Warning from Lagarde

IMF Chief Lagarde: World Economy Risks Depression-Era Collapse In Demand

Nikkei.com,

24 January, 2012

The global economy faces a depression-era collapse in demand if Europe doesn't quickly act to dramatically boost the size of its debt-crisis firewall, implement pro-growth policies and further integrate the euro zone, the head of the International Monetary Fund warned Monday.

"It is about avoiding a 1930s moment, in which inaction, insularity, and rigid ideology combine to cause a collapse in global demand," IMF Managing Director Christine Lagarde said in prepared remarks before the German Council of Foreign Affairs in Berlin. "A moment, ultimately, leading to a downward spiral that could engulf the entire world," she said.

The dire warning from the IMF's top executive is designed to spur political action in Europe and within the Group of 20 industrialized and developing economies and avoid the political stagnation she said exacerbated the crisis.

Last year, "policymakers let an old wound fester, and in doing so made the situation worse," she said, speaking ahead of a euro-area finance ministers' meeting in Brussels Tuesday.

Lagarde said unless euro-zone leaders urgently build a bigger emergency bailout fund, two of the euro zone's largest economies, Italy and Spain, risked insolvency as the cost of financing their debt spikes upward. Economists said failures in the two economies could spark a global financial and economic meltdown, and IMF staff are urging Europe to at least double the size of their firewall to around EUR1 trillion.

Insolvency in those two nations "would have disastrous implications for systemic stability," she said.

"Adding substantial real resources to what is currently available by folding the European Financial Stability Fund into the European Stability Mechanism, increasing the size of the ESM, and identifying a clear and credible timetable for making it operational would help greatly," she said.

Lagarde said it's also essential the European Central Bank fills the gap before leaders can build a bigger firewall, continuing to provide liquidity to stabilize banks funding and sovereign debt. Analysts say that, based on its average weekly bond purchases, the ECB could cover more than EUR1 trillion in ailing countries' bonds in the year.

In the face of strong pressure from the U.S. and the IMF, Germany and some other northern European nations have been resistant to bulking up the public emergency fund, fearing it may prevent further fiscal belt-tightening in the weak Mediterranean economies. There's also political resistance to paying more for the bailouts than already doled out.

Still, last week, Germany's federal foreign minister said Berlin is "deeply and firmly committed" to the euro zone.

"The euro and Europe...is the answer to the darkest chapter in our history and it's also our life insurance in times of globalization," said Guido Westerwelle in Washington, D.C., after meeting with Lagarde and the U.S. Treasury Secretary.

Lagarde is also seeking to boost the IMF's lending resources by more than $500 billion to a reserve pool well over $1 trillion, including roughly $200 billion promised by Europe. Boosting IMF financing will be one of the highest priorities for the G-20 finance ministers' meeting in Mexico City next month. While the U.S. has said it won't contribute, China, Japan and Brazil have indicated their open to funneling cash to the IMF if Europe is more proactive in dousing its debt fires.

"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," Lagarde said.

Given the looming downside risks created by the European debt crisis, the IMF chief said the IMF is lowering its growth forecasts for most parts of the world, even in the emerging markets that have helped drive economic expansion such as Asia and Latin America.

"Even these lower forecasts assume a constructive policy path that is by no means assured," she said. The IMF is due Tuesday to release updates to its World Economic Outlook, Fiscal Monitor and Global Financial Stability Report.

In Europe, Lagarde said the IMF sees a "sizable risk" that inflation will fall well below target next year, raising debt burdens and further hurting growth. Thus, additional and timely monetary easing will be important to reduce such risks, she said.

By boosting their firewall, Europe will also be able to help banks in the region to raise their capital levels without cutting lending.

As part of the region's integration, the IMF chief said monetary union needs to be supported by financial integration through unified supervision, a single bank resolution authority and a single deposit insurance fund. She also said Europe could finance itself through euro bonds, bills or a debt redemption fund.

"Political agreement on a joint bond to underpin risk-sharing would help convince markets of the future viability of European economic and monetary union," she said.