Is there a whole lot of good in those little ‘0’s?

The G20 leaders met on 2nd April with the task of saving the banks and the world. They had a broad agenda: co-ordinated macroeconomic actions to revive the global economy, reforms and improvement to the financial sector and reform of international financial institutions. With such ambitious aims and divisions -some ideological- already formed, many expected a failure. While the G20 summit did not produce any surprising conclusions, it did reach an amiable and well-meaning consensus.

It should be noted that the worst of the crisis is widely believed to be over. Many of the risk-taking funds and investment banks blamed by many for the crisis have completed the process of deleveraging, and have now started to return to risk assets. While most world economies remain in recession, surveys of economists indicate that most economies will return to growth by early 2010. With a disastrous economic spiral no longer a serious threat, the scope for the G20 to change the macro-economic situation was limited.

{{ quote The G20 meeting was long overdue. Had such a meeting occured in late 2007, it is possible, yet unlikely, that much of the trauma of the fianancial crisis could have been averted. }}

In light of this, the action by the G20 on macroeconomic issues was remarkably restrained, given the aim of ‘co-ordinated macro-economic actions to revive the global economy’. No firm commitments were made by any country on fiscal stimulus. The only substantial move made was an increase in the funds available to the IMF, by $1.1trn.

The IMF’s role is to support developing countries experiencing a serious macro-economic or financial crisis. However, the increased financing made available only reiterates an implicit guarantee that developed nations would ensure the IMF had sufficient funds to provide loans to rescue developing countries. As such the increase in funds may reduce the risk premium attached to emerging market assets and secure increased investment, but it will not fundamentally change the world macroeconomic situation.

If anything, the major impact of the increase in resources available to the IMF will be its inflationary effect. $250bn of the promised trillion will be provided by an ‘SDR allocation’. The SDR, or Special Drawing Right, is an artificial currency that can be exchanged between IMF members in exchange for hard currency. In an SDR allocation, a country’s account with the IMF is credited with a number of SDRs, much like printing money. As the SDR is set as a fixed basket of US dollars, pounds, euros and yen, an SDR allocation effectively expands the supply of these currencies, causing them to depreciate. Therefore, the SDR allocation should increase inflation for the major developed economies.

The issue of protectionism is mentioned repeatedly in the G20 statement, yet few concrete steps are taken to avoid it. Unlike any previous recession, global trade is far more vital to the global economy than it ever was before. Global trade is ninety-six percent of world GDP, against fifty-five percent in 1970. Supply chains for almost any product span several countries. In this situation, the impact of trade tariffs would be devastating. Firms would be forced to find new domestic suppliers and consumers for their product, and those who did not find new markets would be forced to close. Facing such a significant threat, the best the G20 could do was to renew the promises that have been made for decades on this issue.

In its statement, the G20 stated their commitment to the Doha round of trade talks and to the principle of free trade. They asked the WTO to police new trade policies to ensure they are compliant with the principles of free trade. The WTO is already mandated to do this, yet for years it has been sidelined or ignored by its members. Since the same commitment was made at the last G20 meeting, in November, China has banned selected EU agricultural products, India has banned Chinese toys, the EU has introduced new agricultural export subsidies and a tariff on Chinese steel products. Clearly, the commitment to free trade in the G20 statement is nothing new and will have no effect on the world economy.

The more significant long-term effects of the G20 will be seen in the area of financial regulation. Following the financial crisis of 1929, rules such as the ‘uptick rule’ and the Glass-Steagall Act held back the US financial sector and wider economy for generations, until the authorities chose not to enforce them, allow them to be circumvented or repeal them. Around the world, these failures are being revisited as similar rules are being considered.

The significant change is the commitment to regulation of systemically significant hedge funds. Hedge funds are large pools of private capital, open only to sophisticated investors. Because they are available only to sophisticated investors and deal only with sophisticated counterparties, they are very lightly regulated and can make the risky and illiquid investments that correct financial markets. At the moment, hedge funds are able to make a market in asset-backed securities, allowing banks to remove ‘toxic assets’ from their balance sheets. With regulation of systemically important hedge funds, their ability to perform their role in the markets will be significantly impaired, and market bubbles, like the housing bubble that caused this crisis, may be more severe.

The key theme of the G20 meeting and statement was a re-shuffling of the economic power structure. Much of the statement is occupied by description of the financing which will be made available to developing countries. Developing countries will have more votes in IMF elections, and the appointment of heads of the IMF and World Bank will be based on merit, instead of the previous system where heads were effectively chosen by the US and EU. The Financial Stability Board, which includes developing countries, will replace the Financial Stability Forum. The inclusion of developing countries, while it will not substantially change the world economy in the next few years, will reduce friction between countries as they reach developed status, which is probably a significant benefit in the long term.

The G20 meeting was long overdue. Had such a meeting occurred in late 2007, it is possible, yet unlikely, that much of the trauma of the financial crisis could have been averted, and emerging markets and the wider economy could have been insulated from the crisis. In the current climate, the lack of firm action is probably a good thing. Any significant expansionary economic action would have been too inflationary to justify the increase in growth and the risk is that a significant increase in regulation would damp financial markets at their lowest point, increasing the magnitude of cyclical booms and busts.


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