The European Governments, especially EU led by President Nicholas Sarkozy of France, argued in Washington at the G20 summit (14-15 November) that since the 1980s, finance has become a quintessentially global phenomenon with money and credit flows washing (excessively) across borders. 
(Since 2000, for example, banks' international obligations grew from less than $12tn or 20% ratio to world GDP at end-2000 to more than $37tn or 60% ratio to world GDP by end-2007. This growth coincides with growth in world trade & trade payments imbalances and the rise in securitization of bank assets that caused the present credit crunch). 
Sarkozy said that financial entities are thus able to exploit the inability of nation states to tax or regulate them (international banks) effectively. Consequently, Europeans call for a new global financial architecture that starts with, and gives primacy to, new cross-border global financial regulatory authorities. These global institutions are currently established. 
The idea is to extend all of them to a wider membership, to be constructed, and will be a G20 core project for the immediate future including placing the IMF more centrally, which not all emerging economies may welcome? 
The Europeans note that existing international regulatory institutions, like the Basel Committee on Banking Supervision and the Financial Stability Forum, have very limited membership, cannot issue binding standards and rules, are heavily influenced by the financial lobby, and have proven to be totally inadequate both in predicting the financial crisis and in acting to stem it. All this made it into the final G20 statement that the European Commission is now busy working on, and this will include expanding G20 to work with G192 (the DOHA grouping of countries) and the UN. The United States’ (last days of the Bush administration) posed a counter-argument that rested on the integrity unto itself of the nation state, locating the primacy of regulatory authority in national governments, and only adds new, cross-border forms of transnational collaboration and co-ordination. This reflects the stance of the US towards international bodies of the last 8 years, but can be expected to change dramatically under the new incoming Obama administration.
The USA's legacy position on global reform starts with existing national regulatory regimes, upgrading them considerably (USA is at least 1 year behind Europe in implementing Basel II prudential rules), and expanding them to encompass new financial instruments and institutions heretofore unregulated.
Both sides agree in the importance of more transparency that includes bringing credit trading into regulated exchanges or at least clearing houses and examining the role and qualities of credit ratings agencies. This ought to include the qualities of major stock exchanges.
The North Americans (with UK support) argue that a national-based approach offers the best tools for the broadest possible political control because it is rooted in oversight by national governments, their executives and parliaments, which are themselves subject to popular (democratic) oversight, however imperfect. Behind these arguments, however, lie both ideology and the desire to protect the U.S.’s and UK’s financial sectors’ competitiveness as the dominant global financial industry centres. (Note that half of the EU's financial assets are managed and traded in the UK). The G20 Communiqué avoided direct reference to the national/ multinational debate and papers over any cracks between the U.S. and European positions. Several other Atlantic fault-lines emerged at G20, such as between a monetary and fiscal response, between reducing the market price of borrowing or more Government borrowing and spending. 
Europe wants to go faster, broader, and deeper with new regulations than the U.S. and wants more co-ordination of policy interventions, but does not translate this also into more global spending to recover faster out of recession. The risks of the G20 Communiqué are that some governments will pay more attention to the interests of their own financial lobbies than to the interests and urgent neglobally of their own citizens equitably with citizens worldwide, and that the emerging markets, developing economies, where over two thirds of the world's population live will see in this merely a power-grab by the club of rich nations seeking world dominance by financial means? The Communiqué refers to the "fight" against unccoperative states and tax havens (though these are usually places with tiny populations, but might in certain aspects apply to BRIC states - Brazil, Russia, India, China). 
A host of immediate measures have been agreed to in the G20 Communiqué to be done by the next G20 meeting in March 2009, and pushing into the long grass the Atlantic Trench divisions that some might see as between the Anglo-Saxon model of liberal finance and the European of social welfare responsibility? The irony of this is that the USA has actually been far more generous externally than the EU, not least by running historically massive trade deficits (c. $1tn) that have fed into BRIC countries' high growth rates. 
The new OBAMA administration has indicated it will be more inclusive globally, but it faces domestic protectionist lobbying. If its fiscal stimulis package (worth 8% ratio to GDP) and financial stability measures show signs of working during 2009, it will have the space to formulate new positions closer to that of the EU. The effectiveness of G20 lies in the detail and that still has to be worked out. Principles, broad guidelines and indicators as to specific criteria e.g. Basel II and whatever a new Bretton Woods will indicate are on the official agenda. There are four that can become minimum demands:1. Total transparency – all financial instruments and all financial institutions to report fully on quality of markets and transaction data and this information made available to the public;
2. All banking assets & liabilities backed by capital reserves under Basel II, especially the economic capital calculation for buffer reserves to limit uninhibited leveraging;
3. All current and future financial instruments, and all systemically important financial service firms, market institutions, investment houses and financial information services brought under global standards of financial regulation;
4. New national and global regulatory systems to be subject to the widest and deepest democratic participation, including oversight, monitoring, and access to decision-making with participation of all G192.
The global financial meltdown is one of several converging world economic system crises caused largely by a free-for-all market fundamentalism over the need for civic responsibility globally, which is one way of seeing the matter, or it is more directly the result of severe trade and payments imbalances.
This neo-liberalism has permeated especially OECD countries' governance systems at every level: local, national, regional, and global. Consequently, as global problems worsen to converge with financial crisis and recession cycles, so too may inequality within and across alll borders. 
The same recklessness that led to insolvency at the core of financial systems is also at risk of a pro-cyclical response that deepens inequality world-wide over the coming decades. The financial crisis (credit cycle) is doubling the downturn (depth and persistence) in economic cycles. The private financial institutions receiving taxpayer bailouts should be obliged to lend to the real economy in order to ease the transformation to recovery, and to an environmentally more robust world economy.
By Martin Wolf, 2 december 2008
ReplyDeleteThe world has run out of willing and creditworthy private borrowers. The spectacular collapse of the western financial system is a symptom of this big fact. In the short run, governments will replace private sectors as borrowers. But that cannot last for ever. In the long run, the global economy will have to rebalance. If the surplus countries do not expand domestic demand relative to potential output, the open world economy may even break down. As in the 1930s, this is now a real danger.
To understand this, one must understand how the world economy has worked over the past decade. A central role has been played by the emergence of gigantic savings surpluses around the world. In 2008, according to forecasts from the International Monetary Fund, the aggregate excess of savings over investment in surplus countries will be just over $2,000bn (see chart).
The oil exporters are expected to generate $813bn. Remarkably, a number of oil-importing countries are also expected to generate huge surpluses. Foremost among them are China ($399bn), Germany ($279bn) and Japan ($194bn). As a share of gross domestic product, China’s current account surplus is forecast at an astonishing 9.5 per cent, Germany’s at 7.3 per cent and Japan’s at 4 per cent. In aggregate, the oil exporters, plus these three countries, are forecast to generate 83 per cent of all surpluses.
Surplus countries often enjoy contrasting their prudent selves with the profligacy of others. But it is impossible for some countries to spend less than their incomes if others do not spend more. Lenders need borrowers. Without the latter, the former will go out of business.
In 2008 the big deficit countries are, in order, the US, Spain, the UK, France, Italy and Australia. The US is far and away the biggest borrower of them all. These six countries are expected to run almost 70 per cent of the world’s deficits. (It should also be noted that the world seems to be running a $350bn surplus with itself.)
One might argue that Spain, France and Italy merely offset Germany’s surpluses within the eurozone. It is true that the eurozone as a whole is forecast to run a small deficit of $66bn. This does not mean that Germany’s vast surpluses have no global macroeconomic impact. Despite being the world’s second largest economic area, the eurozone makes next to no contribution to offsetting surpluses elsewhere. Furthermore, pressures on the eurozone’s deficit countries are growing. Fiscal crises are at least conceivable in some cases.
As I have pointed out previously, the most interesting feature of the global imbalances has been the corresponding pattern of domestic financial imbalances. The sum of net foreign lending (gross savings, less domestic investment) and the government and private sector financial balances (the latter the sum of corporate and household balances) must be zero. In the case of the US, the counterparts of the net foreign lending this decade were, first, mainly fiscal deficits, then government and household deficits equally and, finally, government deficits, again (see chart). During recessions, the private sector retrenches and the government deficit widens. Similar patterns can be seen in other high-income countries, notably the UK. Housing booms helped make huge household deficits possible in the US, the UK, Spain, Australia and other countries.
So where are we now? With businesses uninterested in spending more on investment than their retained earnings, and households cutting back, despite easy monetary policy, fiscal deficits are exploding. Even so, deficits have not been large enough to sustain growth in line with potential. So deliberate fiscal boosts are also being undertaken: a small one has just been announced in the UK; a huge one is coming from the incoming Obama administration.
This then is the endgame for the global imbalances. On the one hand are the surplus countries. On the other are these huge fiscal deficits. So deficits aimed at sustaining demand will be piled on top of the fiscal costs of rescuing banking systems bankrupted in the rush to finance excess spending by uncreditworthy households via securitised lending against overpriced houses.
This is not a durable solution to the challenge of sustaining global demand. Sooner or later – sooner in the case of the UK, later in the case of the US – willingness to absorb government paper and the liabilities of central banks will reach a limit. At that point crisis will come. To avoid that dire outcome the private sector of these economies must be able and willing to borrow; or the economy must be rebalanced, with stronger external balances as the counterpart of smaller domestic deficits. Given the overhang of private debt, the first outcome looks not so much unlikely as lethal. So it must be the latter.
In normal times, current account surpluses of countries that are either structurally mercantilist – that is, have a chronic excess of output over spending, like Germany and Japan – or follow mercantilist policies – that is, keep exchange rates down through huge foreign currency intervention, like China – are even useful. In a crisis of deficient demand, however, they are dangerously contractionary.
Countries with large external surpluses import demand from the rest of the world. In a deep recession, this is a “beggar-my-neighbour” policy. It makes impossible the necessary combination of global rebalancing with sustained aggregate demand. John Maynard Keynes argued just this when negotiating the post-second world war order.
In short, if the world economy is to get through this crisis in reasonable shape, creditworthy surplus countries must expand domestic demand relative to potential output. How they achieve this outcome is up to them. But only in this way can the deficit countries realistically hope to avoid spending themselves into bankruptcy.
Some argue that an attempt by countries with external deficits to promote export-led growth, via exchange-rate depreciation, is a beggar-my-neighbour policy. This is the reverse of the truth. It is a policy aimed at returning to balance. The beggar-my-neighbour policy is for countries with huge external surpluses to allow a collapse in domestic demand. They are then exporting unemployment. If the countries with massive surpluses allow this to occur they cannot be surprised if deficit countries even resort to protectionist measures.
We are all in the world economy together. Surplus countries must willingly accommodate necessary adjustments by deficit countries. If they decide to sit on the sidelines, while insisting that deficit countries deserve what is happening to them, they must prepare for dire results.
Five ways to start the world economic recovery
ReplyDeleteBy George Magnus, FT December 18 2008
After the Minsky Moment – where euphoria tips into crisis, named after Hyman Minsky – the capitulation of economic activity has been rapid and severe. The outlook is as dark as the doomsayers assert. The only thing that stands between today’s dire economic prospects and a lost decade similar to Japan’s in the 1990s is the competence and authority of macroeconomic policy. We have a long way to go, but for five reasons, even doomsayers can start to feel the force, so to speak.
First, governments have already acted decisively to preserve the integrity of the formal banking system, while the so-called shadow banking system is collapsing. Over $8,000bn (€5,650bn, £5,150bn) of programmes to stem the collapse in credit and housing have been announced but it is too soon to declare victory. To strengthen banks in the recession and sustain lending, European banks will need a further $100bn-$150bn of capital, while US banks, including regional banks, should quickly be allocated most of the unspent Tarp money of $350bn.
Second, governments must continue to facilitate the enormous task of sustaining credit flows and restructuring debt. Bankruptcies are inevitable but additional direct lending programmes, asset purchases and government guarantees are needed to keep liquidity flowing to good corporate and residential borrowers, especially while bank balance sheets are constrained by the need to soak up bad assets that were previously held off-balance sheet. Equity-for-debt swaps will be required for companies with excessive debt.
Third, the full force of fiscal policy needs to be deployed to contain the depth of the recession and credit losses and the impact on jobs and incomes. British, German and French programmes amount to a little over 1 per cent of their gross domestic product, but much of what is being proposed in the eurozone constitutes window-dressing, while the effectiveness of the UK’s value added tax cut is being lost in the sea of retailer discounting. European nations, including Germany, will need to do more in 2009 as the recession deepens.
The forthcoming US programme, expected to be about $600-$700bn (or about 4 per cent of GDP), will compensate for much of the private sector’s withdrawal of spending and borrowing. President-elect Barack Obama intends to create or save 2.5m jobs by the end of 2010 and advocates the nurturing of technology, green and alternative energy projects, as well as healthcare and education initiatives. The effects of such programmes may not be felt until 2010-11, but this is no reason not to implement them.
Fourth, as a period of (hopefully short-lived) deflation looms, we are about to see if the expected potency of monetary policy – in the form of quantitative easing – is a myth. It did not really work in Japan because it was a decade late and was also inadequately pursued. The Federal Reserve has now promised to keep the policy rate at 0.0-0.25 per cent “for some time”, and said it would use its balance sheet “further” to support credit markets and economic activity. Its assets have already grown nearly threefold to $2,200bn since the Lehman failure, and will be over $3,000bn by the end of the year. As European rates tumble towards 0–1 per cent, other central banks will find they also have to adopt unorthodox forms of monetary policy.
Quantitative easing helps to keep short-term rates near zero and could peg longer-term rates too. The Fed, for example, will buy not only securitised assets but also Treasuries in an attempt to lower credit spreads, the cost of capital and all private borrowing rates. It could eventually buy other private assets, including equities. Ultimately, the Fed could purchase Treasuries directly from the government. Public debt would not rise and concerns about future tax burdens would be negated. The new concern would be higher inflation, but this is a convoluted argument and for another day.
Fifth, when trust has been shattered, economic agents need effective leadership and want confidence in public authorities. We cannot plug these into an economic model, but they matter a lot. Expectations about Mr Obama, his macro-economics team, and the Fed mitigating and then reversing our economic predicament, may have become excessive, but why not? The Fed and Mr Obama possess both competence and authority, and seem prepared to embrace the holistic approach, described here, to address this destructive deleveraging recession.
The writer is senior economic adviser, UBS Investment Bank, and author of The Age of Aging (October 2008)
What a superb piece! Are you going to add to it in anticpation of the next G20 event?
ReplyDeleteYours respectfully
Giles Wilkes
Chief Economist
www.freethink.org (run by www.centreforum.org).