IMF: Past and Present Protocol

15 january 2013

Due to the recent market gyrations and capital market consternation in Europe, it seems as though the International Monetary Fund (lMF) will loom quite large in the future finance plans of many European countries. Unlike the new Tom Cruise movie ”Ghost Protocol” in which an agents actions are disavowed and officially unrecognized, the IMF now has a clearly present protocol and will be an agent to aid in liquidity and crisis prevention. The organization recently announced a new program that would “bolster the flexibility and scope” of emergency programs and is effectively providing short term assistance to countries through its’ Precautionary Credit Limit (PCL). The duration of most loans is 1-2 years along with another 6 month facility. During the G20 summit, a Precautionary Liquidity Line (PLL) was unveiled in Cannes, these allow loans of up to 5 times the countries financial contribution. If the loans go to a second year they can reach 10 times the countries contribution. Currently, Macedonia was the only country that was able to qualify and draw down, while Italy initially did not request the loan it submitted its’ willingness to monitoring and review by the IMF during the Berlusconi administration. This was a much needed concession that will serve to create the discipline needed to execute austerity measures and further instill sorely needed confidence in the soveriegn’s credit.

However, given the amounts and the terms of the PLL, these facilities wouldn’t warrant Italy going through the process due to its massive debt–under its current terms. The IMF’s objectives aim to increase liquidity while creating stability is both timely and fortuitous as it seems that the number of countries requesting aid increases, an additional benefit of the IMF is that it can borrow from central banks giving it additional options to leverage funds issued with Special Drawing Rights (SDR’s). These programs can help to create supplemental leverage and additional viable options to lengthen terms for banks with weak balance sheets. The programs come when most are clamoring for the European Central Bank (ECB) to become the  buyer of last resort—something newly minted ECB president Mario Draghi has stated that he wouldn’t do. Although Draghi seems to be a parrot of his predecessor Jean Claude Trichet, we can distinctly feel the hand of Angela Merkel and the Bundesbank guiding their actions. If the recent  report in the Italian newspaper LaStampa is true, the IMF is currently preparing a $799 billion dollar loan  package–there would seem to be a distinct collusion of efforts with these new tools to allow mandates to be maintained while creating additional buying power. This would warrant a review of previous IMF European Director Antonio Borges supposed mis-statements of loans to other countries, after which he was replaced by the more tight-lipped Reza Moghadam. If this were to be true it would reduce political pressure on the ECB for intervention.

In truth, the main focus of the ECB is to prevent inflation, however other permutations of the ECB’s lending mandate could aid the eurozone countries such as lending to financial institutions who purchase sovereign bonds along with lending to the IMF or purchasing issuances in Special Drawings Rights (SDR) by them–a circumstance that becomes more likely everyday. Another possibility is transforming the European Financial Stability Facility into a bank to amplify leverage and then having both the IMF and ECB participate in lending facilities for it….but that is another discussion I will pursue later.

The general issue is that the weakness in markets is almost palpable. Now more than ever before–execution of the austerity plans is crucial as the faith in the CDS  market will be questioned by institutional players as they see the rules bent to accommodate the governments that they placed the money with. This greatly reduces the viable institutional investors which increases the incidence of participation by the western controlled IMF. It is my belief that we may well be watching the end of the european debt crisis, I believe that this will potentially end in less than a quarter. Remarkably, we might see the IMF play a larger surface role of stemming the crisis as we inevitably see one of two scenarios emerge:

a. Involuntary haircuts which will trigger write downs beginning in France and most likely only leaving Germany with an intact rating or;

B. Witness unlimited printing of paper by the ECB as they abandon their mandate and begin to purchase the debt of Portugal, Spain and Italy directly or indirectly through instruments issued by the IMF. In this scenario central bank easing will be excessive.

The immediate reaction will be an artificially stronger euro  whose power will rapidly evaporate. The result will be a recession and weak market in Europe in combination with a tepid market in the U.S.  This means a weaker euro and stronger dollar, so the trade will be sell the euro and buy dollars. The safe havens will be US Treasuries, UK Gilts and the Bund. Be on the lookout for the tail of this trade as the recession in Europe will almost ineveitably end up on U.S. shores later as we will not have built a robust enough stock market and a strong dollar will push down stocks.