The IMF’s latest report on the eurozone is an astonishing document. When the full history of this episode is written, this “Article IV Consultation” will be cited as a key exhibit.
The euro area crisis has reached a new and critical stage. Despite major policy actions, financial markets in parts of the region remain under acute stress, raising questions about the viability of the monetary union itself.”The adverse links between sovereigns, banks, and the real economy are stronger than ever. Financial markets are increasingly fragmenting along national borders.
It said the eurozone is unworkable in its current form, a half-baked currency union that spreads contagion like wildfire without the backup machinery to contain the damage:
The euro area is in an uncomfortable and unsustainable halfway point. While it is sufficiently integrated to allow escalating problems in one country to spill over to others, it lacks the economic flexibility or policy tools to deal with these spillovers.Crucially, the euro area also lacks essential financial and fiscal policy tools to stabilise the monetary union. As the crisis has illustrated, without a strong common financial stability framework, banking problems are hard to contain and resolve in an integrated market.
Most of southern Europe is at serious risk of a “debt-deflation spiral”, and the dangers are masked by the austerity taxes themselves. “This disinflationary environment in much of the periphery will make it difficult for many countries to reduce the burden of debt.”
Europe’s leaders have still failed to grasp the nettle:
The deepening of the crisis suggests that its root causes remain unaddressed. The crisis calls for a much stronger collective effort now to demonstrate policymakers’ unequivocal commitment to sustain EMU. Only a convincing and concerted move toward a more complete EMU could arrest the decline in confidence engulfing the region.”As a result, the pernicious feedback loop between banks and sovereigns, as well as market fragmentation, have been accentuated during the crisis. In some cases, the necessary provision of ECB liquidity has led to further sovereign bond purchases by banks, deepening this link even more.The adverse bank-sovereign feedback loops at the heart of the crisis have intensified. Concerns about banks’ solvency have increased because of large sovereign exposures, particularly in periphery countries. Some sovereigns, in turn, are struggling to backstop weak banks on their own.Intra-euro area capital flight has created deintegrating forces in sovereign bond markets, interbank markets and lending and deposit markets.
There is a “drastic decline in interbank activity”:
A failure of a large and systemic bank could test the ability of the ECB and crisis facilities to stem contagion. And reform slippage at the country level could have large negative spillovers throughout the euro area. The fear of euro area exit, if not countered swiftly and effectively, could spread to other economies perceived to have similar characteristics.
In other words, the process has become self-feeding and extremely dangerous. The monetary transmission mechanism has completely broken down (as the Bank of France’s Christian Noyer warned earlier this week). The whole world is at risk.
The IMF exhorts the EU authorities to go all-in with Eurobonds and a genuine banking union with pan-EMU deposit guarantees.
It calls for “sizeable” QE by the European Central Bank – the full monty, not the pinprick efforts undertaken so far – “preannounced over a given period of time, buying a representative portfolio of long-term government bonds”. That is: do what the Fed is doing, at long last.
“If the IMF report was a film it would be a summer blockbuster to match Batman,” said Gary Jenkins from Swordfish.
“It’s difficult to argue with the basic thrust of the IMF’s report, in the sense that if they want to save the eurozone, the politicians probably do have to take dramatic action. However I dare say that if there is going to be a move towards a full United States of Europe some people might quite like to vote on it,” he said.
For those of us who have been gently suggesting over the years that there might be a few structural problems with monetary union, the IMF report comes as bittersweet vindication:
Adverse feedback loops are stronger in a monetary union than elsewhere. These adverse feedback loops are amplified by the absence of a domestic exchange rate that could buffer the impact of intra-euro area sudden stops on the borrowing costs of sovereigns, and that would help compensate the adverse impact of fiscal efforts on domestic demand compression by an exchange rate depreciation stimulating exports.
That is: the victim states can’t break out of the trap through devaluation. They cannot offset a fiscal squeeze with exchange (or monetary) stimulus. They are suffocated:
Moreover, sovereign borrowing costs can rapidly spiral out if market anticipations turn out pessimistic, making fiscal adjustment more difficult to achieve unless the monetary authority signals the possibility of future loosening.
That is: EMU membership makes it harder to sort out public finances. This is the exact opposite of the claim we always heard from the euro missionaries, that the “discipline” would force wayward states to behave. In fact it makes it near impossible for them to keep their debt trajectories under control:
Limited labor mobility in the euro area impedes adjustment to idiosyncratic shocks. If workers move in response to differences in wages and job opportunities, they reduce disparities in unemployment rates and real wages across regions. However, while there is some evidence that labor mobility in the euro area has increased in response to the crisis, it remains fairly limited.Only about 1 per cent of the working age population changes residence within their country in a given year, and even less move between euro area countries. This compares to about 3 per cent in the US, 2 per cent in Australia, and slightly less than 2 per cent in Canada.
We told you so here at the Telegraph. The safety valves of labour mobility and fiscal transfers in euroland are totally inadequate.
It would be very interesting to know exactly what has been going on at the IMF board over recent weeks. One hears that the White House – with the full support of China, Japan, Brazil, and others – has finally lost patience with Europe’s leaders. (I use that term euphemistically, since I don’t mean Monti, Hollande, Cameron, or even Rajoy, but one doesn’t want to be accused of picking on a defenceless, much-maligned, and vulnerable country between Poland and The Netherlands).
The IMF could hardly be clearer. It is a pre-emptive move to pin responsibility for the coming deluge exactly where it belongs:
On those who created this doomsday machine and pushed it through as a federalist Trojan horse, with scant concern for Europe’s democracies; on a second group of people who ran it for a decade with high-handed arrogance, disregarding warnings as the North-South gap grew to dangerous levels; and on a third group of leaders – led by Chancellor Angela Merkel – who now refuse to face up to the awful implications of what has happened.
The IMF is the leader of the Eurosceptic camp now.
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