Former Treasury guy and DC insider Tony Fratto tweets…
Photo: Tony Fratto
People are going crazy for the new George Soros speech on Europe, which is available on his official website.
We called it brilliant and a dynamo in our post on it yesterday.
The hedge funder who first passed it onto us called it “unbelievable.”
One of our favourite China bloggers, the pseudonymous Also Sprach Analyst called it “The best thing ever written on the euro crisis.”
The bottom line is that the speech is getting praised and passed around and going viral in a way that most speeches about the Eurozone don’t.
Photo: World Economic Forum, Flickr
So you have to ask: Why is this speech going nuts?Well there’s a lot in it for people to like. He gives a nice roundhouse kick to the Germans, which is usually pretty popular. And he says that the Eurozone has 3 months to fix the crisis, which provides a perfect hook for headline-writers.
But what’s special about the speech is his characterization of the Euro as being itself being a “bubble.”
Now the word “bubble” gets abused a lot. Every little boom is called a bubble these days. And things that have nothing to do with market valuations (like the big pile of student loan debt being taken on) get called bubbles improperly.
But Soros is onto something here.
Let’s back up for a second. A nagging question that we’ve had is: Why did it take so long for the Euro to go into crisis? This may seem like an absurd thing to say, since the common currency has barely been around longer than a decade. And yet that seems like a long time, given that from the moment each country gave up fiscal sovereignty, they relegated themselves to, as Paul Krugman has characterised it, the same fiscal status as a third world country, having to borrow in someone else’s currency.
But markets ignored this fact for a long time.
Here’s a version of a popular chart, which shows the spread between Spanish and German borrowing costs (red line) as well as Italian and German borrowing costs (blue line) going back to 1980.
For years and years, Italy and Spain paid way more than Germany to borrow money. Then that spread got collapsed to virtually zero during the 2000s (the early days fo the Euro currency and the so-called great moderation), and now the spreads have widened dramatically, which in the big context, just looks like mean reversion.
It’s a conundrum that at the exact same time that Spain and Italy relegated themselves to third-world borrowers (borrowing in a currency they couldn’t control) the market deemed them equal to Germany in borrowing power.
Soros’ bubble analogy and his characterization of the arc of the Euro project really helps make this understandable.
These four paragraphs really form the meat of the speech. They’re worth reading in full:
I contend that the European Union itself is like a bubble. In the boom phase the EU was what the psychoanalyst David Tuckett calls a “fantastic object” – unreal but immensely attractive. The EU was the embodiment of an open society –an association of nations founded on the principles of democracy, human rights, and rule of law in which no nation or nationality would have a dominant position.
The process of integration was spearheaded by a small group of far sighted statesmen who practiced what Karl Popper called piecemeal social engineering. They recognised that perfection is unattainable; so they set limited objectives and firm timelines and then mobilized the political will for a small step forward, knowing full well that when they achieved it, its inadequacy would become apparent and require a further step. The process fed on its own success, very much like a financial bubble. That is how the Coal and Steel Community was gradually transformed into the European Union, step by step.
Germany used to be in the forefront of the effort. When the Soviet empire started to disintegrate, Germany’s leaders realised that reunification was possible only in the context of a more united Europe and they were willing to make considerable sacrifices to achieve it. When it came to bargaining they were willing to contribute a little more and take a little less than the others, thereby facilitating agreement. At that time, German statesmen used to assert that Germany has no independent foreign policy, only a European one.
The process culminated with the Maastricht Treaty and the introduction of the euro. It was followed by a period of stagnation which, after the crash of 2008, turned into a process of disintegration. The first step was taken by Germany when, after the bankruptcy of Lehman Brothers, Angela Merkel declared that the virtual guarantee extended to other financial institutions should come from each country acting separately, not by Europe acting jointly. It took financial markets more than a year to realise the implication of that declaration, showing that they are not perfect.
Bubbles always look stupid and unjustifiable in retrospect, but at the time they usually contain an internal, coherent logic. And as Soros puts it, the logic of this bubble was: Anytime the existing Eurozone structure reached an impasse, the leaders would fix it.
If it had been inevitable that the market would evolve towards full fiscal integration, then it made perfect sense to treat Italy and Spain as de facto risk-free borrowers. Within the logic of the bubble, it made sense for the spread between Italian and Spanish and German borrowing costs to collapse to zero.
But as Soros notes, the financial crisis, and Merkel’s declaration that each country would be responsible for their own bank bailouts crushed the logic of the bubble.
When the bubble logic was over, then all of the related assumptions, like the risk-free-ness of the peripheral nations came into question, and the sovereign debt crisis began.
Bottom line: Soros’ speech is going viral because he fills in a big piece of the narrative. And although some are whining that he’s giving the speech ex-post facto, most people aren’t even good at explaining what happened in the past.