The Bennett Newsletter
"G20 Sea-change"
G20 and the IMF have undergone a sea-change: they recognise the need to bite the bullet on debt. G20’s Korean meeting has ended with a realisation that the world is suddenly different. The meeting began with most delegates acknowledging that growth was very vulnerable and needed fiscal stimulus, but eventually the group switched to emphasising the necessity of strengthening their fiscal frameworks by reducing budget deficits and debt. It is an important change, and one this columnist has been urging for some time.
As recently as April, the last G20 communiqué called for fiscal stimulus to be maintained until the recovery had picked up steam. IMF policy also urged stimulus. The need for reinforcing the recovery is obvious in the poor US jobs data and the plunging price of oil. Moreover, tightening budgets, especially in Europe, will also slow growth. The US spoke strongly at Busan (South Korea) against an austerity drive as it would jeopardise global growth.
An analytical narrative of the meeting may be interesting. It was immediately clear that the issue was between those counties which prioritised redressing public finances and those who wanted growth first. There were other issues, like the perennial call for China to revalue the Renmimbi, and the impact of market news, especially stock market weakness associated with the European sovereign debt crisis, in which Hungary had become of concern.
There was a clash of personality too, Timothy Geithner was very persuasive that “fiscal tightening won’t succeed unless we are able to strengthen confidence in the global recovery”. But the bears won. The star was French finance minister, Christine Legarde who called for getting public finance in order. She received support from an unexpected quarter, George Osborne, the new British Finance minister, departed from the usual “me too” of Labour’s response to American initiatives, by arguing strongly (and perhaps decisively) for fiscal rectitude.
The milieu
G20 met in Busan, the centre of Asia’s burgeoning plastic surgery industry, with assumptions that the talking shop would reiterate the need for ongoing fiscal stimulus to sustain the fragile global recovery. Each delegation brought additional concerns. It was assumed that the UK would again line up with the USA in challenging China on the Yuan. But George Osborne had called in Beijing en route and broke ranks. The Asian’s wanted to signal support for the Euro to stop its haemorrhage. Despite their own budget deficit, France wanted fiscal rectitude as it does not want to support the indigent Greeks, Irish, Spanish and other Euro-area supplicants. Many bankers were present to lobby for an end to the IMF’s proposed new taxes to create a fund to fight future crises.
Clashes immediately occurred. Timothy Geithner pressed for a continuation of the stimulus, and provided a new twist by arguing that the US consumer could not continue to drive global demand: other countries had to stimulate their domestic markets. Geithner raised important issues in decrying also the current stress on exports, which would eventually lead to competitive devaluations. Although Geithner was talking sense, the US no longer predominates unless its allies are lined up in support.
The IMF was initially dutiful. Dominique Straus-Kahn emphasised that cutting deficits in rich counties could hurt growth over the next two years: fiscal consolidation would shave a massive 2.5% off global growth and cost 30 million jobs in G20 countries.
Markets meanwhile were in turmoil. Wall Street fell to a four-month low on news that job creation (except for census workers) was below forecast, and the euro was in a deep plunge on debt-servicing fears. Hungary has emerged as a country with increased difficulty in convincing bond vigilantes that it is viable.
Incidentally, Hungary is an interesting case for New Zealand. These two countries have a sovereign debt of comparable size (about 30% of GDP) and much larger private sector debt associated with housing. Hungary’s housing debt problem seems almost insurmountable as its banks borrowed unhedged in Swiss currency to obtain low interest costs but now have a run-away capital loss problem as the Florin devalues.
Market turmoil had two effects: it strengthened the call for action on budget deficits and debt, but paradoxically it weakened proposed restriction on banks. At the meeting, the British and Americans had supported an IMF proposal to add a tax on banks to create a new fund to support bailouts. This sensible insurance programme was voted down. Tightening the capital requirements of banks (proposed by the Bank of International Settlements) was also voted down because it would reduce credit supply and hamstring the recovery. Bank lobbyists earned their keep, ensuring the banks continue to get away scot-free.
The Outcome.
My first impression is that, for all the hawkish talk on better fiscal management, most counties will be slower than expected ( except Brazil) in raising interest rates. The G20 delegates came to understand that the recovery is very fragile and that raising interest-rates could inflict damage. I have looked at several regional Federal Bank statements and they support keeping near-zero interest rates for an even more “extended period”. Similar statements have emanated from England, Russia and the EU. Countries which were on a tightening trend, like Australia, Canada and India are signalling a slowdown. This might apply to the RBNZ too.
The communiqué recognises that the recovery is multispeed, but it still tries to impose some universal improvement through improving the quantity and quality of bank capital in order to reduce moral hazard, and protect tax-payers against more bailouts. It acknowledges that “significant challenges remain” in maintaining growth and in containing the collateral damage in ongoing fiscal deficits and accumulating debt.
The implication is that there has been too much emphasis of growth. Some stimulus will remain, ideally in the form of low interest rates, but more attention must be paid to reducing budget deficits and controlling debt, both private and public. At best, the world outlook in most industrialised countries is for a very grim battle to get ahead. The outcome is uncertain and even minor interest rate rises, could bring another recession.
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