Considering a Greek, Portuguese and Irish default
George Soros. (Getty Images)
September 15th, 2011
10:00 AM ET

Considering a Greek, Portuguese and Irish default

Editor's Note: George Soros is Chairman of Soros Fund Management. For more, visit Project Syndicate or follow it on Facebook and Twitter.

By George Soros, Project Syndicate

To resolve a crisis in which the impossible has become possible, it is necessary to think the unthinkable. So, to resolve Europe’s sovereign-debt crisis, it is now imperative to prepare for the possibility of default and defection from the eurozone by Greece, Portugal, and perhaps Ireland.

In such a scenario, measures will have to be taken to prevent a financial meltdown in the eurozone as a whole. First, bank deposits must be protected. If a euro deposited in a Greek bank would be lost through default and defection, a euro deposited in an Italian bank would immediately be worth less than one in a German or Dutch bank, resulting in a run on the deficit countries’ banks.

Moreover, some banks in the defaulting countries would have to be kept functioning in order to prevent economic collapse. At the same time, the European banking system would have to be recapitalized and put under European, as distinct from national, supervision. Finally, government bonds issued by the eurozone’s other deficit countries would have to be protected from contagion. (The last two requirements would apply even if no country defaulted.)

All of this would cost money, but, under the existing arrangements agreed by the eurozone’s national leaders, no more money is to be found. So there is no alternative but to create the missing component: a European treasury with the power to tax and, therefore, to borrow. This would require a new treaty, transforming the European Financial Stability Facility (EFSF) into a full-fledged treasury.

But this presupposes a radical change of heart, particularly in Germany. The German public still thinks that it has a choice about whether to support the euro. That is a grave mistake. The euro exists, and the global financial system’s assets and liabilities are so intermingled on the basis of the common currency that its collapse would cause a meltdown beyond the capacity of the German authorities - or any other - to contain. The longer it takes for the German public to realize this cold fact, the higher the price that they, and the rest of the world, will have to pay.

The question is whether the German public can be convinced of this argument. Chancellor Angela Merkel may not be able to persuade her entire coalition of its merits, but she could rely on the opposition to build a new majority in support of doing what is necessary to preserve the euro. Having resolved the euro crisis, she would have less to fear from the next election.

Preparing for the possible default or defection of three small countries from the euro does not mean that those countries would necessarily be abandoned. On the contrary, the possibility of an orderly default - financed by the other eurozone countries and the International Monetary Fund - would offer Greece and Portugal policy choices. Moreover, it would end the vicious cycle - now threatening all of the eurozone’s deficit countries - whereby austerity weakens their growth prospects, leading investors to demand prohibitively high interest rates and thus forcing their governments to cut spending further.

Leaving the eurozone would make it easier for the most distressed countries to regain competitiveness. But, if they are willing to make the necessary sacrifices, they could also remain: the EFSF would protect their domestic bank deposits, and the IMF would help to recapitalize their banking systems, which would help these countries escape from their current trap. Either way, it is not in the European Union’s interest to allow these countries to collapse and drag down the entire global banking system with them.

The EU’s member countries, and not only those in the eurozone, must accept that a new treaty is needed to save the euro. That logic is clear. So the discussions about what to include in such a new treaty ought to begin immediately, because, even with European leaders under extreme pressure to agree quickly, negotiations will necessarily be a prolonged affair. Once the principle is agreed, however, the European Council could authorize the ECB to step into the breach, indemnifying it from solvency risks in advance.

Having in sight a solution to the eurozone’s sovereign-debt crisis would be a source of relief for financial markets. Even so, because any new treaty’s terms will inevitably be dictated by Germany, a severe economic slowdown would be almost certain. That might induce a further change of attitude in Germany, in turn allowing the adoption of counter-cyclical policies. At that point, growth in much of the eurozone could resume.

The views expressed in this article are solely those of George Soros. Copyright: Project Syndicate, 2011.

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Topics: Debt Crisis • Economy • Europe

soundoff (16 Responses)
  1. hadeze

    unfortunately neither the US or the EU is known for speedy action .. eg... the recent US budget debacle ... will the EU be able to act before Greece defaults mid October (another tranche of some 10 billion EUR are required in Athens) ...

    September 15, 2011 at 10:54 am | Reply
  2. j. von hettlingen

    "The EU’s member countries, and not only those in the eurozone, must accept that a new treaty is needed to save the euro".
    Dear Mr. Soros, by the time this new treaty is drafted and ratified, the Euro crisis might be over!. Have you been speculating in Swiss Francs lately. You did with British Sterling some 19 years ago and earned nearly $ 1 billion.

    September 15, 2011 at 11:34 am | Reply
  3. Onesmallvoice

    The one good idea here that nobody seems to think about is having each European country go back to using their old currencies and forget the Euro. In fact like I said before, the idea of uniting Europe was never a good one in the first place. Remember Adolf Hitler and Napoleon Bonaparte? They had the same idea!!!

    September 15, 2011 at 2:25 pm | Reply
  4. rightospeak

    Mr. Soros is the last guy to listen to. He is very rich and he is not about to save anybody from anything , but he is to make money on misfortunes.
    Let the countries default and run out the crooks that suck their blood. The European kolkhoz experiment may be coming to an end much to Mr. Soros's disappointment.

    September 16, 2011 at 6:58 pm | Reply
  5. rightospeak

    What happened to my comments ? Not politically correct ?

    September 16, 2011 at 7:41 pm | Reply
  6. koli

    All bull, this so called crisis is nothing but anothe swine flue scare and it is to make us all not feel bad when the 3 big guys take the world... but careful, russia and china is watching so....

    September 18, 2011 at 6:18 am | Reply
  7. Metal27

    I believe all 17 member countries must approve any of the changes proposed by Mr. Soros, That will not happen; the changes are too major for them to contemplate. So, if he and other analysts are correct, Europe will drag us all into recession.

    September 18, 2011 at 1:21 pm | Reply
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  9. Paul Johnston, PhD Economics

    Greek Leaders are liars and criminals who have stolen everything from the Greek People and the People will soon REVOLT in MASS. Their Politicians lied their way into the EU and should never have been in it to begin with!

    September 19, 2011 at 1:03 am | Reply
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