AMERICAN FUTURE

In today’s FT, Gillian Tett contrasts how well American banks prepared for the possibility of a U.S. default last summer and how European banks are now preparing — or not preparing — for a break-up of the eurozone. The comparison isn’t reassuring.

Here’s what she says about the banks on this side of the pond:

Last summer, some of America’s largest banks secretly stocked their cash machines with the maximum possible supply of notes. The reason? In July 2011, the bankers feared that the US might be about to suffer a technical default, because Congress could not agree on measures to raise the debt ceiling.

So, they decided – after collective discussions – to keep those ATMs stuffed with greenbacks to ensure that consumers would never panic about running out of cash if that “worst-case” default scenario transpired.

In the first half of 2011, large banks such as JPMorgan and Bank of New York Mellon are thought to have each spent about $50m ensuring that their contracts were legally watertight in the event of a US default, and that repo deals and financial markets were continuing to function (along with those ATMs.)

At this week’s meeting of the World Economic Forum, eurozone leaders have stressed their commitment to keeping the single currency intact. And the consensus among senior bankers is that the most likely scenario for the eurozone for the foreseeable future is continued muddling through. Hardly anyone, however, expects a truly positive “solution” soon, and most think that a break-up or exit scenario remains entirely possible. Accordingly, most large banks are now secretly preparing contingency plans – just in case.

This time, says Tett, some large banks may be spending far more than $50 million, since the task is dramatically more complex: they have to review the fine print of all legal contracts for any euro exit, and to ensure that financial market transactions are watertight, or at least hedged. Many large banks are also trying to make sure that their liabilities in peripheral countries are matched with assets inside the same country – rather than across the eurozone as a whole.

Here’s the crux of the matter:

In Europe today, however, it appears that there is little – or no – similarly collaborative move. Or if there is, it is so utterly secret that not even senior bankers know about it yet. On an individual level, most large banks insist they are well prepared (though many express concern that the exchanges or settlement systems seem less organised). But nobody appears to have spoken extensively to anyone else, far less to any central government group.

Why? One problem is that the banking landscape in Europe is far more fragmented than in America. Another is weak European banks are now too distracted, or cash-poor, to prepare for a vague risk. There is also a deep reluctance among some eurozone bankers to admit they are preparing for a worst case, which would risk undercutting their own politicians. And some bankers argue that if a truly serious crisis materialised (such as the exit of Italy, say) it would be so devastating and complex that planning would be pointless.

If you’d told me that I would someday agree with Coulter on anything — anything! — I would have told you that you were out of your mind.

But it’s happened. She prefers Romney to Gingrich. So do I.

Here’s some choice excerpts from her column at townhall.com:

To talk with Gingrich supporters is to enter a world where words have no meaning. They denounce Mitt Romney as a candidate being pushed on them by “the Establishment” — with “the Establishment” defined as anyone who supports Romney or doesn’t support Newt.

Newtons claim Romney is a “moderate,” and Gingrich the true conservative — a feat that can be accomplished only by refusing to believe anything Romney says … and also refusing to believe anything Gingrich says.

. . . without the federal government, Gingrich would be penniless. He has been in Washington since the ’70s, first as a congressman, then becoming a rich man on the basis of having been a congressman. Most egregiously, he took $1.6 million to shill for Freddie Mac, one of the two institutions directly responsible for the housing crash that caused the financial collapse. (Or one of three, if you consider Barney Frank an institution.)

To act as if Obamacare is the same thing as “Romneycare” is just a word game, on the order of acting like a “gun” has the same properties as a “gunny sack,” or “fire” is the same thing as a “firefly” . . . For those of you who still think Romneycare is the worst possible sin a Republican candidate could commit — even worse than taking money from Freddie Mac as it destroyed the economy — that doesn’t help Gingrich: He supported Romneycare . . .

Now here’s something (among many other things) I didn’t know and that might be useful to Obama’s re-election campaign: “the nation’s leading conservative think tank, The Heritage Foundation, helped draft Romneycare. Indeed, Bob Moffit, Heritage’s senior fellow on health care issues, can be seen in the picture of the bill-signing ceremony, standing proudly behind Romney.”

Child of the sixties that I am, my reactions to this revelation (at least for me) are can-you-dig-it and far-out.

More from Coulter on Gingrich and Romneycare:

But Gingrich did more than support Romneycare. As former senator Rick Santorum has pointed out, Gingrich supported a FEDERAL individual mandate to purchase health insurance from 1993 until five minutes ago — i.e., at least until a “Meet the Press” appearance just last May.

She sums things up this way:

In a world where words have meaning, Mitt Romney is not the “moderate” in this race. He is the most conservative candidate still standing, with the possible exception of Rick Santorum, who is bad on illegal immigration . . .

Romney is “moderate” only in demeanor — which is just another word game. His positions are more conservative than Gingrich’s, but he doesn’t scare people like Gingrich does. Ronald Reagan and Jesse Helms were moderate in demeanor, too. No one would call them political moderates.

Romney is the most electable candidate not only because it will be nearly impossible for the media to demonize this self-made Mormon square, devoted to his wife and church, but precisely because he is the most conservative candidate.

Conservatism is an electable quality. Hotheaded arrogance is neither conservative nor attractive to voters.

Ann, I agree: if we’re to have a Republican president, let it be Mitt, not Newt.

Is this the kiss of death for Gingrich? Could be.

Any comment by me would be superfluous.

“Gross inequality is not a new phenomenon, but the fact that this year’s survey respondents selected severe income inequality as the most likely global risk to manifest in the next 10 years suggests that concern about its consequences is growing.”

– World Economic Forum, “Global Risks 2012”

Reporting from the World Economic Forum in Davos, the FT’s Gillian Tett takes note of the unprecedented concern at the conference about growing income inequality. In “Income disparity tops list of concerns,” she says:

That is a striking turnround. Until this year the issue of inequality never appeared on the risk list at all, let alone topped it. In the past, Davos delegates have worried about the risks posed by “asset price collapse”, “oil price shock”, “natural resource shortages” or “banks”. But in Wednesday’s debates it became clear why income disparity now appears on the WEF list of concerns. Apart from the fact inequality has been thrust into the political debate in the US, UK and France, the question of social stability has leapt on to the agenda as a result of the Arab spring. Even before the delegates arrived, a report from the World Economic Forum showed that the risk Davos delegates believe is most likely to cause turmoil this year is “income disparity”.

From the report:

On an unprecedented scale around the world, there is a sense of receding hope for future prospects. Gallup polling data in 2011 reveal that, globally, people perceive their living standards to be falling, and they express diminishing confidence in the ability of their government to reverse this trend. Their discontent is exacerbated by the starkness of income disparities: the poorest half of the global population owns barely 1% of the global wealth, while the world’s top 1% owns close to half of the world’s assets.⁶. Figure 13 provides a global snapshot of inequality, while Figure 14 shows a rise in inequality across many developed economies.

Figure 13

[Note that the United States is second only to Mexico in income inequality among OECD countries]

Figure 14

This is the Session Summary of the debate to which Tett refers:

TIME Davos Debate on Capitalism

Wednesday 25 January

Is 20th-century capitalism failing 21st-century society?

In partnership with the World Economic Forum, Time magazine hosts this debate focusing on the uncertain future of capitalism.

Key Points

• Some critics of capitalism argue that growing income inequality and high unemployment indicate that the capitalist economic system has failed society and needs to be reformed.
• Others argue that income inequality is driven not by corporate power but by factors including technological development and the emergence of a highly interconnected global market.
• To make capitalism fair, focus should be on investing in education and promoting innovation and creativity.
• Young people, especially young entrepreneurs, can drive the transformation of capitalism so that it better serves the needs of society.

Synopsis

The financial and economic crisis that has roiled the world for more than three years unleashed a torrent of criticism against large financial institutions. They are irresponsible risk takers concerned only with maximizing profits, the detractors argued, adding that global banks enjoy unfair advantages because they are too big to fail or let fail. As unemployment, particularly among young people, has risen sharply, the debate over the role of the banks has widened. Growing income inequality in both developed and developing economies has raised questions about the dominance and power of corporations and how well businesses are meeting their social responsibilities.

Is 20th-century capitalism failing 21st-century society? Sharan Burrow, General Secretary, International Trade Union Confederation (ITUC), Brussels; Global Agenda Council on Employment & Social Protection, thinks so. The business community “has lost its moral compass,” she reckoned. “We must redesign the model. We must reset it. Stop the greed. Unless employers and workers sit down with governments, the system will continue to fail.” Companies fight against increasing the minimum wage, even though doing so would only slightly reduce their profits, she asserted.

Other panellists disagreed with Burrow’s view that business lacks morals. “The business community has not lost its moral compass,” asserted David M. Rubenstein, Co-Founder and Managing Director, Carlyle Group, USA. “Capitalism may be the worst economic system except for any of the others.” Businesses do not think about ways to reduce wealth and jobs, he added. To ensure that capitalism is fair, focus on improving laws and regulations, investing in education and promoting innovation and creativity, Rubenstein advised.

Growing income inequality is fuelled not by bad corporate governance but by “far deeper forces”, including the development of technology, the emergence of a global market and the need for innovation, Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance, Booth School of Business, University of Chicago, USA, explained. These forces are increasing the demand for skills and pushing pay higher. “These are not going to be affected by corporate governance,” Rajan told participants. “The right debate is about how we get the innovation and creativity we need.”

Ben J. Verwaayen, Chief Executive Officer, Alcatel-Lucent, France, and a World Economic Forum Foundation Board Member, concurred: “We need to talk about innovation, real sustainability and reforms – not about corporations and greed. It’s about decision-making. We suffer from nostalgia. We are not going back to the world that we knew. We have to go for transformation. We have to talk about job creation, not job security.”

From the floor, a critic of capitalism called for vision, not nostalgia. Old institutions and ways of thinking have to be disrupted, he said. A Global Shaper from Egypt said that it is important to establish platforms that allow young people to create jobs for themselves so they are not waiting for jobs to be created for them. “We absolutely need young entrepreneurs and they should be supported,” Burrow replied. But she cautioned against dismissing “the old industrial age”. Technology, especially innovations developed by skilled young people, will be needed to improve the way the “old” economy works, she remarked.

These days, many corporations and other organizations including the World Economic Forum are concerned about what young people are thinking and doing, Rubenstein observed. “Corporations recognize that change is coming from young people.” Noted Verwaayen: “You don’t have to wait for permission. Maybe in the past it was asking; today it’s just doing.”

Other Key Takeaways

Responding to the criticism that irresponsible lending contributed to the global financial crisis and that large banks enjoy unfair advantages, Brian T. Moynihan, Chief Executive Officer, Bank of America, USA, said that banks are global and large in size because they reflect the breadth and presence of their customers. “Our power, size and capabilities come from our clients. Our revenue is representative of the economic activity taking place. We are big because our clients are [global] and we support them.”

Contributors

Sharan Burrow, General Secretary, International Trade Union Confederation (ITUC), Brussels; Global Agenda Council on Employment & Social Protection
Brian T. Moynihan, Chief Executive Officer, Bank of America, USA
Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance, Booth School of Business, University of Chicago, USA
David M. Rubenstein, Co-Founder and Managing Director, Carlyle Group, USA
Ben J. Verwaayen, Chief Executive Officer, Alcatel-Lucent, France; Foundation Board Member

Well (as Ronald Reagan said on numerous occasions), it’s time for this blog to start focusing on American politics — a subject I’ve come close to ignoring since I started posting last June.

I’ll start with “Incoherent party, incoherent candidates” from the Economist, which hits the mark:

REPUBLICANS are clearly not too enthused about Mitt Romney. Nor are they wild for any of the alternatives . . .

Mitt Romney looks like a weak phony in this election campaign because he has to pretend to believe with all his heart in orthodox tea-party conservative positions that he transparently doesn’t really believe in. We know this because in the past, Mr Romney supported health-care reform including an individual mandate along the lines of the system he instituted in Massachusetts, essentially the same system as Obamacare. And in the past, he supported a cap-and-trade system for limiting greenhouse-gas emissions to address climate change. But at the time, both of those were orthodox Republican Party positions . . . There were very few established Republican politicians who hadn’t taken positions in the George W. Bush era (or the Newt Gingrich era!) that pose ideological problems for them in the tea-party era . . .

Republicans’ disenchantment with their current presidential candidates is not an incidental characteristic of this crop of candidates. It’s a structural feature of a contemporary Republican Party whose pieces don’t hang together. Pro-Iraq-war neoconservative Republicans cannot actually live with Ron Paul Republicans. Wall Street-hating anti-bail-out Republicans cannot actually live with Wall Street-working bail-out-receiving Republicans. Evangelical-conservative Republicans cannot actually live with libertarian, socially liberal Republicans. Deficit-slashing Republicans cannot live with tax-slashing Republicans. Medicare-cutting Republicans cannot live with Medicare-defending Republicans. These factions have been glued together over the past three years by the intensity of their partisan hatred for Barack Obama, and all of the underlying resentments that antipathy masks. Republicans have buried their differences by assaulting everything Mr Obama supports, and because Mr Obama is a pretty middle-of-the-road politician, that includes a whole lot of things that many Republicans used to support. They are disenchanted with their candidates because their candidates are incoherent, but their candidates are incoherent because the base is incoherent. If the GOP wins this election, the party’s leaders are going to be confronted with that incoherence pretty quickly.

Englishman Robert Skidelsky, author of the monumental three-volume biography of John Maynard Keynes, notes (correctly) that deficit reduction is the centerpiece of most governments’ current fiscal policy. The rationale, in his words (and correctly stated) is that

“A government with a “credible” plan for “fiscal consolidation” supposedly is less likely to default on its debt, or leave it for the future to pay. This will, it is thought, enable the government to borrow money more cheaply than it would otherwise be able to do, in turn lowering interest rates for private borrowers, which should boost economic activity. So fiscal consolidation is the royal road to economic recovery.”

This very “plausible” narrative, he says, has five “major fallacies.” He makes some good points, but Skidelsky’s counter-narrative has at least two major fallacies:

• First, while the assumption that there is always an interest rate on sovereign debt that’s high enough to attract investors is — in theory, at least — true, he ignores the possibility — as we’ve seen in various eurozone countries — that the interest rate that equilibrates supply and demand may, with the passage of time, result in sovereign bankruptcy.
• Second, after admitting that sovereign default is “bad,” he says that “life after default goes on much as before.” This statement, offered without explanation or example, ranks rather high on the all-time list of heroic assumptions.

Here’s the narrative with which he disagrees. I’ve highlighted those parts with which I’m in agreement.

“First, governments, unlike private individuals, do not have to “repay” their debts. A government of a country with its own central bank and its own currency can simply continue to borrow by printing the money which is lent to it. This is not true of countries in the eurozone. But their governments do not have to repay their debts, either. If their (foreign) creditors put too much pressure on them, they simply default. Default is bad. But life after default goes on much as before.

Second, deliberately cutting the deficit is not the best way for a government to balance its books. Deficit reduction in a depressed economy is the road not to recovery, but to contraction, because it means cutting the national income on which the government’s revenues depend. This will make it harder, not easier, for it to cut the deficit. The British government already must borrow £112 billion ($172 billion) more than it had planned when it announced its deficit-reduction plan in June 2010.

Third, the national debt is not a net burden on future generations. Even if it gives rise to future tax liabilities (and some of it will), these will be transfers from taxpayers to bond holders. This may have disagreeable distributional consequences. But trying to reduce it now will be a net burden on future generations: income will be lowered immediately, profits will fall, pension funds will be diminished, investment projects will be canceled or postponed, and houses, hospitals, and schools will not be built. Future generations will be worse off, having been deprived of assets that they might otherwise have had.

Fourth, there is no connection between the size of national debt and the price that a government must pay to finance it. The interest rates that Japan, the United States, the UK, and Germany pay on their national debt are equally low, despite vast differences in their debt levels and fiscal policies.

Finally, low borrowing costs for governments do not automatically reduce the cost of capital for the private sector. After all, corporate borrowers do not borrow at the “risk-free” yield of, say, US Treasury bonds, and evidence shows that monetary expansion can push down the interest rate on government debt, but have hardly any effect on new bank lending to firms or households. In fact, the causality is the reverse: the reason why government interest rates in the UK and elsewhere are so low is that interest rates for private-sector loans are so high.”

Today, the IMF released updates to its three major publications: the World Economic Outlook (WEO), the Global Financial Stability Report (GFSR), and the Fiscal Monitor (FM).

Their release was preceded by Managing Director Lagarde’s speech at the German Council on Foreign Relations, the full text of which is as follows:

As we turn the page on a turbulent year, a year in which so much of what could go wrong did go wrong, many look to the future with trepidation and foreboding. They worry about uncertain economic prospects, dwindling job opportunities, and rising inequality. About what kind of future awaits their children.

Indeed, in the economic outlook that the IMF will release tomorrow, we will lower growth forecasts for most parts of the world. Even these lower forecasts assume a constructive policy path that is by no means assured.

In too many places, uncertainty is holding back demand and the willingness to lend. A legacy of high public and private debt is hurting economic prospects. The global financial system remains fragile.

In an interconnected world like ours, these forces are feeding each other across borders. Capital flows to emerging markets have already dropped off, and growth is expected to slow even in the most vibrant parts of the world economy. Low-income countries are especially vulnerable.

Yet before we indulge in yet another bout of collective pessimism, which is becoming something of a global sport, let me ask a simple question—why did 2011 turn out so badly?

I would argue that it was not because of any fresh wound to the global economy. No, it was driven instead by a lack of a collective determination to reach a cooperative solution. We saw many false starts and half measures in 2011—in Europe, but also, for instance, in the United States with its debt ceiling debacle.

Put simply, policymakers let an old wound fester, and in doing so made the situation worse.

Looking at it from this perspective, 2012 must be a year of healing. But as Hippocrates put it long ago: “Healing is a matter of time, but it is sometimes also a matter of opportunity”.

And today, it has to be an opportunity of our making. Otherwise, we could easily slide into a “1930s moment”. A moment where trust and cooperation break down and countries turn inward. A moment, ultimately, leading to a downward spiral that could engulf the entire world.

I remain ever hopeful. I believe we can avoid such a scenario. I say this for a simple reason: we know what must be done. That is my core message to you today—although the economic outlook remains deeply worrisome, there is a way out. Now the world must find the political will to do what it knows must be done.

I would like to lay out the core elements of a policy path forward, in three broad aspects:

• First, the path for the euro zone.
• Second, the role of the rest of the world.
• Third, the particular role and responsibility of the IMF.

Policies in the euro zone

I will start with Europe, which is at the center of concerns—not only because of the historical project it represents but, more pointedly, because of the extensive trade and financial linkages that bind everyone else to it.

In coming to grips with Europe’s crisis, I want to acknowledge up front just how far the euro zone has come in addressing the new realities it faces.

Eurozone countries have established their cross-border safety net with the European Financial Stability Facility (the EFSF) and outlined a permanent version of it with the European Stability Mechanism (the ESM)—only two years ago, this was heresy. They have taken a harmonized approach to recapitalizing banks, and set up a systemic risk board. Governance reforms to enforce stronger and more effective fiscal discipline are in train and individual countries are taking tough decisions to rein in fiscal deficits. In addition, the European Central Bank has unleashed impressive resources to make long-term liquidity available to banks.

These major steps must be recognized. Yet I would not be the first to argue that these moves form pieces, but pieces only, of a comprehensive solution. Many within Europe are themselves making this point with increasing forcefulness.

Let me therefore offer my perspective on what remains to be done. There are three imperatives—stronger growth, larger firewalls, and deeper integration.

First, stronger growth. This has a number of dimensions.

With the euro area economy slowing sharply, inflation is already declining and we see a sizable risk that it will fall well below target next year, raising debt burdens and further hurting growth. Additional and timely monetary easing will be important to reduce such risks.

Stronger growth also means preventing banks from going into reverse gear, contracting credit in the face of market pressure. Solutions should focus on raising capital levels—rather than cutting back lending—as the way to boost capital ratios. Maintaining orderly funding conditions is also imperative.

On fiscal policy, resorting to across-the-board, across-the continent, budgetary cuts will only add to recessionary pressures. Yes, several countries have no choice but to tighten public finances, sharply and quickly. But this is not true everywhere. There is a large core where fiscal adjustment can be more gradual. Automatic stabilizers, which let tax revenues fall and spending rise as the economy weakens, should certainly be allowed to operate. And those with fiscal space should support the common effort by reconsidering the pace of adjustment planned for this year.

Some countries still have much to do to boost their competitiveness and growth potential. For this, structural reforms are critical, however medium or long-term their impact might be. As experience tells us, fiscal sustainability depends, ultimately, on generating long-term growth.

Second, we need a larger firewall. Without it, countries like Italy and Spain, that are fundamentally able to repay their debts, could potentially be forced into a solvency crisis by abnormal financing costs. This would have disastrous implications for systemic stability. Adding substantial real resources to what is currently available by folding the EFSF into the ESM, increasing the size of the ESM, and identifying a clear and credible timetable for making it operational would help greatly. Action by the ECB to provide the necessary liquidity support to stabilize bank funding and sovereign debt markets would also be essential.

We must also break the vicious cycle of banks hurting sovereigns and sovereigns hurting banks. This works both ways. Making banks stronger, including by restoring adequate capital levels, stops banks from hurting sovereigns through higher debt or contingent liabilities. And restoring confidence in sovereign debt helps banks, which are important holders of such debt and typically benefit from explicit or implicit guarantees from sovereigns.

This brings me to my third point—deeper integration. In a sense, the crisis is a crisis of incomplete integration. At the euro-area level, the fundamentals look good—the current account is balanced and inflation and the fiscal deficit are both low. But the euro area does not handle internal imbalances well. In addition, a single financial market cannot rely on legal and institutional frameworks that operate on an asymmetric national basis.

To break the feedback loop between sovereigns and banks, we need more risk sharing across borders in the banking system. In the near term, a pan-euro area facility that has the capacity to take direct stakes in banks will help break this link. Looking further ahead, monetary union needs to be supported by financial integration in the form of unified supervision, a single bank resolution authority with a common backstop, and a single deposit insurance fund.

The euro area also needs greater fiscal integration—it is not tenable for seventeen completely independent fiscal policies to sit alongside one monetary policy. To complement its “fiscal compact”, the area needs some form of fiscal risk-sharing, which would allow for common support before economic dislocation in one country develops into a costly fiscal and financial crisis for the entire euro area.

A number of financing options are available to support such risk sharing, including the creation of euro area bonds or bills or, as proposed by the German Council of Economic Advisors, a debt redemption fund. Political agreement on a joint bond to underpin risk sharing would help convince markets of the future viability of European economic and monetary union.

Policies in the rest of the world

Let me now turn to my second broad area—policies in the rest of the world. I have dwelt on Europe only because it is at the epicenter of the current crisis and thus key to the global outlook. But other economies have at least as important a role in getting to a better outcome.

The United States, as the world’s largest economy and the center of the global financial system, has a special responsibility. Yes, it is recovering, but at a timid pace, and unemployment—while declining—remains unacceptably high.

The key policy priorities must be to relieve the burden of household debt and to deal decisively with the issue of public debt.

On housing, we have been calling for ways to make mortgage debt sustainable, including programs to facilitate write-downs. I understand the legal and political complexities but the current strategy is not working satisfactorily, and we need a rethink.

On public debt, American policymakers need to find a way past the partisan impasse, grasping all reasonable means of bringing down tomorrow’s deficits—including by reforming entitlements and raising revenue—without bringing down today’s economy.

This brings me to another worrisome tendency in many quarters—to view fiscal policy as a morality play between profligacy and responsibility. Political and market commentary is too often cast in these terms. Yet markets themselves have been schizophrenic about fiscal tightening, at times rewarding it with lower interest rates, and at other times recoiling at the implied growth slowdown and pushing up interest rates.

To reiterate our advice: credible measures that deliver and anchor savings in the medium term will help create space for accommodating growth today—by allowing a slower pace of consolidation.

What about other countries and regions?

In Japan, there is no way to avoid a credible consolidation plan that brings down public debt in the years ahead. Japan also needs reforms to raise long-term growth.

Countries with current account surpluses, whether advanced or emerging, also have a role to play—primarily by shifting to domestic demand to support global growth. After all, global deficits will shrink only if surpluses shrink too.

Here, China can help itself and the global economy by continuing to shift growth away from exports and investment, toward consumption. To get there, I’m thinking of such measures as fiscal support to household consumption and expanding social safety nets, and liberalizing the financial system. These are all reforms that the Chinese government itself has embraced.

One more point: We must not let financial regulation slip off the policy agenda. We simply cannot carry on with the financial sector that gave us the global financial crisis. We need a safer and more stable financial system, one that serves rather than destabilizes the real economy. While policymakers have made a lot of progress, they still need to complete the reform agenda and ensure that the new standards are implemented in a way that is consistent across countries.

The role of the IMF

Let me now turn to the role of the IMF, my third and final issue.

Clearly, a cooperative path means that all countries must work together with a common diagnosis toward a common solution.

A key role of the IMF is to lay out the inter-dependencies between countries and push for a cooperative outcome.

But the IMF can provide much more than analysis, advice and exhortation.

It can also provide financing when needed. I am convinced that we must step up the Fund’s lending capacity. The goal here is to supplement the resources Europe will be putting on the table, but also to meet the needs of “innocent bystanders” infected by contagion, anywhere in the world. A global world needs global firewalls.

In the coming years, we estimate a global potential financing need of $1 trillion. To play its part, the IMF would aim to raise up to $500 billion in additional lending resources. Right now, we are exploring options and consulting the membership.

In addition to resources, the IMF can also provide a “commitment mechanism” to lock in good policies when funding is not needed. Italy’s request for IMF monitoring of its policies is a good example of this.

Finally, because there has been so much loose talk about special “European bailouts”, let me reiterate a few points. Our financing is for all members, euro area or otherwise. We only lend to individual countries that request support and make strong policy commitments. That said, any support we provide to euro area countries must be anchored in a clear policy framework for the entire euro area. To safeguard our members’ resources, we have a responsibility to lend into sustainable debt positions. Our role is to catalyze, not indefinitely replace, private financing.

Conclusion

Let me wrap up. Although we all know what must be done, I realize that none of this will be easy. I understand the great political challenges facing policymakers.

I understand the frustration of the Europeans, who have built such a remarkable project out of the ruins of World War II. No, monetary union did not get everything right, but the global financial crisis that started across the Atlantic exposed its vulnerabilities more starkly. I also understand why Europeans feel that the difficult decisions they have taken are not being sufficiently recognized.

I also understand the frustrations of the rest of the world. Just as they were picking up the pieces after the 2008 crisis, they watch their recovery being blown off course by trouble in Europe. They wait for a resolution to this crisis that never seems to come, on a continent they feel is rich enough to resolve its problems on its own.

I understand the pain felt in those European countries that need to adjust, and the difficulty of sharing the burden in a way that is socially fair. But I also understand the feelings in countries that have been thrifty, asked to help those who could have managed their economies more prudently.

But what we must all understand is that this is a defining moment. It is not about saving any one country or region. It is about saving the world from a downward economic spiral. It is about avoiding a 1930s moment, in which inaction, insularity, and rigid ideology combine to cause a collapse in global demand.

The longer we wait, the worse it will get. The only solution is to move forward together. Our collective economic future depends on it.

More than most, Germany understands the virtues of determined solidarity. Through its experiences with its Soziale Marktwirtschaft and unification, it showed what can be accomplished by bringing everybody together in service of the common good. The world needs a strong leadership role from Germany today, and it is Germany’s core interest to provide such a role.

Let me end with a quote from Goethe: “It is not enough to know, we must apply. It is not enough to will, we must do.” (Es ist nicht genug, zu wissen, man muß auch anwenden; es ist nicht genug, zu wollen, man muß auch tun). This is the challenge of our year ahead.

Below the fold are the summaries and charts from the publications.

Continue reading ‘International Monetary Fund Updates’ »

As indicated by the fact that I haven’t added to this series of posts since the start of the year, the recent decoupling of the US equity market from events in Europe has made me complacent. I figure that the best way to prevent myself from paying (figuratively and literally) the consequences of overconfidence is to make sure that I once again pay very close attention to the goings-on “over-there.”

——————–

The FT’s Wolfgang Münchau is upset with the IMF for earmarking 91% of its definitive commitments to programs in Europe. He says “no” to these two questions:

• Would an increase in IMF funds to bail out the eurozone be justified?
• Should non-eurozone countries participate in raising new capital?

Here’s his case:

It is not necessary because the eurozone has the financial capacity to help itself . . . Considering that the eurozone is economically unconstrained, and among the richest regions in the world, the request to involve the IMF in hypothetical future rescue operations is morally reprehensible. What is happening here is that eurozone member states find it hard to commit additional funds to the rescue operations, and find it politically more expedient to channel resources through the IMF as a way to bypass national parliaments.

But there is an even more important argument in my view. The way the eurozone member states have been dealing with the crisis has increased the chances of a catastrophic outcome. An extension of the IMF’s commitments is very likely to support current policies.

[...] The eurozone’s cumulative policy errors are turning a liquidity squeeze into a solvency crisis. And herein lies an acute risk for the IMF. If Italy were to become trapped in a long recession, the probability would increase significantly that it would not be able to repay its debt, currently at 120 per cent of GDP. News reports from Italy suggest that the IMF is about to forecast a two-year recession for the country, which could well lead to an increase in the debt-to-GDP ratio at the end of that period. Italy’s future solvency is entirely dependent on market interest rates and the prospect of a return to strong and sustainable economic growth. I struggle to think how this can be accomplished without a fiscal union and much greater burden-sharing.

There are additional technical arguments that would favour more cautious IMF involvement. Mario Blejer, the former governor of the central bank of Argentina, argued recently that the IMF’s preferred creditor status could become a problem, as an IMF loan would automatically subordinate every other bondholder. The probability of a default on those defaultable bonds is thus significantly higher. Furthermore, the situation could become so acute that the IMF’s seniority might fail, which in turn would endanger its capacity to lend at low interest rates.

There are several proposals on the table for how to involve the IMF in a clever way. But they all are subject to the same problem. Any outside liquidity assistance would encourage the eurozone to proceed with policies that are aggravating the crisis.

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Evidently, Münchau was responding to IMF chief Lagarde, who today said that the Fund was ready to help the eurozone and was seeking to increase its lending resources by up to $500 billion. She went on to say that the IMF estimates that in coming years, additional global financing of potentially $1 trillion could be needed.

She then said that there are three imperatives are needed to fully restore confidence: stronger growth, larger firewalls, and deeper integration. Regarding the second of the imperatives, Lagarde called on European policymakers to create a larger firewall. Without it, she stated, countries like Italy and Spain, that are fundamentally able to repay their debts, could potentially be forced into a solvency crisis by abnormal funding costs―a development she warned would have disastrous consequences for systemic stability.

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The FT reports that, soon after Lagarde’s address, Germany appeared to soften its longstanding resistance to increasing the eurozone’s rescue funds (to €750 billion) in exchange for strict budget rules in a new fiscal compact.

According to German and eurozone officials, Angela Merkel is prepared to let the existing European Financial Stability Facility, which has about €250bn in unused funds, run in parallel with its successor, the €500bn European Stability Mechanism, the launch of which has been brought forward to July.

In return the German chancellor wants eurozone heads of government to sign up to rules to cut budget deficits and public debt that are much tougher than those currently foreseen by eurozone governments.

The most recent version of the fiscal compact would allow governments to breach deficit limits in “periods of economic downturn” – a phrase criticised by the ECB as an “escape clause” that could lead to “easy circumvention” of what are meant to be cast-iron rules.

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On a positive note, US money market funds have begun moving back into European bank paper, a sign that central bank efforts to backstop key institutions are improving risk appetite.

This past week, the funds were buyers in increased issuance of French and Spanish banks’ commercial paper, according to bankers. Notes issued by US banks with foreign parents rose $6bn to $152bn and foreign domiciled bank notes outstanding rose nearly $3bn to $133bn, according to figures from the Federal Reserve.

Last year, money market funds were sellers of many European banks’ short-term commercial paper as worries grew about the repercussions of a possible European sovereign default. That was a critical factor in market anxiety, as the highly rated funds’ $2.7tn in liquid assets are a key source of dollar funding.

Money market funds bought French bank paper with maturities as long as one month, as well as small amounts of Spanish bank paper, according to bankers. The funds also bought longer-dated UK, Dutch and Scandinavian bank paper, up to six-month maturities.

The move comes despite France losing its triple A-rating but after a series of strong auctions for Spanish and French sovereign debts and hopes that Greece will reach agreements with creditors to avoid a default in the spring.

The former President, who presided over the Roaring Nineties, says that “Charity needs capitalism to solve the world’s problems“:

Charity alone will not solve the world’s problems. Capitalism can help and at the same time put people back to work. There has always been a gap between what the government can provide and what the private sector can produce, a gap charities have long helped to fill. But as our world and economies evolve, we have an opportunity and a responsibility to reconsider how to fill this gap – to rethink the relationship between economic and social challenges, so that benefits and opportunities are available to more people.

First, this rethinking is necessary because people are demanding it. From Zuccotti Park to Tahrir Square, people are standing up and saying that for too many citizens the current systems are not working.

Second, the financial crisis has made plain that the path we were on was unstable and unsustainable. While our global economic system has brought benefits to many, it has also exacerbated inequalities, both within and among countries. Too much inequality not only hurts the poor and stifles the dreams of the middle class, it also hinders productivity and growth.

Finally, our increasing interdependence strengthens the link between our prosperity at home and prosperity abroad. It is hard to sell things people cannot afford to buy. Also, economic privation breeds political resentment with all its costly consequences. We therefore have a vital stake in the fates of others – a stake that extends beyond compassion to political stability and economic security.

How do we change course, to merge social and economic progress? Haiti offers us some lessons. Earlier this month, when I travelled there to mark the second anniversary of its devastating earthquake, I could feel a palpable change in the country. Much of this has to do with the focus and drive of the new government. But a lot of it is also due to the approach of Haiti’s friends and partners – an approach driven more by empowering people and communities than by imposing external solutions. My good friend Denis O’Brien and the Digicel Group not only employs 70,000 Haitians, they also rebuilt the famed 19th-century Iron Market bazaar, one of the capital’s landmarks, to create jobs for others, and give charitably to education to ensure that there will be a better educated, more employable workforce. Another example from Haiti is an innovative fund set up by the Carlos Slim Foundation and Frank Giustra to invest in entrepreneurs – giving them a hand up, not a handout.

We are starting to see the success of this new approach in other countries and sectors as well, in the approach of the Bill and Melinda Gates Foundation, in companies such as Walmart, Google and Procter & Gamble that have shifted their corporate culture from promoting social responsibility to increasing shared value.

This is the lesson that we learnt while working to solve the Aids crisis, when the pharmaceutical industry moved from being a low-volume, high-margin business to a low-margin, high-volume one with guaranteed payments. Today, this system is providing millions of people around the world with lifesaving HIV/Aids treatments at much lower costs while also improving the profitability of the companies involved. Similar lessons were learnt from our work with farmers in Africa: by helping them access the fertilisers, seeds and markets they need, we could provide them with a fundamentally more sustainable way to lift their families from poverty than we could ever hope to achieve through traditional charity. The lessons of this work and the benefits of boosting productivity are clear.

The common thread through all this evidence is that private wealth can effectively advance the public good when governments, businesses and non-governmental organisations work together to share expertise and implement lasting solutions. When our bottom line is more about strengthening the future than maintaining the present, and when our financial interests are aligned with our social ones, we will be closer to the kind of world we want all our children to live in.

One of the ways in which I have been trying to support the work of leaders around the world as they rethink our approaches to global problems is via the vigorous discussions and diverse commitments that are generated through our Clinton Global Initiative. To date, members of CGI have made more than 2,100 commitments that have already improved, or are now helping, the lives of nearly 400m people in 180 countries. Many of these commitments reflect the new approach to problem-solving by better aligning the interests and objectives of private corporations, governments and non-governmental organisations. Beyond their specifics, the goal of these projects is to work ourselves out of a job – not to generate perpetual aid dependence.

These efforts benefit both the communities they target and the corporations and philanthropists involved, diversifying their businesses, expanding their markets, training more potential workers and helping to create a culture of prosperity. All this enhances profits, increases economic inclusion and gives more people a stake in a shared future.

Because of these developments, and in spite of current economic conditions, I am hopeful for the future. The problems we face are solvable: we have the means. What we need is innovation, imagination and commitment. The most effective global citizens will be those who succeed in merging their business and philanthropic missions to build a future of shared prosperity and shared responsibility.

There are, of course, a wide variety of opinions. This paper discusses most, if not all, of them. Take your pick.