George Soros: Merkel Leading Europe in the Wrong Direction, German Bond Bubble

By: Bloomberg

BLOOMBERG EXCLUSIVE: Billionaire investor George Soros spoke to Bloomberg TV's Francine Lacqua, calling on Europe to start a fund to buy Italian and Spanish bonds.

Soros said, "There is a disagreement on the fiscal side...unless that is resolved in the next three days, then I am afraid the summit could turn out to be a fiasco. That could actually be fatal."

Soros also said that, "Merkel has emerged as a strong leader," but "unfortunately, she has been leading Europe in the wrong direction."

Soros on Europe's crisis:

"Basically there is an interrelated problem of the banking system and the excessive risk premium on sovereign debt - they are Siamese twins, tied together and you have to tackle both. It's recognized that you have to do that and there is no widespread agreement on what to do on the banking side. It's the beginning of a banking union and there is a disagreement on the fiscal side and unless that is resolved in the next 3 days then I am afraid that the summit could turn out to be a fiasco, and that could be fatal, because you are facing the possibility of Greece leaving the euro and perhaps the European Union and you need to strengthen the remaining euro structure to withstand that shock."

On Angela Merkel:

"Well actually Angela Merkel has emerged as a strong leader. Unfortunately she has been leading Europe in the wrong direction. I think she is acting in good faith and that is what makes the whole situation so tragic and that is a big problem that we have in financial markets generally - that you could have a false idea, a false ideology, a false interpretation which is reinforced by reality. In other words it works for a while until it stops working and that is what is called a financial bubble - which, you know, looks very good while it is being formed and everyone believes in it and then it turns out to be unsustainable...The European Union could turn out to have been a bubble of this kind unless we realize there is this problem and we solve it and the solution is there. I think everybody can see it, all we need to do is act on it, and put on a united front, and I think that if the rest of Europe is united, I think that Germany will actually recognize it and adjust to it."

On whether yields there's a risk of contagion continuing if a strong proposal doesn't come out of the EU summit:

"That is right, and there is then a serious threat of the euro breaking down and that is not to be neglected because it's quite serious. But even if you manage to avoid, let's say an 'accident' similar to what you had in 2008 with the bankruptcy of Lehman Brothers, the euro system that would emerge would actually perpetuate the divergence between creditors and debtors and would create a Europe which is very different from the Europe as an open society that fired people's imaginations and led to the creation of the European Union. It would transform it into a hierarchical system where the division between creditors and debtors would become permanent...It would lead to Germany being in permanent domination. It would become like a German empire, and the periphery would become permanently depressed areas."

On what Europe needs:

"What you need is a European fiscal authority that will be composed of the finance ministers but would be in charge of the various rescue mechanisms, the European Stability Mechanism, and the one that preceded it and it would be empowered to issue treasury bills, to set up a debt reduction fund and actually buy up the excess stock of that that has accumulated in the hands of particularly Italy and Spain and finally combine issuing treasury bills. Those treasury bills would yield 1% or less and that would be the relief that those countries need in order to finance their debt."

"Euro bonds are not possible because Germany would not consider euro bonds until you have a political union, and I think it's actually quite justified, it should come at the end of the process not at the beginning. This would be a temporary measure, limited both in time and in size, and thereby it could be authorized according to the German constitution as long as the Bundestag approves it, so it could be legal under the German constitution and under the existing treaties. What it means is the political will by Germany to put it into effect and that would create a level playing field so that Italy and Spain could actually refinance its debt on reasonable terms."

On whether he believes Germany would be content with a smaller euro zone:

"I think Greece leaving the euro zone or being pushed out is now a real expectation and this is what is necessary to strengthen the rest of the euro zone because the way the financial markets work they can actually push a country like Italy into default - see this is what the weakness of the euro as it is currently structured because a developed country has no reason to default because it can always print money. By printing money it can devalue the currency and people can lose money by buying debt but there is no danger of default, but the fact that the individual members don't now control the right to print money - they have given that right over to the central bank you see, and that has created this situation with a European country that could actually default and that is the risk that the financial markets price into the market and that is why say ten-year bonds yield 6% whereas British 10-year bonds yield only 1.25%. That difference is due to the fact that these countries have abandoned the, surrendered their right to print their own money and they can be pushed into default by speculation in the financial markets."

On the chances today of Greece leaving the euro:

"It's very hard to see how Greece can actually meet the conditions that have been set for Greece, and I think the Germans are determined not to modify those conditions seriously so I think one has to now calculate on Greece being forced out of the euro - that's what we have to prepare for."

On how the treasury bill would be priced:

"It would be sold on a competitive basis but right now there are something like over 700 billion euros are kept on deposit at the European Central Bank earning a quarter of one percent because the interbank market has broken down so then right then you have got 700 billion that would be very happy to earn let's say three-quarters of a percent instead of one-quarter, and the treasury bills by being truly riskless and guaranteed by the entire community would yield current conditions less than one percent."

On whether he believes Greece will exit the euro forever:

"No, actually it's quite possible that it could actually, depending on how it is arranged and whether it's orderly or disorderly, it's possible that Greece could re-enter but what I am really afraid of and really most disturbed about is that the euro would hold together but it would create a Europe that actually nobody wanted. It would put Germany at the center of an empire which would actually be very beneficial in many ways to Germany but politically I think it would be unacceptable and it's not something that the majority of Germans want."

On whether German bunds are in a bubble:

"Yes...Certainly they have benefited and they are far too low-yielding if you had no world conditions, in other words the high price or low yield of the German bonds is a fever chart measuring the distress in the financial markets."

On the chances of Spain, then Italy, needing a full-blown bailout:

"If you have this thing, then the Spanish banks would be recapitalized which would add to the debt of the Spanish debt, but if the Spanish, the excess debt is financed at 1% then it's no problem then this will help that also and if you resume growth then the decline in the housing market would not be as severe as it would be if you have a folding economy so Spain would be also in a position to come out of the recession."

On Mario Monti:

"Monti is a caretaker, he is a technocrat so he has no political base but I think that he would have to say that he cannot serve as a technocrat if there is no support from Germany and what would Europe do without Monti, so Monti can push Merkel but and this is in a strong position to do that because he has done his best in structural reforms and he could do more if actually this was something that didn't come out in the discussion, that, Germany is worried that if you provide this kind of support then countries like Italy would stop pursuing structural reforms and that is not the case because by having a great benefit from it and losing the benefit if you abandon the structural reforms is I think a stronger guarantee that they will not abandon it than anything else."

bloomberg.com

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