Carlyle Group's Sarkozy: Euro Needs To Be A 'Real Currency'

The euro zone needs to tackle key structural issues and make the euro a "real currency" to deal with its ongoing debt crisis, Olivier Sarkozy, head of the global financial services team at Carlyle Group LP (CG), said Wednesday.

Recent political uncertainty in Greece has heightened concerns that the country could exit the euro zone and has reignited worries about contagion risks to the monetary union's larger economies.

The euro "has to become a real currency" for the euro zone to stay together, Sarkozy said while speaking at the Global Private Equity conference in Washington.

For that to happen, "ultimately Europe has to get cross-collateralized by Germany," he said. "If a euro zone is to remain in place it's got to have in its center that German economic engine, because otherwise it's just not credible"

Also, while the euro has held up relatively well, currency investors need to be extremely careful, because the European Central Bank balance sheet has become "increasingly constrained," he said. It already has surpassed that of the U.S. Federal Reserve to reach $4 trillion, an "unsustainable" level, according to Sarkozy, who is the half-brother of the former French president, Nicolas Sarkozy.

The ECB will need to "print trillions before they can get themselves out of this mess," he said. Sarkozy warned that market reaction to any large increase in the amount of euros in circulation, will put "lots of pressure on the currency."

Meanwhile, the latest developments in Greece could trigger talks of a third round of liquidity injections into Europe's financial system, through long-term refinancing operations, or LTROs, Sarkozy said. The ECB pumped more than EUR1 trillion into the region's banking sector in the form of three-year loans in December and February.

But "don't be fooled" by such a near-term "antibiotic," Sarkozy said. "We are going to run out of these pills, and when we do we're going to have to figure out something fast."

While past LTROs have helped stabilize the financial system in Europe, they remain "inefficient" and haven't come close to dealing with structural issues, he said. At the heart of the problem in the euro zone, beyond the high levels of sovereign debt, is the banking system's liquidity issue, Sarkozy said.

Europe's banks, with $55 trillion in assets, are primarily funded by channels other than deposits, providing a "far less stable source of financing than deposits," he said. As a result, the banking sector has hoarded liquidity to ensure ongoing solvency. They went from being the biggest buyers of European sovereign debt to the biggest sellers in August, when there was a run on the liquidity of the European banking system, he added.

To address this issue, the banking system needs to shrink down to a more stable size, about $32 trillion in assets, Sarkozy said.

By Erin McCarthy, Dow Jones Newswires, 212-416-2712; erin.mccarthy@dowjones.com

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