MUNICH – Last summer, the financier George Soros urged Germany to agree to the establishment of the European Stability Mechanism, calling on the country to “lead or leave.” Now he says that Germany should exit the euro if it continues to block the introduction of Eurobonds.
Soros is playing with fire. Leaving the eurozone is precisely what the newly founded “Alternative for Germany” party, which draws support from a wide swath of society, is demanding.
Crunch time is fast approaching. Cyprus is almost out of the euro, its banks’ collapse having been delayed by the European Central Bank’s provision of Emergency Liquidity Assistance, while euroskeptic parties led by Beppe Grillo and Silvio Berlusconi garnered a combined total of 55% of the popular vote in the latest Italian general election.
Moreover, the Greeks and Spaniards are unlikely to be able to bear the strain of economic austerity much longer, with youth unemployment inching toward 60%. The independence movement in Catalonia has gathered so much momentum that a leading Spanish general has vowed to send troops into Barcelona should the province hold a referendum on secession.
France, too, has competitiveness problems, and is unable to meet its commitments under the European Union’s Fiscal Compact. Portugal needs a new rescue program, and Slovenia could soon be asking for a rescue as well.
Many investors echo Soros. They want to cut and run – to unload their toxic paper onto intergovernmental rescuers, who should pay for it with the proceeds of Eurobond sales, and put their money in safer havens. The public already is being misused in an effort to mop up junk securities and support feeble banks, with taxpayer-funded institutions such as the ECB and the bailout programs having by now provided €1.2 trillion ($1.6 trillion) in international credit.
If Soros were right, and Germany had to choose between Eurobonds and the euro, many Germans would surely prefer to leave the euro. The new German political party would attract much more support, and sentiment might shift. The euro itself would be finished; after all, its primary task was to break the Bundesbank’s dominance in monetary policy.
But Soros is wrong. For starters, there is no legal basis for his demand. Article 125 of the Treaty on the Functioning of the European Union expressly forbids the mutualization of debt.
Worst of all, Soros does not recognize the real nature of the eurozone’s problems. The ongoing financial crisis is merely a symptom of the monetary union’s underlying malady: its southern members’ loss of competitiveness.
The euro gave these countries access to cheap credit, which was used to finance wage increases that were not underpinned by productivity gains. This led to a price explosion and massive external deficits.
Maintaining these countries’ excessive prices and nominal incomes with artificially cheap credit guaranteed by other countries would only make the loss of competitiveness permanent. The entrenchment of debtor-creditor relationships between the states of the eurozone would fuel political tension – as occurred in the United States in its first decades.
In order to regain competitiveness, the southern countries will have to reduce their goods prices, while the northern countries will have to accept higher inflation. Eurobonds, however, would impede precisely this outcome, because relative prices in the north can be raised only when northern savers invest their capital at home instead of seeing it publicly escorted to the south by taxpayer-financed credit guarantees.
According to a study by Goldman Sachs, countries like Greece, Portugal, and Spain will have to become 20-30% cheaper, and German prices will have to rise by 20% relative to the eurozone average. To be sure, if Germany were to leave the common currency, the road back to competitiveness would be easier for the southern countries, since the rump euro would undergo devaluation; but the crisis countries’ fundamental problem would remain as long as the other competitive countries remain in the eurozone. Spain, for example, would still have to cut its prices by 22-24% relative to the new eurozone average.
From this perspective, the crisis countries would not be spared painful retrenchment as long as they remained in a monetary union that includes competitive countries. The only way to avoid it would be for them to exit the euro and devalue their new currencies. But, so far, they have not been willing to go this route.
Politically, it would be a big mistake for Germany to exit the euro, because that would reinstate the Rhine as the border between France and Germany. Franco-German reconciliation, the greatest success of the postwar period in Europe, would be in jeopardy.
Thus, the only remaining option, as unpleasant as it may be for some countries, is to tighten budget constraints in the eurozone. After years of easy money, a way back to reality must be found. If a country is bankrupt, it must let its creditors know that it cannot repay its debts. And speculators must take responsibility for their decisions, and stop clamoring for taxpayer money whenever their investments turn bad.