Photo: World Economic Forum, Flickr
George Soros has been producing some of the best and clearest stuff on the Euro crisis lately.In a speech in Italy recently he brilliantly laid out why the Euro was like a bubble, and why it’s in crisis today. Of course, it left people wanting a solution.
Now he’s delivering on that.
In an article to be published on Tuesday in the Financial Times, titled How Europe Can Save Europe, he notes that on its current path the Eurozone is heading for the opposite of the open society ideal dreamed up by the Euro’s founders, and that instead the Eurozone is heading towards an anti-democratic world of German dominance and European subservience. Even Merkel, Soros believes, doesn’t actually want to live in this world.
So how does Europe get solved.
Here’s the nut of the piece:
Merkel argues that it is against the rules to use the European Central Bank to solve eurozone countries’ fiscal problems – and she is right. ECB President Mario Draghi has said much the same. Indeed, the upcoming summit is missing an important agenda item: a European Fiscal Authority (EFA) that, in partnership with the ECB, could do what the ECB cannot do on its own.
In particular, the EFA could establish a Debt Reduction Fund – a modified form of the European Debt Redemption Pact that was proposed by Merkel’s Council of Economic Advisers and endorsed by Germany’s Social Democrats and Greens. In exchange for specified structural reforms in Italy and Spain, the Fund would acquire and hold a significant portion of their outstanding stock of debt. It would finance the purchases by issuing European Treasury bills – joint and several obligations of the member countries – and pass on the benefit of cheap financing to the countries concerned.
The Treasury bills would be assigned a zero-risk rating by the authorities and treated as the highest-quality collateral for repo operations at the ECB. The banking system has an urgent need for risk-free liquid assets. Banks are currently holding more than €700 billion of surplus liquidity at the ECB, earning only one quarter of 1% interest. This assures a large and ready market for the bills at 1% or less.
Soros goes onto argue that this European Fiscal Authority could impose reasonable fines associated with failures to enact reforms. They wouldn’t be instant death penalty fines (which is the way Europe operates now) but punitive enough to prevent the free-rider problem that bedevils any attempt to backstop peripheral governments.
Eventually, after the reforms happen, Eurobonds could be established.
Soros doesn’t say it specifically, but just taking this step would probably massively improve peripheral borrowing costs (in Spain and Italy) simply thanks to the expectation that there was a path in place to take the worst-case scenario (a sovereign blowup in either of those two countries) totally off the table.
One of the things I heard repeatedly when I was in Greece was the frustration that what could have been a tiny problem (solving the debt of Greece, which is just 2% of Eurozone GDP) has been allowed to allowed to mushroom, because there was nothing ever serious and credible to solve the problem.
Would the Germans ever go along with Soros’ scheme? It’s possible. The fact of the matter is that noises out of Merkel and Finance Minister Schauble lately have been along the lines of: If you’re willing to give up fiscal control, burden sharing is possible. A big question remains on order and timeline and whether it can all be done at once.
All this being said, it doesn’t sound like Soros is particularly optimistic, and he is worried that the upcoming EU summit could turn into a “fiasco, which could well prove lethal.”