FYI | Nov 17 2008
By Greg Peel
This weekend in Washington saw a meeting of what is known as the “Group of 20” nations – those representing the most powerful economies in the world. It’s a little bit of a misnomer, as the G20 is actually 19 nations plus the European Union. The European Union itself consists of 27 nations, although just to confuse the issue there is cross-over.
Meetings of the G20 are not common, and one can imagine that getting 20 countries to agree on something over a weekend is no small task. More common are meetings of the G7 – the most powerful among the powerful. The G7 consists of the United States, Japan, Germany, France, Italy, The United Kingdom and Canada.
To bring that up to the G20, we add Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, South Korea and Turkey, and the European Union.
The European Union consists of 27 countries which trade as a bloc, and as a bloc the EU has an economy greater than that of the US. Of the 27 members only 15 have adopted the euro as their currency. Germany, France, Italy and the UK are all members, so by adding the EU to the G19 you add Austria, Belgium, Bulgaria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, Greece, Hungary, Ireland, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain and Sweden.
In other words, 42 nations were represented in Washington, one way or another, representing about 90% of the world economy.
The reason they were there is because the world’s economy is in dire straits. Prior to the meeting we learnt that Europe is the first to officially record a recession – being two consecutive quarters of negative GDP growth. It is actually the 15 members of the euro currency which have collectively fallen into recession, posting negative 0.2% growth in the third quarter following the same result in the second. The full EU also posted a negative 0.2% figure but was on zero in the second quarter. The biggest economy within the EU – Germany – saw a negative 0.2% following a negative 0.4% previously. The second biggest – the UK – saw an ominous 0.5% drop following a zero result previously. Let’s not get hung up on the definition – Europe is in recession.
That Europe should be the first major economy to enter recession is illustrative of why the G20 saw urgent cause to meet in Washington on the weekend. For we all know that the real problem is derived in the US – creator of the subprime mortgage, the CDO, the CDS, and forty times leverage for investment banks. But in today’s financial world interconnectivity ensures that no significant economy can operate in isolation. The world has weaved a tangled web. No economy can be spared the ramifications of the actions of others.
We all now appreciate the common chaos theory adage that a butterfly flapping its wings in South America can cause a typhoon in Japan (or variations on that theme). If the theory needed any proof then it has come in the knowledge that an unemployed garbage collector defaulting on a mortgage he should never have been given in Jacksonville Florida in early 2007 has led to the UK seeing negative GDP growth of 0.5% in the September quarter of 2008.
The global financial crisis of the twenty-first century is a result of the rapid movement into the Third Age of modern mankind. The Agricultural Revolution brought about the First Age of civilisation some eight thousand years ago, leading to the creation of democracy and the rise and fall of mighty empires. The Industrial Revolution ushered in the Second Age in the late nineteenth century. Therein followed two world wars and, in between, the Great Depression. By late in the twentieth century we were experiencing the Information Revolution – that of the internet and ever-increasing computer power in ever-decreasing chips. This is the Third Age, and it is this age that more than ever before has connected the world through a web of information channels.
Perhaps Sir Walter Scott might look down and suggest an amendment to his famous poem – “Oh what a tangled world-wide web we weave”.
The Information Age has allowed world trade to expand at a rapid pace, allowed for developed nations to outsource their manufacturing and service centre bases to emerging nations, and allowed large financial institutions to transcend borders. The “developed” world has expanded and homogenised, and inextricably interconnected.
Little did Joseph Heller realise when he wrote his iconic Catch-22 that the line “What’s good for M & M Enterprises is good for the country” would still be able to be satirically applied today. Heller lampooned the shortcomings of “modern” capitalism back in 1961, highlighting a self-feeding economic circle. The collapse of the world economy in 2008 has close correlation with the collapse of M & M Enterprises.
Prior to September 2008, the world was still hanging on to a notion that the global economy remained divided along distinct lines. It was first thought in 2007 that the “subprime crisis” would be contained in the US. When the situation became more worrying, the International Monetary Fund concluded that Europe and even Japan would rise to balance the economic problems in the US, and it was a common assumption that the booming Chinese economy was “decoupled” from the US. Australia took much solace in the latter, being more worried about too-rapid economic growth in early 2008 than ever contemplating recession.
It took the fall of Lehman Bros to prove everyone wrong, but if it hadn’t have been Lehmans then some other event would have at some point inevitably triggered the financial market implosion of the last three months. The world now faces recession, of that there is little disagreement. And the world now realises the extent of global financial connectivity that transcends old-world concepts of nation-states and borders. To address the problem, and to ensure it never happens again, a globally coordinated plan is needed.
Enter the G20.
Rome was neither built nor dismantled in a day, and nor was the G20 ever going to solve the world’s problems in a weekend. However, the first step towards the solution of any problem is recognising there is one, and the hasty organisation of a G20 meeting is testament to just that. It would have been easy to turn the meeting into a US-bashing fest, if one assumes the heart of the problem lies in the world’s most powerful individual economy, but it would not have been helpful. To be helpful the G20 needed to acknowledge that a new global order needs to be established – a united regulation of the global economy.
That, at least, had to be the second step. The first was to react immediately to the problem at hand and prevent further economic collapse.
Again, it was never going to be possible to draw up a consummate plan of global attack among twenty representatives in one weekend. Thus with the UK prime minister Gordon Brown taking a leading role, the G20 nations collectively agreed to continue to stimulate their own economies individually as the most effective means of preventing further hardship. Stimulation would be both fiscal – pumping government money into the economy – and monetary – cutting interest rates. This is exactly what everyone has been doing anyway but whereas previously it was a case of “follow the leader” now all have agreed in the merit of such policy and thus can feel comforted to keep up the good work as part of a team effort. In short, all members agreed to keep doing “whatever it takes”.
To address the second step, it had to first be decided just who was to blame for the global economic crisis. No doubt there would have been small groups happy to point the finger squarely at the US over informal drinkies, but given the US dollar is the agreed reserve currency and no country can honestly say they are completely blameless in letting it get to this point there was little to be gained from playground behaviour. To that end, it was agreed by the end of the summit that “policy-makers, regulators, and supervisors in some advanced countries” were the culprits.
In other words, “us”.
With that established, the next task was to figure out how to prevent the disaster ever happening again. Meetings of the G20 and even the G7 are notorious for achieving a lot of talk and a little action, and usually the sort of “agreeing to move forward with unbinding commitments” type rhetoric that Sir Humphrey Appleby would have been most proud to have drafted. One only need take the example of the World Trade Organisation – of a similar membership – and the infamous “Doha round” of trade talks which have continued unresolved for seven years.
And so like guilty school children, this time the G20 agreed upon what is loosely a six-point plan of immediate action, or at least immediate action in the form of an agenda for reform to be ratified at the next summit, planned for March 31. Between now and then the details will be honed. Like any summit of world-leaders, this plan was drafted before anyone actually arrived. It just needed a collective stamp of approval.
The first step is an agreement to complete the Doha round of trade talks by the end of the year.
Thereafter things get a bit hazier, but include better risk management practices at banks, accounting standards to be put in place to account for notorious “off-balance sheet vehicles”, standards to address the conflict of interest of ratings agencies (which advise on the creation of instruments they then rate, and profit from the practice), the development of a clearing house for credit default swaps (already underway in the US) and an assessment of the adequacy of hedge fund best practises, which will prove the first step towards regulation of the global hedge fund industry.
Perhaps the most significant step, nevertheless, was agreement on the creation of a “college” of supervisors of the world’s biggest banks. The college will be drawn from regulators of many countries. This is an acknowledgement that the global financial market has, as always, moved ahead of the regulators, and as always regulation needs to catch up. This time that catch-up will be globally coordinated and overseen. Homogenous global regulation for a homogenous global financial market.
Agreement to act on such measures in time for the next summit in March was enough for host George Bush to declare the G20 meeting a great success. Bush would have no doubt hoped to have left such a legacy, for it will be Barack Obama in the chair at the next meeting, and a Democratic Congress that leads the charge on the wider agenda of reforms.
Those reforms have been tabled as a total of 47 action items in eight pages of the official document released after the summit. Their focus is to establish a series of new safeguards for the fragile and opaque global financial system. The attempt therein is to better flag risky practices and shortcomings in regulation so that the domino effect of corporate failure cannot again lead to such an economic disaster as has been experienced in 2008.
The G20 wants to keep a strict eye on South American butterflies.
George Bush was also pleased that the plans suggested at the summit did not amount to an attempt to undermine the fundamentals of free market capitalism per se. However, by its very definition free market capitalism can never be fully controlled. Regulation will always chase market practice – practice that is questionable in retrospect but nevertheless legal at the time. The market also fears a swing back to over-regulation – regulation that might be socially laudable in its intent but economically stifling in its application.
Wall Street did not respond favourably ahead of the meeting, falling sharply on Friday. But little can be drawn from the move, given squaring up on a Friday has become common practice and given the present lack of participants means sharp falls can occur in ten minutes flat. Such moves are not reliably representative of more general sentiment. The global market knows it will take time for the G20’s actions to bear fruit, and the immediate plan of doing “whatever it takes” (fiscal and monetary stimulus) implies to some there is no immediate coordinated plan at all. But either way the great deleveraging process continues and that has not been forced by any global government regulation. It has been forced by free market capitalism at work.
The focus is now on the global economy and just how bad things might yet get. If “whatever it takes” does manage to put a floor under markets from here, the next problem is just how quickly economic growth can return if weighed down by the sort of over-zealous regulation that may ultimately result from this first G20 gathering. There are few who would not agree that “something had to be done”, other than those who believe the only solution is to let global chaos run its full course – the ultimate purge. But among those appreciating the need for reform, it then becomes a case of balance.
As the history of modern mankind has passed through each of the previous Ages, there has been disruption. Disruption that requires a long process to reach resolution, if ever at all. The Third Age will prove no different.
