On George Soros’ three recommendations: An assessment

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:

  1. 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),
  2. 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
  3. 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.

Conclusion

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.

31 thoughts on “On George Soros’ three recommendations: An assessment

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  9. I copy from a very interesting article “Out of Control” (in my opinion, a must to read – all 4 parts): http://www.spiegel.de/international/business/0,1518,781590,00.html

    … For example, says Taylor, he is “sure” that legendary speculator George Soros is “plotting against the euro.” Although Soros denied such accusations in an interview with SPIEGEL last week, he also said: “Financial markets have a very safe way of predicting the future. They cause it.”

    My question: would you ever trust a gambler?

    • Better question: Would you ever trust a politician? –> deduce since the Euro is a poitical project the amount of trust it should have is that of a politician!

    • My tragedy is the politicians can be trusted to do the wrong thing. Your tragedy is that you labour under the illusion that markets, left to their own devices, work well.

    • And my tragedy is that while politicians cannot be trusted ,while economists do not all see the world as it is ,while bankers don’t care ,while the golden immature little boys care only for their bonuses and coming up with ways to steal ,while true economy and politicians have become the concubines of the financial markets ,while the financial markets have become just a tech trick ,while technology and computers is used for manipulation of all kinds ,

      i want to escape this life and do not have any ammo (money) left ,for this is our prison and energy and all of the above ,one way or another ,will continue to exist.

      Any solution will come from them and any solution will be absorbed by them.
      Spongebobs of corruption and leading psychic parasites.

      But noone can be the ultimate winner and its fun to fight.
      Get them.

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  11. Pingback: Irish Left Review · Why Eurobonds are Essential and Fiscal Union a Folly (Or how to escape the equally untenable positions of German economists Thomas Straubhaar and Otmar Issing)

  12. Yanni,

    More on Soros comments, I understand why he mentions that Greece should exit the eurozone. Greece has a serious competitiveness problem that could be partially fixed quicker with a new currency.
    However, I do not get why Greece should exit the EU altogether.
    Does he imply that he would like Greece (or Portugal ) to put trade barriers ? Isn’t he a proponent of free trade ?
    I understand that you cannot reply on his behalf, put what is your feeling about this ?

    • Greece should not be in the eurozone. But this does not mean that it ought to exit. It is a subtle but huge difference. Any exit from the eurozone will spell the eurozone’s end. Soros and Rubini, despite their otheerwise sound analysis, do not seem to grasp how fragile the eurozone is and the speed with which it will disintegrate the moment even a small, inconsequential country, like Greece. exits. On one point he is right: If Greece were to exit the eurozone, it would be legally imperative to exit the EU. Why? Because the Greek state would have forcibly to convert the euros in our bank accounts to drachmas. But then we could, as citizens of the EU, take the Greek state to the European courts and win…

  13. Just want to thank you Yani for your contributions and this blog which I sincerely appreciate.

    All the best,
    Chris (cardesigner semiextraordinaire)

  14. Soros with his second argument sees exactly what I see (and many others in the markets I suspect) and which I have raised as an objection to the central idea of your modest proposal dear Yani. That if you have the ECB issue eurobonds on behalf of member state economies without puting in place strictly enforced fiscal governing rules (through a treasury or similarly capable institution) then there is no reason for member states to all of a sudden become fiscally responsible. No serious investor would believe that reselling the same fruit under a new brand name but without changing any of the individual fruit suppliers and enforcing strict quality controls, would make the same bad fruit more desirable. At least not in the long or even medium run.

    • If this is what Sorors ‘sees’, then you are both wrong, respectfully. But I do not think he sees that. It is simply the case that he has not considered the possibility of ECB-issued bonds. Thankfully many others do see this point. Including FT’s Alphaville, Gulio Tremonti (Italy’s finance minister), Gordon Brown and many of the traders that I speak to. Then again, I may be wrong. In which case a new 1930s beckons.

    • Just to be clear, I think the questionable part is not the ECB or anybody else for that matter, issuing bonds on behalf of member states. The problem in my view is that if this is not done together with some serious fiscal planning rules practically and convincingly enforced across the board, it will be seen by the market yet just another temporary gimmick.

  15. Soros may see his own interests as extending beyond the limited domain of his wallet! Not all rich folk subscribe to the pursuit of social-darwinist fascism (that Darwin himself would have been horrified by) roughly along the lines pursued by that austrian corporal with the chaplin moustache, albeit in a lite version. Although it is true that in USA this this rather narrow ‘philosophy’ still seems to underpin a lot of what goes on.

    Of course it is amazing that any genuinely ethical and aware folk get to the top at all, given the odds seem to be generally stacked against them nearly everywhere, as far as I can tell. Miraculous almost! But it does seem to happen, though not often enough maybe.

    On another note do I detect a smidgen of vanity in your post Yanis? That is to say to his credit Soros is no Johnny-come-lately either on the Eurobond issue. I know that he wrote an article in the FT on February 22nd 2010 arguing they were needed (headline _’The Euro will face bigger test than Greece’ I think). He may have even earlier posts, I don’t know.

    Soros seems acutely aware of the role of luck in his career, attributing it mainly to the good fortune of having had a unique family that was able to encourage and foster the necessary qualities to survive and even prosper after the holocaust. And others like Buffett are not afraid to acknowledge their success to be dependent in many ways on the work of all those creating and supporting vital material and social infrastructure, without which folk like him would never have been able to get started at all let alone prosper.

    Also his interest in philosophy may help as Socratic dialogue is perhaps the father of clear thinking.

    Your less than perfect commenter …

  16. Soros may see his own interests as extending beyond the limited domain of his wallet! Not all rich folk subscribe to the pursuit of social darwinist fascism (that Darwin himself would have been horrified by) roughly along the lines that austrian corporal with the chaplin moustache. Although it is true that in USA this this rather narrow ‘philosophy’ still seems to underpin a lot of what goes on. However I reckon it is amazing that any genuinely ethical and aware folk get to the top at all, given the odds seem to be generally stacked against them nearly everywhere, as far as I can tell. Miraculous almost!

    On another note do I detect the some of the human weakness of vanity in even our host blogger, Yanis? That is to say Soros is no Johnny-come-lately on the Eurobond issue. I know that he wrote an article in the FT on February 22nd 2010 arguing they were needed (headline _’The Euro will face bigger test than Greece’ I think). He may have earlier posts I don’t know.

    Soros seems acutely aware of the role of luck in his career, attributing it mainly to the good fortune of having had a unique family that was able to encourage and foster the necessary qualities to survive and even prosper after the holocaust. And others like Buffett are not afraid to acknowledge their success to be dependent in many ways on the work of all those creating and supporting vital material and social infrastructure, without which folk like him would never have been able to get started at all let alone prosper.

    Also his interest in philosophy may help as Socratic dialogue is perhaps the father of clear thinking.

    Your less than perfect commenter himself…

  17. Mr. Varoufakis, I agree with your analysis on George Soros’ article.

    I just want to know a bit more on the mechanics of the eurobond. Issuing a eurobond would imply a mutualization of the system’s debt right? Something which is fiercely rejected by Germany. But let’s say they finally agree on it (within their own context of course, which might be -or probably is- quite different than what you have been arguing for).

    Your modest proposal is indeed very solid and I agree with it, but wouldn’t the transferring of debt to the ECB overload it with too many burdens that could potentially jeopardize its credibility and thus the whole plan?

    Moreover can we be certain that by transferring part of the national debt to the ECB, therefore not involving the credibility of other states (as Soros and others suggest), will not have an impact on the “healthy” parts?

    In your proposal it seems that no member-state will be affected since it is a relation between the ECB and the state, but will it be treated as such by the markets or will they still treat it as yet another application of the failing EFSF logic?

    Perhaps this could transfer the source of contagion to a different level. Of course I know that you also have in mind a new role for the EIB which changes the dynamic…

    At any rate these are some persistent questions regarding the eurobond, which I think are also shared by others.

    Thanks.

  18. Even if 2 & 3 points are somehow viable, I really cannot imagine the time consuming negotiations to take place, in contrast with the current emergency conditions our global economy lives in. But…is there enough time even for point #1?

  19. Isn’t it possible that he is in a position to make against own interests’ recommendations ,because he doesn’t care about money that much any more ,but has other agendas at heart?

    This comment may be of limited nature ,but i can’t get out of my mind ,that if a solution is to be found ,it would be better for them ,that the solution is not of Greek origin.

    Something similar by someone like Soros is perfectly acceptable.

    • I disagree. Soros has for years been making recommendations that go against his own interests. If you read his book on the Crash of 2008, this is clearly a man with pretensions that extend well beyond his bottom line. In that sense, he is special. A little like David Ricardo who wrote and spoke passionately against the interests of his own class (the landowners).

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