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.
Indeed.
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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