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

7 comments

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[...] when Mohamed El-Erian writes about the effect of the arrest if DSK’s career is over, we can take him as describing [...]

Mr. El-Erian, what is so unsustainable about Greece selling off their assets, increasing their pensions and lowering the ridiculous benefits for their civil servants ? Moody calculated the worst case scenario on Greece: 34,4 billion. Truly, a 700 billion remaining ECB budget is more then sufficient to help the lenders. But no more freebies to Greece. Because that is what brought Greece into problems in the first place. And let Greece go down, you know it has no tangible implications for the rest of the EU economy.
Start believing it: Keynes is dead. He had to do without expectations economy and the world is a much smarter and well-informed place then it was. Nobody believes in freebies any more except the old socialists.

Posted by FBreughel1 | Report as abusive

[...] CEO Mohamed El-Erian disagrees. Writing for Reuters, he warns that the IMF losing [...]

Assuming the allegation is true, it raises more fundamental questions about Mr. Strauss and the management of the IMF. Focused (until very recently) on the developing world, it is curious that the maid was African. Again, assuming the allegation is true, obviously Mr. Strauss has serious psychological/psychiatric problems that, by default, impact his decision-making process. What has been the impact of these medical (assumption of guilt) problems on the global economic environment, specifically the developing world?

Posted by futuresmkt | Report as abusive

Looks like good implications to me – if the claims are true, of course. Would one really want a guy like this involved in the leadership of the IMF? Whatever the impacts on the International Monetary Fund, it’s well worth them to get a guy like this out of there. If it erodes confidence in the institution, then it is well-deserved for putting such a guy in power.

The effects are beside the point, this guy shouldn’t be in power if the claims are true, the ends don’t justify the means, and regardless of the effects, if he’s guilty, he needs to go. The IMF needs to be held accountable for its choices of leaders, ESPECIALLY because of its power – if that throws a wrench in its proceedings – tough.

Even if it means some problems to the global economy, we cannot know what problems would have been caused by such an immoral person in the leadership. It was bound to cause trouble, and best to fix it now before the potential for him to cause even more trouble substantiates.

Posted by Jzyehoshua | Report as abusive

Who knows what evils a guy with a moral compass like DSK was involved in behind the scenes, or would have been involved in? Who is to say that whatever global economic woes to result are any worse than the evils he already perpetuated, or would have instituted?

IF DSK is guilty here, he needs to go – which is probable given the previous scandals he’s been linked to. The IMF cannot afford such a person at its helm – period. That it even put such a person in leadership should harm its reputation. Effects are beside the point. Get an honest person in there and start being accountable.

Posted by Jzyehoshua | Report as abusive

The IMF needs urgently a person able to lead a completely change of actions to a global level. The name is Luis Inacio Lula da Silva, ex-president of Brazil. There is no other able to gather momentum to this sluggish economic global outlook. He is the truly “brigde constructor”. Together with Henrique Meireles ex-president Central Bank of Brazil is able to change the way growth in the global markets performs.

Posted by PedroBatista | Report as abusive

The reports coming out on DSK’s past are dark indeed. Can we trust the IMF to spend our money wisely, maybe $100 billion soon, without even a proper vetting process for their top man? How can he not be vulnerable to blackmail with such a weakness and influence on how the IMF’s huge fund is used? It’s time for the US to reevaluate all its foreign loans, grants, and assistance.

Posted by kolea | Report as abusive

The word is out ! ECB has refused de-structuring Greece”s debt ! What a good, sensible decision ! Exact words from Lorenzo Bini Smaghi “a solution for reducing debt but not paying for it will not work “. And that is how the EU solves the free-rider and moral hazard problem in one decision. Still not convinced, Mr.El-Erian ?

Posted by FBreughel1 | Report as abusive

[...] Strauss-Kahn allegations are consequential for the global economy (Mohamed El-Erian). [...]

[...] talked about the European debt crisis, how to make Egypt’s revolution successful, the IMF, Dominique Strauss-Kahn and Christine Lagarde and what he learned from his recent visit to Tokyo, [...]