Monday, November 24, 2014

Germany’s Choice

FRANKFURT – 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 monetary 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 EU itself. That would be a tragedy of historic proportions, which only German leadership can prevent.

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 eurozone members to the status of a Third World country over-extended in a foreign currency. Subsequently, the heavily indebted member countries were treated as if they were solely responsible for their misfortunes, and the structural defect 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 to convert their entire stock of government debt into Eurobonds, the positive impact would be little short of the 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% 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.

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% 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 compare favorably 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, Eurobonds would not eliminate divergences in competitiveness. Individual countries would still need to undertake structural reforms. The EU 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 even more uneven.) But Germany’s acceptance of Eurobonds would transform the atmosphere and facilitate the needed reforms.

Unfortunately, Germany remains adamantly opposed to Eurobonds. Since Chancellor Angela Merkel vetoed the idea, it has not been given any consideration. The German public does not recognize that agreeing to Eurobonds would be much less risky and costly than continuing to do only the minimum to preserve the euro.

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 Eurozone would still compare favorably with those of the US, UK, and Japanese bonds.

The reason is simple. Because all of 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 eurozone in their home markets. They would also incur losses on their claims and investments denominated in euros.

By contrast, if Italy left the eurozone, 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 eurozone, but it is less obvious which of the two alternatives would be better for the country. Only the German electorate is qualified to decide.

If a referendum in Germany were held today, the supporters of a eurozone 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 no more than the minimum to preserve the euro. This is clearly Merkel’s preferred choice, at least until after the next election.

Europe would be infinitely better off if Germany made a definitive choice between Eurobonds and a eurozone exit, regardless of the outcome; indeed, Germany would be better off as well. 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.

Read an extended version of this argument in George Soros's blog post, "A European Solution to the Eurozone's Problem."

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (26)

    Please login or register to post a comment

    1. CommentedJay Thadeshwar

      A huge number of economists and investors have suggested that Eurobonds, also called as “stability bonds”, can be one of the best ways to solve the crisis. The bonds would jointly be written by all 17 member states and would be harmonized by changes in EU treaties like tight financial and budgetary coordination. These bonds would efficiently finance the member countries by presumably trading with a low yield. It would also exclude the need for supplementary expensive bailouts and help the members to find their way out of the trouble.
      Here is what a friend of mine has written about remedies to eurozone crisis -

    2. Commentedjracforr jracforr

      The EU provided Greece with all the capital it needed when there was a run on the banks which is the technical equivalent of a nation printing money to protect the value of it's currency,therefore the fatal flaw mentioned in this paragraph has been addressed. The real problem to the world's financial system are the currency speculators and manipulators who created this crisis in the first place

    3. CommentedKuruvilla Abraham

      Isn't it hard to see EU as an association of equal states when from times predating the Golden Hoard, Western Europe has been a fragmented continent. Historians and Sociologists and not just Economists and Politicians must jointly introspect as to what divides Europe. Is it language, food or religion? Shouldn't they beware of the Tower of Babel?

    4. CommentedProcyon Mukherjee

      The European solution cannot simply be Euro bonds, as the new structure of European financial assets show a steep increase in the government bonds (as equities are still way off the peaks) and further increase has its implications; in fact 50% increase in all government bonds is only centered in Europe. Without reseting of global capital flows which has already got skewed, with emerging market trends showing reversal of flows, Euro bonds as a singular solution to Europe's all problems is just a pipe-dream.

    5. Portrait of Nils-Göran Areskoug

      CommentedNils-Göran Areskoug

      Counterpoint from Stockholm.

      True, creditors lose when debtors leave. But the remaining ship would be released of its overload and circumvent the rock. With Eurobonds Germany feels trapped in obligations to feed eternally the black sheep in the family. This is all about how to lead by incentives.
      The risk remains that Eurobonds would not be felt as a strong enough incentive for the South to improve its competitiveness. If so, South may never catch up within foreseeable future.
      Soros provides an insightful analysis of the functional mechanisms of financial markets as they work today. But that might be only one side of the coin. A hidden factor that could disrupt his predictions would be a historic shift in the world economic paradigm. If not only the euro but perhaps the whole financial system is a misconstruction that might be within sight. Although catastrophic for a while it would force legislators and market actors to rethink the economic system. This system should rely on real, human and social values, not on fictitious game. Financial market systems, central as well as private banking included, are man-made and serve a societal need. Their function is to stabilize exchange of value.
      Another factor goes even deeper. It is about psychology. A look at the map of Europe makes me ask: What motivates the loser to try revenge and what drives the sinner to correct? Who is to take the hit? Germany wants to save itself from being shipwrecked “again” (and they retain a good memory of the past). They want to avoid being retraumatized, this time by unlimited obligations should its golden export industry come to face uphill struggle against depreciated currencies (YEN).
      Therefore, I believe, the major players in this game need to reassure Germany and offer them an attractive advantage in return for its life-saving operations and the role as “insurer-of-last-resort”.
      Moreover, Soros internal reflexivity would need to be anchored externally by allowing an economy to reflect what it is intended to reflect: intentional dynamics of interacting people who senses the values of things and ideas and who get motivated by their visions for the future. The problem is the loss of cultural roots among both politicians and corporate leaders. This is the disease that needs urgently to be cured to counterbalance the current crisis.
      Also, a crisis always entails a chance of change. That opportunity is explored in my comment on George's extended version, entitled “Bonds and Bonding between Brothers of North and South”:

    6. CommentedPaul A. Myers

      Overall, this is an excellent analysis because it posits a framework of analyzing the problem while offering two credible paths forward. Undoubtedly these are the choices that will get a hard look after the German election if not during the election.

      I would prognosticate that the Germans should try to get all the structural and fiscal reform they can get and then go forward with Eurobonds since it offers the Great Virtue of Stability and probably is the least cost, most growth option available.

    7. CommentedPaul A. Myers

      The danger of any meaningful structural reform or tough-minded integration of fiscal policies would also disappear.

      Surprising that someone as sophisticated as Soros would come up with such a simple panacea solution. Possibly he had lunch at the Elysee?

    8. CommentedGiles Conway-Gordon

      George Soros’ first prescription for solving the Euro crisis looks flawed.
      He is certainly right in deploring the catastrophic social results of euro membership now playing out in Greece, Spain, Portugal and Italy (and soon to spread to France) but his remedy for the adoption of Eurobonds seems misguided.
      Unless Mr. Soros is recommending that the indebted countries simply shed all liability for their debts and shift them onto the Eurozone (i.e. the unconditional, open-ended joint liability and sovereign financing which is presently prohibited), enabling the uncompetitive Euro members to swap their existing debt for Eurobonds will be entirely ineffective unless there is a simultaneous large fall in the value of the euro. Unless this occurred, the weight of the debts would be unchanged and would need to be borne somewhere. It would be no different from unlimited financing by the European Central Bank under its OMT program, except that the creditors would be individual investors rather than the central bank of the Eurozone.
      The likely market result would be that the bond rates applied to individual countries would vary, as now, depending on the market’s judgments of each country’s prospects of returning to sustainable growth and financial stability. This would, in theory, give the periphery countries time to carry out ‘necessary reforms’ to their economies. However, as Mr. Soros notes, Eurobonds will not ensure recovery. With public debt already above or near the level of GDP in all the countries mentioned above, the likely result, if the interest rates they pay on the new Eurobonds exceed, as now, their growth rates, will simply be to propel them further towards the event-horizon of debt default (or towards the counterpart of this, ever-increasing bond rates). They would soon be in the same position as Greece today. (Mr. Soros’ faith in the ability of governments to stimulate economic growth is misguided. Japan over the last two decades, and the USA and the UK more recently, have demonstrated conclusively the impotence of traditional Keynesian measures in certain circumstances.)
      However, his alternative remedy, that Germany leave the Eurozone, is much more realistic. The fact is that any durable solution to the crisis must enable the peripheral countries, which include for this purpose France, to return to sustainable positive growth. This will not happen while they share a currency with Germany. As Mr. Soros says this is no fault of Germany; her dominance of Europe is a simple geo-political fact which has been a permanent feature of the European scene for more than 150 years. Germany was able to benefit from having a weak euro as its currency during years while it adjusted to the absorption of East Germany; it is time to ‘renvoyer l’ascenseur’ and help the rest of the Eurozone to undertake their own adjustments.
      Finally, Mr. Soros’ reverence for the ‘small group of far-sighted statesmen’ is deeply regrettable. These wise men and their followers (fighting, as senior politicians always do, the dangerously irrelevant battles of yesteryear) have led to the creation of a social, political, financial and economic catastrophe of huge proportions. So far from practising pragmatic ‘piecemeal social engineering’ they systematically ignored and suppressed any public accountability in their pursuit of creating the bureaucratic tyranny which the EU has become (the description, from more than a decade ago, is that of Larry Siedentop, then a lecturer in politics at Oxford, in his book ‘Democracy in Europe’). The result is as far from the European (and Popperian) democratic and libertarian ideals that inspired Mr. Soros, and many of us, as it is possible to be. The real tragedy is that the possibility of a sensible collaboration among the European nations (which would, realistically, grow slowly and incrementally over decades) will be set back a generation or more.
      Giles Conway-Gordon

    9. CommentedJohnny (MoneyWonk)

      Soros is correct. And I would like to add, even if the Southern countries did leave the Euro, they would not be able to print currency fast enough to pay their obligations with their plunging exchange rate.

    10. CommentedFrank O'Callaghan

      There has been an abdication of power by society and a grab by banks and private interests.

      Society will be forced to strike back.

    11. CommentedAlberto Santos

      "By creating an independent central bank, member countries have become indebted in a currency that they do not control" I disagree, what Governments have fault is in controlling the banks. All the Eurozone cental banks have always had the capacity to establish cash reserve requirements, thus limit the money creation and money in circulation in their own country, why did not do that? well, you can imagine why. The problem is not that the Euro is strong, the problem is structural, they have a market, but they don't have products to sell in those markets. That is why Finland for example, could recover from the 90's crisis, even when devaluation wiped out the Finnish SMEs because the debt value increased, as the Finnish mark lost value at the same time the cost of borrowing increased too, but still they had products that could sell, "paper and Nokia", and that is not the currency, it is structural, so Germany leaving the Euro would not have much effect in gaining competitiveness for the indebted countries, quite the opposite in fact.

    12. CommentedGerald Silverberg

      I actually said something quite similar in a blog back in Sept. 2011 ("Germany would be doing everyone a favor"):

        CommentedCarol Maczinsky

        Yes, but a German exist is economist trolling, no solution. On the other hand no other member of the common currency is forced to stay a member in the eurozone, and nations are free to commit financial suicide or explore their path to insane, dig their hole as deep as they may get, see Cyprus.

    13. Commentedotto ruthenberg

      please accept that Germans resist the devaluation of their savings and pensions with the prospect of higher inflation which Eurobonds would entail. this is pretty much consensus here from poor to rich. if this europe wont come to a political union it might es well seperate, relearn the lessons of awful governance with their own petty currencies and hopefully come back to shape a better europe. but buying out all the run up bad debt at face value ist just a silly proposition.

    14. CommentedTomas Kurian

      ....eliminate divergences in competitiveness. Individual countries would still need to undertake structural reforms...

      This is a perfect example of misunderstanding of today´s Europe(world-wide indeed) problems. Increasing the competitiveness through "structural reforms" is not the solution. If (successful, not known yet how) would only reverse the problem to the other side. Permanently trying to defeat another country is not a sustainable fix.

      This economical theory ( ) proves, that even with balanced international trade in EU the problems would not disappear, as there would still be forces in play ( unspent profits, savings) that are requiring permanent deficits or expansionary monetary policy( which are not applied now just because some countries like Germany are getting by with huge trade surpluses and so don´t need them)

      In chapters 6-6.2 of my theory it is clearly described why increasing competitiveness leads nowhere.

      We need a new financial framework, which would eliminate the need to constantly win over somebody to gain money through trade surpluses. This theory provides a suggestion how to achieve this through fully digital financial system and direct taxation of capital in connection with moderately expansionary monetary policy and subsidies.

      Read more at :

    15. CommentedJoshua Ioji Konov

      The 20+% VAT, the Low Taxes, the majority of Subsidies in the EU consequent into a trickle-down approach of economics benefiting the have by taking from the have not, which approach could had worked fine in the past but it is pro-cyclical and counterproductive in the very presence of very congested globalized marketplace of high productivity and industrialized China. Moreover, the German government senses the dysfunctionality of many European economies and mistakenly insist on such austerity to fix the system, however the austerity measures are pro-cyclical too; but it is highly improbable of just monetary policies to solve the puzzle... some macroeconomic changes are needed, indeed...

    16. CommentedAvraam Dectis

      The speech was at the ECB? The article does not describe the audience.

      It is always a pleasure to read Mr. Soros.

      There is, or was, a third option. The ECB could have punched out a stromg QE/monetization of all euro area countries, with amounts equal to the same percentage of each country's GDP. That would have saved Greece and thus Cyprus.


    17. CommentedJ. C.

      the question is: who would buy those eurobonds denominated in Euros if knows that all remaining countries need to depreciate the currency to rebalance their CA??

        CommentedP. Foofootos

        who buys GBP bonds? who buys JPY bonds? These countries are currently depreciating their currencies (Japan massively, UK moderately)....

    18. CommentedJ. C.

      "Eurobonds issued by a Germany-less Eurozone would still compare favorably with those of the US, UK, and Japanese bonds."... Aren´t the low spreads (US, UK, JPY) a consequence of the "flight to quality"? and, if this german-less eurobonds are issued and similar credit quality to US, JPY and UK, which would be the "bad assets" that investors are running from?? The risk of Euro depreciation would be present on those Eurobonds and that would keep their spreads on high levels... Not very clear on this... Agree with the currency side of the equation, but Germany will never leave the euro to leave the currency in which it´s a creditor to it´s own luck...

        CommentedP. Foofootos

        No, the low spreads are indicative of a "flight to safety" (ie to countries controlling their currencies)

    19. CommentedPaul Jonker-Hoffrén

      But the point in Germany, apart from the obvious political circumstances, is that the Bundesfervassungsgericht has declared anything remotely resembling Eurobonds incompatible with the German constitution.

        CommentedOdysseas Argyriadis

        And what about it? Half or more of the legislation voted in Greece on the demand of the creditors is incompatible with the Greek constitution but that is apparently of no issue...

    20. CommentedMarco Cattaneo

      Germany will neither leave the euro nor accept Eurobonds. But there is a feasible, better alternative: weaker countries to issue their own independent moetary instruments, to circulate ALONGSIDE the euro, using them to reduce taxes on labor so to realign competitivess with Germany.

    21. CommentedFrank O'Callaghan

      A brilliantly clear bit of writing and thought!

      The other great issue, that of inequality, is neglected. Most of the burden of the crisis falls on the shoulders of those who had no part in it's creation. The 90% who are far from wealthy are paying for a mess that has benefited the top 10%.

      The huge accumulation of wealth by a tiny minority over the last 30 years or so has occurred in parallel with the creation of huge debt and unfunded liabilities for states and whole classes.