on a different process could move the Overton Window in a more egalitarian direction.
    In the USA, I presume that the lowest members of the military or financial hierarchies receive better treatment than their counterparts in farming or construction. The appearance of these discontinuous outcomes between industrial sector hierarchies points to the manner in which the national income is distributed and how preferences are meted out by political elites and not by markets by choosing where the money goes. (Banks being able to create money obviously have a certain advantage, just sayin’.)

    1. Left in Wisconsin

      “Sectoral” implies that owners and workers in an industry share interests against owners and workers in other sectors. In the 20th century, sectoral strategies in places like Germany and Sweden were very effective because export industries could be prioritized (over, say, banking and finance) and the economic gains from strong manufacturing export performance could then be shared with the rest of the economy.

      But the current situation is different. As noted above, even in Germany with continued strong export performance, the manufacturing unions aren’t strong enough to insist on their fair share of the gains (mostly due to threat of outsourcing), much less demand these gains be shared with the rest of the German workforce, much less be shared with the rest of the European working class. Also, U.S.-led globalization has led to both relentless wage pressure on workers and unions everywhere but also driven a finance-based global integration that has, for example, made Germany’s once conservative banking sector now among the worst global blood suckers.

      So it’s not clear how a sectoral approach leads to clearer thinking. Whereas class warfare, even if the term gives many people the creeps, hits the nail on the head. I do think once (if) working people get (re)organized enough to challenge current economic organization, there will be value in making alliances with (owners of firms in) economic sectors that add real value and work to solve real problems like global warming against “leech capital.” But that time is still a ways off. And until the former come to their senses and dissociate from the latter, any alliances should be ad hoc and driven by the interests of working people, not owners.

  17. c1ue

    Intellectually interesting, but there are many counterpoints to what Mr. Pettis has raised above.
    1) The assumption Mr. Pettis made is that all parties are acting in a beneficial manner. When I say beneficial, I mean that any given party’s actions are not motivated by a desire to take advantage of the other.
    A well worn neoliberal playbook example of this is to take exactly the capital export model noted above, but to close it out via a privatization of sovereign assets during the austerity end game.
    2) There is a big difference between economically accelerating a stagnating nation (France in 1870 due to 2 generations of post Revolution land reform leading to population and economic stagnation) vs. a high 2nd world/low first world nation (Greece in 2015). What are the increases in communications, transportation or other infrastructure by which Greece would enjoy massive rates of growth? Greece isn’t China of 1990 nor is there a magic wand of industrialization stages that can be deployed.
    3) The characterizations of bubbles noted above are poorly delineated. Japan’s and China’s bubbles both took poor nations and propelled their per capita prosperity upwards to an amazing degree (5x for Japan, 4.5x for China). Yes, the end result was large debt, but it was accompanied by massive growth.
    In contrast, the US’ GDP was literally flat from 1906 to 1934.
    Greece’s GDP in 2015 will be the same as it was in 2004, if not lower, and may very well test the level last seen when Greece entered the eurozone in 2001.
    Spain’s GDP performance from 1999 to date is far more like China or Japan than Greece, albeit far poorer in absolute growth (2.5x).
    Greece did see a nearly 2.5x growth from euro entry to peak, but equally it has seen massive GDP losses since then that half of the growth has already been lost.
    No conclusions here, merely pointing out what I see as qualitative differences.

  18. MyLessThanPrimeBeef

    Who to blame? As Pettis points out here, not nations, but economic groups.

    Which groups?

    I commented in the Links post, if the creditors don’t want to write down the Greek debt, they can do the following:

    1. claw back from bankers who profited from Greece’s less-than-qualified entry

    and 2. Greek oligarchs who pocketed enough of the capital inflow.

    Treat the whole episode as a crime.

  19. MyLessThanPrimeBeef

    Four questions.

    1. Instead of selling domestic bonds in 1871-1873, could France have just printed more money?

    2. Was that indemnity or even the post WWI German reparations really the largest in history? Even bigger than the one the Spaniards exacted from the conquered Incas (or the Aztecs)?

    3. Don’t the money-thirsty Germans deserve to ‘suffer’ their second French Indemnity today? That would be karma in action.

    4. Once the Germans saw their savings soar in 2005, what should they have done? As Pettis points out, in advanced countries, mostly non-productive investment. Why is that the class? Something about us humans? Should advanced countries avoid soaring savings then?

    1. Mel

      1. I don’t think so. That’s the effect a Gold Standard has. Stuff that’s recognized internationally as money can’t just be printed.

      4. Pettis has another great blog post on the nature of what economists call savings. Savings are defined as the difference between production and consumption, or as the difference between investment and consumption. Ramifications are explored.
      So the Westies didn’t see their savings soar. The extra production was saved for them, and basically allocated to the East.
      Non-productive allocation in advanced economies is just a happenstance; advanced economies typically have their productive allocations covered. Then any sudden extra allocations have to go to other things that are less productive.

  20. Sanctuary

    “1. If a huge amount of capital, equal say to 10-30% of a country’s annual GDP, is forcibly distributed to an enormous group of entities within that country in a short time period, and if the only way in which to distribute this capital is through a wide variety of banks, with biases such that the more optimistic and irresponsible the bank, the more it profits, and the more optimistic and irresponsible the borrower, the more it receives, is it meaningful to refer to either side as behaving “irresponsibly”, and if so, which side? Does this sound like a loaded question? If it is, can it be rephrased in a less loaded way?”

    To answer this question, I’d say yes it is meaningful to label the primary irresponsible parties and those parties are the banks that irresponsibly lent money and the governments that constructed regulations to enable irresponsible lending. No one ever wants to lay the blame where it truly belongs and because no one does it happens again and again. The only parties that have fiduciary and legal responsibilities to assess the credit worthiness of individuals or the efficacy/legality of a prospective investment are the banks and government officials. I can ask for money all day long, it’s up to the person with the money to decide if I am worth the risk and even then it’s their responsibility to recognize that it is still a RISK and hence not society’s responsibility to make you whole if the investment goes south.

    Do you really think we’d keep having these bubbles over and over if bankers and government officials were forced to eat their losses and/or go to jail? Having that happen would incentivize them to come up with new procedures/structures that qualitatively manage the next massive capital flow so that individual organizations increasingly suffer for profiting from increasingly irresponsible lending. A sort of bancor for private lending.

    1. Gee

      Bravo, another way of making my point, which is that the incentives are all screwed up, and that the people allocating credit are expecting to benefit first from the allocation, and then from the cleaning up after the reckoning. If they know they can privatize the gains and socialize the losses, why wouldn’t they? What we’re debating now is the 2nd part of the equation…the fight only exists because the assumption is that the creditor class is NOT going to take any costs of their own stupid decisions.

  21. Matt Pappalardo

    The key may be getting ordinary German (or all European?) workers to recognize their precarious position under the current EU institutional framework/order. It’s doubtful that the EU elites will make substantive concessions without effectively being forced to do so via the exertion of popular political pressures. Thus, fostering a sense of sectoral/class solidarity will likely be a necessary prerequisite to any successful effort in this area.

    Professor Pettis’ concerns about the potential rise of radicalism or vulgar populism are certainly valid, but Syriza’s leadership appears to be charting a reasonable course for genuine reform within the Eurozone. Having said that, I am aware of the potential pitfalls moving forward. It’s difficult to give the present crop of EU power brokers the benefit of the doubt.

  22. AQ

    All I kept thinking while reading was privatize the profits, social the losses. Then my mind went to leverage. What type of leverage did these “German” banks/lenders have? How many times did they lend the same “money” out? How much profit did they make during the boom? When the tallies come together, yes, the number says there’s this great big debt remaining but how much are they actually out (of their original “money” not leveraged money) when all is said and done?

    And, if this debt has more to do with owners vs. workers, then why are the creditors allowed to extract “public” common goods/investment/work? it’s very much like the state and the ‘capitalism as a system’ is only there to enforce the rights of a certain class of people.

    1. Gee

      Darn it! Should have read the comments all the way through…we’re totally on the same page, but you were first.

  23. Chauncey Gardiner

    Thank you so much for the link to Michael Pettis’ thought provoking post. As Yves (very infrequently) says with respect to particularly complex issues, “This is beyond my pay grade”. I would certainly acknowledge that I fall into that category on this matter. Nonetheless, I think it is important to try to understand what is occurring, as I believe Greece’s situation is not only similar to that of others in the EU, as Michael Pettis noted with respect to the dynamics between Germany and Spain, and the historic similarities to the aftermath of the Franco-Prussian War and French reparations, but may also have repercussions with respect to how central banks and supranational creditors are viewed generally. There seems to me to be an increasing public sense in the U.S. and among some senior elected officials that these unelected central bankers and these “official” creditors have crossed the Rubicon, and not in a good way.

    In practical terms of how elected European leaders extricate their nations and the EU from this engineered morass, there was an interesting related article authored by Joseph Stiglitz in the Guardian this past week. Stiglitz posited this idea:

    “When companies go bankrupt, a debt-equity swap is a fair and efficient solution. The analogous approach for Greece is to convert its current bonds into GDP-linked bonds. If Greece does well, its creditors will receive more of their money; if it does not, they will get less. Both sides would then have a powerful incentive to pursue pro-growth policies.

    Seldom do democratic elections give as clear a message as that in Greece. If Europe says no to Greek voters’ demand for a change of course, it is saying that democracy is of no importance, at least when it comes to economics. Why not just shut down democracy, as Newfoundland effectively did when it entered into receivership before the second world war.

    One hopes that those who understand the economics of debt and austerity, and who believe in democracy and humane values, will prevail. Whether they will remains to be seen.”


    I don’t know if the majority of holders of Greek debt, which are now “official” supranational vehicles and entities, would agree to his approach, which I consider to be both reasonable and very likely also beneficial to Germany. On its face, Stiglitz’ suggestion seems to me to have merit. And a related question is what alternatives these creditors have, even under London law? It doesn’t appear to me that the Greeks are about to willingly surrender their ports, Adriatic oil drilling and mining concessions, islands and other assets to anyone, and particularly to these entities with their shadowy ownership structures that simply don’t pass the smell test.

    1. an.on.

      “powerful incentive to pursue pro-growth policies”

      true, but “growth” to what ends? growth for the sake of satisfying creditors who push any and all growth measures simply for the sake of maximizing their return on capital?

      Greece “grew” during the lead up to the 2004 Olympics with all that infrastructure spending. and how is that infrastructure being utilized now, besides rotting away back to dust? and even if it could utilized in a productive way, was it built to last even close to as long as the ancient temples that were built without the benefit of all of our current glorious mechanical technology or was it built in a shoddy manner so as to satisfy the maximum amount of greedy hands skimming off the budget?

      maybe growth for the sake of growth is what needs to be questioned.

  24. John Merryman

    As someone who long ago gave up trying to figure out all the ramifications of political, economic and social activities, I delved into philosophy and then physics, in trying to understand the underlaying processes at work. Unfortunately these fields proved heavy in the epistemic posturing and light on the ontological insights. What I did come to appreciate is that all this linear causality is embedded in ever larger thermodynamic feedback loops and this essay is a very well researched example of that dynamic at work. As Newton put it, for every action, there is an equal and opposite reaction. What he failed to mention is that while actions are necessarily linear, the reactions are not.
    If I was to put the problem in one observation, it would be that money is a contract, which we treat as a commodity. What gives bankers power is the fact that everyone wants more money and they are riding the crest of this wave and while we all focus on the top of that wave, its real power derives from those desires of the whole society.
    The basis of the value of this money is public debt and unless the rewards are retuned to those incurring the risks, it is all destined to fail. Money is a medium, like a road system and we will need to treat it as a form of public utility and not private property. It is the circulation system of society, not just the economy, as much of our social relations get quantified in monetary terms. There was a time when government was private and the monarchists never thought “mob rule” could be made to work, but the kings managed to cook their golden goose, by losing sight of their larger civic function. Now the bankers are doing the same thing. They obviously thought that going to central banks to issue the currency was a brilliant piece of work, as the banks then didn’t have the responsibility to issue their own notes, but history will record it as the first step in making the monetary system a public function, like government.
    The problem is that in order to create money, some entity has to be willing to issue debt. I think we will eventually go back to an essentially organic system of exchange, where local governments, businesses and communities revert to creating varieties of currencies. It will undoubtfully slow down economic activity, but then looking at the state of the world, that would be a long term benefit.

  25. Stefan

    [Rookie question]
    Why doesn’t the Greek government issue a drachma scrip ( 1 Dr=1 Euro) to pay for the teachers and workers it wants to rehire, and for internal operations generally, including taxes, and then get really serious about tax collection?

    1. Yves Smith Post author

      First, it would apparently take months to issue scrip. Second, I am just about 100% sure but can’t find the exact provision that it is violation of eurozone rules to issue a national currency.

      If it was going to break rules flagrantly, Greece would be better off printing more euro (it has a printing press) and waiting to see how long it took the eurocrats to figure out what it was up to. The Greek-printed euro notes do have a different code. I believe their serial #s end in a Y.

      1. Stefan

        Couldn’t the establishment of parallel currencies within the Eurozone provide breathing room for nations such as Greece, Spain, Italy, France, etc. to ameliorate unemployment and undertake fiscal moderations while still addressing long term debts? (If it takes time and is against the rules, well…so be it.)

      2. Adam Eran

        I believe Warren Mosler came up with a work-around for this. The Greeks issue zero interest bonds (“consols”?) they will accept in payment for taxes. It’s a “money thing” other than a euro, but it would take the pressure off.

        The trouble with such lovely “good ideas,” however is that they might trigger EU reprisals, and given the Greeks dependence on the EU for food and fuel, making allies elsewhere (I’ve read Argentina and Russia suggested) may be just as high a priority as re-hiring teachers.

  26. Gee

    If you read but a few sentences, do not miss this one :

    “I think most analysts understand that costs will rise during the restructuring process. I am not sure they understand, however, that delays will impose even heavier costs during the many years of subsequent adjustment. ”

    This has been kicked around here in more vernacular forms in the comments, but it is really the crust of the issue, once you disregard the nationalistic tendencies and just think about the human costs.

  27. Gee

    and if you managed to read more than two sentences, the next few not to miss are probably just as important, as they clearly resolve the issue of “cui bono?” and how austerity in its current incarnation, could not be any less fair – I would say this is still not quite accurate, as Pettis thinks the middle suffers, when it fact, he had already stated earlier that the serfs were doing the real suffering (succatash):

    ” I am hesitant to introduce what may seem like class warfare, but if you separate those who benefitted the most from European policies before the crisis from those who befitted the least, and are now expected to pay the bulk of the adjustment costs, rather than posit a conflict between Germans and Spaniards, it might be far more accurate to posit a conflict between the business and financial elite on one side (along with EU officials) and workers and middle class savers on the other. “

  28. Gee

    oh, and while Im at it, you cannot forget the impact of an investment boom on those about to be left out, especially when it centers on housing. First, there is always the nesting instinct, the wanting to be a homeowner, and wow, look at prices, if we dont BORROW (from germany) and buy now, we’ll be left out. And even IF you manage to not entertain that rationale, what happens? You still have to live somewhere, and the second option is not to buy, to rent, and suffer from the inflation in rents that the investment led inflation in home prices touches off in the second round.

    So, as Pettis had mentioned in earlier posts, these capital flows feed upon themselves once they get going, which is more evidence of the causal chain, and why you should start it.

  29. Gee

    So, did Spain have a choice?

    “The second assumption is that Spain had a choice in what it could do with the German money that poured into the country, and so it must be held responsible for its having mis-used hard-earned german funds.”

    The people were going to do what they were going to do, as stated earlier. But why not try macroprudential policies during the inflows of capital to restrain foolish impulses? So, even if you CAN borrow like a crazy person, at 0% interest for 100 years to buy a home, you could STILL enforce a downpayment that cannot be borrowed. But oddly enough, no one in the financial sector wanted to do that, in part, because they know that if they do, they only hurt themselves, the financial interests, the capital owners who are benefiting from the rising prices. But they ALSO know that when it falls apart, the cost will be allocated to the middle and lower tiers that Pettis describes. SO again, more reason to see who is at fault.

    Now, you may say, well, if you tighten rules in one place, the capital will just flow to some other speculative investment, and that may be true, but what does that say about the nature of the flows and what we can say about the causation, if the impact cannot be avoided if if one tries? Ah, yes, no one tried, so that sort of gives you your answer.

  30. EmilianoZ

    Pettis’ argument amounts to something like this: Since the beginnings of time we’ve always behaved badly. So, let’s forget about this and do what we’ve always done (have the middle class pay). Maybe the German middle class doesnt believe in repeating history, maybe they want to try something new. Maybe its time to try preventing the next crisis and experimenting fairer ways to resolve them.

  31. Hans Suter

    Not all German workers were hit by wage compression. The picture is far more complex. It was the creation of a dual labour market that was a solution for Germany and a problem for the South of Europe. At least that’s what Storm and Naastepad explain in there paper. Here’s an appetiser and at the end you’ll find the link to the paper:
    “The main factors influencing differences in international competitiveness and growth across countries are technological (non-price) competitiveness and (high-tech) productive capabilities. Joseph Schumpeter (1943, p. 84) summarized the key point vividly as follows:
    “Economists are at long last emerging from the stage in which price competition was all they saw. ( … ) But in capitalist reality, as distinguished from its textbook picture, it is not that kind of competition which counts, but the competition from the new commodity, the new technology, the new source of supply, the new type of organization ( … ) —competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.”
    If this holds true anywhere, it should be true for Germany, which is dominating world markets for medium- and high-technology manufacturing goods and services. Germany has a market share of 18% in the total world exports of the top-100 most complex products—against France 3.6%, Italy 3.1%, and Spain 0.9% (Felipe and Kumar 2011) —and “up-market products”, which fetch the highest prices, account for more than half of German exports.”

  32. dbk

    I hope to reread Pettis tomorrow, but from my initial reading on Friday morning, for me the key question that emerged was how these periodic massive surpluses might be better managed and shepherded by recipients – who frequently end up as largesse’s victims (e.g. junk mortgage debacle).

    It’s not as if there aren’t plenty of ways for surpluses to be invested (addressing climate change, sustainable energy, rethinking-rebuilding-repairing the world’s infrastructure for the twenty-first century to name just a few), but that such investments don’t yield the profits banks and other financial institutions with surpluses are seeking.

    A very important raison d’etre for this blog is to raise, again and again and again, the need for genuine bank oversight and regulation – not just in the U.S., but globally, because capital has now been freed of national borders and constraints. In the particular case in point here – Germany’s outflow of massive surpluses to the Eurozone periphery – the beneficiaries were/are banks behaving badly – but this is how banks behave if they’re not regulated for the public benefit. And the victims, as Pettis rightly points out, were/are – in both Germany and the periphery – workers (by which I assume he means “the working poor”) and middle-class savers (by which I assume he means “those with enough put aside to be taxed into poverty”).

    The new PM has just begun his presentation of the government’s programmatic statement – the entire country is listening. The mood in the street is hard to describe – everybody’s sort of in shock, wondering whether this government actually means to do what it said it would. My sense is that they do. There is a feeling that a new paradigm is coming – we don’t know what it will be like, but it’s as if the entire populace is saying with one voice, “Okay, if the government means what they say, we stand by them, whatever it takes.”

  33. Tom

    Sorry, Pettis paper is a lot of longwinded bull. His argument can be summed up like that: Germany used artificial wage suppression and thereby gained an unfair advantage over her neighbours. That resulted in a trade imbalance that was recyceld (in Pettis eyes forcefed) into Spain. The whole premise is utterly wrong. Germany has the strongest unions of any big country in the West and although Pettis likes to believe it it is simply not true that any German government can decree wage moderation. In fact skilled German factory workers get among the highest wages in the world. An unemployed worker in Germany gets support from the Government that amounts to roughly 1500€ per month plus rent and free healthcare plus assorted other goodies. For life!!! Since the often maligned reforms of Schroeder (supposedly the reason for German wage stagnation) an unemploye3d worker has to take any work or else work for 1 € an hour. But he gets unemployment money on top. I know this all sounds unbelievable but that is the gospel truth., Just like that German universities are completely free not only for Germans but also for foreigners. If Pettis knew economic history he would know that Germany has always run a trade surplus whenever she had equal access to foreign markets. The reason is an extremely efficient industrial system with high qualification at all levels. it is basically cultural. the nineties were an exception as then the GDR had to be paid for. As soon as german industry had expanded its capacity it was back to the old pattern. The difference was the Euro. Whereas before all countries would regularly devalue aginst the Mark that was no longer possible. The Euro is a misconstruction for countries that are not culturally compatible. That is it. I am sick and tired of listening to German professors hinting at the supposed moral failings of Spaniards et al (never explicitly called as such but hinted at) but equally tired of people like Pettis who have never seen a shop floor but blame the whole situation on supposed German designs. I know that internal data like the profitabilty of various factories within companies like MAN or ABB aren´t readily available to outsiders. A little digging though should suffice to notice that an ABB factory in Shanghai is no more profitable than the factory doing the same stuff in Malmoe. Although wages in China are a tenth of the wages in Malmoe. Wage restraints don´t explain anything. YOu can have the lowest wages in the world but will never develop an export economy unless the regulatory environment, the skills and and and is there. Simple as that. Too simple for most economists.

  34. Jerry Goldstein

    An interesting analysis with a historical perspective, but I think it misses two very important points:

    1. National Deficits are a key component. Reckless governmental spending by Greece – both past and present – cannot be ignored, and doom the country’s future. Northern Europe should not, and will not subsidize such flagrant spending habits.

    2. Exports and related internal production are key determinants of a nation’s economic well-being. Greece is particularly weak in this regard — with no foreseeable likely improvement. Selling Retsina and olives just isn’t enough.

    Forgiveness of past Greek debt will do little to resolve either of these major shortcomings.

    1. Yves Smith Post author

      The Greeks did not “recklessly spend.” Their debt exploded due to the direct effects of the crisis (every major economy saw a huge rise in debt to GDP as tax revenues fell and automatic stabilizers kicked in, which economists regard as a good thing), and the way the bailouts were handled (90% of the money Greece got went to banks. They were used to launder money to French and German banks).

      The problem Greece has had for a very long time is that only a small % of its population pays taxes, like 30%. That portion of the population is actually taxed pretty heavily even by Eurozone standards. The rest, primarily the oligarchs but also a lot of small businessmen, including doctors, pay no or close to no taxes. Prior to Syriza, the ruling parties were thick with the oligarchs and thus not willing to crack down on all the tax evasion.

Comments are closed.