Why Are the French So Determined To Run The IMF – And What Will It Cost You?

By Simon Johnson

Just a few years ago, eurozone countries were at the forefront of those saying that the International Monetary Fund had lost its relevance and should be downsized.  The organization was regarded by the French authorities as so marginal that President Nicolas Sarkozy was happy to put forward the name of a potential rival, Dominique Strauss-Kahn, to become managing director in fall 2007.

Today the French government is working overtime to make sure that a Sarkozy loyalist and the leader of his economic team – Finance Minister Christine Lagarde – becomes the next managing director.  Why do they and other eurozone countries now care so much about who runs the IMF?

The euro currency union has a serious problem, to be sure, with the likes of Greece, Ireland, and Portugal, but it is beyond bizarre that these countries now find themselves borrowing from the IMF.  The IMF typically lends hard currency to countries that have “balance of payments” crises – meaning that they have been importing more than they were exporting, and the previous private sector capital inflows (typically loans of some kind) that financed this current account deficit have now dried up. 

Greece has a current account deficit but its money, the euro, is one of the world’s hardest currency – it is a “reserve currency” meaning that central banks and private business keep their rainy day funds in euros (as well as dollars, yen, Swiss francs, and perhaps still British pounds.)  The eurozone as a whole does not have a current account deficit. 

I recall vividly discussions with eurozone authorities in 2007 – when I was chief economist at the IMF – in which they argued that current account imbalances within the eurozone had no meaning and were definitely not the business of the IMF.  Their argument was that the IMF was not concerned with payments imbalances between US states (all using the dollar), and we should likewise back away from discussing the fact that some eurozone countries, like Germany and the Netherlands, had large surpluses on their current account while others, like Greece and Spain, had big deficits.

Those eurozone treasury and central bank officials had a point.  After all, if one of the deficit countries got into trouble, it could be helped out by other members of the currency union.  As the euro is a reserve currency – and a highly regarded one, for example it remains strong relative to the dollar – the IMF is essentially now lending euros to the eurozone in its various bailout programs.

Why does this make sense?

It doesn’t – unless you understand that the goal of these various bailouts is to ensure that German and French taxpayers do not realize the full extent of their losses or the ways in which their banks have been completely mismanaged.

Take the most generous interpretation of IMF lending to Greece – it is like the U.S. Troubled Asset Relief Program, in the sense that there will be a great deal of outlay but all or most will be repaid in nominal terms.

Such lending could be made just as easily by other eurozone countries, either from current resources or by borrowing in the markets – for example, Germany has plenty of fiscal credibility and issues some of the lowest risk sovereign debt available.  But even if the money lent to Greece in this fashion were all paid back, this would look bad – to German voters (and to French voters, as France would have to lend also).

Such loans are much more risky than commonly supposed.  The IMF does eventually get its money back nominally, but not always in real terms (adjusted for inflation) and definitely not on a risk-adjusted basis (i.e., the interest rate charged does not include proper compensation for the risks being taken).  There is a very real possibility that some or all of the monies lent will not be paid back in the foreseeable future.

The International Monetary Fund is, in this regard, essentially a credit union owned by 187 countries – with voting based on ownership shares that reflect relative economic size.  The European Union “owns” about 30 percent of IMF, so 70 percent of any money at risk belongs to other countries: about 17 percent US, 7 percent Japan, 35 percent emerging markets, plus some more mixed sets of countries.

The managing director of the IMF is the impresario of any bailout.  The big decisions must be negotiated with all significant stakeholders but this still leaves enormous scope for discretion.

If Ms. Lagarde becomes managing director she can directly influence the terms of IMF involvement – and based on her negotiating position to date within the eurozone, we can presume she will lean towards more money, easier terms, and above all no losses for the banks that made foolish loans.

Increasingly it looks like the eurozone leadership, under French guidance, will go for the Full Bailout option, in which all Greek debt is bought up by the IMF, by the European Central Bank, and by other eurozone entities.  This debt will be held to maturity – and any creditor who did not yet sell will be made whole (those who already sold at a loss are out of luck).

This course of action will be expensive, in terms of nominal outlays and in real risk-adjusted terms, because whatever terms Greece gets must also be offered to Ireland and Portugal.  The IMF may need to raise more capital or – more likely – tap its credit lines from member governments.

To be clear, the Full Bailout is still painful for the debtor countries – their fiscal adjustments will involve spending cuts, tax increases and asset sales.  But the motivation is not generosity.

The Europeans greatly fear their own “Lehman moment” – in which any attempt to impose even moderate losses on creditors will cause chaos throughout the financial system.  The French and Germans fought hard against increasing capital requirements under Basel III and the results of various European banking “stress tests” have been completely noncredible – particularly as they did not take into account serious sovereign debt default scenarios.

The French want to sway decision-making at the IMF in order to use US, Japanese, and poorer countries’ money to conceal from their own electorate that the eurozone structure has led all its members into serious fiscal jeopardy – some borrowed heavily, while others let their banks lend irresponsibly and thus created a large contingent liability. 

The best way to hide the true cost is to have other people’s taxpayers foot the bill, preferably with the least possible transparency.  There is a lot at stake for eurozone politicians.  Ms. Lagarde will run the IMF.

An edited version of this post appeared yesterday on the NYT.com’s Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

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Don't Believe What You're Hearing About Budget Talks

My column from today's Roll Call talks about how all the rumors about what's being decided in the various budget discussions going on in and around Washington are likely wrong.

 

Don’t Believe What You Hear About the Budget Talks

•               June 21, 2011, Midnight

Last week was the point in this year’s budget negotiations when everyone’s worst fears about what would happen seemed to be on the verge of being realized.

The combination of increasingly happy talk about the summit being led by Vice President Joseph Biden and President Barack Obama’s golf outing with Speaker John Boehner (R-Ohio) seemed to have every blogger, pundit and interest group convinced that what they least wanted either was on the verge of happening or had already been agreed to.

If you listened closely, the rumors indicated that everything — from significant tax changes to substantial Social Security cuts — not only was on the table but was coming together in a package that would soon be ready for political prime time and would fly through the legislative process.

This is a routine part of the federal budget debate and the fiscal equivalent of one of the five stages of grief.

I first noticed it during the Andrews Air Force Base budget summit in 1990, when I received a series of calls from people inside and outside the Beltway who could not possibly know what was actually happening.

They all said one side or another in the negotiations had already agreed to the particular spending cut or tax increase they were most worried about.

Although some of those calls were from people who wanted to see whether I could confirm or assuage their fears, most were genuinely convinced that what they had heard or imagined was true.

For the record, my phone started to ring just as the Andrews summit was beginning — that is, while some of the negotiators were making opening statements and others were still trying to find the bathroom. It’s also important to note that virtually none of these “my-budget-sky-is-falling” concerns turned out to be true.

This year’s negotiations have already produced the same type of premature and very likely inaccurate misgivings as typically occur whenever those involved with the federal budget get together to talk about what can, should and needs to be done.

And this year there may be more reason to think that what someone considers a budget nightmare is going to come true given the magnitude of the problem, the few relatively easy deficit reductions that are still available and the paucity of spending and revenue options that numerically and politically are possible. (Note to deficit hawk groups: The formal and ad hoc recommendations you so publicly support are not as novel as you want everyone to believe because they are really little more than what’s available.)

But as is also the case at this stage of the budget negotiations, there are still many reasons to think the fears about budget nightmares are far more imagined than real.

This year, for example, it’s not at all clear that those involved in the budget discussions actually have the authority to negotiate a deal that will be accepted by enough Representatives and Senators to enact the legislation.

The antipathy of the tea party wing of the Republican Party for Boehner and House Majority Leader Eric Cantor (R-Va.) on budget issues has been both stated and demonstrated many times this year.

It also seems to have gotten worse since April, when 59 House Republicans defied their leadership and voted against the final continuing resolution for fiscal 2011.

Given that a debt ceiling increase is even more politically toxic than the CR, it’s likely that anything Boehner might agree to while playing golf with the president or Cantor agrees to as part of the Biden-led summit won’t be acceptable to large numbers of the House GOP caucus.

The same is true on the other side of the aisle because it’s not clear that an administration-negotiated deal will be acceptable to all Democrats.

This is especially the case now because the president’s Osama bin Laden bump in the polls is over and his approval rating again is hovering between 46 percent and 49 percent.

In addition, it’s becoming increasingly obvious to many that the almost guaranteed opposition by a substantial number of Republicans to a debt ceiling increase means that no bill can pass the House without substantial Democratic support. That math will prevent the president from agreeing to the type of budget agreement the GOP says it must have.

On top of everything else, there are strong indications that, contrary to initial statements by some on Capitol Hill, Wall Street will react negatively and that what so far has been limited pressure on Members of Congress to raise the debt ceiling will be substantially different in the not-too-distant future.

In recent weeks two of the three agencies that Wall Street relies on for bond ratings — Moody’s and Fitch — both issued warnings about the implications of not increasing the government’s borrowing limit.

Last week, Federal Reserve Chairman Ben Bernanke used some of the strongest language he has ever used when talking about fiscal policy to say that the debt ceiling should not be tied to deficit reduction.

The continuing threat of a default by Greece has clearly concerned investors. If worry about a country whose gross domestic product is almost a rounding error compared to the U.S. economy can roil the markets, what will a growing hint of a similar problem by the United States do?

Finally, there is the growing recent concern about the U.S. economic recovery and the worry about the effect of short-term deficit reductions on the GDP and unemployment that is increasingly in vogue.

This is why, like the calls I received when the Andrews summit got under way, much of what’s being said about a possible budget deal needs to be heavily discounted.

The current discussions may have been going on for a while, but in many respects, it’s still way too early in the process to think that anything has been decided.

 

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