Monday, July 12, 2010

Soros on the Euro.

Pretty depressing stuff. On the role of Germany:
"And this brings me to the gravest defect in the euro’s design: it does not allow for error. It expects member states to abide by the Maastricht criteria—which state that the budget deficit must not exceed 3 percent and total government debt 60 percent of GDP—without establishing an adequate enforcement mechanism. And now that several countries are far away from the Maastricht criteria, there is neither an adjustment mechanism nor an exit mechanism. Now these countries are expected to return to the Maastricht criteria even if such a move sets in motion a deflationary spiral. This is in direct conflict with the lessons learned from the Great Depression of the 1930s, and is liable to push Europe into a period of prolonged stagnation or worse. That will, in turn, generate discontent and social unrest. It is difficult to predict how the anger and frustration will express itself.

The wide range of possibilities will weigh heavily on the financial markets. They will have to discount the prospects of deflation and inflation, default and disintegration. Financial markets dislike uncertainty. Meanwhile, xenophobic and nationalistic extremism are already on the rise in countries such as Belgium, the Netherlands, and Italy. In a worst-case scenario, such political trends could undermine democracy and paralyze or even destroy the European Union.

If that were to happen, Germany would have to bear a major share of the responsibility because as the strongest and most creditworthy country it calls the shots. By insisting on pro-cyclical policies, Germany is endangering the European Union. I realize that this is a grave accusation but I am afraid it is justified.

To be sure, Germany cannot be blamed for wanting a strong currency and a balanced budget. But it can be blamed for imposing its predilection on other countries that have different needs and preferences—like Procrustes, who forced other people to lie in his bed and stretched them or cut off their legs to make them fit. The Procrustes bed being inflicted on the eurozone is called deflation.

Unfortunately Germany does not realize what it is doing. It has no desire to impose its will on Europe; all it wants to do is to maintain its competitiveness and avoid becoming the deep pocket for the rest of Europe. But as the strongest and most creditworthy country, it is in the driver’s seat. As a result Germany objectively determines the financial and macroeconomic policies of the eurozone without being subjectively aware of it. When all the member countries try to be like Germany they are bound to send the eurozone into a deflationary spiral. That is the effect of the policies pursued by Germany and—since Germany is in the driver’s seat—these are the policies imposed on the eurozone.

The German public does not understand why it should be blamed for the troubles of the eurozone. After all, it is the most successful economy in Europe, fully capable of competing in world markets. The troubles of the eurozone feel like a burden weighing Germany down. It is difficult to see what would change this perception because the troubles of the eurozone are depressing the euro and, being the most competitive of the countries in the eurozone, Germany benefits the most. As a result Germany is likely to feel the least pain of all the member states.

The error in the German attitude can best be brought home by engaging in a thought experiment. The most ardent instigators of that attitude would prefer that Germany leave the euro rather than modify its position. Let us consider where that would lead.

The Deutschmark would go through the roof and the euro would fall through the floor. This would indeed help the adjustment process of the other countries but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative and there would be widespread unemployment. German banks would suffer severe exchange rate losses and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations: pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Let me emphasize that this scenario is totally hypothetical because it is extremely unlikely that Germany would be allowed to leave the euro and to do so in a friendly manner. Germany’s exit would be destabilizing financially, economically, and above all politically. The collapse of the single market would be difficult to avoid. The purpose of this thought experiment is to convince Germany to change its ways without going through the actual experience that its current policies hold in store.

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