By Bill Wilson | Net Right | Jan. 24, 2011
Sometimes, government officials tell the truth, and when they do, watch out. It might be a good idea to hold on to your wallet.
A recent example is International Monetary Fund Managing Director Christine Lagarde commenting on the European debt crisis in Berlin on Jan. 23. Even though the European Financial Stability Facility (EFSF) has already committed €440 billion, the European Central Bank (ECB) €220 billion, and the IMF €78.5 billion to propping up troubled sovereigns Portugal, Italy, Ireland, Greece, and Spain (PIIGS) — some €738.5 billion, or almost $1 trillion in total — Lagarde said, “these moves form pieces, but pieces only, of a comprehensive solution.”
If Spain and Italy enter the equation, said Lagarde, all bets are off, saying a “larger firewall” was needed. Without it, Italy and Spain “could potentially be forced into a solvency crisis by abnormal financing costs.”
“I am convinced that we must step up the Fund’s lending capacity,” Lagarde declared, adding, “The goal here is to supplement the resources Europe will be putting on the table, but also to meet the needs of ‘innocent bystanders’ infected by contagion, anywhere in the world. A global world needs global firewalls.”
Saying the world’s financing shortfall “[i]n the coming years” could be as much as $1 trillion, the IMF chief proposed a dramatic expansion of her agency. “To play its part, the IMF would aim to raise up to $500 billion in additional lending resources,” she said, alluding to a proposal already on the table to double the Fund’s $364 billion of quotas. That includes doubling the United States’ quota in the fund to $128 billion.
The current $364 billion of quotas, plus $564 billion in New Arrangements to Borrow brings the IMF’s total lending capacity to about $928 billion, of which it has committed about $254 billion according the Fund. That leaves about $674 billion that should be in its war chest, or about €523 billion.
It is said the ECB has a natural limit of about €300 billion it can put towards sovereign debt bonds, with about €80 billion left in its arsenal. And the €440 billion EFSF has already offered €177 billion to prop up Portugal, Ireland, and Greece, leaving €263 billion to lend.
In total, the ECB, the EFSF, and the IMF — if it dedicated all of its resources singularly to refinancing European debt — have about €866 billion left to give. That’s on top of the €738.5 billion that’s already on the table.
Overall, that’s €1.6 trillion based on all current arrangements, but that is still not enough to guarantee the €3 trillion of consolidated debts of the PIIGS, most of which is Italian.
So, Lagarde wants to expand the IMF by another $500 billion, or €388 billion. But even then, she’s still €1 trillion short, which is probably why she has proposed that the additional €500 billion European Stability Mechanism (ESM) be combined with the EFSF. And the rest could be taken up by the printing press: “Action by the European Central Bank to provide the necessary liquidity support to stabilize bank funding and sovereign debt markets would also be essential.”
So, Lagarde does have the semblance a plan to at least nominally guarantee all of the debts of the PIIGS.
But it assumes the IMF uses all its remaining lending capacity to prop up Europe, to which Lagarde has warned, “Our financing is for all members, euro area or otherwise.” In other words, don’t count on the IMF to blow its whole capacity on propping up public pensions and welfare payments in Italy.
It also assumes that the €500 billion ESM is even adopted, but states like the United Kingdom are already opposed, saying it would violate their sovereignty. And that the ECB will further violate the Lisbon Treaty prohibitions against sovereign debt purchases, blowing past its self-imposed €300 billion limit.
But even if all these guarantees do come to fruition, there is a broader concern. Lagarde is basically saying that private demand for European debt has all but disappeared, and will not be restored unless governmental institutions guarantee every bit of it. That contradicts Lagarde’s claim that Italy and Spain “are fundamentally able to repay their debts”.
They are not able to do so. And the plan being presented by Lagarde is not for troubled sovereigns to retire their unsustainable debt loads or to even cut spending on a net basis. It is to essentially use a printing press to provide refinance loans, kicking the can down the road for future generations to deal with — with the caveat that by then the problem will be much, much worse.
Lagarde is treating this cancer as if it was some sort of temporary liquidity problem, but it is not. It is a long-term insolvency problem, and one that can only be solved with balanced budgets and an actual reduction of these debts.