European recession next year "almost inevitable" - Soros

U.S. billionaire investor George Soros delivers his keynote speech during a Institute of International Finance (IIF) conference in Vienna June 10, 2010.

LONDON (Reuters) - Europe faces almost inevitable recession next year and years of stagnation as policymakers' response to the euro zone crisis causes a downward spiral, billionaire U.S. investor George Soros said on Tuesday.

Flaws built into the euro from the start had become acute, Soros told a seminar, warning that the euro crisis could have the potential to destroy the 27-nation European Union.

The euro's lack of a correction mechanism or of a provision for countries to leave it could be a fatal weakness, he said.

Germany had imposed its criteria on how a 750 billion euro (674 billion pounds) euro zone rescue mechanism should be used and was imposing its own standards -- a trade surplus and a high savings rate -- on the rest of Europe, Soros said.

"But you can't be a creditor country, a surplus country, without somebody being in deficit," he said.

"That's the real danger of the present situation -- that by imposing fiscal discipline at a time of insufficient demand and a weak banking system, by wanting to have a balanced budget you are actually ... setting in motion a downward spiral," he said.

Germany would do relatively well because the decline in the euro had boosted its economy, he told the seminar on the euro zone crisis organised by two thinktanks, the European Council on Foreign Relations and the Centre for European Reform.

"Germany is going to smell like roses but (the rest of) Europe is going to be pushed into a downward spiral, stagnation lasting many years and possibly worse than that," he said.

"In other words, I think a recession next year is almost inevitable given the current policies," Soros said, later clarifying that he meant a recession in Europe as a whole.

WARNS OF SOCIAL UNREST

"If there is no exit, (it) is liable to give rise to social unrest and, if you follow the line, social unrest can give rise to demand for law and order and (sow the) seeds of what happened in the inter-war period," he said.

Political will to forge a common fiscal policy in Europe was absent and since Europe was liable to move backwards if it did not advance, "the crisis of the euro could actually have the potential of destroying the European Union," he said.

European banks had bought large amounts of the sovereign bonds of weaker euro zone countries for a tiny interest rate differential, Soros said.

"That's one of the reasons why the banks are so over-leveraged and why the German and the French banks own Spanish bonds," he said.

"Now ... they have a loss on their balance sheets which is not recognised and it reduces the credibility of those banks so the banking system is in serious trouble," he said.

"The commercial paper market, for instance, in America is now refusing to lend to European banks so there is even a funding crisis and the ECB (European Central Bank) has to step in and the banks are unwilling to lend to each other," he said.

(Editing by Chizu Nomiyama.)