Germany Chastises Canada, Sort Of…

Germany reiterated calls today for Canada to participate in the beefing of the IMF funding. The IMF is currently seeking to raise its war chest to 430 Billion dollars in preparation of possible new bail-outs in Europe to serve as a firewall against liquidity contagion of sovereign debt financing. Canadian Prime Minister Stephen Harper and his finance minister Jim Flaherty have resisted demands for the country to participate. While Canada has received praised from Germany for its take on austerity it continues to be admonished for showing little ‘solidarity’ in matters of bailing out Europe.

Harper has repeatedly said that taxpayers in Canada would not participate in financing the welfare state of some of the Richest nations of the World. It must be noted however that Germany is showing a little lack of consistency in its criticism. Much of the political difficulties in the current European sovereign debt crisis stems from Berlin’s refusal to risk its own taxpayer moneys on alleviating required austerity in the Eurozone periphery, so how can Angela Merkel, Germany’s Chancellor, turn around and ask of Canadians what it won’t ask of its own people.

When a country goes bankrupt it makes sense to stabilize that country’s finances and currency through an IMF led debt restructuring with the objective in mind to return that country to a sustainable growth path and government spending. But when the World is faced with the likes of Greece whose sense of state welfare entitlement is so strong that it refuses the policy prescriptions attached to IMF lending, why should the World backstop its governmental spending. European style welfare states require generous taxpayer funding and strong longterm growth to be sustainable, countries desirous of receiving lending from the IMF must accept a model that both generates growth and taxes heavily. For countries to achieve those dual requirements they cannot be hampered by distorted fiscal incentives, which lax IMF lending standards embody.

It should be unacceptable that the IMF, funded by every country in the World including its poorest, should serve as a tool to preserve un merited entitlements in the richest nations of the World. The Conservative governments stand is that the IMF should only serve the Worlds poorest governments, this isn’t right, the World Bank is there to help the poorest, the IMF’s role should be to stabilize the World’s financial system by increasing sovereign liquidity to governments hampered by temporary market pressures.  But Harper is right with regards to who those fledging governments are.

Spain is a prime example of a relatively responsible government facing pressures outside its control and in need of a temporary backstop. Greece however is the antithesis of a responsible nation, underserving of outside help since all its problems are internal. Canada should increase its participation in funding the IMF, but this extra funding should come with conditions. Those conditions should be that the IMF serve strictly the needs of governments willing to accept the longterm rebalancing of their public expenditures, as has been the historical norm. Countries that dither and object to bail-out conditions ex-post, should be blacklisted so that the IMF may concentrate its ressources on countries like Spain who can actually benefit from it and Ireland who has shown responsibility and a willingness to proactively deserve it.

Germany has made many correct economic arguments over the course of the current crisis, let’s hope she can continue to make them consistently going foreword.

IMF Going All Out Keynes

Keynes once opined that in an effort to boost aggregate spending the government should hire unemployed workers to dig holes, bury money in them and then hire more workers to unearth the cash. In a similar verve, Ben Bernanke illustrated his thoughts on monetary stimulus by proposing to have helicopters drop money on neighbourghoods where spending falls the most during recessions. Following in this intellectually rigorous train of thought is the International Monetary Fund. In chapter 3 of its April World Economic Outlook The IMF submits research on housing slump prolonged recessions. They come to the conclusion that housing slumps following recession prohibit or even reverse consumption resumption. That is to say if your house looses half its value (a.k.a. your average Joe lost half his life savings) as a consumer you’ll probably pull back from spending. That this wasn’t obvious to one of the most important institutions of the global economy is in itself a source of worry. More worrying still, is the solution proposed.

The fact that government interventions in housing markets is not recognized as the main culprit of the last crisis is a sad fact on its own. That governments are being asked to further expand their lack of clout over real-estate markets is simply despairing. The IMF’s proposal is for governments to develop debt forgiveness schemes for distressed homeowners during recessions. Their rational is that when recessions occur income drops, leading to an initial drop in demand for housing and an increase in supply. This in turn drives down home values. As leveraged homeowners home equity turns negative they begin to default on their mortgages. This is exactly what happened in the States. The IMF believes that a vivious circle develops whereby drops in home values curbs spending and increases defaults leading to net wealth compression leading to more  drops in consumption and so on and so forth. The IMF believes that if corrections in housing markets can be mitigated, output slumps will be less severe.

This is all true. The problem is the part on mitigating housing price drops. The IMF thinks governments should do that and they propose it should be done through debt forgiveness schemes. Now, one might ask if it were so easy why in the hell haven’t banks done this already? The IMF would argue its some perfectly competitive market where banks are afraid of individually doing the debt forgiveness effort and other banks profiteering from said efforts. Two things, first collusion is illegal so of course they wouldn’t start a debt reduction country club and second, because it’s stupid. Banks are in the business of evaluating what levels of debt are appropriate that’s their job! If it was a good idea to reduce debts they wouldn’t need the IMF’s politburo encouragements to do it.

More seriously however is the moral dilemma argument. If banks or countries start instituting debt forgiveness schemes consumers will have an incentive to over pay for homes in expectation of a market correction. This will fuel higher prices and housing bubbles which were the source of the problems in the first place. One might argue that the laws governing home defaults in the US act as a de facto debt forgiveness mechanism. As their home equity turned negative Americans had the legal cover to rationally decide to walk away from their homes when their equity turned negative. That mechanism is partially to blame for the savageness of the housing downturn in the US.

So let’s recapitulate. Americans don’t save enough. Americans walk away from financial responsibilities and in so doing jeopardized their country’s economic health. The IMF wants countries to de-insensitivize savings (by punishing banks with debt forgiveness plans) and wants less people to be financially responsible for their houses. Keynes’ legacy of moral hazard lives on and strong apparently. International economic institutions seem to be breeding ground for backward economic discourse nowadays . Kinda reminds me of this one trade theory teacher I had, who had worked at the WTO, and taught our class that China’s Renmimbi was significantly overvalued. not even a joke…. sad times eh?

Financial professionals joke about academics getting into teaching or researching because they weren’t smart enough to make it in the private sector. I’m gonna go out on a limb and believe that for now.