Both authors are very sophisticated economists (which is evidenced by the fact that they can disagree but still respect one another…).
The bottom-line of this sophisticated exchange is the question: how can the debt service burden (i. e. the interest expense) be lowered for the deficit countries? The underlying asumption is that the current interest expense is far to high for countries living through enormous adjustment periods.
First of all: this assumption is correct! In “normal” times, interest rates should be market rates in order to optimize the allocation of financial resources. Restructuring times are not normal times. During restructuring times, the guiding principle must be to do everything which makes it possible for normal times return again. Available resources must be predominantly used to making the return of normal times possible and not for the payment of market rates.
To accomplish this, Prof. Varoufakis recommends ECB-bonds. Others recommend Eurobonds. Both are fairly complex structures which may or may not accomplish the objective. This is why I would like to make the following comments.
First, the easiest way to lower a country’s interest expense is to simply lower the interest rate. That could be accomplished with the stroke of a pen.
And, secondly, lowering the interest rate does not necessarily mean that lenders are “giving something away”. Typical in any financial restructuring are “success triggers”: a lender might forgive some of his loans in exchange for shares of the borrower. If the restructuring is successful, the shares will gain value and the bank can recover some of its loss. Or, the total interest rate is divided into two portions: “cash interest” and “capitalized interest”. Only cash interest flows through the budget. Suppose the lenders want an interest rate of 4%. Fine with Greece, provided that only 1% thereof is the cash portion and the rest is capitalized for, say, 20 years.
Will all these obligations which are being postponed into the future every get paid 100%? Probably not, but that is besides the point. The point is that existing Greek debt currently trades between 10-20% of nominal value and if that percentage were to increase to, say, 50% or even more because of successful restructuring policies, it would already be a major success.
The best option would be to have a low cash interest rate and even cap the amount of interest expense at a certain percentage of government expenditures.
Approximately two-thirds of Greece’s sovereign debt is in the hands of the Troika/ECB at this point. To approve something like the above would require a telecon among a handful of people. If they agreed, then the remaining private creditors would have no alternative but to agree also.