Germany’s Resistance May Prove ‘Fatal’ to Europe: George Soros

Germany’s resistance to a banking union and stimulus measures is in the way of a solution to Europe’s debt crisis, and could turn this week’s meeting of the region’s leaders into a “fiasco”, according to billionaire investor George Soros.

George Soros
Source: World Economic Forum
George Soros

German Chancellor Angela Merkel has so far rebuffed all proposals to help relieve Spain and Italy from the jump in their borrowing costs and has resisted allowing the European Central Bank (ECB) to step up buying of peripheral sovereign debt. That poses a threat to the region’s stability, Soros said in an editorial in the Financial Times on Monday.

“This threatens to turn the June (28) summit into a fiasco which may well prove fatal because it will leave the rest of the euro zone without a strong enough firewall to protect it against the possibility of a Greek exit,” Soros wrote.

“Even if a fatal accident can be avoided, the division between creditor and debtor countries will be reinforced and the “periphery” countries will have no chance to regain competitiveness because the playing field is tilted against them.”

France and Italy are urging Germany, the region’s largest economy, to take decisive action to end the two-and-a-half-year old debt crisis as Spain’s 10-year bond yields jumped to more than 7 percent last week. Merkel has opposed “premature” proposals for issuing euro-area bonds backed by the ECB, arguing that such debt can’t be sold until there is a full fiscal union for the region.

This is however “unrealistic and unreasonable”, Soros said, adding that a political, fiscal and banking union have to be “developed together step-by-step”.

The first step towards this would be for the EFSF (European Financial Stability Fund) to immediately take over the ECB’s holdings of Greek bonds, and the ECB to start buying Spanish and Italian bonds. This will calm financial markets and pave the way for a political and banking union, Soros said.

Concerns over Europe, particularly Spain’s and Italy’s ability to finance their debt, caused the two nations’ bond yields to spike earlier in the week. They have since retreated, aided by speculation that European leaders will take action at the Brussels meeting on Thursday.

Spain’s 10-year-bond yields retreated to 6.38 percent on June 22 and comparable Italian yields slid to 5.8 percent after climbing to as much as 6.17 percent on June 18.

A longer-term solution has to be found for the crisis in Europe, Soros said, and he proposed a so-called European Fiscal Authority (EFA) to be set up to buy Spanish and Italian bonds in exchange for structural reforms.

Under Soros’ proposal, this fund will buy the bonds with European Treasury Bills issued and backed by the ECB and every euro zone member-nation. These Bills would therefore receive a zero-risk weighting from regulators and have very low yields.

There should be plenty of demand for the Treasury Bills, especially from banks which urgently need risk-free liquid assets, Soros added.

“Banks are currently holding more than 700 billion euros ($878 billion) of surplus liquidity at the ECB, earning only one quarter of one per cent interest,” Soros said. “This assures a large and ready market for the Bills at one percent or less.”

The EFA would also have the authority to impose a fine or other form of penalty should a participating country fail to live up to its commitments, Soros said, adding that the countries would then have to agree on debt reduction programs, which would not jeopardize economic growth.

This should pave the way towards banking, fiscal and political union and the German parliament should not be in the way of such a solution, Soros said.

“If the rest of Europe is united behind this proposal and the Bundestag (German parliament) rejects it, Germany must take full responsibility for the financial and political consequences,” he warned.

- By CNBC's Jean Chua