My worst fears about the weekend gathering in Washington of world leaders to discuss the financial crisis were realized overnight when the statement after their meeting was released. It contained a host of generic fluff and very little mention of the specific actions required to tackle the gargantuan economic problems of today.
The statement accompanying the meeting, held under the Group of 20 (G-20) banner, could have been put together by a bunch of first-year economics students. It probably was, but that’s not what worries me about the initiative. In the opening part of the statement, the following section seemed positive: “Our work will be guided by a shared belief that market principles, open trade and investment regimes, and effectively regulated financial markets foster the dynamism, innovation, and entrepreneurship that are essential for economic growth, employment, and poverty reduction.”
After paying lip service to the idea of free market principles in the introduction, every aspect of the statement from then on relates to market, fiscal and monetary intervention on an epic scale by the assembled bureaucrats. In the next section on “root causes of the current crisis” is the following gem:
Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.
Right there you have the prevailing notion that government intervention is what will help the global economic system recover; indeed it was the absence of dialogue between these super-smart folks that led us to the current swamp. In related news, pigs were seen flying over Washington all day, but I digress.
Discussing “Actions taken and to be taken”, the statement goes on to say the following, laying the grounds for justifying pretty much any action by any government anywhere in the world but more importantly also bringing in the widely discredited multilateral agencies such as the International Monetary Fund (IMF) back into the global picture: “As immediate steps to achieve these objectives, as well as to address longer-term challenges, we will:
- Continue our vigorous efforts and take whatever further actions are necessary to stabilize the financial system.
- Recognize the importance of monetary policy support, as deemed appropriate to domestic conditions.
- Use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability.
- Help emerging and developing economies gain access to finance in current difficult financial conditions, including through liquidity facilities and program support. We stress the International Monetary Fund’s important role in crisis response, welcome its new short-term liquidity facility, and urge the ongoing review of its instruments and facilities to ensure flexibility.
- Encourage the World Bank and other multilateral development banks (MDBs) to use their full capacity in support of their development agenda, and we welcome the recent introduction of new facilities by the World Bank in the areas of infrastructure and trade finance.
- Ensure that the IMF, World Bank and other MDBs have sufficient resources to continue playing their role in overcoming the crisis.”
Right here we have the makings of a return to the world economic order of yore, namely for the governments of the Group of Seven (G-7) leading industrialized nations to continue their spendthrift ways banking on the savings of emerging countries, while the latter remain happy in their role as supplicants to the global economy rather than assuming a leading role as is warranted by current fundamentals.
The return of international finance’s Terrible Twins is further proof of a hankering for the orthodoxy of export-oriented emerging economies securing access to financing as arranged by these shoddy bankers. It is amazing to me that countries like South Korea, Brazil and India signed up to this nonsense despite the very real structural problems created by these very programs in the recent past for these countries by the IMF.
Against these ideas there is an alternative of emerging countries floating their currencies and relying on internal consumption, which would predicate increased capital inflows for emerging countries at the cost of increasing capital costs for G-7 members. This option was apparently never even brought up in the meeting.
Secondly, the idea that emerging countries face multiple tariff barriers that keep millions in poverty was also not sufficiently discussed in the Washington meeting. To wit, Europe’s Common Agricultural Policy (CAP) is singularly responsible for the poverty, starvation and malnutrition of millions of people in Africa and Latin America, yet there was not a mention of this unfair trade barrier in the Washington meeting. Instead, the idea of circling back to the status quo in one form or another appears to have taken precedence.
Reforming financial markets
Something must have gone wrong in Washington because the next section of the statement relating to financial system reforms actually makes sense in places. I am guessing this was simply an oversight by the assembled officials; actual implementation will probably fail to follow any of the principles laid down. Paragraph 9, which details the common principles of reform, has the following five guiding headlines:
1. Strengthening transparency and accountability.
2. Enhancing sound regulation.
3. Promoting integrity in financial markets.
4. Reinforcing international cooperation.
5. Reforming international financial institutions.
I am really happy to note in this section that European attempts to reduce disclosure on financial assets by banks have come to naught. The 2009 leadership of Brazil, the United Kingdom and Korea to implement a series of recommendations will coordinate the G-20 Finance Ministers Group. Personally, I found that trio an odd choice, with only Brazil having a functioning financial system not overwhelmed by near-term liabilities. Then again, finding countries with relatively unstressed financial systems is a fairly difficult matter and perhaps the assembled leaders wanted to have people with sufficient experience of pain – for example the UK – participating in the recovery plans.
That seems fine overall. The specific areas of recommendations being laid out are as under:
- “Mitigating against pro-cyclicality in regulatory policy.
- Reviewing and aligning global accounting standards, particularly for complex securities in times of stress.
- Strengthening the resilience and transparency of credit derivatives markets and reducing their systemic risks, including by improving the infrastructure of over-the-counter markets.
- Reviewing compensation practices as they relate to incentives for risk taking and innovation.
- Reviewing the mandates, governance, and resource requirements of the IFIs [international financial institutions].
- Defining the scope of systemically important institutions and determining their appropriate regulation or oversight.”
The next section on Open Global Economy isn’t worth reading, containing as it does platitudes about the World Trade Organization, the Doha round and so on without any substantive discussion on handling current conflicts on tariff barriers and capital flows.
The rest of the document deals with specific recommendations relating to the implementation of the five principles of reform as laid out previously. Of these, the move towards accounting standardization will help resolve a number of capital flow constraints, regulatory arbitrage and other egregious misuses of fiduciary principles in the financial markets.
Another welcome initiative in the financial market section is the reform of the over-the-counter market for credit default swaps (CDS), which will almost surely move to an exchange-traded or electronic trading format in the next few months. The need for this market is paramount more now than ever before, and I am happy that the G-20 has understood the rationale for a continued broadening of this market, rather than a reversal or even a shutdown as was suggested by a number of government officials in the US and Europe of late.
Overall, the G-20 meeting strikes me a missed opportunity for discussing a broadening of the world’s economic engine by inculcating stronger measures towards consumption in emerging countries and moving them away from the IMF-orthodoxy of remaining suppliers of cheap goods to developed countries.
Failures in the financial system need to be addressed, but the root cause of a misallocation of capital from high-growth areas to lower-growth areas, that is from savers in countries like China, Brazil and India to the overextended consumers and pensioners of the US and Europe, was not discussed let alone addressed.
The coming wave of Keynesian spending across the world will only intensify this misallocation of capital as emerging countries continue to hold nearly worthless pieces of government debt issued by G-7 countries in return for vacuous promises of continued economic growth.
Then again, perhaps it is not the G-7 countries that are to blame for suggesting ways of keeping themselves economically relevant; such moves after all reflect their self-preservation instinct. What galls me is that leaders of countries such as Brazil, China and India bought into this malarkey.