European governments are backing the establishment of a monetary fund that would rush to the aid of the euro zone's crippled economies.
Like its global namesake, a European Monetary Fund would attempt to reduce economic instability among its members, the 16 countries that share the euro, and bail out any of its states in danger of defaulting on their debts.
Those countries share a common currency and central bank but, while there are rules governing fiscal issues, a European version of the International Monetary Fund would bring more of a sense of economic and fiscal union to the region.
On Monday, as Greece's Prime Minister George Papandreou was touring Western capitals to seek financial support for his ailing country, several European governments signalled they would back the creation of an EMF.
The European Commission, the executive arm of the European Union, said preliminary work to create the EMF is already under way, and a proposal to launch the new institution could be ready by late June. Wolfgang Schauble, Germany's Finance Minister, told the German media that details of the EMF would be revealed "soon."
Germany's Economics Minister, Rainer Bruederle, threw his support behind the proposal, as did German Chancellor Angela Merkel. "I think the idea is a good one," she told reporters yesterday.
The support for an EMF had an immediate positive effect on the debt markets. By the end of the trading day in Europe, the cost of insuring Greek sovereign debt had fallen about 13 basis points to 285 basis points. That meant it cost $285,000 (U.S.) to insure each $10-million amount of bonds against default. Ten days ago, before the Greek government passed its spending clampdown package, the cost was about $400,000. (A basis point is 1/100th of a percentage point.)
While debt investors applauded the effort to launch the EMF, there was no shortage of critics who argued it would be redundant or even counterproductive. Some said it might never get launched, given the endless political squabbling and horse trading among EU countries. They note that an Asian Monetary Fund was proposed in 1997, when a financial crisis gripped several East Asian countries. Thirteen years later, it has yet to come to life.
The EMF idea was put forward last month by Deutsche Bank chief economist Thomas Mayer and Daniel Gros, director of the Centre for European Policy Studies in Brussels. In their view, the EMF would provide the financial discipline that the euro zone's own stability and growth pact failed to deliver.
The pact ostensibly limited budget deficits to 3 per cent of gross domestic product, and public debt to 60 per cent of GDP. The limits were ignored by many euro zone countries, notably Greece, whose deficit last year was 12.7 per cent. The EMF would be funded by countries in breach of their EU budget rules. Based on the formula envisaged by Mr. Mayer and Mr. Gros, the EMF fund would have built up some €120-billion ($163-billion) in reserves since the start of monetary union in 1999. Financial assistance would be dispersed to the countries hit hard, but only if they adopt fiscal plans, such as spending cuts, approved by the EMF.
How the real EMF would work, what powers it would have, how it would be funded, and how it would compete with the IMF are not known.
Juergen Matthes, senior economist at the Cologne Institute for Economic Research, in Germany, thinks the EMF is fatally flawed even before it is launched.
He said little more than "ego" is the motivating force behind the EMF. Accepting help from the IMF, which is based in Washington and widely seen by Europeans as an "American" institution, even though it is run by a Frenchman, would be an admission that the euro zone countries are incapable of solving their own problems.
Mr. Matthes said a European institution would find it difficult to enforce fiscal discipline on its European members, in the same way the EU's stability and growth pact failed to prevent budget deficits from ballooning, and shied away from fining the guilty countries for fear of deepening the EU's north-south divide. Discipline, he said, would best come from a disinterested, outside party - the IMF. "In the end, the EMF will be politically unable to force quick adjustment," he said.
Simon Ballard, senior credit strategist in London for RBC Dominion Securities, agrees that the IMF would have greater success in enforcing fiscal discipline on miscreant euro zone countries than the EMF, because of the EMF's insider status. "The IMF would draw a much cleaner line in the sand," he said.
Both Mr. Matthes and Mr. Ballard agree that funding the EMF could be a problem if the bulk of that funding comes from the weakest countries. "If you are taking money from countries that are close to default, you are punishing the countries that are in the worst shape," Mr. Matthes said. "How would you get more money from Greece?"
The IMF has not said what it thinks about the EMF proposal. In any event, the EMF's launch would come months, perhaps years, too late to help Greece, which may have trouble rolling over more than €20-billion of debt in April and May. Greece has made it clear that it will seek help from the IMF if the euro zone countries cast it adrift.