As far as Germany is concerned, the drama of the euro crisis is over. The subject was barely discussed in the country’s recent election campaign. Chancellor Angela Merkel did what was necessary to ensure the euro’s survival, and she did so at the least possible cost to Germany – a feat that earned her the support of pro-European Germans as well as those who trust her to protect German interests. Not surprisingly, she won re-election resoundingly.
But it was a Pyrrhic victory. The eurozone status quo is neither tolerable nor stable. Mainstream economists would call it an inferior equilibrium; I call it a nightmare – one that is inflicting tremendous pain and suffering that could be easily avoided if the misconceptions and taboos that sustain it were dispelled. The problem is that the debtor countries feel all the pain, while the creditors impose the misconceptions and taboos.
One example is Eurobonds, which Merkel has declared taboo. Yet they are the obvious solution to the root cause of the euro crisis, which is that joining the euro exposed member countries’ government bonds to the risk of default.
Normally, developed countries never default, because they can always print money. But, by ceding that authority to an independent central bank, the eurozone’s members put themselves in the position of a developing country that has borrowed in foreign currency. Neither the authorities nor the markets recognized this prior to the crisis, attesting to the fallibility of both.
When the euro was introduced, the authorities actually declared member states’ government bonds to be riskless. Commercial banks could hold them without setting aside any capital reserves, and the European Central Bank (ECB) accepted them on equal terms at its discount window. This created a perverse incentive for commercial banks to buy the weaker governments’ debt in order to earn what eventually became just a few basis points, as interest-rate differentials converged to practically zero.
But interest-rate convergence caused economic divergence. The weaker countries enjoyed real-estate, consumption, and investment booms, while Germany, weighed down by the fiscal burden of reunification, had to adopt austerity and implement structural reforms. That was the origin of the euro crisis, but it was not recognized at the time – and is not properly understood even today.
Converting all outstanding government bonds – with the exception of Greece’s – into Eurobonds would be by far the best remedy. It would require no transfer payments, because each country would remain responsible for servicing its own debt. And it would impose stricter market discipline on debtor countries than they currently face, because they could issue Eurobonds only to refinance maturing ones; any additional borrowing would have to be in their own name, and markets would impose penalty rates for excessive borrowing.
Yet Eurobonds would substantially reduce the heavily indebted countries’ borrowing costs and go a long way to reestablishing a level playing field in the eurozone. Germany’s credit rating would not be endangered, because Eurobonds would compare favorably with bonds issued by other major countries.
Eurobonds would not cure disparities in competitiveness; eurozone countries would still need to undertake their own structural reforms. But they would remedy the euro’s main design flaw. All the alternatives are inferior: they either involve transfer payments, perpetuate an uneven playing field, or both. And yet, owing to Merkel’s opposition, Eurobonds cannot even be considered.
Greece, too, is a victim of its creditors’ misconceptions and taboos. Everyone knows that it can never pay back its debt, most of which is held by the official sector: the ECB, eurozone member states, or the International Monetary Fund. After undergoing a lot of pain and suffering, Greece is close to posting a primary budget surplus. If the official sector could forgo repayment as long as Greece meets the conditions imposed by the Troika (the ECB, the European Commission, and the IMF), private capital would return and the economy could recover rapidly.
I can testify from personal experience that investors would flock to Greece once the debt overhang was removed. But the official sector cannot write down its debt, because that would violate a number of taboos, particularly for the ECB.
Germany would do well to remember that it has benefited from debt write-downs three times in its history. The Dawes Plan of 1924 sought to stagger Germany’s reparations payments for World War I. The Young Plan of 1929 reduced the sum that Germany owed in reparations and gave the country much more time to pay. The post-World War II Marshall Plan provided debt relief as well.
French insistence on harsh reparations payments after World War I clearly prepared the ground for the rise of Hitler. The rise of Greece’s neo-fascist Golden Dawn is a similar phenomenon.
These two examples justify my description of the euro crisis as a nightmare. Only Germany can end it, because, as the country with the highest credit rating and largest and strongest economy by far, it is in charge.
Germany, mindful of its recent history, does not want to be cast in the role of a hegemonic power; the current situation is not the result of some evil German plot. Still, Germany cannot escape the responsibilities and liabilities that go with that role. It must learn to act as a benign hegemon. Doing so would earn Germany the lasting gratitude of the countries that are currently subordinated to it, just as the Marshall Plan earned the United States the lasting gratitude of Europe. Failure to seize this moment would, I believe, lead to the disintegration and eventual collapse of the European Union.
Of course, many countries have lived through nightmares and survived. But the EU is not a country; it is an incomplete association of sovereign states that will not survive a decade or more of stagnation. That is not in Germany’s interest, and it would leave Europeans worse off than they were when they embarked on the EU project.
Making a U-turn is never easy for political leaders, but elections do provide an opportunity for a policy change. The best way to make one would be for Merkel’s next government to appoint an independent expert commission to evaluate the alternatives, without regard to the prevailing taboos.
George Soros is Chairman of Soros Fund Management and Chairman of the Open Society Foundations. A pioneer of the hedge-fund industry, he is the author of many books, including The Alchemy of Finance and The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means.