EUROPEANS could use a little cheering up this week. One man who is trying to do that is George Soros. He knows his way around a currency crisis, of course, and he isn't usually accused of being a Pollyanna. Soros thinks it is not too late to save Europe and the euro but he warns that time is running out and that Europe's leaders must fundamentally change their strategy to succeed.
Let's start with the bad news. “Right now, the crisis has hit a new high, because there's an unresolved government crisis in Greece and in Italy,” Soros said this week from Warsaw.
“There is also a looming worsening of the financial crisis because all the efforts to leverage the European Financial Stability Facility (EFSF) have run into legal or technical difficulties,” he said, referring to the EFSF, the bailout fund for the eurozone.
“That means that currently Europe has no ring fence against a possible Greek default, and that is what is pushing the market into a renewed panic,” Soros said. “I expect the market to fall into despair and panic and I expect that to get worse.”
Despair may indeed be the right emotion, if you accept Soros' prediction of what will happen if European leaders don't get ahead of the markets: “This crisis is potentially bigger than the crash of 2008, because we have survived the crash of 2008 and we have not yet survived this one. There is a danger if they get it wrong, then you have a financial meltdown,” he told me in Budapest last week. “If there is a disorderly default in Greece, and the rest of the euro zone has not been insulated from contagion, then you could have a meltdown not only of the Greek financial system, but of the European and in fact the global financial system because we are so interconnected.”
So far, so dire. But Soros has two ideas that should perk you up. One is about the bazooka, and one is about the most important woman in the world.
The bazooka is the financial weapon Europe has created to defend ailing European economies from the skeptical traders who are betting against them. To end the crisis, Europe needs a bazooka big enough to convince the markets that making a wager against Frankfurt will be futile and expensive.
Until now, the story of this financial crisis is one of European leaders consistently being one step behind the markets: bringing a fist to a knife fight, then a knife to the gunfight and never bringing out the bazooka. Conventional wisdom and the verdict of the markets this week is that the European Financial Stability Facility war chest of 440 billion euros, or US$600bil, is a continuation of this pattern of insufficiency.
Soros disagrees: “It actually has the bazooka in its hand, provided it uses it in the right way.”
To do that, Soros said, Europe must first acknowledge what its bazooka is too small to achieve: rescue Europe's faltering members directly. The bailout fund, he said, “was designed as a way of providing guarantees on government bonds, but for that purpose it is clearly inadequate. It cannot be stretched to cover Italy and Spain.”
But the bailout fund is big enough, Soros thinks, to save Europe in a different way. “It needs to be used to guarantee the banking system,” he said. “That would create a lender of last resort, which is currently lacking.”
The bailout fund, he continued, could take the solvency risk, which is beyond the legal mandate of the European Central Bank. “And for that,” he said, “there is plenty of money.” Thus shored up, the banks would be able to buy the high-yielding government debt of the European countries that are currently struggling to find lenders.
Banks would be encouraged to hold their liquidity in government bonds, Soros said, which they could sell to the European Central Bank at any moment. “So, it is the equivalent of cash, and it would yield more than cash, therefore they would hold it,” Soros said. “That would allow countries like Italy and Spain during this crisis period to borrow at negligible cost.”
His plan, Soros said, would make Italy's debt “sustainable, because the ECB has any amount of money for the purpose of providing liquidity. At the same time, it would not violate the law against the ECB directly financing the governments.”
The Soros plan is essentially a way to get around Europe's fundamental economic flaw: It has a single currency, but no lender of last resort. “It's a trick, but a trick that would work.”
The European crisis has metastasised because Germany has been adamant about blocking precisely this sort of trick. The second reason for Soros' relative optimism is his conviction that Germany and its leader, Chancellor Angela Merkel the aforementioned most important woman in the world have recently had a crucial change of heart.
“It is entirely in the hands of Germany,” Soros said. “Angela Merkel's attitude has changed. She recognizes that the euro is in mortal danger and she is willing to risk her political future to save it. I think she recognises that Germany has caused the crisis to get out of control, and she is now determined to correct that.”
Merkel is very good at getting what she wants, so fans of Europe and the euro should be somewhat reassured by Soros's verdict. But only somewhat. Soros is a persuasive salesman of his plan to rescue Europe, but his most telling remark comes when I ask him what he would do if he were still actively trading.
“I would be sitting on the fence like everybody else, because the situation is so uncertain.” - Reuters
COMMENT By CHRYSTIA FREELAND, thestar.com.my
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