So far the European authorities have been taking an incremental approach to the crisis. With no clear solution in sight they have been doing whatever is necessary under the pressure of crisis. But now I think they are coming to the end of the road.
To keep their banking system together they need to deal with two separate problems – liquidity and solvency. The central bank is designed for liquidity while the institution that can deal with problems of solvency is a treasury.
The situation is now very clear: you need to create the missing ingredient, namely a European treasury. Because of the lack of a treasury to date, the European Central Bank has been pushed into a position where it is pushing the line of solvency risk.
The member states have to agree on the creation of a common treasury in principle and then provide some form of guarantee that they will indemnify the ECB from the solvency risks that it may be taking.
This was vigorously opposed by the ECB’s German board members. In the short run the ECB will have to do most of the hard work. It is very much in the tradition of a central bank whose primary task is to preserve the financial system and that has to take precedence over those concerns. That justifies it stepping over the mark if that is absolutely necessary.
Although the recent ruling of the German constitutional court makes it clear that they have ruled the EFSF constitutional, they won’t allow any further steps. That is why we come to this point where we have to change.
The member states of the eurozone have to get together and recognize that they need another treaty creating the missing ingredient of the euro. That will take several years to actually implement and the devil will, of course, be in the detail.
Under the pressure of a crisis the impossible becomes possible. So I think it is really in Germany that the leadership has to take this step because they are the main creditor nation with the high rating.
The most important thing now is to strengthen the remaining members to prevent the contagion that would affect Italy and Spain and maybe other countries from causing similar problems. This will be best done in the form of some kind of Eurobond.
Right now that is an unspeakable term. However the ECB could provide short-term credit, reduce its own interest rate and make the credit available at technically low cost to Italy and Spain until the European treasury is created, the treaty is passed and Eurobonds are established.
This will be the outcome because the alternative would be disastrous. It’s really a question for people, particularly in Germany, to realize that they really don’t have a choice: the euro exists, you have a banking system that is very solid, you have got assets and liabilities based on a common currency.
If you disrupt it, the whole banking system gets disrupted and you have a banking crisis in which the global economy would be pushed into a serious depression.
The international community has to play a very important role. This is an issue that affects them all. Already the implications of this are felt in the emerging markets because European banks are the main suppliers of credit to the emerging markets, both in south-east Asia and in Latin America.
And hopefully different opinions will prevail and people will realize that while we need to deal with the deficits over the longer term, when you are in a period of insufficient demand it is appropriate to provide fiscal stimulus as well as monetary stimulus. This is the lesson that should have been learnt from the Great Depression. Some have learnt it, others have not.
Christine Lagarde, the managing director of the IMF, gave a very perceptive and courageous speech at Jackson Hole, urging the Europeans to recapitalize their banking system. She was rebuffed.
There is now a need for true Europeans to come forward. I think for this European problem you need a European solution. So you need a new movement of true Europeans who recognize that the present arrangements are not sustainable.
The IMF did raise $1 trillion but obviously the size of the problem is bigger than the capital of the IMF and that is why you need international cooperation. Right now it is more important for the eurozone to raise the capital for its Treasury.
You do need to have a new treaty but it has to be a European solution because whether you like it or not, the euro exists, the banking system has its assets and liabilities in a common currency. If that’s disrupted the banking system breaks down and you cannot unscramble the omelette.
George Soros, chairman of Soros Fund Management LLC, was interviewed by Taimur Ahmad.