| Soros on the eurocrisis Apr 11th 2013, 11:58 It's rather long, but quite interesting. I've done my best to fillet it down to a readable length, but obviously the whole thing is better. http://www.guardian.co.uk/business/2...-crisis-speech Quote:
Unfortunately, the Maastricht treaty was fundamentally flawed. The architects of the euro recognised that it was an incomplete construct: a currency union without a political union. The architects had reason to believe, however, that when the need arose, the political will to take the next step forward could be mobilized. After all, that was how the process of integration had worked until then.
But the euro had many other defects, of which neither the architects nor the member states were fully aware. For instance, the Maastricht Treaty took it for granted that only the public sector could produce chronic deficits because the private sector would always correct its own excesses. The financial crisis of 2007-8 proved that wrong. The financial crisis also revealed a near fatal defect in the construction of the euro: by creating an independent central bank, member countries became indebted in a currency they did not control. This exposed them to the risk of default.
Developed countries have no reason to default; they can always print money. Their currency may depreciate in value, but the risk of default is practically nonexistent. By contrast, less developed countries that have to borrow in a foreign currency run the risk of default. To make matters worse, financial markets can actually drive such countries into default through bear raids. The risk of default relegated some member countries to the status of a third world country that became over-indebted in a foreign currency.
Prior to the financial crisis of 2007-8 both the authorities and the financial markets ignored this feature of the euro. When the euro was introduced, government bonds were treated as riskless. The regulators allowed commercial banks to buy unlimited amounts of government bonds without setting aside any equity capital, and the European Central Bank accepted all government bonds at its discount window on equal terms. This created a perverse incentive for commercial banks to accumulate the bonds of the weaker member countries, which paid higher rates, in order to earn a few extra basis points. As a result interest rate differentials between the various government bonds practically disappeared.
The convergence of interest rates caused a divergence in economic performance. The so-called periphery countries, Spain and Ireland foremost among them, enjoyed real estate, investment and consumption booms that made them less competitive, while Germany, weighed down by the cost of reunification, engaged in far-reaching labour market and other structural reforms that made it more competitive.
In the week following the bankruptcy of Lehman Brothers, the global financial markets literally ceased to function and had to be put on artificial life support. This required substituting sovereign credit (in the form of central bank guarantees and budget deficits) for the credit of the financial institutions whose standing was impaired. The emphasis placed on sovereign credit revealed the hitherto ignored feature of the euro, namely that by creating an independent central bank the euro member countries signed away part of their sovereign status.
That would have been the moment to take the next step toward fiscal as well as monetary union but the political will was lacking. Germany, weighed down by the costs of reunification, was no longer in the forefront of integration. Chancellor Merkel read public opinion correctly when she declared that each country should look after its own financial institutions instead of the European Union doing it collectively. That was a step backwards. In retrospect it was the beginning of a process of disintegration.
It took financial markets more than a year to realize the implications of chancellor Merkel's declaration, demonstrating that they too operate with far-from-perfect knowledge. Only at the end of 2009, when the extent of the Greek deficit was revealed, did the financial markets realize that a member country could actually default. But then the markets raised the risk premiums on the weaker countries with a vengeance. This rendered commercial banks whose balance sheets were loaded with those bonds potentially insolvent and that created both a sovereign debt and a banking crisis. The two are linked together like Siamese twins...
...The creditors are in effect shifting the whole burden of adjustment on to the debtor countries and avoiding their own responsibility for the imbalances. Interestingly, the terms "center" and "periphery" have crept into usage almost unnoticed, although in political terms it is obviously inappropriate to describe Italy and Spain as the periphery of the European Union. In effect, however, the euro had turned their government bonds into bonds of third world countries that carry the risk of default. This fact was ignored by the authorities and it is still not properly recognised. In retrospect, that was the root cause of the euro crisis...
... all the blame and burden fell on the "periphery" and the responsibility of the "center" has never been properly acknowledged. The periphery countries are criticized for their lack of fiscal discipline and work ethic, but there is more to it than that. Admittedly the periphery countries need to make structural reforms, just as Germany did after reunification. But to deny that the euro itself has some structural problems that need to be corrected is to ignore the root cause of the euro crisis. Yet that is what is happening.
In this context the German word "Schuld" plays a key role. As you know it means both debt and responsibility or guilt. This has made it natural or "selbstverständlich" for German public opinion to blame the heavily indebted countries for their misfortune. The fact that Greece blatantly broke the rules has helped to support this attitude. But other countries like Spain and Ireland had played by the rules; indeed Spain used to be held up as a paragon of virtue. Clearly, the faults are systemic and the misfortunes of the heavily indebted countries are largely caused by the rules that govern the euro. That is the point I would like to drive home today...
...The burden of responsibility falls mainly on Germany. The Bundesbank helped design the blueprint for the euro whose defects put Germany into the driver's seat. This has created two problems. One is political, the other financial. It is the combination of the two that has rendered the situation so intractable.
The political problem is that Germany did not seek the dominant position into which it has been thrust and it is unwilling to accept the obligations and liabilities that go with it. Germany understandably doesn't want to be the "deep pocket" for the euro. So it extends just enough support to avoid default but nothing more, and as soon as the pressure from the financial markets abates it seeks to tighten the conditions on which the support is given.
The financial problem is that Germany is imposing the wrong policies on the eurozone. Austerity doesn't work. You cannot shrink the debt burden by shrinking the budget deficit. The debt burden is a ratio between the accumulated debt and the GDP, both expressed in nominal terms. And in conditions of inadequate demand, budget cuts cause a more than proportionate reduction in the GDP — in technical terms the so-called fiscal multiplier is greater than one.
The German public finds this difficult to understand. The fiscal and structural reforms undertaken by the Schroeder government worked in 2006; why shouldn't they work for the eurozone a few years later? The answer is that austerity works by increasing exports and reducing imports. When everybody is doing the same thing it simply doesn't work...
...Chancellor Merkel would have liked to put the euro crisis on ice at least until after the elections, but it is back in force. The German public may be unaware of this because Cyprus was a tremendous political victory for Chancellor Merkel. No country will dare to challenge her will. Moreover, Germany itself remains relatively unaffected by the deepening depression that is enveloping the eurozone. I expect, however, that by the time of the elections Germany will also be in recession. That is because the monetary policy pursued by the eurozone is out of sync with the other major currencies. The others are engaged in quantitative easing. The Bank of Japan was the last holdout but it changed sides recently. A weaker yen coupled with the weakness in Europe is bound to affect Germany's exports.
If my analysis is correct, a simple solution suggests itself. It can be summed up in one word: eurobonds.
Eurobonds are the joint and several obligations of all member states. If countries that abide by the fiscal compact were allowed to convert their entire existing stock of government debt into eurobonds, the positive impact would be little short of the miraculous. The danger of default would disappear and so would the risk premiums. The balance sheets of the banks would receive an immediate boost and so would the budgets of the heavily indebted countries because it would cost them less to service their existing stock of government debt. Italy, for instance, would save up to 4% of its GDP. Its budget would move into surplus and instead of austerity, the government could apply fiscal stimulus. The economy would grow and the debt ratio would fall. Most of the seemingly intractable problems would vanish into thin air. Only the divergences in competitiveness would remain unresolved. Individual countries would still need structural reforms, but the main structural defect of the euro would be cured. It would be truly like waking from a nightmare.
To avoid any misunderstanding, I am proposing the conversion of the existing stock of government bonds into eurobonds, not the redemption scheme put forward by chancellor's council of economic advisors...
...There are also widespread fears that eurobonds would ruin Germany's credit rating. eurobonds are often compared with the Marshall Plan. The argument goes that the Marshall Plan cost only a few percentage points of America's GDP while eurobonds would cost a multiple of Germany's GDP. That argument is comparing apples with oranges. The Marshall Plan was an actual expenditure while eurobonds would involve a guarantee that will never be called upon. The cost to Germany of agreeing to eurobonds has been greatly exaggerated.
Guarantees have a peculiar character: the more convincing they are, the less they are likely to be invoked. The US never had to pay off the debt it incurred when it converted the debt of individual states into Federal obligations. Germany has been willing to do only the minimum; that is why it had to keep escalating its commitments and is incurring actual losses. The fiscal compact, backed up by a well functioning fiscal authority would practically eliminate the risk of default. eurobonds would compare favorably with the bonds of US, UK and Japan in the financial markets. Admittedly, Germany would have to pay more on its own debt than it does today but the exceptionally low yields on Bunds is a symptom of the disease plaguing the periphery. The indirect benefit Germany would derive from the recovery of the periphery would far outweigh the additional cost incurred on its own national debt...
...There are also widespread fears that eurobonds would ruin Germany's credit rating. eurobonds are often compared with the Marshall Plan. The argument goes that the Marshall Plan cost only a few percentage points of America's GDP while eurobonds would cost a multiple of Germany's GDP. That argument is comparing apples with oranges. The Marshall Plan was an actual expenditure while eurobonds would involve a guarantee that will never be called upon. The cost to Germany of agreeing to eurobonds has been greatly exaggerated.
Guarantees have a peculiar character: the more convincing they are, the less they are likely to be invoked. The US never had to pay off the debt it incurred when it converted the debt of individual states into Federal obligations. Germany has been willing to do only the minimum; that is why it had to keep escalating its commitments and is incurring actual losses. The fiscal compact, backed up by a well functioning fiscal authority would practically eliminate the risk of default. eurobonds would compare favorably with the bonds of US, UK and Japan in the financial markets. Admittedly, Germany would have to pay more on its own debt than it does today but the exceptionally low yields on Bunds is a symptom of the disease plaguing the periphery. The indirect benefit Germany would derive from the recovery of the periphery would far outweigh the additional cost incurred on its own national debt...
...The fact remains that the large majority of the German public is adamantly opposed to eurobonds. Since chancellor Merkel vetoed eurobonds, the arguments I have put forward here have not even been considered. People don't realize that agreeing to eurobonds would be much less costly than doing only the minimum to preserve the euro. That is how misconceptions can become engrained in public opinion.
It is up to Germany to decide whether it is willing to authorise eurobonds or not. But it has no right to prevent the heavily indebted countries from escaping their misery by banding together and issuing eurobonds. In other words, if Germany is opposed to eurobonds it should consider leaving the euro and letting the others introduce them.
This exercise would yield a surprising result: eurobonds issued by a eurozone that excludes Germany would still compare favorably with those of the US, UK and Japan. The net debt of these three countries as a proportion of their GDP is actually higher than that of the eurozone excluding Germany.
This surprising result can be explained by comparing the consequences of Germany leaving the euro to a heavily indebted country, like Italy, leaving.
Since all the accumulated debt is denominated in euros, it makes all the difference which country remains in charge of the euro. If Germany left, the euro would depreciate. The debtor countries would regain their competitiveness. Their debt would diminish in real terms and, if they issued eurobonds, the threat of default would disappear. Their debt would suddenly become sustainable. Most of the burden of adjustment would fall on the countries that left the euro. Their exports would become less competitive and they would encounter stiff competition from the euro area in their home markets. They would also incur losses on their claims and investments denominated in euro. The extent of their losses would depend on the extent of the depreciation; therefore they would have an interest in keeping the depreciation within bounds. After initial dislocations, the eventual outcome would fulfill John Maynard Keynes' dream of an international currency system in which both creditors and debtors share responsibility for maintaining stability. And Europe would escape the looming depression.
By contrast, if Italy left, its euro-denominated debt burden would become unsustainable and it would have to be restructured. This would plunge the rest of Europe and the rest of the world into a financial meltdown, which may well prove beyond the capacity of the monetary authorities to contain. The collapse of the euro would likely lead to the disorderly disintegration of the European Union and Europe would be left worse off than it had been when it embarked on the noble experiment of creating a European Union...
...Let me sum up my argument. I contend that Europe would be better off if Germany decided between eurobonds and exit than if it continued on its current course of doing the minimum to hold the euro together. That holds true whether Germany agreed to eurobonds or decided to leave the euro; and it holds true not only for Europe but also for Germany, except in the very near term.
Which of the two alternatives is better for Germany is less clear-cut. Only the German electorate is qualified to decide. If a referendum were called today the eurosceptics would win hands down. But more intensive consideration could change people's mind. They would discover that the cost to Germany of authorising eurobonds has been greatly exaggerated and the cost of leaving the euro understated.
To state my own views, my first preference is eurobonds; my second is Germany leaving the euro. Either choice is infinitely better than not making a choice and perpetuating the crisis. Worst of all would be for a debtor country, like Italy, to leave the euro because it would lead to the disorderly dissolution of the European Union.
| My bold This article says that Soros might have spared himself the trouble, because Germany is not going to change direction. http://www.guardian.co.uk/business/n...s-or-euro-exit |  |
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