DSK

The Baseline Scenario


--------------------------------------------------------------------------------
Metternich With A Blackberry

Posted: 20 Mar 2010 05:48 AM PDT

By Simon Johnson

If watching the twists and turns in European politics – “should we bailout Greece?”, “should we bring in the IMF?”, “should the Greeks go directly to the IMF, cutting out the EU?”, etc - has your head spinning and reminds you of overly complicated and opaque episodes from the history books, then you have actually caught the main point. European power structures and alliances webs are being remade before your eyes.

Is this all random – just the collision of disparate national interests with no coherent plans on any side? Or are there some strong, deliberate, and very personal hands at work guiding key pieces into place?

Prince Metternich worked long and hard to manoeuvre countries and people before and after 1815, cynically and cleverly building a system of interlocking interests that suited him – and his employer, the Austrian/Habsburg Emperor. Is there a modern Metternich now at work? Most definitely: Yes.

If you’ve followed the twists and turns of the global dimensions that emerged from the financial crisis of 2008-09, you’ll know that the IMF was transformed from an organization that was being euthanized by the G7 to an important element in the G20’s back-up financing for emerging markets (with the most dramatic turn of events in the run-up to the London summit in April 2009) – and definitely part of what helped stabilize confidence around the world.

This sequence of events created a great opportunity for the IMF’s Managing Director, Dominique Strauss-Kahn (known to friends and foe alike as DSK), to relaunch his political career in France – he previously ran for the presidency but could not secure the socialist nomination, and taking the IMF job seemed to everyone (including President Sarkozy, who lined it up) as akin to being marooned on a desert island. But DSK is – like Metternich – a master of the opportunity, a man who knows when to move and when to stand still, and someone always working a network of long-cultivated European political contacts (including socialists in Greece).

DSK’s objective is to cast himself as the savior of Europe - undoubtedly this would play well with the French electorate – and of course he is greatly aided by the serious underlying problems within the eurozone in general and for Greece in particular (back story is here). As he controls the IMF absolutely and completely, he has access to the best global economic intelligence as well as the means to make large loans to countries at low interest rates. He must of course bring others with him, but this is not hard – the White House, for example, could not care less about who ends up running Europe and at what growth rate, as long as it does not blow up.

President Sarkozy’s aim at this point is naturally to keep DSK and the IMF as far from the action as possible. But Sarkozy has three problems.

The Greeks have learned fast how to play international economic diplomacy – threatening to bring in the IMF in a way that would embarass the European leadership. Without question, they are being coached by people close to DSK. Watch the masters at work.
German voters really do not want to be involved in anything that looks or feels like a bailout. A low interest rate loan to Greece would really upset them. The Germans could do something off-balance sheet (i.e., get their banks to provide cheap credit to Greece), but the German banking system is already so ridden with governance problems and hidden bailouts that this is not appealing to the elite.
If you provide financing to Greece at anything other than low interest rates, the numbers simply do not make sense (we take you through this here.) Merrill Lynch pushed back against us this week with a report arguing that if Greece can borrow again at the level of German interest rates, everything would be fine – this is, of course, a legitimate point, but a cursory look at Merrill’s relatively sanguine research reports on Greece prior to the crisis (and also at their assessments of global credit markets prior to fall 2008) does not suggest that the “don’t worry, be happy” scenario is high probability.
Sarkozy is also an expert tactician and he is not finished yet – entering the weekend, the ball is definitely in his court. Expect further “let’s do it without the IMF” options to surface now – in particular, Sarkozy will try to scare the Germans regarding how the European Central Bank (ECB) would be undermined if the IMF enters the arena. Sarkozy can also commit, behind the scenes, to support Axel Weber for the ECB presidency – something top Germans want more than they want almost anything else in the world.

And what if Strauss-Kahn prevails and the IMF makes a loan to Greece, would this save the day? Not necessarily – remember that DSK’s goal is to just to look good until he leaves the Fund to run more openly for the presidency, which is probably no more 12 months from now. His incentive would be to put in place a relatively small program of funding that does not ask Greece to do too much up front; if this explodes later (as seems likely), that would not be his problem.

Sensible program design and dealing with the core underlying issues in a reasonable manner – including confronting the looming issue of “debt restructuring” – is not likely. This is French electoral politics after all.