The world economy
Redesigning global finance
Government leaders cannot rewrite the rules this weekend. But they can still do some useful things
IT IS tempting to dismiss the upcoming G20 meeting as a piece of political theatre. Presidents and prime ministers from a score of rich and emerging economies will descend on Washington, DC, ostensibly to remake the rules of global finance. Several have talked grandly of a sequel to the 1944 Bretton Woods conference, which created the post-war system of fixed exchange rates and established the International Monetary Fund and World Bank. That is nonsense. The original Bretton Woods lasted three weeks and was preceded by more than two years of technical preparation. Today’s crisis may be the gravest since the Depression, but global finance will not be remade in a five-hour powwow hosted by a lame-duck president after less preparation than many corporate board meetings. Yet for three reasons it is still a meeting worth having.
The first is that this could mark the beginning of a better multilateral economic system. The G20, created after the emerging-market crises a decade ago, is not perfect for today’s problems. It excludes a big economy with an admired system of financial regulation (Spain) but includes a mid-sized country that has become irrelevant to global finance because of its own mismanagement (Argentina). Still, the G20 includes most of the key parts of the rich and emerging world, making it a better forum for global economic co-operation than the G7 group of rich countries, which has until now held the stage.
Don’t just stand there
In the short term that co-operation, and this weekend’s meeting, should focus on the second good reason for the Washington summit: crisis management. Although the panic in the credit markets shows signs of abating, the economic news gets ever grimmer. Global demand is slumping as rich economies plunge into what, collectively, could be their deepest recession since the 1930s. Pernicious deflation, though still unlikely, is no longer an idle risk (see article). Emerging economies are being hit hard by weakening exports and the collapse of private capital flows. The G20 summiteers cannot prevent this, but they can stave off a slump with zealous and co-ordinated action to prop up domestic demand and provide resources to cash-strapped emerging economies.
Some countries understand the urgency. China’s stimulus plan, even if it is a little less dramatic than first trumpeted, is an important step (see article). Others, such as Germany, are being woefully timid (see article). A collective commitment by those who can afford it will pack more punch than individual initiatives. Useful too, would be a pledge to cushion the slump in private capital flows to emerging economies, through both central-bank swap lines and the IMF. Countries with ample reserves, particularly China, Japan and the oil exporters, should promise now, and without preconditions, that they will lend to the IMF if it needs cash in the coming months. The G20 should also pledge its unequivocal support for free trade—a pledge that would gain credence if the leaders made a commitment to complete the Doha round of trade talks.
But what of the larger ambitions of “fixing” global finance? Here the temptation for hollow promises is greatest of all (see article). The summiteers can make progress, but only if they temper their hyperbole with realism and humility.
International finance cannot just be “fixed”, because the system is a tug-of-war between the global capital markets and national sovereignty. As cross-border financial flows have expanded and big financial institutions have far outgrown their domestic markets, finance has become one of the most globalised parts of the world economy. At the same time, finance is inherently unstable, so the state has to play a big role in making it safer by lending in a crisis in return for regulation and oversight. Governments broadly welcome the benefits of global finance, yet they are not prepared to set up either a global financial regulator, which would interfere deep inside their markets, or a global lender of last resort. Instead, regulated financial firms are overseen by disparate national supervisors (in America they are sometimes state-based). The IMF helps cash-strapped countries, but the fund was conceived in an era when capital flows were restrained. It is puny relative to the size of global markets today.
This tug-of-war helped create today’s mess. Disparate rules led to loopholes and “regulatory arbitrage”. Many emerging economies sought to protect themselves against sudden outflows of foreign capital by building up vast foreign-exchange reserves. That fuelled the global credit bubble. Given today’s crisis, the incentives to amass reserves have only grown.
The contradictory desires for national sovereignty and global capital markets limit the room for an overhaul. For all the grand rhetoric, no politician is proposing to cede sovereignty to a global regulator, let alone create a true global lender of last resort. Nor is anyone proposing a wholesale effort to curb capital flows (which is just as well). With no great design on the drawing board, it is better to concentrate on the more modest goal of improving the current muddled contraption through a series of politically feasible enhancements that together could amount to a third justification for this meeting.
Refit the existing engine
One example is Gordon Brown’s idea of a “college of supervisors” to oversee the biggest financial firms. Another is a global set of norms on what should be regulated and how: from hedge funds to leverage limits, national regulators would do a better job if they acted in concert. By all means start to look at schemes to revamp the IMF by scaling back Europe’s presence and enhancing emerging economies’ clout. But it would be a mistake to rely only on the IMF. The Fed’s new swap lines with other central banks are an important reassurance for countries that face a liquidity squeeze; those swap lines deserve to be systematised and broadened.
Modest as they sound, such repairs will be difficult and time-consuming. This summit should get them off to a start. It won’t earn anyone a place in the history books alongside John Maynard Keynes and Harry Dexter White. But it would be a lot more useful than more gusts of grandiose rhetoric.
Economic gloom in Europe
The euro zone's first recession
Economic output slumps across Europe
WITH hindsight, the European Central Bank’s decision to raise interest rates in July looks unfortunate. On Friday November 14th the European economy officially fell into its first recession in the ten years since the euro was introduced. Economic output among the 15 countries that share the euro fell by 0.2% in the third quarter from the previous one, marking a second consecutive quarter of falling output, the usually accepted definition of a recession.
The turn in Europe’s fortunes is sharp: in July economists only saw a roughly one-in-three chance of a recession, according to a poll by Bloomberg. It is also worryingly broad-based: a lack of credit is cramping consumer spending, business investment and exports in economies all across the region. One of the worst affected is Germany, the world’s biggest exporter and Europe’s biggest economy, where gross domestic product slumped by 0.5% in the quarter, after falling 0.4% in the previous quarter.
Germany’s woes owe much to cooling demand for the machine-tools, heavy equipment and other capital goods it churns out. Demand for these had been strong in recent years as emerging markets soared and high commodity prices spurred investment in mines, railways and ships. But with emerging economies slowing and commodity prices falling, new infrastructure projects are being shelved and ship orders cancelled. With orders and industrial output falling fast economists now expect a prolonged slowdown in Germany. Those at Commerzbank, a German bank, now expect output to contract by about 0.8% in the fourth quarter and perhaps by another 1% next year.
The ferocity of the downturn in Germany should cause it to consider using fiscal policy more aggressively to boost domestic demand in an economy that, until recently, has been powered largely by exports. It is well placed to do so. Its government bonds are prized by investors fleeing risky assets and it is entering the recession with a small budget surplus. A modest package unveiled on November 5th seems too small to provide much of a lift. “While we are sceptical that simply spending more money would help very much, the case for tax cuts, notably for aggressive cuts in the job-destroying payroll taxes, has never been stronger,” says Holger Schmieding, an economist at Bank of America.
Across most of the rest of Europe, the outlook is also grim. Output of all of Europe’s 27 economies, not just those sharing the euro, also slid by 0.2% in the quarter. The economies of Spain, Italy and Britain all shrank in the third quarter. Britain and Spain are likely to be hurt particularly by downturns in household spending as consumers worry about collapsing house prices and high levels of debt. In Britain and Italy there is little room for fiscal easing.
One country that has so far dodged recession is France. Its economy unexpectedly grew by 0.1% in the third quarter, buoyed by consumer spending and corporate investment. Most economists had expected it to shrink by 0.1%. Yet France may have merely postponed the inevitable, with many expecting its economy to shrink in the fourth quarter. Some signs of this are already emerging in the car industry where Renault and PSA Peugeot Citroen have both suffered falls in car sales and will cut production.
Amid the gloom there are however some grounds for hope. One is that the euro has plunged by over a quarter against the dollar in the past four months. The long preceding period of euro strength may have left European firms stronger, by forcing them to be more efficient. Its fall should now give exporters a better shot against American rivals in emerging economies (although exports to Britain, where the pound is weak, may be harder to achieve). European firms have also been quicker to gain a foothold in these markets. The euro-area’s exports to oil-producing countries, for instance, are more than three times bigger than America’s, according to the European Central Bank.
Another is that inflation is now falling sharply. Consumer-price inflation slipped to 3.2% in October from 3.6% a month earlier. Some economists now expect it to fall below the ECB’s target of 2% next year, allowing the bank to cut rates forcefully. That earlier caution may now be thrown to the wind.
Nov. 14 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said central bankers worldwide are prepared to take additional actions as needed to unfreeze credit markets, citing continued strains even amid ``tentative improvements.''
``The continuing volatility of markets and recent indicators of economic performance confirm that challenges remain,'' Bernanke said today at a panel discussion hosted by the European Central Bank in Frankfurt. ``For this reason, policy makers will remain in close contact, monitor developments closely and stand ready to take additional steps should conditions warrant.''
Bernanke led the ECB and other central banks last month in the broadest coordinated interest-rate cut in history. The Fed also removed limits on currency-exchange programs with four of its counterparts, including the ECB, and agreed to provide $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore.
Economic data this week signaled that policy makers have failed to avert a global downturn. Gross domestic product in the 15 euro nations contracted 0.2 percent in the third quarter and the Organization for Economic Cooperation and Development predicted yesterday that the economies of its 30 developed member nations will shrink next year by 0.3 percent.
``Monetary policy actions have not resolved the ongoing strains in financial markets,'' Bernanke said in prepared remarks at the ECB conference, which is marking the 10th anniversary of the euro. ECB President Jean-Claude Trichet, Bank of Israel Governor Stanley Fischer, People's Bank of China Deputy Governor Su Ning and Banco de Mexico Governor Guillermo Ortiz are also scheduled to speak.
Fourth Consecutive Drop
Retail sales in the U.S. dropped in October by the most since records began in 1992, the U.S. Commerce Department said today. The 2.8 percent decrease was the fourth consecutive drop. Purchases excluding automobiles also fell by the most ever.
Bernanke said ``financial markets remain under severe strain,'' while noting ``tentative improvements in credit-market functioning.''
He didn't specify what new steps central banks could take. The Fed, ECB, Bank of England and other central banks have all lowered rates since the coordinated cut on Oct. 8. While the governments probably won't coordinate fiscal policy, their actions will likely become increasingly similar, Bernanke said.
``It's increasingly likely there will be a convergence'' in fiscal policy, Bernanke said in response to an audience question.
`Sharp Deterioration'
Central banks created the currency swap lines in response to ``strong demand for dollar funding'' in the U.S. and other countries, Bernanke said. The ``recent sharp deterioration'' in interbank and other funding markets, where some financial institutions normally got dollars, left some companies ``without adequate access to short-term dollar financing,'' he said.
Since the coordinated rate reduction, the Fed has cut its benchmark rate another half-point to 1 percent. The central bank has provided more than $1 trillion in loans to financial institutions to mitigate the worst credit crunch in seven decades and head off a global recession. The Federal Open Market Committee next meets Dec. 16.
``Bernanke's remarks make us think another coordinated rate cut cannot be ruled out,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. There is ``no hint that the Fed has run out of bullets,'' he said.
Corporations with investment-grade credit ratings were paying a premium of about 6 percentage points above comparable Treasuries to issue debt as of Nov. 4, up from 5 points a month earlier and 2.5 points in May, according to Merrill Lynch & Co.
`Vibrant' Economy
``Central bankers and other policy makers around the world must continue to work together to address disruptions in credit markets and to promote a vibrant global economy,'' Bernanke said.
The U.S. economy may contract at a 3 percent annual pace this quarter, the median estimate in a Bloomberg News survey of 59 analysts this month. Economists don't expect growth to resume until the three months ending in September 2009. The Fed is forecast to reduce the federal funds target rate to 0.75 percent by the end of December and 0.50 percent in the first quarter.
Fed governors and district-bank presidents updated forecasts at the FOMC's Oct. 28-29 meeting. Those will be released along with the meeting minutes on Nov. 19.
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