Monday, April 6, 2009

The London summit has not fixed the crisis

By Wolfgang Münchau
Published: April 5 2009 19:35 Financial Times

For the first time since the crisis erupted two years ago, global leaders went a few millimetres beyond what was expected of them. The decision by the Group of 20 developed and emerging nations to commit $1,100bn (€816bn, £741bn) in new funds for international institutions is no doubt substantial. It will allow the International Monetary Fund to deal with the current and future torrent of balance of payment crises more effectively. But the London summit comprehensively failed to do what it set out to do. Not one of its resolutions will move the world a small step closer to resolving the global economic crisis.

As world leaders return home, they will be confronted by the reality of the decisions they have not taken. They will return to economies in which bankruptcies and unemployment are about to rise to the highest levels since the Great Depression. They will face an outraged public that seeks to exact revenge on bankers and banks.

The longer they wait, the harder it will be to take the needed decisions. Many of those decisions, such as the recapitalisation of the global banking system, will become a lot more expensive, and politically difficult, if we procrastinate while the economy deteriorates further.

The forward looking indicators do not tell us the situation is getting better. US house prices are down 30 per cent, and have further to fall. Countries with large current account deficits are cutting consumption of imported goods. One of the results will be that the combined export surpluses of Japan, China, and Germany will shrink dramatically. World trade has been collapsing faster than during the Great Depression.

The monetary indicators are also absolutely awful. In Europe, both real and nominal growth of M3, a broad measure of money, is falling on a month-by-month basis – with no turnround in sight. Whether you look at this as a Keynesian or a monetarist, you come to the same conclusion: the world economy is in serious trouble.

The monetary authorities are close to having exhausted their ammunition. Money market interest rates are close to zero almost everywhere – and that includes the eurozone. We are now all moving towards what the Federal Reserve calls credit easing, a policy designed to alleviate bottlenecks in specific pockets of the credit market. The US and UK have adopted those policies, and the eurozone will follow suit with some delay. It will probably happen next month. And then what?

Not much, actually. Governments are now in a wait-and-see mode – wait until those existing stimulus packages kick in, and see how the economy responds. The US administration will wait until the public-private partnership, proposed by Tim Geithner, the US Treasury secretary, takes off. It will see how fast and effective the programme to buy “legacy assets” from US banks turns out to be. Chances are that it will succeed on its own limited terms, but it will not solve the problem of an undercapitalised banking sector. And US taxpayers may not like the idea that they are spending billions of dollars and have not saved the banks.

I would expect that, as we return from the summer holidays, governments will start to discuss a new round of stimulus and bank rescue packages.

The politics of bank rescue are toxic. A former European finance minister reminded me that, from a political perspective, there is nothing in it for a rational politician. Handing over hundreds of billions of euros to the banks is akin to political suicide, no matter how you do this.

But this only makes the need for co-ordinated global policy action even stronger. If you undertake this gargantuan political act while others are not, you bear all the political costs and reap none of the benefits. Bank rescue is a task that will test even the most gifted political orator. The best way to do it is as part of a global effort. The public would only accept it if it believes there is a realistic chance that the aid will solve the problem and in return they will insist on a minimal degree of fairness. The real problem with the US bank rescue plan is that it may exhaust the public’s sense of fair play.

The G20 summit has ducked the important question of bank rescue beyond a few meaningless and self-congratulatory statements. Instead, our leaders showed more interest in future crises than in the current one. But the probability that another crisis may break out soon, is inversely related to the length and depth of this one. The longer this crisis lasts, the more absurd the G20’s order of priorities will seem.

If the crisis shows no sign of ending in the autumn, our great leaders may gather for another desperate summit, in another city, facing another set of protesters, producing yet another series of desperate but ineffective pledges to save the world economy, embedded in another pretentious communiqué. The London summit has shown us what “We, the leaders of the Group of Twenty” can do, and what they cannot. The G20 has shown that it can fix international institutions, but not the biggest economic crisis in our lifetime.

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