di Yanis Varoufakis, 29 agosto 2014
In this article I ask a question on everyone’s lips: Almost everyone agrees that the Eurozone was a one-legged giant; a monetary union lacking a political ‘leg’ to stabilise it. If so, why has the Euro Crisis (which surely strengthened that view on the back of its ferocity and durability) not strengthen the hand of the federalists? Of those who were, supposedly, waiting to pounce upon any opportunity to create a United States of Europe? (This article was compiled from extracts of a keynote speech I have on 25th August 2014 at the University of Tampere, Finland, in the context of a conference entitled Power, Knowledge and Society.)
«Monetary Union is an attempt to usher in Federation through the back door.»
Margaret Thatcher, 1990
We now know that Mrs Thatcher was wrong. The Euro Crisis, that broke out in th aftermath of the 2008 global financial implosion, was a splendid opportunity for federalists in Berlin, Brussels and Paris to push for the federal moves that they, purportedly, always planned to make on the back on the common currency.
Just look at the so-called Banking Union that the EU has agreed. The unification of banking sectors across the Eurozone, which was and is absolutely essential for the survival of the Eurozone, was recently proclaimed in name to be denied in practice.
This raises a poignant question: The United States also had serious trouble consolidating its union, its federation. It took a century of deliberation, a bloody civil war, a series of banking crises and depressions and, of course, the Great Crash of 1929, not to mention the civil rights marches in the 1960s (which spawned Lyndon B. Johnson’s Great Society) for the United States to achieve proper political unity. But with every crisis, the United States pulled closer together.
Europe is doing the opposite. It is coming apart. Even though we came to the brink in 2012, when Mr Mario Draghi, the head of the ECB, admitted that the euro was about to collapse (famously invoking the ‘convertibility risk’), not only did we not come closer together but, indeed, we did precisely the opposite, if one looks at the reality behind the rhetoric.
The question is: Why was Mrs Thatcher wrong? Why was a genuine political union not on the cards? Why is this crisis causing the re-nationalisation of many areas of policymaking, including the link between banks and governments? Why is the crisis failing to produce an Alexander Hamilton or a Franklin Roosevelt but, instead, reinforces unendingly the centrifugal forces tearing the EU edifice down?
The asymmetrical political economy of the Eurozone
Right from the beginning, the original signatories of the Treaty of Rome, the founding members of the European Economic Community, constituted an asymmetrical free trade zone. And when new member-states, like Greece, Portugal etc. entered, the free trade zone became even more asymmetrical.
To see the significance of this asymmetry, take as an example two countries, Germany and Greece today (or Italy back in the 1950s). Germany, features large oligopolistic manufacturing sectors that produce high-end consumption as well as capital goods, with significant economies of scale and large excess capacity which makes it hard for foreign competitors to enter its markets. The other, Greece for instance, produces next to no capital goods, is populated by a myriad tiny firms with low price-cost margins, and its industry has no capacity to deter competitors from entering.
By definition, a country like Germany can simply not generate enough domestic demand to absorb the products its capital intensive industry can produce and must, thus, export them to the country with the lower capital intensity that cannot produce these goods competitively. This causes a chronic trade surplus in Germany and a chronic trade deficit in Greece.
If the exchange rate is flexible, it will inevitably adjust, constantly devaluing the currency of the country with the lower price-cost margins and revaluing that of the more capital-intensive economy. But this is a problem for the elites of both nations. Germany’s industry is hampered by uncertainty regarding how many DMs it will receive for a BMW produced today and destined to be sold in Greece in, say, ten months. Similarly, the Greek elites are worried by the devaluation of the drachma because, every time the drachma devalues, their lovely homes in the Northern Suburbs of Athens, or indeed their yachts and other assets, lose value relative to similar assets in London and Paris (which is where they like to spend their excess cash). Additionally, Greek workers despise devaluation because it eats into every small pay rise they manage to extract from their employers. This explains the great lure of a common currency to Greeks and to Germans, to capitalists and labourers alike. It is why, despite the obvious pitfalls of the euro, whole nations are drawn to it like moths to the flame.
What does it take for an asymmetrical monetary union to survive?
The United States proves that an asymmetrical monetary union (e.g. between California and Missouri) can succeed. Nonetheless, most asymmetrical monetary unions, wherever and whenever tried in combination with free trade and deregulated capital movements, ended up in tears and retribution. The Gold Exchange Standard in the mid-war period, the various pegs between domestic currencies and the US dollar (in S.E. Asia, Argentina, Mexico etc.), the European Exchange Rate Mechanism, which crashed and burned in 1993, the Eurozone that followed the latter’s collapse etc. they all resembled invasions of Russia – that is, a brisk beginning full of enthusiasm and hope, rapid progress that seemed unstoppable, followed by a heart-wrenching slowdown as Cruel Winter took its toll, ending up with blood on the snow and infinite retributions thereafter.
What is the ingredient that allows an asymmetrical monetary union, involving free trade and free capital movements, to survive? An efficient Extra-market Surplus Recycling Mechanism is the answer. Mechanisms for recycling surpluses come in two different guises: Market-based ones, that rely on the financial system to channel surpluses, in the form of loans and credit, to the deficit countries and regions. And extra-market recycling mechanisms that rely on political institutions and some form of collective agency; e.g. fiscal transfers within a federation, the Marshall Plan etc.
Can Market-Based Recycling suffice, without Extra-Market Recycling? Under no circumstances. Here is why:
When asymmetrical national economies are bound together with politically engineered fixed exchange rates, as was the Gold Exchange Standard of the 1920s or the Eurozone today, there is a tendency for capital violently to migrate from the surplus to the deficit countries. From the Germanies to the Greeces of the monetary system. Why?
Because the German trade surpluses cause capital to accumulate in Germany, pushing real interest rates down there. At the same time, Greece is starved of capital and so the Greek real interest rate rises, attracting the money slushing around in the German banks. And if the exchange rate is fixed, German bankers labour under the self-reproducing illusion that they need not worry about a drachma devaluation, and so they lend to the Greeks as if there is no tomorrow.
These capital flows from the banks of the surplus country to the deficit country build bubbles in the deficit country which therefore experiences Ponzi-growth that, in turn, creates demand for more German exports, therefore reinforcing German surpluses while magnifying the deficits of the deficit areas.
Alas, the bubbles at some point burst. When they do, un-payable debts pile up in deficit countries like Greece. If the political response to this insolvency is to put all the burden of adjustment, and debt repayment, on the weak, insolvent shoulders of the deficit countries, the result is permanent depression there and a slow-burning recession in the surplus countries, as the deficit nations can no longer afford to import from them. Ponzi-growth thus gives rise to ponzi-austerity…
None of this is, of course, new. It is the story of the mid-war, Great Depression. That Europe saw it fit to repeat that piece of sorry economic history in the 21st Century is mindboggling.
What is most disturbing, however, is not that our leaders do not understand these simple facts of macroeconomics. What astounds and depresses the sober onlooker is that their incomprehension leaves them completely unashamed!
Looking for an explanation in the European Union’s history
To understand why Europe has not been egged on by its Euro Crisis toward the adoption of a federal Extra-market Surplus Recycling, and why its leaders continue to dither, we need to delve into the EU’s history, its DNA so to speak.
As Europe was exiting the WW2 nightmare, the New Dealers that were in power in Washington at the time began to plan for a United Europe as part of a global design that would last for at least two decades.
Having dealt with the Great Depression in the 1930s, and as WW2 was ending, the New Dealers’ most immediate grand fear was that the American economy would slip into another depression after 1949, as factories would begin to lay off workers once the war effort ended. With the dollar the only convertible currency, the new crisis would spread like a bushfire through the rest of the capitalist world.
Being the sole surplus nation globally, they understood that the only way of avoiding this calamity would be to recycle their own surpluses to Europe and to Japan in order to create the demand that would keep their own factories producing all the gleaming new products, washing machines, cars, television sets that American industry would switch to producing. Thus, the project of ‘dollarising Europe’ began. A most impressive hegemonic program that demonstrates vividly the sharp difference between hegemony and authoritarianism. And reminds us of how badly today’s Europe needs an hegemonic, as opposed to an authoritarian, Germany.
The New Dealers understood that their own industrialists, as well as business in Europe and in Asia, craved a fixed exchange regime that would afford them certainty. But they also understood that a fixed exchange rate regime, like the Gold Exchange Standard, would create bubbles that would then burst leaving nothing but tears and un-payable debts behind, and, possibly, a devastated global capitalism ready to fall prey to the emerging Soviet Union.
So, here is what they decided: They would re-create a fixed exchange rate regime (which came to be known as the Bretton Woods system) but equip it with an Extra-market Surplus Recycling Mechanism in order to stabilise it (with the Marshall Plan being only one of its, even if the most vivid, manifestations), to prevent imbalances between the deficit and the surplus nations from exceeding certain levels, to stop bubbles from forming (by introducing strict capital controls) and, in cases of recession, to inject capital as well as liquidity into the affected economies to prevent a depression that might spread throughout global capitalism.
To underpin the dollar-anchored fixed exchange rate system (also known as Bretton Woods) they selected the yen and the DM and set out to reinforce the industrial foundations on which these currencies sat. So Germany and Japan, the recently defeated nations, were to become the regional powerhouses east and west of the American Goliath.
However, powerhouses need ‘vital spaces’ – large markets around them capable of producing the demand for all the products that come off the production lines and which the German and the Japanese markets could simply never absorb. Thus the New Dealers had to answer the question: Where will demand come from for German and Japanese manufactures? In the case of Germany, the answer was: the rest of Europe – what we now know as the EU. In the case of Japan the original idea was to turn China into Japan’s vital space but when Mao wrecked that idea the United States did not hesitate to turn its own backyard into Japan’s vital space.
To implement this plan for Europe as part of America’s global planning, Washington had to overcome a major obstacle: the French demand that German industry be dismantled!Indeed, seven hundred German factories were destroyed by the allies and the agreement of Allied Command was that another thousand should follow. That had to change. To bring the French elites around to their idea of a German Powerhouse at the heart of a United Europe, the New Dealers offered Paris a simple deal: Accept the notion of a re-industrialised Germany dominating a Northern and Central European heavy industry cross-border cartel and we shall offer the graduates of the Grand Ecoles the opportunity to administer the cartel’s institutions and to the French bankers access to German surpluses.
The one Frenchman that put up the greatest resistance against this plan was none other than General De Gaulle. Eventually, and once elected President, he changed his mind and went along with America’s European Economic Community (EEC). “The EEC is a horse and carriage” de Gaulle once said to a journalist. “Germany is the horse and France is the coachman”. And when Henry Kissinger asked him how he would prevent German dominance of the EEC, de Gaul answered: Par la guerre! One wonders what Mr Hollande’s thoughts would be on this subject today…
Washington had to make one major concession for the EEC to be built along the Franco-German axis: European Unity would be built upon a cartel of heavy industry, rather than on the Americans’ preference for fairly competitive markets.
The process, once it began, was inexorable. First a German dominated cartel of coal and steel emerged, with a cross-border French-dominated administration. Once tariffs on coal and steel were removed, it was a natural next step to remove all tariffs. But to co-opt French farmers, a common agricultural policy was established the purpose of which was to extract the farmers’ consent to a free trade zone by handing over to them a chunk of the cartel’s monopoly profits. The Treaty of Rome was no more than a codification of that deal.
This fledgling European Economic Community created large surpluses that fuelled post-war prosperity in a stable world environment where the Bretton Woods system was constantly stabilised by the United States which took it upon themselves to recycle to Europe and to Asia almost 70% of their surpluses – but also to regulate ruthlessly all large financial flows. That was the Golden Age of low unemployment, low inflation which spawned the dream of Europe’s shared prosperity. It was (at the expense of treading on European sensibilities) an American triumph.
Alas, by the late 1960s it was dead in the water. Why? Because America lost its surpluses and could no longer stabilise the global system by recycling surpluses it no longer had. Never too slow to accept reality, the United States announced the end of that era. The calendar read: 15th August 1971. The dollar was de-coupled from gold, from the yen, and from Europe’s currencies. John Connally, Richard Nixon’s Treasury Secretary, visited Europe to tell our Europe’s smacked leaders: “The dollar is our currency but it is yourproblem”.
Europe had suddenly become unhinged!
Europe’s monetary experiment
All of a sudden, Germany was buffeted by a rising DM against the dollar while Italy and other countries that were crucial for northern European exporters were pegging their currency to the falling dollar. The post-war, American, design of a Central European heavy industry cartel, plus a common agricultural policy cutting the (mainly) French farmers into the deal, was in peril.A fixed exchange rate regime was imperative to keep it going. Thus Europe set off on the road to creating its own Bretton Woods within the EU. Tragically, they ended up with something much more like the Gold Exchange Standard than a European Bretton Woods. Why? Because they never planned for an Extra-market Surplus Recycling Mechanism!
Did President Giscard d’Estaing and Chancellor Helmut Schmidt, who negotiated in secret the European Monetary System in the 1970s, not know this? Did Francois Mitterrand and Helmut Kohl not know what they were doing when putting together the Eurozone in the early 1990s? Were Europeans merely unschooled to this very simple economic principle? I think they did know. Their problem was that the political arithmetic on which they relied was not conducive to the idea of extra-market surplus recycling within the EU. And here is the rub. Therein lies our collective misfortune.
Three were the reasons why an Extra-market Surplus Recycling Mechanism was not included in the European monetary design. The first was that the strains within the European family were too great. Indeed, France, Germany, Spain and Italy got bogged down into monetary warfare that lasted from 1971 until the 1990s. The second was that such a mechanism requires a powerful hegemon to set it up. Neither Germany nor France had that power on their own, either in the 1970s or in the 1990s, and were incapable of acting in unison to create it. Third, and most importantly, the need for an intra-European Extra-market Surplus Recycling Mechanism subsided by the early 1980s because of the United States and its audacious new global role.
Let’s for a moment go back to 1971. As the American authorities were dismantling the Brettton Woods system they adopted an audacious strategic move: once the United States had lost its external surplus position, and could no longer be global capitalism’s surplus recycler, it would (in Paul Volcker’s inimitable words) have to recycle “other people’s surpluses”. How? Instead of tackling the nation’s burgeoning twin deficits, America’s top policy makers were to do the opposite: boost them!
And who would pay for these deficits? The rest of the world! How? By means of a permanent transfer of capital that rushed ceaselessly across the two great oceans to finance America’s deficits, attracted to Wall Street by the prospect of higher returns. The deficits of the US economy, thus, operated for decades like a giant vacuum cleaner, absorbing other people’s surplus goods and surplus capital. In turn, powered by America’s deficits, the world’s leading surplus economies, Germany, Japan and, later, China, kept churning out the goods that America absorbed. Almost 70% of European and Asian profits were being transferred back to the United States, in the form of capital flows to Wall Street. And what did Wall Street do with it? It financed the rise of financialisation; a process which the French and German banks joined in enthusiastically.
This was the reason why Europe, despite having introduced an unsustainable Gold Standard in its midst, seemed to be prospering: the necessary intra-European surplus recycling was provided by the Franco-German banks on the back of the global recycling generated by America’s twin deficits and completed by the flow of global capital to New York. Wall Street’s bubbles financed Europe’s internal bubbles (especially in the Periphery) as well as the importation of Europe’s, and of course, Asia’s, net exports to the United States.
Europeans, like the Bourbons who remembered everything and learned nothing, assumed that America’s recycling role would survive ad infinitum. On the basis of this foolhardy assumption, they imagined that Europe does not need an Exta-market Surplus Recycling Mechanism of its own. That, once again, it would rely on the Americans for all the surplus recycling Europe needed. Thus, European leaders set out to recreate the Gold Exchange Standard within the European Union, demonstrating a grandiose failure of perception of what they were about to do. Keynes had described the Gold Standard as “a dangerous and barbarous relic of a bygone era”. Little did he know that Europe would recreate it in the late 1990s and defend it to the hilt after our 1929 hit in 2008.
Quite naturally, when following Wall Street’s collapse in 2008, America lost its capacity to recycle the world’s surpluses, it immediately ceased generating the aggregate demand that had hitherto stablised the European Union. At the very same time, Wall Street’s toxic money, that had hitherto ‘lubricated’ intra-European surplus recycling via the preposterously badly managed Franco-German banks, turned to ashes.
The rest is history. The Eurozone’s architecture was incapable of sustaining such shockwaves and it has been unraveling every since. Once Europe’s leaders barricaded themselves in the iron cage of radical denial that the Eurozone was in a systemic crisis, the European Union’s foundations began to crumble. The European Parliament elections of 2014, and the rise of organised misanthropy from Denmark to Greece and from France to Hungary, offer generous evidence to that effect.
Why is Europe incapable of moving in a federal direction now?
Many Europeans, deep down, hoped that Mrs Thatcher was right. That monetary union was an ‘underhanded’ move toward federation. That, perhaps, President Mitterrand and Chancellor Kohl knew that the euro, once created, would sooner or later cause a crisis which would then place their successors in a dilemma between (a) allowing the common currency to collapse or (b) moving toward political union. Even if this were true, it now turns out that Mitterand’s and Kohl’s successors, our current leaders, are incapable of (or unwilling to) proceed in a federal direction, preferring to allow the Eurozone to continue along a path of fragmentation which causes the fault lines between surplus and deficit countries to deepen irreversibly. The question, however, remains: Why?
Despite its numerous faults and toxic politics, the American Constitution evolved through an unabashedly political process of conflict between vested interests, between federal and states authorities, between capitalists and labour unions. The United States has been a political process from its inception, well before turning into a fully-fledged fiscal union. Economic and financial power was, of course, always at the heart of that political process and played a substantive role in the outcome of the ongoing political struggle. Nevertheless, economic power in the United States, while highly concentrated, was of a relatively fluid type. The dominant corporations came and went, their power being fairly widely dispersed. The mighty corporations of the 1900s are no longer central to the political game in Washington today, having been displaced long ago by ‘upstarts’. There were even instances when the federal government would attack and destroy large cartels, even confine for decades the financial genie into a tight, proverbial, bottle (e.g. Standard Oil, the Glass-Steagall Act).
In contrast, the European Union’s bureaucracy was always built as a democracy-free, even a politics-free, zone. Its founding fathers, men like Jean Monnet, harboured a deep distaste for democratic politics and aspired to creating a technocracy in Brussels that would direct Europe’s macro-economy in a corporatist manner in the interests of the Central European heavy industry cartel. Many of the Central European corporations that were dominant inside that cartel in the 1950s are still dominant within it today. In contrast to the fluidity of the United States spectrum of corporate power, the Central European industrial terrain is remarkably stable and in a stable relationship of co-dependence with Brussels; i.e. with the European Union institutions that were created to administer the legal and institutional framework functional to the interests of the ubiquitous Central European cartel. In this context, it seems natural that the European Common Market was an attempt at de-politicising the European integration project and subjecting it to the guidance and administration of unelected technocrats who would consistently reduce politics to management and democracy to consultation.
Mrs Thatcher’s error was to mistake the Central European, traditionalist, corporatist, and highly conservative notion of a ‘Europe of Nations’ for a penchant for a Federal Europe. There was never any political project, backed by powerful European interests, to create a federal, democratically elected government. The idea was always to erect a mighty bureaucracy that would work together with, and on behalf of national governments, in a manner that makes democratic accountability utterly impossible. How? Whenever an elected minister, or Prime Minister for that matter, returns home with a European deal that her or his own Members of Parliament find unfathomable, the retort is simple: “It was the best I could achieve.” Clearly, the ‘Europe of Nations’ is a super-state decision-making process lacking any mechanism by which electorates, and their elected representatives, can scrutinise its decisions. 
The ‘Europe of Nations’, seen from this perspective, was utterly consistent with and functional to the dominance of the capital goods, heavy industry cartel that was the foundation and motivating force of our, supposedly, United Europe. The notion of a Federal Republic where the sans culottes of France, of Spain, heavens forbid of Greece, would elect a common, a federal government on a one-person-one-vote basis, and have real influence on how United Europe would be administered, was and remains anathema to our elites and leaders. It simply did not, and does not, compute.
Thus, the EU’s radical reluctance to move in a federal direction following the Euro Crisis is not a mystery, after all. No cartel that controls the administration of its vital space directly wants to concede this exorbitant privilege to some democratically elected central government. Especially when a huge, expensive bureaucracy has been set up in Brussels precisely to preclude this. A bureaucracy that includes some very skilled technocrats who harbour a deep, Platonic, contempt for both history and democracy.
Well meaning Europeanists, who dream of that which Mrs Thatcher feared (i.e. a Federal Europe) fail to understand that it is not a simple matter to graft a federal democracy upon a Brussels-based technocracy representing the unholy alliance between run-of-the-mill apparatchiks, a powerful Central European cartel of heavy industry, national politicians who have their own cosy relationship with bankrupt local bankers, and large international banks.
They need to grasp what a Herculean task it would be to inject genuine representative democracy into the institutional mélange representing this unholy alliance, which has evolved into a European Union atavistically inimical both to democracy and to any form of extra-market surplus recycling.
If anything, the Euro Crisis has made this titanic task even harder. It is for this reason that, faced with a stark choice between fragmentation and federation, the European Union is currently drifting toward the former.
In the next article I shall be proposing, along the lines of the Modest Proposal, ways in which the European Union can be stabilised in a manner that makes possible a clean break from its undemocratic posture and from an ignominious future.
 Anyone who argues that the European Parliament fills, or can potentially fill, that role is clearly innocent of any understanding regarding what a real Parliament does. ⇑