The failure of the G-20

After Toronto which marked a turning point toward fiscal austerity, the G-20 in Seoul focused on the so-called war of currencies.  The 4-page communique stresses the importance of "re-balancing" the global economy, "coordinating" policies and refraining from "competitive devaluations". Not a single word about the reevaluation of the yuan nor on the recent moves of the FED to inject money in the US economy (which reduces interest rates and renders the US market less attractive for global investors thereby lowering the value of the dollar).

China  and the US are the two big players in the current war of currencies. Neither of them is ready to make concessions. Other nations try to reduce the value of their currencies to stimulate exports and therefore create jobs. So the real problem is not just about global imbalances; it is mainly about imbalances between the US and China. In the US, income inequalities are rising dramatically, with more income concentrating at the top 10% and this reduces the relative income of the American middle class. This means more pressure on exports to fill the gap.

In China, an increasing share of income goes to the productive sector rather to Chinese consumers - just like Germany. this reduces the relative income (in terms of purchasing power) of the Chinese relative to scale of domestic output produced by the Chinese economy. This also means more pressure on exports to fill the gap.

Targeting currencies is not effective to stop trade imbalances. A reevaluation of the remimbi will have an effect on trade balance if China responds by reducing real interest rates or expanding credit - which in fact it did after the reevaluation of the remimbi in 2005 and which japan did after the Plaza accord. The expansion of cheap credit offset the impact of the appreciation of the currency and the trade surplus continued to grow. It would be much more effective to target current account imbalances to re-balance the global economy.

The broad agreement on global recovery is meaningless. The truth is that more needs to be done to ease tensions that are moving the global economy closer to the edge of irresponsible protectionism. The key responsibility rests with China and the US, and any move towards a new monetary order will depend on their respective economic policies.

http://www.financialtaskforce.org/wp-content/uploads/2010/11/Seoul_Summit_Leaders_Declaration.pdf

The divisive Toronto Agenda

The G-8 and G-20 meetings in Toronto have a long agenda of complex issues on which rich and developing countries seek a common approach to set out new governance rules. Topics include banking levies, financial regulation, currency controls and many others.

From Toronto, bad news: there will not be at the G 20 an agreement on the levy on financial transactions. The reason is quite interesting: rich countries like US, UK, France and Germany want it but there is a strong resistance from the banking sector; other countries such as Canada, India and China, much less affected by excessive speculation- due to their relatively more traditional and stable banking sector, do not see any reason to penalise their own banks.

On financial reform, the US administration will pursue a 'unilateral' approach. Just before the meetings, the Senate approved a package of financial reform, including a tax on banks worth 19 billion $ to prevent future financial crisis. It includes a list measures including tougher powers for the Federal reserve to oversee 'too big to fail' banks, registration of hedge funds and the creation of a consumer agency to regulate mortgages.

The second issue of contention concerned fiscal policy opposing fiscal consolidation to reduce debt to GDP ratios and the pursuit of fiscal stimulus to sustain recovery. The final statement reflects this compromise: 'Reflecting this balance, advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016' . But Obama - supported (only) by India- warned the eurozone and Germany in particular that early cuts to public spending might undermine the signs of recovery. It is also significant that the final statement stated that Germany and China should contribute to growth in global demand : 'Surplus economies will undertake reforms to reduce their reliance on external demand and focus more on domestic sources of growth'.

The Toronto meeting reflects in fact the strategic division on the response to the crisis between the European 'doctrine' (stability and budget deficit reduction) and the US conception based on maintaining fiscal stimulus plans to sustain the recovery of their economy. The feeling is that nations are concentrating on their own economies ignoring global welfare and aid to the most vulnerable countries. Unilateralism in areas such as financial regulation and trade is unproductive. Uncoordinated financial rules may be self-defeating because of the need for regulatory arbitrage. Does it make sense that the US will pass its new financial regulation law but no agreement on the Basel III rules on bank capital requirements has been reached.

In sum, the outcome of the G-2O meeting has been deplorable, but not for failing to co-ordinate fiscal policy. This is the least of its sins; it has failed on the main issues which are decisive for better global governance.

http://g20.gc.ca/toronto-summit/summit-documents/the-g-20-toronto-summit-declaration/

G-20: the return to economic orthodoxy

The 'hawks' are back and took over the G-20. The final declaration* of the 4-5 June meeting in Busan states: "Those countries with serious fiscal challenges need to accelerate the pace of consolidation. We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions".

It seems that there has been a shifting attitude relative to the previous Washington communique issued on 23 April which insisted that demand stimulation policies" should be maintained until the recovery is firmly driven by the private sector and becomes more entrenched".

Historical experience in the 30s show that drastic cuts to public spending during a grave recession are not only ineffective in terms of reducing public deficits but also socially harmful. Restrictive fiscal policies - if not conducted wisely and gradually - may have opposite effects, as they might depress further the economy and reduce tax revenues, therefore further increasing public deficits.

So, what should be done? One possibility would be to wait that the economy recovers in order to allow central banks to use monetary policy to offset the contraction of economic activity resulting from budget austerity. But here again the 'hawks' ask for further budget cuts in the face of high unemployment and interest rates close to zero.

One might argue that the situation in Greece represents a serious warning against any further rise in public debt. But this cannot be taken as a general situation. Countries with high public debt are Spain and Greece (leaving aside the specific situation of Italian public debt being largely held by domestic financial institutions and households) ; they belong to the euro area and they have overvalued assets due to huge capital inflows in previous years. The risk is thus a prospect of deflation over coming years. However, for other countries, there is no objective reason to conduct immediately such policies. Ten year bonds in the UK yielded interests of 3,51%, in the US 3,21% and in Japan, 1,27%.

So where does this radical shift toward austerity stem from? the answer is that Finance ministers and governors of central banks of the G-20 are convinced that expenditure cuts would reassure investors. They just care about how world markets would react if the leading economies were not ready to make further sacrifices. But the idea that these sacrifices might be useful or even be harmful for large segments of the society does not count at all.

So the message is that if the leading economies will not pursue these virtuous policies along the lines of the G-20 and other organizations, it will undermine the fragile basis of economic recovery to satisfy hypothetical demands of investors for more austerity.

*http://www.g20.org/Documents/201006_Communique_Busan.pdf

Tobin Tax is back?

At the G-20 in St Andrews on 7 November, the British PM Gordon Brown has proposed a levy on financial transactions to stabilize markets and raise new resources. This is nothing else than the so-called 'Tobin tax' ( proposed by the Nobel Price for Economics James Tobin in 1972) . Since then, that proposal was discussed in several occasions, but in particular after the two important financial crises which preceded the current one: in 1992 where the European Monetary System was under threat after the massive speculative attacks against the Sterling and the lira (which lost about 30% of its value) putting the Italian economy in a quasi default situation; the Asian crisis in 1997, which had devastating consequences for some Asian economies with riots and demonstrations for hunger.

The Tobin tax consists in a minimum levy on financial transactions , for instance 0,5% (as proposed by Prof. Tobin in an interview to Der Spiegel in 2001). In global finance, gains could be infinitesimal but the high frequency of operations and the large sums involved yield gigantic profits . So even a low tax could result in cancelling a large volume of transactions, which would not be profitable, although markets would gain in stability. Furthermore, tax revenues would be significant : at 0,5% it is estimated that they would represent more than 80 billion dollars a year, which according to many would be sufficient to eradicate extreme poverty in the world.

Such tax requires a large consensus among the most powerful governments and so far it has been opposed by all financial agents- which is not surprising- and also by many economists. According to opponents, speculation may be bad ethically speaking but has an important role in financial markets operation to guarantee financial liquidity. We can still think that the risks deriving from the Tobin tax might be deliberately overstated: even George Soros, who gave rise to the currency crisis in 1992, declared that the tax would have undermined his interests, but that it could have beneficial effects for the world economy.

It is not surprising that the proposal has been endorsed by all opponents of globalization, but Prof. Tobin himself argued that his idea was intended to make the world economy work better, although he also supported the idea to use it as a remedy to fight poverty. Created in 1998, an international organisation called Attac* supports the idea of introducing such tax to promote social justice.

Hitherto Europe was divided on the tax, with on the one hand France and Germany in favor and the United Kingdom against it. Gordon Brown's declaration in support of the tax is most welcome, although he made clear that the tax revenues would go into a fund for the State to intervene in bailouts. There is thus an important nuance: it would be reinvested in the country for emergence purposes not to redistribute resources to eradicate poverty. In any event, an agreement among European states will not suffice, and would need to be endorse by G-20. In the final declaration**, there is no mention of this tax but the discussion is far from being over.

* Attac (Association for the Taxation of Financial Transactions for the Aid of Citizens ) - http://www.attac.org/
¨** http://www.hm-treasury.gov.uk/d/2009_communique_standrews.pdf

G-20: a global economic government?

Just one year after the financial crisis which started in the US the G-20 gathered in Washington, London and now in Pittsburgh, leaders from both rich countries and emerging powers which represent about 85% of the world output and almost two thirds of the world population. It was created in September 1999 after the financial crises of the nineties, but it was nothing more than a forum for dialogue among finance ministers and central bank governors of 19 nations and the European Union. Since the G-20 in Washington (Nov.08), the meeting is held at the level of Heads of State twice a year. We can ask whether it will now be more effective because it includes important new players like China, India and Brazil, or whether it will simply be more unwieldy.

Leaders agreed on a far reaching effort to revamp the world economic system*. The agreements, if carried out by national governments, would lead to much tighter regulation over financial institutions, complex financial instruments and bonuses. They could also lead to greater coordination and more external scrutiny over the economic strategies of individual countries, including the United States.

Most economists agree that the imbalances caused by the huge US trade deficit and related surpluses in China, Germany, Japan and oil exporters, contributed to the global financial and economic crisis. In fact, world growth was underpinned by surplus dollars from China and oil exporters recycled back to US consumers by the financial system. But that mechanism collapsed in 2007 as defaults from subprime borrowers surged and the financial system was severely affected with bailouts of banks and insurance companies in many countries.

In order to achieve a more balanced growth, the United States will be expected to increase its savings rate, reduce its trade deficit and address its huge budget deficit. Countries like China, Japan and Germany will be expected to reduce their dependence on exports by promoting more consumer spending and investment at home.

Whilst there is agreement on the need for harmonization of economic policies to avoid global imbalances, the leaders pledged not to withdraw stimulus measures until a durable recovery is in place. They agreed to co-ordinate their exit strategies, while also acknowledging that timing will vary from country to country depending on the forcefulness of measures in place. However, there will be no enforcement mechanism along the lines of the European stability and growth pact to limit budget deficits. For the first time ever, each country agreed to submit its policies to a “peer review” from the other governments as well as to monitoring by the IMF.

Nobody can doubt that the Obama administration is taking the reform agenda forward but it will face resistance from European nations which pursue national interests above all. The German government is determined to resist any firm commitment that would reduce its current account surplus and would not cede sovereignty on core economic decisions.

Another set of decisions concerns the governance structures, in particular the rebalancing of the IMF with developing countries at least 5% more of the voting rights by 2011 and the enhanced role of the Financial Stability Board (FSB) for early warning on emerging risks. Taken together the IMF overhaul with the expanded powers of the G-20 mark an important step in global governance.

Too much or too little? Some countries expected to go further, for example in capping trading bonuses , reforming global institutions or imposing sanctions to countries for not respecting their commitments.

What is at stake is the future of capitalism. The big question is whether G-20 would bring radical reforms to ensure a safer and more equal world or just save it from future crises. For the time being, it looks like an embryonic world economic government.

*http://www.g20.org/Documents/g20_summit_declaration.pdf

G-8 in L'Aquila: success or failure?

The recent G-8 summit in L'Aquila, a small Italian town devastated by an earthquake, has raised many expectations. The agenda was ambitious, with three specific issues - climate change, aid to poor countries, mainly Africa and Iran- and a more general topic on the global economic crisis and the diagnosis on various policy responses.

On the economic crisis, diverging views exist between the US president - whose diagnosis is that the situation will get worse as the unemployment rate rose to 10% - and the other leaders (at the other extreme, the Italian PM considered that the worst is over and that the employment situation is not that dramatic!). In a recent interview (FT 1O July) , Larry Summers, former Treasury secretary and chief economist of the Obama administration said: “I don’t think the worst is over ... It’s very likely that more jobs will be lost. It would not be surprising if GDP has not yet reached its low. What does appear to be true is that the sense of panic in the markets and freefall in the economy has subsided and one does not have the sense of a situation as out of control as a few months ago.” If there is no consensus on the diagnosis and the causes of the crisis, it will be difficult to find common solutions.

Most newspapers and analysts have given ample information and commentary on the main outcomes of the G-8 meeting. On Iran, there was unanimity (including Russia) to condemn violence and repression as well as the negation of holocaust. On climate change, all countries accepted the principle of 2° C temperature increase as a limit, but emerging countries did not agree to cut their gas emissions. This will be a central topic for discussion at the Copenhagen summit, but the novelty is the US commitment to make significant cuts in gas emissions and to focus on renewable energy as a basis for their economic recovery programme.

On the aid issue, - perhaps the only succesful outcome of the meeting- world leaders pledged to commit $20bn over three years for a “food security initiative” to develop agriculture in poor countries, but aid agencies responded with scepticism, pointing to broken promises and switch in aid budgets. The G8 pledge at Gleneagles four years ago to give $50bn in development aid by 2010, with half going to Africa, has left a gap of at least $15bn so far. The summit statement addressed the scepticism, declaring: “Commitments to increase overseas development aid must be fulfilled. The tendency of decreasing ODA and national financing to agriculture must be reversed.”

Last but not least: the governance rules. The Italian Finance Minister has submitted, with the support of OECD experts and the German government, a 13 p document titled Global Legal Standards, which sets out a set of principles and ethical values- e.g. transparency, fight against corruption and tax fraud, fight against monopolies- on which, of course, there was unanimous consensus. But the rules still need to be defined and agreed by all countries before they can be enforced to banks and other financial institutions.

Since its inception by Giscard D'Estaing in the Rambouillet summit in 1975, the G-8 has been a forum of discussion and exchange of views on world affairs among the leading nations. It is not meant to take decisions as no country has transferred any part of sovereignty to it. After l'Aquila- which was in fact a G-14 summit- , it will be the G-20 in Pittsburgh to take over as a governance structure including China, India, Brazil and other emerging countries.

As Shakespeare's Portia says in The Merchant of Venice, ' If to do were as easy as to know what were good to do, chapels had been churches, and poor men's cottages princes' palaces'. It might be easier to set objectives, but more difficult to deliver them - in other words we need to establish the right institutions and start the processes that will achieve these objectives.

Global governance: a new economic order?

Global governance is the key word today. In most people minds, it is ascertained that governance is not government. It is not the ideal of the 'world government' praised by St Simon, that is being revived. In his book on 'Global governance' (1995), Desai tries to clarify what this could mean: 'It is the provision of the Rule of Law, a symmetric framework in which the weak as well as the strong are subject to the same rules". Can we at the present juncture envisage the possibility of even a minimal framework?

The Bretton woods system had worked at least for two consecutive decades in the post war period until its disruption when the gold standard was replaced by the dollar. But when it failed, it was not immediately obvious what would replace it. The floating exchange rates prevailed, particularly for major currencies, dollar, yen and D-mark. Then came a long period of low inflation and steady growth because of the growth of India and China which created a supply shock to put dowward pressure on prices. Deflationary tensions were avoided temporarily by a loose monetary policy that encouraged asset bubbles which eventually led to the current financial crisis.

Some Western governments (in particular britain and the US) have huge trade as well as budget deficits and will have to pay a price in terms of higher taxes to meet the interest of the debt and the claims of foreign creditors. The Economist (14 May) writes: 'Creditor nations tend to set the rules and the new global monetary system will be unable to operate without the approval of China, a creditor country that controls and a managed currency. It has been assumed that China will have to move towards the western model. But why not the other way round?

It is perhaps premature to say that a new global order is coming into existence, but this will not happen without China, and possibly India, Russia and Brazil, which are trying to increase their influence over the so-called 'Western world'. The significance of this major shift in the balance of power is that there has been a process of correction in which the powerful nations are not anymore in a position to set the rules for the rest of the world.

Our hope is that these corrective forces - with the rise of globalisation and new economic powers- will contribute (paradoxally) to establish a more democratic international order. Along with this, we need stronger international institutions to set new economic rules to promote well being, high employment and sustainable growth. But also a new political framework, including rules to enforce respect of human rights, especially for citizens from weaker states (asylum, refugees, migrations,..). It's all about the future of mankind, not only the interests of the strong.