Changing of Lagarde: there is economic trouble ahead

Christine Lagarde is a teetotal vegetarian who once won a bronze medal in the French national championships for synchronised swimming. She still goes to the gym every day, cycles up to 30km once a week and swims as often as she can.

As well as being super-humanely fit, Lagarde clearly likes to be in control. She once told an interviewer: “Success is never complete. It’s an endless combat. Each morning one must put one’s capacities to the test once again.”

But this grande dame de classe plays games too. In a recent TV interview “60 Minutes,” with John Dickerson of CBS News, Lagarde reveals how she pretends to drink when meeting her international peers at their swanky dinners and receptions.

The most important thing to do, she explains to Dickerson while having lunch at her Normandy home, is that you take the glass of wine, swirl it around and check out the colour with the flair of a sommelier.

Then she takes a deep inhalation, smells and seemingly sips the wine – but she doesn’t swallow a drop.  What she does instead, and here she points to her throat, is swallow hard so your fellow drinker sees your Adam’s apple move.

The result?  Lagarde keeps her wits about her, while others are busy losing theirs while downing the liquor. They don’t even notice the trick.

It’s a delicious detail that tells you much about the personality of the former head of the International Monetary Fund who becomes Europe’s most powerful central banker next week.

Playing tricks with fellow diners is one thing but Lagarde will need more than sleight of hand when faced with the awesome task of taking over from Mario Draghi at such a critical time for the eurozone.

Draghi has left her to deal with an almighty hangover. The continent is suffering from weak growth, the uncertainty of Brexit and EU supply chains, a collapse in manufacturing, the impact of trade wars between the US and China and Europe’s powerhouse, Germany, close to recession.

Lagarde’s predecessor, whose reputation has gone from Super Mario to Count Draghila over his eight year stint, has used up most of the levers available to him. Starting with his “big bazooka” – his whatever it takes policy to save the euro – Draghi has gone on to slash interest rates in an effort to stimulate demand and pile up the continent with quantitative easing.

Interest rates are floating along the bottom, while in some countries they are negative -Danish banks are offering negative rates on mortgages. Bonds in Germany, the Netherlands, Austria, Finland, Belgium and Spain are trading at negative yields.

Lagarde is well aware of the extraordinary situation she faces at the ECB. As IMF head, she has warned repeatedly of the dangers of ballooning commercial debt and low rates leading to a global downturn.

It’s a siren call the IMF continues to repeat. It estimates that companies now hold about  $19tn (£15tn) of debt, which could turn into a time bomb should there be another global recession because corporates would not be able to repay that debt. Add into that the impact of trade tiffs between the US and China, estimated to knock nearly 1% off GDP next year, and you have the scene set for what the IMF calls a “synchronised downturn.”

What’s more, the IMF reckons about 40% of the corporate debt is concentrated in eight  countries – the US, China, Japan, Britain, France, Italy and Spain – and would be impossible to repay if there was a downturn half as serious as that of the 2008 crash.

Ironically, rather than being the stimulus for growth that central bankers had hoped for, low interest rates have led to companies and countries taking on more debt.

Yet at the same time, there are many healthy companies bursting with cash in the bank –  it’s estimated there is a $2 trillion cash mountain sitting in the EU alone. But those companies are not investing the money because they are worried about potential problems with future growth and the impact of trade wars.

Households are also building up savings: across the eurozone, the average savings rate is now 13% while in Germany it is 18%.

In other words, we are in a state of stasis.

It could be that Lagarde’s experience of the IMF – and her years spent gallivanting around the globe – could come in handy at the ECB. Countries working together is one of her driving philosophies, as is her belief that the US must keep up its global leadership role.

As she also told CBS’s Dickerson, it’s crucial the US and the EU work together: “ If things go wrong in one part of the world, it is going to affect the rest of the world as well. We buy American products in huge quantities.”
“The United States buys European products in huge quantities. Massive numbers of European firms have set up shops in the US. Vice-versa. We penetrate each other’s markets.”

More optimistically, she adds that: “There’s a bottom to everything, but we’re not at that bottom at this point in time.”

Britain’s former governor of the Bank of England, Mervyn King, doesn’t share her half-glass full approach. At the IMF’s recent annual meeting, Lord King was at his most pessimistic as he warned the world is sleepwalking towards a fresh economic and financial crisis.

Indeed, Lord King, who was in charge of the Bank during the 2008 financial crash, stunned his Washington audience with his pessimism : “Another economic and financial crisis would be devastating to the legitimacy of a democratic market system.“ What’s more, he said: “By sticking to the new orthodoxy of monetary policy and pretending that we have made the banking system safe, we are sleepwalking towards that crisis.”

And the US, he added, would suffer “financial Armageddon” if its central bank, the Federal Reserve, did not have the weapons to fight another catastrophe such as the sub-prime mortgage collapse.

This was clearly a dig at President Trump, who has caused such political conflict with his constant criticism of the Fed boss, Jay Powell, for not bringing down interest rates fast enough.

Lord King’s most interesting point – and well worth taking on board – is that there has been no fundamental questioning of the ideas that led to the crisis of a decade ago.

That failure to face up to the need for action on many policy fronts has led to the demand stagnation of the past decade, and he’s right.

Without action to deal with the structural weaknesses of the global economy, he predicts we are at risk of another financial crisis, emanating this time not from the “US banking system but from weak financial systems elsewhere.”

He pointed out that world economy is stuck in a low growth trap and that the recovery from the slump of 2008-09 is weaker than that after the Great Depression. By contrast with now, politicians and bankers moved to reform their economies after previous great financial crashes such as the depression of the 1920s and 30s. “Following the Great Inflation, the Great Stability and the Great Recession, we have entered the Great Stagnation.”

So what to do ? Luckily, Lord King does have masses of ideas for reform. He would like to see global imbalances ironed out but also reforms to the banking system which, in EU, is still laden with debt. Countries with big surpluses should be encouraged to spend while China and Germany must become less export-dependent. Other countries, such as the UK and the US, should be encouraged to become less reliant on commercial property.

If Lagarde is as smart as she thinks she is, she will invite Lord King for a drink.