International Monetary Fund (IMF) Chief Warns of Great Depression II.

January 24, 2012 – International Monetary Fund (IMF) Chief Warns of Great Depression II: The global economy faces a depression-era collapse in demand if Europe doesn’t quickly act to dramatically boost the size of its debt-crisis firewall, implement pro-growth policies and further integrate the euro zone, the head of the International Monetary Fund warned.

It is about avoiding a 1930s moment, in which inaction, insularity, and rigid ideology combine to cause a collapse in global demand,” IMF Managing Director Christine Lagarde said in prepared remarks before the German Council of Foreign Affairs in Berlin. “A moment, ultimately, leading to a downward spiral that could engulf the entire world,” she said.

The dire warning from the IMF’s top executive is designed to spur political action in Europe and within the Group of 20 industrialized and developing economies and avoid the political stagnation she said exacerbated the crisis.

Ms. Lagarde said unless euro-zone leaders urgently build a bigger emergency bailout fund, two of the euro zone’s largest economies, Italy and Spain, risked insolvency as the cost of financing their debt spikes upward. Economists said failures in the two economies could spark a global financial and economic meltdown, and IMF staff is urging Europe to at least double the size of their firewall to around €1 trillion.

Insolvency in those two nations “would have disastrous implications for systemic stability,” she said.

In the face of strong pressure from the U.S. and the IMF, Germany and some other northern European nations have been resistant to bulking up the public emergency fund, fearing it may prevent further fiscal belt-tightening in the weak Mediterranean economies. There’s also political resistance to paying more for the bailouts than already doled out.

Ms. Lagarde is also seeking to boost the IMF’s lending resources by more than $500 billion to a reserve pool well over $1 trillion, including roughly $200 billion promised by Europe. While the U.S. has said it won’t contribute, China, Japan and Brazil have indicated they are open to funneling cash to the IMF if Europe is more proactive in dousing its debt fires.

“The goal here is to supplement the resources Europe will be putting on the table, but also to meet the needs of ‘innocent bystanders’ infected by contagion anywhere in the world,” Ms. Lagarde said.

Given the looming downside risks created by the European debt crisis, the IMF chief said the IMF is lowering its growth forecasts for most parts of the world, even in the emerging markets that have helped drive economic expansion such as Asia and Latin America.

In Europe, Ms. Lagarde said the IMF sees a “sizable risk” that inflation will fall well below target next year, raising debt burdens and further hurting growth. Thus, additional and timely monetary easing will be important to reduce such risks, she said.

By boosting their firewall, Europe will also be able to help banks in the region to raise their capital levels without cutting lending.

As part of the region’s integration, the IMF chief said monetary union needs to be supported by financial integration through unified supervision, a single bank resolution authority and a single deposit insurance fund. She also said Europe could finance itself through euro bonds, bills or a debt redemption fund.

The European Union is the world’s largest economy, followed by the United States and China. As the EU crisis continues, China’s growth continues to moderate and the U.S. faces a continuing bleak economic picture; the potential for Great Depression II increases.

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