The G20 want to discuss how to bolt the stable doors – they should try looking for some horses first.
The putative agenda for the G20 is all about better regulation of the financial world to prevent a repeat bubble. I am all for that. The overblown regulatory industry of the last decade failed spectacularly to do one simple thing – keep lending and borrowing within prudent limits. Next time round we do not need more regulators, just regulators who use the powers they have to keep some overall size control on financial institutions balance sheets.
However, we are not in the luxurious position governments are spinning we are in. They want us to believe the banks have been saved by Gordon, Paulson and others, that money markets are gently returning to normal and all we need to worry about is some future credit binge. If only.
What we should be worrying about is recession. Last month 250,000 more Americans became unemployed. The car industry in Europe and the USA has fallen off a cliff, leading to financial distress amongst major companies, factory closures, and more job losses. Property related businesses in the USA, the UK, Spain and other distressed centres have seen a huge decline in the volume of business as well as a big fall in the value of any property assets they own. Steel makers now have to cut capacity. Retail staff hang around little used tills, worrying how much longer they will have jobs. This recession is finding its way into most nooks and crannies of the advanced economies. It will leave a trail of devastation in its wake – job losses, bankruptcies, broken dreams, damaged families, dislocated businesses.
Beneath the surface of their soundbites and their political games, the governments of the west are worrying about how to dig their economies out of the mire they have driven them into. There are now three main policy options being pursued, and two being considered.
1. Cutting interest rates. This is the best and in some ways the most important. It was high interest rates and tight money which triggered the collapse. Overborrowed countries, however, need to tread carefully.
2. Making more cash and short term borrowing available to banks, with guarantees to assist markets. If anything makes the money markets work again, this will. It is going to take time and unbelievable sums in cash to do so.
3. Buying shares in banks, to recapitalise them quickly. This is a foolish policy, as it puts the taxpayer on too much risk, and delays the cuts in costs and inefficiencies which the banks need to make to do better in the future. It limits the scope for interest rate cuts.
4. Bringing forward public spending on capital projects. This is being considered on both sides of the Atlantic. In practise it is slow to work, as projects take time to bring to contract stage. At the margin it is helpful, and shows “something is being done”, but cannot be done on the scale to power us out of the slump.
5. Tax cuts to give people more spending power, to encourage more demand. This too could be a useful contributor, and worked in the second quarter in the USA. It can only be done by countries with a sufficiently strong financial position to afford it.
What should be done?
I would do four out of the five policies above. Even the UK could afford some borrowing for short term tax cuts, if it stopped buying bank shares on the scale envisaged. I would also want the international meeting to address the wider issue of the big global imbalances.
China and the oil producers have too much in reserves and savings. The west has been overspending and borrowing too much. There needs to be short term transitional arrangements, and a longer term fix.
In the short term a combination of weaker western currencies and less demand at home should force more into export. The UK and the US have to start earning their higher living standards by selling more abroad and producing more at home. During the transition period the IMF needs to strengthen its reserves from the cash and reserve rich countries of the world, to relend to the strugglers. China needs to make more progress in freeing its currency, and in stimulating her internal demand to provide a market for the world to aim at. There need to be further relaxations of barriers to trade to encourage more export to the cash rich countries.
China and the Gulf states will probably carry on lending more money to the West, and buying shares in Western companies. We need their money to sustain our overborrowed lifestyle, and they have few other places to put their cash. We need to free capital and currency markets, and markets for goods and services, as much as possible to speed and facilitate the movements needed to right the imbalances. Now is exactly the wrong moment to impose new controls and to think protectionism is the answer. The answer for the West is not less world trade, but more world trade where we are selling rather than buying.
Western governments, instead of subsidising bankers bonuses, should be making heroes of the exporters. We need them now to right our accounts and help us wipe off the big deficits of the bubble years.