Strauss-Kahn allegations are consequential for the global economy

By Mohamed El-Erian
May 16, 2011

By Mohamed A. El-Erian
The opinions expressed are his own.

This weekend’s detention of the IMF’s chief on allegations of sexual assault has implications that go well beyond the impact on Dominique Strauss-Kahn’s (or, as he is commonly known, DSK) international prestige. They could also impact the IMF, France, market uncertainty and the well-being of the global economy.

We must wait to make a full assessment until we know the outcome of ongoing police investigations into allegations that, according to his lawyer, DSK intends to “contest vigorously.” Having said that, some commentators are already taking the view that the IMF could lose its managing director, and that France could lose a leading candidate for next year’s presidential elections.

Should he be forced to step down, DSK would be the third successive head of the IMF to leave suddenly. Once again, this would catch the institution with a selection process for the top position that is still overly dominated by politics, horse-trading between Europe and the US and other outmoded characteristics.

The IMF, whose shareholders are 187 member countries, would have two choices if it has to replace DSK quickly: Retain its feudalistic approach, or implement an open merit-based selection process based on clear criteria and a transparent process.

The first would allow the Fund to move quickly in appointing a new head, but doing so uses a method that lacks credibility and legitimacy. The second would correct a long-standing deficiency, but slow the appointment.

Under either approach, the IMF would inevitably operate under a huge cloud. This would erode the confidence of an institution that, under the personal authority of DSK, has taken significant financial and reputational risk in making loans to countries whose medium-term debt viability is far from robust. It would undermine its effectiveness in responding to new challenges. And it would pull the rug from under initiatives aimed at enabling it to play a more effective role in global policy coordination and, more generally, in improving global economic governance and filling a damaging vacuum at the center of the international monetary system.

The IMF’s loss, if it were to occur, would also be a blow to the socialist party in France. DSK was widely anticipated to seek his party’s nomination for the presidential race; and polls suggested that he would have been well placed to challenge President Sarkozy’s pursuit of a second term.

France now faces the possibility of an even more complex, and a more polarizing presidential campaign. This would come at a time when the country heads both the G-8 and G-20, and when it plays a stabilizing role at the center of Europe now that the Merkel-led government in Germany, the other large economy at the core of the region, is facing growing political strains.

Undoubtedly, there are countries that are, and should be wondering about the impact that all this could have on them. Greece is first among them.

Desperate to avoid a debt restructuring, Greece is heavily dependent on exceptional official assistance. Up to now, a DSK-led IMF has shown little hesitation in aligning itself with a controversial European approach that uses liquidity to address a solvency problem — essentially, piling new debt on top of Greece’s already excessive debt.

A possible DSK departure from the IMF would make the institution less enthusiastic for an approach that has already shown signs of slippage, ineffectiveness and overall fatigue. Should this materialize, the ECB and EU would find it extremely difficult to continue to pursue a course that is shifting dubious liabilities from private creditors to European tax payers yet failing to deliver to Greece either the reality or the promise of economic growth and jobs. In the process, market uncertainty will grow as the probability of debt restructurings also increases in the two other peripheral economies needing large bail outs (Ireland and Portugal).

The allegations facing DSK are serious and will — and should — take time to be investigated properly and sorted out. In the meantime, and unfortunately for the wellbeing of the global economy, they have caught the IMF still without a proper selection process, and Europe still without a sustainable solution to the debt crisis in its periphery.

Mohamed A. El-Erian is the CEO and co-CIO of PIMCO, and author of “When Markets Collide.”

Editor’s note: Some news stories have mentioned El-Erian as a possible candidate to run the IMF.

Photo: A man stands behind front pages of newspapers about International Monetary Fund (IMF) chief Dominique Strauss-Kahn’s arrest, at a central Athens kiosk May 16, 2011. Strauss-Kahn makes his first appearance in court on Monday since being accused of trying to rape a hotel maid in a case that sent shockwaves through French politics and left the IMF in turmoil. REUTERS/John Kolesidis

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