George Soros has written an interesting essay on the crisis and the euro in the current issue of the New York Review of Books.
His explanation of the structural problems of the eurozone is succinct:
“The euro was an incomplete currency to start with. In 1992, the Maastricht Treaty established a monetary union without a political union. The euro boasts a common central bank but it lacks a common treasury. It is exactly that sovereign backing that financial markets are now questioning and that is missing from the design. That is why the euro has become the focal point of the current crisis.”
He then goes on to explain how this incomplete structure created the conditions for crisis: (article continues below)
“The introduction of the euro in 1999 brought about a radical narrowing of interest rate differentials. This in turn generated real estate bubbles in countries like Spain, Greece, and Ireland. Instead of the convergence prescribed by the Maastricht Treaty, these countries grew faster and developed trade deficits within the eurozone, while Germany reigned in its labor costs, became more competitive, and developed a chronic trade surplus. To make matters worse, some of these countries, most notably Greece, ran budget deficits that exceeded the limits set by the Maastricht Treaty. But the discount facility of the European Central Bank allowed them to continue borrowing at practically the same rates as Germany, relieving them of any pressure to correct their excesses.”
For Soros the key to resolving the crisis is for Germany to stop insisting on pro-cyclical policies. In other words it needs to be prepared to continue with a fiscal stimulus as long as the European economy is weak.
Other measures he proposes are broadly Keynesian. They include compulsory recapitalisation of the banks, a loosening of monetary policy and investing in infrastructure.
“More fundamentally it ignores the deeper problems of the world economy”
However, it follows from the arguments in my recent Fund Strategy cover story on the eurozone that there are at least two problems with Soros’s arguments.
He underestimates the extent to which the eurozone’s problems can be resolved by structural reform. A monetary union of independent nation states faces inherent stresses and strains. These are especially difficult to manage at times of general economic volatility.
More fundamentally it ignores the deeper problems of the world economy. In particular the difficulty it is having in generating new rounds of growth.
The eurozone crisis is one manifestation of more general structural problems in the world economy.