Tue | May 30, 2023

Europe proposes its own IMF

Published:Wednesday | March 10, 2010 | 12:00 AM

As Europe struggles with a debt crisis, the idea of a European Monetary Fund is quickly taking hold.

Such a body could be a lender of last resort and keep financially troubled governments from unsettling the euro and global markets, the way the recent Greek-debt crisis has.

That is the kind of thing the International Monetary Fund (IMF) usually does - but for the European Union (EU) to turn to that Washington-based body would be humiliation.

The open and urgent question: do European leaders have the backbone - whatever the working title of their new fund - to enforce tough new rules meant to safeguard the euro? And will a bailout fund just encourage more trouble?

A key lesson from the ongoing worries over whether Greece can pay its debts has been the vague EU response to the escalating difficulties of one of its members - one of the main reasons why the markets responded so negatively to the growing crisis in Greece was that no one knew what, if anything, the EU would, or could, do.

The crisis exposed the euro's deeper vulnerability - no way to keep governments from breaking rules against running up big debts and undermining the currency.

Sentiment toward the euro deteriorated so sharply that the very future of the single currency became a subject of open debate and its exchange rate plunged from around US$1.51 in December to a low of US$1.3610 on Monday.

Now the Europeans, or at least the 16 countries that use the euro, appear to have grasped the nettle - they have to get their house in order, find a way to tighten budge-tary discipline, and figure out how to rescue countries in trouble.

The creation of a European equivalent to the IMF could be a key pillar of a post-crisis eurozone and all the signs are that the idea is getting support across the eurozone.

German Finance Minister Wolfgang Schaeuble broached the idea over the weekend and, on Monday, Chancellor Angela Merkel, leader of the eurozone's biggest country, came out in favour, calling it a "good and interesting idea".

Insufficient instruments

The current situation suggests that "our instruments are not sufficient" to cope with such situations, Merkel told foreign journalists. She stressed that "we want to be able to resolve our problems in the future without the IMF".

"The questions, of course, must be asked: who pays in, how does one pay in, how independent is it from the (European) Commission, and so on," Merkel said.

She said such a fund would require changing the EU's basic agreement, recently updated December 1, with the entry into force of the Lisbon treaty streamlining decision-making.

But, she said, if the EU wants to be capable of acting, "it will always run into situations in which the Lisbon treaty can't be the end of the story".

The move would insure the region against being brought low by its weakest link, something leaders failed to do back in 1999 when the currency was launched.

Later, they added rules limiting deficits. But countries broke them, and the EU let them get away with it.

The European Commission said Monday that negotiations over the creation of such a body could conclude as early as July 1, but offered no details about what powers it would have and how it would be funded.

One powerful voice, Juergen Stark, a member of the top executive committee of the European Central Bank, said it was a bad idea.

Stark said it would create a perverse incentive for countries not to clean up their balance sheets properly and, thereby, undermine the euro's stability.

"Every country is accountable for its public finances and, thereby, its debt. It would be the start for a system of financial compensation that could become very expensive, set the wrong incentives and, finally, be a burden for countries with solid public finances," Stark wrote in an article for Tuesday's issue of the German economic daily,

Economists have been urging the idea for some time.

In a February paper, Daniel Gros, director of the Centre for European Policy Studies in Brussels, and Deutsche Bank chief economist, Thomas Mayer, said a European Monetary Fund (EMF) could bail out troubled governments, and then use the threat of cutting off rich EU support payments to force them to bring spending practices into line.

And the EMF could set up the possibility of an orderly default for an indebted state in which the EMF could offer bonds at a discount to holders of defaulted debt, limiting the crippling ripple effects of a default.

That, Gros told the AP, gives the region the ability to keep a troubled member from holding the whole eurozone hostage.

"It's about protecting the euro zone," he said.

"Eurozone countries have a choice - they can just go on like they are, Greece can spend and spend and eventually they will have to pay up" to sort out the mess. "Or they can do this and eventually they are able to say 'no' to Greece."

Emf funding

The EMF's funding could come only from countries whose debts and deficits breach the European union thresholds, the paper says - a proposal likely to appeal to Germany, where the idea of taxpayers bailing out profligate small countries is deeply unpopular.

The idea could have ripples worldwide, said former IMF chief economist Simon Johnson. Talk of a EMF could re-ignite the case for an Asian Monetary Fund (AMF), which was first aired back in 1997 in the wake of the Asia crisis.

A Japanese proposal was welcomed across Asia but died when Washington balked for fear of losing influence.

"This is huge news on the international arena because it opens the way up to the AMF, and a big slap in the face for the US Treasury and the IMF," said Johnson, now a professor at MIT.

The IMF, for generations, has had to contend with accusations, particularly in the developing world, that it is an arm of the US government, though it has always been headed by a European since its creation from the ashes of World War II.

Johnson said there's no reason why an EMF or an Asian equivalent could not work together with the IMF - they could be more like "neighbourhood pharmacies", offering countries budgetary advice and preventative medicine for moderate financial illness, while the IMF would be more like "a hospital for when the blood was gushing out."

Johnson reckons that, at a minimum, eurozone countries will have to provide around US$250 billion worth of capital at the outset and a ?500-billion credit-line facility if it's going to be a worthwhile endeavour.

"If they did that, the financial markets would stand up and salute," said Johnson.

The creation of an EMF potentially could get tangled up with French domestic politics. French officials had no immediate comment, but many think President Nicolas Sarkozy is widely considered to be a force against allowing the IMF to help Europe.

Current IMF chief Dominique Strauss-Kahn is a potential rival for president and Sarkozy may not want to see him become the saviour of the euro.

- AP