Thursday, September 13, 2012

George Soros: "Germany Must Lead or Leave"

George Soros has produced a fascinating article for the New York Review of Books: The Tragedy of the European Union and How to Resolve It. The article provides a long and detailed explanation of the situation the euro zone countries find themselves in, and how they managed to get there. He provides an excellent summary, but much of what he has to say has been said before in terms of approaches to extricating the group of countries from its dilemma. However, what is of most interest is that he does suggest an alternate approach that I had not heard proposed before.

Soros fears that Europe will continue to follow the path of least resistance which is to do the minimum necessary to keep the euro zone from falling apart. But that approach cannot go on forever and eventually the debtor countries will decide they have no recourse but to depart in order to disencumber themselves of their debt and the repressive measures imposed on them. Soros predicts that if that happens then not only the euro zone, but the European Union itself will disassemble under the burden of the hostility that has been generated.

"The policies pursued under German leadership will likely hold the euro together for an indefinite period, but not forever. The permanent division of the European Union into creditor and debtor countries with the creditors dictating terms is politically unacceptable for many Europeans. If and when the euro eventually breaks up it will destroy the common market and the European Union. Europe will be worse off than it was when the effort to unite it began, because the breakup will leave a legacy of mutual mistrust and hostility. The later it happens, the worse the ultimate outcome. That is such a dismal prospect that it is time to consider alternatives that would have been inconceivable until recently."

Most of the discussion of nations leaving the euro zone has focused on what it would mean if one of the debtor nations found it necessary to depart. The previously inconceivable alternative Soros puts forward is for one of the creditor nations to leave, and, in particular, the biggest creditor nation of all.

"In my judgment the best course of action is to persuade Germany to choose between becoming a more benevolent hegemon, or leading nation, or leaving the euro. In other words, Germany must lead or leave."

Soros prefers the former path, but believes the departure of Germany from the euro zone would be beneficial to the remaining debtor countries, and although financially painful for Germany it would eventually thrive as well.

He differentiates between what would happen if a debtor nation left the euro system from the ramifications of Germany’s departure.

"If a debtor country leaves, its debt increases in value in line with the depreciation of its currency. The country concerned could become competitive; but it would be forced to default on its debt and that would cause incalculable financial disruptions. The common market and the European Union may be able to cope with the default of a small country such as Greece, especially when it is so widely anticipated, but it could not survive the departure of a larger country like Spain or Italy. Even a Greek default may prove fatal. It would encourage capital flight and embolden financial markets to mount bear raids against other countries, so the euro may well break up...."

"By contrast, if Germany were to exit and leave the common currency in the hands of the debtor countries, the euro would fall and the accumulated debt would depreciate in line with the currency. Practically all the currently intractable problems would dissolve. The debtor countries would regain competitiveness; their debt would diminish in real terms and, with the ECB in their control, the threat of default would evaporate. Without Germany, the euro area would have no difficulty in carrying out the U-turn for which it would otherwise need Chancellor Merkel’s consent."

Germany has long benefited from being in the euro zone by utilizing a joint currency that is of lower value than Germany’s unique currency would have been. This has helped boost their export-driven economy. On exit it would lose that benefit and see losses on any investment denominated in euros as the depreciating of that currency proceeded. Soros believes this economic shock is survivable.

"The common market would survive but the relative position of Germany and other creditor countries that may leave the euro would swing from the winning to the losing side. They would encounter stiff competition in their home markets from the euro area and while they may not lose their export markets, these would become less lucrative. They would also suffer financial losses on their ownership of assets denominated in the euro as well as on their claims within the TARGET2 clearing system. The extent of the losses would depend on the extent of the euro’s depreciation."

"After the initial shock, Europe would escape from the deflationary debt trap in which it is currently caught; the global economy in general and Europe in particular would recover and Germany, after it has adjusted to its losses, could resume its position as a leading producer and exporter of high-value-added products. Germany would benefit from the overall improvement."

This, of course, is not the desired path.

"The same result would be achieved, with less cost to Germany, if Germany chose to behave as a benevolent hegemon. That would mean (1) establishing a more or less level playing field between debtor and creditor countries and (2) aiming at nominal growth of up to 5 percent, in other words allowing Europe to grow its way out of excessive indebtedness. This would entail a greater degree of inflation than the Bundesbank is likely to approve."

Soros explains in detail in the article how those two goals could be accomplished.

Given that Soros has the eventual economic outcomes correct, how does one convince Germany to become either a benevolent hegemon, or to leave? Soros is a bit fuzzy on that. He suggests that France might have enough clout if it united with other countries to counter German domination.

"Taking the side of the debtor countries and challenging the policy of austerity would allow France to resume the position of leadership it held during Mitterrand’s presidency. That would be a more dignified position than being a passenger with Germany in the driver’s seat. Still, it would take great courage for France to part ways from Germany in the short run."

His suggested alternative:

"The campaign to change German attitudes will therefore have to take a very different form from the intergovernmental negotiations that are currently deciding policy. European civil society, the business community, and the general public need to mobilize and become engaged. At present, the public in many eurozone countries is distressed, confused, and angry. This finds expression in xenophobia, anti-European attitudes, and extremist political movements. The latent pro-European sentiments, which currently have no outlet, need to be aroused in order to save the European Union. Such a movement would encounter a sympathetic response in Germany, where the large majority is still pro-European but under the spell of false fiscal and monetary doctrines."

Is this a movement...or a revolution? If Soros can see a path that returns Europe to the place we have come to love, then let’s go for it!

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