George Soros Warns of European Deflationary Debt Spiral.

January 26, 2012 – George Soros Warns of European Deflationary Debt Spiral: “The austerity that Germany wants to impose will push Europe into a deflationary debt spiral,” Mr. Soros warned, adding that the political disintegration of the European Union will inevitably follow if the economy does spiral out of control.

Structural reforms alone will not do it,” Mr. Soros said. “There will have to be fiscal stimulus and that fiscal stimulus will have to come from the EU, jointly and severally guaranteed by the member states. Euro bonds are needed in one form or another.”

Mr. Soros called on the authorities to adopt a plan pioneered by the late Italian central banker Tommaso Padoa-Schioppa, under which the European Financial Stability Facility would buy short-term treasury bills at low interest rates from countries with troublesome debt burdens.

He noted that while the European Central Bank’s latest long-term refinancing operations had reduced funding costs for the likes of Spain and Italy in the short term, those bond markets remain “dangerously exposed.” The Padoa-Schioppa plan would offer immediate and urgently needed budgetary relief, and protect the two countries against interest-rate risk.

Such a plan, he added, “would strengthen the…government” in Italy, by making it clear to the Italian people that there were benefits from adopting the kind of reforms unveiled by technocrat Prime Minister Mario Monti last week.

Mr. Soros stressed the need for the ECB to react aggressively to deflationary risks as well as inflationary ones, warning that German political opinion in particular was one-eyed, focusing only on the risks from inflation. He nonetheless argued that Germany had throughout the crisis acted in good faith, saying that Germans “genuinely believe” in the policies they are recommending.

But he was gloomy on the outlook for the “patently insolvent” Greece, whose failure to agree a deal on debt restructuring with its private creditors was making a default look more likely.

“The odds are going in that direction,” Mr. Soros said, adding that the situation was made more difficult by lobbying from elements of Greek business, which would prefer to settle their tax arrears in a reintroduced and devalued drachma rather than in euros.

He also noted that the presence of both the major political parties in the Greek government was an additional problem, inasmuch as “they are preparing for elections, so there is a very unfavorable political dynamic operating.”

He said this was one of the major differences between the Greek and Italian situations.

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