Felix Salmon

George Soros and the two choices facing Europe

By Felix Salmon
June 4, 2012

There’s a good reason why the likes of Paul Krugman, Joe Weisenthal (twice), Cullen Roche, Ezra Klein, and everybody else are raving about George Soros’s analysis of what went wrong in the Eurozone: it’s really good. The big theme is that the European-unity project is a bubble, which could burst at any minute. But it’s the granular analysis in this 4,400-word speech which really makes it worth reading.

Essentially, Soros characterizes the European project as being a bit like a runner, moving at a steady clip in the direction of greater unity. Running is a weird thing: it’s basically the art of falling over continuously in a particular direction. So long as you keep on moving forwards, you can maintain a dynamic equilibrium. But stopping is really hard, because whenever you try to do that, you’re out of balance:

The process of integration was spearheaded by a small group of far sighted statesmen who practiced what Karl Popper called piecemeal social engineering. They recognized that perfection is unattainable; so they set limited objectives and firm timelines and then mobilized the political will for a small step forward, knowing full well that when they achieved it, its inadequacy would become apparent and require a further step. The process fed on its own success, very much like a financial bubble.

The problem here is that the statesmen didn’t understand that they were running: they thought they were walking. They thought that while forward momentum was a good thing and maybe even necessary, ever-greater union was in and of itself a good thing, which would bring the continent closer together and make it stronger. With hindsight, by contrast, we can see that it was a way of turbo-charging the European bubble, and setting it up for a catastrophic pop if and when the process of integration didn’t continue far beyond what was politically feasible circa Maastricht.

The bubble was a consequence of the convergence trade, which in turn, says Soros, was a function of BIS risk weightings:

When the euro was introduced the regulators allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital; and the central bank accepted all government bonds at its discount window on equal terms. Commercial banks found it advantageous to accumulate the bonds of the weaker euro members in order to earn a few extra basis points. That is what caused interest rates to converge which in turn caused competitiveness to diverge. Germany, struggling with the burdens of reunification, undertook structural reforms and became more competitive. Other countries enjoyed housing and consumption booms on the back of cheap credit, making them less competitive. Then came the crash.

The problem here is that the convergence trade could probably have been better described as a divergence trade: it created a two-tier Europe, with a strong creditor-filled center funding a weak debtor-filled periphery. And as a result the political union — which had always been the necessary other shoe to drop — became impossible, rather than inevitable.

At this point, says Soros, optimistically, Europe still has three months to pull together a comprehensive package to save the union — a package which is just as economically necessary for Germany as it is for Spain. But politically, getting this done is going to be incredibly hard: “the disintegration of the European Union,” says Soros, is “just as self-reinforcing as its creation”.

The economic necessity for Germany, here, is a product of Target 2, the mechanism by which the Bundesbank’s balance sheet now holds €660 billion in peripheral-country claims. Germany needs to throw money, more or less continuously, at the European periphery at this point, because if it doesn’t, its central bank will suddenly find itself insolvent to the tune of roughly €1 trillion. That wouldn’t be the end of the world: if Germany got its Deutschmark back, then the Bundesbank could simply print €1 trillion worth of Deutschmarks to fill that hole. But a world where the Bundesbank is willing to print €1 trillion worth of Deutschmarks is simply not the world we’re living in, and the Germans will do pretty much anything to avoid that outcome.

Which leaves us with the only alternative:

Germany is likely to do what is necessary to preserve the euro – but nothing more. That would result in a eurozone dominated by Germany in which the divergence between the creditor and debtor countries would continue to widen and the periphery would turn into permanently depressed areas in need of constant transfer of payments. That would turn the European Union into something very different from what it was when it was a “fantastic object” that fired peoples imagination. It would be a German empire with the periphery as the hinterland.

This is, in a nutshell, the bet I have with Joe Weisenthal. He, like Soros, says that Europe — including Greece — will become a German empire, where the Germans reluctantly dole out a stream of transfer payments to a resentful periphery. I’m taking the other side of that bet, because I think it’s politically impossible, in a union of democratic nations. And also because I think that even if perpetual transfer payments to Spain are justifiable, perpetual transfer payments to Greece are not. Either way, here’s the video.

13 comments so far | RSS Comments RSS

Soros’ analysis is mostly inaccurate.

The root and the source of the problem in both Europe and US come from the financial sector as well as policy makers that work for politicians who in turn serve their voter base’s stupidity and ignorance.

Posted by trevorh | Report as abusive

OK, you both have part of the problem – per Felix, Greece staying is unstable (but how – see below); Joe is right on its nondistinctness – put these together – the debtor-sides politicians in other peri-countries will ask for the same deal (politicians being as slimy as the monarchs before them) and crash goes the edifice. Unless Germany et al (creditors) want to pay for all of them, creating a new USSR of Europe (you pretend to work, we pretend to support you). So the instability is the “me-too” of other debtors.

Posted by Sir_Douglas | Report as abusive

So I take Felix’s ultimate position, except the all the periphery will vote out within a couple of years – once they see the situation, voters will clamor for out – why CHOOSE both repression and depression when you think you can choose only one

Posted by Sir_Douglas | Report as abusive

trevorh, maybe you can expand on why you think Soros is wrong? Stating the crisis is caused by “the financial sector” isn’t much of an analysis itself. And attributing it to politicians and their motives isn’t a cause, but more of a reason why it was allowed to happen and why it isn’t getting fixed.

I actually thought Soros was right on target, and not just because he (like me) attributes bubbles to positive feedback loops in action, but he so correctly points out that economics is not a peer of physical sciences, as it relies on the unpredictable decisions of billions of people with imperfect information.

Posted by KenG_CA | Report as abusive

Felix, I’m with you on this one. Mostly for historical reasons: I can’t think of a single example when difficult economic times led to the formation of bigger states or bigger integration in the past, but there are many examples when they led to disintegration of empires, unions and federations. Why is it going to be any different this time?

Posted by Doly | Report as abusive

“I can’t think of a single example when difficult economic times led to the formation of bigger states or bigger integration in the past,”

Doly, not that I comparing present day Germany to the one of ~80 years ago, but they did have horrible economic times (far worse than what Greece is enduring now), and they did (at least temporarily) expand their empire. I don’t think it will happen again, mainly because Germany doesn’t want that headache.

I don’t think it will lead to disintegration, either, because that’s not in Germany’s or the weak nations’ best interests, and they know it. There will be a solution (most likely partial) that nobody will like, but it will be better than the alternative.

The ECB can print money, I don’t know why they just don’t go ahead and do that, and make loans to the troubled countries, at high interest rates, even if they know re-payment isn’t imminent. It’s better for Germany than having Germany loan them the money directly. And as long as the US is sustaining deficits, and China ties their currency to the dollar, they won’t suffer too bad.

Breakup is not an option, and neither is default.

Posted by KenG_CA | Report as abusive

The bet is on what is going to happen, not what should happen to produce the least-bad outcome – so, either lad could be right; it’s a political guessing-game as they have set it up, not a “find the best outcome” contest. But let’s suppose the Euro pols are a little ahead of our two contestants, and look for something better than “kick Greece out” or “transfer union Uber Alles” – what might that be?

The single Euro currency was, we now know, “a bridge too far”. But two Euro currencies may not be. Don’t kick Greece out, but let it and the other weak use the existing Euro, and let the ECB do what it has to for them. The strong migrate to another currency – also administered by the ECB – which adopts a monetary policy appropriate for them. The single market remains intact in all other respects.

It’s the elegant solution because it recognizes two key facts – the solution must be comprehensive and include all the weak in a single stroke in order to succeed, not be confined just to Greece. And, everyone’s debts are denominated now in the existing Euro currency – this is really the crucial item.

I’ll be the utter fool (again) – and bet the Euro pols find the right (third) answer in time to avoid disaster, and both our chums then lose – to me. Make me a 50:1 “dog”, though.

Posted by MrRFox | Report as abusive

I honestly thought that the title of the video was
“Will Greece save Euro?”
And the answer is yes in both scenarios
1)In the Case of Grexit Ecb will inject huge amounts of liquidity into the sovereign markets and thus Eurobonds will defacto be created via Target 2.
2)If Greece stays this will mean that some kind of transfer union will be created, probably inolving debt writedowns, that will make the European union a plausible project and will avoid the tranfomation of southern Europe into dessert.

A bet I am willing to make with both of you, and I can cook wonderfull greek that goes well beyond tzatziki and mousaka.

Posted by eris | Report as abusive


Very simple, people vote themselves benefits with their favourite politicians.

Financial sector creates all sorts of bubble, debt, scams, etc.. to inflate the economy so the politicians can temporarily fulfill their promises at the same time ripping off rich rewards.

Now is the time that the mess is so bad.
Simple logic: lie begets lie, you have to create scam and bubble to fulfill stupid promises.

It’s that simple.

I have a feeling that the time for China will come a lot faster than one expected, their leaders don’t have to pander to voters.

Posted by trevorh | Report as abusive

Trevor, you’re not really saying anything different than what Soros said. However, the way you say it will only make people defensive, for nobody wants to hear that they are responsible for the problem, even if they are.

Rather than assigning blame, Soros chooses to identify problems that have to be rectified, and maybe people will respond. But if you call them liars and scammers and say they rip off people, they will not do anything you suggest, because they will be addressing the names you call them, rather than the problems they might be causing.

Posted by KenG_CA | Report as abusive


From what I understand and what seems to be clear, Soros is basically saying integration and unity in Europe is the main source of trouble. That is just flat wrong.

He blames the unity-project as the bubble.
It’s the bad fiscal discipline that is the bubble and the problem.

Krugman et al want more borrowing and diluting of money supply. Otherwise, their bankers cousins will run out of way to make money. This is the deadly bubble!!

Posted by trevorh | Report as abusive

What a load of codswallop. Running is nothing like falling over continuously in a certain direction. Stopping is very easy, unless you are not paying attention. Just like walking!

I’ve even seen you running, Felix. Well, sort of. And you were by no means falling

Posted by ACMurray | Report as abusive

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/