Economic history is filled with bouts of financial euphoria followed by painful mornings after. When nations awake saddled with debts incurred to finance wars, episodes of failed speculation, or grand projects that haven’t paid off, they have two choices. Either the creditor class prevails at the expense of everyone else, or governments find way to reduce the debt burden so athat the productive power of the economy can recover.
Muddy Waters Research, a specialist in Chinese companies, on Thursday issued a blockbuster “strong sell” rating on Toronto-listed Sino-Forest Corporation, a self-described “commercial forest plantation operator in China”.
But this was no ordinary “sell” rating: Muddy Waters both initiated coverage on the forestry company, which listed in Canada via a reverse takeover in 1995, and accused it of a “stratospheric” fraud.
In response, the Toronto market authorities suspended trading in Sino-Forest stock — trading symbol TRE.TO — pending a clarification or two.
Has this been the first policy shift since the arrest of Dominique Strauss-Kahn? A lingering dispute between the International Monetary Fund and the European Union has come out in the open. It is about the EU’s hesitance in supporting Greece all the way through next year. The IMF is saying to the EU: unless you agree to new loans for 2012, we are not going to risk our shareholders’ funds and pay the next tranche of the old loan. That tranche is due on June 29. If the stand-off is not resolved, Greece will default in July.
I understand that this was already the position when Mr Strauss-Kahn was running the IMF. But if he was still in charge today, I suspect, he would have tried, and possibly succeeded, to persuade the political leadership of the EU to accelerate the discussion about a second loan. Or he would have tried to postpone the publication of the latest IMF/EU report on progress on Greek economic reforms and debt sustainability. I would have been a touch more confident that a really damaging accident could be avoided.
Mr Strauss-Kahn turned out to be the right man in the right job at the right time. Initially, I had my doubts about the appointment of yet another Frenchman and a politician, at that, to run such a central international institution. I was wrong. Mr Strauss-Kahn proved to be a bold decision-maker, an effective politician and a competent economist. This combination is very rare. None of the candidates under discussion is likely to do the job as well as he did during the worst of the global and then eurozone financial crises.
Of course, it was widely expected that Mr Strauss-Kahn would shortly depart from the IMF, to run for the French presidency. But if he had won, he might have transformed the eurozone’s ability to manage its current internal crisis. Certainly, he would have brought to this task abilities the current French president, Nicolas Sarkozy, lacks: above all, intellectual weight and so credibility with policymakers in Germany, Europe’s premier power.
Mr Strauss-Kahn was among the very few senior European policymakers to whom the German leadership, particularly Angela Merkel, the chancellor, paid attention. At crucial moments, he was able to bring Europeans together. Indeed, he even seemed able to bring a divided German government together. I cannot imagine who could replace him. When there exist so many divisions within Europe and the decisions ahead are so complex and fraught, his absence will be keenly felt.
Dominique Strauss-Kahn tried to shake up this institution. He brought in Olivier Blanchard from MIT, one of the world’s most prominent macroeconomists, as the IMF’s chief economist. He gave Blanchard a free rein, which he quickly used to harshly criticize the orthodoxy within the IMF.
Last fall, the IMF published a study in its World Economic Outlook that showed that fiscal austerity in the wake of the economic crisis would further contract demand and raise unemployment. This reversed the institution’s historic role; the IMF officially became a voice for expansion and employment rather than contraction and austerity. (…)
If the charges against Mr. Strauss-Kahn hold up, then he will not be around to carry this effort forward. As far as for what the future holds, his interim successor, John Lipsky, was a former vice president at J.P. Morgan. This could mean that the whole world will suffer for Mr. Strauss-Kahn’s criminal conduct.
From the rubble and fear of World War II, the West built a collective fantasy. We would be safe. This time, we would no longer need to rely on the kindness of princes or generals. Institutions would do their work instead. Organization Men could protect our economies, maintain a new currency, and keep the peace.
If true, Dominique Strauss-Kahn’s actions in a $3,000 Manhattan hotel suite are despicable and tragic. More lurid details will tumble out soon enough. It will be a fitting moment for our times: The IMF on TMZ.
In short, Greece is in a Catch 22: creditors know it lacks the credibility to borrow at rates of interest it can afford. It will remain dependent on ever greater quantities of official financing. However that creates an even deeper trap.
Assume, for example, that half of Greek debt were to be held by senior creditors, such as the International Monetary Fund and the European stability mechanism, which is to replace the current European financial stabilisation mechanism in 2013. Suppose, too, that the reduction in debt needed to secure lending from private markets, on bearable terms, were to be 50 per cent of face value. Then private creditors would be wiped out. Under such a dire threat, no sane lender would consider offering money on bearable terms. A take-over of Greek debt by official funders makes return to private finance even more unlikely.
The Tea Partiers don’t care about the debt ceiling. To them, it’s a giant bargaining chit to shrink government. Nor do they worry about credit markets. If the full faith and credit of the U.S. government is no longer honored, so much the better.
You see, Tea Partiers hate government more than they hate the national debt. They refuse to reduce that debt with tax increases, even with tax increases on the wealthy, because a tax increase doesn’t reduce the size of government. The Tea Partiers’ real aim is to shrink the government.
But the Street and big business dislike the national debt more than they dislike government. And they wouldn’t even mind a small tax increase on wealthy people like themselves in order to cinch a deal on raising the national debt. They have so much money they’d scarcely notice.
On November 16th, European finance ministers urged [finance minister Brian] Lenihan to accept a bailout to stop the panic spreading to Spain and Portugal, but he refused, arguing that the Irish government was funded until the following summer. Although attacked by the Irish media for this seemingly delusional behaviour, Lenihan, for once, was doing precisely the right thing. Behind Lenihan’s refusal lay the thinly veiled threat that, unless given suitably generous terms, Ireland could hold happily its breath for long enough that Spain and Portugal, who needed to borrow every month, would drown….
Ireland’s Last Stand began less shambolically than you might expect. The IMF, which believes that lenders should pay for their stupidity before it has to reach into its pocket, presented the Irish with a plan to haircut €30 billion of unguaranteed bonds by two-thirds on average. Lenihan was overjoyed, according to a source who was there, telling the IMF team: “You are Ireland’s salvation.”
The deal was torpedoed from an unexpected direction. At a conference call with the G7 finance ministers, the haircut was vetoed by US treasury secretary Timothy Geithner who, as his payment of $13 billion from government-owned AIG to Goldman Sachs showed, believes that bankers take priority over taxpayers. The only one to speak up for the Irish was UK chancellor George Osborne, but Geithner, as always, got his way. An instructive, if painful, lesson in the extent of US soft power, and in who our friends really are.
The debt crisis in Greece has taken on a dramatic new twist. Sources with information about the government’s actions have informed SPIEGEL ONLINE that Athens is considering withdrawing from the euro zone. The common currency area’s finance ministers and representatives of the European Commission are holding a secret crisis meeting in Luxembourg on Friday night.
If there were doubts about the UK government’s liquidity, creditors would sell bonds in return for sterling deposits. They might then sell those sterling deposits for foreign currency. The pound would depreciate. But new holders of sterling deposits would need to buy sterling assets, probably including bonds. If the worst came to the worst, the Bank of England could tide the government over until fiscal stringency worked. The depreciation of sterling would also stimulate net exports, raising confidence in fiscal prospects. Thus, the UK cannot face a liquidity crisis in its sterling debt and any doubts about solvency are likely to lead to helpful adjustments.
For Spain, however, doubts about liquidity can readily arise. These risk creating self-fulfilling expectations, as rates of interest rise and money leaves the country. The result would be illiquidity in both the market for public debt and the banking system. The country has, in effect, become like a developing country that has borrowed in foreign currency, except to the extent that the ECB finances the banking system. Yet that makes the latter very like the IMF: it is determined to get its money back.
The tight financial controls associated with post-Depression financial regulation and the introduction of the Bretton Woods system enabled a period of financial repression that persisted from the end of the war to around 1980. This period was characterised by low real interest rates (during this time they were quite often negative) persistently, modestly high inflation rates, and rapid reduction in debt levels thanks largely to this “financial repression tax”. It was an incredibly effective mix of policies:
For the United States and the United Kingdom, the annual liquidation of debt via negative real interest rates amounted to 3 to 4 percent of GDP on average per year. Such annual deficit reduction quickly accumulates (even without any compounding) to a 30-40 percent of GDP debt reduction in the course of a decade. For other countries, which recorded higher inflation rates the liquidation effect was even larger.