Lack of euro treasury key to crisis and to recovery

Lack of euro treasury key to crisis and to recovery

Thursday, January 02, 2014

THE architects of the euro knew that it was incomplete when they designed it.

By George Soros

European authorities were confident, however, that if and when the euro ran into a crisis, they would be able to overcome it. After all, that is how the EU was created, taking one step at a time, knowing full well that additional steps would be required.

With hindsight, one can identify other deficiencies of which the euros architects were unaware. The euro was supposed to bring about economic convergence, but it produced divergences instead, because its architects did not realise that imbalances may emerge not only in the public sector, but in the private sector as well.

After the euro came into force, commercial banks could refinance their holdings of government bonds at the discount window of the European Central Bank, and regulators treated government bonds as riskless. This caused interest-rate differentials between various countries to shrink, which generated real estate booms in the weaker economies and reduced their competitiveness.

At the same time, Germany, suffering from the after-effects of reunification, had to tighten its belt. Trade unions agreed to concessions on wages and working conditions in exchange for job security. That is how the divergences emerged. Yet the banks continued to load up on the government bonds of the weaker countries in order to benefit from the minuscule interest-rate differentials.

The consequences of the lack of a common treasury first became apparent after the bankruptcy of Lehman Brothers in 2008, when governments, in order to prevent financial markets from collapsing, had to guarantee that no other systemically important financial institution would be allowed to fail.

At that time, Angela Merkel rejected a Europe-wide guarantee, insisting that each country should guarantee its own institutions. Interestingly, interest-rate differentials widened only in 2010, when the newly-elected Greek government announced that the previous government had vastly understated the true fiscal deficit.

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Lack of euro treasury key to crisis and to recovery