By George Soros for the Financial Times:
Far from abating, the euro crisis has recently taken a turn for the worse. The European Central Bank relieved an incipient credit crunch through its longer-term refinancing operations. The resulting rally in financial markets hid an underlying deterioration; but that is unlikely to last much longer.
The fundamental problems have not been resolved; indeed, the gap between creditor and debtor countries continues to widen. The crisis has entered what may be a less volatile but more lethal phase.
At the onset of the crisis, the eurozone’s break-up was inconceivable: assets and liabilities denominated in the common currency were so intermingled that it would have caused an uncontrollable meltdown. But, as the crisis has progressed, the eurozone has been reoriented along national lines.
The LTRO enabled Spanish and Italian banks to engage in very profitable and low-risk arbitrage in their own countries’ bonds. And the preferential treatment received by the ECB on its Greek bonds will discourage other investors from holding sovereign debt. If this continues for a few more years, a eurozone break-up would become possible without a meltdown – but would leave creditor countries’ central banks holding big claims that would be hard to enforce against debtor countries’ central banks.
The Bundesbank has seen the danger. It is now campaigning against the indefinite expansion of the money supply, and it has started taking measures to limit the losses it would sustain in a break-up. This is creating a self-fulfilling prophecy: once the Bundesbank starts guarding against a break-up, everybody will have to do the same. Markets are beginning to reflect this.
The Bundesbank is also tightening credit at home. This would be the right policy if Germany was a freestanding country, but the eurozone’s heavily indebted members badly need stronger demand from Germany to avoid recession. Without it, the eurozone’s fiscal compact, agreed last December, cannot possibly work. The heavily indebted countries will either fail to implement the necessary measures or, if they do, they will fail to meet their targets because of collapsing demand. Either way, debt ratios will rise, and the competitiveness gap with Germany will widen.
Whether or not the euro endures, Europe is facing a long period of economic stagnation or worse. Other countries have gone through similar experiences. Latin American countries suffered a lost decade after 1982, and Japan has been stagnating for a quarter of a century; both have survived. But the European Union is not a country and it is unlikely to survive. The deflationary debt trap threatens to destroy a still-incomplete political union.
Continue reading.
Far from abating, the euro crisis has recently taken a turn for the worse. The European Central Bank relieved an incipient credit crunch through its longer-term refinancing operations. The resulting rally in financial markets hid an underlying deterioration; but that is unlikely to last much longer.
The fundamental problems have not been resolved; indeed, the gap between creditor and debtor countries continues to widen. The crisis has entered what may be a less volatile but more lethal phase.
At the onset of the crisis, the eurozone’s break-up was inconceivable: assets and liabilities denominated in the common currency were so intermingled that it would have caused an uncontrollable meltdown. But, as the crisis has progressed, the eurozone has been reoriented along national lines.
The LTRO enabled Spanish and Italian banks to engage in very profitable and low-risk arbitrage in their own countries’ bonds. And the preferential treatment received by the ECB on its Greek bonds will discourage other investors from holding sovereign debt. If this continues for a few more years, a eurozone break-up would become possible without a meltdown – but would leave creditor countries’ central banks holding big claims that would be hard to enforce against debtor countries’ central banks.
The Bundesbank has seen the danger. It is now campaigning against the indefinite expansion of the money supply, and it has started taking measures to limit the losses it would sustain in a break-up. This is creating a self-fulfilling prophecy: once the Bundesbank starts guarding against a break-up, everybody will have to do the same. Markets are beginning to reflect this.
The Bundesbank is also tightening credit at home. This would be the right policy if Germany was a freestanding country, but the eurozone’s heavily indebted members badly need stronger demand from Germany to avoid recession. Without it, the eurozone’s fiscal compact, agreed last December, cannot possibly work. The heavily indebted countries will either fail to implement the necessary measures or, if they do, they will fail to meet their targets because of collapsing demand. Either way, debt ratios will rise, and the competitiveness gap with Germany will widen.
Whether or not the euro endures, Europe is facing a long period of economic stagnation or worse. Other countries have gone through similar experiences. Latin American countries suffered a lost decade after 1982, and Japan has been stagnating for a quarter of a century; both have survived. But the European Union is not a country and it is unlikely to survive. The deflationary debt trap threatens to destroy a still-incomplete political union.
Continue reading.
