Sunday, April 14, 2013

Lessons from Soros

A very interesting 'essay' by George Soros.

Causes of the European crisis: Sovereign debt crisis, banking crisis and divergences in competitiveness

"When the euro was introduced, government bonds were treated as riskless. The regulators didn’t require commercial banks to set aside any equity capital, and the European Central Bank discounted all government bonds on equal terms. This created a perverse incentive for commercial banks to accumulate the bonds of the weaker member countries in order to earn a few extra basis points. As a result interest rate differentials practically disappeared."

"Only at the end of 2009, when the extent of the Greek deficit was revealed, did the markets realize that a Eurozone country could actually default. But then they raised risk premiums on all the weaker countries with a vengeance. This rendered commercial banks, whose balance sheets were loaded with those bonds, potentially insolvent and that created both a sovereign debt and a banking crisis - the two are linked together like Siamese twins."

One of my favourite parts:
"There is a close parallel between the euro crisis and the international banking crisis of 1982. Then the IMF and the international banking authorities saved the international banking system by lending just enough money to the heavily indebted countries to enable them to avoid default but at the cost of pushing them into a lasting depression. Latin America suffered a lost decade."
And this is what ought to happen to at least the peripheral countries of Europe. 
The odd thing (one of them anyway) about this crisis is that, one could blame Greece for flouting the rules, but "Spain and Ireland had played by the rules; indeed Spain used to be held up as a paragon of virtue."


Germany has a responsibility here - one which it didn't want. Understandably, they say that the debtors need to go through their issues, why should Germany dole out its moneys?

The essay is quite beautiful because Soros has spent a large amount of his time understanding behaviour:

"Guarantees have a peculiar character: the more convincing they are, the less they are likely to be invoked. The US never had to pay off the debt it incurred when it converted the debt of individual states into Federal obligations. Germany has been willing to do only the minimum; that is why it had to keep escalating its commitments and is incurring actual losses."

He suggests:
"If my analysis is correct, a solution practically suggests itself. It can be summed up in one word: Eurobonds. If countries that abide by the Fiscal Compact were allowed but not required to convert their entire existing stock of government debt into Eurobonds, the positive impact would be little short of the miraculous. The danger of default would disappear and so would the risk premiums. The balance sheets of banks would receive an immediate boost and so would the budgets of the heavily indebted countries because it would cost them less to service their existing stock of government debt."

He strongly believe that Eurobonds could solve the problem at a certain level:
"By contrast, if Italy left, its euro-denominated debt burden would become unsustainable and it would have to be restructured. This would plunge the rest of Europe and the rest of the world into an uncontrollable financial meltdown. The collapse of the Euro would likely lead to the disorderly disintegration of the European Union and Europe would be left worse off than it had been when it embarked on the noble experiment of creating a European Union. So, if anyone must leave it should be Germany, not Italy."

"Let me sum up my argument. I contend that Europe would be better off if Germany decided between accepting Eurobonds and leaving the euro than if it continued on its current course of doing the minimum to hold the euro together. That holds true whether Germany chose Eurobonds or exit; and it holds true not only for Europe but also for Germany, except perhaps in the very near term."

Very interesting.
I like the potential of his second preference: Germany leaving the Euro. 


1 comment:

  1. I hope the crisis in Europe will soon end. They need to solve this problem quickly if they don't want this conflict become worse.

    economic problems

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