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Discord Mounting in the European Union (II)

EU time bomb

Right on time for the conflicts in the European Union at the center of which Germany has found itself comes an IMF report unprecedented in its self-criticism. This report acknowledges the organization's serious mistakes in developing and implementing the anti-crisis program for Greece. In particular, the report documents the unforeseen consequences for the economy of reducing state expenditures when the recession was already underway, excess optimism in assessing the chances of returning the country to the debt market, and delays in restructuring the state debt using private creditors… In essence, it is a refutation of the provisions of the anti-crisis program which was originally advocated by Germany and its Chancellor, Angela Merkel.

A departure from self-assurance and excessive optimism – perhaps it is these words which best characterize the essence of the IMF report. Its experts admit that they overestimated both the significance of their own prescriptions and the Greek economy's potential for recovery, and even the Greek politicians' ability to fulfill the conditions of the program. [1]

Do not forget that the IMF was one of the three key participants in the financial «rescue» of Greece from the very beginning, along with the European Commission and the European Central Bank (ECB). It was by the decision of the Eurocommission-ECB-IMF triumvirate that Greece received several anti-crisis payments totaling almost 250 billion euros over the course of 2010-2012 on the condition that it would conduct a policy of very strict budget economy. The international saga of the saving of Greece, as well as the integrity of the Eurozone, included massive protests in the country, two elections, the growth of contradictions in the EU itself, and, ultimately, the bank crisis in Cyprus, which was tied to Greek debt securities.

Technically, the EU and the IMF accomplished their main task: Greece did not leave the Eurozone, although a few years ago the leading world financial institutions assessed the likelihood of such a possibility at 70%. On the other hand, it was not realistically possible to change the situation in the Greek economy, the range of «problem» countries in the Eurozone has grown to include Cyprus and (according to some indicators) Slovenia, and in the EU itself more and more heated discussions are taking place about who should save whom at what cost. As the British publication The Economist figuratively but fairly noted, «It is hard to know how the flapping of butterfly wings in Cyprus might fan the broader storm.» [2]

Recently published data on the Eurozone confirms a 0.2% reduction in its total GDP in the first quarter of this year, and 1.1% on an annualized basis. Previously experts expected the economy of the Eurozone to go down 1% year over year. The volume of retail sales in the Eurozone in April went down by 0.5% compared to March and by 1.1% on an annualized basis. The experts were previously optimistic about these figures as well. They expected a 0.2% reduction in sales month to month and 0.6% year over year. [3] Thus, the European crisis, despite the efforts of the EU and the IMF, has not gone anywhere.

In addition, as the IMF experts themselves admit, the assistance to Greece was rendered in violation of its own requirements and Fund procedures. These procedures prohibit the issuance of new loans to a country which is already in the depths of financial crisis, as the chances of repayment are nearly nonexistent. To justify their actions, the authors of the report point to the necessity of giving the Eurozone the possibility to «gain time» and «build a wall which will protect other vulnerable members and shield the world economy from serious upheaval». Whether or not the building of such a wall was successful judging by the example of Greece is a rhetorical question.

It is obvious that the reasons for this IMF report are deeper than a simple analysis of the situation in Greece. The matter is that the «strict economy» anti-crisis strategy has recently come up against increasingly harsh criticism, and not only from «problem» countries. For example, the British newspaper The Financial Times points out, with references to the opinions of authoritative international economists, that Europe's main hopes for overcoming the crisis are connected not with a budget economy, but with «external demand» for export goods from Europe. However, in order to increase exports it is necessary to develop production, not economize. Nevertheless, it is the leadership of the European Union itself which hastened to criticize the IMF report. [4]

It is symptomatic that the IMF's «self-incriminating» report was published several days after a very telling session of the European Commission devoted to analyzing the situation in the Eurozone. As a result of this session, the highest executive body of the EU made a critical decision to allow some European Union member countries to delay the implementation of strict economy measures. What this means is that they will be given additional time to bring their budget figures into conformity with Maastricht criteria. Among these countries are France, Spain, Poland, Portugal, the Netherlands and Slovenia. In particular, France received another two years to reduce its budget deficit to 3% of its GDP. Spain, Poland and Slovenia received similar deferrals. The Netherlands and Portugal can count on an additional one-year respite. European Commission President Jose Manuel Barroso urged country leaders to use the extra time wisely, first and foremost to increase the competitiveness of their national economies. Barroso's main ire was directed toward France, since it is this country which «over the course of the past 20 years has been steadily losing its competitiveness,» and therefore is now in need of «significant structural reforms». [5]

Thus it is difficult to escape the conclusion that both the EU and the IMF, independently of one another, are beginning to abandon their previous course of making harsh budget limitations a priority in fighting the crisis.

However, things are not that simple. There is one more key player in the global geopolitical (and geoeconomic) games: the U.S. Federal Reserve System. And it is against it that the IMF has directed a new critical blow.

Having admitted its mistakes with regard to Greece, the International Monetary Fund primarily blamed the Federal Reserve and other large central banks for the world financial crisis. According to IMF economists, the Fed unjustifiably lowered the discount rate in the early 2000s and did not raise them in time. Then banks, «losing their heads» as a result of cheap money, gave millions of risky loans which to this day are pulling the world economy down. The Fed's current games with low rates will end with the same kind of disastrous crisis, believe IMF experts.

The logic of the report's authors is outwardly fairly simple. Based on Federal Reserve statistics they studied the link between short-term interest rates and what risks banks take. In other words, they asked the following question: Do low interest rates and a soft money policy really stimulate the granting of risky loans?

The IMF analysts believe that they do. After all, it is the discount rate established by central banks (in this particular case, the U.S. Federal Reserve) which determines the interest rates for bank loans. Consequently, the lower the interest rates, the greater the stimulus for giving risky loans and, accordingly, the more risky loans are taken out by individuals, organizations and entire countries. To use financial terms, when monetary policy is weakened, the risky component of banks' credit portfolios increases. [6]

Interestingly, the IMF experts did not limit their study to the U.S. They were able to find a similar dependency in the material on Spain and Bolivia. There it also happened that the lower the interest rate was on loans, the greater the likelihood was of «bad» loans. In other words, lowering the discount rate or even keeping it unchanged for a long period «leads to growing risk». Not only the size of interest rates, but also how long they stay low influences risk growth; the longer rates are low, the stronger their influence on risk growth, state the authors of the report.

However, that, so to speak, is one side of the coin. Opponents of the IMF insist that without low discount rates and inexpensive loans, it is impossible to stimulate production and business activity, and thus to overcome the crisis. 

It is easy to see that the IMF's main argument against the Federal Reserve is its criticism of the policy of pumping up the economy and the banking system with «cheap» money and loans. But what about the activities of the EU anti-crisis funds headed by the European Stability Mechanism (ESM), which are under the control of the IMF itself (along with the European Commission and the ECB)?

It is worth noting that currently it is not the U.S. which is at the epicenter of the arguments about the role of the discount rate and other financial tools in the dynamics of the crisis, but Japan. In recent months the new government of Japanese Prime Minister Shinzo Abe has been implementing a plan for the country's economic recovery based on financial stimulation and a softening of credit policy. In particular, this plan calls for relaxing the rules for investing in the country's pension funds and giving them the option of buying more stock. So far the plan is working. In particular, according to recent data, the growth of Japan's GDP for the first three months of 2013 was 1% on a quarterly basis and 4.1% on a yearly basis. According to earlier estimates by experts, economic growth of 0.9% on a quarterly basis and 3.5% on a yearly basis had been predicted. And the U.S. Department of Labor recently announced that the number of jobs in nonagricultural sectors had increased by 175,000. Analysts expected a more modest increase of 163,000.

Nevertheless, the U.S. Federal Reserve is wary of terminating its program of financial stimulation of the national economy. «Statistics from the U.S. give the market a reason to grow, as they are better than predicted, but not so much as to engender fears that the stimulation will end,» stated an expert from the company Daiwa Securities Group Inc., Kenzi Siomira. [7] «U.S. labor market statistics turned out to be better than expected, but not positive enough to reduce stimulation of the economy,» confirms SMBC Nikko Securities analyst Ryota Sakagami. [8]

«The Eurozone still represents the greatest threat to world financial stability. This is caused not least of all by unhealthy «incest» between banks and borrower states. Efforts to equalize profit and loss in their «daughters» on the scale of individual countries have not decreased at all,» states The Financial Times, adding, «The world banking system and regulation have already cracked.»

The head of the U.S. Federal Reserve, Ben Bernanke, is in full agreement with the British publication, emphasizing that European banks are still excessively dependent on their consolidated debt, and the political leadership of the EU is slower than its American colleagues to force banks to consolidate their balance. [9] So arguments about anti-crisis strategies and laying blame for the crisis in the European Union are just getting started.