Tuesday, March 31, 2009

Special article for Hurriyet Daily News: Buck Rogers and the 25 Sentries

Below is the unedited version of a special column I wrote for Hurriyet Daily News. It was designed as part of an excellent series on the global meltdown and what to do about it. I wrote the article Thursday evening at Elmadag Starbucks; it appeared in today's paper. You can see the final (edited) version at the Hurriyet website: Although I do not agree with all the editors' edits all the time, I have to give them credit for the title. Their title is much better than my original one, which was a bit cheesy. BTW, the hard copy has really nice graphs, for which the credit goes to my editors as well. Well done guys, I couldn't have chosen better myself...

God created the world in six days. The leaders of the Group of Twenty countries have just one to save it (there are actually 25 of them at this meeting and hence the title). But the cure to any illness comes from the right diagnosis. In a similar vein, to discuss what the G-20 should do and will do on April 2, one first needs to be clear on what is behind the crisis and why the crisis is taking so long to resolve.

First of all, while I am not a big fan of the maestro myself, easy US monetary policy during the last years of the Greenspan era did not cause the current mess, although it provided the necessary nice & warm cultivation environment in the form of a liquidity flush. Similarly, financial innovation was not the culprit, lax financial supervision & regulation coupled with distorted incentives were. But if this was it, we would not have been dealing with a global crisis, just a bigger version of the numerous crises of the past two decades such as the time when genius failed (LTCM fallout and the Asian crisis), savings & loans fiasco and the dotcom crash. At a more fundamental level were the global current account imbalances that have been eloquently brought to light by Financial Times Economics editor Martin Wolf in his weekly columns for the past couple of years and his most recent book. These balances were to be corrected sooner or later; the catalysts above contributed to a rapid and therefore damaging unraveling rather than a slow and steady adjustment.

Given the nature of the crisis, the first priority of the G-20 should be to agree on a global response so that these global current account imbalances will shrink rather than get amplified. After all, everyone needs to chip in wood to light a strong fire, as a proverb from China, which has started the largest stimulus package along with the United States, aptly puts. However, imposing strict guidelines, such as the IMF proposal of a fiscal stimulus of 2% of GDP, should be avoided on many grounds. First, a one-size-fits-all jacket ignores each country’s unique economic structure. For example, while the German stimulus seems to pale in comparison to the American one when the actual numbers are compared, adjusting for automatic stabilizers brings it to the same level. Similarly, as Tolstoy noted in the opening sentence of Anna Karenina, all happy families are alike, but every unhappy family is unhappy in its own way. Each country has different room for fiscal policy, based on their balances at the onset of the crisis and their monetary policy stance, among other things. For example, contrary to the conventional wisdom, the consequences of attempting a stimulus of Chinese proportions would be devastating for the Turkish economy. So, the G-20 should be agreeing on general guidelines rather than specific targets and emphasizing the willingness to act together, not only now but also in the future.

But this is barely enough, given the financing woes of many emerging markets. The Institute of International Finance, the global association of financial institutions in Washington, DC, forecasts capital flows to emerging and poor countries to retract to USD 165bn in 2009 from almost a trillion in 2007. While emerging markets like Turkey have not had much trouble in tapping domestic markets so far, the private sector has not been so lucky. Therefore, the IMF’s resources should definitely be at least doubled to USD 500bn, so that the Fund does not run out of funds soon. Other matters related to improving the IMF, such as defining a new role and drawing up new voting rights, should be put to sleep for now in favor of expediency. One exception could be extending this week’s reforms on doing business with emerging markets to low-income countries.

A third direction the G-20 should take is a clear stance against protectionism. While a global protectionist backlash similar to the aftermath of the Great Depression is unlikely, anti-dumping cases and buy-domestic clauses are surging not only in dirigiste countries such as France but also in bastions of laissez faire capitalism such as the United States. Further protectionism would cause world trade to contract much more than the optimistic 9% forecast of the World Trade Organization. I should emphasize that I am hoping for a bit more than polished words from the meeting, as talk is cheap. In fact, a recent Word Bank note reports that 17 of the very same 20 who had “underscored the critical importance of rejecting protectionism” back in November at the summit in Washington, DC have resorted to various protectionist measures since then.

The G-20 is likely to adopt measures similar to the ones above when it meets next week, even though we will have to wait and see if they will be able to walk the walk rather than just talk the talk. That much I am not worried about. What I am concerned about is that they will attempt at much more and end up achieving much less, especially as the G-20 agenda is more and more looking like a grocery list, with anything but the kitchen sink thrown in. For example, even more ambitious than an overhaul of the IMF I advised against above, the G-20 has been charged with setting up a global financial regulatory structure, creating an early warning system to prevent future crises and help the poor, who are starting to get affected from the crises.

Some of these measures are debatable. For example, the much-touted-for Spanish banking regulation model, where banks have to adapt cyclical capital provisioning, may help marginally at best. Similarly, global regulation may not be the optimal response, as Harvard-based Turkish economist Dani Rodrik has argued eloquently in a recent article in The Economist. Other measures make sense from an economic point of view, but homo sapiens is not only homo economicus, but also homo politicus. Such ambitious proposals are likely to divert the G-20 from the real problem at hand. To me, it seems downright silly that many are concentrating on preventing future fires without putting out the current one at first. Moreover, a more ambitious list also means more potential sources of discord, which is likely to lead to end-results that will not satisfy anyone.

As for the market response, despite some like George Soros are expecting miracles from the meeting, my sense is that the market is not too optimistic. Therefore, the risk of a negative reaction is quite low, unless the world leaders come out completely empty-handed. In this sense, I am crossing my fingers that the meeting will not be diluted by China’s demands for a new reserve currency or the recent Czech anger at the US fiscal profligacy- both countries will be present at the meeting, the latter because it is holding the EU presidency. Such outbursts reflect the growing worries on the decline in the dollar and at a more fundamental level who will bear the burden of the US fiscal stimulus at the end of the day, another important debate that should be postponed.

But if the G-20 does not act decisively next week, there will not be many trees left to save in the next wildfire.

Emre Deliveli is an independent consultant. His daily Economics blog is at http://emredeliveli.blogspot.com/.

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