Assessing George Soros’ latest plan for saving the eurozone: Prelude to Modest Proposal 3.0

In a few short weeks I shall be discussing the ‘Future of Europe’ in a panel comprising distinguished commentators including George Soros. In preparation, I decided to take a closer look at Soros’ latest proposals for the eurozone. Here are some preliminary thoughts emanating from these proposals which I also compare and contrast to our Modest Proposal. 

Soros’ plan works as follows: The ECB guarantees that it will buy any newly issued member-state bonds (Italian and Spanish ones in particular) from all comers and at face value. To bypass the twin no bail out clauses (Lisbon and ECB charter), the EFSF-ESM would insure the ECB for any losses on these bonds. This means that the European Banking Authority will be able to treat these bonds as cash, for the purposes of bank accounting. Thus, the banks would choose to keep member-state bonds, including the periphery’s, on their books so long as their yields exceed the interest rate offered by the ECB on money deposited with it. Competition among banks would then drive bond yields close to the ECB overnight rate of, currently, 1%. As for the older bonds, now that the periphery will no longer be in dire straits (regarding the refinancing of their new debt issues), they will also see their yields fall substantially.

One may question whether the flimsy EFSF-ESM could carry the burden of insuring the ECB for all these bonds that will flood into its balance sheet. Soros claims that it should not be a problem since, under his scheme, member-states cannot and will not default. A never ending virtuous circle will therefore have been established. Which brings us to the usual question, that I can hear many posing in earnest, concerning moral hazard: If peripheral member-states know that the ECB will turn their bonds into money, and that the EFSF-ESM will insure these bonds in case of their defaulting, what is their incentive to limit spending and reining in their deficits?

Soros’ answer is that the fact that the ECB will now become central to the viability not just of the peripheral banks but also of the sovereigns promises to keep the politicians in check and in awe of Mr Draghi. However, Soros does not elaborate on what sanctions the ECB will exact upon potentially recalcitrant governments, once it has guaranteed their bonds at par. It seems that the only answer to this is acquiescence to the inane, procyclical Fiscal Pact first proposed by Mrs Merkel. Herein, therefore, lies the first weakness of Soros’ proposal: it will either crash on the shoals of Europe’s selective obsession with moral hazard (i.e. worrying stiff about moral hazard when it comes to governments but not an iota when it comes to zombie banks) or it will be dragged into the abysmal logic of constitutional bans on structural deficits.

Setting aside this difficulty, Soros’ main claim is that his plan would directly deal with the problem Italy and Spain are facing today: namely, of having been relegated to the state of developing nations that have borrowed in a foreign currency. As for the current patch up ‘solution’, Mr Draghi’s LTRO, he would dismiss it as less effective and potentially more dangerous than his own proposed scheme. And he would be correct in saying so. For not only is the LTRO infusing huge amounts of liquidity into our zombified banks, thus removing any incentive the bankers have to recapitalise, but it is also ineffective in its task of indirectly funding the sovereigns (since, even though it offers banks an opportunity to indulge in ‘riskless’ arbitrage, by buying sovereign bonds, only a portion trickles to the sovereigns as the banks hoard as much cash as possible in order to disguise the gaping holes in their own books).

I have no doubt that the above is correct. However, there are a number of problems with Soros’ proposal. The main one is that he is recommending that, in the final analysis, Europe devises a ‘trick’ by which to allow the ECB to print a few trillion euros so as directly to finance the sovereigns. Soros’ idea may be more elegant than different variants of the ECB-monetisation idea; e.g. Mr Geithner’s crude suggestion that the ECB leverage the EFSF and then have the EFSF buy all new and/or bond issues of fiscally distressed countries; or the proposal that the ECB set minimum targets for peripheral spreads and intervene in the secondary markets accordingly. Yet, its central logic is not substantially different: The ECB will be printing money in order to prop up sovereign debt directly (and not through the circuits of the banking system).

Where there is a will there is a way. If Europe wanted to opt for direct ECB monetisation, it would find a way to do it. Alas, Europe’s problem is the absence of the necessary will to support a proposal like Soros’. Indeed, if Germany decided to let the ECB monetise the periphery’s debt directly (as opposed through, the banks, as with the LTRO), Soros’ method would offer a nice fig leaf behind which to disguise this massive change in its collective mind. The problem, however, as I am sure George Soros understands, is that Germany has not made its mind up to monetise the debt directly. Soros may have an excellent point, that the mere announcement of his form of indirect (bank-EFSF-mediated) monetisation will ensure that no actual money-printing will be necessary. But this is besides the point: Germany is still resolute in its commitment to keeping at bay even the ‘imagining’ of direct ECB-mediated monetisation. In addition, there are also another two weaknesses in the Soros proposal: One pertains to the long run ‘solution’, the other to the strategy for growth that Soros is acutely aware is needed, and which he does mention in his article as something that needs to come from the Union (as opposed to the member-states).

Beginning with the long term, Soros understands well that his scheme (which has the EFSF-ESM guarantee the ECB’s guarantee of member-state bonds) is only a temporary palliative for relieving the debt crisis, until something more permanent and solid is put in place. And what might that be? His answer is loud and clear: jointly issued and severally guaranteed eurobonds. This is, I trust, an error which weakens his case. It is true that Mrs Merkel is allowing the rest of us to imagine that, in the distant future, if like good boys and girls we all adorn the fiscal straitjacket that she is proposing, she will let us have our Eurobonds, at least in the fullness of time. Well, this is, I fear, but a stratagem. Mrs Merkel, whoever happens to be Germany’s Chancellor, will never concede to interest rates that are a weighted average between Germany’s and Portugal’s. With good reason too.

Indeed, as the Crisis is dragging on, it takes an heroic disposition to imagine that the German public will inch more closely towards the disbandment of the bunds in favour of jointly issued eurobonds. Quite the opposite will be the case. German taxpayers will rather see the DM return, with all the demerits it will bring regarding loss of export markets et al, than blend their debt with that of the despised periphery.

Turning, lastly, to the need for a growth spurt that is uniquely capable of ending the debt crisis, Soros’ proposal only alludes to its importance. It is not integrated with a plan for spearheading such growth. The task we ought to give ourselves is to find ways of blending our proposals for countering the eurozone’s structural debt crisis with steps that aim at an investment-led recovery spanning the whole continent (and not just the periphery). The way to link these two grand projects, upon which the future of Europe depends, is to overcome a conceptual error at the heart of the assumption that eurobonds must be guaranteed by member-states, just like the EFSF-bonds are presently. The fact is that it is perfectly possible to issue eurobonds without member-state guarantees, without a european Treasury, without a Debt Agency and without whatever else would turn the common bond issuing exercise into something akin to California and Ohio jointly guaranteeing US Treasury Bills. How?

As Stuart Holland and I have been proposing for a while now, the ECB ought to issue its own eurobonds, under its own name, without anyone else guaranteeing them, and use them to shore up existing Treaties, i.e. by servicing (as opposed to buying) the Maastricht-compliant debt of the eurozone member-states that choose to participate in this, effectively, Debt-Conversion-Scheme. The fact that the remaining Maastricht-exceeding debt remains the sole responsibility of the member-states will offer sufficient safeguards, by itself, against moral hazard and removes the need to introduce a messy, and authoritarian, political-cum-constitutional mechanism by which to circumscribe the member-states’ autonomy. In one simple move (having ECB issue debt in its own name in order to service the eurozone’s Maastricht-compliant debt), we will have removed the two main German objections to Union Bonds: (a) the moral hazard objection and (b) the objection based on the (correct) prediction that jointly issued bonds will have yields reflecting the weighted average of German and Greek interest rates).[1]

More importantly, once the ECB begins to issue bonds on behalf of the Union, it becomes possible to link the debt-conversion process with the much needed investment-led recovery  program; with something akin to a New Deal for Europe. As we suggest (Policy 3 of the Modest Proposal), idle global savings can be channelled into productive investments within the whole of the EU. The key is to allow investment to be co-financed (a) by the EIB itself (through the issuance of its own bonds, something the EIB has been doing for decades) and (b) by net issues of project-specific ECB-bonds. A target could be set centrally that involves (a) gross investment for the EU as a whole and (b) patterns of investment such that this ‘surplus recycling’ is made sensitive to the internal balance of payments’ problem. E.g. aggregate investment (financed by EIB and ECB bonds) could be linked to the eurozone’s overall growth performance while the distribution of these funds within the different regions of the eurozone (as opposed to countries) can be calibrated to counter-act the growing trade imbalances.


Soros’s plan is on the right track but suffers from three demerits: It runs against German sensibilities vis-à-vis money printing for the purposes of direct sovereign-debt-finance that bypasses the banks. Secondly, it violates Germany’s legitimate rejection of having its interest rates stretched upwards by eurobond issues that it must jointly issue and back with the periphery. Thirdly, Soros’ plan does not incorporate any mechanism for effecting (a) the desperately needed New Deal for Europe and (b) countering the growing internal imbalance of payments problem (which is, after all, the root problem of the eurozone architectural design). In this light, I still think that our Modest Proposal, suitably amended to take onboard some key ideas by George Soros and others, remains the most fruitful avenue toward a decent European future. Now that the LTRO is about to reveal its weaknesses, and the eurozone crisis is on the verge of a fresh, nasty twist (courtesy of Spain and other major economies entering deeper into recession), it is perhaps time, for Modest Proposal 3.0…

[1] The obvious question here is: And who will backstop these ECB-bonds? The answer is: While the ECB-bonds will be guaranteed by the ECB itself (and not by the surplus, AAA-rated, countries), it is the member-states that will be, under the supervision and even coercion, of the ECB meeting, long term, the maturing ECB-bonds repayments (that are issued in order to service the member-states’ Maastricht-compliant part of their debt). Additionally, we could have the ESM-EFSF guarantee, in a manner resembling Soros’ idea, part of these debts by the member-states to the ECB.


  • Proffesor i have a question,not very relative to the topic though.
    Do you think that debt/gdp ratio is an appropriate measure?I dont really understand how can it be a meaningfull indicator while debt is being accumulated over years and years and gdp only counts for the current year while all previous years of gdp dont count?
    Wouldnt for example debt service/gdp be more appropriate since it measures the current effect of debt over the current gdp ?

  • Yani,
    As the joke goes, if the old lady does not want to cross the street, the boy scouts cannot push her across. This is indeed the Achilles’ heel of all proposals, modest, immodest or indecent.

  • 1) George Soros Says “Credit Default Swaps Are Instruments Of (Financial) Destruction And Should Be Outlawed”

    2) Davos: Soros Wants Global Bank Regulatory System

    3) Soros: Dollar Is Done, World Needs A New Reserve Currency
    3.1. “China must be part of the new world order.”
    3.2. “The dollar’s decline should be orderly.”

    4) Interview – Why Soros Bought $2 Billion In Italian Bonds

    5) The Greek Experiment
    Michael Hudson: Greek crisis used to find out how far finance can drive down wages and privatize

  • Yanis,
    Glad to see you’ve done homework on Soros’ plan, particularly comparing and somewhat integrating Soros’ proposals with the Modest Proposal. If he can be made an ally in getting a growth agenda in place for Europe it could make a huge positive difference in the near and medium term for “the future of Europe”. The alliance of the conservative political parties of Europe with the big banks must be broken. Soros knows this but skirts the issue by proposing direct ECB ‘printing’ and Eurobond issuance and not criticising the LTRO directly.Trying to tip-toe around Merkel will not work – I knew the minute the elections enabled her to acheive her conservative coalition enabling her to abandon the grand coalition with the Social Democrats that Europe was in trouble.

    On another note, here’s tidbit from Eurointelligence blog on Munchau’s agreement with you on cause of global financial crisis –

    Wolfgang Munchau on the role of money in the economy

    In a review of a new book to be launched in Germany today, Wolfgang Munchau writes in his Spiegel Online column that the German economic establishment has a somewhat simplistic notion of the role of money in an economy, and vastly exaggerates the role central banks are playing in determining the economy-wide interest rates. He refutes the notion that the Fed’s monetary policy was the main causes of the global financial crisis, and argues that the main causes were global imbalances and their associated financial flows which drove down market interest rates in the US. He says the focus on a single man’s action obfuscate German’s own role in the crisis.

  • I agree ECB-sponsored bonds are the way to go.

    As to the frequently raised argument of “where is the incentive for fiscal discipline and limiting future spending” there is a very simple answer to this too.

    The first pool of debt, call it the “old debt” would center around existing and outstanding sovereign debt obligations of the member states.

    Towards issuing new debt, exceeding the limits of the collective “old debt”, the participant members would need to adhere to a new set of rules which will expressly address the concerns of fiscal discipline. In other words issuance of new debt (beyond the collective limits of the old debt) will be a “subject to” proposition.

    And when I say “beyond the collective limits or the old debt”, I mean the following: Most sovereign debt matures and then gets replaced at par. So when we have a collection of old debt reaching maturity and then is replaced by an equal amount, such new debt which does not exceed the old debt will fall under the 1st pool.

  • Great speech Daniel Hannan – named Germany no longer needs Europe but drills much deeper into the Euro crisis than that

  • @No EU dictatorship
    March 16, 2012 at 22:37 #

    Rather the EU Parliament is always full. Unfortunately they have zero power because the EU Commission has usurped the Parliament completely. All decision making in EU is now done in the German/neoliberal controlled European Central Bank and the EC.

    Turkey has one of the world’s fastest growing economies, Greece the opposite. The neoliberals would like to have the Turkish ‘stimulus’, plus a big export market.

    • Correct the commission and their non elected dictators are even worse than this parliament that has no demos.

      I have no preference for Turkey being an EU member over Greece or vice versa. Ijust think that Turkey joining would help to dissolve the EU altogether. That would be a chance for a new start, supported by the people, not just an elite political project.

  • Dear Professor Varoufakis,
    It seems that you have failed to notice that European politicians (led by Mrs Merkel) just forced “zombie” banks to swallow a huge haircut on their holdings of Greek government bonds. This would indicate to any unbiased observer that their “obsession with moral hazard” is not as selective as you claim it to be.
    More generally, I think your analysis is interesting and often illuminating but would be more persuasive if you made a more diligent effort to be objective and constructive

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