This post will seem more disrespectful to George Soros than it actually is. As the following quotation shows, Soros correctly diagnoses the problem and comes very close to nailing the solution:
To be a little more specific, let me suggest the outlines of a European solution to the euro crisis. It involves a delicate two-phase maneuver, similar to the one that got us out of the crash of 2008. When a car is skidding, you first have to turn the steering wheel in the direction of the skid, and only after you have regained control can you correct your direction. In this case, you must first impose strict fiscal discipline on the deficit countries and encourage structural reforms; but then you must find some stimulus to get you out of the deflationary vicious circle—because structural reforms alone will not do it. The stimulus will have to come from the European Union and it will have to be guaranteed jointly and severally. It is likely to involve eurobonds in one guise or another. It is important, however, to spell out the solution in advance. Without a clear game plan Europe will remain mired in a larger vicious circle in which economic decline and political disintegration mutually reinforce each other.
Here’s what Soros is right about:
1. He’s right that countries like Greece must tighten fiscal policy as they are running out of investors willing to lend them money and not be repaid.
2. He’s right that the eurozone desperately needs stimulus.
What’s the obvious solution? They need tighter fiscal policy in the periphery and strong monetary stimulus from the ECB to sharply raise NGDP growth in Europe. But there is no mention of monetary policy at all. And yet his diagnosis virtually cries out for a market monetarist solution.
Instead Soros seems to imply the deus ex machina of eurobonds saving the day. But countries like Germany will rightly see that as a move toward fiscal union, a way to get them to pay for the economic policy mistakes of the poorer regions. Read the following facts and tell me how likely this is to work:
1. One of the major parties in Italy’s governing coalition is the Northern League. Their support is largely based on resentment against the way the north of Italy has to pay taxes to subsidize the south. Some want to secede. Even though southerners are fellow Italians. In contrast, the US has no major political movement to split the country along regional lines. The US fiscal union is not a model for Europe.
2. Southern Italy isn’t the only fiscal burden, the same is true of Greece, Andalucia, and Portugal. Even worse, their problems are not due to something like the legacy of slavery, or the mistreatment of native Americans, which makes at least some Americans have a sense of obligation to lower income ethic groups.
3. If there really were a fiscal union, the regions I mentioned would not be first in line, as many parts of Eastern Europe are much poorer. They’re not all in the euro yet, but they are moving in that direction. So add big subsidies to Eastern Europe on top of those to the southern periphery.
4. West Germany recently spent an enormous amount of money bailing out a very small country called East Germany. Even though East Germans are the same culture, and even though ethic ties count for a lot in Germany (as compared to say France), the West Germans were resentful of the amount of money they had to spend.
5. West Germany is not a rich country. Its income per capita (PPP) isn’t much different from poor American states like Alabama or Arkansas.
Given those facts, how many people believe fiscal union is a feasible long term policy response to the failures of the eurozone? Why would Germany and Finland and the Netherlands and Austria agree to this sort of new regime? Will Germans get to vote on boondoggle public spending projects in Sicily?
I’m under no illusion that NGDP targeting is on the immediate agenda for the ECB. But if we keep pushing these ideas it’s possible to at least imagine a change of heart, where the Germans (correctly) realize that NGDP targeting, eurozone breakup, and fiscal union are the three alternatives, and NGDP targeting is the lesser of evils. Fiscal union? I just can’t see how it can work. I don’t know why Soros doesn’t see that as well.
PS. I’m not saying the north won’t end up providing a partial bailout this time. I’m saying they’ll be very reluctant to make that the new fiscal regime for Europe. Does Europe want to move to a permanent state of fiscal crisis?