G20: ‘Developing a new economic order’…

G20 SUMMIT

RESPONDING to John McDonnell MP (Labour) whose article entitled, “We need a new world economic order“, appeared on the website of the Guardian Newspaper, dated Friday 14 November, 2008.

Mr. McDonnell writes:

… “Barack Obama has decided not to attend the G20 summit convened by George Bush and the lack of involvement by India, China and the developing world in the G7 means that the best we can hope for is that this Saturday’s talks are a preparatory session for a more inclusive and wider ranging summit in the New Year”

… “In the meantime, millions of workers worldwide will lose their jobs and homes as the recession bites. Many more people in the developing world will be pushed over the edge of poverty into destitution, with starvation putting many lives at risk. The demand for change, which elected the first black president of the US, has the potential to grow into a demand for change in the system that produces such insecurity and suffering”

… “Instead of the G20 summit, we need a new, accountable architecture of global economic co-operation.”

NEW ECONOMIC GLOBAL ORDER

Global forums require considering the views of all nations, particularly those nations that will emerge in the future as possible superpowers, before any consensus can be reached in how world policies are formulated. India and China, for instance, absent at the G20 gathering, have huge colossal potential economic bargaining positions and, without them, the forum by which Mr. Brown and M Sarkozy stand will be seen as immediately diluted.

However, essentially, any attempt to stop the world sliding deeper into crisis has to be welcome. More regulatory powers, cross-border co-operation and controlling the vast sums of monies paid to huge multi-conglomerates in the form of excessive executive salaries must be addressed following the abyss that followed the near collapse, recently, of financial markets.

• Chris Colvin, Guardian (15 Nov 2008): “Our chance for a working regulatory regime“

… “Bretton Woods II is a rare opportunity for world leaders to combat destructive regulatory business cycles”

ESSAY

Saturday 15 November, 2008

Today, world leaders will sit around a table in Washington DC, in an attempt to fix global finances. Many people believe, though, that national governments are being presumptuous as they attend this weekend’s global economic summit.

Commentators and politicians around the world have been speaking of creating version 2 of Bretton Woods following the demise of world financial and capital markets since the near collapse after the effects of sub-prime lending and poor market regulation. Bretton Woods was the response and agreement reached in 1944 following the Great Depression after World War II. At that time, this meant creating the IMF, the World Bank and a body to oversee world trade. Gordon Brown’s task of reinventing the ideology behind Maynard Keynes or in replacing Winston Churchill, the Prime Minister at the time, in terms of a global economic deliverance, is a tall and mighty order.

Presumptuous because the craftsmen of 2008 have grabbed the credit before they have earned it, rather like all those subprime householders did. Prior to the 1944 accord, more than two years of grueling technical work had laid the ground for the wartime conference of officials and finance ministers. Then, in stark contrast to now, prime ministers and presidents had other things to deal with. The leaders gathering for this G20 gathering, a mix that comprises industrial and emerging countries, plus representatives from the European Union, have cobbled together an agenda in a few frenetic weeks. Expect no shortages of promises: just what these will be worth will depend on future summits yet to come.

• Guardian Editorial, Saturday 15 November 2008: “Time to think big“

The Editor of the Guardian writes:

… “So this weekend will not provide any answers; but we can hope that it asks the right questions. The best it could do is kick-start a reform process which involves many more countries. The G20 is an improvement on the G7 club of industrialised nations, but it cannot be right that Johannesburg is the sole representative of Africa at this meeting, or for Central America to be entirely excluded.”

The gathering is bound to stir up a debate about the institutions that supposedly oversee the international economy. By convening G20 – rather than the closed, nepotistic rich club of G7 – the old economic order has, essentially, acknowledged that the rest of the world has become too important, rather than dismissing countries like India and China or vast chunks of the African continent. Critically, the key economic question hovering over these and any future talks is what new order should take the place of what has gone, before? Discussions, at the very least, should create a bull market in new schemes for global economic governance.

Attempting to articulate ‘Bretton Woods 2′, according to some economists, is filled with vainglory. The agenda is vague and sprawling, what of the need to escape platitudes and hypocrisy? There will likely be disagreements, especially on the issues of sovereignty or where competitiveness is directly threatened. The recent international financial collaboration is fraught with bitter in-fighting and complexity.

Will this summit be different to any other? Evidence suggests may be not. For example, consider how Gordon Brown and Nicolas Sarkozy, the French president, have vied to claim paternity of the summit for their own domestic reasons. Mr. Sarkozy, determined once again to show he is a man of action, will find it easier to force through domestic reform if he can show he is idiosyncratic to the Anglo-Saxon free market ideology.

The British prime minister has been calling for a global gathering for some weeks emboldened no-doubt by international acclaim for his adoptive plan in rescuing Britain’s banking system. But, rather than moving towards ever tightening regulation, has Mr. Brown reverted, paradoxically, in protecting the free-market City of London from the Gallic machinations of M Sarkozy?

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IN THE RUN-UP to this summit dozens of different proposals had been produced. Broadly speaking, they tended to fall within one of three areas: how to limit the crisis because it is starting to move from the rich world to emerging economies; the flaws associated with financial regulation which have been laid bare and to which G20 will wish to correct; or the imbalances connected with global macroeconomics.

Omnipresent economic gloom might, however, be the best reason for hoping that something concrete might come out of this summit. The credit crisis, which has had a savaging effect on financial markets, has now broken loose to make its weight felt in the real economy. The IMF has already lowered its forecast for global growth next year by 0.8 percentage points, to 2.2%; the rich world is in recession and unemployment, foreclosures and bankruptcies, corporate and personal, are rising sharply. Developing economies are suffering because investors from richer countries are retreating to their own home markets in protecting the funds they have at their disposal.

Such painful pressures demand an ambitious and reactionary response. The Federal Reserve noted recently, too, that “We are witnessing a fundamental reassessment of the value of every asset in the world”. Establishing a new financial architecture seems, therefore, urgently needed to what is certainly the greatest economic challenge of our time.

Efforts must involve concerted and continued cuts in both interest rates and government spending. Several countries have been talking in harmony about a co-ordinated fiscal stimulus in helping to offset a collapse of private-sector demand. China set the standard, in the last few days, with a huge spending plan worth in the region of $600 billion, or 15% of its GDP. Not all countries, of course, can muster such financial resources, but, both the U.S. and Britain are preparing to act. With concerted international effort, countries will find that each national stimulus buys more confidence than it would do alone.

In the area of financial regulation, some changes being sought ought to be easy to agree on, such as ensuring that banks and other financial institutions stop holding their assets off-balance-sheet, and by putting capital aside for potential future failures in a wide range of securities. Bringing market order against the risks associated with credit-default swaps could be achieved by routing business, within 120 days, through clearing houses rather than private settlements by investors. Credit-default swaps trade the risk that borrowers will not honour bonds.

At the heart of difficulties lie cross-border rules in finance. Finance, is of course, every country’s business and, as this current financial calamity has shown, what happens deep inside one national financial system can wreak havoc the other side of the world. In the U.S. subprime lending was a relatively small bit of the overall mortgage market and yet, the cascade of failing credit and risk aversion that began in America, partly as a result of weak and inadequate supervision, has spread not just to the overstretched banking systems of Europe, but also now to banks within emerging markets.

Conversely, though, nation-states invidiously exercise the right in overseeing their own banks. This is not done merely out of principle, or a desire to see that the regulations suit their own financial institutions, but is done because when a crisis strikes, the nation-state invariably foots the bill for a bail-out.

At this point, it was worth reflecting a little on history. The tug between national and supranational regulation has gradually led to specific arrangements for the international banking system. In the 1980s, for example, the United States and Britain became anxious over the rapid expansion of Japanese banks, which by 1988 accounted for nine of the world’s ten largest by assets; up from just one at the start of the decade. What concerned the West was that Japanese regulators allowed their banks to count shareholdings as core capital. Cheap and inexpensive capital fed their growth, which proved reckless as the subsequent collapse of the Japanese stock-market showed.

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Sunday 16 November, 2008

• Observer Editorial: “Britain’s not ready for the new global economy“

The Editor of the Observer writes:

… The leaders of 20 of the world’s biggest economies were never, in a single afternoon, going to solve a crisis that has been a generation in the making. But there is some reassurance in the fact that they are ready to talk about coordinated action. It is worth recalling that the last equivalent economic crisis drove America to isolationism, much of Europe to fascism and the world to war.

… The scale of cross-border money flows makes the task even harder today than it was in the Forties. It makes governments more vulnerable to market volatility and panicky flights of capital. The era of globalisation has eroded national sovereignty. To restore stability, politicians need to reassert control, but if they cannot do so collectively, they will come under domestic pressure to do so unilaterally with protectionist measures. If diplomacy fails, the crisis will trigger a collapse in world trade. Recession will then surely become depression.

UNDER the auspices of the Bank for International Settlements (BIS), a kind of central bankers’ central bank in Basel, Switzerland, the big economies agreed to set common standards for what counted as capital and how much a bank should actually hold in order for that institution to qualify as safe. Their negotiations were partly about rules in order to make the global financial system more resilient. But, they were, essentially, about a trade dispute, over what the West saw as a subsidy to Japan’s banks. Such an ambiguity between the common good and national interests complicates the nature of all financial negotiations – including any that may follow the G20 summit.

According to regulatory design assessments carried out at the Bank of England, regulators looked at the financial stability of central banks, particularly within the area of systemic risk one bank at a time. The assumption drawn was that if each institution was safe, then the system as a whole would be too. Dogmatically, though, when banks were in receipt of an array of subsidies, or when regulators are constrained by money and time, the situation becomes very isolationist and protectionist.

Such a “micro-prudential” philosophy always remained questionable. Banks tend to own similar assets and, in a crisis, the capital of the entire banking industry tends to fall which implies that the instability of one bank can undermine the standing of the next bank. A need perhaps in driving a new “macro-prudential” kind of regulatory system that seeks to take account, more robustly, of the whole system’s vulnerabilities, as well as the health of individual banks, by, say, adjusting capital charges over the economic cycle.

The strengths of the original Basel standards lay in being reasonably simple to negotiate and administer. But, there-in also lay inherent weaknesses. Banks, for instance, soon started to favour business that was profitable, or risky, but which, under Basel’s raw definitions, escaped appropriate capital charges. As the banks adapted to Basel, so the rules became less useful.

This gave rise to the creation of Basel 2, which began in the late 90s. It sought in striking a different balance, by asking banks to be more sophisticated in assessing the risk element of their assets and, hence, their capital requirements. But, such complexities came at a high cost. Negotiations dragged on for years as governments jostled for a deal that would give their own banks an advantage. Observations suggested that banks would accept all sorts of arbitrary provisions as long as the end result was in reducing the amount of capital they had to put aside.

Basel 2 is a flawed agreement. Although not in force, it already requires to be updated. Its primary failing is its reliance on rating agencies and the banks’ own models of the risks they are carrying. In addition, the agreement did not allow for the evaporation of liquidity that prevented the banks from financing their businesses.

Bank capital standards contain important benchmarks and lessons for the future. Talks dragged on because their objectives were unclear, the subject matter complex, negotiators always fighting for the upper hand and little sense of urgency. Even if this can be corrected, the schedule of work has expanded. Supervision, for example, may need to extend beyond banks, to any financial institution whose failure might threaten financial stability – including some large hedge funds and non-bank financial companies such as GE.

The capital-standards regime also needs to become more macro-prudential. Regulators need to be able to put more trust in the risk models of banks and rating agencies by supplementing them with simple rules about the level of borrowing. Banks might issue new securities, for instance, in serving as a gauge of investors’ faith in them.

Difficulties arise. For example, it will take time. As urgency fades and negotiators drown in complexity, national interest may gain at the expense of collective safety. The original dilemma, too, remains: international rules require enforcement, but nation-states demand sovereignty. The IMF wants an inspectorate; a World Financial Organisation with disciplinary panels has been proposed, and the EU wants “colleges” of national regulators for each bank and an IMF that can provide an early warning system of pending crises.

Whilst it is important that the world continues to focus on financial regulation, G20 or any other future summit should not ignore the macroeconomics that preoccupied the original Bretton Woods in 1944.

Those countries that had grown used to incoming foreign capital suffered when those flows reversed. To protect themselves in future, they started to run current-account surpluses and in amassing foreign-exchange reserves. The U.S. and Britain were eager in helping Asia save, even though their own spendthrift ideologies meant they were running the corresponding deficits.

Surpluses may seem all very well, but they cannot continue to accumulate for ever. If there is a need in violently unwinding, instability will result. Much of the cheap money recycled from those countries holding large surpluses found its way into housing and other assets in the West. It became far too much in hoping that it would flow out of those assets in an orderly way.

The conflict between sovereignty and safety is even less easy to disentangle than it is in financial regulation. Whilst no country would agree to live by a rule that it should balance its current account, the IMF has said that current-account surpluses and deficits can help countries cope with shocks and finance investment. No international orgnaisation, though, like the IMF, could plausibly have the autonomy or the resources in making credible promises to back all those economies suffering from large capital flights during a crisis.

Yet, this conundrum leads straight-back to a beefier IMF. It is still too small in saving the world but, backed by swap lines from the three large central banks – the Federal Reserve, the European Central Bank and the People’s Bank of China – its financial leverage could be greatly enhanced. For that to work, and for the IMF to lose some of its stigma, rich countries would have to admit more emerging economies to the fund’s board. Result would mean more difficult negotiations.

What will come of the G20 summit in Washington, DC, held over the weekend of 15th November, 2008?

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© Mark Dowe 2008: all rights protected

mark.dowe@googlemail.com

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Reference/Appendage:

• Economist [13 November 2008]: The Global Economic Summit, “After the fall”