George Soros' proposal is to use European Financial Stability Facility (EFSF), and its successor the European Stability Mechanism (ESM), to insure the European Central Bank (ECB) against the solvency risks on any newly issued Spanish or Italian sovereign debts that they might buy from commercial banks. And those debt instruments could be equivalent to cash, the most liquid asset, so that Italy and Spain can refinance their debts at much cheaper than their current borrowing rate, at close to 1%. Italy would experience the cost of borrowing decline rather than increase from the current rate of 4.3%. When those two countries can refinance themselves, the country has the liquidity to emerge from the verge of so-called bankruptcy.
He mentions that the European authorities go for the Long-Term Refinancing Operation (LTRO) of the ECB. Under this plan, European banks would receive unlimited amounts of liquidity, but not to any states, for up to three years. Soros thinks it allows Italian and Spanish banks to buy the government bonds of their own country and engage in carry-trade operation which proves to be very profitable. This operation seems to provide no risks as, if the country defaulted, the banks would be insolvent. The difference between the two schemes is that for George Soros' plan, the EFSF and ESM backs up the ECB to guarantee against the default of the country, so that the borrowing cost could be reduced significantly, helping them to refinance much more easily. But the LTRO is to refinance the banks, without any insurance from the authorities.
In any crisis time, the creditors are in the driver’s seat. That is why Germany is taking up the role of saving the euro. Soros thinks that the cuts in government expenditures that Germany wants to impose on other countries would push Europe into a deflationary debt trap. So the circle would begin from the expenditure decrease, reducing the budget deficits, then wages and profits are being reduced. That leads to a slowdown in the overall economy; tax revenue would be subject to the decrease as well. So with the same amount of debt burden on the countries, whereas the GDP might contract, the ratio of debt to the GDP would rise, requiring further budget cuts, and it comes back to the beginning of the vicious circle.
Dated back, the boom phase of the European Union has been called “a fantastic object” – an unreal but attractive object of desire, by psychologist David Tuckett, and it was transformed from European Coal and Steel Community, step by step. During the boom, the Germany was the main driving force. The process of the boom culminated with the Maastricht Treaty in 1992 and the introduction of the euro in 2002. Soros said it was followed by a period of stagnation which turned into the process of disintegration after the 2008 crash. The Maastricht Treaty set up a monetary union, without political union. The euro currency got the common central bank to provide liquidity, but it lacked a common treasury to deal with solvency risks in the time of crisis. According to Soros, people who created Euro believed that only public sector is capable of producing unacceptable economic imbalances, then the invisible hand would correct the imbalances created by the market, the supply and demand model. In addition, the safeguards which were already available are enough to correct the public sector imbalances. As the result, the government bonds were treated as riskless assets which banks could buy and hold without allocating any reserves for them.
Because of that perspective, people around the world could not believe that a country can go defaulted, and the government bonds of all European members were in the equal quality. So in order to gain few percentage points, banks load up on the weaker European member government bonds. And then one day, the new Greek government revealed that the national deficit was much bigger than had been announced, then the disastrous flaw of the euro is revealed: no mechanism of enforcing payments for the debtors, no exit mechanism from the euro, and the European members cannot print the euro out, and the statutes of ECB strictly prevents itself from lending to member countries, only lending to banks.
Soros said that all we need to do is to reassert the principles of open society and recognize that the prevailing order is not cast in stone and rules are in need of improvement. We all need the European solution for the euro crisis; the national solution would lead to the dissolution of the European Union.
Last but not least, George Soros suggested that it would be two phase maneuver for euro crisis. First is to impose strict fiscal discipline on the deficit countries and encourage structure reforms, then we must find stimulus to get us out of the deflationary vicious cycle. The stimulus should come from the EU and has to be guaranteed, a eurobonds might be one type of that.