DSK's Departure Is Next Nail In Euro's Coffin

Edmund Conway Daily Telegraph May 20, 2011

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By Edmund Conway Economics Last updated: May 19th, 2011

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The euro's death is long overdue

It is time to rewrite the euro's obituary. Until last weekend, no-one would have supposed that the single currency might meet its fate at the hands of an anonymous Guinean housemaid in an upmarket New York hotel. But it is now increasingly clear that Dominique Strauss-Kahn's arrest, and his resignation today as managing director of the International Monetary Fund, represent a crippling blow for the euro project.

In any other time, the resignation of an IMF head wouldn't have been particularly relevant beyond a small and relatively wonkish circle. Yes, it would have prompted some brow-beating about the relevance of an institution created nearly 70 years ago for an entirely different time and economy. Yes, there would have been questions about whether the new MD should come from an emerging economy rather than from Europe, as is traditionally the case (under a political compromise at the time of the Fund's creation). But few IMF successions have been as significant as the one we are facing today "“ and not just because of the nature of Strauss-Kahn's departure, nor even the fact that he had, until the weekend, been cruising towards the French presidency.

Though few liked to spell it out explicitly, the fact is that without DSK at the helm of the IMF, the euro may have crumbled altogether far earlier than now looks likely. It is not merely that the Fund rescued Greece, Portugal, Ireland and others on the Eurozone periphery with bail-outs in the past couple of years. It would have done so regardless; indeed, it pumped money into plenty of other troubled economies, including Pakistan and Ukraine. But look closer at the terms of the loans and it becomes clear that under DSK the IMF played a subtle but vital role in safeguarding the existence of the euro.

For when the IMF lends out to economies facing as severe balance of payments crises as these, it usually recommends that, as well as cutting spending and raising taxes, the recipient country devalues its currency and restructures its debts (both represent a kind of soft default).

In this case, short of leaving the euro entirely there was no way Greece et al could have taken the devaluation option. Restructuring the debts would have triggered a European banking crisis because of the web of internal investment between euro member states. Both options, in other words, would have pretty rapidly caused an existential Eurozone crisis. So inevitably when the Fund's technicians suggested them, they were quickly silenced by the powers-that-be.

Then there's the bail-out of Latvia in late 2008. Like a number of its neighbours, the country is hoping to join the euro and so had tied the value of the lat to the euro. Devaluation would have been the country's most painless means of adjusting. And yet when the IMF lent to it, Strauss-Kahn pointed out quite firmly that it was keeping the peg (and hence hopes of euro membership), even at the cost of quite horrific austerity (teachers' salaries, to give one example, have been cut by half).

A key plank of DSK's platform in running for the French presidency was to be able to claim that he singlehandedly saved the single currency, and while life is obviously rather more complicated than that, he certainly had a pretty good claim in that regard.

Considering the counterfactual for the euro had Strauss-Kahn not been there during the crisis, it is hardly surprising that European heads of state are so desperate for him to be succeeded by a European. But they face a far tougher challenge pushing through their chosen candidate than in previous years.

There is nothing in the IMF's constitution which stipulates that the IMF head has to be a European "“ this was something typically agreed upon informally by IMF members behind closed doors. However, consensus was reliant upon the goodwill and support both of the US and the developing/emerging world members who usually let the Europeans get their way. This time around, US Treasury Secretary Tim Geithner has indicated previously that he is in favour of more diversity at the top of the IMF, while the emerging economic juggernauts of China, India and Brazil are far more powerful and vociferous, and are unlikely to accede to another old-school old-world person in charge of such an important body.

The stakes, then, are not only high but are stacked against the Europeans. And from their perspective the timing of Strauss-Kahn's arrest is particularly unfortunate, coinciding with critical discussions about the next stage of the Greek bail-out. In short, it is finally becoming impossible to deny that Greece (and potentially other struggling euro members) cannot survive unless it does one of those two things Strauss-Kahn refused to countenance: devalue or default. No wonder Brussels is so worried about who takes over next.

PS: It’s probably worth pointing out that all of the above makes it doubly unlikely that Gordon Brown stands any chance of taking over from DSK. Even if you choose to ignore the entrenched resistance to another European IMF head, or the eloquent case against Brown mapped out by Jeremy Warner today – even if you imagine for a moment that David Cameron would endorse his predecessor for the job, the fact remains that the Europeans would never allow a Brown candidacy. As far as the French and Germans are concerned, this is a job for a euro crusader. Can you honestly imagine they would treat with anything but disdain the candidacy of someone who so forcefully opposed Britain’s euro membership?

Tags: Dominique Strauss-Kahn, DSK, euro, France, Germany, greece, imf, International Monetary Fund

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DSK's Departure Is Next Nail In Euro's Coffin

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