The
"euro crisis” is generally seen as a currency crisis, but it is also a
sovereign debt and, even more, a banking crisis. The situation is complex. The
complexity has bred confusion, and this has political consequences. Europe’s
various member states have formed widely different views and their policies
reflect their views rather than their true national interests. The clash of
perceptions carries the seeds of serious political conflicts.
The
solution that is about to be put in place will, in effect, be dictated by
Germany, without whose sovereign credit no solution is possible. France tries
to influence the outcome but in the end must yield to Germany because its
triple A rating is dependent on being closely allied with Germany.
Germany
blames the crisis on the countries that have lost competitiveness and run up
their debts, and so puts all the burden of adjustment on debtor countries. This
is a biased view, which ignores the fact that this is not only a sovereign debt
crisis but also a currency and banking crisis – and Germany bears a major share
of responsibility for those crises.
When
the euro was introduced it was expected to create convergence but it brought
divergence instead. The European Central Bank treated the sovereign debt of all
member countries as riskless and accepted them at its discount window on equal
terms. Banks that were obliged to hold riskless assets to meet their liquidity
requirements were induced to load up on the sovereign debt of the weaker
countries to earn a few extra basis points. This lowered interest rates in
Portugal, Ireland, Greece, Italy and Spain and generated housing bubbles – at
the same time as Germany had to tighten its belt to cope with the costs of
reunification. The result was a divergence in competitiveness, and a banking
crisis that affected German banks more strongly than most of the others. Truth
be told, Germany has been bailing out the heavily indebted countries as a way
of protecting its own banking system.
The
arrangements imposed by Germany protect the banking system by treating
outstanding sovereign debt as sacrosanct; they also put all the burden of
adjustment on the debtor countries. The arrangements are reminiscent of the
international banking crisis of 1982, when the international financial
institutions lent the debtor countries enough money to service their debts
until the banks could build up sufficient reserves to exchange their bad debts
for Brady bonds in 1989. That caused a "lost decade” for Latin America. Indeed,
the current arrangements penalise the debtor countries even more than in the
1980s because they will have to pay hefty risk premiums after 2013.
There
is something inconsistent in bailing out the banking system once again and then
bailing in the holders of sovereign debt after 2013 by introducing collective
action clauses. As a result, the European Union will suffer something worse
than a lost decade; it will endure a chronic divergence in which the surplus
countries forge ahead and the deficit countries are dragged down by the burden
of accumulated debt. The competitiveness requirements will be imposed on an
uneven playing field, putting deficit countries into an untenable position.
Even Spain, which entered the euro crisis with a lower debt ratio than Germany,
could be dragged down.
Berlin
is imposing these arrangements under pressure from German public opinion, but
the German public has not been told the truth and so is confused. The solution
to the euro crisis to be put in place this week will set in stone a two-speed
Europe. This will generate resentments that will endanger the EU’s political
cohesion.
Two
fundamental modifications are required. First, the European financial stability
facility must rescue the banking system as well as member states. This will
allow the restructuring of sovereign debt without precipitating a banking
crisis. The size of the rescue package could stay the same because any amount
used for recapitalising or liquidating banks would reduce the amount lent to
sovereign states. Bringing the banks under European supervision rather than
leaving them in the hands of national authorities would help restore confidence
in the banking system.
Second,
to create an even playing field, the risk premium on the borrowing costs of
countries that abide by the rules will have to be removed. That could be
accomplished by converting most sovereign debt into eurobonds; countries would
then have to issue their own bonds with collective action clauses and pay the
risk premium only on the amounts exceeding the Maastricht criteria. The first
step could and should be taken immediately at Thursday’s summit; the second
will have to wait. The German public is a long way from accepting it; yet it is
needed to re-establish a level playing field. This has to be made clear to give
deficit countries hope they can escape from their deficit predicament if they
work hard enough at it.
Source:
Financial Times
George
Soros | Financial Times | March 22, 2011
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