Christine Lagarde, former swimmer, U.S. Capitol intern, and French finance minister who took over the International Monetary Fund last year is the woman trying to save the world economy. And she may succeed. Her goal is convincing world leaders to bankroll the formation of a new firewall to prevent the Greek crisis from spreading to other indebted economies. She is not asking for small change: Half a Trillion US dollars, mostly from the G20.
Her greatest challenge is not only to convince non-eurozone political leaders to contribute when their own economies are in trouble. It is also to sell the concept that the astronomical sovereign debt of some nations of the eurozone is not the main problem. Rather, It is the economic stagnation. Without economic growth, all the shoring up of the critical spots, Greece, Portugal, Spain, Italy will just accomplish gaining some breathing time.
The European economies must outgrow their debt and the first fundamental step should be devaluating the euro to make European exports more competitive and imports into Europe more expensive. Ideally, the euro should descend to parity with the U.S dollar.
Ironically, it is the strongest economy in Europe, Germany, that opposes devaluing the common currency. The first reason is that German exports are still strong . The second reason is historical: Devaluation of the Reichmark during the Great Depression led to high inflation and the rise of the Nazis to power in 1932.
Thus chancellor Merkel has made the point of blocking the reduction of the prime rate by the ECB while pushing the troubled neighbors to the south to adopt unpopular austerity measures. But the austerity measures reduce aggregate demand in those economies and such reduction is incompatible with growth. Short term spending with long tern austerity only works if the aggregate demand increase attained with the first is sustainable through the latter.
Private investors may be taking up to a 70% loss in the restructuring of the Greek debt. European banks are hoarding cash to withstand the blow. We may see how the rearrangement works out by mid March. There is a lot at at stake for everyone, including the United States, itself with a huge sovereign debt and anemic growth. Let’s all hope that Mme. Lagarde’s firewall stands.