Monday, September 10, 2012

I Agree With Soros: At Least, With Regard To The Euro

Soros thinks Germany is leading the Euro into dissolution (excerpt):

Soros calls for Germany to 'lead or leave euro'

International financier George Soros has called for Germany to "lead or leave the euro" days before a crucial ruling on the eurozone's bailout fund by Germany's constitutional court.

Mr Soros argued that the eurozone should target 5% economic growth.

That would require the bloc to abandon German-backed austerity measures and accept higher inflation, he says.

He also backed a new European Fiscal Authority financed by VAT receipts to oversee eurozone government finances.

In an article published in Monday's New York Review of Books, Mr Soros said that Germany should become a more "benevolent" leading country or exit the single currency: "Either alternative would be better than to persist on the current course." …

…The ESM is an integral part of the European Central Bank's bond-buying scheme, announced on Thursday.

Debtor governments would have to make a formal request for help - a bailout - from the ESM or its sister fund the EFSF.

But, Mr Soros said that the ECB plan to ease the pressure on indebted nations such as Spain and Italy could deepen divisions within the eurozone.

The ECB's bond-buying programme may save the euro but it is also a step towards the permanent division of Europe into debtors and creditors, he said…

…Germany's central bank is also likely to oppose Mr Soros' 5% economic growth target. For the region's wealth to grow so strongly, prices and wages are also likely to rise sharply leading to inflation above the ECB's 2% target for several years.

Mr Soros said the strong expansion in European wealth would allow the eurozone "to grow its way out of its excessive debt burden."

Mr Soros insists that "if the members of the euro cannot live together without pushing their union into a lasting, they would be better off separating."

Although, he pointed out, it matters who leaves the euro. He advocates a German exit instead of a departure by Greece and weaker economies.

"A German exit would be a disruptive but manageable one-time event, instead of the chaotic and protracted domino effect of one debtor country after another being forced out of the euro by speculation and capital flight."

By leaving, the euro is likely to fall in value making eurozone-made goods cheaper for consumers overseas and also in Germany.

However, a return to the Deutschmark would make German-made goods more expensive overseas and within the eurozone which could hurt German exporters.

Germany is also the home to the European Central Bank and the biggest national creditor to indebted nations within the eurozone such as Greece, Portugal and Ireland all of which would make Germany's exit from the eurozone logistically difficult.

As far as the growth target and the idea of Germany making the exit instead of Greece or Portugal or any of the other PIIGS, I find myself fully in agreement with Mr Soros (though I think I made these same points almost a year ago). The growth target is essentially another version of NGDP targeting, which quite a few prominent economics bloggers have been advocating.

To bring down Europe’s debt burden without a multi-year depression and all that entails in lost output and physical and human capital deterioration, you either need expansive fiscal or monetary expansion to generate growth (to maintain nominal incomes and thus tax yields) and higher inflation (which subdues money demand, while reducing the real burden of debt).

The former isn’t possible without busting already overburdened government balance sheets, which means at heart this is a call for the ECB to take a far more aggressive stance than it has already done. Sterilised bond buying, unlimited though it may be, just doesn’t cut the mustard.

For Germany to leave the Euro area also makes sense because it’s German economic fundamentals that are out of line with the rest of Europe, and not really Greece’s or Portugal’s or Spain’s (and yes, that includes France).

As it stands, what we’re seeing is a succession of band-aids while the patient bleeds to death. Germany’s strategy is really to attempt to fix the missing institutional arrangements that would make the Euro viable in the long term – but the success of this approach depends on the individual countries in the Euro eventually giving up fiscal autonomy. and I don’t think that’s politically doable, even in the crisis climate that Europe is in right now.


  1. It really doesn't matter which country leaves, the immediate impact is horrible.

    Germany, whether it or any combination of the PIIGSF, leave will see its currency appreciate (i'm imagining capital flows from the indebted countries into Germany). The German export machine will likely take a big hit and the irony is that they themselves will have to bail out those affected industries causing another fiscal bomb ~ mitigated if the Germans allow their Central Bank to remain a Lender of last resort (not likely).

    The non-Germans will see their currency depreciate and get a good boost of forex earnings. But the extent of which this will help is uncertain. Their remaining (and quite considerable) external debt servicing charges is already crippling Greece, a negative exchange rate shock is likely to drag in everyone else. And during the entire time these economies have to deal with bank runs and inflation (whether that last one is needed is debatable). Again, mitigated if the Central Bank is a LOLR.

    ...But really, like you've implied, it'll just be better now just for a LOLR and get everyone to run deficits for the moment. Unless the other idea to circumvent this problem is to have a build up of capital controls within the region, which will also spark a panic and more countries will be cut off from the liquidity they desperately need.

  2. I can follow your thought process and somewhat agree with your point. But I thought fred bergsten in "Why the Euro Will survive?" made a compelling argument. He noted the institutional, fiscal, competitiveness and banking failures of EURO but one of his statement is telling for me. He wrote: "...since Europe is an affluent region, solving the crisis is a matter of mobilizing the political will to pay, rather than the economic ability to pay". Each country is essentially currently bargaining the best position for itself. They know the collapse of Euro will be a political and economic disaster so they did just enough to stave off the Euro collapse, and that gave them further room to assert their position. Bergsten call it playing"playing chicken" politics.
    This seems compelling fro m what I gather. I guess we have to wait to see how it unravels.

  3. Sorry, run off my feet yesterday, so haven't had a chance to reply.


    The price adjustments you're describing are happening right now, but in a much more horrible way. At heart, this is about competitiveness or lack thereof, and the locus of the divergence in Europe is Germany, where productivity is orders of magnitude higher than even France.

    In the absence of an exchange rate adjustment where we get an adjustment of real prices without having to adjust internal domestic prices, the price adjustment (of debt, wages and goods) has to happen internally through deflation. But this runs up against the constraint of nominal price stickiness, particularly of debt and wages. Since nominal prices would be difficult to move downwards, the response has to come via adjusting real economic activity, i.e. corporate bankruptcy and high unemployment. Secondly, since real economic activity adjusts more slowly than exchange rates or financial markets, the adjustment will be considerably slower and more protracted.

    It's not a question of avoiding the pain of adjustment, which will happen anyway. It's a matter of choosing the least destructive path.


    Bergsten is wrong on one score - this is not really a debt crisis, which is just a symptom, not a cause, of Europe's problems. Europe has to find a permanent solution to the inconsistency between monetary union and fiscal sovereignty, and the divergence caused by sharply differing labour productivity. Even if they manage to get the ESM off the ground, it's at best a temporary solution.

    1. I disagree that's its just wholly a differences in competitiveness (although admittedly it is one of the bigger issues). If that were true, the vast differences in competitiveness between Malaysian states or American states would cause something similar to happen in these monetary unions.

      Think more to the point (which you have pointed out) is the inability of the policymakers to come up with a credible fiscal union to match its monetary union. Of course, the limited, and constrained role of the ECB does not help at all.

      Horrific short-term (i'm stressing the short-term here) internal price adjustments - whether or not it is due to a breakup of countries - do not need to happen if policymakers can step up to the plate.

    2. Jason, the same thing does happen within any monetary union, including our own and the US. The difference is that with a concurrent fiscal union, fiscal transfers can occur without the drama we're seeing now in Europe. We also see much greater labour and capital mobility within combined monetary and fiscal unions, which also mitigates differences in output, productivity and prices.

      The long term solution for Europe, as you say, is a fiscal union, but I don't see that happening even over the medium term. It would require a much greater sacrifice of sovereignty than I think Europeans are willing to pay. The ESM alone is not credible enough. Eurobonds alone is not credible enough. Given the slowness of real economy transitions, fiscal transfers need to be semi-permanent, not crisis-induced one-offs.

      But even moving along this route, deflation and depression in the periphery is still a requirement. It's not going to resolve Spain and Greece's 25% unemployment rate for instance.