Billionaire investor George Soros believes the euro zone bond market is facing a similar situation to the banking system in 2008 and wants the European Central Bank to step in to stop a self-fulfilling crisis of confidence.
“As regulators still treat government bonds as the safe core of the financial system, this vicious circle threatens the stability of financial institutions, not only in the euro zone but also in the rest of the world,” Soros, the chairman of Soros Fund Management, said in a co-written article with Peter Bofinger of Würzburg University in Tuesday’s Financial Times.
Without action, Soros believes recessionary pressures will intensify making the situation in the bond market worse.
“It’s a perfect vicious circle,” he wrote in the article.
With Germany and Chancellor Angela Merkel unwilling to accept a joint euro zone Eurobond and the European Financial Stability Fund not being seen by the market as a credible mechanism for shoring up confidence in the bond market, Soros believes the ECB is the only institution that can solve the crisis.
“The financial markets are testing the ECB and want to find out what it is allowed to do,” wrote Soros, in whose opinion it is imperative that the ECB not fail its next test. “The central bank must stop the bond run at all costs because it is endangering the stability of the single currency. The best way to do it in the near term is to impose a ceiling on the yield of sovereign bonds issued by governments that follow responsible fiscal policies and are not subject to adjustment programs.”
The ECB must be prepared to buy unlimited bonds until the market understands the central bank will defend key levels, Soros wrote.
“Normally central banks fix only short-term interest rates but these are not normal times. Government bonds that were considered risk-free when financial institutions acquired them, and are still treated as such by the regulators, have turned into the riskiest of assets,” he said.
“Italian and Spanish bonds are viewed as too risky to buy with a yield of seven percent because they are regarded as toxic, and the yield could just as easily rise to 10 percent. Yet the same bonds would be attractive long-term investments in the current deflationary environment, at say four percent, as long as the excessive risk is removed by imposing a five percent ceiling on interest rates,” Soros pointed out in the article.
The problem for those who back such a plan is that the Bundesbank and German government remain vociferously opposed to unlimited ECB buying.
“The interest rate ceiling should be regarded as an emergency measure. In the medium term it could encourage politicians to abandon fiscal discipline,” said Soros.