Plans for European Monetary Fund well advanced

European politicians have revealed that a European Monetary Fund is already in the planning phase. The reports suggest that this fund may be the mechanism through which the Eurozone will defend the sovereign debt of members and impose austerity conditions where necessary. The Europeans have – for political reasons – stressed that this fund will not compete with the IMF. However,  it is clear that the fund’s purpose is to prevent a recurrence of the Greek situation without the need for IMF intervention. The first decisions in creating the fund are already set to made next week.

When the Greek sovereign debt crisis reached a critical state last month, it became apparent that the Eurozone lacked a credible mechanism through which both to defend a sovereign debtor like Greece and to impose harsh austerity measures to ensure compliance with the stability and growth pact. This is now seen as a fundamental flaw in the design of the Eurozone. Crucially, politicians in core Europe were under enormous pressure to force Greece to make binding commitments to budget deficit reduction in exchange for some type of bailout.

The Maastricht Treaty, which is the basis for the Eurozone, has a bailout clause in Article 119 that comes into effect when difficulties arise. It allows assistance:

where such difficulties are liable in particular to jeopardize the functioning of the common market or the progressive implementation of the common commercial policy. 

Moreover, the Lisbon Treaty, which amends the Maastricht Treaty, has similar language in Article 122 where it reads that the EU may intervene with aid where a member state is:

seriously threatened with severe difficulties caused by natural disasters or exception occurrences beyond its control, the Council [of governments] on a proposal from the Commission may grant, under certain conditions, Union financial assistance to the member state-concerned.

This is all fine and good. However, deciding what kind of assistance to offer has been an intractable political problem. The only statement from the EU on the debt crisis in Greece to date offered no financial commitments for Greece and was merely a show of “psychological and political support.” Some have argued all along that this is all that was needed. However, if things spiral out of control for Greece or other affected Eurozone members like Spain or Portugal, the EU will need a better solution.

And they have found one in the proposed European Monetary Fund – which most definitely is an alternative to the IMF.

When Ireland was the talk of the town, I predicted that they would eventually need to go to the IMF to resolve their difficulties. But, Ireland resolved its problems through harsh austerity measures. As Greece was unwilling to take these same measures, a sovereign debt crisis ensued. However, the EU have been unwilling to use the IMF in Greece’s case for three principal reasons:

  • This gives the Americans 9and the Chinese) a say in EU fiscal and monetary policy;
  • The IMF head Dominique Strauss-Kahn is a political rival of the French President Sarkozy who Sarkozy wants to prevent from claiming an economic achievement;
  • The Europeans see the use of IMF in the Eurozone as a humiliation because many see the IMF as a vehicle to help developing countries who cannot fend for themselves

So, it seems the IMF is out and the European Monetary Fund is in.

Financial Times Deutschland provides a little colour in my translation below. Notice the provision to specifically preclude Euro member states from receiving financial assistance from the IMF, something Greece has threatened to do.

The [German] federal government is working on a Monetary Fund for the euro area. "For the internal structural design of the euro zone, we need an institution that has the experience of the IMF and analogous implementation authority," Finance Minister Wolfgang Schäuble (CDU) said to the “Welt am Sonntag” newspaper. He will make suggestions about this soon.

According to information obtained by FTD, plans in the Finance Ministry are well advanced. Schäuble still wants to co-ordinate plans with the French government in order to push them through more easily at a European level. According to information from within EU circles, the first preliminary decisions could even come next week.

The plans in Berlin suggest that liquidity support for euro member states would be available in future debt crises. This would be subject to strict conditions. The Euro Group would decide unanimously whether one is helped, and under what conditions – to the exclusion of the affected member. Euro countries would also promise to receive no money from the International Monetary Fund (IMF). This is to avoid a situation in which the U.S. or China has influence on internal Eurozone affairs.

In order to maintain pressure on borrowers and investors, aid from the Fund shall under no circumstances be taken for granted. Rather, the possibility of state insolvency must continue to exist. As a last resort withdrawal from the monetary union should also be possible.

Preventively, violation of the Stability and Growth Pact must be punished much more severely than previously, according to the Finance Ministry plans. Thus, in the future, the EU could withhold funds from the Cohesion Fund if a deficit country is not saving enough. Voting rights of a euro area country could be suspended for at least a year if the country is in breach of European monetary rules.

The plans for a European Monetary Fund is an admission that the Stability and Growth Pact has failed in the debt crisis. So far, the currency regime of the euro-zone provides no help for a distressed member. In Greece, crisis pushed the rules to the limit: Investors bet on a Greek bankruptcy. The speculation subsided only after leading euro-zone countries such as Germany, granted a sort of implicit guarantee for Greece.

These reports that a European Monetary Fund is coming are very credible. And I believe this will be the mechanism through which future sovereign debt crises within the Eurozone will be handled.

Watch for commentary from non-Eurozone member states like Sweden, Demark and the UK for an idea of whether this mechanism will be successful. I would also be interested in whether the UK gets cover because they are outside the Eurozone. I anticipate this will be a sticking point since the Structural Funds and Cohesion Funds that will be used as the stick for austerity are EU-wide, whereas the principle problem here is a mismatch between fiscal and monetary sovereignty within the Eurozone. The UK could then be seen as a free rider, able to benefit from EU-wide bailouts without having to enter monetary union.


Pläne für EU-Währungsfonds werden konkreter – Der Standard Austria

Schäubles Eurofonds-Pläne liegen schon in der Schublade – Financial Times Deutschland

  1. Anonymous says

    Eventually if there is no other plans let Greece to orderly default on some bonds and German and French banks which invested into the country without “due diligence” will simply acknowledge the loss. It’s like the sub-prime experience: if banks continue to invest in junks without further analysis, governments and other international organisations should not continue bail them out. I must say that in this respect German bankers are unfair: they invest in sub-primes or in bonds with high interest rates and lower rating, then when their bets turn sour they go back to governments and ask for help. Can we stop this?

    1. Edward Harrison says

      Agreed. The German and French banks are loaded with toxic paper. Assuredly, they are over-exposed in Greece and Spain and other places where interest rates were higher just as they were in subprime. They were clearly reaching for yield in a reckless way – we’ve already seen that.

      Should they be bailed out? Of course not. Will they be? Well, let’s wait and see what happens in Greece. If Greece defaults, the number of possible scenarios increase markedly.

      1. Marshall Auerback says

        They could all avoid bailout via a 1 trillion euro per capita distribution to all countries from the ECB, which helps to bring their debt ratios down. Ultimately, they can repeat the exercise until the debt ratios are below the stupid SGP thresholds and they can all sustain higher rates of domestic demand via fiscal policy. Martin Wolf was right to highlight the inconsistent position of Germany: it wants to be a huge exporter but at the same time wants the nations it exports to to destroy the purchasing power in their economies through fiscal austerity programs. Unless Germany is prepared to increase domestic demand then it cannot expect fiscal austerity among its principle trading partners to help its export ambitions. The fact that Germany is now in this imbroglio is a reflection of the failed structure of the EMU. The Germans will never admit that but that is the core problem. The French seem to understand this better, judging from the recent comments of Christine Lagarde, their finance minister.

        1. Edward Harrison says

          I don’t see a money drop as a likely political scenario given German domestic opinion. Whether it works is another question. Politically, it’s not feasible.

          1. Marshall Auerback says

            You can comment on the politics more knowledgeably than me. I’m just making an economic observation. They are all in the same roach motel together, including Germany, and the sooner the Germans recognise that, the quicker we’ll get to a viable solutuon. Right now, we’re just putting Band-Aids on cancerous lesions.

        2. Edward Harrison says

          I’ve given up on that. You saw my “mindset won’t change” post:

          After two plus years of economic stagnation, we’ve reached a point – everywhere it seems – where policy making is increasingly dominated by political concerns. People are fed up with the status quo. They want no more economic pain. And it’s my feeling that this has led people to crawl back into their ideological positions and hold firm.

          This is what I see happening in Europe. This is what I see happening in healthcare, on stimulus and on deficits in the U.S. and it is what I see happening in the U.S. – China debate as well.

          It makes sense that in 1931 the same general recession weariness began to manifest itself in the same political way – and that this increased the likelihood of a catastrophic depression.

          Ultimately, this leads us back to the stimulus package and bailouts and their importance. You only get one crack. This is what I said in early 2009. It was what Krugman was saying. And he was right. Obama wasted a golden opportunity; he should have applied a LOT more stimulus, nationalized and liquidated bankrupt financial institutions, and hit the reset button. The Chinese, at least, understood the stimulus part.

          Now, we are still in an economic malaise and the political battle lines are hardened. Frankly, the collective political mindsets will not change. Unless we do a miraculous V-shaped recovery, there is a lot of downside from here in Europe, the U.S. and globally.

Comments are closed.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More