Sunday, November 23, 2014

How Europe Can Rescue Europe

LONDON – At their meeting in Rome last Thursday, the leaders of the eurozone’s four largest economies agreed on steps towards a banking union and a modest stimulus package to complement the European Union’s new “fiscal compact.” Those steps are not enough.

German Chancellor Angela Merkel resisted all proposals to provide relief to Spain and Italy from the excessive risk premiums that both countries are now confronting. As a result, the EU’s upcoming summit could turn into a fiasco, which may well prove lethal, because it would leave the rest of the eurozone without a strong enough financial firewall to protect it from the possibility of a Greek exit.

Even if a fatal calamity can be avoided, the division between creditor and debtor countries will be reinforced, and the “periphery” countries will have no chance to regain competitiveness, because the playing field is tilted against them. This may serve Germany’s narrow self-interest, but it will create a very different Europe from the open society that fired people’s imagination and propelled European integration for decades. It will make Germany the center of an empire and permanently subordinate the “periphery.” That is not what Merkel or the overwhelming majority of Germans stand for.

Merkel argues that it is against the rules to use the European Central Bank to solve eurozone countries’ fiscal problems – and she is right. ECB President Mario Draghi has said much the same. Indeed, the upcoming summit is missing an important agenda item: a European Fiscal Authority (EFA) that, in partnership with the ECB, could do what the ECB cannot do on its own.

In particular, the EFA could establish a Debt Reduction Fund – a modified form of the European Debt Redemption Pact that was proposed by Merkel’s Council of Economic Advisers and endorsed by Germany’s Social Democrats and Greens. In exchange for specified structural reforms in Italy and Spain, the Fund would acquire and hold a significant portion of their outstanding stock of debt. It would finance the purchases by issuing European Treasury bills – joint and several obligations of the member countries – and pass on the benefit of cheap financing to the countries concerned.

The Treasury bills would be assigned a zero-risk rating by the authorities and treated as the highest-quality collateral for repo operations at the ECB. The banking system has an urgent need for risk-free liquid assets. Banks are currently holding more than €700 billion of surplus liquidity at the ECB, earning only one quarter of 1% interest. This assures a large and ready market for the bills at 1% or less.

Should a participating country subsequently fail to abide by its commitments, the EFA could impose a fine or other penalty, which would be proportionate to the violation, thereby preventing enforcement from becoming a nuclear option that can never be exercised. This would provide strong protection against moral hazard. A successor government in, say, Italy, would find it practically impossible to break any commitments undertaken by Italian Prime Minister Mario Monti’s current administration. With practically half of Italy’s debt financed by European Treasury Bills – producing an effect similar to a reduction in the average maturity of its debt – a successor government would be all the more responsive to any punishment imposed by the EFA.

After a suitable period, the participating countries would enter into debt-reduction programs tailored in a way that does not jeopardize their growth. This would be the prelude to the establishment of a full political union and the introduction of Eurobonds. Of course, the issuance of European Treasury bills would require the approval of the Bundestag, but it would be in conformity with the German Constitutional Court’s requirement that any commitment approved by the Bundestag be limited in time and size.

It is not too late to turn this proposal into a political declaration that outlines not only the long-term goal of a political union, but also a road map toward a fiscal and banking union. Guided by this declaration, the eurozone’s financial-rescue fund, the European Stability Mechanism (ESM), could immediately take over the ECB’s holdings of Greek bonds; the ECB could start accumulating Spanish and Italian bonds; and Italy and Spain could implement the structural reforms needed to qualify for the Debt Redemption Fund.

This agenda would bring immense relief to the financial markets. Equally important, it would change Europe’s political dynamics from negative to positive.

The main obstacle is that German politicians remain mired in a “can’t do” mode. Merkel insists that a political union should precede a full-fledged fiscal and banking union. That is both unrealistic and unreasonable. The three have to be developed together, step-by-step. There can be no treaty or constitutional clause preventing the establishment of the EFA if the German electorate, as represented by the Bundestag, approves it; otherwise, the ESM could not have been created. If the rest of Europe is united behind this proposal, and the Bundestag rejects it, Germany must take full responsibility for the financial and political consequences.

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    1. CommentedKir Komrik

      Thanks again for offering some great insight in to the problems in the EU

      Mr. Soros proposes "... a European Fiscal Authority (EFA) that, in partnership with the ECB, could do what the ECB cannot do on its own".

      and then,

      "Should a participating country subsequently fail to abide by its commitments, the EFA could impose a fine or other penalty, which would be proportionate to the violation, thereby preventing enforcement from becoming a nuclear option that can never be exercised. This would provide strong protection against moral hazard."

      imo, bingo.

      While it isn't everything I would want, it is going in the right direction. EU needs a General Federation ( as a legal entity to guide it.

      I am frankly encouraged to know that there is someone like Mr. Soros in the role and position he holds.

      - kk

    2. Commentedpeter fairley

      Deficit reduction fund? Can you send the life insurance guy back in to explain that please? I die or get hurt and someone else gets money? I am going to get hurt no matter what? Why I gotta fund? AND reduce what they owe me, my pension fund, my bank, my life insurance co. my country? Can I vote for somebody besides Merkel soon?

    3. Portrait of Asgeir B. Torfason

      CommentedAsgeir B. Torfason

      It looks like Merkel just looked like giving in on the meeting last Friday. According the Wolfgang Munchau she was the real winner, and if there will be no eurozone bonds then there will be no eurozone, see:
      So it will be very interesting to read the next article by Soros on this issue here, hopefully soon.

    4. CommentedGiles Conway-Gordon

      It is sad, and more than a little ironic, to see George Soros bewail the abandonment by the European Union of the inspiring goal of an 'open society' while strongly advocating political union (along with fiscal and banking union) as a solution to the present Eurozone crisis.
      The structures he proposes, besides constituting only a short-term financial fix for the deep-seated economic disparities which lie at the base of the crisis, would be a further and decisive step towards the systematic suppression of democratic accountability in Europe in favour of an authoritarian bureaucratic tyranny. He should perhaps reread The Open Society and Its Enemies.

    5. CommentedStepan February

      The only penalty that will work is surrender of sovereignty. Anything short of that will be non-rehabilitative and counterproductive.

    6. CommentedStepan February

      Germany is allergic to grand pan-european vision because of the looming reductio ad hitleritum. Thus, Germany is not willing to support Europe beyond its parochial self-interest. Its a delicate balancing act, but I think Merkel is playing it right. Europe will fall into Germany's lap one way or another, no need to fret. Just wait until they volunteer to submit.

    7. CommentedPaul A. Myers

      My rough-cut calculation shows that from 1998 to 2009 France's public debt increased about 90 percent and GDP by about 80 percent. For someone like President Hollande to agree to the Soros proposal would be to bet against his own economic structure, against his long-term trendline.

      So underneath Hollande's "growth agenda" is an assumption of growing the GDP through additional debt.

      To go with something like the Soros proposal would be for Hollande to plan on achieving economic results significantly more "conservative" than anything done by Sarkozy, who presided over a great expansion of France's public debt for a so-so increase in GDP.

      So what many European leaders are talking about is a new politics to finance the old economic model. No one really seems to be talking about new economic models. And that is what the "sovereignty" argument is really about: the old economic models are deeply embedded in the sovereignty of the national states and they don't want to reconfigure.

    8. CommentedJohn Leontop

      Dear most respected Mr. Soros (and breaker of the Bank of England),

      Thank you very much for your profound advice on managing the Eurozone.

      Nevertheless, I wonder how Mrs. Merkel could reply to the following questions from her electorate:

      Why did we bring all the sacrifices of the Schröder reforms when we were called the sick man of Europe having no real wage increases for the last ten years?

      Why do we have export surpluses? Are we so liked by everybody else that they bend over backwards to please us by buying some of our products?

      Why do we have to wait until the age of 67 to enjoy the fruits of our labor in old age whereas Monsieur le Président wants his people to enjoy le Midi when they are sixty?

      Why should we pay for bankers that have been making tons of bonuses between 2004 and 2007 (and before that) and now come back to socialize the losses?

      Do free market rules not apply to financial institutions especially banks?

      Would it not be imperative to solve the „Too big to fail“ issue?

      Could we not do away with a lot of the economists, advisers, regulators, bureaucrats etc. by letting the free market work its way? Who pays for all theses people anyway?

      Why should we bail out investors and their agents who have neglected their most basic function of credit analysis and thereby their fiduciary responsibility?

      Why should we have any trust in a debt reduction fund imposing fines on a country not abiding by its rules when we have experienced the Maastricht treaty to have been blatantly broken by our own politicians and the French government?

      Is the rule of law still applicable or how do we explain the state financing by the ECB (please refer to its Charter)?

      Why is it that to the best of my knowledge all the most prominent and successful companies that have evolved during the last ten years and that provide unemployment have not originated in Europe?

      I have spent sleepless nights to find an answer to these questions, unfortunately to no avail.

      Maybe you could help me.

      Yours truly

      John Leontop

      PS I think in the name of human solidarity you should grant me unlimited access to your credit card

    9. CommentedFlip Bibi

      Germany can do whatever it wants. It's first obligation is to the German people, and then Europe; and you are asking it to do the opposite. When a privet citizen asks for a loan from company X, the individual has to abide by the rules set by the company. Germany has done the same thing. You are asking the Germans to be responsible of the irresponsability of others. Bah! Since WWI Germany has been bashed, now here you are calling Germany to stop holding Europe hostage. Or is it Mr. Soros that you are banking on another Black Wednesday but for the Germans and not the Sterling again? You can't get the loan from Germany and set your own rules to pay them back. The division between creditor and debtor has existed since Feudalism and it will never stop.
      What needs to be done is that the EU needs to stop think about what Germany has done and focus of creating a new set of laws that are enforceable and realistic. What has been done has been done, now it is time to think what can be done if this was to happen again. You state that "..participating countries would enter into debt-reduction programs tailored in a way.." you are calling for regulations that would be different across Europe, thus one country will think that it is being taken advantage over another. If you treat Greece harshly, you can't treat France, with a white glove. Either it is the same for all or not worth. Your call of "European unity" conflicts with your idea of tailoring solutions.

    10. CommentedFrank O'Callaghan

      Very good in so far as it goes. Europe has tried market manipulation in the common agricultural policy. Setting the price in an open market by intervening at a set price point. This was possible because the price set was not unreasonable or was not seen to be. Also, the material good were agricultural and resistant to 'virtualisation' as they cannot be conjured out of nowhere.

      Not surprising that some of the more outlandish comments refer to taxation. The lightening of taxation on the most mobile capital and the great widening of the wealth gap between the ultra rich and the great majority of humanity over the last quarter century is one of the factors involved in this 'crisis'. A concerted world wide Tobin tax might be a sop in the direction of fairness but to deal with the fundamental problem we require less inequality. Our needs may be met with only a fraction of our productive capacity. This has profound meaning for growth. A paradigm shift will be imposed upon us if we do not choose to make it ourselves. We must distribute work, wealth, power, responsibility and resources more equally. Survival demands it, perhaps the survival of those who do not feel the danger.

    11. CommentedGary Marshall

      Hello Mr. Soros,

      In conventional economics you are right -- Greece and the other troubled nations have no good options. But in progressive economics, they have a very good option: the abolition of Taxation. Absurd on the face of it, but not so when examined.

      Below is the very simple proof for this measure.

      If you or anyone can find the flaw, I shall be more than happy to give the reward of $50,000. None have yet been successful.

      Its not the end of the world, but a new beginning.



      The costs of borrowing for a nation to fund public expenditures, if it borrows solely from its resident citizens and in the nation's currency, is nil.

      Why? Because if, in adding a financial debt to a community, one adds an equivalent financial asset, the aggregate finances of the community will not in any way be altered. This is simple reasoning confirmed by simple arithmetic.

      The community is the source of the government's funds. The government taxes the community to pay for public services provided by the government.

      Cost of public services is $10 million.

      Scenario 1: The government taxes $10 million.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      No community government debt, no community
      government IOU.

      Scenario 2: The government borrows $10 million from solely community lenders at a certain interest rate.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      Community government debt: $10 million;
      Community government bond: $10 million.

      At x years in the future: the asset held by the community (lenders) will be $10 million + y interest. The deferred liability claimed against the community (taxpayers) will be $10 million + y interest.

      The value of all community government debts when combined with all community government IOUs or bonds is zero for the community. It is the same $0 combined worth whether the community pays its taxes immediately or never pays them at all.

      So if a community borrows from its own citizens to fund worthy public expenditures rather than taxes those citizens, it will not alter the aggregate finances of the community or the wealth of the community any more than taxation would have. Adding a financial debt and an equivalent financial asset to a community will cause the elimination of both when summed.

      Whatever financial benefit taxation possesses is nullified by the fact that borrowing instead of taxation places no greater financial burden on the community.

      However, the costs of Taxation are immense. By ridding the nation of Taxation and instituting borrowing to fund public expenditures, the nation will shed all those costs of Taxation for the negligible fee of borrowing in the financial markets and the administration of public

      Gary Marshall

    12. CommentedAnton Van Boxtel

      A bit of a nitpicky kind of comment, but I've heard the word "risk premium" being misused a little too often in the context of bond yields. If the yield spread is a compensation for the expected loss from a country's possible default, there is no risk premium. Saying there is - and I'm not saying there isn't - a risk premium means that you believe the yield spread above "safe" bonds is more than the expected loss from a country's default. Saying these premiums are "excessive" means that they're higher than could be expected given a normal degree of risk aversion. Nonetheless, I don't disagree with the author that debt mutualization is possibly the only way out, given the fact that the periphery economies are essentially credit rationed.