|Brazil’s Lula da Silva and China’s Hu Jintao met in London
at the G-20 summit. Photo: Xinhua/Lan Hongguang.
In early April, the executives of 19 countries and the European Union traveled to London to confront a common challenge: rescue the global financial system.
Mortgage lending "exuberance," repackaged as "toxic" securities, had been pumped into the veins of global finance by the twin hearts of global capitalism, Wall Street, and the City of London. The contagion had spread out of control.
A pre-summit news conference in Brasilia did not go over so well for British Prime-Minister Gordon Brown. He spoke first, praising Brazilian president Lula da Silva as a globally respected leader. In turn Lula said the crisis was:
"…created and disseminated by irrational behavior, by white people with blue eyes, people who before the crisis seemed to know it all, but who now, as it turns out, know nothing."
In only a few decades, we have seen the savings-and-loans scandal, the meltdown of the Asian tigers, multiple crises and hyper-inflation in Latin America, the impoverishment of Africa, hedge fund collapse, dot com, housing bubbles, and now a credit bubble (fuelled by Asian savings) whose explosion affects the real economy. Again the same solution is offered: save the system by nationalizing private debt while maintaining shareholder and bondholder value, the market agents themselves imploring governments to intervene and pleading for central banks to print more money before it was too late.
This crisis is big, very big. Previous efforts have failed. Trillions of good dollars have been thrown after bad. The G-20 leaders announced in their communiqué that the "crisis […] has deepened since we last met." The communiqué describes their plans as "the largest fiscal and monetary stimulus and the most comprehensive support program for the financial sector in modern times." They "pledged to do whatever is necessary." They were "undertaking an unprecedented and concerted fiscal expansion […] that will, by the end of next year, amount to $5 trillion, raise output by 4%, and accelerate the transition to a green economy."
Lofty expectations indeed.
Stephen Roach, chairman of Morgan Stanley Asia, interviewed in the Financial Times tempered this enthusiasm, describing the meeting as:
" […] a great show, there’s a lot of self-congratulation going around, it was long on ceremony, but for me, I thought it was short on substance […] so I worry that we’re deluding ourselves […]. I don’t think this summit really accomplished much in signaling an end to this crisis. I don’t see much in the way of breakthroughs. I think we could see a modest rebound in the next few years. The recovery will be anemic, tentative, and very fragile at best."
Three Leagues of the G-20
The Group of 20 Nations with Spain (G-20) divide roughly into three leagues; the heavyweights of the G-7 (The United States, Germany, Japan, France, and the UK) the welterweight BRICs (Brazil, Russia, India, and China) with South Africa, Saudi Arabia, and South Korea, and the light but nimble featherweights like Argentina, Turkey, Indonesia, and others. The G7 is lead by the U.S. delegation and supported by British Prime Minister Brown and Chancellor of the Exchequer, Mr. Alistair Darling.
The run-up to the April 2nd meeting was grueling. The cost of national financial bailouts has spiraled out of control and taxpayers are complaining of rising costs. In the welterweight league, China and Brazil are unusually feisty and they have support from other non-heavyweights. Pre-G-20 announcements indicated a reshuffle and they were ready to force an upset. Their funds might be made available to assist the effort, to be coordinated by the International Monetary Fund (IMF), but together they promise not to pay anything until recognized as budding heavyweights by means recognition in accelerated IMF reform.
At stake is the grand prize of financial seigniorage,1 a largess only available to the country printing currency in which all others become indebted. After WWII this became the singular privilege of the U.S. dollar and was institutionalized in the Bretton Woods institutions—the IMF and the World Bank. Charles DeGaulle called this an "exorbitant privilege" and his adviser Jacques Rueff called it a "deficit without tears."
In 2009, the United States is the deficit king, which is affecting confidence in its use as the global currency of trade, debt, and national reserves. The dollar is still confident that it will take this prize home, as it has done since the end of WWII even after President Nixon made a significant rule-change in 1971 by divorcing the dollar from gold as a floating fiat currency whose value is based on trust.
But there has been a last-minute challenge from an outsider, the Chinese Yuan.
The Chinese Challenge
China Daily journalists summed up the last G-20 Washington agreement in November with refreshing clarity:2
"To help countries hurt by the crisis, British Prime Minister Gordon Brown is pushing for the resources of the International Monetary Fund to be expanded. The fund, he said, should function like an ‘international central bank.’ The trouble with this idea is that there are only a handful of candidates with enough cash to pour money into the IMF—Japan, China, and oil producers like Saudi Arabia.
To persuade these countries to increase their contributions would require giving them a larger role in the governance of the fund. And that would mean reducing the influence of Britain and other European countries."3
Zhou Xiaochuan, governor of the People’s Bank of China, has been leaking startling announcements to the press since late March.4 One paper entitled "Reform the International Monetary System" suggested a significant IMF rule-change. The timing and feasibility of these changes shall be hotly debated after the G-20 meeting.
Requests for IMF rule changes are not unusual. Changes oppose the interests of the G-7 so they are regularly diluted or delayed. The timing of the Chinese announcement is key. Chinese experts have been reviewing IMF technical rules and are suggesting expanded use of a little known instrument invented in 1969 called "Special Drawing Rights" (SDRs) even suggesting that world reserves should migrate to SDRs. The de-facto world reserve currency has been the U.S. dollar since it took over from the pound sterling early in the 20th century. Shifting reserves to the SDR would share seigniorage, now almost monopolized by the U.S. dollar, replacing it with the SDR basket of currencies (today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar).5
"The agreements we have reached today, to treble resources available to the IMF to $750 billion, to support a new SDR allocation of $250 billion, to support at least $100 billion of additional lending by the MDRs,6 to ensure $250 billion of support for trade finance, and to use the additional resources from agreed IMF gold sales for concessional finance for the poorest countries, constitute an additional $1.1 trillion program of support to restore credit, growth, and jobs in the world economy."
The two key issues are referred to in the G-20 communiqué as "fund and reform."7 The order of these terms is chosen with care (fund before reform and not vice versa). IMF funding and IMF reforms are intimately linked. Some reform is being offered now, including opening up leadership of the World Bank and the IMF to non-U.S. and non-Europeans respectively. This change is symbolic since the U.S. veto power in the IMF is still in place and changes in voting rights and Article 4 privileges8 requested by the Chinese are also still pending. Also, importantly, national reserves9—for now—shall stay primarily in U.S. dollars.
Back in Bretton Woods in 1944, John Maynard Keynes suggested an international currency—his unfortunately named "Bancor"—as a key component of a new global financial system. The Bancor was blocked and the dollar took its place. Later the IMF was allowed to create a limited basket of currencies called the SDR for its internal accounting. The SDR is the closest that the IMF has come to recognizing John Maynard Keynes’ idea of a world currency. Subsequent use of the SDR has been restricted and it is not a reserve currency. The Chinese are asking why not, especially as they are sitting on two trillion in dollar-denominated investments and they’re beginning to get nervous.
China is willing to pay for some extraordinary changes in 2009. It has the cash and is being asked to fund the IMF/Financial Stability Forum (FSF)10 to shore up public coffers worldwide. But China wants its currency to be part of the basket of SDR currencies, and they want their payments recognized by greater IMF voting rights that reflect the weight of the largest manufacturing economy on the planet. Zhou Xiaochuan puts it this way:
"The frequency and increasing intensity of financial crises following the collapse of the Bretton Woods system  suggests the costs of such a system to the world may have exceeded its benefits. The price is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies [the U.S. dollar]. Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional [IMF] flaws."
In short the Chinese want to be recognized as the heavyweight players they really are.
Also important is who owns the world’s gold reserves. China currently has less gold reserves than the IMF. The IMF plans to sell about 400 tons of its gold to pay for "an additional $6 billion in concessional financing." This sale was originally planned to be used to fund the IMF when developing world borrowers bailed out of their loans with the IMF, leaving it without interest income. The rules governing that sale may help to rebalance gold reserves, a key component of any reserve strategy in a crisis world.
G-20 Plans and Results
Round one of the G-20 negotiations ended in Washington, November 2008, with a "plan" signed by all parties. It included a statement that all G-20 countries would push for ratification of the moribund Doha round of WTO negotiations. The G-20 officials kept a scorecard and the results were published in the London G-20 summit as the "Progress Report on the Actions of the Washington Action Plan."11 While progress has been made on all but a few of the issues agreed in Washington, some of the more thorny ones have been pushed to the side. Each issue is covered in three columns in the report: (agreement, progress since November, and what comes next). For example, in Washington G-20 leaders agreed that:
"Authorities should ensure that financial institutions maintain adequate capital in amounts necessary to sustain confidence. International standard setters should set out strengthened capital requirements for banks’ structured credit and securitization activities."
The following "progress" was announced:
"National authorities have taken a number of steps, appropriate to national circumstances, to ensure that banks have adequate capital."
But in the section "next steps" in April the caveat was added:
"Until recovery is assured, the international standard for the minimum level of capital should remained unchanged."
Another example of a key Washington declaration was the intent to regulate Credit Default Swaps (CDS)—a key market "innovation" responsible for huge financial credibility problems, not to mention most of the U.S. losses in AIG:
"Supervisors and regulators, […] should: speed efforts to reduce the systemic risks of CDS and over-the-counter (OTC) derivatives transactions; […]"
International regulations threaten the industry lobby and self-regulatory board, "The International Swaps and Derivatives Association (ISDA),"12 but when we look at the actions proposed it seems they have little to fear. Some commentators13 have suggested eliminating the CDS industry completely, but its nominal value of $62 trillion makes this unlikely in the short term. In "Next Steps" we find market self-regulation creeping back in:
"Leaders call on the industry to develop an action plan on standardization by autumn 2009."
When Does Monetary Easing Become Currency Abuse?
Even the heavyweights have found it difficult to agree on tactics. The urgency of financial regulation—proposed by Germany and France—was tempered by resistance from the United States, who instead pushed for a global stimulus package, which the Germans in turn are more cautious about. Further stimulus packages—the UK/U.S. proposal for printing money to get out of the recession (politely referred to as monetary easing)—is still being resisted by the European Central Bank.
On the issue of global financial regulation, the United States seems to have had a recent change of heart. In testimony to the U.S. Congress on March 26, Treasury Secretary Timothy Geithner called for a "massive overhaul" in financial regulation—not "modest reforms at the margin," but rather "new rules of the game." In a statement before the house financial services committee on the 27th of March, he stated that the United States: "hope[s] that we can work with the Europeans on a global framework."
The United States and China have been in a standoff of financial mutually assured destruction for years. The U.S. Treasury accuses the Chinese authorities of competitive devaluation of their currency, but to do this, the Chinese needed massive reserves in dollars, the purchase of which was a cheap loan of Chinese savings to the United States.
President Obama left no doubts as to his opinion on the trustworthiness of the U.S. dollar. Countering Chinese concerns, Obama retorted:
"As far as confidence in the U.S. economy or the dollar, I would just point out that the dollar is extraordinarily strong right now. And the reason the dollar is strong right now is because investors consider the United States the strongest economy in the world with the most stable political system in the World."
What about the WTO?
In the London G-20 April communiqué, clause 23 calls for the G-20 countries come to an agreement on the Doha round of the WTO trade agreements.
"We remain committed to reaching an ambitious and balanced conclusion to the Doha Development Round, which is urgently needed. This could boost the global economy by at least $150 billion per annum. To achieve this we are committed to building on the progress already made, including with regard to modalities."
The "at least $150 billion per annum" boost to the global economy as a result of signing the Doha round is a hotly debated and highly speculative estimate, based on models that in turn are fed with data projections from WTO estimates.14 Not only are numbers speculative, the benefits vary drastically from country to country. This same independent study that indicates benefits that might accrue from textile liberalization in Doha notes:
"[…] liberalization is worth $57 per person in the high-income world, versus less than $5 per person in the developing world."15
The April G-20 communiqué shows that, despite the crisis, "free" trade and market flexibility are still the order of the day. Even as the United States, Britain, Germany, Ireland, and many other nations quietly nationalize their banking sectors, Communist China no less warns of the perils of protectionism and complains of "Made in America" stipulations. Topsy-turvy, neoclassical economics appears to have found itself locked in a 1990s time warp.
Multinational corporations—especially financial multinationals—insist on the importance of unrestricted cross-border financial flows. The media mantra is that protectionism backfired in the 1930s depression and must be avoided at all costs. Economics historians tell us that the United States turned a bad recession into a depression by imposing trade protectionism in the Smoot-Hawley act, passed in 1930. The British neoclassical economics magazine, The Economist, notes that:
"Governments have vowed to resist a descent into protectionism. There has been some backsliding, but no sign of a repeat of the beggar-thy-neighbour lunacy of the 1930s."16
Globalized transnational capital requires that neoclassical economists prevent governments from imposing capital controls. In fact, capital controls can be effective in protecting the banking sector from crisis outflows that caused the Argentine financial collapse in 2001/2002.17 For the moment, transnational capital can breathe easily; the G-20 included a section on "Resisting protectionism and promoting global trade and investment," assuring stakeholders that:
"We will not retreat into financial protectionism, particularly measures that constrain worldwide capital flows, especially to developing countries."
Developed and Developing World Scenarios
In G7 countries, stimulus packages encourage spending sprees, but much of the developing world has been forced to cut back on public spending by IMF loan contingency plans. Apart from being blatantly unfair, this dual standard flies in the face of economic logic.18 Developing countries need emergency funds, but they need to stimulate their economies in the medium to long term because they indebted themselves to hard currencies (which have become relatively harder) and because developed countries need the custom. High interest rates for contingency loans are designed to promote rapid payback, thereby preventing what the IMF calls the risk of "moral hazard."19 Improvements have been made on the issue but they were not detailed in the April communiqué; it simply stated in clause 18:
"It is essential that […] resources can be used effectively and flexibly to support growth. We welcome in this respect the progress made by the IMF with its new Flexible Credit Line (FCL) and its reformed lending and conditionality framework which will enable the IMF to ensure that its facilities address effectively the underlying causes of countries’ balance of payments financing needs, particularly the withdrawal of external capital flows to the banking and corporate sectors. We support Mexico’s decision to seek an FCL arrangement."
Absent capital controls, transnational banking is now acting like a sponge soaking up liquidity in the developing world and transferring it to their head office, thereby further deteriorating liquidity problems in the developing world.
Private globalized finance has leaped ahead of the parallel institutions that should have been responsible for its governance—currently the IMF and the FSF (soon to be replaced by the new Financial Stability Board (FSB). What Lula calls "irrational activities" have pushed the financial system to a breaking point, little fault of its own the developing world is paying the piper.
One counterintuitive result is the strengthening of the dollar, a short-term result of massive flows of capital seeking a flight to quality. "Quality," for the moment at least, is believed to be found in liberalized economies with deep financial systems. This leaves developing countries, whose currencies are artificially devalued to aid their export sector, with even less credit in hard currencies. The developing world’s currency problem is circular. It is the currency system itself that is the problem. The difference now is that this problem is not just experienced by the developing world but the developed world is experiencing it too.
The Question of Growth
As the G-20 met inside, thousands of demonstrators filled the streets of London. They seemed to be more concerned with the global environment than the global economy. In the spirit of: "Nature does not do bailouts," Carlos Taibo, professor of political science in the Autonomous University of Madrid articulated a criticism of the whole effort to stimulate spending and economic growth.20 He argues that in place of stimulus packages we should instead embrace shrinkage:
"The dominant vision in the opulent societies is that economic growth is a panacea which cures all ills. […] in the rich countries we need to reduce production and consumption because we are living beyond our means. It is urgent to curtail emissions because they damage the environment and because we are beginning to run out of vital raw materials. Economic growth imperatives find themselves blunted by the reality of the environment and the planet’s resources.
One of the ways to measure this issue is the ‘ecological footprint.’ This is a measure of the surface area of the planet, both land and sea, which we require to maintain current economic activity. If in 2004 this footprint was already one and a quarter times the size of planet Earth, according to many it shall cover two planet earths—if one can envisage such a concept—by 2050."
It’s not likely this perspective will find its way into the G-20 deliberations. In its communiqué, the G-20 makes many mentions of sustainability, but in 15 of the 16 cases they refer to fiscal or economic sustainability and only once to ecological sustainability.
- Defined as the net revenue accrued from issuing money.
- The English translation of an article entitled "Washington Summit Targets at Crisis [sic]."
- The dollar, the euro, and other currencies participate in the SDR basket but the Chinese Yuan does not.
- Multilateral Development Banks.
- The Chinese and their allies, including Brazil and Argentina, wanted a "reform and then fund" strategy for the IFIs (especially the IMF). The order of the clause in the G-20 communiqué is significant.
- Explicitly mentioned in Zhou Xiaochuan’s paper.
- A change, that should it happen at all, shall have to be done gradually.
- Soon to be replaced by the Financial Stability Board (FSB).
- Example: http://www.atimes.com/atimes/Global_Economy/JL04Dj03.html.
- For an analysis of various estimates and how they could be divided between the rich and the poor countries of the planet, see Tufts University’s GLOBAL DEVELOPMENT AND ENVIRONMENT INSTITUTE: The Shrinking Gains from Trade: A Critical Assessment of Doha Round Projections, http://ase.tufts.edu/gdae/policy_research/shrinking_gains.html.
- Ob. Cit.
- In Argentina 2001/2002 the country had followed IMF rules and relaxed capital controls so they were not protected.
- Iniciativa Para La Transparencia Financiera: La acción internacional es imprescidible; Roberto Frenkel: http://www.itf.org.ar/lectura_detalle.asp?id=38.
- In light of the recent Madoff case, this term possibly requires a redefinition.
- En defensa del decrecimiento, Carlos Taibo: http://alainet.org/active/29535.