Busy, Busy, Busy

Nouriel Roubini

The G-20's crowded agenda.

The policy actions taken by the G-20 countries and others--including aggressive fiscal and monetary stimulus, increased funding to the IMF and backstopping financial systems globally--helped stop the economic freefall. The economic outlook has improved since the last G-20 meeting in April, but the challenge of navigating toward sustainable growth is equally difficult, and the coming period brings the risk of policy missteps as countries begin to plan their exit strategies. On the eve of the G-20 meeting in Pittsburgh, there remain significant divides over the timing and scope of exit strategies from monetary accommodation, the path toward fiscal consolidation and the drive for financial regulatory reform.

Financial regulation will continue to be a key part of the leaders' debate. New capital requirements seem more likely, in the vein of suggestions raised by the Bank of International Settlements (BIS) and the Financial Stability Board. The recent meeting of the G-20 finance ministers and central bank governors supported such moves. The meeting broke, however, without an agreement on compensation reforms to avoid a pro-cyclical focus on short-term returns, a policy championed by the European Union. However, banks' balance sheets are still impaired.

All G-20 countries have pledged to maintain fiscal and monetary accommodation for as long as is required to ensure a stable recovery. That implies that countries and central banks might begin exiting at different paces. Some countries have already begun to remove some of the excess monetary accommodation (Israel and China are perhaps the most noticeable), and others are likely to follow through with rate hikes or other measures later this year and in 2010. The record growth in national debt will force some countries toward fiscal consolidation in the not-so-distant future, though tax hikes could weaken a recovery of private demand.

While G-20 leaders are likely to repeat their pledge to support the Doha round of multilateral trade talks, real movement on removing trade barriers is unlikely in the coming months, given that trade remains weak. Some countries, like Canada, have unilaterally removed barriers in sectors that benefit domestic investment, but overall, more sluggish trade will raise the incentive for trade barriers. In fact, trade disputes are on the rise, particularly between the U.S. and China. In September, the U.S. raised tariffs on Chinese tires, a move that was countered by Chinese investigation of U.S. trade practices. Although these disputes may not escalate and spread, given the importance of the bilateral trade relationship, action on trade seems unlikely.

The U.S. wants to put a focus on reducing global imbalances and promoting the sort of structural reforms that would increase domestic demand in export-focused economies like China. Imbalances have narrowed since the onset of the financial crisis, with the U.S. current account deficit falling to $98 billion in the second quarter of 2009, but it remains to be seen if this narrowing will be sustainable once consumption begins to grow again. The Chinese fiscal stimulus and those of other export-oriented countries have supported domestic consumption, yet consumption in these countries is not yet a major growth driver, either for the countries themselves or for the world. In fact, Chinese consumption may continue to lag overall growth in 2009 and 2010. Many economists worry that the crisis and financial shocks might increase emerging market countries' propensity to self-insure through collecting reserves, which could exacerbate imbalances. Meanwhile, some economists continue to debate the role of global savings and investment ratios played in financial instabilities.

Even if global imbalances are a problem, it remains unclear whether the G-20 is the best forum through which to address them. It is perhaps too large and too diverse a group to tackle the issues of imbalances and sustainable demand in an effective manner. The U.S. and China agree that the U.S. needs to save more and China needs to consume more; but they differ on the timing of such a shift and how to bring it about. Boosting China's consumption would require reallocations of capital between the corporate and the household sector as well as patching holes in the social safety net to reduce the propensity to save for health, education and retirement.

G-20 leaders will probably avoid making specific reference to individual currencies, and will particularly avoid references to the U.S. dollar. A new plaza accord to support the dollar seems unlikely. Yet the most vocal U.S. creditors, like Russia and China, are likely to make only very muted calls for new reserve assets and fiscal consolidation in the U.S. The voicing of dollar solvency concerns in June only added to pressure on the U.S. dollar and increased these countries' (dollar-dominated) reserve accumulation. The increase in use of the IMF's special drawing right (SDR) through IMF bonds is one step. Yet for now, all plausible alternatives to the U.S. dollar lack liquidity and, in some cases, convertibility. China and Japan in particular have continued to purchase U.S. government debt, lest their currencies appreciate. But should U.S. fiscal consolidation be delayed, these creditors might not be as willing to provide financing.

Despite the fact that almost all the major countries are making significant steps in promoting renewable energy--in part because of job-creation hopes--countries remain divided over the timing and scope of emissions cuts. Most of the G20 leaders attended the U.N. climate summit earlier this week, sponsored by U.N. Secretary General Ban Ki-Moon, which attempted to ease the roadblocks on the way to the December 2009 Copenhagen summit. While countries agree on long-term emissions-cutting goals, they doubt the sincerity or ability of their counterparts to make the near- and medium-term sacrifices.

In particular, emerging markets and developing economies are reluctant to agree to any emissions caps that might cool their growth, and European leaders have grown weary of delays in the passage of the U.S. climate change bill. However, the reduction of global emissions in 2008 from lower consumption and industrial output might bring some breathing space. Yet even if an overarching grand bargain seems hard to achieve, domestic policies are changing--even in the U.S. and China, the largest emitters.

Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes. (Read all of his columns here.) Rachel Ziemba, a senior analyst at Roubini Global Economics, assisted in the writing of this column.