Friday, October 31, 2014
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The Hazard of Second Best

NEWPORT BEACH – The international community risks settling for second best on two key issues to be discussed this month at global meetings in Washington, DC: the lingering (if currently somewhat dormant) European debt crisis, and the selection of the World Bank’s next president. It is not too late to change course, but doing so will require the United States and governments in Europe to resist harmful habits, and emerging countries to follow up effectively on recent initiatives.

In the last few days, European leaders, including French President Nicolas Sarkozy and European Central Bank President Mario Draghi, have declared that the worst of the eurozone crisis is over. Others, like French Finance Minister Francois Baroin, have gone even further, claiming that Europe “has done its part,” and that it is now up to other countries to do theirs.

These announcements should come as no surprise. Having experienced prolonged turmoil, the eurozone is currently in a period of relative tranquility. The courageous reform measures implemented by Mario Monti, Italy’s technocratic prime minister, have eased immediate concerns that Greek dislocations might tip other European countries – much bigger and harder to rescue – into insolvency. Europe’s decision last week to bolster its internal financial firewalls has reinforced the resulting positive impact on market sentiment.

But, as important as these steps are, the recent tranquility has been more borrowed than earned. Since December, the ECB has twice deployed long-term refinancing operations, which provide unlimited three-year financing to banks at 1% interest. This has given the banking system more time to increase capital and improve asset quality. It has also reduced several governments’ financing costs. What it does not do, and is not meant to do, is resolve Europe’s twin problems of too little growth and too much debt.

If it is not careful, Europe risks falling into the trap of trying to shift responsibility for its problems onto others, rather than building on recent progress. That temptation is partly reflected in efforts to press officials from around the world to agree this month to a major increase in the International Monetary Fund’s resources, with emerging economies footing a significant part of the bill.

In pivoting from internal to externally-financed firewalls, Europe is pushing a political agenda that is not yet warranted by economic and financial realities. Europeans are about to embark on another round of elections, in both core and peripheral EU countries, as well as a referendum in Ireland. Recent history suggests that these votes are unlikely to favor ruling parties unless they can signal some progress in resolving the crisis.

The rest of the world should counter the risk of European complacency, and the US should take the lead. But US officials no longer seem interested because they need to secure Europe’s support for another second best this month: the anointment of the American candidate, Jim Yong Kim, as the World Bank’s new president.

For the first time in its nearly 70-year history, the Bank’s executive board is also considering two non-Americans for the job: the Colombian Jose Antonio Ocampo and the Nigerian Ngozi Okonjo-Iweala. The nomination of these two unambiguously qualified and experienced individuals to compete with Kim is an important first step in changing the feudalistic practice whereby nationality has been the overriding criterion for selecting the World Bank’s president (as well as the choice of the IMF’s managing director, which Europe controls).

All three candidates meet US President Barack Obama’s justified insistence that “a development professional…head the world’s largest development agency.” But this does not make them equal. They are not.

A consensus has emerged that, when judged by the Bank’s own criteria for the job, the highly respected Okonjo-Iweala dominates the other two candidates. On that basis, she has already gained the endorsement of influential observers and opinion-forming media outlets. Moreover, her appointment would speak to other important initiatives with which Obama has aligned himself, including efforts to fight corruption, strengthen meritocracy, and support gender equality.

I suspect that, in their hearts, US officials know that Kim, while an inspired nominee, is not the best candidate. Yet their historical attachment to a harmful nationality-based entitlement stops them from opting for the best. Meanwhile, Europeans are happy to hold their tongue as a reward to the US for having supported their nationality-based appointment last year of Christine Lagarde to head the IMF.

The responsibility of resisting two second bests now falls to emerging countries. It is up to them to do the right thing this month. And, for the first time in my career observing the international monetary system, they are in a position to take three important steps.

First, since they are expected to contribute significant financial resources, emerging economies can postpone bolstering the IMF until the eurozone does more to improve the policy mix in member countries and further strengthens its financial firewalls and fiscal harmonization.

Second, by asking Ocampo to step aside in favor of Okonjo-Iweala, they can unite their votes behind a highly credible merit-based appointment for the World Bank.

Finally, they can put pressure on their Western counterparts by maintaining momentum on the alternative of a “development bank for the South,” an initiative that received support at last week’s BRICs meeting in India.

The considerations of Realpolitik that influence global meetings often lead to second-best compromises as a means of avoiding more costly inaction. By contrast, this month’s discussions in Washington can and should opt for the first best. But this will happen only if emerging countries play their cards well, and if Europe and the US do what is in their own best longer-term interests, as well as those of the global economy.

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  1. CommentedJonathan Lam

    Gamesmith94134: The Hazard of Second Best

    French Finance Minister Francois Baroin, have gone even further, claiming that Europe “has done its part,” and that it is now up to other countries to do theirs.

    What would Mr. Baroin expected in the outcome of the stronger Euro at 1.3 to a dollar? Since it sound relevant to the strength of its Euros, it is the first haircut to foreigners’ currencies under the 1% bank loan credits. Does your investment lose itself through the processes of fiat Euros? Perhaps, Mr. Baroin knew the stock is coming to an adjustment, then, the other countries should dump the Stock and buy their bonds and compress 50—75% off their investment since ECB and IMF from getting their 2 trillion equity or credits for salvage the EU debts.

    Some are disgust at the déjà vu again, it is not even July; but some may reminiscent of “October” as EFSF failed to aggregate a targeted capacity again. Just after the sale in Spain’s debt failed its target sum, and Greece future is bleak, so is the PIIGS. The ECB also said the interest rate on its deposit facility would remain at 0.25 percent, and the rate on the marginal lending facility would stay at 1.75 percent. The market reacted in the credit crunch that the Dow Jones in sliding off 13000 after China stocks cut 3% to apply in its financial lookouts.

    There is a crack in the dollar at 76 to 79 the jump in Dow Jones by 20% after the 9600. Swiss banks are forced to purchase its bonds because their overloads of Euros currency that included debts and credits, some said of CDS tradeoff. I do not blame them if I saw yahoo cut 2000 employments, Best buy closed 1500 stores, Sears closed 150 stores that many may see as correction to globalization. In addition, the Brazil is not bending on the inflow of US to more acquisition and merger, and BRICS is raising its criticism on the equitable currency exchange under the throw weight system of IMF. It is plainly disadvantage to their floating rate when EU and FED margin its free flow of credits at 1-1.75%.

    In the last days on the Greek debts interest rate jumped and Spain’s debt came short in sale. More and more investors are questioning on the downturn on the Stock markets that I believe the credit crunch resurface in the EU banks which suffered from the contraction of the China’s growth at 7.5% from 9%, and overshadowed by its trade deficit from January; in addition, the currencies exchanges rates are shifting their compatibilities after the effects of protectionism and inflation roaming.

    Consequently, dumping of Euros is inevitable even if those debts are traded. However, the extended additional debts make the system worse than before the Bael II with lesser growth.

    Some would question if EU and US could have their 54% votes to the World Bank in choosing its chief; and BRICS demanded the recalculation of the current currency exchange rate, and ASEAN have already developing its own mutual agreement in its 13 currencies to a standardize exchange. Somehow, IMF should find it way to correct its system to compensate when imbalance occurs as fixed rate and floating rate meets. How its system compensate when 1.75% and 7% interest rate is being exchanged? Otherwise, the wall of protectionism is not going away.

    I see more of significant equitable value changes in US and EU even in Germany after more inflation hit and lesser growth in a downward trend after June if the haircut is not reversing the debt and GDP. What else can the developing nations do if their accomplishment is not apt to those are floating with a weight fixed to their central banks? It may not be contagion but sinking to the bottom for depression to a new start is not other countries have in their mind.

    Mr. Mohamed A. El-Erian gave the best descriptions on Europe’s decision last week to bolster its internal financial firewalls, these steps are, the recent tranquility has been more borrowed than earned.

    May the Buddha bless you?

  2. CommentedCaitlin Luview

    It is interesting that in the concluding paragraph, the author, perhaps unknowingly, points to both the overall problem and thus by reference, to its solution.

    "...opt for the first best. But this will happen only if emerging countries play their cards well, and if Europe and the US do what is in their own best longer-term interests, as well as those of the global economy."

    The problem is that Europe and the US are currently incapable of doing what is best both for themselves and the global economy, because these two positions are currently opposites, making them mutually exclusive, rather than mutually inclusive. Is what is best for Europe the same as what is best for America? Is what is best for America the same as what is best for Europe? In an egoistic system, the answer to both questions is NO. In a system of mutual reciprocity, altruism, the answer to both questions is YES.

    Until we all come together in one great common family of humanity, we will continue to have attitudes from the habits of the old system of egoism, rather than the system of nature that we are evolving into, which requires altruism, compassion, and mutually reciprocal agreements in responsibility to do the best possible good for others, and in that, every best possible good for everyone is served, grown, and nurtured to ultimate flourishing.

    As long as there is any individual nation's leadership expressing this kind of isolationist "me, me, me" attitude, "claiming that Europe 'has done its part,' and that it is now up to other countries to do theirs," the unity for the best beneficial good of everyone that is now required in our globalized integral world, is still in the distance, keeping us all in jeopardy.

    I really like and completely agree with what the commenter Zsolt Hermann has said above: "No superficial adjustments can help, only a total rethink, and rebuilding of the whole global, interconnected socio-economic human system. The World Bank itself, while important is really a side issue, just another financial institution in the hands of the top layers for their own subjective, self calculating games. It does not matter who is heading these institutions until the whole attitude, foundation changes."

  3. CommentedZsolt Hermann

    The main problem in Europe is not only that we delude ourselves with the temporary recovery that was clearly borrowed and not earned.
    The main problem is that we judge everything, crisis or recovery by the state of the financial institutions.
    But the state of the financial institutions tell us nothing about the true state of the nations, how the general population is doing, whether they can cope with the austerity measures, whether they can sustain themselves according to accepted standards, whether the unemployment is easing at all, especially in the younger generations, and so on.
    We know it by know that the present measurements tell us nothing about the steadily growing inequality in between the top and lower layers of society and we can see world wide that all the bail out, stimulus packages, tax changes are aimed at making the strong stronger and the weak weaker.
    This predictable reflex reaction simply worsens the situation, since our whole socio-economic model is based on the population consuming what the top layers brainwash them to buy, but as the consumers are disappearing from the horizon, the already faltering machinery completely collapses. At the end everybody will be on the losing side.
    No superficial adjustments can help, only a total rethink, and rebuilding of the whole global, interconnected socio-economic human system.
    The World Bank itself, while important is really a side issue, just another financial institutions in the hands of the top layers for their own subjective, self calculating games. It does not matter who is heading these institutions until the whole attitude, foundation changes.

  4. CommentedProcyon Mukherjee

    One would be pleasantly surprised at the phrase ‘relative tranquility’ to be applied to a league of nations as mired by current controversy as the EU when the economics of Central Bank sops have under-performed dramatically against the rising needs of a whopping majority of members as growth rates have almost stalled; the long term cost of these sops at negative real interest rates is only a confirmatory signal of more disorder, not less. To pass on the burden to some of the emerging economies through a craftiness as vividly described is condemnable at the least.

    Procyon Mukherjee

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