Euro Crisis : Soros on the Euro’s deficiencies and what needs to be done

Excellent George Soros essay on NyBooks – The Crisis & the Euro. In it he forensically examines the structural issues with the single currency, points out Germany’s critical role within the project and how they have been making bad policy decisions, and how this threatens political and social stability within the union. All is not lost, as he outlines three steps that need to be taken (cleansing the banks, huge monetary stimulus to offset fiscal tightening, European infrastructure investment funded by the Europen Investment Bank). The full essay is well worth reading, but ends on a downer as the postscipt makes clear that events since this essay was penned have taken a turn for the worse with the liklihood of any of his solutions being adopted diminishing at the recent G20 conference.

Let me first analyze the defects of the euro and then examine Germany’s attitude. The biggest deficiency in the euro, the absence of a common fiscal policy, is well known. But there is another defect that has received less recognition: a false belief in the stability of financial markets. As I have tried to explain in my writings, the crash of 2008 conclusively demonstrated that financial markets do not necessarily tend toward equilibrium; they are just as likely to produce bubbles. I don’t want to repeat my arguments here because you can find them in my lectures, which have recently been published.

All I need to do is remind you that the introduction of the euro created its own bubble in the countries whose borrowing costs were greatly reduced. Greece abused the privilege by cheating, but Spain didn’t. Spain followed sound macroeconomic policies, maintained its sovereign debt level below the European average, and exercised exemplary supervision over its banking system. Yet it enjoyed a tremendous real estate boom that has turned into a bust resulting in 20 percent unemployment. Now it has to rescue the savings banks, called cajas, and the municipalities. And the entire European banking system is weighed down by bad debts and needs to be recapitalized. The design of the euro did not take this possibility into account.

Another structural flaw in the euro is that it guards only against the danger of inflation and ignores the possibility of deflation. In this respect the task assigned to the European Central Bank is asymmetric. This is due to Germany’s fear of inflation. When Germany agreed to substitute the euro for the Deutschmark it insisted on strong safeguards to maintain the value of the currency. The Maastricht Treaty contained a clause that expressly prohibited bailouts and that ban has been reaffirmed by the German constitutional court. It is this clause that has made the current situation so difficult to deal with.

And this brings me to the gravest defect in the euro’s design: it does not allow for error. It expects member states to abide by the Maastricht criteria—which state that the budget deficit must not exceed 3 percent and total government debt 60 percent of GDP—without establishing an adequate enforcement mechanism. And now that several countries are far away from the Maastricht criteria, there is neither an adjustment mechanism nor an exit mechanism. Now these countries are expected to return to the Maastricht criteria even if such a move sets in motion a deflationary spiral. This is in direct conflict with the lessons learned from the Great Depression of the 1930s, and is liable to push Europe into a period of prolonged stagnation or worse. That will, in turn, generate discontent and social unrest. It is difficult to predict how the anger and frustration will express itself.

He also details the dangers for Germany in leaving the Euro –

The Deutschmark would go through the roof and the euro would fall through the floor. This would indeed help the adjustment process of the other countries but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative and there would be widespread unemployment. German banks would suffer severe exchange rate losses and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations: pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

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  • Seymour Major

    The is a really brilliant piece by Soros. One wonders if Soros’s thought experiment has already been tried on Angela Merkel and the German Cabinet.

    The scariest point he makes is this:

    “Unfortunately Germany does not realize what it is doing. It has no desire to impose its will on Europe; all it wants to do is to maintain its competitiveness and avoid becoming the deep pocket for the rest of Europe”

    The majority of Germans see Europe as a begging bowl queue. Any payout, such as the payment for Greece is politically unpopular.

    That makes it extremely difficult for the German politicians to take a more pan-European approach to the way they deal with their own budget and how they handle the crisis of the Southern States.

    The other thing is, Soros himself is highly influential. What the Germans do from now on is going to be followed even more closely. The more insular they appear, the more likely it is that there will be a crisis in the money markets.

  • Greenflag

    ‘but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative and there would be widespread unemployment.’

    Soros might well think that – however actual economic and export performance during the years 1965 through to 2000 a period when the British pound devalued from some 14 German marks for 1 pound sterling to less than 3 marks per pound sterling showed the ‘pain’ was mostly felt in the UK . Germany became the worlds biggest exporter and the UK lost it’s major engineering and manufacturing industries . While it’s true that Thatcher’s ‘deregulation ‘ of the financial sector led to a boom in British based financial services that boom has left the UK somewhat high and dry . One of the reasons why the UK is not in favour of some of the more aggressive financial reforms at the G8 /G20 as proposed by the Germans and French and the Americans to a lesser extent is because the UK remains more dependent on the financial sector (s)ome 12% of the economy iirc)

    The link below shows that the German economy seems not immune to some of the benefits even if short term of a depreciating euro and the same will apply to the Irish economy . Meanwhile in an ironic reverse of currency history the UK now finds itself with an ‘over valued ‘ pound which according to the standard economist expectation should ‘worsen’ Britain’s trade balance .

    Perhaps Mr Soros sees another ‘killing’ on the horizon given that the UK retains the ‘sovereignty’ to devalue it’s currency at least in theory .

    http://news.bbc.co.uk/2/hi/business/10549906.stm

  • The biggest deficiency in the euro, the absence of a common fiscal policy, is well known.

    False. The biggest deficiency in the Euro is that it is a Fiat currency backed by nothing, that can be printed at will by a central bank. The average lifespan of all fiat paper currencies throughout history is 16 years, and the Euro is no different. It was doomed to collapse from the beginning as all fiat currencies are.

    But there is another defect that has received less recognition: a false belief in the stability of financial markets. As I have tried to explain in my writings, the crash of 2008 conclusively demonstrated that financial markets do not necessarily tend toward equilibrium; they are just as likely to produce bubbles.

    False. Bubbles are caused by central banks controlling the supply of money and interest rates. Austrian Business Cycle demonstrates that this is the case, and it is the reason why Austrian Economists were and are able to identify and predict these bubbles.

    All I need to do is remind you that the introduction of the euro created its own bubble in the countries whose borrowing costs were greatly reduced. Greece abused the privilege by cheating, but Spain didn’t. Spain followed sound macroeconomic policies, maintained its sovereign debt level below the European average, and exercised exemplary supervision over its banking system. Yet it enjoyed a tremendous real estate boom that has turned into a bust resulting in 20 percent unemployment. Now it has to rescue the savings banks, called cajas, and the municipalities. And the entire European banking system is weighed down by bad debts and needs to be recapitalized. The design of the euro did not take this possibility into account.

    The Euro, had it been based on gold, would not have been the cause of this. A gold standard currency enforces fiscial discipline by its nature, i.e. it cannot be printed out of thin air. The entire fundamental basis of George Sorors’ economic theories and ideas is fallacious.

    Another structural flaw in the euro is that it guards only against the danger of inflation and ignores the possibility of deflation.

    False. The euro, as a fiat currency, is designed to be inflated. Inflation is an increase in the supply of money; that is what inflation is by definition and that is all it is. To say that the Euro guards against inflation is completely absurd.

    In this respect the task assigned to the European Central Bank is asymmetric. This is due to Germany’s fear of inflation. When Germany agreed to substitute the euro for the Deutschmark it insisted on strong safeguards to maintain the value of the currency. The Maastricht Treaty contained a clause that expressly prohibited bailouts and that ban has been reaffirmed by the German constitutional court. It is this clause that has made the current situation so difficult to deal with.

    The German government was warned before the advent of the Euro that it must be backed by gold, but they rejected this idea because they, as politicians, need to be able to inflate the Euro (print it) to meet their expenditure needs. The Euro (and all fiat currencies) are nothing more than a criminal counterfeiting exercise.

    And this brings me to the gravest defect in the euro’s design: it does not allow for error. It expects member states to abide by the Maastricht criteria—which state that the budget deficit must not exceed 3 percent and total government debt 60 percent of GDP—without establishing an adequate enforcement mechanism. And now that several countries are far away from the Maastricht criteria, there is neither an adjustment mechanism nor an exit mechanism.

    If the Euro had been properly designed, based on gold and nothing else, then none of this would be an issue.

    That will, in turn, generate discontent and social unrest. It is difficult to predict how the anger and frustration will express itself.

    The unrest that we are seeing is not only a matter of the currency, but of the Socialist policies of the EU states, that are running systems that are unsustainable. The people who are rioting are the parasites that live off of the production of the people who actually create value. The next set of riots are going to come from the people whose savings are being destroyed by inflation, as the socialist governments print money to prop up their regimes.

    This is the truth that George Soros and his ilk will not tell you, not only because it is not in their interest to do so, but they are not equipped with the correct economic truths to tell you what is really going on.

    I suggest you Google, ‘Austrian Business Cycle’ to start to learn about what money really is and how the states are destroying the value of your savings.