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Tuesday 22 Aug 2017 | 05:40 | SYDNEY
Tuesday 22 Aug 2017 | 05:40 | SYDNEY

IMF faces existential threat to Euro



23 May 2011 14:10

Provided that the European Council can agree on a credible candidate, a European seems certain to replace former IMF Managing Director Dominique Strauss-Kahn. Talk of the job going to an emerging country national is just wishful thinking.

For the Europeans, the stakes are simply too high: there is an existential threat to the Euro.

Steering around this possibility, remote though it is, requires a trusted 'insider'. No matter how much talk there is of 'appointment on merit', there are enough Europeans who can pass this technical test to make it meaningless as a way of breaking the European stranglehold on the position.

It is difficult to overstate how much damage the crisis has done in the peripheral countries of Greece, Ireland and Portugal. There has always been a serious internal contradiction in the Euro arrangements: monetary policy is set for the Euro area as a whole, but fiscal policy is left to individual countries. The Stability and Growth Pact was designed to constrain fiscal policy, but even Germany had trouble staying within its strictures.

The last vestige of fiscal discipline was represented by a specific 'no bail-out' provision in the EU rules, which might have warned creditors that lending to Greece was not the same as lending to Germany. But markets largely ignored this: the peripheral countries (and some less peripheral, such as Italy) found new freedom to borrow overseas cheaply, and fiscal discipline evaporated.

When Greece's problems became acute a year ago, a strong case could be made for a debt restructure, with substantial hair cuts for creditors to reduce the debt to manageable levels. This would have been a serious blow to bank balance sheets, particularly in Germany and France, with some banks needing government support. But at least it would have been a domestic fiscal transfer, leaving the 'no bail-out rule' intact.

The EU, however, decided to contradict the rule, forming a temporary assistance facility and planning a permanent one for 2013

Without a restructure, the current assistance of Euro €110 billion will need to be substantially supplemented. The European Central Bank (which holds around Euro €50 billion of Greek debt) refuses to even mention the word 'restructuring'. German and French banks are still carrying the Greek debt at face value and are no more ready to bear their losses than they were a year ago.

The IMF (and Strauss-Kahn) was central to last year's rescue. Not only did the IMF provide Euro €30 billion to the rescue package, but it turned a blind eye to Greece's insolvency. Having missed the opportunity for a definitive solution a year ago, the can of worms has been opened, and no one can agree on how to put them back again.

This crisis is deeply mired in politics, and doesn't lend itself to a purely technical solution. How could a non-European pick up the pieces of this Humpty Dumpty and hold it together for a bit longer, at least until the politicians can get through their next election? There is simply no constituency for a technically-driven solution.

Of course it can be argued that the Latin American crisis of twenty-five years ago did not require a Latin American to be put in charge of the rescue, nor an Asian during the Asian Crisis of 1997. But these are glib debating points that serve only to highlight the reality of international power. As in any long-standing club, the status quo at the IMF is protected not just by the formal rules and votes (which have barely moved in favour of emerging countries over the past decade), but also by the informal cliques with their trade-offs and quid-pro-quo understandings.

Emerging-market countries will get a turn, but not when there is so much at stake. In any case, there is no consensus among emerging countries to nominate a serious candidate. The unlikeliness of a non-European head of the IMF is emphasised by the candidates that have been put forward, such as Stan Fischer, currently Governor of the Bank of Israel, who orchestrated the IMF's ill-conceived handling of the 1997 Asian Crisis.

What should Australia think about all this? Our standard response would be to go with the flow. But if an emerging-country candidate is ever going to become head of the IMF, a different selection process is needed. An expert committee should propose a candidate who is both technically outstanding and not a politician (as suggested by former IMF chief economist Raguhram Rajan). Now might be the time to seek agreement on this.

Photo by Flickr user xmatt.

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