Soros's sorrows

Germany needs to make up its mind: agree to Eurobonds or leave the Euro. Here's George Soros's argument and here's a broadly positive comment by Wolfgang Münchau (in German). I broadly agree that Eurobonds would go a long way to solve the current debt crisis of European periphery countries but I see two problems in the longer-term: one economic and one political.

First, let's assume the debt crisis is solved through Eurobonds. But after that we are still faced with very substantial imbalances in the Eurozone that are mainly due to German export surpluses. At the moment most politicians seem to think that this problem should be solved by lowering costs in the periphery. Hence austerity. Critics say that this should be addressed either by countries leaving the Euro and devaluating their currency or by inflating costs in Germany and other core countries. However, both arguments assume that German exports are price elastic, that is will fall if their prices increase. However, German exports are strong even to countries with very low costs of production such as China. It might well be that the strong international demand for a range of German products is not mainly due to their competitive price but to the fact that there is are no equivalent substitutes available. This share of exports that is driven by qualities of the produce and not its price may be substantial.

This would mean that tinkering with exchange rates and internal inflation or deflation would not do much to address trade imbalances. What would then be needed are development and industrialisation programmes for the European periphery. Such programmes might be very successful but they also require a level of political integration that seem utopian at the moment.

Second, once Eurobonds have solved the debt crisis what would make sure that periphery countries address their structural economic problems? This is one of main concerns of German politicians at the moment and while it seems overblown in the case of most periphery countries it should be a real concern in the case of Italy and Greece. Unlike Spain or Ireland, these countries were not dragged into this crisis because they had to bail out their banks. The debt crisis in Italy and Greece reflects their political instability. It is not a coincidence that both countries now have unelected governments of experts. Spain and Ireland may not have good governments but their political system continues to function even under great strain. These political problems of Greece and Italy will not go away if Eurobonds are adopted and they may be solved by greater European integration. But until the decadent political institutions of Greece and Italy are substituted by European structures there is still plenty of time for plenty of things to go wrong.