GLOBAL FINANCIAL CRISIS: by Colin TeeseNews Weekly
Disentangling the new world disorder
, December 6, 2008
The priority of financial institutions should be to fund the development and maintenance of the real economy, writes Colin Teese.Don't get too excited just yet about the G20 summit. The rest of the world is yet to share our view of its importance. More than anything else, this probably explains why President George W. Bush, when talking to our Prime Minister, revealed that G20 wasn't within his immediate attention span.
Even so, the meeting was probably worthwhile, and G20 may turn out to have a brighter future than the hopelessly unrepresentative G7.
It also gave President Bush a chance to make some headlines. Before the meeting began, he made a plea for the leaders to save capitalism. This seemed hardly necessary, since no serious observer had ever suggested capitalism was under threat.
President Bush's task was hopeless. The version of capitalism he wanted saved was born in the United States at the end of the Cold War, and appropriately characterised as the "Washington Consensus".New ideology
In the process, the International Monetary Fund (IMF) and the World Trade Organization (WTO) had their original purposes corrupted to serve a new ideology which the world's only remaining superpower hoped to impose on the rest of us.
The new ideology was in fact a form of recycled globalisation, revised and re-jigged for the 21st century. Essentially, it advocated the unfettered operation of market forces, including the deregulation of financial markets and the pursuit of free trade.
In practice, this has turned out to be a particularly naïve and toxic form of capitalism. Deregulation of financial markets alone has ushered in a destabilisation of world economic activity and prosperity on a scale which, only a year ago, would have seemed unimaginable. It has also seriously diminished the power and influence of the United States.
The Bush plea went unheeded in the G20. Indeed, the entire deregulationist push was already being rejected in exalted US economic circles. Alan Greenspan, formerly Chairman of the US Federal Reserve bank — and once among its most prominent advocates — had publicly given up on it.
President Bush wisely changed tack during the G20 meeting. At the end, he seemed to be moving further away from the old ideology than any other leader at G20.
The communiqué issued at the meeting's end routinely endorsed the idea of free trade as a growth stimulus. All participants — including our own Prime Minister — declared themselves committed to this proposition.
Yet, after the meeting, President Bush is quoted as saying, "I'm a free trade person, until you're told that if you don't take decisive measures our country could go into a depression greater than the Great Depression."
He was speaking from the heart, in the knowledge of the imminent collapse into bankruptcy of the three major US car manufacturers. In doing so, the President was going further than his own party. Up to now, Republicans in Congress have been holding up the use of public funds to bail out General Motors.
Bush's message was clear: saving jobs in the US was more important than free trade. True, he is a lame-duck president, but it is hard to imagine that his successor will think otherwise. We can expect the new Congress to get in behind new President Barack Obama — that is, if GM and Ford are still there to be saved.
Russia seems to be following the US example. Others, no doubt, will join in. Let us hope the Rudd Labor Government gets the message.
Thus far, the G20 seems to be thinking of re-jigging the International Monetary Fund (IMF). Almost certainly, this won't be enough.
Whether or not the big Western powers are ready for it, the real need is to re-shape international economic relations. Joseph Stiglitz, the Nobel prize-winning economist, has said, correctly, that a new Bretton Woods-style agreement is needed.
Bretton Woods was one of the agreements negotiated toward the end of World War II, within the framework of the United Nations Organisation, to rebuild international economic relations.
It established the General Agreement on Tariffs and Trade (GATT) to help give direction and purpose to nations' management of their trade policies, and to avoid an outbreak of excessive protectionism.Postwar reconstruction
The IMF was structured to maintain international financial stability and stimulate trade flows. The World Bank had responsibility for postwar reconstruction and development.
In the past 20 years, all of these agencies have been swallowed up by unrestrained free market ideology. As a result, they are no longer able to function effectively.
GATT was transformed into the World Trade Organization (WTO) in the dying years of the 20th century. A vastly expanded role was assigned to it, embracing more legalistic and prescriptive rules rather than the mere guidelines of the GATT and taking its reach beyond merely the trade in goods.
The new prescriptive rules, in particular, have not moderated the tendency of the major parties to adopt protective actions as they saw fit.
Worse still, as multilateral negotiations within the WTO on matters of importance to the big players become more difficult, the tendency, now widespread, has been for the membership, large and small, to take refuge in bilateral agreements.
Almost always, these have not been in conformity with WTO rules, but the agency has been powerless to do anything about them.
Most important of all, the WTO has been totally unrealistic in its approach to the trade in agriculture — even more so than the GATT. The WTO seems to be showing all the elements of a dysfunctional agency.
The IMF was effective as the instrument through which the US managed to underwrite world trade. This enabled the Western trading nations to maintain more or less fixed currency relativities.Disruption and instability
There is nothing more corrosive to trade flows than the disruption and instability which result from floating currencies.
Under that system, traders need to take costly insurance against any losses they might face as currencies rise and fall by comparison with each other. Alternatively, they must gamble on the direction of currency movements.
Once the US was no longer able to guarantee to maintain the value of the dollar, the US's trading partners had to abandon fixed currency relationships. That happened in August 1971.
The World Bank has long ceased to serve its original development purpose. It still makes loans to Third World countries for development purposes, but for the last 25 years these have been conditional on the borrowers arranging their economies in accordance with the Washington Consensus. Few have been willing or able to do this — and those who have been prepared to do so have not fared well.
The breakdown in the effectiveness of these agencies has helped get the world into its present mess.
They can't help the recovery process, and they must be recast to reflect current world economic realities if we are to avoid lurching back into the financial mess from which we are now trying to escape.
The ideological commitment of international regulatory agencies has resulted in financial markets being encouraged to dominate the real economy — both domestically and internationally.
Speculation in currencies for its own sake seems to have done the most damage. Financial transactions amount annually to $600 trillion dollars, whereas world trade is only about $10 trillion.
More or less fixed relationships between national currencies will discourage currency speculation. How to do it? No nation has the power and/or the will to do what the US managed for the 25 years after World War II. Failing that, some kind of international financial agreement would be the next best option. That too, will be difficult.
What might be possible is a series of regionally-based currencies, like the Euro, which the regions could agree to hold in some kind of stable relationship with each other.
Regulation of domestic financial institutions must also be addressed. Its purpose should be to fund growth in the real economy, and to ensure that inter-bank lending is continued.
Letters of credit, which have been the traditional financial lubricant for international trading, are a mechanism absolutely dependent upon banks being able to trust in the solvency of each other. Governments and banks around the world must restore and maintain this system at full effectiveness — this is more important for trade flows than trade liberalisation.
As to trade rules, the WTO experiment failed because it overreached itself and because it became embroiled in the promotion of ideology. We need a narrower pragmatic focus (one confined again to the trade in goods) and a more realistic attitude to what can and might be possible regarding agricultural trade.
It is, for example, utterly futile to pursue the idea that the major temperate-zone agricultural producers should abandon their subsidy programs.
Take grain, for example. US and European Union grain-producers could not function without subsidy. Yet their production is absolutely essential to world food needs.
Is it realistically possible to imagine that other sources of unsubsidised production could make up for what would be lost if the US and EU subsidies were abandoned?
None of what has been suggested in this article should be taken as the last word on what needs to be done to solve our existing problems.
Instead, it should be seen as an attempt at pointing us in the right future direction.
It is, however, hoped that, as a starting point, there can be some agreement on the need to curtail currency speculation, and to ensure that the focus of financial institutions is to fund the development and maintenance of the real economy, and to finance international trade.— Colin Teese is a former deputy secretary of the Department of Trade.