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How the IMF and US were party to Greece's tragedy

After helping to maintain the integrity of the European monetary union, the U.S. and the I.M.F. seem to have finally realized the danger of leaving more than half of West's economies in a state of chaotic recession.

The huge waste and appalling mismanagement – displayed during the Greek debt negotiations – have also shown to the Washington pair that they were partly responsible for an intractable euro area crisis and a serious economic and political weakening of the Western alliance.

Now, in fairness to a de facto manager of the world economy (I.M.F.) and its principal shareholder (the U.S.), it is true that they did try to do the proverbial "something." But they did that without the determination necessary to get the Europeans back from the precipice.

Worrying in his re-election campaign about the one-fifth of U.S. exports going to Europe, President Obama called in vain a number of times on the German chancellor to withdraw her devastating austerity diktat to the sinking euro area economies. Repeated appeals of the American president were not only turned down; they were also publicly ridiculed. The German leader bristled that "adding more debt to an already large debt" made no sense.

As a result, the euro area was left to bleed as the German chancellor ordered that "those who violated the budget rules (French, Italians, Portuguese and Greeks), and those who failed to supervise their banks (the Spanish), had to be taught a lesson." Predictably, deepening recessions and rising unemployment swept away from power the incumbents in France, Italy, Spain, Portugal and Greece.

Growth, growth, growth

Much after the damage was done, the I.M.F. eventually denounced the obvious: Austerity measures imposed by Germany under conditions of euro area's declining demand, output and employment were wrong. Growth was better, they said.

And then, after months of bruising scuffles with the Greeks, the I.M.F. recognized another fairly obvious issue: Greece needed debt restructuring to give some oxygen to its asphyxiated economy. That was another grotesque reversal, because the request for debt restructuring was consistently denied to the Greek government since last January.

Luckily, Washington sprang back into action as it became clear that Germany was pushing Greece out of the monetary union – a calamity that would have caused unpredictable political and security issues for the Atlantic community.

The danger now is that the U.S. will drop the ball, as it gets distracted by the unfolding election campaign, new and old Middle East crises and China's rising challenges in East Asia.

That would be a great pity and an unforgivable mistake because Germany won't give up.

Smarting from having been blocked by the U.S. in its attempt to get rid of Greece, Germany is now picking a fight with the E.U. Commission because it helped to keep Athens in the monetary union. By accusing Brussels of "overstepping its administrative, record-keeping duties," it looks like Berlin is getting back at the Commission's President Jean-Claude Juncker, who dared to call Germany out for "playing its domestic politics on the back of the euro." German media are also reporting that Berlin is now writing the rules which would make it easy to throw the countries out of the monetary union if they failed to dance to Teutonic tunes.

Debout la France (Stand up, France)

Who will put up a fight against this? Mired in its own continuing unpopularity and rising unemployment, the French government will probably do nothing. Its grandiose euro area plans announced for next fall won't even cross the Rhine. Sadly, Paris remains Europe's second fiddle, as it has ever since the feisty Jacques Chirac left the presidency in 2007. And it is a sign of times that an "authentic Gaullist party," Debout la France, has only two seats in the French parliament.

It is, therefore, quite likely that a latent euro crisis will continue as Germany pushes aside French "solidarity" initiatives by insisting on existing commitments -- that France cannot meet -- for sharply falling deficits toward a budget balance by 2017.

Here are some numbers to show that such an unreasonable rush to fiscal consolidation would be economically and politically destabilizing.

The euro area's gross public debt in the first quarter of this year came in at 92.9 percent of GDP (or 9.4 trillion euros) – an entire percentage point above the previous quarter and 32.9 percent above the monetary union's treaty rule set at 60 percent of GDP.

How can the euro area get all this red ink down? Barring a sustained and politically unacceptable inflationary outburst, the only orderly way of doing that is through rising tax revenues in a growing economy and a tight cap on public spending. That should generate steadily rising primary budget surpluses (i.e., surpluses before interest charges on public debt) that would, over time, stop and reverse the growth of public debt.

And here is how difficult that is. The euro area debt shot up from its most recent low of 77.5 percent of GDP (in 2008), despite the primary budget's shift from a deficit of 2.7 percent of GDP to a 1 percent surplus last year.

Or take the case of Italy. The public debt in the first quarter of this year soared to 135.1 percent of GDP (or 2.2 trillion euros) from 132.1 percent in the previous quarter – even though the primary budget surplus was kept between 4 and 5 percent of GDP in the last three years.

And here is the fallout: Over that period, Italy's GDP went down at an average annual rate of 1.7 percent, the unemployment rose from 10.6 percent to 13 percent, and the output gap (economy's deviation from its productive potential) now stands at more than 6 percent – second only to Greece.

All this shows that only a resumption of the euro area economic growth and sustained primary budget surpluses will lead to a decline of public debt. Like most things in a responsible statecraft, that will require a patient and disciplined work, enforced through political cooperation – not a self-righteous bullying – at the highest levels of the treaty-bound sovereign nation states.

Investment thoughts

The European Central Bank (E.C.B.) knows that its easy credit stance has to offset tight budget policies as the euro area continues its long and difficult process of fiscal consolidation.

Institutional changes toward euro area's unified fiscal and debt management policies seem unlikely. That would require major sovereignty transfers, with treaty and constitutional changes, that neither France nor Germany seem ready to implement in the run-up to their general elections in 2017. The shape of the monetary union – and whether it will exist at all – will depend on political forces taking the helm in Paris and Berlin in the spring and fall, respectively, two years from now.

Backed up by the U.S., the I.M.F. efforts toward Greece's debt restructuring will probably make some headway, because the multilateral lender has enough leverage to overcome the German opposition. That would give space to Athens for growth, structural reforms and political stability.

Your investment strategy can count on the E.C.B. to literally do "whatever it takes" for the euro area's incipient economic recovery.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.