If Europe Wins the IMF Election, Europe Could Lose

The contest for the managing director post at the IMF has become a duel between Christine Lagarde, France's Minister of Finance, and Agustin Carstens, the head of Mexico's central bank. Lagarde is favored. Since the IMF was founded at the end of World War II, its top position has always been held by a European. Its international finance counterpart, the World Bank, has traditionally been headed by an American. Thus, the Allies in World War II divided the financial world, circa 1945.

Now, things have changed. The emerging markets members of the IMF are growing restless. They fear that Lagarde will be too Euro-centric in dealing with the European sovereign debt crisis, allowing the borrowers to control the lender. Many support Carstens with the hope of maintaining international balance. Since the emerging markets members are growing much faster than the European members, their influence is on the rise.

If Lagarde wins, the commitment of emerging markets members to the IMF could weaken just at the time the world needs strong international financial institutions. If Carstens wins, reality is that he would probably have to assist weak European nations to about the same extent as would Lagarde. The major banks of the world evidently have a great deal of exposure to the European sovereign debt morass, and the IMF, even if headed by a Mexican, would have little choice but to ride to the rescue. Such an IMF could do so with much less risk of offending emerging markets nations. And if Carstens would impose tougher conditions than Lagarde, that might be a good thing, as the European Union is by all appearances a one-trick dog that can only kick the can farther down the road.

The IMF is one of the few means by which emerging market powers like China, Brazil, India, South Korea and others provide aid to Europe. Having per capita income levels much lower than Europe's, the emerging markets nations can offer Europeans little or no direct aid lest they rile up their own citizenry. If their commitment to the IMF sags, its capacity to lend to needy nations could diminish.

The U.S. is in the hot seat. It likely has the voting power (16%) to turn the election one way or the other. America has deep financial and economic ties to Europe. Even though the Euro is a rival to the dollar, America would be deeply affected by any European financial crisis. But America's austerity driven politics today preclude any direct bailout. There won't be a 21st Century Marshall Plan. The IMF, indeed, is one of the few ways America can assist Europe. The smart play might be for the U.S. to support Carstens. After all, China holds trillions of U.S. dollar denominated securities. Brazil has recently been a fairly significant buyer of U.S. Treasuries. A rift with emerging markets nations is hardly in America's interests. We might soon need a bailout ourselves, and if so, it won't come from Europe.

Did Dominique Strauss-Kahn Just Mess Up the Derivatives Market?

In the arrest in New York yesterday of Dominique Strauss-Kahn, the managing director and head of the International Monetary Fund, on charges of attempted rape, unlawful imprisonment, and a criminal sex act, the financial press got a rare tabloid-quality story. Financial reporters may be gleeful now, having an opportunity to step back from EBITDA, NAV, SIPC, CDO, and MERS, and turn to allegations of an international financial leader, buck nekked, lying in wait to ambush a hotel maid, chasing her down a hallway and generally behaving like he follows Attila the Hun on Twitter. All reporters need to be good writers, but the truly successful ones have the hunter's instinct for knowing when to pounce. Strauss-Kahn, who might have thought he was the hunter, surely has no trouble hearing the howling of the pack closing in on him.

As a matter of law, Strauss-Kahn remains innocent until proven guilty. But the charges seem to have blown up his political prospects--he had a good chance of becoming the next president of France. And his career in finance is impaired. Another consequence is the new, enlarged bailout for Greece that the EU has been working on may be delayed. Strauss-Kahn, an internationalist who was sympathetic to bailouts, will have trouble getting bail for himself, let alone Greece. He was arrested four hours after the alleged crimes, while seated in a jetliner at JFK International Airport minutes away from leaving for Paris. That's a prosecutor's wet dream (whoops, sorry) for arguing against bail. And it's kind of hard to organize an EU-wide sovereign bailout if you're sitting in jail, eating baloney on white, WWII surplus canned fruit, and week-old brownies. A day of that and never mind haute cuisine. A Croque-monsieur and a demi de biere would seem pretty good.

The IMF says it will soldier on with work on the bailout. And surely it will, because international financial organizations don't justify their existence by saying no. But one can't help but wonder whether some players in the derivatives market who bet on a bigger Greek bailout are wondering if they're going to get margin calls. Even if the arrest of Strauss-Kahn doesn't move credit default swap prices a lot, most traders who play with derivatives mainline margin credit. A little price move can sometimes f . . . foul things up. Strauss-Kahn's arrest by itself won't trigger a financial crisis. But it's something that everyone dealing with the EU sovereign debt morass really didn't need.

There is no derivatives contract covering the risk of the head of an international financial organization being charged with acting really sexy in a wolfish way. No matter how much Wall Street's financial engineers churn and crunch data, there will always be some risks that won't be accounted for. That's why banks and other financial institutions need to be well-capitalized. Even if the next head of the IMF is already well on the way to beatification, you can never completely know when the elephant that is the real world is going to plop a heap of dung on your head.

China Bails as Germany Declines to Bail. Will America Bail?

The Chinese government is conducting stress tests on over 1,000 Chinese companies to ascertain how a rise in the value of China's currency, the yuan, would affect them. See http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ahhhMkrA.A.I. This happens at a time when the U.S. and other countries have complained about the strength of the yuan. Members of Congress have threatened to take action against China (although given Congress' record of alacrity on legislative initiatives recently, the Chinese would hardly be quivering in their shoes).

Nevertheless, it is potentially significant that China's government is scoping out the impact of re-valuing the yuan upwards. Americans and other non-Chinese shouldn't delude themselves that their complaints have much to do with China's apparent inclination to re-value. China's economic policies are driven by internal concerns. While the Chinese government hardly is a paragon of transparency, there's probably an overriding reason why China might now re-value the yuan. It has no good investments outside of China for future trade surpluses. The dollar, overall, has dropped during the last decade and can be expected to keep sinking. The Euro is suddenly looking shaky, with the recent surge of EU sovereign debt problems, hinky national accounting systems and preposterous posturing substituting for a solution. The yen offers low-yields and doesn't have attractive long term prospects, not with Japan's massive government debt.

The yuan, by contrast, is likely to be a good investment. Although there is currently a bubbly froth in China's real estate and credit markets (sound familiar?), the People's Republic remains on an upward long term trajectory. By raising the value of the yuan, the Chinese government reduces China's trade imbalances and the cash surplus it needs to recirculate to other countries. U.S. imports to China may rise, although you can bet China's government intends to encourage Chinese companies to redirect their attentions to domestic markets. Throughout the last 30 years of modernization, the Chinese have quietly made a priority of economic self-reliance, encouraging Chinese companies to improve technological applications and productive efficiency, with the goal of competing against and ultimately supplanting foreign companies selling in China. If the yuan is re-valued upward, China's push for self-sufficiency will intensify, and probably enjoy considerable success. Then, the Chinese government will look smart for investing in the yuan and bailing on the currencies of stagnating foreign nations.

Meanwhile, back at the ranch, the EU is starting to look less unified. The French have stepped forward and argued for an explicit bailout of Greece. The Germans, no doubt irked by the fact that France's gallantry would be funded by Germany's wealth, have intimated that perhaps Greece should depart the EU in order to pursue other opportunities (or something to that effect). On a subliminal level, it's disquieting to see France and Germany disagreeing over a nation in the Balkans. At least this time, neither stormtroopers nor poilus are on the alert.

Nevertheless, the Europeans seem to be drifting back toward the dynamics of continental relations in the early part of the preceding century, when nations seemed simply to misunderstand where their neighbors were coming from. France's President, Nicholas Sarkozy, by proposing a concrete bailout plan for Greece, was inviting Germany's Chancellor, Angela Merkel, to commit political suicide. Seeing as how Merkel worked her way up the political ladder to become Germany's first female chancellor, self-immolation isn't likely to be in her playbook. While the French electorate is surely applauding Sarkozy's efforts to allocate some of Germany's wealth to Greece, Germany's electorate will only encourage Merkel to flip Sarkozy a pelican, or something like that. This isn't likely to end in a cozy circle with everyone roasting marshmellows and singing Kumbaya.

Greece has threatened to go to the IMF for assistance if the EU doesn't soon come up with a concrete bailout plan. The Germans shrugged. Without German participation, there will be no EU bailout plan because France and other pro-bailout nations have only the courage of Germany's convictions.

Thus, it may pass that Greece goes to the IMF. That's when Greek prime minister George Papandreou's quiet visit with President Obama last week may acquire greater significance. While next to nothing has been said publicly about the purpose and outcome of that meeting, it wouldn't be a surprise to see an American contribution to the IMF not long after Greece applies for help. After all, doughboys and GIs twice went over there to solve Europe's problems. Greenbacks may have to make the same trip soon.