Can Lagarde and the IMF save the Euro?

For Germany and France, certainly.

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It is not up to Mme. Lagarde and the IMF to save Europe. Europe has to save itself by addressing two critical issues: (1)sovereign debt in the Mediterranean countries (Greece, Italy, Spain and Portugal), which is the result of a bloated welfare state, excessive regulation, tax evasion, and chronic government deficits; and (2) the European Union’s own internal structural imbalances caused by Germany’s export driven model of growth which depends on unsustainable import demand by its European partners. German consumers will have to spend more. The Mediterranean countries will have spend less and become competitive. Lagarde will have to tread carefully and not appear to play favorites, especially when it comes to French creditors who are biggest holders of Greek (junk) bonds.

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It’s not too late to save the Euro zone, but tough choices lie ahead. That’s Lagarde’s strength: she’s not an economist, she’s a good politician, and the choices ahead are as much political as economic.

Of course, that wasn’t Lagarde’s argument in running: rather, she made the case that because the Euro zone is the current epicenter of the financial crisis, someone from within the crisis is best suited to deliver the necessary medicine. My colleague Richard Gowan pointed out that that’s roughly the equivalent of marching into your local bank and claiming that because you’re long overdue to pay off your overdraft, you should be bank manager. Still, the political case for Lagarde is strong, at least within Europe.

Internationally, the interesting fact of Lagarde’s victory at the IMF is the way the BRICS countries coalesced around her. This was in no way an endorsement of the notion that Europe should retain the IMF-seat, just as the United States has always held the World Bank presidency. Each of the BRICS had an alternative candidate, and as a matter of principle strongly rejected the idea of Europe continuing in the spot vacated by DSK’s dramatic fall. However, the BRICS could only agree on the principle, not the practicalities, and none could agree to each other’s candidates. For all the talk of the ‘BRICS’ or the ‘rise of the rest’, Lagarde’s smooth victory is a reminder that at least as much divides the BRICS as unites them.

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Lagarde and the IMF will not save the Euro.

The Chinese will save the Euro at least for the forseeable future. Europeans will think they are saving the Euro because they will refinance their sovereign debt by selling it to the Chinese. Just this week the Chinese agreed to buy  Polish debt and British debt and Beijing won’t stop there. The next European debt the Chinese buy will be denominated in Euros. 

Buying the Euro debt means the Chinese won’t let the Euro fail. The Chinese are already the Americans’ principal banker and soon they will be the Europeans too. The Euro will be “saved” but even more power will be shifted from the North Atlantic zone to China.

This is not happening just because the Chinese have embarked on a long-term plan to become a dominant world power. It is happening because the countries which heve previously dominated have now lost the will to discipline themselves. They are selling their sovereign debt and their power to China.The price of “saving” the Euro will be high.

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Though the IMF also provides short term financing to Greece, over 100 billion Euros so far, and bail-out support for Portugal and Spain, “Saving the Euro” is a Eurozone job, especially up to France and Germany who hold most Greek debt. Greece needs more time to repay loans and help to service debt since market interest rates are now beyond Greek austerity capacity.

This will hopefully avoid Greek default. But saving the Euro’s future needs systemic reform. It is obvious a common currency cannot survive with widely differing fiscal and social policies, and behavioural divergences on tax evasion. EU member states always resisted closer economic coordination for sovereignty and political reasons. Now, Eurozone members at least must accept the reality of much stricter conditions and controls on policies and behaviour of all, or German taxpayers will pull the plug on supporting non-performers.

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Whether Christine Lagarde and the IMF can save the Euro is an open question. Lagarde has intimate knowledge of the European financial system but so did her disgraced predecessor. The lessons of the Euro crisis lie elsewhere. The problems of Greece, Spain and Portugal stem in part from lack of fiscal discipline and in part from the weakness of their economic base at a time of upheaval in the world markets. But they were not the only EU countries to blame for their lack of fiscal discipline. Big EU countries, France included, have time and again failed to respect their commitments to maintain their inflation rates below the commonly agreed-upon threshold. By so doing, they contributed to weakening the ability of the European Central Bank to implement its monetary policy. They also set the tone for smaller EU countries, which could always blame them for trying to force onto others what they were not willing to do themselves. In an interconnected world, be it at the level of the EU or more globally, major powers are trendsetters, whether for good or ill. This lesson should not be lost on the United States as it grapples, in its own turn, with putting its financial house in order.

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Only the Eurozone can save the Euro, and doing so will mean expulsion of the weakest members and/or a deeper political union.

The IMF can prolong the Greek tragedy and other sovereign debt dramas in the EU, but only EU members can decide if they are willing to pay the political and fiscal price of a true monetary union. Ms Lagarde should concentrate on saving the IMF.

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