Who should lead the IMF?

Writing for Project Syndicate Eichengreen gives an answer:

"Now, however, the rumor mill is heating up with gossip that the Fund’s managing director, Dominique Strauss-Kahn, will leave in order to oppose Nikolas Sarkozy in the 2012 French presidential elections. Sarkozy’s popularity is hitting new lows, and Strauss-Kahn’s friends say that he has never made a secret of his political ambitions."

"A lame-duck managing director would hamstring the Fund. Already there is a sense that the IMF is reluctant to tell Europe more forcefully how to handle its problem with Greece because the managing director must be careful to avoid meddling in Europe’s internal politics."

"On top of this now comes the interesting news that the IMF has appointed Zhu Min, previously a deputy governor of the People’s Bank of China, as special adviser to Strauss-Kahn. Zhu will thus be part of the core management team."

¡It was't ready!

In this post I quoted Krugman, Eichengreen and Roubini in order to have a Euro-zone’s Big Picture.

Krugman said that the troubles came from the adoption of the euro before Spain and Greece were ready:

Now what? A breakup of the euro is very nearly unthinkable... As Berkeley's Barry Eichengreen puts it, an attempt to reintroduce a national currency would trigger "the mother of all financial crises". So the only way out is forward: to make the euro work, Europe needs to move much further toward political union, so that European nations start to function more like American states.

But that's not going to happen anytime soon. What we’ll probably see over the next few years is a painful process of muddling through: bailouts accompanied by demands for savage austerity, all against a background of very high unemployment, perpetuated by the grinding deflation I already mentioned.

It’s an ugly picture. But it’s important to understand the nature of Europe's fatal flaw. Yes, some governments were irresponsible; but the fundamental problem was hubris, the arrogant belief that Europe could make a single currency work despite strong reasons to believe that it wasn’t ready.

Eichengreen emphasized the failure to create a "proper emergency financing mechanism"

[…] reating the euro was not a mistake, but it could still be a mistake in the making. The Greek crisis shows that Europe is still only halfway toward creating a viable monetary union. If it stays put, the next crisis will make this one look like a walk in the park.

Completing its monetary union requires Europe to create a proper emergency financing mechanism. Currently, other member states can provide assistance to Greece only by bending the rules, which prevent them from lending except in response to natural disasters or circumstances beyond a country's control. This heightens uncertainty. When Europe’s leaders do help, it makes the public and markets think that they are being dishonest. If it is the Lisbon Treaty that creates these problems, then the Lisbon Treaty should be changed.

Roubini requested a "partial bailout by the EU and the ECB […] in order to avoid the risk of contagion to the rest of the euro zone"

A shadow or actual International Monetary Fund program would vastly enhance the credibility of a policy of fiscal retrenchment and structural reforms. Under the former, the European Commission would impose fiscal and structural conditionality on Greece, while the EU and/or ECB would provide financing, which would be absolutely necessary, because announcing even the best conceived reform program would not be sufficient to restore lost policy credibility. Markets will remain skeptical, especially if implementation leads to street demonstrations, riots, strikes, and parliamentary foot-dragging. Until credibility is re-established, the risk of a speculative attack on public debt – reflected in the current rise in credit default swap spreads – would linger, given the ongoing budget deficit and the need to roll over maturing debt.

Since the European Union has no history of imposing conditionality, and ECB financing could be perceived as a form of bailout, a formal IMF program would be the better approach. The most successful programs undertaken in the presence of a risk of a fiscal and/or external debt financing crisis were those – as in Mexico, Turkey, and Brazil – where a large amount of liquidity/financing support by the IMF beefed up an increasingly credible commitment to adjustment and reform.

Sovereign spreads are already pricing the risk of a domino effect from Greece to Spain, Portugal, and other euro-zone members. The EU and the ECB are worried about the moral hazard of any "bailout". But that is precisely why a credible IMF program that ties financial support to the progressive achievement of fiscal and structural reform goals is the right way to teach Greece and the other PIIGS how to fly.

Risky, Costly and Complicated

Eichengreen listed the risks for countries tempted to abandon the Euro

"[…] The temptation to exit the euro area remained, the technical barriers to exit would be almost impossible to surmount. It would be straightforward for a parliament or congress to pass a law mandating that the state and other employers would henceforth pay workers and pensioners in the new national currency. But with wages and other incomes redenominated into that national currency, it would become necessary to redenominate the mortgages and credit card debts of residents into the national currency as well. Currency depreciation would otherwise have adverse balance sheet effects for households, leading to financial distress and bankruptcies."

Only time will tell

Accordingly with Barry Eichengreen:

"China is making a big push to encourage greater international use of its currency, the renminbi. It has an agreement with Brazil to facilitate use of the two countries’ currencies in bilateral trade transactions. It has signed renminbi swap agreements with Argentina, Belarus, Hong Kong, Indonesia, South Korea, and Malaysia. Last summer, it expanded renminbi settlement agreements between Hong Kong and five mainland cities, and authorized HSBC Holdings to sell renminbi bonds in Hong Kong. Then, in September, the Chinese government issued in Hong Kong about $1 billion worth of its own renminbi-denominated bonds."

"All of these initiatives are aimed at reducing dependence on the dollar both at home and abroad by encouraging importers, exporters, and investors to make more use of China’s currency. The ultimate goal is to ensure that China eventually gains the flexibility and financial prerogatives that come with being a reserve-currency country."

For the moment, the patient is stable

Barry Eichengreen señala que es complicado poder determinar el valor tipo de cambio en el corto plazo (vs. euro o vs. yen o vs. renminbi o vs. una canasta de divisas), el mismo se equivoco en "Why Now is a Good Time to Sell the Dollar". Señala que la volatilidad del dólar en los últimos meses se origina por la re-configuración del apetito al riesgo global. Sin embargo dos factores estructurales deben de considerarse como claves:

The one thing that could precipitate the demise of the dollar would be reckless economic mismanagement in the US. One popular scenario is chronic inflation. But this is implausible. Once the episode of zero interest rates ends, the US Federal Reserve will be anxious to reassert its commitment to price stability. There may be a temptation to inflate away debt held by foreigners, but the fact is that the majority of US debt is held by Americans, who would constitute a strong constituency opposing the policy.

The other scenario is that US budget deficits continue to run out of control. Predictions of outright default are far-fetched. But high debts will mean high taxes. The combination of loose fiscal policy and tight monetary policy will mean high interest rates, sluggish investment, and slow growth. Foreigners – and residents – might well grow disenchanted with the currency of an economy with these characteristics.