Tuesday, June 26, 2012

Soros' case for an EZ debt agency lopsided

Soros' support for an EU debt agency is presented as follows (Guardian, ProSyn):
His proposed debt reduction fund would issue bonds guaranteed by all member states "and pass on the benefit of cheap financing to the countries concerned".
The "countries concerned" would submit to a structural reform plan as payback for these guarantees. Recipient countries who break rules would be punished in proportion to the violation. It is effective, argues Soros, because, unlike a nuclear option, it can be exercised. Perhaps, but something important is missing...

Also: Argentina's dramatic rebound after its  2002 default, and a misrepresentation of the consequences of Greece's exit in a VoxEU article.

Moral hazard

The nuclear option, or, if you prefer, Joker card, that should have been central to Soros' analysis, of course, is that a recipient country can leave the Euro club and repudiate its debt. Whatever gradual punishment Soros had in mind, it then becomes irrelevant.

The debt agency that borrowed on behalf of a departing country, and therefore the countries that remain in the Euro, would still be obligated to service that debt. The contrary would contradict the "bonds guarantee" clause.

It is quite possible there may come a time when a country such as Greece, Ireland etc. sees the gain from exercising this nuclear option as exceeding its cost. In fact, Nouriel Roubini says it's overdue (ProSyn).

The loss for countries that stay in the Eurozone should Greece exit and default in full is estimated at €342 (4% of the EZ GDP). [1]

There are lesser drawbacks in Soros' analysis. Ultimately, the decision to punish is political. France and Germany were the first offenders of the SGP (around 2003) and were never punished. Spanish and Ireland were paragons of fiscal virtue, the former getting praise from JC Trichet for its "structural reforms" (ECB-Watch). It was all a mirage.

[1] L’exposition cumulée de la zone euro à la dette grecque, hors Eurosystème, atteindrait au maximum 199 milliards d’euros (2,3 % du PIB de la zone euro, tableau de synthèse), dont 52 milliards d’euros pour l’Allemagne (2 % du PIB) et 65 milliards d’euros pour la France (3,3 % du PIB). Si l’on inclut l’exposition à l’Eurosystème, l’exposition cumulée de la zone euro à la dette grecque atteindrait 342 milliards d’euros (4 % du PIB de la zone euro), dont 92 milliards d’euros pour l’Allemagne (3,6 % du PIB) et 95 milliards d’euros (4,8 %) pour la France.—OFCE, note nº20, 2012.


Argentina's situation in the 1990s has parallels with that of Greece today. Contracting public debt in US dollars (and having to peg the peso to the dollar) was equivalent to a monetary union with the US. Paul Krugman describes Greece's boom/bust in terms of capital bonanza/flight, but that is quite valid for Argentina in that period. Keeping in mind the default occurred in 2002, appreciate its consequence (Google/publicdata):

Untapped solution

Consider this: Germany is the only (big) country in the EZ that can afford to increase its (primary) deficit. Right now, its fiscal deficit is only 1% of GDP. A Keynesian spending spree would increase demand for imports by way of income elasticity and the upward pressure on hitherto depressed wages. The increased demand would leak (amongst others) in neighboring countries, thus improving their CA/budget balance, which is what peripheral countries need most

Naturally, there are feedback effects to take into account but, overall, it is the obvious way for Germany to help its neighbors. Assuming the situation of, say, Greece, begins to improve,  Germany's nightmare of seeing default also begins to go away.

Moreover, Germany would be getting goods and services (tourism comes to mind, in the case of Greece) for its money. That seems more rewarding than the promise of "structural reform", whose worth is debatable.

It's not a silver bullet, but it has the advantage of being actionable right away. Yet it remains untapped. What is the benefit of the proposed institutional overhaul (Guardian) if Germany hasn't been able to accept, let alone act on, this simple logic?


  1. Wall Street Journal's half truth on AG analogy about exiting GR or ES or PT exiting the Euro.

    May 19, 2013 - WSJ - By Tom Catan and Marcus Walker - Thinking the Unthinkable: Quitting a Currency


    [A]bandoning parity with the dollar was seen as too excruciating to undertake, because almost all debts and business contracts were in the U.S. currency. After three years of recession, though, Argentines appeared to decide en masse that whatever came next couldn't be worse than the unending depression needed to keep their pesos interchangeable with dollars. On a balmy night in December 2001 [...] Argentina defaulted on its debt soon after, and then the country abandoned the peso's peg to the dollar. [...] Argentina, with its ups and downs since devaluation, isn't a model for Europe. Rather, it's a cautionary tale.

    My comment:

    Look at the graph in this post that shows AG's DGP rebound in 2001, and ask yourself if 'smoke and mirrors' is an adequately qualifies the bold-highlighted sentence by these two authors.

  2. PS: So 'unthinkable', the term 'Grexit' was never coined... Denial echoed by DE-FinMin using incantations warning of a revolution.

    Reuters, UK - May 28, 2013 - Germany sees "revolution" if welfare model scrapped


    German Finance Minister Wolfgang Schaeuble warned that failure to win the battle against youth unemployment could tear Europe apart, while abandoning the continent's welfare model in favour of tougher U.S. standards would cause revolution.

  3. PS2: I know how to call it, the 'Argentina blindspot'.