George Soros, in his recent FT article, puts forward three proposals toward arresting the euro crisis. One and a half of these are spot on. The remaining (one and a half) range from the ill-thought to the catastrophic. Here is why I think this:
In brief, George Soros makes three points:
- that the EFSF turns into a eurozone-wide supervisor and TARP-like recapitaliser of the banking system (which is almost identical a recommendation to Policy 2 of our Modest Proposal),
- that the eurozone issues common bonds (eurobonds) that are jointly guaranteed by all eurozone member-states (and perhaps in a quantity that even exceeds 60% of the eurozone’s GDP), in exchange for a loss of fiscal autonomy in proportion to the number of eurobonds the member-state is asking to be issued
- that an exit mechanism is put in place for member-states that find it hard to live by these new rules (meaning Greece, primarily)
It is not the first time that Soros weighs in this debate. Indeed, his previous letter (back in March) to the FT was a breath of fresh air – see here for my commentary at the time. Unfortunately, this time his proposal, though along the lines of the earlier one, contains a number of gremlins that diminish the usefulness of that which Soros is proposing.
On the first proposal, (1) above, I have nothing to say except to pile much deserved praise on his take. How could it be different since, effectively, Soros adopted in its entirety Policy 2 of our Modest Proposal. On the second proposal (2), however, I have some serious reservations. Lastly, proposal (3) is calamitous, as it (in my humble opinion) undoes all the good points that preceded by introducing a mechanism that will guarantee the eurozone’s demise. But let’s take these, (2) and (3) one at a time:
(2) Jointly guaranteed eurobonds in exchange for centralised fiscal limits
That eurobonds must be issued in order to shrink the overall debt burden of the eurozone is not something I shall contest, since it is a main axis around which our Modest Proposal has been turning well before George Soros’ came onboard. Where I beg to differ is in the nature of these bonds and, primarily, his idea that some new Treasury be constituted that issues these bonds after a decision making process in which member-states have differential voting rights, in inverse proportion to the funding they seek through the eurobond issues.
My objection is both practical, political and economic: Practical, in the sense that it will almost impossible to agree on how to set up with new Treasury or Debt Agency; especially so in view of the need to amend the Lisbon Treaty. To cut a long story short, by the time Europe does this the euro will no longer… exist. As for the political objection, asking Germans to accept that the interest rate Germany pays to borrow will edge up toward a level reflecting the joint creditworthiness of the eurozone as a whole (for this is what jointly guaranteed eurobonds would do) will more likely than not yield a large coalition in Berlin that will prefer to exit the euro than to save it. Finally, at the level of macroeconomics, the idea that national fiscal policy autonomy will be forfeited in inverse proportion to the member state’s refinancing difficulties will, yet again, lead to a eurozone fiscal policy that squeezes fiscally (i.e. via what will be equivalent to new austerity) the parts, e.g. Spain and Italy, that are in greatest need of growth. Effectively, the Soros proposal for this new Debt Agency or Eurozone treasury will institutionalise the foolish principle of pro-cyclical fiscal policies for the most depressed regions of the Union.
Soros’ error, in my estimation, is conceptual. He assumes that eurobonds must be guaranteed by member-states, just like the EFSF is currently. He is right in spotting the madness of the EFSF’s heterogeneous funding guarantees (i.e. the way in which the triple-A nations are asked to bear the burden of the ‘fallen’ states) but wrong to suggest that what we now need is eurobonds that are jointly guaranteed by all the member-states. How else could it be? Our Modest Proposal’s Policy 1 has the answer: No state guarantees are necessary and no new, complex, politically impossible, European Treasury or Debt Agency are necessary. Instead, the ECB ought to issue its own eurobonds, under its own name, and use them to shore up existing Treaties, i.e. by servicing the Maastricht-compliant debt of the eurozone member-states simply, automatically and without any prolonged negotiations. The fact that the remaining Maastricht-exceeding debt remains with the member-states will offer sufficient safeguards, by itself, against moral hazard and removes the need to introduce a messy political mechanism by which to circumscribe the member-states’ autonomy.
Soros makes the good point that transferring the Maastricht-compliant debt to the Centre may not be enough, given the extent of the current debt crisis. I beg to differ provided Policy 3 of the Modest Proposal is implemented: That is, provided the European Investment Bank is energised, as we suggest, in order to centralise large-scale investment that will combine both the public and private sectors. For if each member-state is guaranteed a substantial degree of investment annually from the EIB (e.g. 4% to 5%), in addition to having its Maastricht-compliant debt serviced by the ECB, the current Crisis will have been seen off. Moreover, once the Maastricht-compliant debt and a large Marshall Plan-like investment program are in place eurozone-wide, then it may well be possible, and desirable, to agree on a mechanism that supervises the drafting and execution of member-states’ budgets – without, however, instituting the loss of autonomy. This can be done in the only way that is politically sustainable and fathomable: according, that is, to the Bostonian principle of No Taxation Without Representation.
Exit mechanism for Greece and others
This is the Achilles Heel of the latest Soros proposal. Soros argues that an exit mechanism is important as both a disciplinary device and a means of defending the solidity of the new eurozone from the infectious effects of having in its ranks a member-state that, come what may, cannot abide by the new rules. What he fails to recognise, however, is that the moment you put such a mechanism in place you give speculators a target: A pretext for betting on which member-state will leave, which will follow, what effect these exits will have on the rest etc. It is a recipe for disaster which I have explained fully here (in the context of what I playfully called the Eagles’ Doctrine). To put it bluntly, a common currency area cannot afford to have exit doors. The imminent exit of the weakest will give the strongest a gargantuan incentive to leave first.
Soros is spot on regarding the role that the EFSF must evolve into and correct in his assessment that the eurozone without eurobonds is history. However, his vision on who should issue these eurobonds is problematic, as is his recommendation about a new institution that must handle them. The new eurobonds must be issued by the ECB. Period. Moreover, they must be utilised not only for the purposes of debt management but also in conjunction with the European Investment Bank in a large, joint program of investment-led recovery for the eurozone as a hole. Finally, the exit option that he touts must be allowed to die the quiet death that it richly deserves.