George Soros – Economy Watch

Europe’s Last Hope – Will Germany Step Up? : George Soros

George Soros — Thu, 18 Aug 2011 07:49:30 +0000

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18 August 2011.

Time is running out for the eurozone. Unless a euro-bond regime of one kind or another can be reached, the euro will break down. As the EU’s largest and best-rated economy, Germany has a critical role to play in Europe’s future. But the Germans are not willing to accept any level of responsibility. Till the day they do, Europe is headed towards a breakdown of the euro that will precipitate a banking crisis beyond the control of global financial authorities.

18 August 2011.

NEW YORK – Financial markets abhor uncertainty; that is why they are now in crisis mode. The governments of the eurozone have taken some significant steps in the right direction to resolve the euro crisis but, obviously, they did not go far enough to reassure the markets.

At their meeting on July 21, the European authorities enacted a set of half-measures. They established the principle that their new fiscal agency, the European Financial Stability Fund (EFSF), should be responsible for solvency problems, but they failed to increase the EFSF’s size. This stopped short of establishing a credible fiscal authority for the eurozone. And the new mechanism will not be operative until September at the earliest. In the meantime, liquidity provision by the European Central Bank is the only way to prevent a collapse in the price of bonds issued by several European countries.

Likewise, Eurozone leaders extended the EFSF’s competence to deal with banks’ solvency, but stopped short of transferring banking supervision from national agencies to a European body. And they offered an extended aid package to Greece without building a convincing case that the rescue can succeed: they arranged for the participation of bondholders in the Greek rescue package, but the arrangement benefited the banks more than Greece.

Perhaps most worryingly, Europe finally recognized the principle – long followed by the IMF – that countries in bailout programs should not be penalized on interest rates, but the same principle was not extended to countries that are not yet in bailout programs. As a result, Spain and Italy have had to pay much more on their own borrowing than they receive from Greece. This gives them the right to opt out of the Greek rescue, raising the prospect that the package may unravel. Financial markets, recognizing this possibility, raised the risk premium on Spanish and Italian bonds to unsustainable levels. ECB intervention helped, but it did not cure the problem.

The situation is becoming intolerable. The authorities are trying to buy time, but time is running out. The crisis is rapidly reaching a climax.

Germany and the other eurozone members with AAA ratings will have to decide whether they are willing to risk their own credit to permit Spain and Italy to refinance their bonds at reasonable interest rates. Alternatively, Spain and Italy will be driven inexorably into bailout programs. In short, Germany and the other countries with AAA bond ratings must agree to a eurobond regime of one kind or another. Otherwise, the euro will break down.

It should be recognized that a disorderly default or exit from the eurozone, even by a small country like Greece, would precipitate a banking crisis comparable to the one that caused the Great Depression. It is no longer a question whether it is worthwhile to have a common currency. The euro exists, and its collapse would cause incalculable losses to the banking system. So the choice that Germany faces is more apparent than real – and it is a choice whose cost will rise the longer Germany delays making it.

The euro crisis had its origin in German Chancellor Angela Merkel’s decision, taken in the aftermath of Lehman Brothers’ default in September 2008, that the guarantee against further defaults should come not from the European Union, but from each country separately. And it was German procrastination that aggravated the Greek crisis and caused the contagion that turned it into an existential crisis for Europe.

Only Germany can reverse the dynamic of disintegration in Europe. That will not come easily: Merkel, after all, read the German public’s mood correctly when she made her fateful decision, and the domestic political atmosphere has since become even more inhospitable to extending credit to the rest of Europe.

Merkel can overcome political resistance only in a crisis atmosphere, and only in small steps. The next step will likely be to enlarge the EFSF; but, by the time that step is taken, France’s AAA rating may be endangered. Indeed, by the time Germany agrees to a eurobond regime, its own AAA standing may be at risk.

The only way that Europe can escape from this trap is by acting in anticipation of financial markets’ reactions, rather than yielding to their pressure after the fact. This would require intense debate and soul-searching, particularly in Germany, which, as the EU’s largest and best-rated economy, has been thrust into the position of deciding the future of Europe.

That is a role that Germany has been eager to avoid and remains unwilling to accept. But Germany has no real choice. A breakdown of the euro would precipitate a banking crisis that would be beyond the global financial authorities’ ability to control. The longer Germany takes to recognize this, the higher the price it will have to pay.

By George Soros

Copyright: Project-Syndicate, 2011

George Soros is chairman of the Soros Fund Management, which functions as the primary advisor for the Quantum Group of Funds – started in the early 1970s by Soros and Jim Rogers. Soros is famously known as “the man who broke the Bank of England” in 1992, when the Quantum Fund forced the United Kingdom to devalue the pound. Soros is also known for his philanthropic work, mainly in support for liberal ideals and causes.

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The European Union’s Catalogue of Failures: George Soros

George Soros — Mon, 18 Jul 2011 04:45:08 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

18 July 2011.

On 1 November 1993, the European Union was formally established with the Maastricht Treaty – a culmination of a vision that began over 50 years ago when a small group of European politicians recognised the need for greater European integration to combat the wave of extreme nationalism that devastated the continent during World War II. Yet today in the face of a deepening debt crisis, Europe stands divided. George Soros, chairman of Soros Fund Management, warns that unless a Plan B is adopted, Europe faces “incalculable consequences.”

18 July 2011.

NEW YORK – The European Union was brought into existence by what Karl Popper called piecemeal social engineering. A group of farsighted statesmen, inspired by the vision of a United States of Europe, recognized that this ideal could be approached only gradually, by setting limited objectives, mobilizing the political will needed to achieve them, and concluding treaties that required states to surrender only as much sovereignty as they could bear politically. That is how the post-war Coal and Steel Community was transformed into the EU – one step at a time, understanding that each step was incomplete and would require further steps in due course.

The EU’s architects generated the necessary political will by drawing on the memory of World War II, the threat posed by the Soviet Union, and the economic benefits of greater integration. The process fed on its own success, and, as the Soviet Union crumbled, it received a powerful boost from the prospect of German reunification.

Germany recognized that it could be reunified only in the context of greater European unification, and it was willing to pay the price. With the Germans helping to reconcile conflicting national interests by putting a little extra on the table, the process of European integration reached its apogee with the Maastricht Treaty and the introduction of the euro.

But the euro was an incomplete currency: it had a central bank but no central treasury. Its architects were fully aware of this deficiency, but believed that when the need arose, the political will could be summoned to take the next step forward.

That is not what happened, because the euro had other deficiencies of which its architects were unaware. They laboured under the misconception that financial markets can correct their own excesses, so the rules were designed to rein in only public-sector excesses. And, even there, they relied too heavily on self-policing by sovereign states.

But the excesses were mainly in the private sector, as interest-rate convergence generated economic divergence: lower interest rates in the weaker countries fuelled housing bubbles, while the strongest country, Germany, had to tighten its belt in order to cope with the burden of reunification. Meanwhile, the financial sector was thoroughly compromised by the spread of unsound financial instruments and poor lending practices.

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A Process of Disintegration

With Germany’s reunification, the main impetus behind the integration process was removed, the financial crisis unleashed a process of disintegration. The decisive moment came after Lehman Brothers collapsed, and authorities had to guarantee that no other systemically important financial institution would be allowed to fail. German Chancellor Angela Merkel insisted that there should be no joint EU guarantee; each country would have to take care of its own institutions. That was the root cause of today’s euro crisis.

The financial crisis forced sovereign states to substitute their own credit for the credit that had collapsed, and in Europe each state had to do so on its own, calling into question the creditworthiness of European government bonds. Risk premiums widened, and the eurozone was divided into creditor and debtor countries. Germany had changed course 180 degrees from the main driver of integration to the main opponent of a “transfer union.”

This created a two-speed Europe, with debtor countries sinking under the weight of their liabilities, and surplus countries forging ahead. As the largest creditor, Germany could dictate the terms of assistance, which were punitive and pushed debtor countries towards insolvency. Meanwhile, Germany benefited from the euro crisis, which depressed the exchange rate and boosted its competitiveness further.

As integration has turned into disintegration, the role of the European political establishment has also reversed, from spearheading further unification to defending the status quo. As a result, anyone who considers the status quo undesirable, unacceptable, or unsustainable has had to take an anti-European stance. And, as heavily indebted countries are pushed towards insolvency, nationalist political parties – for example, Finland’s True Finns – have grown stronger, alongside more established counterparts elsewhere in Europe.

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Europe Needs a Plan B

Yet Europe’s political establishment continues to argue that there is no alternative to the status quo. Financial authorities resort to increasingly desperate measures in order to buy time. But time is working against them: two-speed Europe is driving member countries further apart. Greece is heading towards disorderly default and/or devaluation with incalculable consequences.

If this seemingly inexorable process is to be arrested and reversed, both Greece and the eurozone must urgently adopt a Plan B. A Greek default may be inevitable, but it need not be disorderly. And, while some contagion will be unavoidable – whatever happens to Greece is likely to spread to Portugal, and Ireland’s financial position, too, could become unsustainable – the rest of the eurozone needs to be ring-fenced. That means strengthening the eurozone, which would probably require wider use of Eurobonds and a eurozone-wide deposit-insurance scheme of some kind.

Generating the political will would require a Plan B for the EU itself. The European elite needs to revert to the principles that guided the Union’s creation, recognizing that our understanding of reality is inherently imperfect, and that perceptions are bound to be biased and institutions flawed. An open society does not treat prevailing arrangements as sacrosanct; it allows for alternatives when those arrangements fail.

It should be possible to mobilize a pro-European silent majority behind the idea that when the status quo becomes untenable, we should look for a European solution rather than national ones. “True Europeans” ought to outnumber true Finns and other anti-Europeans in Germany and elsewhere.

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