This post originally appeared on the blog of the Peterson Institute for International Economics
A letter to Christine Lagarde, Managing Director of the International Monetary Fund (IMF)
Dear Madame Lagarde,
Europe is in deep trouble, possibly on the verge of catastrophe, and as a consequence so might be the world. You represent that world and you need to act quickly and decisively, and I am afraid somewhat solitarily. You need to quickly mobilize international resources to help address the problem in Europe, which in turn would help minimize the risks to the rest of the world.
You will have to fight and win this case on intellectual merits because most of the major powers will either explicitly resist you (Europe, especially Germany), subtly undermine you (the United States), or not support you enough (China and India).
Europe will keep telling you that they will call upon the Fund if and when they need it. You too keep echoing that by saying, “If Europe needs us…etc., etc.” You should stop taking your cues from Europe. Europe thinks it has the resources to avoid this Armageddon—maybe it does but it, or rather Germany and the European Central Bank, are behaving as if they do not have the money or are unable to mobilize the money. In any event, you and the world cannot afford to dance to the tune of European dithering and brinkmanship. The fact is there is some—non-trivial and rising—probability that Europe and the world will need the resources of those able to provide them in large quantities and quickly to avert meltdown or its aftermath. You need to mobilize those resources fast.
The fact is a tectonic shift has occurred in the global economy: The identity of potential international borrowers and creditors in the future has changed. More and more of the larger countries and yesterday’s creditors are today’s potential borrowers. Some have indeed started borrowing, and the queue of those with cap in hand outside your door is lengthening.
Today’s financial crises, like the 2008–09 crisis in the United States, requires invocation of the Powell doctrine: the application of overwhelming force. Calming markets requires occasionally reminding them that they can be reduced to irrelevance by enough firepower on the other side. Combine this doctrine with the prospect of many countries the size of Italy borrowing from the IMF in the years ahead, and you quickly realize that the IMF needs at least 1 if not 2 trillion dollars worth of resources, hopefully most of it serving as insurance. But if you actually do need to use the money, wouldn’t you be glad that you had mobilized it beforehand? The case for a bigger IMF is therefore both short-term—dealing with Europe—but also long term because of the nature of the countries that have become potential supplicants.
You cannot get these large sums of money right away, but you need to make a start right now. You need to present a plan to that effect in the next few days and dare the G-20 finance ministers, who are due to meet soon, to overrule you. Remember, you have first-mover advantage. You propose. You define the default. You shape the status quo. Effort is required on the part of the others to defy or obstruct you.
I want to go through the depressing list of sources of opposition or lack of support for such a plan and how to deal with them. But let me offer advice on who you should have on your side in order to take on this weighty array of naysayers.
Brazil and Russia: Brazil and Russia have shown that they will support you. Brazil genuinely believes in the need for cooperation in times of trouble and has already offered to put up some cash. And Russia likes to flaunt its oil wealth and desperately wants to regain its Soviet-era seat at the table. Forget the motivation, take the cash and support. Hopefully, other oil exporters—such as Norway and Saudi Arabia—will also contribute.
China: Following the oil is generally a good strategy, but following China is essential. Only China has the kind of cash to make your initiative succeed. There are two ways to persuade China: the direct way and the manipulative way. The direct way is to say that China, for its contribution, will be given a much bigger say in the way the IMF is run.
I have written elsewhere that China needs to be given power in the IMF equivalent to that of the United States and greater than that of Europe. You need to convince China that you will make that argument forcefully and if necessary take on your erstwhile French colleagues if they resist. That is key. On this you must speak with conviction and daring.
Remember, China’s leaders may not have to face voters periodically, but they are vulnerable to these telling questions domestically: why should we invest our billions to rescue much richer countries, banks, and individuals when there is poverty at home? Wouldn’t that be immoral hazard? The one way they can take their population along would be for Chinese leaders to say, “The returns for rescuing the rich are not just that we help ourselves because they buy our goods and we need to help them to continue doing so. The returns also are that the world has finally recognized that we the Chinese will have the same status as the United States in determining how to run the world. The world has now accorded us this status.” Tapping into that nationalist pride—wounded since Lord George Macartney set foot on Chinese soil in 1793–94—should not be underestimated.
If that is not enough, play the Japan card. Get the Japanese—consistently underestimated for their qualities as good global citizens—to contribute another few hundred billion dollars to the IMF, and China will be shamed or goaded into matching its Asian rival. That dynamic has been at work in Asia, for example, in the context of the Chiang Mai initiative to set up an Asian Monetary Fund. Exploit it at the multilateral level.
And, of course, you might want to gently remind the Chinese that some of the resources they would be contributing to the IMF were acquired on the back of beggar-thy-neighbor exchange rate policies. Plowing them back for the collective good through the IMF would be partial redemption for those policies.
Now for the naysayers.
United States: The United States will not support you in this effort. The United States has an incentive to believe that the IMF does not need more firepower because it knows that, fiscally compromised as it is, it cannot contribute to any extra resources and will therefore see your initiative—correctly—as leading to a reduction in its power and influence. No superpower will happily acquiesce in being stripped of such power, and the United States is no exception. Equally, though, if you do set this ball rolling, there are enough people with good sense and cosmopolitanism in this somewhat fading power who will come around to your position and be willing to make your case domestically.
Europe: Clearly, Europe will resist you not just because it thinks it can solve its problems on its own. As important, Europe, and especially France, projects its power internationally through the IMF in which it has acquired inordinate influence, and will be loath to give it up. But it will have to. You will have to remind the Europeans: In financial institutions, creditors have power, not debtors. And for several decades in the IMF, Europe has behaved like a powerful creditor. But now it is a debtor or at least forced itself into being a debtor. You must stress that what was good for the European goose is now good for the Beijing duck.
But you should also tell your French friends this: An IMF that is seen to be involved in, and helping/rescuing Europe, should offend European pride enough for the Europeans to try and find more of the resources on their own. That is why many in Europe resisted IMF involvement in the sovereign debt crisis last year. This resistance applies in particular to Germany and the European Central Bank. Dangling the threat of outside help can elicit more European effort.
The moral hazard brigade: Then you will have to take on the moral hazard fetishists—notably Germany but also people on the far right in the United States—who will see a bigger fund as encouraging reckless behavior in the future. Your argument should be that countries—especially democratic ones—are less prone to moral hazard. Ask Prime Minister George Papandreou of Greece or even the soon-to-depart Prime Minister Silvio Berlusconi how pleasant it is to be a supplicant and to implement austerity measures dictated by outsiders. Or tell them about why the Asians will do their best never to borrow from the IMF because of the humiliation involved.
Germany: But in convincing Germany you must also outline how this crisis might damage Germany economically. If the euro area falls apart, it would reflect the failure of the core (Germany) to hold it together. Germany has potentially speeded that end because of its reluctance to finance Greece and stimulate its own economy, which would provide opportunities for Greece and other periphery countries to export. The consequence of a euro implosion would be the worst of all adverse competitiveness shocks for Germany. Once the euro collapses, and as the neo-drachma, nuovo-lira, nuevo-peseta, and even nouveau–French franc rise from its ashes, their values are likely to settle at levels producing a 50 percent real appreciation of the neue–Deutsche Mark. Germany would face collapsing exports, plummeting growth, and soaring unemployment—and not that much fiscal firepower to throw at these dire problems. These troubles could be seen as the payback for its miserliness today. Avoiding that outcome should make Germany rethink its domestic policies and its resistance to IMF involvement.
(As an aside, please do ask the Germans what model of political economy they had in mind when they offered the Greeks the deal of austerity for the next ten years so that they could reach a debt-to-GDP level in 2020 of 120 percent of GDP, a level which Italy today finds difficult to defend vis-á-vis markets. How is austerity today, followed by more austerity tomorrow, an acceptable strategy for democratically elected politicians? In German, is there a different expression for “light at the end of the tunnel?”)
India: If India is not willing to contribute at least 25 percent of what China will, ask them why they deserve a seat at the high table. At least, tell them to stop complaining about the inequities of the international system if they do not exert themselves even a little to rectifying them.
Mme. Lagarde, yours is an unenviable task. But you have the bully pulpit, a fount of goodwill, the power of making a compelling argument, the first-mover advantage.
Greece is sinking, Rome is burning, and one of humanity’s most lofty projects—that strove to overcome difference for the sake of achieving a common ideal—is imperiled. Europe needs help to be saved from itself and the world needs to be saved from Europe too. Please stop taking the phone calls from Berlin, Brussels, Paris, and Frankfurt. Please be the internationalist that the world hopes and expects you to be. And please hurry.