On Thursday, the ECB announced its most powerful scheme yet to stem the crisis in Europe. Its chief, Mario Draghi, promised that the central bank would buy “unlimited” quantities of short-term peripheral bonds of fiscally-strapped countries, provided they enter a program with outside oversight guaranteeing that they make fiscal adjustments.
What makes this bailout plan different than all other plans before it is that it looks like a real commitment by the ECB to put its unlimited balance sheet to work, provided governments play ball on political measures.
So what happens now in Europe?
In the New York Review of Books, George Soros has an absolute must-read on how things can develop at this point.
It’s a long article that’s basically split into two parts.
The first is Soros’s dazzling explanation of how the Eurozone got into crisis. It’s essentially re-write of the now-famous speech that he gave in Italy earlier this summer that for a few days was the talk of everyone in finance.
As Soros explains, the fundamental flaw of the Eurozone is the inability of countries to create their own currency. He argues that the architects of the Eurozone always knew this was a problem, but that they anticipated the creation of a fiscal super-structure in due time. It was only post-Lehman, when Angela Merkel declared that every country would be individually responsible for bailing out their own banks, that it became clear that there was no fiscal super-structure in the offing. And not long afterwords, investors started realising that European sovereigns were significant credit risks, without a backstop.
Fast forward to now, and Soros starts his new article with the following note:
In a fast-moving situation, significant changes have occurred since this article went to press. On August 1, as I write below, Bundesbank President Jens Weidmann objected to the assertion by Mario Draghi, the president of the European Central Bank, that the ECB will “do whatever it takes to preserve the euro as a stable currency.” Weidmann emphasised the statutory limitation on the powers of the ECB. Since this article was published, however, it has become clear that Chancellor Merkel has sided with Draghi, leaving Weidmann isolated on the board of the ECB.
This was a game-changing event. It committed Germany to the preservation of the euro. President Draghi has taken full advantage of this opportunity. He promised unlimited purchases of the government bonds of debtor countries up to three years in maturity provided they reached an agreement with the European Financial Stability Facility and put themselves under the supervision of the Troika—the executive committee of the European Union, the European Central Bank, and the International Monetary Fund.
The euro crisis has entered a new phase. The continued survival of the euro is assured but the future shape of the European Union will be determined by the political decisions the member states will have to take during the next year or so. The alternatives are extensively analysed in the article that follows.
So right off the bat, Soros is saying something big here, that with the September 6 decision by the ECB, the “survival of the euro is assured.”
However, what that survival looks like remains of deep concern to Soros.
He explains why he always supported the establishment of the Euro:
When it was only an aspiration, the European Union was what psychologists call a “phantastic object,” a desirable goal that captured many people’s imagination, including mine. I regarded it as the embodiment of an open society. There were five large states and a number of small ones and they all subscribed to the principles of democracy, individual freedom, human rights, and the rule of law. No nation or nationality was dominant. Although the Brussels bureaucracy was often accused of a “democratic deficit,” elected parliaments had to give approval of the major steps.
But the future of Europe could easily end up as the opposite of an open society. The September 6 decision by the ECB doesn’t level the playing field between nations. Peripheral nations will still pay a premium in the market to borrow, and Europe will still be a collection of successful creditors and poor debtor nations, whose policies are at the whim of the creditors.
The European Union that will emerge from this process will be diametrically opposed to the idea of a European Union that is the embodiment of an open society. It will be a hierarchical system built on debt obligations instead of a voluntary association of equals. There will be two classes of states, creditors and debtors, and the creditors will be in charge. As the strongest creditor country, Germany will emerge as the hegemon. The class differentiation will become permanent because the debtor countries will have to pay significant risk premiums for access to capital and it will become impossible for them to catch up with the creditor countries.
The divergence in economic performance, instead of narrowing, will become wider. Both human and financial resources will be attracted to the centre and the periphery will become permanently depressed. Germany will even enjoy some relief from its demographic problems by the immigration of well-educated people from the Iberian Peninsula and Italy instead of less qualified Gastarbeiter from Turkey or Ukraine. But the periphery will be seething with resentment.
Soros then sees two different alternatives to this depressing conclusion.
One that would work is for Germany to just leave the Eurozone. If it did, there might be a one-time disruption, but it’s much less thorny for a creditor nation to leave than a debtor nation. Investors would happily redenominate their assets into Deutsche Mark. And this would allow the remaining Eurozone to inflate to use inflation to achieve the necessary nominal GDP to escape past debts. It would also allow the currency to fall to an appropriate level ensuring the region’s competitiveness.
The other option is for Germany to lead as a benevolent hegemon. For this to happen, Europe needs to establish a fiscal counterpart to the ECB: A European Fiscal Authority that would have the ability to make big economic decisions on behalf of member states. Soros’s ideas get fairly technical, and include having the fund by sovereign debt in excess of 60% of GDP in exchange for fiscal reforms, and so on. These purchases would be financed either by the ECB or by short-term jointly guaranteed bonds, with the idea of funding at low rates for the benefit of weaker countries.
Soros believes that this would be constitutionally consistent with Germany, but that the main problem is simply political in Germany (as it always has been).
Ultimately he concludes that what sill needs to happen is for a campaign to wake Germany out of its slumber, and get it to step up.
The campaign to change German attitudes will therefore have to take a very different form from the intergovernmental negotiations that are currently deciding policy. European civil society, the business community, and the general public need to mobilize and become engaged. At present, the public in many eurozone countries is distressed, confused, and angry. This finds expression in xenophobia, anti-European attitudes, and extremist political movements. The latent pro-European sentiments, which currently have no outlet, need to be aroused in order to save the European Union. Such a movement would encounter a sympathetic response in Germany, where the large majority is still pro-European but under the spell of false fiscal and monetary doctrines.
Currently, the German economy is doing relatively well and the political situation is also relatively stable; the crisis is only a distant noise coming from abroad. Only something shocking would shake Germany out of its preconceived ideas and force it to face the consequences of its current policies. That is what a movement offering a workable alternative to German domination could accomplish. In short, the current situation is like a nightmare that can be escaped only by waking up Germany and making it aware of the misconceptions that are currently guiding its policies. We can hope Germany, when put to the choice, will choose to exercise benevolent leadership rather than to suffer the losses connected with leaving the euro.
The Euro is at a turning point. The ECB’s decision was a major step towards resolving the sovereign debt crisis. What Soros is talking about now is the political and economic battles to come.
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