- Otmar Issing, one of the fathers of the euro, correctly
states the principle on which the single currency was founded. As he wrote
in the FT last week, the euro was meant to be a monetary union but not
a political one. Participating states established a common central bank
but refused to surrender the right to tax their citizens to a common authority.
This principle was enshrined in the Maastricht treaty and has since been
rigorously interpreted by the German constitutional court. The euro was
a unique and unusual construction whose viability is now being tested.
- The construction is patently flawed. A fully fledged
currency requires both a central bank and a Treasury. The Treasury need
not be used to tax citizens on an everyday basis but it needs to be available
in times of crisis. When the financial system is in danger of collapsing,
the central bank can provide liquidity, but only a Treasury can deal with
problems of solvency. This is a well-known fact that should have been clear
to everyone involved in the creation of the euro. Mr Issing admits that
he was among those who believed that "starting monetary union without
having established a political union was putting the cart before the horse".
- The European Union was brought into existence by putting
the cart before the horse: setting limited but politically attainable targets
and timetables, knowing full well that they would not be sufficient and
require further steps in due course. But for various reasons the process
gradually ground to a halt. The EU is now largely frozen in its present
- The same applies to the euro. The crash of 2008 revealed
the flaw in its construction when members had to rescue their banking systems
independently. The Greek debt crisis brought matters to a climax. If member
countries cannot take the next steps forward, the euro may fall apart.
- The original construction of the euro postulated that
members would abide by the limits set by Maastricht. But previous Greek
governments egregiously violated those limits. The government of George
Papandreou, elected last October with a mandate to clean house, revealed
that the budget deficit reached 12.7 per cent in 2009, shocking both the
European authorities and the markets.
- The European authorities accepted a plan that would reduce
the deficit gradually with a first instalment of 4 per cent, but markets
were not reassured. The risk premium on Greek government bonds continues
to hover around 3 per cent, depriving Greece of much of the benefit of
euro membership. If this continues, there is a real danger that Greece
may not be able to extricate itself from its predicament whatever it does.
Further budget cuts would further depress economic activity, reducing tax
revenues and worsening the debt-to-GNP ratio. Given that danger, the risk
premium will not revert to its previous level in the absence of outside
- The situation is aggravated by the market in credit default
swaps, which is biased in favour of those who speculate on failure. Being
long CDS, the risk automatically declines if they are wrong. This is the
opposite of selling short stocks, where being wrong the risk automatically
increases. Speculation in CDS may drive the risk premium higher.
- Recognising the need, the last Ecofin meeting of EU finance
ministers for the first time committed itself "to safeguard financial
stability in the euro area as a whole". But they have not yet found
a mechanism for doing it because the present institutional arrangements
do not provide one although Article 123 of the Lisbon treaty establishes
a legal basis for it. The most effective solution would be to issue jointly
and severally guaranteed eurobonds to refinance, say, 75 per cent of the
maturing debt as long as Greece meets its targets, leaving Athens to finance
the rest of its needs as best it can. This would significantly reduce the
cost of financing and it would be the equivalent of the International Monetary
Fund disbursing conditional loans in tranches.
- But this is politically impossible at present because
Germany is adamantly opposed to serving as the deep pocket for its profligate
partners. Therefore makeshift arrangements will have to be found.
- The Papandreou government is determined to correct the
abuses of the past and it enjoys remarkable public support. There have
been mass protests and resistance from the old guard of the governing party,
but the public seems ready to accept austerity as long as it sees progress
in correcting budgetary abuses and there are plenty of abuses to
- So makeshift assistance should be enough for Greece,
but that leaves Spain, Italy, Portugal and Ireland. Together they constitute
too large a portion of euroland to be helped in this way. The survival
of Greece would still leave the future of the euro in question. Even if
it handles the current crisis, what about the next one? It is clear what
is needed: more intrusive monitoring and institutional arrangements for
conditional assistance. A well-organised eurobond market would be desirable.
The question is whether the political will for these steps can be generated.
- The writer is chairman of Soros Fund Management and author
of the Soros Lectures, published by PublicAffairs this month