IMF Chief Warns of 1930s Style Depression

Sunday, 18 Dec 2011 01:04 PM

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The world is teetering on the brink of a 1930s-style depression, and policymakers worldwide must take action now — not just in Europe but everywhere — if the global economy is to avoid falling into a pit of economic meltdown, says Christine Lagarde, managing director at the International Monetary Fund.

Ratings agencies are flying more and more warning flags on fears the European crisis is getting worse, and another onslaught of downgrades could begin within a few months.

Lagarde, a former French finance minister, warns "economic retraction, rising protectionism, isolation and ... what happened in the 30s," await the world unless the crisis ends.

"There is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super-advanced economies that will be immune to the crisis that we see not only unfolding but escalating," Lagarde said in Washington this past week, according to the Financial Times.

"It is not a crisis that will be resolved by one group of countries taking action. It is going to be hopefully resolved by all countries, all regions, all categories of countries actually taking action."

Fitch Ratings rattled battle-weary European markets by slapping a negative outlook on France, meaning the country still carries an AAA rating but a downgrade is becoming increasingly likely.

That move, the latest in a series of European downgrades or threats of such from other ratings agencies like Moody's and Standard & Poor's, prompted high-ranking French officials to criticize the move and point out that London deserves blame if Paris does.

Bank of France Governor Christian Noyer said downgrading France would be "unjustified concerning the economic fundamentals."

"Or else they should start by downgrading the United Kingdom, which has higher deficits, as much debt, more inflation, and less growth than we do, and whose credit is collapsing," Noyer was quoted by the daily Le Telegramme as saying, according to the Associated Press.

U.K. officials, meanwhile, say France's comments caught them off guard.

"We have put in place credible plans for dealing with our deficit – the credibility of our plan can be seen in what happened with the interest rates on our bonds," said a spokesman for U.K. Prime Minister David Cameron.

"The markets clearly don’t agree with Noyer," a U.K. Treasury official added.

The U.K. ruffled feathers recently by being the only country at a 27-member EU summit not to vote in favor of greater fiscal integration.
The U.K. said it had the most to lose from the summit's accord, such as imposing taxes on financial transactions like stock trades.

That summit drew criticism from Fitch as well.

Not only did Fitch warn France could be the next to see its rating suffer, the agency said the continent's policymakers won't live up to the commitments they made at the summit, pointing out in a statement that "a 'comprehensive solution' to the eurozone crisis is technically and politically beyond reach," according to Reuters.

"Of particular concern is the absence of a credible financial backstop. In Fitch's opinion, this requires more active and explicit commitment from the ECB to mitigate the risk of self-fulfilling liquidity crises for potentially illiquid but solvent Euro Area Member States," Fitch said.

The European Central Bank (ECB) has refused to jump in and act like a lender of last resort, pointing out that the measures it could take, such as buying sovereign bonds issued by troubled countries, would go against its mandate to keep inflation rates within comfort zones.

Furthermore, ECB officials have insisted that monetary policy should not relieve politicians from doing their part and making tough and arguably politically unpopular decisions such as fresh public-sector layoffs and tax hikes to right ailing economies.

Eurozone countries insist, however, that they will do what it takes to end the crisis and prove Fitch and other naysayers wrong.

"We all know that Europe has not been able to convince markets that its governance set-up and its measures against the crisis were enough," Italian Deputy Economy Minister Vittorio Grilli tells Il Sole 24 Ore, as reported by Reuters. "More integration and more effective instruments are needed. We are not yet there."

Many market watchers agree that calm seas and blue skies don't lie on the horizon, at least not in the near future.

"The world is playing a game of hot potato right now. There are more and more banks and investors seeking to sell assets and more assets seen as toxic. So you have more hot potatoes — such as, European bank debt and European government debt. The only player with oven mitts is the European Central Bank, but it's refusing to be the lender of last resort. And at the same time, there are fewer and fewer places to hide from market volatility," says Tony Crescenzi, a market strategist at Pimco, the world's largest bond fund, in an interview with the Associated Press.

"This environment is likely to linger into 2012.

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