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Investor George Soros: Germany Must Accept Eurobonds or Leave Euro

George Soros says that Germany must accept Eurobonds or leave the European common currency zone. Zoom
REUTERS

George Soros says that Germany must accept Eurobonds or leave the European common currency zone.

Despite a period of relative calm last year, the euro crisis is creeping back in 2013. In an essay for SPIEGEL ONLINE, star investor George Soros argues that the situation would improve dramatically were Germany to accept Eurobonds. Absent such acceptance, Berlin should consider leaving the euro zone, he argues.

The euro crisis has already transformed the European Union from a voluntary association of equal states into a creditor-debtor relationship from which there is no easy escape. The creditors stand to lose large sums should a member state exit the union, yet debtors are subjected to policies that deepen their depression, aggravate their debt burden and perpetuate their subordinate position. As a result, the crisis is now threatening to destroy the European Union. That would be a tragedy of historic proportions which can only be prevented with German leadership.

The causes of the crisis cannot be properly understood without recognizing the euro's fatal flaw: By creating an independent central bank, member countries have become indebted in a currency that they do not control. At first both the authorities and market participants treated all government bonds as if they were riskless, creating a perverse incentive for banks to load up on the weaker bonds. When the Greek crisis raised the specter of default, financial markets reacted with a vengeance, relegating all heavily indebted euro-zone members to the status of third world countries over-extended in a foreign currency. Subsequently, the debtors were treated as if they were solely responsible for their misfortunes and the structural defects of the euro remained uncorrected.

Once this is understood the solution practically suggests itself. It can be summed up in one word: eurobonds.

If countries that abide by the EU's new Fiscal Compact were allowed but not required to convert their entire stock of government debt into eurobonds, the positive impact would be little short of miraculous. The danger of default would disappear, as would risk premiums. Banks' balance sheets would receive an immediate boost as would the heavily indebted countries' budgets. Italy, for example, would save up to 4 percent of its GDP. Its budget would move into surplus, and fiscal stimulus would replace austerity. As a result its economy would grow and its debt ratio would fall. Most of the seemingly intractable problems would vanish into thin air. It would be like waking from a nightmare.

Eurobonds Would Not Ruin Germany's Credit Rating

In accordance with the Fiscal Compact, member countries would be allowed to issue new eurobonds only to replace maturing ones; after five years the debts outstanding would be gradually reduced to 60 percent of GDP. If a member country ran up additional debts it could borrow only in its own name. Admittedly, the Fiscal Compact needs some modifications to ensure that the penalties for noncompliance are automatic, prompt and not too severe to be credible. A tighter Fiscal Compact would practically eliminate the risk of default.

Thus, eurobonds would not ruin Germany's credit rating. On the contrary, they would favorably compare with the bonds of the United States, the United Kingdom, and Japan.

To be sure, eurobonds are not a panacea. The boost derived from eurobonds may not be sufficient to ensure recovery; additional fiscal and/or monetary stimulus may be needed. But having such a problem would be a luxury. More troubling, is that eurobonds would not eliminate divergences in competitiveness. Individual countries would still need to undertake structural reforms. The European Union would also need a banking union to make credit available on equal terms in every country. The Cyprus rescue made the need more acute by making the field more uneven. But Germany accepting eurobonds would totally change the atmosphere and facilitate the needed reforms.

Unfortunately, Germany remains adamantly opposed to eurobonds. Since Chancellor Merkel vetoed the idea, they have not been given any consideration. The German public doesn't realize that agreeing to eurobonds would be much less risky and costly than continuing to do only the minimum to preserve the euro.

The Case for Germany's Exit

Germany has the right to reject eurobonds. But it has no right to prevent the heavily indebted countries from escaping their misery by banding together and issuing them. If Germany is opposed to eurobonds it should consider leaving the euro. Surprisingly, eurobonds issued by a Germany-less euro zone would still compare favorably with the bonds of the United States, the United Kingdom and Japan.

The reason is simple. Since all the accumulated debt is denominated in euros, it makes all the difference which country leaves the euro. If Germany left, the euro would depreciate. The debtor countries would regain their competitiveness. Their debt would diminish in real terms and, if they issued eurobonds, the threat of default would disappear. Their debt would suddenly become sustainable.

At the same time, most of the burden of adjustment would fall on the countries that left the euro. Their exports would become less competitive and they would encounter heavy competition from the rump euro zone area in their home markets. They would also incur losses on their claims and investments denominated in euro.

By contrast, if Italy left the euro zone, its euro-denominated debt burden would become unsustainable and would have to be restructured, plunging the global financial system into chaos. So, if anyone must leave, it should be Germany, not Italy.

There is a strong case for Germany to decide whether to accept eurobonds or leave the euro zone, but is it less obvious which of the two alternatives would be better for the country. Only the German electorate is qualified to decide.

Not in Germany's Interest

If a referendum were held today, the supporters of a German exit would win hands down. But more intensive consideration could change people's mind. They would discover that the cost to Germany of authorizing eurobonds has been greatly exaggerated, and the cost of leaving the euro understated.

The trouble is that Germany has not been forced to choose. It can continue to do nothing more than the minimum to preserve the euro. This is clearly Merkel's preferred choice, at least until after the elections.

Europe would be infinitely better off if Germany made a definitive choice between eurobonds and exit, regardless of the outcome. Indeed, Germany would be better off as well except perhaps in the very near term. The situation is deteriorating and in the longer term it is bound to become unsustainable. A disorderly disintegration resulting in mutual recriminations and unsettled claims would leave Europe worse off than it was when it embarked on the bold experiment of unification. Surely that is not in Germany's interest.

This essay has been published with the kind permission of Project Syndicate.

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1. Flawed proposal
stevej8 04/10/2013
This proposal if enacted would merely enable chronic heavy debtors to temporarily diminish their borrowing costs, the very thing (combined with fiscal indiscipline) that got them into the current spot. Reducing the eurobond debt to 60% of gdp after 5 years (how is not made clear), and requiring them to borrow over that in their own name, would simply mean they will still be able to run up excess debt loads, by adding whatever additional debt 'in their own name' they desire to the 60% of eurobond debt (assuming they even get down to that level, hard to believe given the current debt reduction difficulties and resistance). In fact eurobonds would make it easier for them to run heavy debt loads by discounting the first 60% (or indeed all initially), transferring part of the direct overall risk to Germany, and therefore more easily being able to add another 60% or more, which no matter what fine words are spoken at time of signing, could on previous form simply not be trusted, especially in light of the increasingly brazen attempts to blackmail Germany over remote history for current problems. And an ECB once empowered to issue such bonds could not necessarily be trusted either, from a German point of view, as Germany could in future be outvoted on borrowing limits etc.(or also in other EU bodies). Once Germany surrenders to this method of debt-pooling, it is finis for sober German finance, sooner or later. And the risk of default remains, and systemic instability. As for the proffered alternative, the idea that Germany should be the one punished for running its finances properly, and certain others rewarded for not doing so, let alone that a Germany-less euro would even be viable or meaningful as such, is nonsense. France would soon see how pleasant it is to be the anchor of a currency populated by chronic heavy debtor states. Nor is it to be expected that other 'northern' nations would opt to remain if Germany left, which would effectively end the Euro as the Euro, it would more properly be called something like the 'Medo', and Germany's interest in subsidising Med nations via the EU would be called into question, Germany can exist outside the EU too, if it is to be penalised for anchoring a sound Euro. The same goes for other 'northern' nations. The fact is that if the Med nations want a viable EU and Euro, they have to abide by the principles they were founded on, and not attempt by pressure and blackmail (abetted by Mr Soros, who perhaps sees some financial advantage in such an outcome, if he is not merely content to be hailed as the saviour of the Med economies), to turn both (EU and Euro) into playthings for their own financial and political indiscipline and even delinquency. The basic principles of sound finance and economy remain unaltered, and nations that having not abided by them and made a mess of the gift they received on EU and EZ entry (ie subsidies and lower interest rates), are the ones who should leave if they no longer wish to be a part of the project, and be willing to take the consequences of doing so. If they wish to remain, then they have to sort themselves out in accordance with the basic agreed principles from the start, and not expect debt pooling without a corresponding degree of financial and even political union where necessary, the only possibly viable counterweight to shared liability. Mr Soros' proposal, where not merely self-interested, is in its current form at least naively utopian, as well as inadequately detailed and ironclad against abuse in the future, and his framing of the alternatives unfair and unsound. It may be that he genuinely wishes to solve the debt crisis besetting Europe, but attempting to rekindle the anti-German critique that has become so facilely common, under a veneer of economic objectivity, and shift the loss to Germany one way or another, without the current program having had time to work out properly (given the resistance to the necessary reform in some cases), will merely prolong the problem and create new ones if addressed in the way he suggests. Despite Mr Soros' use of terms like alchemy (in the past) and magic in discussing such matters, they are no substitute for serious and sober consideration of hard facts, and the hard facts in this case render unlikely the wonderful outcome he imagines.
2. Objective Soros?
ersein 04/10/2013
It is customary in the United States that observers/analyst/commentators on financial/commercial questions indicate if they have direct or indirect personal interests in the products or policies they recommend. This was not done in this interview. Question: Does Mr. Soros own directly or indirectly any European Bonds or similar debt instruments; or, does he have financial interests in Europe that could be impacted by the Euro crisis?
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