Does the euro have a future?

By George Soros
September 15, 2011

By George Soros
The opinions expressed are his own.

The euro crisis is a direct consequence of the crash of 2008. When Lehman Brothers failed, the entire financial system started to collapse and had to be put on artificial life support. This took the form of substituting the sovereign credit of governments for the bank and other credit that had collapsed. At a memorable meeting of European finance ministers in November 2008, they guaranteed that no other financial institutions that are important to the workings of the financial system would be allowed to fail, and their example was followed by the United States.

Angela Merkel then declared that the guarantee should be exercised by each European state individually, not by the European Union or the eurozone acting as a whole. This sowed the seeds of the euro crisis because it revealed and activated a hidden weakness in the construction of the euro: the lack of a common treasury. The crisis itself erupted more than a year later, in 2010.

There is some similarity between the euro crisis and the subprime crisis that caused the crash of 2008. In each case a supposedly riskless asset—collateralized debt obligations (CDOs), based largely on mortgages, in 2008, and European government bonds now—lost some or all of their value.

Unfortunately the euro crisis is more intractable. In 2008 the U.S. financial authorities that were needed to respond to the crisis were in place; at present in the eurozone one of these authorities, the common treasury, has yet to be brought into existence. This requires a political process involving a number of sovereign states. That is what has made the problem so severe. The political will to create a common European treasury was absent in the first place; and since the time when the euro was created the political cohesion of the European Union has greatly deteriorated. As a result there is no clearly visible solution to the euro crisis. In its absence the authorities have been trying to buy time.

In an ordinary financial crisis this tactic works: with the passage of time the panic subsides and confidence returns. But in this case time has been working against the authorities. Since the political will is missing, the problems continue to grow larger while the politics are also becoming more poisonous.

It takes a crisis to make the politically impossible possible. Under the pressure of a financial crisis the authorities take whatever steps are necessary to hold the system together, but they only do the minimum and that is soon perceived by the financial markets as inadequate. That is how one crisis leads to another. So Europe is condemned to a seemingly unending series of crises. Measures that would have worked if they had they been adopted earlier turn out to be inadequate by the time they become politically possible. This is the key to understanding the euro crisis.

Where are we now in this process? The outlines of the missing ingredient, namely a common treasury, are beginning to emerge. They are to be found in the European Financial Stability Facility (EFSF)—agreed on by twenty-seven member states of the EU in May 2010—and its successor, after 2013, the European Stability Mechanism (ESM). But the EFSF is not adequately capitalized and its functions are not adequately defined. It is supposed to provide a safety net for the eurozone as a whole, but in practice it has been tailored to finance the rescue packages for three small countries: Greece, Portugal, and Ireland; it is not large enough to support bigger countries like Spain or Italy. Nor was it originally meant to deal with the problems of the banking system, although its scope has subsequently been extended to include banks as well as sovereign states. Its biggest shortcoming is that it is purely a fund-raising mechanism; the authority to spend the money is left with the governments of the member countries. This renders the EFSF useless in responding to a crisis; it has to await instructions from the member countries.

The situation has been further aggravated by the recent decision of the German Constitutional Court. While the court found that the EFSF is constitutional, it prohibited any future guarantees benefiting additional states without the prior approval of the budget committee of the Bundestag. This will greatly constrain the discretionary powers of the German government in confronting future crises.

The seeds of the next crisis have already been sown by the way the authorities responded to the last crisis. They accepted the principle that countries receiving assistance should not have to pay punitive interest rates and they set up the EFSF as a fund-raising mechanism for this purpose. Had this principle been accepted in the first place, the Greek crisis would not have grown so severe. As it is, the contagion—in the form of increasing inability to pay sovereign and other debt—has spread to Spain and Italy, but those countries are not allowed to borrow at the lower, concessional rates extended to Greece. This has set them on a course that will eventually land them in the same predicament as Greece. In the case of Greece, the debt burden has clearly become unsustainable. Bondholders have been offered a “voluntary” restructuring by which they would accept lower interest rates and delayed or decreased repayments; but no other arrangements have been made for a possible default or for defection from the eurozone.

These two deficiencies—no concessional rates for Italy or Spain and no preparation for a possible default and defection from the eurozone by Greece—have cast a heavy shadow of doubt both on the government bonds of other deficit countries and on the banking system of the eurozone, which is loaded with those bonds. As a stopgap measure the European Central Bank (ECB) stepped into the breach by buying Spanish and Italian bonds in the market. But that is not a viable solution. The ECB had done the same thing for Greece, but that did not stop the Greek debt from becoming unsustainable. If Italy, with its debt at 108 percent of GDP and growth of less than 1 percent, had to pay risk premiums of 3 percent or more to borrow money, its debt would also become unsustainable.

The ECB’s earlier decision to buy Greek bonds had been highly controversial; Axel Weber, the ECB’s German board member, resigned from the board in protest. The intervention did blur the line between monetary and fiscal policy, but a central bank is supposed to do whatever is necessary to preserve the financial system. That is particularly true in the absence of a fiscal authority. Subsequently, the controversy led the ECB to adamantly oppose a restructuring of Greek debt—by which, among other measures, the time for repayment would be extended—turning the ECB from a savior of the system into an obstructionist force. The ECB has prevailed: the EFSF took over the risk of possible insolvency of the Greek bonds from the ECB.

The resolution of this dispute has in turn made it easier for the ECB to embark on its current program to purchase Italian and Spanish bonds, which, unlike those of Greece, are not about to default. Still, the decision has encountered the same internal opposition from Germany as the earlier intervention in Greek bonds. Jürgen Stark, the chief economist of the ECB, resigned on September 9. In any case the current intervention has to be limited in scope because the capacity of the EFSF to extend help is virtually exhausted by the rescue operations already in progress in Greece, Portugal, and Ireland.

In the meantime the Greek government is having increasing difficulties in meeting the conditions imposed by the assistance program. The troika supervising the program—the EU, the IMF, and the ECB—is not satisfied; Greek banks did not fully subscribe to the latest treasury bill auction; and the Greek government is running out of funds.

In these circumstances an orderly default and temporary withdrawal from the eurozone may be preferable to a drawn-out agony. But no preparations have been made. A disorderly default could precipitate a meltdown similar to the one that followed the bankruptcy of Lehman Brothers, but this time one of the authorities that would be needed to contain it is missing.

No wonder that the financial markets have taken fright. Risk premiums that must be paid to buy government bonds have increased, stocks have plummeted, led by bank stocks, and recently even the euro has broken out of its trading range on the downside. The volatility of markets is reminiscent of the crash of 2008.

Unfortunately the capacity of the financial authorities to take the measures necessary to contain the crisis has been severely restricted by the recent ruling of the German Constitutional Court. It appears that the authorities have reached the end of the road with their policy of “kicking the can down the road.” Even if a catastrophe can be avoided, one thing is certain: the pressure to reduce deficits will push the eurozone into prolonged recession. This will have incalculable political consequences. The euro crisis could endanger the political cohesion of the European Union.

There is no escape from this gloomy scenario as long as the authorities persist in their current course. They could, however, change course. They could recognize that they have reached the end of the road and take a radically different approach. Instead of acquiescing in the absence of a solution and trying to buy time, they could look for a solution first and then find a path leading to it. The path that leads to a solution has to be found in Germany, which, as the EU’s largest and highest-rated creditor country, has been thrust into the position of deciding the future of Europe. That is the approach I propose to explore.

To resolve a crisis in which the impossible becomes possible it is necessary to think about the unthinkable. To start with, it is imperative to prepare for the possibility of default and defection from the eurozone in the case of Greece, Portugal, and perhaps Ireland.

To prevent a financial meltdown, four sets of measures would have to be taken. First, bank deposits have to be protected. If a euro deposited in a Greek bank would be lost to the depositor, a euro deposited in an Italian bank would then be worth less than one in a German or Dutch bank and there would be a run on the banks of other deficit countries. Second, some banks in the defaulting countries have to be kept functioning in order to keep the economy from breaking down. Third, the European banking system would have to be recapitalized and put under European, as distinct from national, supervision. Fourth, the government bonds of the other deficit countries would have to be protected from contagion. The last two requirements would apply even if no country defaults.

All this would cost money. Under existing arrangements no more money is to be found and no new arrangements are allowed by the German Constitutional Court decision without the authorization of the Bundestag. There is no alternative but to give birth to the missing ingredient: a European treasury with the power to tax and therefore to borrow. This would require a new treaty, transforming the EFSF into a full-fledged treasury.

That would presuppose a radical change of heart, particularly in Germany. The German public still thinks that it has a choice about whether to support the euro or to abandon it. That is a mistake. The euro exists and the assets and liabilities of the financial system are so intermingled on the basis of a common currency that a breakdown of the euro would cause a meltdown beyond the capacity of the authorities to contain. The longer it takes for the German public to realize this, the heavier the price they and the rest of the world will have to pay.

The question is whether the German public can be convinced of this argument. Angela Merkel may not be able to persuade her own coalition, but she could rely on the opposition. Having resolved the euro crisis, she would have less to fear from the next elections.

The fact that arrangements are made for the possible default or defection of three small countries does not mean that those countries would be abandoned. On the contrary, the possibility of an orderly default—paid for by the other eurozone countries and the IMF—would offer Greece and Portugal policy choices. Moreover, it would end the vicious cycle now threatening all of the eurozone’s deficit countries whereby austerity weakens their growth prospects, leading investors to demand prohibitively high interest rates and thus forcing their governments to cut spending further.

Leaving the euro would make it easier for them to regain competitiveness; but if they are willing to make the necessary sacrifices they could also stay in. In both cases, the EFSF would protect bank deposits and the IMF would help to recapitalize the banking system. That would help these countries to escape from the trap in which they currently find themselves. It would be against the best interests of the European Union to allow these countries to collapse and drag down the global banking system with them.

It is not for me to spell out the details of the new treaty; that has to be decided by the member countries. But the discussions ought to start right away because even under extreme pressure they will take a long time to conclude. Once the principle of setting up a European Treasury is agreed upon, the European Council could authorize the ECB to step into the breach, indemnifying the ECB in advance against risks to its solvency. That is the only way to forestall a possible financial meltdown and another Great Depression.

This essay is reprinted with permission from the author, and from the New York Review of Books, where it was originally published.

PHOTO: A woman walks past a pizza shop with a sign of a euro coin used to advertise its prices in central Madrid, September 13, 2011. REUTERS/Paul Hanna

39 comments

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The only solution I see is to break up the Euro system. They are trying to save the unsavable, instead of just letting it go. The Euro system was built because Europeans wanted a counterweight to the U.S., without the equivalent political system. You can’t cobble political systems of member states and cover them with a single currency. There is no control over the member states’ actions. So, instead of letting go and admitting that they made a mistake to begin with, they keep trying to fix one mistake with another mistake. The entire structure is just not supportable. You have disparate needs of the member states, how can you have a single solution to everyone’s problems? One size solution does not fit all.
And they have the same problems U.S. has: they must protect their markets from low cost products coming in from Asia. But their politics has been captured by greed also, so they are paralyzed. So, we had a working system before the latest upheavals began, but then, because our capitalists decided they wanted more, we had to disturb it. So until everything crashes and burns they are not going to be satisfied. We now have to wait until it does. We must let greed run its course.

Posted by contrarianview | Report as abusive

The problem is very basic. Socialism! Why would anyone working in Germany want to pay for someones 40 year retirement in Greece! Add all the financial wizardry and financial expertise you want. It is time to start thinking INSIDE the box again!

Posted by LDavid217 | Report as abusive

This article is New World Order propaganda.

“The outlines of the missing ingredient, namely a common treasury, are beginning to emerge.”

Take money from the people and give it to the bankers or the government.

Posted by JamesLove | Report as abusive

I actually disagree with the premise of this article. “The euro crisis is a direct consequence of the crash of 2008.”

The euro was doomed from the beginning, 2008 just hastened it’s demise.

The Euro was developed, ostensibly, to be a direct competitor to the US Dollar. There was a second, more important agenda in play. The monetary policies of many European nations were creating record dept well before it was a “public” issue, as it is now. The Euro was a way to “spread the debt” (yeah a play on words..lol) to allow these “social contracts” to continue well beyond their normal sustainability.

I’ve said it before and I’ll say it again. Government over-regulation and social entitlements will kill ANY economy, given time.

Posted by jimg662 | Report as abusive

Soros is right ( as usual ) whilst Merkel and Sarkozy are grasping at straws instead of providing decisive leadership. Any chief executive, behaving as they do, would have been fired long ago for promoting and supporting ( with vast funds ) and unworkable business model that could destroy the company. I am deeply disappointed by the lack of clear thinking and in our Eurocrats.

Posted by pavlaki | Report as abusive

The Eurozone possesses an 11,000 ton gold reserve. A reduction in the gold cover ratio, from 15% to 10%, would release 1/3 more “debt free” Euros, with which to amortize or re-purchase a significant portion of the Eurozone sovereign debt. In the case of re-purchase, debt interest payments become disposable income, perhaps 2 trillion Euros per decade, depending on interest rates.

Posted by DarkEnergy | Report as abusive

Politicians know prefectly well what Soros says and solutions he proposes. Problem is that creating European treasury can not be sold to the public. People in Europe are not prepared to leave deeply entrenched concept of sovereign states. At least not before there is significant train crash that is crisis of huge proportions in Europe. What is thus left is policy of small steps and fire extinguishing. As a last resort ECB will play the role of FED and buy bonds to the tune of trillions.

Posted by wirk | Report as abusive

Soro’s is likely trying to protect his own investments. Ask yourself, why do those in power and those with money want to protect the big banks and preserve the current system – at all costs – from failure?
The problem: Too much debt, big banks in danger, bond investors likely to lose alot of money if the banks fail – and no one has the money to rescue them. How can we create the money?
Soro’s solution: create another new entity, a bigger one yet, that can therefore borrow more money and extend the current debts.
The key phrase in his proposed fix: “..with the power to tax, and therefore borrow.”
Who are they borrowing from? and who are they going to tax?

Posted by rhw322 | Report as abusive

shorter soros…
‘why won’t the germans share their money with the rest of europe?’

the eu was in germany’s interest when they joined. they were going to export, and they needed to find a currency that would not appreciate as their export status/gdp grew.

investors continued buying bonds in countries that didn’t deserve a dime, with the ‘implicit’ understanding that the eu would be backing the countries from default.

forget spain and italy…
france has exposed itself to way too many junk bonds. they get flushed, severely, somewhere between the greek default and the acceptance of the inevitablity of italy falling down.

very quietly the french are constructing a new maginot line of defense, which will carefully defend the economic borders of france, while ceding the ‘economic lands’ of 6 other euro cuntries being ditched.

if france could have gone it alone, they would have done so. they are french.

soros making the case for europe? he’s making the case for his assets in europe, not the people.

like the french, soros has been governed by a sense of self presevation, by any means necessary.

selectively impugning germany, without explaining the other guilty parties failures is tragically one sided.

sooner than soros would care for, germans will pursue the path of similar choice. given the option of self preservation, or pumping well over 700 billion euros into countries governed by the greedy, the foolish, and the uncontrite isn’t really a choice.

Posted by always420 | Report as abusive

Soros has made untold billions because he understands economies… The politicians who have shaped Euro policy have lost trillions because they do not understand economies. It seems to me that listening to an expert might be a good thing, no?

Posted by xnormanx | Report as abusive

“Eurozation” of Europe more and more looks like “Dollarization” of Argentina.

Posted by robb1 | Report as abusive

There is no solution. R. Felder is right, meltdown is coming. They may try Euro bonds. Geithner will try to get them to try a bailout.

But the reality is, Germany would have to bail out FIVE other countries (Portugal, Ireland, Italy, Greece, and Spain) to keep the Euro intact. Is it any surprise that they don’t want to do that? Especially since they didn’t create the problems in those corrupt, overspending countries, and also, who’s to say they wouldn’t continue their unaccountable ways even after a bailout?

Would you take this on if you were Germany?

There’s no way. Goodbye Euro.

Posted by NewsLady | Report as abusive

I hear smart Germans are loading up on GOLD…Soros sold his gold awhile ago, before the recent rise. However, I am sure he is looking to destabilize the Euro and make a killing off this crisis…

“The euro exists and the assets and liabilities of the financial system are so intermingled on the basis of a common currency that a breakdown of the euro would cause a meltdown beyond the capacity of the authorities to contain. The longer it takes for the German public to realize this, the heavier the price they and the rest of the world will have to pay.”

Posted by SoundMoney | Report as abusive

This was a helpful explanation to a very complex issue. The concept of bankruptcy works well in private industry and would work here, with the big difference of ECB printing money to pay off certain obligations to prevent financial institutions from collapsing. It might go like this:

1) Greece says sorry, we’re only going to pay 50 cents on the dollar to our bondholders. We going to exchange your 100 cent bonds for these shiny new 50 cent bonds with a 20 year maturity and 2% coupon. ECB agrees to guarantee the new bonds.

2) The ECB buy some of the existing bonds at 80 cents on the dollar from systemically important banks, absorbing the loss when Greece redeems them at 50 cents, again by printing money.

3) Greece gets serious about long-term austerity, meaning substantial reductions in government pension arrangements and raising the retirement age to 70, indexed to life expectancy.

4) The EU overall agrees to one government pension arrangement, similar to the U.S. Social Security program, with a retirement age around 70, phased in gradually.

5) The EU establishes stronger enforcement mechanisms for government revenue and spending targets.

Let’s start solving problems, instead of managing them and creating uncertainty.

Posted by Farcaster | Report as abusive

Soros’ observation of the status of the structure and relationships within the EMU is spot on and just about electrifyingly candid.
His solution of a United States of Europe Treasury may represent his book – unfortunate reality for Billionaire bizfolk – or it may just represent the best effort he can make to try the impossible just once, before we try the necessary.

To continue to say that the alternative is so unthinkable that it must be avoided at all costs is unfortunately a disservice to the people of Euroland.

Such a position ensures that the necessary exit-strategy remains unborn, and the hole from which the quasi-nation must evolve gets that much deeper and that much steeper.

Sorry, George. Think the un-thinkable for the financialists out there, and get back to whether those who opposed the Euro because it was a failed will ever agree to end their sovereignty because they were right.

Not going to happen, George.
No matter how sure you are that it is the only solution that can work and no matter how bad you claim the alternative solutions.

I hope you can spend a few bucks with a back-room operation on how to transition OUT of the Euro and its poisonous, contagious financial web.

I do wish you luck.

Posted by joebhed | Report as abusive

I have some doubts about first set of measures. It will make banks with a lower ratings (and potentially worse risk management) more attractive for depositors as they will pay higher interest with no risk to lose all your money. Moreover, it will encourage banks to make riskier investments that is not good idea in such volatile environment IMHO.

Posted by Vough | Report as abusive

What is going to happen if Greece leaves the Euro and goes back to the drachma. They would be able to pay back their debt with highly depreciated drachma. Yes, many would suffer in Greece, but they are already. Has anyone read good summaries of waht may happen?

Posted by steve18977 | Report as abusive

I found the article most interesting, but Greece’s withdraw from the Euro seems the only real solution to the problem. But for EU politicians this is unthinkable! However, once individuals become MEPs they seem to lose all reason and common sense. For instance the last Eastern European countries to be accepted as full members of the EU were perceived as amongst the most corrupt pin the world. (See Transparency International). The three countries awaiting acceptance are even worse! And the remaining three are perceived as the most corrupt! When I questioned the EU why they had and would allow these corrupt countries to become EU members, the reply was similar to “Don’t look at the quality! Feel the width!” That Prodi asked for a 5% increase in the EU budget, when member states are busy cutting public spending and making other sacrifices, illustrates clearly why many Europeans do not trust either the EU Parliament or the Commission to act in the best interest of its members. When MEPs and EU leaders are so detached from reality, the last things that EU members need is a European treasury with taxing and borrowing powers!

Posted by IRATESCEPTIC | Report as abusive

I remember a friend many years ago telling me a story and it went like this. He was in a meeting with the Tax Office to discuss his outstanding taxes. He owed millions in taxes due to a failed commercial venture. The public servant tax officer at the meeting said to him “listen mate, you are in a lot of trouble unless you pay your taxes by “such and such a date”" and my client responded “As I see it, I am not the one that is in trouble, YOU are the one in trouble, because I have millions of your tax dollars and you need to get that money from me”.
So whilst Europe and the rest of the world, keeps banging on about Greece and whether it should exit the eurozone or not, the reality is that restructuring and an orderly default is required for there to be any hope for Greece to stay in the eurozone and to avoid the meltdown. Allowing Greece to exit the eurozone, apart of the collapse of the banking system and all that that entails with flow on effects to world markets, will also allow the middle east and Asian countries free to invest their billions of surpluses that are itching to be invested in Europe giving these emerging power house economies a foot hold in Europe and access to markets once dominated by the Germans and French. So Germany really needs to find a practical solution fast to this crisis before its euro kingdom collapses and for this to be done, it needs to allow Greece to have a capacity to repay restructured debts. Or is it the case that the Germans and French through the guise of “austerity” are simply stalling for time hoping to acquire as many Greek state assets as possible as a form of foreclosure of sorts, at fire sale prices before the inevitable default and eurozone exit, leaving less for the middle east and eastern investors to scavenge.

Posted by billpeters | Report as abusive