Monday, October 17, 2011

IMF Understates Its Potency, Europe Overstates Its Unity

Mme. Lagarde seems fairly sure that the IMF doesn't need any more boosts to its financial firepower.  This is not comforting in light of a mounting Eurpoean political logjam.  Greek politics are in paralysis, stifling any pro-austerity vote and emboldening civil servants who refuse to do their jobs and citizens who refuse to pay taxes.  German officials are dialing down expectations for next week's EU summit, telegraphing to all parties the high price Germany will charge for acquiescing to even a minimal bank bailout plan.  Europe's inability to stick to the details of an agreed-upon plan has made staving off sovereign defaults much more difficult to solve.  Both debtors and creditors are unwilling to meet in the middle.

If the IMF has already secured a promised backstop from the U.S. then Mme. Lagarde has every reason to be confident that no further reserves are necessary.  The Fed has already established a precedent of unilaterally offering swap lines to foreign banks, which amounted to $16T worth of loan guarantees during the last round of this crisis.  On the other hand, if European political leaders think that tighter vertical EU integration will be the deus ex machina needed, they must know that it will not fit this timeline.  One week is not enough time to both forge a revised EU constitution and ramrod it through every member state's parliament. 

The most probable result of next week's action will be another toothless agreement in principle, followed by noncompliance from the PIIGS and immediate sovereign debt downgrades.  We will then see whether the IMF activates its pre-existing swap lines with the Fed, and whether those loans stay locked into Eurpean banks' reserve requirements as non-hyperinflationary balance sheet decorations.