Soros: Europe’s 3-Month Window
George Soros has laid it on the line. The eurozone will begin to break up, followed by the break-up of the European Union, within three months if the politicians do not come to an agreement to re-write the treaties and centralize power. No other figure has been this apocalyptic and this specific as to the timetable.
He sees this outcome as a catastrophe. I keep thinking: „Free at last! Free at last!“
Soros understands the price movements of currencies better than anyone else. This is how he became a multi-billionaire. He has used massive leverage extremely high risk to speculate in the currency futures markets, often taking the opposite side of trades with central banks. When a man has enough wisdom to beat the currency futures markets, I give him credit. He knows something about currencies.
In a recent essay, he points out that the 2008 crisis created a new realization that there is no consensus about economic theory. He insists that „economic theory has failed“. On the contrary, economic theory has triumphed Austrian economic theory. In 2007, numerous non-academic, non-tenured Austrians predicted the recession of 2008. I called it in late 2006, predicting a 2007 recession. The National Bureau of Economic Research retroactively dated it as having begun in December 2007 just in the nick of time!
Soros goes even further. This failure is the failure of academic economic theory.
I believe that the failure is more profound than generally recognized. It goes back to the foundations of economic theory. Economics tried to model itself on Newtonian physics. It sought to establish universally and timelessly valid laws governing reality. But economics is a social science and there is a fundamental difference between the natural and social sciences. Social phenomena have thinking participants who base their decisions on imperfect knowledge. That is what economic theory has tried to ignore.
This is the criticism made repeatedly by Austrian economists, beginning with Ludwig von Mises exactly a century ago: The Theory of Money and Credit (1912). I cannot imagine a better statement of Austrian theory’s rejection of mainstream economists‘ theory.
Soros has no explanation for the business cycle. Austrian economics does: central bank policies of monetary inflation and monetary stability.
Here is Soros‘ view. „I treat bubbles as largely unpredictable.“ That is, he has no theory of economic causation. Bubbles are followed by busts, he says, which are followed by government regulation. This really is the pattern, but he does not explain how bubbles get started. „According to my theory financial markets may just as soon produce bubbles as tend toward equilibrium.“ In other words, there is no known cause. He has no economic theory. But he has this much right: „Behind the invisible hand of the market lies the visible hand of politics.“
The Euro Crisis
He blames policy-makers for the crisis. „The authorities didn’t understand the nature of the euro crisis; they thought it is a fiscal problem while it is more of a banking problem and a problem of competitiveness.“ Yes, it is: the problem of fractional reserves and fiat money, all supported by the central bank. But he will not admit this.
He adopts the joint conclusion of mainstream Keynesianism, monetarism, and supply-sidism: „And they applied the wrong remedy: you cannot reduce the debt burden by shrinking the economy, only by growing your way out of it.“ But how? He has no clue. The Austrians do: cut government spending, cut taxes, reduce government regulation, and stabilize money none of which is going to be done.
A Bubble Of Faith: The European Union
He says there has been a bubble of misplaced enthusiasm: the European Union. I like this idea.
I contend that the European Union itself is like a bubble. In the boom phase the EU was what the psychoanalyst David Tuckett calls a „fantastic object“ unreal but immensely attractive. The EU was the embodiment of an open society an association of nations founded on the principles of democracy, human rights, and rule of law in which no nation or nationality would have a dominant position.
The EU was in fact the embodiment of globalism: bureaucratic rule, government regulation, and fiat money. „The process fed on its own success, very much like a financial bubble. That is how the Coal and Steel Community was gradually transformed into the European Union, step by step.“ It was transformed by bureaucratic power from above. Jean Monnet’s idea had been operational at the Paris Peace talks in 1919.
He says that Germany used to be at the forefront of this movement in the 1950s. The politicians wanted a united Europe. „The process culminated with the Maastricht Treaty and the introduction of the euro.“ Then came disaster.
It was followed by a period of stagnation which, after the crash of 2008, turned into a process of disintegration. The first step was taken by Germany when, after the bankruptcy of Lehman Brothers, Angela Merkel declared that the virtual guarantee extended to other financial institutions should come from each country acting separately, not by Europe acting jointly. It took financial markets more than a year to realize the implication of that declaration, showing that they are not perfect.
The Maastricht Treaty was fundamentally flawed, demonstrating the fallibility of the authorities. Its main weakness was well known to its architects: it established a monetary union without a political union. The architects believed however, that when the need arose the political will could be generated to take the necessary steps towards a political union.
He is saying that the architects imposed a flawed system on Europe, but in the hope of tightening fiscal control at a later date. That date is now.
In retrospect it is now clear that the main source of trouble is that the member states of the euro have surrendered to the European Central Bank their rights to create fiat money. They did not realize what that entails and neither did the European authorities.
The power to create national money is the heart of Soros‘ vision of what is positive. This is nationalism with a printing press. It means competing rates of monetary depreciation. A precious metals coin system alone has prevented this in history.
Then came the stupid bankers. They thought the PIIGS were Germany. They believed in the equality of debtors.
When the euro was introduced the regulators allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital; and the central bank accepted all government bonds at its discount window on equal terms. Commercial banks found it advantageous to accumulate the bonds of the weaker euro members in order to earn a few extra basis points. That is what caused interest rates to converge which in turn caused competitiveness to diverge.
The 2008 collapse exposed this faith as naive. But critics had said this throughout the 1990s. No one listened. The leaders believed in the EU bubble, to use Soros‘ words. Germany was at the forefront of this faith.
Germany, struggling with the burdens of reunification, undertook structural reforms and became more competitive. Other countries enjoyed housing and consumption booms on the back of cheap credit, making them less competitive. Then came the crash of 2008 which created conditions that were far removed from those prescribed by the Maastricht Treaty. Many governments had to shift bank liabilities on to their own balance sheets and engage in massive deficit spending. These countries found themselves in the position of a third world country that had become heavily indebted in a currency that it did not control. Due to the divergence in economic performance Europe became divided between creditor and debtor countries. This is having far reaching political implications to which I will revert.
It took some time for the financial markets to discover that government bonds which had been considered riskless are subject to speculative attack and may actually default; but when they did, risk premiums rose dramatically. This rendered commercial banks whose balance sheets were loaded with those bonds potentially insolvent. And that constituted the two main components of the problem confronting us today: a sovereign debt crisis and a banking crisis which are closely interlinked.
The creditor nations now want out: „… the creditors are in effect shifting the burden of adjustment on to the debtor countries and avoiding their own responsibility for the imbalances.“ Of course they do. And everyone wants a bailout from the central bank.
He blames the center, meaning the Eurocrats and politicians in the North.
The „center“ is responsible for designing a flawed system, enacting flawed treaties, pursuing flawed policies and always doing too little too late. In the 1980’s Latin America suffered a lost decade; a similar fate now awaits Europe. That is the responsibility that Germany and the other creditor countries need to acknowledge. But there is no sign of this happening.
The European authorities had little understanding of what was happening. They were prepared to deal with fiscal problems but only Greece qualified as a fiscal crisis; the rest of Europe suffered from a banking crisis and a divergence in competitiveness which gave rise to a balance of payments crisis. The authorities did not even understand the nature of the problem, let alone see a solution. So they tried to buy time.
He has this much right. The authorities do not understand the nature of the crisis. He blames politics, not central banking. „… the financial problems were reinforced by a process of political disintegration.“ Now, it’s every nation for itself! Soros hates this. He is a globalist.
While the European Union was being created, the leadership was in the forefront of further integration; but after the outbreak of the financial crisis the authorities became wedded to preserving the status quo. This has forced all those who consider the status quo unsustainable or intolerable into an anti-European posture. That is the political dynamic that makes the disintegration of the European Union just as self-reinforcing as its creation has been. That is the political bubble I was talking about.
At the beginning, the disintegration of the euro was inconceivable. Today, it is quite conceivable. The system is coming apart. There is no time to fix it if there is not immediate action. The banks are de-leveraging. They are selling assets outside their nations. „So the crisis is getting ever deeper.“
The real economy of the eurozone is declining while Germany is still booming. This means that the divergence is getting wider. The political and social dynamics are also working toward disintegration. Public opinion as expressed in recent election results is increasingly opposed to austerity and this trend is likely to grow until the policy is reversed. So something has to give.
Something has to give. But what? Or, more to the point, who? Answer: Germany.
In my judgment the authorities have a three months‘ window during which they could still correct their mistakes and reverse the current trends. By the authorities I mean mainly the German government and the Bundesbank because in a crisis the creditors are in the driver’s seat and nothing can be done without German support.
But will German politicians bite the bullet and bail out the PIIGS? If they wait until this fall, it will be too late. „By that time the German economy will also be weakening so that Chancellor Merkel will find it even more difficult than today to persuade the German public to accept any additional European responsibilities. That is what creates a three months‘ window.“
The treaties must be revised, now. But how? The crisis is here.
There must be bank insurance. „Banks need a European deposit insurance scheme in order to stem the capital flight.“ Paid for by whom?
„They also need direct financing by the European Stability Mechanism (ESM) which has to go hand-in-hand with eurozone-wide supervision and regulation.“ Paid for by whom?
„The heavily indebted countries need relief on their financing costs. There are various ways to provide it but they all need the active support of the Bundesbank and the German government.“ All roads lead to Berlin. It’s bailout time!
German voters say no. „That is where the blockage is.“ Got that? Blockage! People hanging onto their wallets! Why, the short-sighted fools! It’s time to bail out the PIIGS again. Time is running out. It will never stop running out. Germany must suck it up and fork it over. Again.
The authorities are working feverishly to come up with a set of proposals in time for the European summit at the end of this month. Based on the current newspaper reports the measures they will propose will cover all the bases I mentioned but they will offer only the minimum on which the various parties can agree while what is needed is a convincing commitment to reverse the trend. That means the measures will again offer some temporary relief but the trends will continue. But we are at an inflection point. After the expiration of the three months‘ window the markets will continue to demand more but the authorities will not be able to meet their demands.
What will happen next? „It is impossible to predict the eventual outcome.“ The system could break down. „But the trends are clearly non-linear and an earlier breakup is bound to be disorderly. It would almost certainly lead to a collapse of the Schengen Treaty, the common market, and the European Union itself.“
In other words, the entire experiment in European central government is on the line. They have three months to put the system back together. „Unenforceable claims and unsettled grievances would leave Europe worse off than it was at the outset when the project of a united Europe was conceived.“
Hope Springs Eternal
Is all lost? No. Deliverance is coming.
But the likelihood is that the euro will survive because a breakup would be devastating not only for the periphery but also for Germany. It would leave Germany with large unenforceable claims against the periphery countries.
Germany dares not return to its own currency. Why not? That would reduce exports. „And a return to the Deutschemark would likely price Germany out of its export markets not to mention the political consequences.“
Soros is a Keynesian mercantilist. They all are. „So Germany is likely to do what is necessary to preserve the euro but nothing more. That would result in a eurozone dominated by Germany… .“
There must not be budget cutting. There must not be austerity. There must be spending, spending, spending all at Germany’s expense.
The German public cannot understand why a policy of structural reforms and fiscal austerity that worked for Germany a decade ago will not work in Europe today. Germany then could enjoy an export led recovery but the eurozone today is caught in a deflationary debt trap. … In these circumstances it would require an extraordinary effort by the German government to convince the German public to embrace the extraordinary measures that would be necessary to reverse the current trend. And they have only a three-month window in which to do it.
We need to do whatever we can to convince Germany to show leadership and preserve the European Union as the fantastic object that it used to be. The future of Europe depends on it.
Soros is just another Keynesian. He is just another mercantilist. He is just another globalist. What makes him different is his willingness to say that time really is running out on Europe. The politicians must get something in place to replace the disintegrating euro, which will in turn break up the European Union. It all boils down to this: centralized control over each nation’s spending and taxing, and Germany’s endless trade surplus, i.e., the German banks‘ willingness to buy foreign governments‘ IOUs.
I hope we get to test his theory: three months to go, maximum. I hope he loses his bet.
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Copyright © 2012 Gary North