FINANCIAL markets abhor uncertainty; that is why they are
now in crisis mode. The governments of the eurozone have taken some significant
steps in the right direction to resolve the euro crisis but, obviously, they
did not go far enough to reassure the markets.
At their meeting on July 21, the European authorities
enacted a set of half measures. They established the principle that their new
fiscal agency, the European Financial Stability Fund (EFSF), should be
responsible for solvency problems, but failed to increase the EFSF's size.
This stopped short of establishing a credible fiscal
authority for the eurozone. And the new mechanism will not be operative until
September at the earliest. In the meantime, liquidity provision by the European
Central Bank (ECB) is the only way to prevent a collapse in the price of bonds
issued by several European countries.
Likewise, eurozone leaders extended the EFSF's competence to
deal with banks' solvency, but stopped short of transferring banking
supervision from national agencies to a European body.
And they offered an extended aid package to Greece without
building a convincing case that the rescue can succeed: they arranged for the
participation of bondholders in the Greek rescue package, but the arrangement
benefited the banks more than Greece.
Perhaps most worryingly, Europe finally recognised the
principle – long followed by the IMF (International Monetary Fund) – that
countries in bailout programmes should not be penalised on interest rates, but
the same principle was not extended to countries that are not yet in bailout
programmes.
As a result, Spain and Italy have had to pay much more on
their own borrowing than they receive from Greece. This gives them the right to
opt out of the Greek rescue, raising the prospect that the package may unravel.
Financial markets, recognising this possibility, raised the
risk premium on Spanish and Italian bonds to unsustainable levels. ECB intervention
helped, but did not cure the problem.
Heading for a climax
The situation is becoming intolerable. The authorities are
trying to buy time, but time is running out. The crisis is rapidly reaching a
climax.
Germany and the other eurozone members with AAA ratings will
have to decide whether they are willing to risk their own credit to permit
Spain and Italy to refinance their bonds at reasonable interest rates.
Alternatively, Spain and Italy will be driven inexorably into bailout
programmes.
In short, Germany and the other countries with AAA bond
ratings must agree to a eurobond regime of one kind or another. Otherwise, the
euro will break down.
It should be recognised that a disorderly default or exit
from the eurozone, even by a small country like Greece, would precipitate a
banking crisis comparable to the one that caused the Great Depression. It is no
longer a question whether it is worthwhile to have a common currency.
The euro exists, and its collapse would cause incalculable
losses to the banking system. So the choice that Germany faces is more apparent
than real – and it is a choice whose cost will rise the longer Germany delays
making it.
The euro crisis had its origin in German Chancellor Angela Merkel's
decision, taken in the aftermath of Lehman Brothers' default in September 2008,
that the guarantee against further defaults should come not from the European
Union, but from each country separately.
And it was German procrastination that aggravated the Greek
crisis and caused the contagion that turned it into an existential crisis for
Europe.
Only Germany can reverse the dynamic of disintegration in
Europe. That will not come easily: Merkel, after all, read the German public's
mood correctly when she made her fateful decision, and the domestic political
atmosphere has since become even more inhospitable to extending credit to the
rest of Europe.
Merkel can overcome political resistance only in a crisis
atmosphere, and only in small steps. The next step will likely be to enlarge
the EFSF - but by the time that step is taken, France's AAA rating may be
endangered. Indeed, by the time Germany agrees to a eurobond regime, its own
AAA standing may be at risk.
The only way Europe can escape from this trap is by acting
in anticipation of financial markets' reactions, rather than yielding to their
pressure after the fact. This would require intense debate and soul-searching,
particularly in Germany which, as the EU's largest and best-rated economy, has been
thrust into the position of deciding the future of Europe.
That is a role Germany has been eager to avoid and remains unwilling to accept. But Germany has no real choice. A breakdown of the euro would precipitate a banking crisis that would be beyond the global financial authorities' ability to control. The longer Germany takes to recognise this, the higher the price it will have to pay.
*George Soros is chairperson of Soros Fund Management and of the Open Society Institute. This piece comes from Project Syndicate. The opinions expressed are his own.