George Soros’ advice for the euro zone
Europeans could use a little cheering up this week. One man who is trying to do that is George Soros. He knows his way around a currency crisis, of course, and he isn‚Äôt usually accused of being a Pollyanna. Soros thinks it is not too late to save Europe and the euro ‚ÄĒ but he warns that time is running out and that Europe‚Äôs leaders must fundamentally change their strategy to succeed.
Let‚Äôs start with the bad news. ‚ÄúRight now, the crisis has hit a new high, because there‚Äôs an unresolved government crisis in Greece and in Italy,‚ÄĚ Soros said. ‚ÄúThere is also a looming worsening of the financial crisis, because all the efforts to leverage the E.F.S.F. have run into legal or technical difficulties.‚ÄĚ He was referring to the European Financial Stability Facility, the bailout fund for the euro zone.
‚ÄúThat means that currently Europe has no ring fence against a possible Greek default, and that is what is pushing the market into a renewed panic,‚ÄĚ he said. ‚ÄúI expect the market to fall into despair and panic and I expect that to get worse.‚ÄĚ
Despair may indeed be the right emotion, if you accept Soros‚Äôs prediction of what will happen if European leaders don‚Äôt get ahead of the markets: ‚ÄúThis crisis is potentially bigger than the crash of 2008, because we have survived the crash of 2008 and we have not yet survived this one. There is a danger if they get it wrong then you have a financial meltdown. If there is a disorderly default in Greece, and the rest of the euro zone has not been insulated from contagion, then you could have a meltdown not only of the Greek financial system, but of the European and in fact the global financial system because we are so interconnected.‚ÄĚ
So far, so dire. But Soros has two ideas that should perk you up. One is about the bazooka, and one is about the most important woman in the world.
The bazooka is the financial weapon Europe has created to defend ailing European economies from the skeptical traders who are betting against them. To end the crisis, Europe needs a bazooka big enough to convince the markets that making a wager against Frankfurt will be futile ‚ÄĒ and expensive.
Until now, the story of this financial crisis is one of European leaders consistently being one step behind the markets: bringing a fist to a knife fight, then a knife to the gun fight ‚ÄĒ and never bringing out the bazooka. Conventional wisdom ‚ÄĒ and the verdict of the markets this week ‚ÄĒ is that the European Financial Stability Facility war chest of ‚ā¨440 billion, or $600 billion, is a continuation of this pattern of insufficiency.
Soros disagrees: ‚ÄúIt actually has the bazooka in its hand, provided it uses it in the right way.‚ÄĚ
To do that, Soros said, Europe must first acknowledge what its bazooka is too small to achieve: rescue Europe‚Äôs faltering members directly. The bailout fund, he said, ‚Äúwas designed as a way of providing guarantees on government bonds, but for that purpose it is clearly inadequate. It cannot be stretched to cover Italy and Spain.‚ÄĚ
But the bailout fund is big enough, Soros thinks, to save Europe in a different way. ‚ÄúIt needs to be used to guarantee the banking system,‚ÄĚ he said . ‚ÄúThat would create a lender of last resort, which is currently lacking.‚ÄĚ
The bailout fund, he continued, could take the solvency risk, which is beyond the legal right of the European Central Bank. ‚ÄúAnd for that,‚ÄĚ he said, ‚Äúthere is plenty of money.‚ÄĚ Thus shored up, the banks would be able to buy the high-yielding government debt of the European countries that are currently struggling to find lenders.
Banks would be encouraged to hold their liquidity in Treasury bills, Soros said, which they could sell to the European Central Bank at any moment. ‚ÄúSo it is the equivalent of cash, and it would yield more than cash, therefore they would hold it,‚ÄĚ Soros said. ‚ÄúThat would allow countries like Italy and Spain during this crisis period to borrow at negligible cost.‚ÄĚ
His plan, Soros said, would make Italy‚Äôs debt ‚Äúsustainable, because the E.C.B. has any amount of money for the purpose of providing liquidity. At the same time, it would not violate the law against the E.C.B. directly financing the governments.‚ÄĚ
Soros‚Äôs plan is essentially a way to get around Europe‚Äôs fundamental economic flaw ‚ÄĒ it has a single currency, but no lender of last resort: ‚ÄúIt‚Äôs a trick, but a trick that would work.‚ÄĚ
The European crisis has metastasized because Germany has been adamant about blocking precisely this sort of trick. The second reason for Soros‚Äôs relative optimism is his conviction that Germany and its leader, Chancellor Angela Merkel ‚ÄĒ the aforementioned most important woman in the world ‚ÄĒ have recently had a crucial change of heart.
‚ÄúIt is entirely in the hands of Germany,‚ÄĚ Soros said. ‚ÄúAngela Merkel‚Äôs attitude has changed. She recognizes that the euro is in mortal danger and she is willing to risk her political future to save it. I think she recognizes that Germany has caused the crisis to get out of control, and she is now determined to correct that.‚ÄĚ
Merkel is very good at getting what she wants, so fans of Europe and the euro should be somewhat reassured by Soros‚Äôs verdict. But only somewhat. Soros is a persuasive salesman of his plan to rescue Europe, but his most telling remark comes when I ask him what he would do if he were still actively trading.
‚ÄúI would be sitting on the fence like everybody else, because the situation is so uncertain.‚ÄĚ