What next for the euro if France rejects austerity?

By Jeremy Warner

6:41PM BST 23 Apr 2012

At a time when the UK Government is imposing another £16bn of spending
cuts, is abolishing pensioner tax reliefs, and is apparently so
financially stretched that it needs to tax warm pasties, it has
somehow managed to find an additional £10bn to bail out the eurozone.
This from a prime minister who declares himself a “eurosceptic”. Is it
any wonder that the Tories are trailing in the polls?

I’ve found myself genuinely torn by the debate around new loans to the
International Monetary Fund (IMF). On the one hand, I’m a supporter of
multilateral solutions, and find the spectacle of so many countries,
some of them quite poor, coming together to create a bigger and more
credible financial safety net both noble and inspiring.

Britain was one of the founding fathers of the IMF, and whatever the
rights and wrongs of the euro, our future is vitally dependent on a
stable and prosperous Europe. It would have seemed isolationist and
almost gratuitously self-destructive to have stayed out while so many
others were participating.

There is also something in the Treasury argument that this is not real
money, since all commitments to the IMF come from the foreign exchange
reserves and remain largely unused. The additional funds are billed as
merely a contingency which could not in any case have been used for
alternative, public spending purposes. With luck, it will cost nothing
to have participated.

But I also substantially agree with the reservations expressed by the
two major refuseniks, the United States and Canada. There is no
obvious need for more IMF funding outside the growing likelihood of
further eurozone bailouts. We have no idea on what terms the IMF might
lend, but what we do know is that the eurozone is struggling to find
politically acceptable solutions to its crisis, which, to the
contrary, looks ever more intractable.

Future eurozone bailouts are likely to dwarf anything the IMF has done
before; at the same time, there is no credible escape route or
convincing path back to either growth or debt sustainability offered
to any of the afflicted nations. This combination makes future IMF
programmes very much more high risk than anything that has gone

Take the example of Spain. Should Spain need to become part of the
programme, what conditions would the IMF impose? Monetary union
precludes devaluation, which is normally key to re-establishing
competitiveness, while the Spanish government is already enacting a
degree of fiscal austerity and structural reform that is similar in
its scope if not beyond what the IMF would recommend. Far from
improving matters, this is proving self-defeating and making them

In such circumstances, it is hard to see what additional conditions
the IMF could or would impose. Any new lending would in effect be an
unconditional bet on the euro somehow muddling through and solving its
problems. On the evidence so far, such an outcome looks less than

No new narrative emerged from the International Monetary Fund’s spring
meeting in Washington last week on how the eurozone periphery might
regain competitiveness and thereby pay down its deficits.

Almost every viable solution to the debt crisis has been ruled out.
Germany won’t accept either fiscal transfers to fund the deficit
nations, nor will it tolerate the higher level of domestic inflation
that might give the periphery a fighting chance of returning to
growth. Instead, a deflationary race to the bottom of wage and
entitlement cuts is prescribed.

This will in time undoubtedly make the eurozone more competitive, but
for what purpose if a quarter of the workforce is left unemployed and
the rest are living in penury? In the meantime, the eurozone looks to
the IMF to provide the transfers that Germany and others refuse.

As is evident from political developments over the weekend in France
and the Netherlands, support for the approach chosen – austerity and
structural reform – is fast eroding. Euroland faces a groundswell of
populist rebellion. The political consensus around austerity is

But nor yet does there appear to be substantive support, either in
Germany or elsewhere, for the other self-evident solution, which is a
smaller euro shorn of its troublesome south. All rests on the idea
that given time, structural reform will work. Eventually, the faithful
insist, markets will be convinced of this, and start lending again.
And pigs might fly.

For evidence that the deflationary path back to viability can work,
proponents tend to point to Ireland, which has returned to wage
competitiveness and current account surplus. Domestic demand, on the
other hand, remains flat on its back, with unemployment high and fast
becoming structural. This kind of down-at-heel equilibrium is not
obviously a model others would want to aspire to.

I’m not sure why anyone found the outcome of the first round of the
French presidential election a surprise – it was always expected to
result in a Sarkozy/Hollande run-off. Even so, it has helped unsettle
markets anew. The prospect of a president determined to tear up the
fiscal compact throws another giant spanner in the works.

Flanby (the nickname is derived from a form of crème caramel) rejects
the austerity that underpins continued German support for the project.
And to judge by the turnout for Marine Le Pen, nearly a fifth of the
French vote wants out of the euro altogether.

In Washington last week, Christine Lagarde, managing director of the
IMF, qualified her delight in more than doubling the size of the IMF
safety net by saying that this was not in itself a solution. Indeed it
is not.

On how to restart growth, she was all out of answers. To the extent
that she did have a “solution” worth talking about, it was just more
and deeper Europe – including Eurobonds and a federal banking system,
with a single supervisor and resolution regime. This is a view shared,
by the way, by the UK Chancellor, George Osborne. Unfortunately,
neither of these two things is for the moment remotely acceptable to

Time is running out. Support for populist, national alternatives is
growing. It is small wonder that the US and Canada won’t participate
in the IMF fundraising. With no solution in sight, they fear for the
safety of their money.