Germany & the Euro

To the Editors:

George Soros (who I am happy to say is an old friend) argues that, in summary, Germany must “lead or leave” the eurozone [“The Tragedy of the European Union and How to Resolve It,” NYR, September 27]. The underlying analysis of the problem is, as one would expect, thorough and persuasive, especially highlighting the often overlooked asymmetry of adjustment between debtors and creditors.

However, the alternative solutions on offer are, in my view, seriously flawed. Germany’s leaving is unrealistic. Not only is this legally problematical and politically suicidal, but the economic result would be the opposite of the goal of growth. The new German currency would rise precipitously, severely damaging German exports and growth. The rest of the eurozone would lose its locomotive. And the markets would surely doubt that this major event would be the last—confidence in the coherence of the eurozone would be irretrievably shattered.

We now come to the “lead” option, which I suspect is George’s real point as he knows as well as anyone that “leaving” is most improbable. Most outside of Germany would agree with Soros that greater German growth, and somewhat higher inflation, would help the adjustment process. The problem is that most in Germany remain deeply distrustful of anything hinting at higher domestic inflation, and are convinced that the euro solution is for others to adopt Germany’s disciplined example. So, the suggestion that outside pressure could alter these views seems to misunderstand the culture (especially since the grudging acceptance of the plan of Mario Draghi, the chairman of the European Central Bank, is viewed already as a step too far) and is likely to be as counterproductive as any finger wagging always is.

All, instead, should do everything to deepen Germany’s euro involvement by: encouraging and supporting the Draghi plan, and the structural political, budgetary, and banking reforms underway; recognizing the as yet underappreciated measures being taken by Spain, Italy, and Portugal; and welcoming some German stimulus, if it occurs for purely internal reasons, as a response to a German economic slowdown.

The eurozone will, I believe, survive as these steps are progressively realized, albeit with great volatility, including Germany (as it is for better or for worse) as a full member. If this is wrong, the breakup will not involve Germany on the one hand and the rest on the other, but rather a chaotic mixture of countries and/or groups, with drastic consequences for all, including Germany.

Yves-André Istel
Senior Adviser, Rothschild Inc.
New York City

George Soros replies:

My friend Yves-André Istel’s prescription to “do everything to deepen Germany’s euro involvement” suffers from a fatal flaw: Germany is imposing a pro-cyclical counterproductive policy on the debtor countries. This will be reflected in the conditionality that the European bailout funds, the EFSF and the ESM, which are subject to German veto, are likely to impose on a debtor country before the unlimited intervention of the European Central Bank (ECB) can be unleashed.

The ECB’s bond-buying program has arrested an incipient financial collapse. By threatening to punish bear raids, it will put a lid on the interest rates Italy and Spain will have to pay on their government bonds even before the program is activated; but it will not allow them to avoid a depression even after they have submitted themselves to EFSF/ESM supervision.

Additional steps are needed to reverse the downward spiral and they would require additional commitments from the creditor countries. If Germany is unwilling to make those commitments, it will be better for all concerned if Germany withdrew from the euro in an orderly way.

Like many of my pro-European friends, Yves-André Istel cannot imagine how the euro could prosper without Germany as the “locomotive.” Yet the macroeconomic indicators of a debtors’ eurozone would compare favorably not only with the UK but also with the US and Japan and it could issue eurobonds at comparable yields. The burden adjustment would fall on the creditor countries that left the euro. Why, then, should they agree to leave? For a very good reason: it will allow the common market and the European Union to survive and they would be better off than by allowing the euro to disintegrate in a disorderly manner.

The trouble is that a negotiated separation would require a treaty that would take two years to work out during which their costs would mount. The separation would have to precede a treaty and the sooner it is done the less the cost. It is to be greatly hoped that after comparing the costs and benefits of the alternatives, Germany would decide to accept the additional commitments that would be needed to allow the eurozone to grow its way out of its excessive indebtedness. Either alternative is better for all concerned than continuing to do the minimum to hold the euro together.