Markets, World Affairs

The Never-Ending Greek Debt Slavery Saga Revisited


Obedience is not enough. Unless he is suffering, how can you be sure that he is obeying your will and not his own?

George Orwell, 1984

‘To say [Varoufakis’ Adults in a Room] is the best memoir of the Eurozone crisis,’ writes Adam Tooze, ‘is an understatement.’ I would second that had I read others. Memoirs are simply not my genre. But the former Greek finance minister’s testament is a different matter altogether.

Although far from disinterested, Varoufakis is a reliable reporter from the trenches. His critique of the Troika is truly devastating. Simply put: They knew. They knew that their plan was guaranteed to fail. They knew that Greece was bankrupt and would never be able to pay back all the money that it owed. They knew that without debt relief in one form or another, there was simply no path back to sustainability. They knew that austerity was devastating the Greek economy and worsening its debt burden. They knew that pouring good money after bad was a non-solution. They, Varoufakis insists, did not even want their money back.

Yet, utilizing an impressive arsenal of Kafkaesque red tape they obstructed all potential solutions, and using all available means of diplomatic and financial coercion, arm-twisted successive Greek governments to submit to never-ending debt slavery. Why? Adam Tooze explains it best:

The main function of disciplining Greece, Varoufakis tells us, was to serve as a warning to the French of the price of fiscal indiscipline. In other words its purpose was to perpetuate and widen discipline. But that in turn was not so much an economic as a political problem. Berlin wanted to avoid the terrifyingly difficult distributional politics of even larger scale exercises in cross border bail outs and “transfers”. Holding the line in Greece was a way of containing what could have become a spiraling political disaster for the CDU and their coalition partners.

We will return to the strategic rationale for putting Greece in debtors’ prison. But first, How did we get here?

Greece was a victim of global macro forces well beyond its control. In 2001, Greece gave up monetary independence and adopted the euro. This meant that regaining lost competitiveness and correcting macro imbalances would require a real devaluation (ie, wages would have to fall in nominal terms); thus requiring an extraordinarily painful ‘structural adjustment’ programme in IMF-speak.

Bond markets responded to the advent of the euro by compressing sovereigns spreads; meaning that Greece could borrow at virtually the same interest rate as Germany. (See Figure 1.) Greece was thus able to borrow large sums from bondholders—debt that was only revealed to be unsustainable when sovereign spreads widened with the onset of the eurozone crisis.


Figure 1. The spread between Greek and German sovereign bond yields.

At the same time, northern banks dramatically expanded their lending to Greece. Greek debt to foreign banks grew from €135 billion as of 2004Q1—surely up from a much lower level since 2001—to €217 billion in 2008Q1. (See Figure 2.)


Figure 2. Foreign banks’ credit to Greece.

More generally, Shin (2012) has shown that a banking glut in Europe was the principal driver of the financial boom in the European periphery as well as the United States. The idea here is straightforward: Fluctuations in the risk-bearing capacity of global banks drive fluctuations in the supply of credit. But let me offer a more precise thesis.

The credit boom preceding the financial crisis in the US and peripheral Europe was the great sucking sound of the wholesale market for collateralized funding. The extraordinary expansion of mortgage credit to, say, US households was due to demand for raw material (ie, mortgages) required for the manufacture of private-label mortgage-backed securities. (There was a persistent ‘shortage of safe assets’ in the global financial system.) In 2003-07, Pozsar (2015) shows, Wall Street was hard at work feeding the machine it had constructed to intermediate between cash pools (central banks, corporate and state treasuries, money-market mutual funds, et cetera) demanding ultra-safe assets in the money markets and portfolio managers demanding risk assets for their relatively high yields in capital markets. No wonder that Mehrling et al. (2013) describe shadow banking as ‘money market funding of capital market lending’.

Note that the centrality of the wholesale funding market does not undermine the role of the dealers’ risk-bearing capacity as the main state variable (or explanatory variable). To the contrary, funding markets exist in only as much as dealers make them. Physically, the interdealer funding market—the supercore of the dealer ecosystem and hence the global financial system—is a network of phone and Internet connections between traders at global banks. The point is that Shin (2012)’s finding—that fluctuations in balance sheet capacity drive fluctuations in credit supply—is only being fleshed out here; not superseded. [Of course, the risk-bearing capacity of the sell side ought to be measured relative to the financial size of the buy side. See Farooqui (2017) for the primacy of the relative scale of balance sheet capacity in pricing the cross-section of stock returns.]

The preceding paragraphs may seem like a digression. They are anything but. For the ‘excess elasticity’ of global finance was the fundamental reason why Hollande and Merkel had to impose debt slavery on Greece. The denouement of the financial boom unleashed by the unprecedented expansion of European balance sheet capacity came when excessive bank leverage met mounting losses on subprime loans. Germany and France could not acknowledge the scale of the bailout required by the banks to their audiences at home. They had to be bailed out without recourse to more public funds. While American policymakers used the AIG bailout to secretly bail out Goldman Sachs and JP Morgan, the Europeans used the Greek bailout to secretly bail out French, German and Dutch banks.

The [big] three French banks’ loans to the Italian, Spanish and Portuguese governments alone came to 34 per cent of France’s total economy – €627 billion to be exact. For good measure, these banks had in previous years also lent up to €102 billion to the Greek state.…

Why did Deutsche Bank, Finanzbank and the other Frankfurt-based towers of financial incompetence need more? Because the €406 billion cheque they had received from Mrs Merkel in 2009 was barely enough to cover their trades in US-based toxic derivatives. It was certainly not enough to cover what they had lent to the governments of Italy, Ireland, Portugal, Spain and Greece – a total of €477 billion, of which a hefty €102 billion had been lent to Athens. [The €102 billion in this quote is quite likely a typo—that’s the French banks’ exposure to Greece. As Varoufakis tells us later, the German banks’ exposure was €119 billion.] 

So, of every €1000 handed over to Athens to be passed on to the French and German banks, Germany would guarantee €270, France €200, with the remaining €530 guaranteed by the smaller and poorer countries. This was the beauty of the Greek bailout, at least for France and Germany: it dumped most of the burden of bailing out the French and German banks onto taxpayers from nations even poorer than Greece, such as Portugal and Slovakia. 

This disturbing transformation of the banking crisis in the northern core into a sovereign debt crisis on the periphery was accomplished in the very first phase of the eurozone crisis; well before Varoufakis arrived on the scene.

As soon as the bailout loans gushed into the Greek finance ministry, ‘Operation Offload’ began: the process of immediately siphoning the money off back to the French and German banks. By October 2011, the German banks’ exposure to Greek public debt had been reduced by a whopping €27.8 billion to €91.4 billion. Five months later, by March 2012, it was down to less than €795 million. Meanwhile the French banks were offloading even faster: by September 2011 they had unburdened themselves of €63.6 billion of Greek government bonds, before totally eliminating them from their books in December 2012. The operation was thus completed within less than two years. This was what the Greek bailout had been all about.

Thereafter, the European strategy was to enact a morality play to cover up the crime; complete with bloodletting—aka austerity—and moral sermons blaming the victim. The Troika’s treatment of Greece was tantamount to economic warfare. By the time Varoufakis got in the cockpit, the Europeans had developed the full apparatus of control. The reason he found the Troika to be Kafkaesque, is that the insiders were committed to controlling the narrative. They could not negotiate honestly with Varoufakis both because they feared the markets and because they would then be admitting guilt. While some individuals involved in the ‘institutions’ even admitted the crime to Varoufakis, institutionally the Troika was designed to bury the dirty little secret.

This is, of course, not to disagree with Adam Tooze about the role played by political constraints in Berlin, Paris, and indeed, Washington. Indeed, political constraints are precisely what drove the bank bailouts underground and started the Greek Debt-Slavery Saga.

VAROUFAKIS SAYS he had a financial deterrent to get Draghi to back off from financial strangulation and give him breathing room.

[The €33 billion] Greek debt to the ECB were legally momentous: any haircut of that sum or delay in its repayment would open Draghi and the ECB up to legal challenges from the Bundesbank and the German Constitutional Court, undermining the credibility of its overall debt-purchasing programme and causing a rift with Chancellor Merkel, who would never take on both the Bundesbank and the German Constitutional Court at the same time. Facing their combined might, Draghi was sure to find his freedom drastically curtailed, thus undermining the markets’ faith in his hitherto magical promise to do ‘whatever it takes’ to save the euro – the only thing preventing the currency’s collapse. 

‘Mario Draghi is about to unleash a major debt purchasing programme in March 2015, without which the euro is toast,’ I said. ‘The last thing he needs is anything that will impede this.’…I had no doubt that if a Syriza government signalled early on its intention to retaliate by haircutting the Greek SMP bonds held by the ECB in this way, it would deter the ECB from closing down the banks.

Calling the deterrent “potentially very powerful,” Tooze reports that

…the faction within the Tsipras cabinet that wanted to avoid a break was too strong. Varoufakis was never allowed to make the critical threat at the right moment. Greece was driven to a humiliating compromise without ever having deployed its deterrent.

Game-theoretically speaking, whether Varoufakis’ deterrent was effective cannot be answered without knowledge of the preferences of other players. Even if Draghi himself could be deterred, as indeed seems likely, that was only going to grant Greece a short term lease on life. There is no reason to believe that it would’ve forced the Troika to negotiate in earnest. A Greek threat to activate the deterrent could just as easily have yielded a Schäuble solution with the Troika turning the screws to push Greece out of the eurozone in the service of discipline. We cannot answer that without knowing just how much Merkel feared Grexit.

A distinct possibility is that the deterrence strategy was leaked to the Germans by someone in the Greek war cabinet—infiltrated as it was by the Troika—and that Merkel let it be known to Tsipras that the activation of the threat, or perhaps even its deployment against Draghi, would harden the Troika’s stance. What I mean to suggest is this: Tsipras is not a scoundrel. Why did he capitulate if the deterrent was in fact effective? Did he know something about the preferences of Greece’s jailers that Varoufakis did not? Could it be that Varoufakis’ dirty bomb was a recipe for tactical victory but strategic defeat? Is that why Tsipras capitulated instead of deploying the deterrent?

World Affairs

Surprising Role Reversals in the Never-Ending Greek Debt-Slavery Saga

The Never-Ending Greek Debt-Slavery Saga has yielded three remarkable role reversals among core, agenda-setting Western institutions.

If you remember the glory days of the Washington Consensus, the baddest of bad guys in the global neoliberal capitalist order was the International Monetary Fund. It was the star of the currency and sovereign debt crises of the 1980s and 1990s; all of whom had the same basic script:

Step 1. Globally-mobile capital from rich countries would flow into emerging markets (EM), buoying up thinly-traded asset markets and currencies.

Step 2. Shocks to risk aversion back home in the center of the world economy would prompt a dramatic reversal of said capital flows.

Step 3. Rapid capital outflows would lead to a crash in EM assets and of EM currency against the dollar; and therefore, a sharp increase in the dollar-denominated debt of the unfortunate state caught naked when the tide went out.

Step 4. The IMF would step in with a bailout package in exchange for harsh austerity measures and painful reforms that usually included a wholesale privatization of the state’s assets.

Most poor and developing nations wised up around the time of the 1997 Asian financial crisis. All of them, almost without exception, resorted to building up hard currency reserves (mostly dollars) for national insurance during good times. This was the financial equivalent of nuclear proliferation prompted by US aggression. Just as a nuclear deterrent guaranteed insurance against a US invasion, a big enough pile of US dollars ensured freedom from IMF-imposed debt slavery.

One consequence of this international politico-financial interaction was a secular rise in the global savings rate–that Ben Bernanke called the “global savings glut.” (See Figure 1.) In turn, the higher savings rate pushed down global interest rates and powered a credit boom in the United States; with well-known results.



In light of this history it is extremely interesting to watch the IMF play the nice guy through the Greek debt crisis. The IMF has been urging debt relief for years. Northern Europeans in general and Berlin in particular, used to play the good guys back in the 1990s. But since the beginning of the eurozone crisis, Berlin has led northern European creditors on a self-defeating Shylock’s quest. The humanitarian and economic costs of the austerity imposed on debtor countries of the Mediterranean have been substantial across the board. For Greece, they have been nothing short of a catastrophe. (See Figure 2.)


Figure 2. Greek GDP and Prime Age Unemployment (Source: FRED)

Ahead of the negotiations this week, the Fund released an official debt sustainability analysis calling for substantial debt relief, saying that it would only participate if the Europeans could prove that the “numbers add up.” (See panel.)

The Fund proposed 24-year payment deferrals, 40-year maturity extensions, and 1.5 percent caps on interest rates. The only thing that it did not ask for was an outright debt writedown. But it might as well have. The difference is semantic; even if politically potent for the Germans. The fundamental fact is that Greece cannot pay back all the money that it owes. And the Germans know it too.

The Germans were insisting that Greece maintain a 3.5 percent primary surplus, while the IMF has been arguing that no more than 1.5 percent is sustainable. (The primary surplus, receipts less spending before interest payments and debt repayments, is a basic measure of fiscal austerity: 1.5 percent is medium austerity; 3.5 percent is draconian.) The Germans have yielded on this front.

More fundamentally, as with previous deals the current deal amounts to kicking the can (further) down the road. The Europeans will pay the Greeks to repay the Europeans. It’s not even two different institutions! They are literally giving with one hand and taking from the other. German economists Stahmer and Rocholl showed that more than 95 percent of the 216 billion euro Greek bailout has found its way back to the coffers of banks and creditors.

And so the charade of the Never-Ending Greek Debt-Slavery Saga continues.


Now for the third and last role reversal. Remember how the New York Times used to be more progressive and, yes, leftist, than the business press? Not any more. Reading this report by James Kanter, I had to go up twice to make sure I was not reading an opinion piece.

In the very first paragraph, we are told that the IMF is “threatening to create more political and economic uncertainty at an already tumultuous time for Europe.” Later we learn that,

The fund is playing the role of the financial police, adamant that Greece will never return to growth if its debt burden is not sustainable. And Germany is the political pragmatist, leaning on Greece to stick with its austerity commitments lest it set a bad precedent for future bailouts and provoke unrest at home.

One could perhaps forgive this sort of nonsense on the pages of the Grey Lady if it were an Op-Ed by Paul Ryan or another ultraconservative idiot. But on page B2? What the hell is going on at this newspaper? Contrast that to the premier newspaper of global finance (sinister music), Financial Times:

As has now been the pattern for several years, the pressure to recognise reality has come from the IMF. The fund realised much earlier than the eurozone authorities that the programmes of fiscal tightening and microeconomic change being pushed on Greece would not provide a sustainable exit from the country’s recession and sovereign debt burden…

…the eurozone must confront the reality that some form of relief from official creditors is a non-negotiable part of giving the country a chance of returning to economic sustainability.

One way or another, these operations will represent a transfer of resources from the eurozone creditors to Greece, whether or not they are labelled as such and even if they avoid a politically explosive writedown in face value. So be it. The eurozone must shoulder some blame for its predicament.

What is going on with all these role reversals? Next thing you know, the GOP will start ranting against globalization! Oh, wait.




The Hollande-Merkel-Tsipras agreement on Monday is being described as a capitulation by many major newspapers [Telegraph, Bloomberg, Times, BBC, MSN, EU Observer].  “Brutal” and “humiliating” is how The Economist choose to describe the terms of the agreement. The Western press seems to be suffering a bad case of sensationalism and hyperbole. The deal is nothing so dramatic.

The Europeans have done what they do best: Kick the can down the road. It has been manifest for a while that the only way to end the Greek tragedy is substantial outright debt relief. The €86 billion deal is the third bailout package for Greece; the first one was for €110 billion in 2010; and the second in 2012 brought Greece’s debt to foreign creditors up to €246 billion. The probability that Greece will be able to pay back the €320 billion it now owes to foreigners, with or without reform and with or without austerity, is for all practical purposes zero. Major sovereign crises do not get resolved without substantial debt write-offs; as Reinhart and Trebesch have demonstrated. In the official statement, there is so far no recognition of this reality: “The Euro Summit stresses that nominal haircuts on the debt cannot be undertaken.”

Around the time of the Greek referendum, German policymakers were converging to the hardline position that Greece should be pushed out of the eurozone; a position championed by the veteran German finance minister Wolfgang Schäuble. The political optics changed after the results of the referendum were announced. Apparently, Luxembourg Foreign Minister Jean Asselborn’s dire warning to Angela Merkel, that pushing Greece out would be a “catastrophe for Europe”, pulled the Germans back from the brink. Merkel agreed to let Hollande play the good cop routine with Tsipras. Hollande arm-twisted Tsipras to concede on far-reaching reforms in exchange for relief on austerity.

Tsipras has agreed to push through a package of reforms through the Greek parliament. It includes an overhaul of VAT and income taxes, pension reform, labor market and financial reforms, and the privatization of utilities. This is certainly a surrender of sovereignty. But consider that Greek institutions were and are highly dysfunctional and in dire need of reform. That the Greek governement has to push through these difficult reforms under EU supervision is not the worst thing in the world. Even the much-feared labor market reforms only aim to bring Greece up to Western European standards. It is reasonable to expect that the Greeks themselves will be strictly better off as a result of these reforms.

As for austerity, the agreement calls for a primary surplus target of 1, 2, 3, and 3.5 percent of GDP in 2015, 2016, 2017 and 2018. This is an improvement over the 2012 bailout agreement which called for 4.5 percent of GDP in 2014, 2015 and 2016. The numerical proximity of these numbers is an optical illusion. The difference is that between catastrophic and mild austerity. The agreement also calls for what amounts to a medium-term stimulus of €35 billion for Greece. This is a substantial concession to macroeconomic reality.

Greece gets to keep the euro as a ward of the European Union. The ECB will now ensure than the Greek banking system does not implode. The government has to undertake substantial and far-reaching reforms under EU supervision. In exchange for a surrender of sovereignty over national policy to the European Union, the Greeks are spared from continuing to endure the equivalent of a Great Depression. The deal is nowhere close to being ideal. But for what it is, it is not catastrophic for the Greek people.

The Greek saga, of course, is very far from over. It will continue until a substantial portion of the debt is written off. Meanwhile considerably more significant market developments are underway half-way around the world. As I predicted, the asset price bubble in China is beginning to unravel. The stock market collapse is likely just the beginning of a major bust that will eventually lead to a lower-growth trajectory for the Asian giant. We are entering a new, perhaps more violent, phase of turbulence in global markets.