On October 23rd, 2014, we updated our
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Daily Observations 06/18/12
them breathing room. Holding this misplaced optimism, rather than making the hard policy choices
necessary, has been all too common over the past several years and is alarming.
It’s Harder Now to Coordinate Policy than in 2008
In November 2008, I helped organize the first G20 Leaders meeting in Washington DC. While
different in many ways, this week's G20 feels eerily similar to then in that the world is looking to policy
makers for a comprehensive response to a growing crisis (in this case with the pressure aimed
primarily at Germany as opposed to the United States as it was then), and also starkly different in that
the challenge of coordinating a response is so much greater in Europe, where there are divergent
economic interests among sovereigns, the lack of a central decision making authority, immature pan-
European institutions, and an increasingly polarized political environment.
By the 2008 summit, all the key players were largely aligned, they had coordinated a plan, and either
put in place or laid the foundation for many of the key pieces. Bank recaps had already started in the
US and UK and deposit guarantees had been increased in the US and European nations. These
steps and the planning that went into the G20 allowed leaders to communicate a credible
determination to take the bold actions required. The meeting concluded with a commitment to take
“whatever actions are necessary,” to stabilize the financial system, provide monetary support,
increase fiscal stimulation, and provide IMF liquidity facilities for emerging countries. Weeks later the
US and Europe followed with more bank debt guarantees, bank recaps and a commitment from the
central bankers to do whatever it took.
So far the key policy makers in Europe have been unable to forge the underlying agreement
necessary to deliver a plan anytime soon. At the heart of their disagreement lies the tension between
German policy makers believing they first need to secure fiscal union and the ability to tax before
agreeing to further debt sharing, with France, Italy, Spain and the other peripherals calling for more
backstops sooner and not ready to give up fiscal sovereignty. Merkel and Hollande’s recent
comments reflect strains in the French-German relationship and both Italy's Monti and Spain’s Rajoy
are ratcheting up their rhetoric in the face of growing political pressures. Even if Europe’s leaders
agree on the broad contours of a compromise, given the decentralized decision making in Europe,
there is a tremendous amount of work that needs to be done before real fiscal and banking union can
be realized. While we could be surprised, from everything we understand European policy makers
are far from laying that groundwork and many months away from any final agreement on fiscal union.
Something like an FDIC for Europe can only come after that, and then it will still be a question how far
Germany will go to take on the losses.
Leaders outside of Europe are increasingly worried that Europe will drag down their already slowing
economies. The summit offers them a chance to try to help broker agreement among their European
counterparts, while showing their constituencies that they are on top of the crisis. The US and China
are especially concerned. President Obama has little room for stimulus and faces an upcoming
presidential election. Ironically, as this crisis deepens, he and his advisers must be increasingly
worried that Spanish bond yields will become a leading indicator of his election prospects. China's
leaders must manage a transition later this year and are more reluctant to stimulate via a credit
response like in 2008. In the weeks ahead of the meeting, we have already seen a coordinated set of
statements by President Obama and UK Prime Minister Cameron to pressure Chancellor Merkel to
act more decisively. However, there is a limit to the pressure non-EU leaders can exert, reflected by
Merkel’s sharp rebuke to Cameron and calls for leaders outside Europe to stimulate their own
The IMF is the one institution where G20 leaders can put more skin in the game to protect against a
European debt bust. So far we have only seen them commit to an anticipated increase in funds, not
a larger share to Europe. A significant portion of this is likely to come from EM countries and it would
be a mistake to read their commitment just as a reflection of their concern for Europe. They have
been looking to leverage their resources into a larger voting share for years and will likely try to tie
these conversations together, something Merkel has already pushed back on.
What We Will Be Looking For
For all these reasons, we are not expecting much in terms of concrete announcements from this G20,
maybe some more specific and forward leaning support from leaders on more ‘fiscal and banking
union’ in Europe, an increase in IMF resources and the language we have come to expect,
expressing support for European policy makers and a commitment to global growth.
We will more likely know whether any progress was made days later in the comments of key
European policy makers and the output from the EU Leaders meeting the following week. Beyond
vague commitments to a fiscal or banking union, we will be watching for specific indications that:
(a) the French, Spanish and Italians are ready to accept common taxation and spending controls, and
(b) the Germans are prepared to stomach more of the losses through the mutualization of sovereign
debt and bank deposit guarantees.
Finally, we will be looking for how much leaders outside of Europe are willing to help damp the global
risk through such actions as (c) centralized central bank action (or promise of action) or (d) further
IMF commitments, as insurance of a debt bust spilling over.
While potentially complicated by quota conversations, the IMF is likely to get more specific
commitments from EM countries (such as China) for the roughly ~€350bn ($430bn) that was
announced earlier this spring in Washington DC, bringing IMF firepower to around ~€1tn ($1.3tn).
But even if the IMF and G20 leaders agree to an increase of roughly this amount and compromise on
giving a larger share of resources to Europe (say, 30% of lending vs. 16% which would be a
meaningful shift), the upper bound of that commitment is likely ~€300bn (double our baseline).
The problem is even this amount would bring total EFSF/ESM and IMF resources to €1tn, when to us
the potential losses look much higher and the funding gaps remain. Ultimately, it will come down to
Germany and the Europeans to decide who will take these losses and what their roadmap is to
resolve the fundamental problems. Without those questions resolved it’s not clear who will fund them
in the amounts they need.
Policy makers in Europe have a particularly tough road ahead. The fragmented decision making
process in Europe, the number of countries needing financial assistance relative to those who can
provide it, the absence of a true fiscal union, and the limited amount of time that is left make the
challenges of European policy makers much greater than those of American policy makers in 2008.
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