The fiasco of the leveraged EFSF with IMF involvement

Eurogroup chief Juncker: 'Other solutions' are necessary (Photo: consilium.europa.eu)

Yesterday the President of the Eurogroup Jean Claude Juncker admitted that the EFSF will not be able to be levered up to 1 trillion euro as the October 26 Euro summit had initially hoped for (in vain). According to euobserver.com Juncker said "We have talked about leverage though private money, but it would be two or two and a half times an increase so not sufficient and we have to look for other solutions to complement the EFSF and that in my mind will be the IMF,".

Of course back in October when I stated my objections to the plans to leverage the EFSF, I was seen by certain groups as the "euroskeptic". Now Juncker seems to be turning into such "euroskeptic" as well. Juncker's statement is correct, only he failed to tell the whole truth, by sticking on to the wildly optimistic view that private funds can actually lever up the EFSF, 2 or 2.5 times.

The reason this will not happen is rather simple. First when speaking of private funds we are basically referring to private banks. Second within the eurozone such banks that would be perfectly willing to buy the uncertain bonds of the EFSF are hard to be found, if any, either because they have already done the math and have realized that the bailout fund is nothing more than a tower of cards; or even if they are willing to invest, their funds are scarce, given the massive amount of capital they need to amass to meet the capital ratio criteria as set in the latest bank recapitalization programme. Either way the conclusion is rather straightforward, private funds will be insignificant.

So the alternative according to Juncker is to resort to the IMF to cover the gap. Yet the IMF is not an infinite source of wealth from where Europeans can draw funds at will. It also has limited resources, while it draws contributions from countries all over the world who would be more than reluctant to just increase the funding capacity of the IMF.

Understandably this will create all sorts of problems, so they are actually thinking of a new trickery. To allow the ECB to increase the funds of the IMF, an action that will not count as "printing money" and will theoretically get the job done. Yet this too is a Ponzi scheme once worked out that does nothing at all to address the underlying issues and to contain the negative dynamics that are at place.

The next few days will be crucial to see whether European alchemists can produce gold out of thin air, succeeding in buying additional time, or whether the euro will enter the final stages of its disintegration.

Can the ECB print money at no cost? Not at all

The voices calling the ECB to "do something" are increasing. Of course they are ignoring the fact that the European Central Bank is already intervening in the markets, doing much more than what many tend to believe. In its latest communique on November 28 the ECB admitted it has already used €203.5 billion for its Securities Markets Programme - to buy, in other words, sovereign bonds of the European periphery. If we consider that the SMP resumed in August to keep Italy and Spain above water and after knowing that the programme had accumulated approximately €73 billion before, we see that in the last four months the ECB has used more than €130 billion, which is a considerably high amount given that supposedly they are "doing nothing".

But let us not play with numbers here and instead focus on money printing in general. Can you print money at no cost? Will that get society something for nothing? Ultimately is that the way to save the euro? In all cases the answer is "No - not at all". The costs of allowing the ECB to monetize debts ("print money") are many ranging from economic to political.

In my article titled "ECB and democracy: The traps of debt monetization" I painted the political drawbacks of such an act. The ECB has been given the unique task to administer a currency without a counterparty treasury with jurisdiction over the exact same area. This creates an institutional gap that if filled by the ECB alone, leads to all sorts of political imbalances, as the ECB is a supranational entity not a federal one as many falsely think. To bridge this gap in a credible manner, Treaty changes are required, which I doubt can be concluded successfully within the current rigid time frame. Not following the credible, democratic path of Treaty changes by just allowing the ECB to play two roles at once, can distort the political balance in the eurozone, in a highly unpleasant way by ultimately leading to power abuse (also see About the European Central Bank monetizing debts).

On the economic side, printing money has always been and will always be a way of postponing problems not solving them, at the extremely high cost of inflation (and moral hazard in our case). Those who argue that greatly expanding the money supply amid a recession does not lead to inflation are right only if we speak about the short term. Yet this argument holds true under all economic circumstances, as money expansion is not realized immediately, as prices require some time to adjust to the new reality. So it does not really provide any concrete support of the idea of debt monetization, as inflation will inevitably come into play. The qualitative difference between an inflation amid a boom and one amid a recession is that the later is actually far worse. A stagnant economy characterized by increasing unemployment and little to no growth, cannot wish for anything worse than a relatively high level of inflation, since if prices increase at a fast rate, the purchasing power of the already hardly-pressed consumer will diminish considerably, thus reducing even further his/her consumption, effectively leading on aggregate terms to even less growth, which implies a deepening of the recession.

It is important to realize that what we should consider is not just to get out of this crisis, but also the grounds we will prepare for such an exit. If we escape from this crisis, by placing the foundations of another one, we will have effectively done nothing more than a spectacular hole in the water. The crisis of the euro if solvable any longer, cannot and must not be addressed by ECB inflationary policies. More credible, system-wide measures are needed. Ones that will lead to robust growth after the exit, not prepare the environment for another free fall.

Cyprus is on the edge of the cliff

The Republic of Cyprus is facing the increasing threat of coming to the need of a bailout as its economy continues to deteriorate. The malignancies of the Cyprus economy are indeed numerous and are found both in private and public sector.

Cypriot banks suffer from their exposure to debt-ridden Greece, creating a major source of uncertainty regarding their capacity to withstand the mounting pressures. Given the sheer size of the country's banking sector, that is seven times bigger than the GDP of the country; negative expectations about the viability of the broader economy and the state's finances, have naturally been shaped. The 50% haircut that will be imposed on private holders of Greek debt, will have a significant impact on Cypriot banks, who will be forced to raise their Core Tier 1 capital, to withstand the shock and to meet the capital ratio criteria as those were set in the October 26 Euro summit under the bank recapitalizations programme. In practice banks are forced to reduce the amount of liquidity they supply in their attempt to deleverage, as they are in desperate need of 3.6 billion euro until June 30, 2012. For the economic size of Cyprus that is a huge amount of capital if we consider that the GDP is roughly lower than 20 billion euro. This process of bank deleveraging to meet the needs will affect the real economy, as low liquidity amid anemic growth, is hindering business activity.

Reduced liquidity is also part of the government's doings (indirectly at least). The government has been drawing funds out of the internal market to finance its needs since international borrowing costs have long now been at exorbitant rates. Last Friday the rates for 10-year bonds were above 10%, a forbiddingly high borrowing cost. Though this has successfully bought time for the government (that was not used anyhow productively) and saved it from falling a victim to international market speculation, it has had the effect of depriving the economy of much needed liquidity and has pushed up interest rates, making things even worse for the market.

Though it would be quite easy to put the blame on the "reckless" investments of Cyprus' banks, I uphold that the problem is much broader and has to do with a series of structural problems and policy failures. The flaws of the economy of Cyprus are indeed numerous, while the state functions along anachronistic, counter-productive lines. The number of public servants in Cyprus is approximately 53.000 that absorbs around 30% of the total government's spending. Public servants enjoy some of the greatest benefits and high salaries across Europe that are disproportional to their productivity. Though one could be tempted to argue that this is not a problem since they take the money and they spend it, thus stimulating the economy; this conclusion would have been pure fallacy from beginning to end. What matters is not the recycling of the money on the same goods and services, but ultimately what an economy as a whole produces. After all if the logic of people spending money without really being productive was correct, then it would also hold logically true for 60% of workers, or 99%. At that point it is clear that such views are a bunch of nonsense.

Cyprus has a significant portion of the working force in unproductive activities, while much of the country's budget is spent in a highly wasteful manner, when it could either be used to invest in education, improve infrastructure, decrease taxes, or used in other areas of policy that would facilitate business activity, producing real growth. After all according to Eurostat, Cyprus is among the European states with the lowest expected real growth levels in 2012 (0%) and in 2013 (0.7%). These bleak numbers do not come up coincidentally. They are one of the side-effects of not investing in ways to improve the competitiveness and productivity of the real economy.

Competitiveness is something the economy is in desperate need of, yet it seems that this will not come any time soon, again thanks to decades of bad government policies. With its legislation and the incentives it produced, the government managed to give birth to quite strong labor unions, that are now reluctant to give up the generous benefits they got in the period of the "fat cows", prior to the Great Recession. For instance unions of public servants are reluctant to accept a two-year freeze of their lucrative wages, effectively forcing the government to resort to tax policies, so as to raise the funds it requires, since any cuts in the public sector will meet staunch resistance. Plans are now being made to increase taxation on the productive parts of the society, as labor unions are asking for "business" to contribute.

What needs to be said is that "business" is already the largest contributor to government funds, since public servants do not even pay for their pensions. Even if they did though, the rationale of absorbing money out of the productive segments of the economy is indeed ill thought. Increasing taxes amid a recession has always been a self-defeating policy and Cyprus will not be an exception. Higher taxes will only depress growth even further, effectively pushing the country deeper into the hole. Increased taxation amid feeble growth also has a negative on employment. Higher tax costs put even more pressure on employers to release their employees, thus increasing unemployment. And of course the cost of unemployment is paid by the state's budget, in the form of unemployment benefits. Understandably this not the effective way to cut deficits and reduce debts.

There are a series of other issues that could be pointed out within the context of this article, yet the above are enough to depict the environment of uncertainty and big trouble Cyprus finds itself in. Years of government failures, of bad policies and unproductive spending has brought Europe's South-Eastern Mediterranean state on the edge of the cliff where the slightest of imbalances will push the country into a bailout mechanism.

It would be unfair to put the blame of the situation in any group of workers, or on any sector of the economy, either that is public servants, or banks, or "business" in general. The ultimate blame must be put on the government, since it created all this mess, with its ill advised, counter-productive policies. After all as the great Cynic philosopher, Diogenes of Sinope once said, "Why not whip the teacher when the pupil misbehaves?".

President Demetris Christofias is now called to fix the errors of all the administrations that took power the last decades, including his own. Given the structure of the broader issue and the direction his government's policies have taken, I doubt he can do much, or if done I fear it will not be enough.

Common misconceptions about bankrupt Greece

Greece is practically bankrupt since May 2010 when the country could no longer borrow from the international markets, since interest rates were exorbitant. Ever since Greece has been under a bailout programme by the so-called troika, a collective of technocrats coming from the European Commission the European Central Bank and the International Monetary Fund. The bailout programme was officially sealed by the signing of a memorandum by the Greek government and the troika officials. The deal envisaged a 110 billion euro package to be given to Greece in a series of installments. The money given to Greece had two characteristics (i) were accompanied by high interest rates, (ii) had as a prerequisite the implementation of harsh austerity measures to cut the budget deficit to the desired levels. The implications of these policies have been significant in violating human rights and the very principles of democracy. It is important to first have a quick review of the common misconceptions about the matter, to better comprehend the ways in which fundamental rights and values are being violated, to service a debt burden that is impossible to bear.

The first of misconceptions is that the crisis is purely Greek, caused by the internal malignancies of the Greek economy. Though it is true that the Greek state and economy are ill regulated, it is pure fallacy to argue that the crisis is a symptom of these deficiencies. Such an assumption omits the over-leverage of private banks (wide openings in risky ventures) on a eurozone-wide level, the institutional flaws of the Euro architecture and the fact that any member-state of the euro has practically lost a considerable part of its sovereignty and policy tools over economic matters, since those have been transfered to the European level, through the process of European integration. I have explained time and again how the crisis in the entire eurozone is "systemic". What we tend to call "Greek", "Irish", "Portuguese" and other crises are nothing more than emanations of the broader crisis that is deeply rooted in the institutional gaps of the euro. The euro was ill designed from the outset. It was like a riverboat never meant to sail in stormy oceans. So when it did, after the collapse of Wall Street in 2008, it started leaking from left, right and center. Ever since the euro edifice has been unraveling and there is nothing to stop it at the moment. Greece was only the first victim in the domino effect. Now a few years later everyone can see how the crisis is spreading to the other eurozone countries. The sheer size of the Greek economy is ancillary to cause such a stressful situation, suggesting that other more profound problems existed from the very beginning and Greece was nothing more than the scapegoat for many political powers in Europe, to avoid their own responsibilities in the whole story.

The second misconception about Greece is that the bailout is in fact an act of "solidarity" and "partnership" among European states; while the money that Greece receives are ostensibly used to pay wages and pensions. In both occasions reality is quite different. The lion's share of the money Greece receives is used to pay back older debts, in other words it is directed to the creditors of Greece, private banks in the Greek interior and other major European banks. Once one understands how the majority of money goes back to creditors, it becomes crystal-clear that the rhetoric about "solidarity" is a bunch of non-sense. The only reason Greece has been receiving support, is to indirectly bail out private banks, who would otherwise collapse, dragging down with them the broader economy. Last but not least, the money coming from the troika's bailout, is added to the public debt, which means that Greek taxpayers will be called to pay for it. The people at the Economic portal "Zerohedge" have done an excellent job to produce the following chart which depicts what I was just arguing for.

Image Source: Zerohedge

The third fallacy, is that the Greek people were not working enough. The accusations against the "lazy" Greeks reached extreme points of using racist stereotypes. The acronym "PIIGS" which stands for Portugal, Ireland, Italy, Greece, Spain, was not chosen coincidentally. It was/is a way of dehumanizing the people in these countries so as to make draconian austerity subconsciously acceptable to the people in the other European countries. The actual facts prove that this narrative is completely groundless since according to official OECD data, the people in Greece are actually working much more than their counterparts in other countries who are not "lazy". Economist Kash Mansori has done an excellent job in using that data to decompose this myth in his article titled "Where Exactly Are Those Lazy Southern Europeans, Anyway?". Regarding working hours he produces the following chart, which shows how Greeks are in fact working much more than the rest. The reason some speak about competitiveness, is because of the capital stock (the amount of infrastructure, technology, etc.) that is concentrated in Greece, which is indeed less than in other more advanced European economies.

Image source: The Street Light

The fourth and final misconception is directly related to current events. The belief that a different government can prevent Greece from imploding, when it is crystal-clear that technocrats cannot save any country, due to the structural flaws of the euro. The elected ex-prime minister of the country, George Papandreou has resigned from his position and has been replaced, by ex-banker Loukas Papademos, who leads an "interim" coalition government, composed by socialist PASOK, conservatice ND and far-right LAOS. Let alone the blasphemy that the ideological heirs of the Greek military junta (LAOS) are now in power; the task of this new "interim" government is to sign a new multi-annual memorandum with the troika that will bind the futures of every single individual citizen and all political parties. A greater share of national sovereignty will be transferred to unelected agencies, who will in fact run the country until necessary. In a previous article of mine, titled "Democracy in Greece is sacrificed to service an odious debt" I wrote the following:

...democracy seems to be the greatest victim in the whole process, as on one hand national politicians are preparing to accept a new multi-year memorandum that will definitely bring harsher austerity measures and give a greater share of national sovereignty abroad; on the other hand foreign politicians, from European partners to important international players, are putting immense pressure on Greece's two major parties to sign a binging document that will force them to implement in full the decisions of the October 26 European summit. The latter constitutes a clear intervention in the interior of the country as it directly suggests that elected Members of Parliament will be bound by the signatures of their parties' leaders, not to have the option of posing any objections to the new package. Ruling out all choices with orders backed by threats, in a part of the world where democracy is considered the highest of achievements, is by all means unacceptable as it violates the very founding principles of the European Union and modern western civilization in general...

....the Greek debt is odious; first because the loans that were taken in the name of the Greek people were not used for the common good, second the burdens that accompany this debt are disproportional, in many cases inhumane and increasingly undemocratic. Greek people are forced to pay considerably higher taxes, with an exponentially diminishing income, deprived from vital services. Their contributions are not utilized for the social good, to fund public works, or to improve education, health care, or to stimulate the economy. All of their taxes are used in unproductive expenditures with the lion's share going to the payment of interest on older debts that where taken without popular consent, for which the Greek people did not benefit...

...Yes Greece must change. Yes the economy must be liberalized, the tax collection mechanisms be enhanced, political corruption be combated. No sensible person has any objection to the above, for as long as the burdens are proportional and will eventually be for the public good. However none has the right to impose disproportional measures, nor to intervene in the internal affairs of the country in the name of servicing an odious debt. Human dignity, individual liberty, democracy are always above any kind of debt and cannot be violated by any creditor or partner who asks for money with interest, backed by threats.

With all of the above in mind, I may say that European politicians have been hiding behind their Greek finger, all these years, trying to convince public opinion that the crisis is purely Greek, when it is systemic; that the bailouts are an act of solidarity, when in fact the lion's share is used to pay banks, writing the bill on the "ever-generous" Greek taxpayer; that Greeks are lazy, when they work much more than others; and finally that the new Greek government was necessary to save the country from collapse, when it is clear that no country has the policy tools at its disposal to tackle the crisis on its own, since the catastrophic power of the beast we are facing is reinforced by the structural flaws of the euro. In the midst of all this human suffering is immense, the people who are unemployed increase dramatically, the humanitarian crisis in the heart of the Greek capital is getting worse, resembling that of under-developed countries; while democracy is being given away to unelected bodies that become ever more powerful as time passes. All this is caused by the denial of the powers of the European (and local) establishment, to accept that the crisis is fundamentally caused by quasi-bankrupt banks and by a single currency that should have never been created, but was produced to satisfy the arrogance of its architects, who thought that they could design an economic project to achieve political ends.

Why is the eurozone unraveling after the October 26 Summit?

The latest Euro summit was supposed to provide a "comprehensive solution" to the spiraling crisis in the eurozone. Considering the increasing borrowing costs of Italy and Spain, the mounting pressures on the AAA credit rating of France and Austria, the spread of the crisis to Belgium and the failure of the EFSF to raise the desired amount of funds from issuing its own bonds within the process of "levering", no one can possibly argue that the summit was effective anyhow, in at least calming down investors for a short period of time. I was among those who argued from the very beginning that the last summit was a massive failure not only because it did not really produce any definite measures to put a circuit brake to the feedback loops between stressed sovereigns and hardly-pressed banks; but mostly because desperate European elites, found in a desperate situation they had created, produced a series of measures or guidelines that would result in much more problems that they were willing to solve.

The first of these degenerating policies was the further expansion of the scope of the EFSF, the region's bail out fund. Without increasing its actual funds, European leaders gave to this mechanism, which is structured just like the infamous toxic derivatives of Lehman Brothers, an even greater burden effectively assigning to its €250 billion remaining funds the impossible task of covering a €3-4 trillion gap (including bank recapitalizations). I have stated on many occasions my belief that the very structure of the EFSF is toxic, thus from the outset it makes the task of increasing its firepower and scope ever-more degenerative. In the latest summit, European elites came up with the terrible idea of levering up the EFSF, by transforming it into an insurance instrument, which would have the capacity to guarantee the first 20% of the Italian and Spanish debt, to use it in order to issue bonds that would increase its funding capacity from the currently available €250 billion to an estimated €1 trillion. Had the leverage of the EFSF been done by the European Central Bank, the plan could have worked at least in the short-to-medium term. Yet the current setting is disastrous since investors understand that Italy and Spain, by being the third and fourth largest contributors to the EFSF, will effectively be guaranteeing their selves; while also they have the option of investing their money in the much safer German Bunds, so there is no real incentive to buy the bonds of a mechanism that is highly unstable and could easily implode given the amount of pressure it is put on it and the fragile foundations it is established on (the credit ratings of countries who might be downgraded, leading the whole plan to jeopardy) - [for more on the EFSF see Only the ECB can be a bazooka in Europe - EFSF is a tower of cards and The four sources of contagion in the Euro Area].

The second issue is the manner in which the restructuring o the Greek debt will be done. The demand to label the 50% haircut "voluntary", so as to prevent a "credit event" that would trigger the payment of the CDS (Credit Default Swaps) contracts has had a very negative impact on the world economy. It has resulted in the sort of moral hazard, whereby the checks and balances of the global financial system are being violated and undermined by politicians. This has two effects: (i) investors can no longer hedge their investments in the eurozone, by buying CDS, since they have now lost faith in them, implying that they will be much more cautious in providing liquidity to desperate sovereigns, (ii) European elites, succeeded in losing credibility their selves, since there is no guarantee whatsoever that similar "voluntary" haircuts will not be imposed on private investors of Italian, Spanish, Portuguese, Irish and all other debts. In both cases the effect is to reduce much needed liquidity thus making borrowing costs higher. This in conjunction with the lack of automatic stabilizers within the euro area, provide the perfect setting for a "spectacular" run on sovereign bonds that has nothing to stop it (see Nor the ECB nor Technocrats can save Italy).

The third is the bank recapitalizations programme, which is highly problematic and will definitely have the effect of considerably reducing the supply of money in the midst of an overall slowdown in the economy, which suggests that business activity will be deprived of much needed liquidity, in a period were growth is desperately needed. Asking from all eurozone banks to raise their Core Tier 1 capital - and all at the same time - is the sort of fallacy of composition that will lead to a credit crunch until June 30, 2012, when the deadline is (for more see European Bank recapitalizations: An imminent credit crunch).

These are the three main degenerative policies that are already producing more harm than good, to an already hardly pressed eurozone. Yet it seems that the self-destructive propensity of the European leadership is infinite since according to the latest speech of European Commission President, Jose Manuel Barroso, he will soon present plans for "stability bonds" - bonds that will be jointly issued and separately guaranteed by all member-states. From the outset this sounds like complete madness, since it follows the same path of all of the above-mentioned policies, as it will mutualize the system's debt, effectively putting even more pressure to the top ranked states to move downwards, while also these bonds will fall into jeopardy by the mere fact that investors will prefer German Bunds, instead of "stability bonds" that will only lead to further instability.

The inanity of European leaders is unprecedented. The series of self-defeating policies they have come up with these last few years will go down in history as a collection of suicide notes, from a political elite that had no capacity to solve a crisis caused by its own arrogance, errors and consecutive failures to act.

Nor the ECB nor Technocrats can save Italy

Lately two phenomena are occurring within the eurozone that are worth analyzing. The first is that Italian bonds are being traded at exorbitant interest rates above 7%. Should this continue over an extended period of time, Italy's illiquidity will turn into insolvency, considering its insignificant real growth and the amount of debt it has (see A macroeconomic overview of the Italian crisis). With respect to the increasing market pressures the vast majority of analysts agree that the European Central Bank will eventually have to monetize debts to ease the pressure on the eurozone's third largest economy, arguing that the sort of final backstop can be provided by the ECB in an effective way. The second phenomenon is the formation of governments led by technocrats, especially in Italy to a lesser extend in Greece, who supposedly are thought to be better suited for being on the helm at these dire moments for their countries, given their political impartiality and their technical expertise to deal with these economic matters. In both cases I may say that analysts are missing the broader picture, since neither the ECB, nor technocrats can contain the disintegrating dynamics that are in place.

There is this fiction that ECB intervention and the rise to power of technocrats is the way to save Italy and Greece, eventually preventing the euro from unraveling. This would have been a blessing had it only been the whole story, given that those who follow that line of thought err on ignoring the very structure of the euro architecture that lacks shock absorbers to contain a run on sovereign bonds. In addition those who really believe that each country can use policies of its own to prevent collapse, have not realized that the national authorities have no effective policy tools in their hands, since those have been given away in the process of European integration. Countries like Italy and Greece are like planes on autopilot with no levers to change the direction the plane is heading to.

It thus makes no difference at all who will be at the helm. Technocrat or politician, none can control a train on the process of derailment. Resorting to technocrats is nothing more than a mere excuse from politicians in Italy and Greece to avoid their responsibilities on one hand and to hide behind their finger on the other for not stepping up as they ought to, to demand a systematic (euro-wide) treatment to the systemic crisis of the euro - not the sort of shadow play of half-measures that have been making the crisis worse as time passes (See On the new Greek bailout and the Euro package that will die at birth). To cut the long story short, technocrats will not make any difference in the whole process. Their presence cannot reverse the disintegrating dynamics that are in force, since those are beyond their power, given the structure of the euro.

This is where the issue of shock absorbers emerges and why not even the ECB can save a country once a run on its bonds has started and is reaching a critical point. The lack of fiscal transfers within the eurozone, of a surplus recycling mechanism so to speak, coupled with the inability of any sovereign to command its monetary policy provide the perfect setting for a free fall. The reason why that is true, is rather simple: All euro states have the same currency, meaning that a run on bonds will not depreciate the currency of any given country, implying that investors have no incentive to transfer their money from the public to the private sector. This is one fact. The other fact is that each euro state is treated in a perfectly separable way, as national debts have remained with the sate and were not transfered to a genuine fiscal union.

The effect of those two combined is that investors draw their money from let's say Italian bonds and since they have no real incentive to invest in the Italian private sector, given that prices have not fallen, use that money to buy the much safer German bonds. So in practice we witness a transfer of wealth from all stressed sovereigns to German bonds, thanks to the structural gaps of the euro. This also explains in full why the euro as a currency has remained quite strong, since capital is not really leaving the eurozone - it is just reallocated in Germany.

This should not be seen as beneficial for Germany though, since there will be inflationary pressures there, which combined with the continuing fall of aggregate demand for German exports will make Germans worse-off. This whole process is a lose-lose game as money ends up in unproductive investments. Countries like Italy suffer from the lack of liquidity, while countries like Germany suffer from the diminishing foreign demand and the rising domestic inflation, while the euro architecture is unraveling.

The national crises are nothing more than emanations of the broader crisis of the euro. The disintegrating dynamics cannot be contained at a national level. Only system-wide measures that are taken at a European level, oriented towards filling in the institutional gaps of the euro edifice that are the primary source of the crisis, will provide a final backstop to the free fall of the euro and its constituent economies. With all of the above in mind, it is clear, to me at least, that neither the ECB nor technocrats as leaders of states can provide a credible response to the crisis, other than postponing the inevitable. The crisis is rooted in the system's flaws, that is where we should turn our attention to.

ECB and democracy: The traps of debt monetization

Sooner or later the European Central Bank will have to monetize debts to pacify markets, who see the illiquidity of Italy and Spain as an underlying risk that might make their public finances unsustainable within the few years ahead or even sooner, depending on the overall conditions in the Eurozone first and the global economy second. What should be made clear is that the ECB is already buying sovereign bonds from the secondary markets, via its Securities Markets Programme (SMP), though the quantities it purchases are relatively insignificant to shape interest rates and send a clear message to international investors that there is a determined final backstop in the Euro Area. Having already stated on several occasions my belief that the ECB should take a more active role in combating the disintegrating dynamics of the crisis, I now need to point out some issues relating to democracy, transparency and equality with respect to euro member-states, that are often neglected by the vast majority of analysts, for whatever reason that may be.

First of all, the ECB has been given the unique task to issue and control a currency (the euro) without the existence of a counterparty treasury with jurisdiction over the exact same area. The eurozone is a currency union, an area with a single monetary policy (together with all the rest Community acquis), which lacks a unified fiscal policy, or in other words a single authority that would have the power to raise money from its constituent states, by imposing taxes or issuing bonds of its own. Regardless of what was the rationale behind this setting, the gist is that there is a significant institutional gap in the architecture of the euro that makes the management of the crisis ever more challenging. This currently leaves the whole euro with only one policy leg, implying that any efforts to introduce the missing "leg" would either require a cumbersome Treaty change that will take years to be concluded, given the complexity of law-making in the EU and the need for any Treaty change to be ratified by 27 parliaments, making the labor unfeasible within the rigid time frame of the crisis; or alternatively the introduction of ad hoc measures that would give the missing powers to some mechanism that would lack credibility and would most probably be undemocratic, just like the EFSF, or ultimately to assign to the ECB itself the twin task of monetary and fiscal policy.

Given that a credible Treaty change is practically impossible within the time frame available (what Merkel is saying all the time about changing the treaties is mostly to exert pressure on certain governments to pass the necessary reforms), the only real choice, should full scale monetization be allowed, is to either resort to half-measures undertaken by ad hoc mechanisms, or to give all power to the ECB. In either case we are dealing with an issue of democratic illegitimacy and most probably with the over-concentration of powers to unelected bureaus/bodies/agencies/institutions with basically little to no accountability. The ECB for instance is completely independent and no power can tell it what to do. This derives from Article 130 of the Treaty which states the following:

When exercising the powers and carrying out the tasks and duties conferred upon them by the Treaties and the Statute of the ESCB [European System of Central Banks] and of the ECB, neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body. The Union institutions, bodies, offices or agencies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the European Central Bank or of the national central banks in the performance of their tasks.

Given this legal framework, the transfer of considerably more powers to an institution that cannot be controlled by anyone, is certainly not a prudent choice. The institutional gaps of the euro make the ECB a supranational entity, not a federal one, like the Fed in the US, which is from a qualitative perspective quite different since the ECB will in fact be above any state and will therefore have the power to impose its own conditions for monetization and discriminate among the states it wishes to support. This might sound overstretched to some, yet there already exists an instance of such coercion back in August, when a letter dated August 5 was sent from the ECB to the Italian government demanding austerity measures to be taken prior to the intervention in the secondary markets that took place during that time. Who can guarantee that similar actions may not be repeated in the future, especially in the case the ECB is asked to perform the dual task of being the treasurer and the issuer of the currency imposing rules and conditions and making discriminations? This democratic deficit is indeed an important issue, one that needs be considered prior to any steps towards such a direction.

On the flip-side, one might argue that the EU as a whole is already suffering from a similar democratic deficit which of course exists from the national level and it increases as we move higher in the institutional hierarchy. For instance the European Commission is unelected, yet the powers it commands are impressive. The point now is not to raise the issue of democracy in the EU, but to add to the discussion the argument which suggests that since Europe already suffers from a structural democratic deficit and since all measures that have been taken so far to combat the crisis are in most cases democratically illegitimate (excessive powers to the monitoring mechanisms in bailed out countries, democratically illegitimate mechanisms such as the EFSF etc.), why not move deeper in to the hole by adopting in full the sort of Faustian policies that are already exercised?

Regardless of where one stands regarding the argument, the point remains the same. We as Europeans are found in a situation where we have restricted our selves by designing a flawed monetary union and we now come to the point where the ECB will, sooner or later, have to monetize debts to prevent the implosion of the whole project. Democratic or not, this seems to be the only path to safety (combined with a series of other measures of course). Given that our leaders have proven to be quite creative when it comes to devising all sorts of complicated plans and bizarre mechanisms, an optimist might suggest that we should expect them to come up with a way to circumvent the democratic issue that has been raised above. Failing to do so in an effective manner, might well lead to unpleasant consequences, suggesting that this issue requires carefully taken decisions, with full agreement by all parties involved. At any rate we are already walking on a very thin diving line between virtue and vice. Alas we brought our selves to this position.

About the European Central Bank monetizing debts

Italy is facing increasing market pressures at the moment that could transform, if prolonged, its liquidity crisis into a solvency crisis. Amid this increasingly bleak environment most analysts agree that the European Central Bank should step in and act as a lender of last resort by monetizing debts. I myself have long been in favor of the ECB acting as a real central bank that above all protects the currency it issues. Though this would be beneficial for the eurozone at the moment, I realize there are a series of obstacles that prevent the ECB from taking action. Those are moral hazard, potential inflation and the politics involved. I did not include any legal barriers, since the EU Treaty articles do not prevent the ECB from monetizing debts - debt monetization can be done via interventions in the secondary markets, without violating the "no-bailout" clause.

Moral hazard is in my view among the primary concerns of policy-makers. They fear that once they allow the ECB to monetize debts, there will be no end to the cost since whenever there is a precedent other countries wish to take advantage of it and will be well justified to do so while at the same time the credibility of the ECB as the most independent central bank in the world will be lost, whatever consequences this might have on the behavior of investors. Within the context of the eurozone, where debt monetization would be a politically favorable path for many politicians in power in quite a few countries, the fear of moral hazard increases. Yet I think that European leaders are very late to worry about moral hazard in this particular scenario, when massive bailouts have already been given to banks and states, while also, the 50% haircut on private investors holding Greek debt has been labeled as "voluntary", effectively eroding the confidence markets had in the checks and balances provided by the CDS.

A potential rise in inflation is also worrying policy-makers. They believe that the necessary scale of debt monetization, will in fact create oceans of euro, without any real increase in actual products, eventually leading to a rise in prices. Given that euro area annual inflation is estimated by Eurostat at 3%. Many in Europe, especially in the core European countries, Germany first, get chills to the bones when they hear about higher inflation. On the other hand many analysts, argue that in the midst of a recession, the expansion of the money supply does not lead to inflation and even if it did, a mildly higher inflation over an extended time horizon would actually eat in the aggregate debt, effectively reducing debt burdens. Here is what I wrote on the matter in a previous article, titled "Only the ECB can be a bazooka in Europe - EFSF is a tower of cards":

In practice the drafters of the euro had erected a Maginot Line against inflation by creating a very conservative central bank, which current policy-makers do not even consider of revising (see Stricter rules are good - Stabilizing Mechanisms are much better). Our leaders are trapped in the fallacy of following the exact same dogma the drafters of the euro had, by producing measures to address inflationary pressures. This would have been very effective had the issue been one of inflation. The point here is that what we are dealing with and what our leaders fail to grasp is a series of existential pressures, not inflationary ones. Market pressures are mounting due to the lack of confidence in the euro architecture itself to overcome its own rigidities and institutional gaps. Inflation is secondary in importance when the very existence of the euro is challenged. It makes no difference at all to reinforce the Maginot Line, since the weak spot is elsewhere. That is the lack of a final backstop in Europe, a role only the ECB can effectively fulfill.

Apart from the economic concerns, one cannot possibly omit the political dimension of the matter. Political bargaining is of cardinal importance to the way the crisis evolves and European leaders react to it. The continuation of the crisis, is a means through which deep reforms that were postponed for decades can finally take place at once, under the threat of bankruptcy. Below are the four main political dynamics that prevent the ECB from acting as a final backstop (from my article The current economic and political situation in the Euro Area):

The political situation:

• Regardless of how cynical this might sound, the crisis is seen as a unique opportunity to push for the most radical reforms in countries that have been unwilling to implement the necessary changes over the last years/decades (the shock therapy approach). In practical terms, the immense pressures that arise from the prospect of default in Greece first and then in Portugal, Ireland, Italy and Spain give the power to the rest of the eurozone countries to use their economic support to demand much needed reforms.
• Germany, Netherlands, Austria and Finland possess immense bargaining power over the rest of the countries, because of their much more favorable economic position. On the other hand countries like Italy and Spain, despite the fact that they are the 3rd and 4th largest economies of the euro do not even dare to think of speaking their mind as that could easily produce adverse effects in the markets, leading interest rates to new heights, making their position even worse.
• Because of their inability to make propositions, these two countries are trapped in a position where they cannot have any practical impact on political decisions and on the other hand must implement austerity measures that further worsen their economic situation by contracting their economy. Austerity needs to be implemented for the sake of showing compliance to the hard line of the surplus countries and for appeasing the markets, since inaction would be conceived as a sign of inability to deal with fiscal issues, again leading to uncertainty and unrest which would affect interest rates on sovereign bonds (see The ECB captivity and the Italian, Spanish and Belgian prisoners).
• Greece is treated in a way that causes excruciating pain to its society. The harsh treatment is used as a deterrent to any other country, sending a clear message that reforms must take place to avoid the suffering Greece is forced to endure. It is crystal clear that the demands of the 'troika' from Athens go against any economic reasoning and even though most can agree that reforms are more than necessary no sensible person would offer his consent to the sort of austerity policies the troika's officials put forward. The malignancies of the Greek economy-society-state are deep seated and need to be addressed in their totality. Yet this must be done in a way that does not kill the patient.

All of the above form a quite complex situation, where it is by no means easy to allow the ECB to take the role it should always have. Whether the pressures coming from Italy (see A macroeconomic overview of the Italian crisis) will be enough to force policy-makers to change course of action, is a debate that everyone can speculate on. For now the ECB, with the stance it currently has, is in fact part of the problem, in the broader systemic crisis of the euro. In the end only radical measures will save the eurozone and its constituent economies from an apocalyptic implosion. However given the policy idiocy, that characterizes many of the proposals of the post-2008 era, no one can be sure that politicians will be able to act before it is too late.

Merkel and Sarkozy actually propose a perfectly partitioned EU

According to news sources, German Chancellor Merkel and French President Sarkozy are discussing on an "intellectual level" the prospect of creating an official two-speed Europe, with the eurozone moving into greater integration while the rest of EU remaining much looser. The above story is not something new. It is not a surprise to anyone examining the situation in Europe, at least for the last few years. This idea of moving to a more integrated eurozone, with the rest of the EU states falling way behind, is the natural extension of a specific mode of thinking that is deeply rooted in the hardcore, neoliberal monetary policy that applies within the Eurozone, which is a base copy of the German model that has proven to be good for Germany and a few other nations with aggressive export policies, but a complete disaster for all the rest. This mode of thinking is the economic world-view that permeates the very architecture of the single European currency, which advocated that diverging economies, with vastly diverse economies, can form a currency union and achieve convergence only by means of aligning with a rigid, fiscally restrictive policy framework. Indeed the architects of the euro believed that the currency union could hold together without the existence of a genuine fiscal union backing it, or at least a surplus recycling mechanism that would have the capacity to balance the structural trade imbalances within the region, by channeling accumulated surpluses into deficit regions for productive investments, so as to achieve sustainable growth and convergence.

The call for a more "integrated" Eurozone that will greatly distance itself from the rest of the EU, follows the exact same reasoning. The "more Europe" goal underlined in Merkel's statements is in fact a call for more of the same delusions that created the euro, more of the failing fiscal rules that function as a straitjacket for most states, more of the same self-defeating fiscal and monetary policies; while maintaining the same mentality that produced Maastricht Europe, whereby every state is fully responsible of its own finances, despite the inexorable fact that a large portion of state sovereignty is transferred to the European level. Maastricht and the current design of the Euro resulted in an internally perfectly partitioned eurozone, where the periphery was condemned to a structural trade and budget deficit, by means of the "beggar thy neighbor" aggressive exports of some states combined with the rigidities and institutional gaps of the single currency.

The mere fact that such an issue is discussed, even at an "intellectual level", reveals two things: (a) Sarkozy and Merkel have not learned from - or are not willing to accept - their mistakes and obsessions or those of their predecessors, (b) a relatively limited group of states makes plans without considering the broader EU good, since a more integrated eurozone will affect everyone else, without the rest being able to have a say in its internal affairs - thus resulting in a one-way relationship that will naturally lead to a two-tier Europe, rather than "just" two-speed. What Merkel and Sarkozy are thinking of doing, is to completely put aside the principle of a unified Europe, with genuine stabilizing mechanisms in place not just stricter rules; where each state will no longer be treated as a separate entity, but as part of a greater whole; and instead reinforce the same unsuccessful regime that has driven Europe into this despicable mire of recession, where many political achievements are being threatened.

The current manifestation of this indeed narrow-sighted approach, are the demands for front-loaded "fiscal consolidation" (austerity) policies that only see public finances without even mentioning the over-leveraged European banks, while also they appear in the form of official and unofficial adoptions of purely stereotypical statements of "hard working" Northern Europeans and "lazy" Southerners. In any case the facts are against those who slanderously put the blame of the crisis on a particular group of states and their peoples. Reality is that (i) the euro architecture created and expanded trade imbalances, leading to divergence, (ii) many major banks act like black holes, since their underlying insolvency was never addressed, thus their pre-2008 over-leverage has now transformed them into black holes that absorb liquidity and retard growth, (iii) Southern Europeans are actually working more than their cousins in the North, according to official OECD data - the "productivity" narrative is related to the capital stock which is considerably higher in the core countries, (iv) the hawkish policies of the ECB, combined with the fallacy of composition of simultaneous euro-wide austerity measures, the lack of any robust growth drive and the reluctance to mobilize the European Investment Bank, are all constituents of an emblematic policy idiocy, that will go down in history as the best example for future decision-makers to avoid.

Instead of a common truly integrated Europe, Merkel and Sarkozy are clinging on to the same sort of policies, to the very mindset that have kept the eurozone partitioned and have increased imbalances between core and periphery. All that a more "integrated eurozone" will do, in the way Merkel and Sarkozy understand "integration", is to destroy the incentives of entering that currency union, while also cutting the EU into half, with unpredictable political ramifications over stability in the area and effective decision-making. This is not how we, us Europeans, will go forward.

A macroeconomic overview of the Italian crisis

Despite all the discussion around the situation in Greece the real fires are burning elsewhere. Though under the current economic and political setting a disorderly default of Greece would be enough to tear apart the euro, the final blow to the single European currency can in fact be delivered by either its 3rd largest economy, Italy.

Graph 1. Data from Reuters

Italy is too big too fail but it also is too big to bail. French and German banks are heavily exposed to Italian debt, with German banks holding an estimated 118 billion euro of Italian debt, while French banks hold around 284 billion euro (Graph 1 on the right is in US dollars and counts in billions). The debt that private banks hold is staggering and shows that if Italy was to default or to significantly restructure its debt, core European banks would run into serious trouble. Given that European banks are already quasi-bankrupt and will in a few months time come to need for recapitalizations, a hit from Italy is certainly going to be fatal.

Graph 2. Data from the ECB

Italy, is the living proof against the narrative that large fiscal deficits are the problem in the eurozone and thus austerity policies are urgently needed to reduce such deficits (the fiscal discipline delusion) . As seen in the table on the right (Graph 2) Italy has a budget deficit at around 4.6% to GDP, compared with an average 6% at the eurozone, 5.4% from Netherlands and more than 7% in France. What other European partners are asking from Italy right now, i.e. austerity, is a narrow-sighted demand that only seeks to reduce the budget deficit, at the expense of diminishing growth, which at this point would only push the country deeper into the debt vortex. What Italy needs (and the euro area as whole) is growth and this will never come from austerity, especially when such policies are applied by all member-states simultaneously, effectively leading to a disastrous fallacy of composition, where no one spends and everyone cuts. Only growth will push the Italian and the European cart out of the mire of self-fulfilling recession.

What most analysts point out about Italy is the country's debt to GDP ratio that stands at around 120%, when the Stability and Growth Pact envisages a maximum of 60%. Italy's credit rating was downgraded recently, primarily due to such debt levels. Even though Credit Rating Agencies are less influential amid this crisis, because they were utterly oblivious of what was actually happening prior to the Great Recession, the credit rating downgrades are among the signals that the situations gets worse, not better.

For me the real problem of Italy is not its outstanding debt. What worries me the most about Italy is the annual real growth rate, which has been on average less than 1% for the last decade (see chart 3 below from 2001 to 2011). This combined with the current recession in the entire euro area and the overall slowdown in the global economy, suggest that real growth will at best be just above zero (the IMF estimates 1%), thus diminishing any hopes of reducing the debt mountain which stands at approximately 1.8 trillion euro.

Graph 3. Italy Real GDP Growth Chart by YCharts

Currently the country borrows at exorbitant interest rates of more than 6%, which means that in order to pay back debt and interest, Italy must have a growth rate of more than 6.1% which understandably is a utopia. In a November 8 report from Bloomberg we get the following on the matter:

Italy’s 10-year bond yield rose 11 basis points, or 0.11 percentage point, to 6.77 percent at 5:07 p.m. London time, the most since the introduction of the 17-member currency in 1999.

Note that these interest rates are kept at such high levels despite the constant intervention of the European Central Bank in the secondary markets. If these rates are to be maintained for a longer period of time Italy will come to the need of international aid, which practically means to enter a troika (EU, ECB, IMF) programme. However the EFSF, which is the vehicle that offers the funds, is ancillary in funding capacity. The EFSF has a total funding capacity of 440 billion euro, of which only 250 are available since the rest are reserved in the bail out programmes of Greece, Ireland, Portugal. In the latest summit, European leaders agreed to "leverage" the bail out fund to maximize its funding capacity up to 1 trillion. This would theoretically be achieved by guaranteeing the first 20% of the debt of Italy and Spain and use it to seek money from the private sector (how when European banks are practically bankrupt?) or from other sovereigns such as China, who would nonetheless attach all sorts of strings to achieve political ends, hence making an agreement quite distant. The plan to lever up the EFSF is going to die at birth. Here is part of what I wrote some days ago in my article titled "Only the ECB can be a bazooka in Europe - EFSF is a tower of cards":

The EFSF which is supposedly the mechanism through which the fall of states will be prevented is from the outset an unstable structure as it relies on the guarantees of all member-states, including those who are in need of funds. In effect Italy, Spain and the three countries that are under bail out programmes, are providing guarantees to their selves, which are only accepted thanks to the combined gold-platted AAA credit rating of France and Germany, the eurozone's two largest economies. The fundamental flaw in this structure is that France and Germany are in their selves in an unsafe position, since not even their own finances are very stable, either because of the exposure of their banks, which will indirectly bring the need for recapitalizations that have the effect of increasing public debts, or because of the burdens they carry with every country coming to the need of the EFSF, since those are the ones who provide the bulk of the funds.

The Achilles Heel in the EFSF is exactly its dependence on the triple-A credit rating of its two biggest contributors. France in particular has a banking sector that is heavily exposed to the debts of the European South, effectively raising questions of the capacity of the country to cling on to its excellent credit rating. These doubts are further reinforced by (i) the deterioration of Italy and Spain, with Italy being forced to lend money from the markets at an exorbitant interest rate of more than 6%, implying that the area's third largest economy is making steps towards a bailout programme via the EFSF, (ii) the anemic growth in the whole euro area, which is to a large extend caused by the simultaneous fiscal austerity of all member-states, leading to a unique, euro-wide fallacy of composition, reinforced by the overall slowdown in the global economy. With respect to the latter, French President Sarkozy made reference to the need for further fiscal consolidation in his country, suggesting that the national economy will effectively enter a period of contraction. Understandably this setting, leads to a self-fulfilling path to depression, bringing down the whole system, unless some "Good Samaritan" (call me China) shows up. But a Good Samaritan will only show up, if the chances of saving the euro are also good, otherwise he will prefer to invest his capital in other ventures.

All of the above indicate that Italy and consequently the euro are in serious trouble and there seems to be no way out, especially under the current mixture of inane policies European leaders come up with from summit after summit. Apart from the purely economic data, what unsettles investors is the chronic political instability of Italy. The country is being governed in a cartoonist way, which raises fears over the ability of the political elite to provide any serious answers to the pilling problems.

Italy is too big to fail but also too big to bail. The economic fundamentals of the country are quite bleak, while the political system is very unstable. Adding to the internal malignancies of the Italian economy, the euro architecture as a whole does not have any means of backstopping the fall of countries, while the EFSF which supposedly has that function, is an unstable mechanism that could collapse at any moment, should the pressure on it increase. The systemic structure of the crisis (what I have been stressing for months now) is gradually becoming more apparent. Some might speak of contagion to the core. I would say that the Italian crisis is yet another manifestation of the broader crisis of the euro. Alas European elites continue to deny that the Euro architecture is what needs to be redesigned and instead continue to call for front-loaded austerity, hoping that by holding their breath, they will avoid contamination from the plague. If radical reforms and system-wide measures do not take place, the national crises will continue to deteriorate, effectively leading to the collapse of the euro, a single currency that was ill designed from the very beginning.

Democracy in Greece is sacrificed to service an odious debt

A new coalition government between the two major parties in Greece, socialist PASOK and conservative New Democracy, is being formed. The final composition of the new government has not been decided, yet it is clear that it will be given the mandate to negotiate the terms of the new bailout package and lead the country to national elections within the following months. In the meantime democracy seems to be the greatest victim in the whole process, as on one hand national politicians are preparing to accept a new multi-year memorandum that will definitely bring harsher austerity measures and give a greater share of national sovereignty abroad; on the other hand foreign politicians, from European partners to important international players, are putting immense pressure on Greece's two major parties to sign a binging document that will force them to implement in full the decisions of the October 26 European summit. The latter constitutes a clear intervention in the interior of the country as it directly suggests that elected Members of Parliament will be bound by the signatures of their parties' leaders, not to have the option of posing any objections to the new package. Ruling out all choices with orders backed by threats, in a part of the world where democracy is considered the highest of achievements, is by all means unacceptable as it violates the very founding principles of the European Union and modern western civilization in general.

I have time and again stressed that Greece is to be fully blamed for the malignancies of its economy/society/state. I have also made it crystal-clear that the Greek people must finally take the bold and pragmatic decision to abandon all those practices that transformed the country into a barren wasteland. This however does not imply, under any circumstances, that a sense of proportionality should not exist and that any suffering or any violations of principles, values and rights are acceptable. The crisis in Greece, despite all internal maladies, is a manifestation of the broader European crisis, of the systemic crisis of the euro. A Euro that lacks a central bank that would openly act as a lender of last resort, that would maintain all necessary stabilizing mechanisms to balance the structural trade deficits within the area, that would have a well regulated banking sector where private banks would be prevented from being over-leveraged and where mandatory recapitalizations would occur in cases zombie-banks that retard growth existed.

In addition the Greek debt is odious; first because the loans that were taken in the name of the Greek people were not used for the common good, second the burdens that accompany this debt are disproportional, in many cases inhumane and increasingly undemocratic. Greek people are forced to pay considerably higher taxes, with an exponentially diminishing income, deprived from vital services. Their contributions are not utilized for the social good, to fund public works, or to improve education, healthcare, or to stimulate the economy. All of their taxes are used in unproductive expenditures with the lion's share going to the payment of interest on older debts that where taken without popular consent, for which the Greek people did not benefit.

Moreover the 50% haircut on private investors that will ostensibly lead to a debt reduction of a 100 billion euro, is a myth. This number is absolutely indicative, since the math that would lead to that number is filled with unknown variables as negotiations will be carried out in the weeks ahead to finalize the plan. Moreover the official document makes clear mention to "nominal discount will be 50% on notional Greek debt held by private investors" that will be accompanied by "The Euro zone Member States would contribute to the PSI package up to 30 bn euro". From private investors individuals and pension funds will be excluded, while states will provide 30 bn euro to the much-vaunted 100 bn debt reduction, while also bank recapitalizations will be required during the summer. All this proves that the 50% haircut is a derisory number, used to lure the Greek people into believing that its creditors are being kind with them and are making presents out of their good heart.

Yes Greece must change. Yes the economy must be liberalized, the tax collection mechanisms be enhanced, political corruption be combated. No sensible person has any objection to the above, for as long as the burdens are proportional and will eventually be for the public good. However none has the right to impose disproportional measures, nor to intervene in the internal affairs of the country in the name of servicing an odious debt. Human dignity, individual liberty, democracy are always above any kind of debt and cannot be violated by any creditor or partner who asks for money with interest, backed by threats.

Four points about Greek bankruptcy and European inanity

As time passes the crisis in the euro area gets worse. Italy is being forced to borrow at forbiddingly high interest rates, despite the constant intervention of the European Central Bank, while doubts are growing over the ability of France, the eurozone's second largest economy, to hold on to its excellent credit rating (AAA) given the exposure of its banks to the European South's debts and its unsafe fiscal finances. The mere announcement of the Greek Prime Minister, George Papandreou that he was willing to put to a referendum the new bailout package for the country, was enough to plunge international markets into greater uncertainty. There are four fundamental conclusions deriving from the events that recently took place that are worth pointing out.

Firstly the resulting chaos in the markets reaffirmed, in a clear manner, the systemic structure of the crisis in the eurozone. Markets plunged due to the knowledge that a disorderly default of Greece resulting from a negative outcome in the referendum, would trigger a Lehman-like chain reaction that would bring down the Euro area's quasi-bankrupt banking system, effectively putting into serious threat the very finances of core European countries who would then be forced to provide tons of capital to their threatened banks to prevent a complete financial meltdown. In addition the negative reaction of the markets rests in the deep understanding that there is no ultimate backstop in the Euro Area that would prevent a repetition of the Greek tragedy in other countries, thus giving birth to fears over the solvency of Italy, Spain and their banks as well as the credibility and safety of the rest of euro states. Investors do realize to some extend (for now) that the EFSF, the region's bailout fund, which supposedly functions as the ultimate backstop in the Euro Area is in fact a tower of cards as it relies on the guarantees of all member-states including those who are bankrupt or almost bankrupt (see On the new Greek bailout and the Euro package that will die at birth). For as long as the euro lacks all the necessary stabilizing mechanisms and its constituent member-states rely only on inane, simultaneous austerity markets will always remain highly skeptical of the capacity of Europeans to escape from the crisis.

Secondly the Greek political system is unable to provide credible representation for the country and has been proven to be more of a zombie than a vibrant community from where fruitful, progressive ideas would emerge, suggesting that Greece is practically finished. The country will remain above water only for as long as it continues to be the top systemic risk in the eurozone. Dr. Elpida Prasopoulou of the LSE raised some very accurate points about the Greek political system in her latest article titled "Zombie Politics", where she concluded with the following:

In any case, Greece runs out of alternatives. Isolation seems now a very possible prospect and this will not only turn Greece into a barren place with no real prospects of recovery. It will also perpetuate the political practices of the past since there won’t be any space for alternative political propositions to emerge. As such, Greek people will be stuck in the strong embrace of their zombie political system with no real prospect of release.

Thirdly, European elites proved their weakness and ultimate inability to provide an effective response to the prospect of a disorderly default of Greece, apart from bluffs and meaningless threats about forcing the country out of the euro. An exit of Greece from the euro is non-sense, not so because of the absense of a law envisaging such a process, but mostly due to the organic interconnection of Euro member-states. An exit of Greece from the euro, either forceful or voluntary ("voluntary") will have extremely unpleasant economic and political effects on the rest of the euro area. The economic implications are of course the uncontrollable shock waves of the default that will bring in front of serious trouble private banks that are heavily exposed to the Greek debt or to other banks who their selves hold such toxic debt, then states ultimately leading to immense market pressures that can well cause the collapse of the Euro (see Currency Union and Greek Euro exit). While the political ramifications will commence from the existence of a very bad precedent whereby a state is forced out of the euro due to its debts, suggesting that similar action might be taken against other countries whose economic condition resembles that of Greece. In such a case speculation will naturally rise over which state might be the next to follow Greece back to its national currency. In short an exit of Greece from the euro is not only disastrous for the country itself, but ultimate it opens the Pandora's Box for the entire eurozone.

Fourthly, the severity of the situation makes it crystal clear that there are no alternatives for Europe at this stage. The dilemma European elites will soon face is either real, viable solution to the systemic crisis of the Euro that will have to include the abolition of dogmatic economic and political beliefs together with the adoption of radical measures, or the gradual disintegration of the Euro. At any rate what is certain is that the Eurozone is running out of time. At the very best the area will have another two years of life, should all things go as planned. Yet the logic of "other things equal" is almost always proven false in the midst of the current crisis where a mere statement of a Prime Minister (regardless if it was right or wrong) in a country that represents less than 2% of the area's aggregate GDP, can cause such great panic.

The continual denial of European leaders to address the crisis as it really is, has the effect of rendering the whole Euro Area more vulnerable to pressures, contrary to the belief that "significant progress" is made from summit after summit where no actual solutions are presented. European citizens have been forced to bear witness to a cynical shadow play from a collective of political elites accompanied by pompous rhetoric and documents of triumphant self-admiration. The acts of hypocrisy cannot possibly conceal the underlying structural flaws of the euro, the malignancies of Europe's banks and the political weakness to accept the problem in its true form as a crisis of the Euro, not an amalgamation of national crises deriving from fiscal "indiscipline". The crisis is deeply political and will only be solved when Europe's politicians put community good above party interest.

Video Interview of KONTEXT with Aris Chatzistefanou on Greek and Euro crisis

I was informed about the existence of the German web TV with the name "KONTEXT". They produce top quality video footage on a series of important issues. They also have a series of films in the English language. One of them is the interview with Aris Chatzistefanou, director of the documentary "Debtocracy". The interview is titled "EU Troika is driving Greece into a humanitarian crisis". I found KONTEXT quite interesting so I have decided to share with you their interview with Mr. Chatzistefanou:

Quelle: www.kontext-tv.de

Courtesy of KONTEXT (http://www.kontext-tv.de/). The opinions expressed belong exclusively to their respective owners and do not necessarily bind me (Protesilaos Stavrou) or this blog.

Chaos in Europe, the G20 in Cannes and the need for constitutional changes – Interview with Thomas Colignatus

By Protesilaos Stavrou

Thomas Colignatus
Personal website: http://www.dataweb.nl/~cool/
Plan for Europe: http://mpra.ub.uni-muenchen.de/33476/

Thomas Colignatus is a Dutch econometrician (1954) who presents an economic plan for Europe. See an earlier interview, Part 1 and Part 2, or his text in Ekathimerini or the full plan in MPRA. He now has a memo Yes we can, in Cannes directed at President Obama and the G20 in Cannes November 3-4.

-Protesilaos Stavrou: Thomas, there is a quick consensus amongst economists that the euro rescue package only gives a temporary breath of air. I can refer to professor Richard Baldwin at Vox EU and my own analysis that the new Euro package will die at birth. The chief editor of the German Handelsblatt sees Greece falling apart. Now Papandreou calls for a referendum that may cause Greece to leave the eurozone. You advise the parliaments of the Eurozone to reject the rescue package. Europe cannot help itself. How can Obama help, who has such problems in his own country?

Thomas Colignatus: Let us first diagnose Europe. Kanzler Merkel’s strategy is apparently to keep a continual crisis. The current euro treaty has no effective way to force Greece and Italy to adapt their economies. The only way to force them to change their economies in the current setup is by high rates of interest in the market place if they don’t start behaving. Europeans are getting tired of all this and will at one time relinquish more of their national sovereignty to create a federal European fiscal union. At least, that is what Merkel hopes. The Economist reports that Merkel is willing to adapt the German constitution for this. Thus the current European way is muddling through with sticks and carrots. But the price is extremely high and quite risky.

-PS: What do you mean by ‘extremely high and quite risky’ ?

TC: The price is resentment. Voters don’t like leaders who continually present rescue packages that do not work. Voters hate being forced into something that doesn’t seem to work. The risk is a complete loss of confidence. The EFSF stability facility becomes a leveraged fund while the current crisis was created by such leverage. It can implode, and then the European Central Bank has to step in again, but with damaged reputation since it will seem illegal. Kanzler Merkel flirts with the Weimar republic. Greece is falling apart, Spain has 5 million unemployed, and Italy is out of control since Berlusconi does not care much about economics. Merkel hopes that people will opt for a fiscal union but they might as well blow up the EU. Imagine the 1929 Crash.

-PS: And that completes the diagnosis on Europe ?

TC: Not entirely. The plan that I propose contains four pillars and one of these is jobs. The meeting of the eurozone 17 concentrated on money but the earlier meeting of the EU 27 members also included a statement on jobs. This plan miserably fails. It neglects the aggressive export policies of Germany and Holland. It neglects the causes of the Great Stagflation that we are in. It neglects the need for national investment banks. The labour market in Greece and Spain is a disaster and I would reduce working hours by 20% and slash VAT to 1% to allow people to start working again with a decent income in short notice. Naturally the income tax on higher earners would have to compensate for the loss of tax income but the fun thing is that this need not be as much as it seems since you save on unemployment benefits and VAT proceeds are lower anyway because of the economy. Professors of finance and taxation tend to forget about the real economy. The reduction of VAT to 1% is not only a temporary measure but a structural measure to solve one of the causes of the Great Stagflation that we are suffering from since 1970.

-PS: That was Europe. Now the G20. You want President Obama to step in ?

TC: Well, he does not have to step in since Europe could solve it too. But another of the four pillars is the issue of governance. Our democracies in Europe and the US need an amendment to our constitutions. Both continents adopt Montesquieu’s separation of powers of the Executive, Legislative and Judiciary branches of government. Economic theory shows that we need a fourth branch, an Economic Supreme Court. President Obama has been a teacher in constitutional law. Never waste a good coincidence. We do not need a European fiscal union. Each nation can have its Economic Supreme Court filled with its own national scientists. The Italian Premier can be kept under control by Italy’s own economic scientists and not by a German Kanzler or a commissioner from Brussels. The United States of America also need their own Court. The mess in the USA has been caused since President Bush could tell economic untruths to the American public and get away with them. The Obama administration suffers from the same problem.

-PS: The clash last Summer between Obama and the Republicans on the debt ceiling almost brought the US government to a stand-still. Is this one of the things that can be solved by an Economic Supreme Court ?

TC: We have to be very precise here. The US have put the debt ceiling into law and the chaos that this causes shows how unwise it is of the EU to also require that, as in the current plans. Also, when the US would synchronize the elections of President and Congress then such clashes would occur much less. So the link between the idea of an Economic Supreme Court and a debt ceiling does not run over those lines. There is a different connection. The eurozone rescue package calls for independent forecasts of economy and budget. Good forecasts have a scientific base and science in itself is independent. To warrant proper functioning, you put this Court into the constitution. Instead of a debt ceiling you then use a debt target and so on.

TC: There is another aspect of democracy that is important here. The US and France have a Presidential system where voters vote separately for President and Parliament. This system is unwise for more reasons. You can get curious results such as for Bush, Gore and Nader or Chirac, Jospin and LePen, where someone is elected who would not be elected under a better system. The Presidential system in combination with districts also does not give much room for new parties and political innovation and competition. The Parliamentary system with proportional representation where Parliament also elects the Premier is superior because of the single electoral mandate and scope for new parties. Major parties would all supply ministers for government and the real job of Parliament is to control government rather than merely support a coalition. The G20 is a good platform to compare the experience in the EU and the US, in the light of the economic fall-out of the US political system and the disastrous impact of ideologues. If the G20 is willling to consider this, we will get a new world.

-PS: Thomas, thank you for this interview.