Saturday, September 08, 2012

George Soros on the European crisis (Updated with video)

George Soros has two new pieces out about the European currency and economic crisis: The Tragedy of the European Union and How to Resolve It New York Review of Books 09/07/2012 and Why Germany Should Lead or Leave Project Syndicate 09/08/2012.

Here he is in a Reuters video briefly discussing the same issues, Putting burden on debtors will push Europe into depression -- Soros Putting burden on debtors will push Europe into depression 09/08/2012:

In the NY Review piece, he adds a very enthusiastic introduction about events of the past week, the European Central Bank (ECB) announcing a new sovereign debt purchasing program and German Chancellor Angela Merkel's agreement to it:

This [Merkel's announcement] 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 analyzed in the article that follows.
I'm not at all confident that we should assume that the "continued survival of the euro is assured" given the limits of the ECB bond purchasing program just announced and the burden of austerity economics in the eurozone. And Merkel's latest sign of flexibility almost surely has something to do with behind-the-scenes
American pressure to avoid a financial disaster before the US elections in November.

In the Project Syndicate column, he gives this good brief description of the current situation:

Europe has been in a financial crisis since 2007. When the bankruptcy of Lehman Brothers endangered the credit of financial institutions, private credit was replaced by the credit of the state, revealing an unrecognized flaw in the euro. By transferring their right to print money to the European Central Bank (ECB), member countries exposed themselves to the risk of default, like Third World countries heavily indebted in a foreign currency. Commercial banks loaded with weaker countries’ government bonds became potentially insolvent. ...

The euro crisis is a complex mixture of banking and sovereign-debt problems, as well as divergences in economic performance that have given rise to balance-of-payments imbalances within the eurozone. The authorities did not understand the complexity of the crisis, let alone see a solution. So they tried to buy time. [my emphasis]
He repeats his confidence in that column that the ECB action will save the euro. But he also notes, "Since a breakup of the euro would cause immense damage, Germany always does the minimum necessary to hold it together/" And that has been Merkel's modus operandi throughout this crisis. I doubt that she thinks she's doing anything more than that with her latest decision to publicly support the ECB's bond-buying program. And unless the austerity measures end, the debt problem will continue and the economic death-spiral of austerity will continue, with potential enormous political consequences.

And there is no immediate sign of happening. Portugal's Prime Minister Pedro Passos Coelho, for instance, just announced a new round of austerity even after the ECB's action provided some immediate relief on their borrowing costs. (Portugal verkündet neue Sozialkürzungen Spiegel Online 07.09.2012) Soros in the NY Review piece even says, "the debtor countries ... will not be able to regain competitiveness until the pursuit of debt reduction through austerity is abandoned."

The alternatives Soros describes in both articles for the currency union to work seem to be very unlikely for Merkel's government to adopt. As it is, what she's agreed to so far is very controversial in her own governing coalition.

In the longer NY Review article, he reminds us how costly lost opportunities and stupid policies can be. In this case, Angie's policies:

The course of events could have been arrested and reversed at almost any time but that would have required an agreed-upon plan and ample financial resources to implement it. Germany, as the largest creditor country, was in charge but was reluctant to take on any additional liabilities; as a result every opportunity to resolve the crisis was missed.
And the leading left party in Germany, the Social Democrats (SPD), were too immersed in neoliberal ideology themselves to mount the necessary challenges and criticisms to Merkel's disastrous policies. Not the that Greens or the Left Party especially distinguished themselves in that regard either.

The longer piece gives more history of the EU. This is an important observation:

When the Soviet empire started to disintegrate, Germany's leaders realized that reunification was possible only in the context of a more united Europe and they were prepared to make considerable sacrifices to achieve it. When it came to bargaining, they were willing to contribute a little more and take a little less than the others, thereby facilitating agreement. At that time, German statesmen used to assert that Germany has no independent foreign policy, only a European one. This led to a dramatic acceleration of the process. It culminated with the signing of the Maastricht Treaty in 1992 and the introduction of the euro in 2002.

The Maastricht Treaty was fundamentally flawed. The architects of the euro recognized that it was an incomplete construct: it had a common central bank but it lacked a common treasury that could issue bonds that would be obligations of all the member states. Eurobonds are still resisted in Germany and other creditor countries. The architects believed, however, that when the need arose, the political will could be generated to take the necessary steps toward a political union. After all, that is how the European Union was brought into existence. Unfortunately, the euro had many other defects, of which neither the architects nor the member states were fully aware. These were revealed by the financial crisis of 2007–2008, which set in motion a process of disintegration.
This is also a good description of how the debt crisis and inadequate financial regulation interacted with awful results:

When the euro was introduced, government bonds were treated as riskless. The regulators in the various countries allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital, and the European Central Bank accepted all government bonds at its discount window on equal terms. This made it advantageous for commercial banks to accumulate the bonds of the weaker member countries, which paid slightly higher rates, in order to earn a few extra basis points.
And what finance wonk can resist an excellently summarized version of the "Target 2" problem?

At the onset of the crisis a breakup of the euro was inconceivable. The assets and liabilities denominated in the common currency were so intermingled that a breakup would have led to an uncontrollable meltdown. But as the crisis progressed the financial system has been progressively reoriented along national lines. Regulators have tended to favor domestic lending, banks have been shedding assets outside their national borders; and risk managers have been trying to match assets and liabilities within national borders, rather than within the eurozone as a whole. If this continues, a breakup of the euro would become possible without a meltdown, but it would leave the central banks of the creditor countries with large, difficult-to-collect claims against the central banks of the debtor countries.

This is due to an arcane problem in the euro clearing system called TARGET2. In contrast to the clearing system of the Federal Reserve, which is settled annually, TARGET2 accumulates the imbalances between the banks in the eurozone. This did not create a problem as long as the interbank system was functioning because the banks settled the imbalances among themselves through the interbank market. But the interbank market has not functioned properly since 2007 and since the summer of 2011 there has been increasing capital flight from the weaker countries. When a Greek or Spanish customer makes a transfer from his account at a Greek or Spanish central bank to a Dutch one, the Dutch central bank ends up with a TARGET2 credit, offset by a TARGET2 claim against the Greek or Spanish bank. These claims have been growing exponentially. By the end of July this year the Bundesbank had claims of some €727 billion against the central banks of the periphery countries.
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