Steps taken by the European Central Bank to flood its financial system with liquidity may help ease the credit crunch but it won't solve the problem at hand, which is lowering overall debt burdens saddling countries like Italy and Greece, says financier George Soros.
The European Central Bank (ECB) cannot directly intervene in the markets and snap up government held by banks, a move known as quantitative easing.
The bank's mandate prohibits such a move, ECB officials have said.
However, since such easing provides credit-starved financial systems with welcome liquidity, the ECB has given to banks facilities known as Long Term Refinancing Operations, which are low-cost loans made to banks with the hopes the money will make its way across the financial system and ease the crunch.
That's all well and good but instead, Soros writes in a Financial Times blog, Italy and Spain should be allowed to refinance their debt by issuing treasury bills at about 1 percent interest and insured in such a way that commercial banks would be eager to hold them.
"This would greatly improve the sustainability of their debt. Italy, for instance, would see its average cost of borrowing decline rather than increase," Soros writes.
"Confidence would gradually return, yields on outstanding bonds would decline, banks would no longer be penalized for owning Italian government bonds and Italy would regain market access at more reasonable interest rates."
So far, policymakers in bigger European countries like Germany and France advocate making funds available to troubled countries but with austerity measures attached, thus shying away from taking on exposure to those countries via financing backed by the entire European Union.
Whatever course policymakers take, pumping money in banks in the current fashion won't help long-term.
"It did not solve the problem of the heavily indebted countries that now are in a position of a Third World country that it is too heavily indebted in a foreign currency," says Soros, this time to CNBC.
"Gradually it's bringing down the interest rates. However, I don't think it's a strong enough 'ring fence' if and when Greece defaulted. And there is a real danger of that happening, a possibility," Soros says.
"And you need to strengthen Italy and Spain against that."
The International Monetary Fund, a multilateral lending institution, says Europe could tip the world right back into recession.
"The epicenter of the danger is Europe but the rest of the world is increasingly affected," says IMF chief economist Olivier Blanchard, according to Reuters.
"There is an even greater danger, namely that the European crisis intensifies, and in this case the world could be plunged into another recession."
© 2013 Moneynews. All rights reserved.