The Reluctant Firewall

Few experts deny that the eurozone crisis threatens the global economy. A messy unraveling of the euro would have ferocious effects on countries that export to Europe and could produce a global liquidity crisis that would stifle growth — even in countries with little direct exposure. For these reasons, International Monetary Fund (IMF) Managing Director Christine Lagarde has become increasingly apocalyptic in her pronouncements, warning yesterday that the crisis may trigger a repeat of the 1930s economic contraction.

In the face of this crisis, there is a remarkable reality: The world’s undisputed economic and financial leader, the United States, is essentially an observer. Unless the current trajectory changes, the crisis will play itself out in discussions between European leaders.   

To be fair, the United States has been an active — even frenetic — bystander. The Obama administration is clearly alarmed by the course of events, not least because an implosion of the euro might tank the global economy just as the U.S. election approaches. Treasury Secretary Timothy Geithner has toured European capitals on multiple occasions, hectoring leaders and finance ministers about their responsibilities, offering advice, and serving as an informal mediator. His peregrinations have often earned him the annoyance of European finance ministers, but Geithner has persisted. The administration’s involvement has reached even higher; the president himself has repeatedly buttonholed key European leaders in an attempt to engineer a breakthrough.

The vigorous hortatory role cannot mask the reality that the United States is not willing to put new money on the table to address the crisis. The consistent U.S. position has been that Europe has the resources it needs and that only political will is lacking. At the Cannes G-20 meeting last month, the United States reacted coolly to talk of a massive increase in IMF resources and insisted that the organization has all the tools it needs. In the weeks that followed, the United States hasn’t budged from the position that a resolution is, above all, a European responsibility. At most, the United States seems willing to countenance an IMF role as a junior partner.

At a certain level, the American position is indisputable. The crisis is Europe’s making and it can and should be resolved by Europe. But the knowledge that Europe is most guilty will be cold comfort if, as now appears likely, its leaders fail to construct the short-term firewall essential to calm the markets and stop the upward spiral in borrowing costs. Last week’s European summit in Brussels made progress on addressing the euro’s critical architectural flaws but did little to construct that firewall.

We have reached the point where outsiders can no longer fuss and fume about Europe’s political and institutional shortcomings. The critical question is not whether Europe is to blame but whether outsiders can step in where Europe has failed. The world must do so, but it cannot without much more assertive American leadership.

Domestic politics is the key to the Obama administration’s reticence. The administration faces a hostile Congress that has shown no interest in supporting an IMF bailout package. Indeed, some on Capitol Hill have talked of clawing back commitments the United States has already made to the IMF. A wary Obama administration has not even brought before Congress a previously agreed upon doubling of IMF quotas. Meanwhile, the main Republican presidential candidates have opposed any bailout of Europe and there’s no doubt they would make political hay if the administration should move in that direction. In a different political environment, the United States would almost certainly have already stepped forward with resources and helped lead an international response.

The president’s political advisers are no doubt telling him that new U.S. funding for the IMF is a non-starter. But it is a non-starter in large part because the administration has not started making the argument. It has plenty of ammunition to make a compelling case. Funds to the IMF are not budget outlays in the normal sense, so they wouldn’t blow a hole in the deficit. IMF loans have always been repaid, with interest. A massive, market-calming IMF package for Europe could come equipped with tough conditions to ensure that the euro ceases to be a financial weapon of mass destruction.      

What’s more, the administration would not have to provide the bulk of the resources needed for an impregnable defense. European central banks have already committed to contributing several hundred billion dollars to the IMF. China, Brazil, Russia, and other emerging economies with large cash reserves have also signaled a general willingness to contribute. But the Obama administration’s unwillingness to consider any new U.S. contribution has hobbled its ability to lead an international response.

The result is that there is still no credible firewall. The markets have realized that last week’s summit was a dud. Greece is sliding even further into insolvency. Italy’s borrowing rates regularly touch unsustainable levels. Absent dramatic action, the first few months of the new year will likely push the crisis into a terminal phase. 

It is increasingly likely that action will have to emanate from Washington. The Obama administration faces a Hobson’s choice: take on the very unpopular fight that will be needed to boost IMF resources and galvanize an international response, or acquiesce as the eurozone crisis metastasizes, likely tipping the world into prolonged recession. Neither option is appealing, but one is the right thing to do.