Germany will not accept Eurobonds. The exclusion of debt mutualisation schemes was its main condition for giving up the deutschmark and signing the Maastricht Treaty (article 125 TFEU). Moreover, the German Supreme Court has indicated that Germany will require a referendum before Eurobonds can be introduced.



The Bundestag does not have the right to make that decision, because it would change the constitutional basis of the Federal Republic of Germany. And even if a referendum on Eurobonds were held, it it would never find a majority, unless it is coupled with the foundation of a common European state, which is strongly objected to by France. Angela Merkel, who will in all likelihood be re-elected in September, has said that Eurobonds will not come in her lifetime. George Soros should know all that. By suggesting that Germany choose between Eurobonds or leaving the euro, he effectively advocates the euro's destruction.



Even if Germany exits the euro, the competitiveness problems of some of the Eurozone’s southern countries vis-à-vis the economically stronger countries in the north would still be substantial, and they still would have to undergo a process of real devaluation via austerity. George Soros dodges the competitiveness problem by concentrating on the financial side of the crisis. But calming markets by offering public guarantees for investors will not solve the competitiveness problem. On the contrary, it will strengthen the euro and thus exacerbate the competitiveness problems of the south.



In all likelihood, however, Germany’s exit would also trigger the exit of the countries of the former deutschmark bloc (the Netherlands, Austria, Finland and perhaps Belgium). When France proposed in 1993 that Germany leave the EMS, a forerunner of the euro, the Netherlands and Belgium immediately declared that they would also be leaving, and France withdrew its demand. Thus, should Germany be forced to exit, the result would be northern and southern euro blocs, the only question being which bloc France would choose to belong to.



That said, Soros’s suggestion that a sub-group of euro countries could issue joint Eurobonds if they wished to do so is good. Every country should be free to organise a two-speed eurozone if it so wishes. Whether that would improve the credit ratings of the jointly issued bonds is another matter.



His accusation that Germany is imposing austerity is unfair. Austerity is imposed by the markets, not by those countries providing the funds to mitigate the crisis. By now the overall sum of credit via intergovernmental rescue operations and the ECB has reached €1.185 trillion (€707 billion in GIPSIC Target liabilities minus GIPSIC claims from under-proportional banknote issuance, €349 billion in intergovernmental rescue funds, including those from the IMF, and €128 billion in GIPSIC government bond purchases by non-GIPSIC national central banks; see www.cesifo.org), not counting the unlimited guarantees the ECB has given to the states of southern Europe through its OMT programme at the expense, and to the risk, of the taxpayers of Europe’s still-sound economies.



Should the euro break up and the GIPSIC countries default, Germany alone would lose about €545 billion euros, nearly half of the aggregate sum mentioned, since the Bundesbank has carried out most of the net payments on behalf of the GIPSIC countries that are reflected in the Target balances. Germany has the biggest exposure by far among the countries rescuing the eurozone’s crisis-stricken countries, and thus helps to mitigate austerity more than any other country.



George Soros underestimates the risks that debt mutualisation would pose for the future of the eurozone. When Alexander Hamilton, the first US finance minister, mutualised state debts in 1791, he thought this would cement the new American nation. But the mutualisation of debt gave rise to huge moral hazard effects, inducing the states to borrow excessively. A credit bubble emerged that burst in 1838 and drove most of the US states into bankruptcy. Nothing but animosity and strife resulted.



The euro crisis arose because investors have mispriced the risks of investing in southern Europe. This was the reason for the inflationary credit bubble that deprived a number of countries of their competitiveness. Eurobonds are a way of perpetuating this mispricing, keeping the markets from correcting their mistakes. Eurobonds would imply lingering soft budget constraints and huge political moral hazard effects that would destroy the European model.



Soros says countries that fail to implement the necessary reforms after the introduction of Eurobonds would become permanent pockets of poverty and dependency, much like Italy’s Mezzogiorno region today. Indeed, this is what will happen. There will be quite a number of countries of this sort, given the cheap financing available. They will become like the Mezzogiorno, or like East Germany for that matter, and will permanently suffer from the so-called “Dutch Disease,” with chronic unemployment and underperformance but an acceptable living standard.



Soros says that Germany will suffer from exiting the eurozone, because of the revaluation of the deutschmark. This is not true. First, Germany is currently undervalued and would benefit from a limited appreciation via the terms-of-trade effect. The advantage of imports becoming cheaper more than outweighs the losses in export revenue.



Second, the Bundesbank can always prevent an excessive revaluation by selling deutschmarks and buying foreign assets, following the successful Swiss example of last year. Germany would be far better off than now because real foreign assets would replace the Target claims it holds under the present system. Such assets would be safer and generate a higher return. That said, I reemphasise that in my judgment Germany should not exit the euro, because of the political value of the euro as a European integration project and because of its potentially beneficial implications for trade should the current crisis be resolved.



Soros claims that the exit of southern countries would exacerbate their external debt problems, leading them to default on their debt. This is also not true. While exiting and devaluing the new currency would increase their debt-to-GDP ratio, remaining in the euro and cutting prices to enact a real devaluation would do exactly the same. Except for producing inflation in the eurozone, a depreciation, whether external or internal via price cuts, is the only possibility for an uncompetitive country to regain competitiveness and generate a structural current account surplus, which is the only possibility for orderly debt redemption.



Seen this way, a temporary increase in the debt-to-GDP ratio is unavoidable if a country wants to repay its debt and attain a sustainable foreign debt position. In my opinion we should tolerate more inflation in the northern euro countries to help make the eurozone south competitive. But if we try to escort the northern savings via Eurobonds to the south, exactly the opposite will happen. We would destroy the German building boom, which is beginning to lead to higher wage demands and that has the potential for inflating the country.



On another point Soros raises, I do not see why Italy should exit the eurozone, and why it would be “infinitely better off” if Germany exited. Italy has a very low level of foreign debt and a highly competitive economy in the country’s north. According to the study by Goldman Sachs that I cited, it only needs to depreciate against the eurozone average by 10% or less. Italy’s problems are manageable.



If it was true that Germany would suffer after its own exit, Italy would suffer too, because Italy and Germany are extremely closely interlinked via supply chains. The two countries are complements rather than competitors.



George Soros points to Japan’s unsuccessful attempts to solve its problems by monetary austerity of the German kind, and warns against repeating that experiment. Japan clearly did not choose austerity after its banks collapsed in 1997. The BoJ has kept the rate of interest at close to zero since then, while the government debt-to-GDP ratio has increased from 99% (1996) to 237% (2012) because of permanent Keynesian deficit spending. Apart from that, the ineffectiveness of austerity in a country with a flexible exchange rate does not apply to the situation of a country in a currency union. While the flexible exchange rate would sterilise all attempts at increasing competitiveness via deflation, price cuts in a currency union do work wonders, as the Irish example has shown. Ireland has cut its prices relative to the rest of the eurozone by 15% since 2006, and it succeeded in saving its economy.



One final word. George Soros said I “distorted and obfuscated” his argument. If that was the case, I apologise, for the public discourse would make no sense if the antagonist’s view were purposefully distorted. But I still do not see where, and in what sense, that could have been the case.

