Thursday, June 2, 2011

Why Christine Lagarde as Head of the IMF Will Mean Higher Taxes or Higher Inflation for Americans

Former World Bank chief economist Simon Johnson correctly explains the situation:

Today the French government is working overtime to make sure that a Sarkozy loyalist, the leader of his economic team — Finance Minister Christine Lagarde — becomes the next managing director--- Why do France and other euro-zone countries now care so much about who runs the I.M.F.?

...the I.M.F. is now essentially lending euros to the euro zone through its various bailout programs.

Does this make sense?

No, unless you understand that the goal of these various bailouts is to ensure that German and French taxpayers do not realize the full extent of their losses or appreciate the ways in which their banks have been mismanaged.

Such lending could just as easily be made by other euro-zone countries, from current resources or by borrowing in the markets. Germany, for example, has plenty of fiscal credibility and issues some of the lowest-risk sovereign debt available. But even if all the money lent to Greece in this fashion were repaid, this would look bad — to German voters (and to French voters, because France would have to lend, too).

Such loans are much more risky than commonly supposed. The I.M.F. does eventually get its money back nominally, but not always in real terms (adjusted for inflation) and not on a risk-adjusted basis (that is, the interest rate charged does not include proper compensation for the risks being taken). There is a very real possibility that some or all of the monies lent will not be paid back in the foreseeable future.

The I.M.F., which is, in this regard, essentially a credit union owned by 187 countries — with voting based on ownership shares that reflect relative economic size. The European Union owns about 30 percent of the I.M.F., so 70 percent of any money at risk belongs to other countries: about 17 percent to the United States, 7 percent to Japan, 35 percent to emerging-market nations and the rest to other countries.

The managing director of the I.M.F. is the impresario of any bailout and oversees the big decisions that must be negotiated with all significant stakeholders. This leaves enormous scope for discretion.

Ms. Lagarde, or any managing director, could directly influence the terms of I.M.F. involvement — and based on her negotiating position to date within the euro zone, we can presume she will lean toward more money, easier terms and, above, all no losses for the banks that made foolish loans.

Increasingly, it looks as though the euro-zone leadership, under French guidance, will go for the full-bailout option, in which all Greek debt is bought by the I.M.F., the European Central Bank and other euro-zone entities. This debt will be held to maturity — and any creditor who did not yet sell will be made whole (those who have already sold at a loss are out of luck).

This course of action will be expensive, in terms of nominal outlays and in real risk-adjusted terms, because whatever terms Greece gets must also be offered to Ireland and Portugal. The I.M.F. may need to raise more capital or, more likely, tap its credit lines from member governments...

The French want to sway decision-making at the I.M.F. in order to use money from the United States, Japan and poorer countries to conceal from their own electorate that the euro-zone structure has led all its members into fiscal jeopardy: some borrowed heavily; others let their banks lend irresponsibly and thus created a large contingent liability.
The best way to hide the true cost is to have other people’s taxpayers foot the bill, preferably with the least possible transparency. Thus, euro-zone politicians have a lot at stake, and look for Ms. Lagarde to run the I.M.F.
And, since the U.S. has no surplus from which to make payments to the IMF, any money going to the IMF from the U.S. will have to come via taxation, or via borrowing which is likely to be propped up by Fed purchases of most of such Treasury borrowing and, thus, highly inflationary.

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