DSK, the IMF and Europe

This weekend brought a WTF moment from New York that will be bad for Europe, regardless of how the trial turns out.

DSK, Dominique Strauss-Kahn, has been arrested on allegations of attempted rape at the Sofitel in NYC. Since he heads the IMF, folks are now speculating whether it will impair the IMF's ability to play its role in the Euro crisis.

You would think it need not, but the euro zone fund is complex. One-third of the money is provided by the IMF, and Finland reluctantly agreed at the end of last week to support financial aid for Portugal if the IMF is totally happy with the deficit reduction measures that the country's government is implementing.

What DSK's effective departure does is open up a power play for the top role of the fund. With that contest comes an opportunity to upset the existing status quo, and to set new priorities within the fund. You can bet that various camps within the IMF are assessing each other's strengths, thinking of whom they can best work with, securing alliances, hatching plots and so on. 

Europe can only lose from this. In a tradition dating back to the original Bretton Woods agreements of the 1940s, America heads the World Bank and Europe heads the IMF. Both institutions have been reformed to  increase the representation of emerging markets within them, but the effects this will have on the institutional leadership have never been tested. Europe can only get weaker from here on in. It would be revolutionary if a non-European were to take the helm of the IMF. It is inevitable, however, that the opinions of the BRIC countries in particular will carry more weight from this morning onward. America should not be too smug either. The new constellation of interests is somewhat more critical of American public borrowing practices than pre-crisis.

For the moment, the immediate impact will certainly be that the IMF, as it deals with Portugal, will be in the process of transforming itself after a long period of pushing for internal reform. This is less likely to be a naked power struggle and more likely to be one that is done in secret. But DSK is politically finished, his parting has sped up something that has been in the works for years.

This means that Portugal will become the first test of what the new IMF is transforming into. What will it demand? Will it be harder? Or will it be lenient, considering that the Chinese have been lending money when other sources dried up, and are now more powerful in the IMF?

This case will not be the last, for it is now clear to all European leaders that Greece will default on its debt this fall. They've been talking about how to deal with this.

It's time to watch both the IMF and national governments very closely indeed.