Yanis Varoufakis

Europe’s Reverse Alchemy in Full Throttle

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  1. While the meekness of the proposed haircut is, obviously, a problem, it is not the only one. The main source of concern is the insistence that the haircut be pronounced voluntary.
  2. Securing the consent of the bankers means that the haircut is not sufficiently deep (see previous paragraph). Far more worrying however is the following:
  3. Since the Brussels Agreement was announced, a number of hedge funds have been purchasing Greek government bonds (especially those that will be maturing in 2012 and 2013). Why? Because they are planning to call the Europeans’ bluff. If, indeed, the haircut is to be declared voluntary, there is nothing to stop the hedge funds that have just purchased Greek bonds at 35% of their face value from demanding full payment, threatening to go to the IDSA to have the haircut declared involuntary (thus triggering the feared CDSs) if their demand for full payment is not met. If their stratagem works (And it will work if the Brussels Agreement is implemented successfully) Greece’s debt relief will fall much below the €70 billion sum!
  4. The idea of suppressing the CDSs’ triggering, by leaning on the banks, undermines well and truly the Brussels Agreement strategy for dealing with the Italian and Spanish debt crisis – see below.
  5. Lastly, while it is clear from the above that the haircut is woefully inadequate as a means of dealing with the Greek debt, the new round of austerity measures that are part and parcel of the Brussels Agreement, especially in the absence of any tangible commitment on the investment front, border on the criminally negligent. To put it bluntly, they shall guarantee an acceleration of the freefall of Greek GDP to a level that may well fall below €200 billion, at a time when public debt will be floating above €350 billion (once the new loans, the sweeteners for the banks aand the full repayment of several hedge funds are taken into account).

In short, the international (and Greek) press tell their readers/audience that Greece’s ‘salvation’ is predicated upon accepting and implementing the Brussels Agreement. I beg to differ. In view of the above, a Greek consent to the Brussels Agreement strategy for dealing with the Greek debt crisis is equivalent to a nation’s suicide. The obvious alternative is to default within the eurozone (a 100% haircut on pre-May 2010 issued bonds), to utilise all proceeds from privatisations internally, and to cut all sector pay in a top-down fashion till the government’s accounts are balanced.

Verdict: The Brussels Agreement will lead Greece further into the mire, wrecking not only what is left of the Greek social economy but, perhaps more significantly from a N. European perspective, destroying the remnants of Europe’s policy-making credibility both with electorates and markets.

The Agreement’s Third Aim: To prevent Italy’s and Spain’s exit from markets

This was always going to be the greater of the three tasks, in view of Germany’s steadfast objection to having the ECB monetise any part of these countries’ debt, either directly or indirectly (via leveraging the EFSF). The question is: How can the remaining €240 billion of EFSF guarantees stretch to plug a €3000 billion hole without the ECB’s involvement? The answer, of course, is that it cannot happen credibly and the evidence comes in the form of the skyrocketing spreads ever since the Brussels Agreement was signed and announced.

According to the Brussels Agreement, the EFSF will try to fulfil this Herculian task in two ways. First, by offering ‘first loss’ insurance to investors buying Italian and Spanish bonds up to and including a haircut of 20%. In other words, anyone purchasing a fresh issue of such bonds will be insured by the EFSF for a loss of up to 20% of the face value. In effect, this amounts to a digital CDS insurance contract (digital in the sense that they either pay the full loss or nothing) to be offered free of charge by the EFSF, on behalf of the eurozone, to anyone purchasing these unwanted bonds. The hope is that these bonds will, all of a sudden, become desirable. Secondly, the EFSF, a Special Purpose Vehicle (SPV) set up by the EU in May 2010, will set up… another SPV which will attract (or try to attract, more like it) private funds which, in conjunction with some of the EFSF’s own capital, will be used to re-capitalise the banks, assist Greece, continue lending to Ireland and Portugal etc. Here are some reasons why this pig will not fly:

  1. Investors are being asked to assist the eurozone twice: First, to provide capital to the EFSF so that the EFSF can issue the digital CDSs for fresh Italian and Spanish bonds. And, secondly, to buy these same bonds!
  2. Investors are being asked to behave foolishly: On the one hand to accept the idea that holders of Greek debt are forced by the EU to accept a 50% haircut without the benefit of the payouts they were expecting from the CDSs they purchased together with the Greek bonds while, at the same time, trusting the EU’s own issue of digital CDSs on future Italian and Spanish bond issues.
  3. The world in general, and China in particular, is expected to turn a blind eye to the toxic nature of the EFSF which means that either it is too small to deal with the capital black holes facing the eurozone (both its sovereigns and its banks) or its impact will be too toxic if it is given a large sum to play with. (For this argument click here.)

Verdict: The Brussels Agreement comes hot on the heels of the 21st July Agreement which pushed, unwittingly, Italy and Spain off the proverbial cliff. And instead of pulling them out of the ravine, the Brussels Agreement amounts to an official declaration that Europe cannot help these two countries. The very allusion to potential help from China and the IMF amounts to a declaration of failure. What followed in the Italian bond auctions after the announcement of the Brussels Agreement was a foregone conclusion.

Concluding remark

Greece and Italy are in the process of acquiring technocratic governments the stated purpose of which is to ensure that the Brussels Agreement is implemented. If my analysis above is right, their task is hopeless. Technocrats may serve a purpose when working from a rational engineering plan. But when the plan is of the sort discussed here, they are bound to oversee the collapse of the very euro edifice that they were summoned to save. They will then be remembered as Europe’s reverse alchemists (who started with a nugget of gold which they then, almost mysteriously, turned into a piece of lead.).

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Copyright © 2011 · Yanis Varoufakis

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