Regular readers know that while I disagree with George Soros on a number of points, I find him to be one of the keenest observers of world events. And of all the subjects on which George is brilliant, Europe is perhaps his best. Born and raised in Hungary, educated in the UK, and active across the Continent as an investor, speculator and philanthropist since the fall of the Soviet Union, George has a depth and range of knowledge and experience about Europe that is largely unmatched. (Note: though I have known George for many years and although he has given money to Bard College where I teach, I have never asked and he has never offered funding for my work.)
In a speech recently given in Trento, Italy, George lays out his vision of the crisis of the European Union and the prospects for its recovery. It is in part a requiem for a dream; George was among those who saw the promise of the EU and hoped that it would serve as the blueprint for a more enlightened and successful form of governance than anything here in the US.
The first third is a rehash of some basic concepts that George uses to distinguish between the social sciences and the natural sciences. He argues (and I agree) that economics, for all its admirable intellectual achievements, can only be of limited predictive value because human beings and their interactions keep changing the reality economists seek to describe. If, for example, someone comes up with an economic model of the stock market that leads to successful investments, more and more people will start to follow the model. At that point, the stock market itself will change because investors have changed their behavior, and when that happens, the theory will not only no longer work — it may lead to terrible investment disasters.
Once he’s worked through this concept, George turns his attention to what went wrong in Europe — and to what could be done about it. In a nutshell, he says that the Europe of the last twenty years was a kind of bubble: it was a “fantastic object” — something that was so alluring and attractive that people behaved as if it existed even though in fact it did not.
Now that the financial crisis (which George diagnoses as both a sovereign debt crisis like the third world debt crisis of 1982 and a banking crisis) is upon us, the “fantastic object” stands revealed as a delusion and investors and banks all over Europe are ‘re-nationalizing’ their investments and trying to match their liabilities and their assets within their own national markets rather than across the eurozone as a whole. In a perfect world, he says, these portfolio shifts could lead to an orderly breakup of the euro in two to three years time, but this is not a perfect world.
As George puts it:
Correcting the mistakes and reversing the trend would require some extraordinary policy measures to bring conditions back closer to normal, and bring relief to the financial markets and the banking system. These measures must, however, conform to the existing treaties. The treaties could then be revised in a calmer atmosphere so that the current imbalances will not recur. It is difficult but not impossible to design some extraordinary measures that would meet these tough requirements. They would have to tackle simultaneously the banking problem and the problem of excessive government debt, because these problems are interlinked. Addressing one without the other, as in the past, will not work.
Banks need a European deposit insurance scheme in order to stem the capital flight. They also need direct financing by the European Stability Mechanism (ESM) which has to go hand-in-hand with eurozone-wide supervision and regulation. 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.
That is where the blockage is. 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.
It is impossible to predict the eventual outcome. As mentioned before, the gradual reordering of the financial system along national lines could make an orderly breakup of the euro possible in a few years’ time and, if it were not for the social and political dynamics, one could imagine a common market without a common currency. 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. (It should be remembered that there is an exit mechanism for the European Union but not for the euro.) 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.
And what does the world’s most successful financial investor thinks will actually happen?
But the likelihood is that the euro will survive because a breakup would be devastating not only for the periphery but also for Germany… 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 in which the divergence between the creditor and debtor countries would continue to widen and the periphery would turn into permanently depressed areas in need of constant transfer of payments. That would turn the European Union into something very different from what it was when it was a “fantastic object” that fired peoples imagination. It would be a German empire with the periphery as the hinterland.
Read the whole thing to see what one of the EU’s truest friends thinks about the future of the “fantastic object” on which so many hopes have been placed. (H/t @41jellis)