Does the Euro Have a Future? George Soros.# Stock
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The euro crisis is a direct consequence of the crash of 2008. When Lehman
Brothers failed, the entire financial system started to collapse and had to
be put on artificial life support. This took the form of substituting the
sovereign credit of governments for the bank and other credit that had
collapsed. At a memorable meeting of European finance ministers in November
2008, they guaranteed that no other financial institutions that are
important to the workings of the financial system would be allowed to fail,
and their example was followed by the United States.
Angela Merkel then declared that the guarantee should be exercised by each
European state individually, not by the European Union or the eurozone
acting as a whole. This sowed the seeds of the euro crisis because it
revealed and activated a hidden weakness in the construction of the euro:
the lack of a common treasury. The crisis itself erupted more than a year
later, in 2010.
There is some similarity between the euro crisis and the subprime crisis
that caused the crash of 2008. In each case a supposedly riskless asset—
collateralized debt obligations (CDOs), based largely on mortgages, in 2008,
and European government bonds now—lost some or all of their value.
Unfortunately the euro crisis is more intractable. In 2008 the US financial
authorities that were needed to respond to the crisis were in place; at
present in the eurozone one of these authorities, the common treasury, has
yet to be brought into existence. This requires a political process
involving a number of sovereign states. That is what has made the problem so
severe. The political will to create a common European treasury was absent
in the first place; and since the time when the euro was created the
political cohesion of the European Union has greatly deteriorated. As a
result there is no clearly visible solution to the euro crisis. In its
absence the authorities have been trying to buy time.
Advertisement
In an ordinary financial crisis this tactic works: with the passage of time
the panic subsides and confidence returns. But in this case time has been
working against the authorities. Since the political will is missing, the
problems continue to grow larger while the politics are also becoming more
poisonous.
It takes a crisis to make the politically impossible possible. Under the
pressure of a financial crisis the authorities take whatever steps are
necessary to hold the system together, but they only do the minimum and that
is soon perceived by the financial markets as inadequate. That is how one
crisis leads to another. So Europe is condemned to a seemingly unending
series of crises. Measures that would have worked if they had been adopted
earlier turn out to be inadequate by the time they become politically
possible. This is the key to understanding the euro crisis.
Where are we now in this process? The outlines of the missing ingredient,
namely a common treasury, are beginning to emerge. They are to be found in
the European Financial Stability Facility (EFSF)—agreed on by twenty-seven
member states of the EU in May 2010—and its successor, after 2013, the
European Stability Mechanism (ESM). But the EFSF is not adequately
capitalized and its functions are not adequately defined. It is supposed to
provide a safety net for the eurozone as a whole, but in practice it has
been tailored to finance the rescue packages for three small countries:
Greece, Portugal, and Ireland; it is not large enough to support bigger
countries like Spain or Italy. Nor was it originally meant to deal with the
problems of the banking system, although its scope has subsequently been
extended to include banks as well as sovereign states. Its biggest
shortcoming is that it is purely a fund-raising mechanism; the authority to
spend the money is left with the governments of the member countries. This
renders the EFSF useless in responding to a crisis; it has to await
instructions from the member countries.
The situation has been further aggravated by the recent decision of the
German Constitutional Court. While the court found that the EFSF is
constitutional, it prohibited any future guarantees benefiting additional
states without the prior approval of the budget committee of the Bundestag.
This will greatly constrain the discretionary powers of the German
government in confronting future crises.
The seeds of the next crisis have already been sown by the way the
authorities responded to the last crisis. They accepted the principle that
countries receiving assistance should not have to pay punitive interest
rates and they set up the EFSF as a fund-raising mechanism for this purpose.
Had this principle been accepted in the first place, the Greek crisis would
not have grown so severe. As it is, the contagion—in the form of
increasing inability to pay sovereign and other debt—has spread to Spain
and Italy, but those countries are not allowed to borrow at the lower,
concessional rates extended to Greece. This has set them on a course that
will eventually land them in the same predicament as Greece. In the case of
Greece, the debt burden has clearly become unsustainable. Bondholders have
been offered a “voluntary” restructuring by which they would accept lower
interest rates and delayed or decreased repayments; but no other
arrangements have been made for a possible default or for defection from the
eurozone.
These two deficiencies—no concessional rates for Italy or Spain and no
preparation for a possible default and defection from the eurozone by Greece
—have cast a heavy shadow of doubt both on the government bonds of other
deficit countries and on the banking system of the eurozone, which is loaded
with those bonds. As a stopgap measure the European Central Bank (ECB)
stepped into the breach by buying Spanish and Italian bonds in the market.
But that is not a viable solution. The ECB had done the same thing for
Greece, but that did not stop the Greek debt from becoming unsustainable. If
Italy, with its debt at 108 percent of GDP and growth of less than 1
percent, had to pay risk premiums of 3 percent or more to borrow money, its
debt would also become unsustainable.
The ECB’s earlier decision to buy Greek bonds had been highly controversial
; Axel Weber, the ECB’s German board member, resigned from the board in
protest. The intervention did blur the line between monetary and fiscal
policy, but a central bank is supposed to do whatever is necessary to
preserve the financial system. That is particularly true in the absence of a
fiscal authority. Subsequently, the controversy led the ECB to adamantly
oppose a restructuring of Greek debt—by which, among other measures, the
time for repayment would be extended—turning the ECB from a savior of the
system into an obstructionist force. The ECB has prevailed: the EFSF took
over the risk of possible insolvency of the Greek bonds from the ECB.
The resolution of this dispute has in turn made it easier for the ECB to
embark on its current program to purchase Italian and Spanish bonds, which,
unlike those of Greece, are not about to default. Still, the decision has
encountered the same internal opposition from Germany as the earlier
intervention in Greek bonds. Jürgen Stark, the chief economist of the ECB,
resigned on September 9. In any case the current intervention has to be
limited in scope because the capacity of the EFSF to extend help is
virtually exhausted by the rescue operations already in progress in Greece,
Portugal, and Ireland.
In the meantime the Greek government is having increasing difficulties in
meeting the conditions imposed by the assistance program. The troika
supervising the program—the EU, the IMF, and the ECB—is not satisfied;
Greek banks did not fully subscribe to the latest treasury bill auction; and
the Greek government is running out of funds.
In these circumstances an orderly default and temporary withdrawal from the
eurozone may be preferable to a drawn-out agony. But no preparations have
been made. A disorderly default could precipitate a meltdown similar to the
one that followed the bankruptcy of Lehman Brothers, but this time one of
the authorities that would be needed to contain it is missing.
No wonder that the financial markets have taken fright. Risk premiums that
must be paid to buy government bonds have increased, stocks have plummeted,
led by bank stocks, and recently even the euro has broken out of its trading
range on the downside. The volatility of markets is reminiscent of the
crash of 2008.
Unfortunately the capacity of the financial authorities to take the measures
necessary to contain the crisis has been severely restricted by the recent
ruling of the German Constitutional Court. It appears that the authorities
have reached the end of the road with their policy of “kicking the can down
the road.” Even if a catastrophe can be avoided, one thing is certain: the
pressure to reduce deficits will push the eurozone into prolonged recession
. This will have incalculable political consequences. The euro crisis could
endanger the political cohesion of the European Union.
There is no escape from this gloomy scenario as long as the authorities
persist in their current course. They could, however, change course. They
could recognize that they have reached the end of the road and take a
radically different approach. Instead of acquiescing in the absence of a
solution and trying to buy time, they could look for a solution first and
then find a path leading to it. The path that leads to a solution has to be
found in Germany, which, as the EU’s largest and highest-rated creditor
country, has been thrust into the position of deciding the future of Europe.
That is the approach I propose to explore.
To resolve a crisis in which the impossible becomes possible it is necessary
to think about the unthinkable. To start with, it is imperative to prepare
for the possibility of default and defection from the eurozone in the case
of Greece, Portugal, and perhaps Ireland. To prevent a financial meltdown,
four sets of measures would have to be taken. First, bank deposits have to
be protected. If a euro deposited in a Greek bank would be lost to the
depositor, a euro deposited in an Italian bank would then be worth less than
one in a German or Dutch bank and there would be a run on the banks of
other deficit countries. Second, some banks in the defaulting countries have
to be kept functioning in order to keep the economy from breaking down.
Third, the European banking system would have to be recapitalized and put
under European, as distinct from national, supervision. Fourth, the
government bonds of the other deficit countries would have to be protected
from contagion. The last two requirements would apply even if no country
defaults.
All this would cost money. Under existing arrangements no more money is to
be found and no new arrangements are allowed by the German Constitutional
Court decision without the authorization of the Bundestag. There is no
alternative but to give birth to the missing ingredient: a European treasury
with the power to tax and therefore to borrow. This would require a new
treaty, transforming the EFSF into a full-fledged treasury.
That would presuppose a radical change of heart, particularly in Germany.
The German public still thinks that it has a choice about whether to support
the euro or to abandon it. That is a mistake. The euro exists and the
assets and liabilities of the financial system are so intermingled on the
basis of a common currency that a breakdown of the euro would cause a
meltdown beyond the capacity of the authorities to contain. The longer it
takes for the German public to realize this, the heavier the price they and
the rest of the world will have to pay.
The question is whether the German public can be convinced of this argument.
Angela Merkel may not be able to persuade her own coalition, but she could
rely on the opposition. Having resolved the euro crisis, she would have less
to fear from the next elections.
The fact that arrangements are made for the possible default or defection of
three small countries does not mean that those countries would be abandoned
. On the contrary, the possibility of an orderly default—paid for by the
other eurozone countries and the IMF—would offer Greece and Portugal policy
choices. Moreover, it would end the vicious cycle now threatening all of
the eurozone’s deficit countries whereby austerity weakens their growth
prospects, leading investors to demand prohibitively high interest rates and
thus forcing their governments to cut spending further.
Leaving the euro would make it easier for them to regain competitiveness;
but if they are willing to make the necessary sacrifices they could also
stay in. In both cases, the EFSF would protect bank deposits and the IMF
would help to recapitalize the banking system. That would help these
countries to escape from the trap in which they currently find themselves.
It would be against the best interests of the European Union to allow these
countries to collapse and drag down the global banking system with them.
It is not for me to spell out the details of the new treaty; that has to be
decided by the member countries. But the discussions ought to start right
away because even under extreme pressure they will take a long time to
conclude. Once the principle of setting up a European Treasury is agreed
upon, the European Council could authorize the ECB to step into the breach,
indemnifying the ECB in advance against risks to its solvency. That is the
only way to forestall a possible financial meltdown and another Great
Depression.
—September 14, 2011
Brothers failed, the entire financial system started to collapse and had to
be put on artificial life support. This took the form of substituting the
sovereign credit of governments for the bank and other credit that had
collapsed. At a memorable meeting of European finance ministers in November
2008, they guaranteed that no other financial institutions that are
important to the workings of the financial system would be allowed to fail,
and their example was followed by the United States.
Angela Merkel then declared that the guarantee should be exercised by each
European state individually, not by the European Union or the eurozone
acting as a whole. This sowed the seeds of the euro crisis because it
revealed and activated a hidden weakness in the construction of the euro:
the lack of a common treasury. The crisis itself erupted more than a year
later, in 2010.
There is some similarity between the euro crisis and the subprime crisis
that caused the crash of 2008. In each case a supposedly riskless asset—
collateralized debt obligations (CDOs), based largely on mortgages, in 2008,
and European government bonds now—lost some or all of their value.
Unfortunately the euro crisis is more intractable. In 2008 the US financial
authorities that were needed to respond to the crisis were in place; at
present in the eurozone one of these authorities, the common treasury, has
yet to be brought into existence. This requires a political process
involving a number of sovereign states. That is what has made the problem so
severe. The political will to create a common European treasury was absent
in the first place; and since the time when the euro was created the
political cohesion of the European Union has greatly deteriorated. As a
result there is no clearly visible solution to the euro crisis. In its
absence the authorities have been trying to buy time.
Advertisement
In an ordinary financial crisis this tactic works: with the passage of time
the panic subsides and confidence returns. But in this case time has been
working against the authorities. Since the political will is missing, the
problems continue to grow larger while the politics are also becoming more
poisonous.
It takes a crisis to make the politically impossible possible. Under the
pressure of a financial crisis the authorities take whatever steps are
necessary to hold the system together, but they only do the minimum and that
is soon perceived by the financial markets as inadequate. That is how one
crisis leads to another. So Europe is condemned to a seemingly unending
series of crises. Measures that would have worked if they had been adopted
earlier turn out to be inadequate by the time they become politically
possible. This is the key to understanding the euro crisis.
Where are we now in this process? The outlines of the missing ingredient,
namely a common treasury, are beginning to emerge. They are to be found in
the European Financial Stability Facility (EFSF)—agreed on by twenty-seven
member states of the EU in May 2010—and its successor, after 2013, the
European Stability Mechanism (ESM). But the EFSF is not adequately
capitalized and its functions are not adequately defined. It is supposed to
provide a safety net for the eurozone as a whole, but in practice it has
been tailored to finance the rescue packages for three small countries:
Greece, Portugal, and Ireland; it is not large enough to support bigger
countries like Spain or Italy. Nor was it originally meant to deal with the
problems of the banking system, although its scope has subsequently been
extended to include banks as well as sovereign states. Its biggest
shortcoming is that it is purely a fund-raising mechanism; the authority to
spend the money is left with the governments of the member countries. This
renders the EFSF useless in responding to a crisis; it has to await
instructions from the member countries.
The situation has been further aggravated by the recent decision of the
German Constitutional Court. While the court found that the EFSF is
constitutional, it prohibited any future guarantees benefiting additional
states without the prior approval of the budget committee of the Bundestag.
This will greatly constrain the discretionary powers of the German
government in confronting future crises.
The seeds of the next crisis have already been sown by the way the
authorities responded to the last crisis. They accepted the principle that
countries receiving assistance should not have to pay punitive interest
rates and they set up the EFSF as a fund-raising mechanism for this purpose.
Had this principle been accepted in the first place, the Greek crisis would
not have grown so severe. As it is, the contagion—in the form of
increasing inability to pay sovereign and other debt—has spread to Spain
and Italy, but those countries are not allowed to borrow at the lower,
concessional rates extended to Greece. This has set them on a course that
will eventually land them in the same predicament as Greece. In the case of
Greece, the debt burden has clearly become unsustainable. Bondholders have
been offered a “voluntary” restructuring by which they would accept lower
interest rates and delayed or decreased repayments; but no other
arrangements have been made for a possible default or for defection from the
eurozone.
These two deficiencies—no concessional rates for Italy or Spain and no
preparation for a possible default and defection from the eurozone by Greece
—have cast a heavy shadow of doubt both on the government bonds of other
deficit countries and on the banking system of the eurozone, which is loaded
with those bonds. As a stopgap measure the European Central Bank (ECB)
stepped into the breach by buying Spanish and Italian bonds in the market.
But that is not a viable solution. The ECB had done the same thing for
Greece, but that did not stop the Greek debt from becoming unsustainable. If
Italy, with its debt at 108 percent of GDP and growth of less than 1
percent, had to pay risk premiums of 3 percent or more to borrow money, its
debt would also become unsustainable.
The ECB’s earlier decision to buy Greek bonds had been highly controversial
; Axel Weber, the ECB’s German board member, resigned from the board in
protest. The intervention did blur the line between monetary and fiscal
policy, but a central bank is supposed to do whatever is necessary to
preserve the financial system. That is particularly true in the absence of a
fiscal authority. Subsequently, the controversy led the ECB to adamantly
oppose a restructuring of Greek debt—by which, among other measures, the
time for repayment would be extended—turning the ECB from a savior of the
system into an obstructionist force. The ECB has prevailed: the EFSF took
over the risk of possible insolvency of the Greek bonds from the ECB.
The resolution of this dispute has in turn made it easier for the ECB to
embark on its current program to purchase Italian and Spanish bonds, which,
unlike those of Greece, are not about to default. Still, the decision has
encountered the same internal opposition from Germany as the earlier
intervention in Greek bonds. Jürgen Stark, the chief economist of the ECB,
resigned on September 9. In any case the current intervention has to be
limited in scope because the capacity of the EFSF to extend help is
virtually exhausted by the rescue operations already in progress in Greece,
Portugal, and Ireland.
In the meantime the Greek government is having increasing difficulties in
meeting the conditions imposed by the assistance program. The troika
supervising the program—the EU, the IMF, and the ECB—is not satisfied;
Greek banks did not fully subscribe to the latest treasury bill auction; and
the Greek government is running out of funds.
In these circumstances an orderly default and temporary withdrawal from the
eurozone may be preferable to a drawn-out agony. But no preparations have
been made. A disorderly default could precipitate a meltdown similar to the
one that followed the bankruptcy of Lehman Brothers, but this time one of
the authorities that would be needed to contain it is missing.
No wonder that the financial markets have taken fright. Risk premiums that
must be paid to buy government bonds have increased, stocks have plummeted,
led by bank stocks, and recently even the euro has broken out of its trading
range on the downside. The volatility of markets is reminiscent of the
crash of 2008.
Unfortunately the capacity of the financial authorities to take the measures
necessary to contain the crisis has been severely restricted by the recent
ruling of the German Constitutional Court. It appears that the authorities
have reached the end of the road with their policy of “kicking the can down
the road.” Even if a catastrophe can be avoided, one thing is certain: the
pressure to reduce deficits will push the eurozone into prolonged recession
. This will have incalculable political consequences. The euro crisis could
endanger the political cohesion of the European Union.
There is no escape from this gloomy scenario as long as the authorities
persist in their current course. They could, however, change course. They
could recognize that they have reached the end of the road and take a
radically different approach. Instead of acquiescing in the absence of a
solution and trying to buy time, they could look for a solution first and
then find a path leading to it. The path that leads to a solution has to be
found in Germany, which, as the EU’s largest and highest-rated creditor
country, has been thrust into the position of deciding the future of Europe.
That is the approach I propose to explore.
To resolve a crisis in which the impossible becomes possible it is necessary
to think about the unthinkable. To start with, it is imperative to prepare
for the possibility of default and defection from the eurozone in the case
of Greece, Portugal, and perhaps Ireland. To prevent a financial meltdown,
four sets of measures would have to be taken. First, bank deposits have to
be protected. If a euro deposited in a Greek bank would be lost to the
depositor, a euro deposited in an Italian bank would then be worth less than
one in a German or Dutch bank and there would be a run on the banks of
other deficit countries. Second, some banks in the defaulting countries have
to be kept functioning in order to keep the economy from breaking down.
Third, the European banking system would have to be recapitalized and put
under European, as distinct from national, supervision. Fourth, the
government bonds of the other deficit countries would have to be protected
from contagion. The last two requirements would apply even if no country
defaults.
All this would cost money. Under existing arrangements no more money is to
be found and no new arrangements are allowed by the German Constitutional
Court decision without the authorization of the Bundestag. There is no
alternative but to give birth to the missing ingredient: a European treasury
with the power to tax and therefore to borrow. This would require a new
treaty, transforming the EFSF into a full-fledged treasury.
That would presuppose a radical change of heart, particularly in Germany.
The German public still thinks that it has a choice about whether to support
the euro or to abandon it. That is a mistake. The euro exists and the
assets and liabilities of the financial system are so intermingled on the
basis of a common currency that a breakdown of the euro would cause a
meltdown beyond the capacity of the authorities to contain. The longer it
takes for the German public to realize this, the heavier the price they and
the rest of the world will have to pay.
The question is whether the German public can be convinced of this argument.
Angela Merkel may not be able to persuade her own coalition, but she could
rely on the opposition. Having resolved the euro crisis, she would have less
to fear from the next elections.
The fact that arrangements are made for the possible default or defection of
three small countries does not mean that those countries would be abandoned
. On the contrary, the possibility of an orderly default—paid for by the
other eurozone countries and the IMF—would offer Greece and Portugal policy
choices. Moreover, it would end the vicious cycle now threatening all of
the eurozone’s deficit countries whereby austerity weakens their growth
prospects, leading investors to demand prohibitively high interest rates and
thus forcing their governments to cut spending further.
Leaving the euro would make it easier for them to regain competitiveness;
but if they are willing to make the necessary sacrifices they could also
stay in. In both cases, the EFSF would protect bank deposits and the IMF
would help to recapitalize the banking system. That would help these
countries to escape from the trap in which they currently find themselves.
It would be against the best interests of the European Union to allow these
countries to collapse and drag down the global banking system with them.
It is not for me to spell out the details of the new treaty; that has to be
decided by the member countries. But the discussions ought to start right
away because even under extreme pressure they will take a long time to
conclude. Once the principle of setting up a European Treasury is agreed
upon, the European Council could authorize the ECB to step into the breach,
indemnifying the ECB in advance against risks to its solvency. That is the
only way to forestall a possible financial meltdown and another Great
Depression.
—September 14, 2011