You Cannot Be Serious: US Strategy for the G20

According to the WSJ this morning (top of p.A1), the US is pushing hard for the G20 to adopt and implement a “Framework for Sustainable and Balanced Growth,” which would amount to the US saving more, China saving less, and Europe “making structural changes to boost business investment” (and presumably some homework for Japan and the oil exporters, although that is not stressed in the article).

This is pointless rhetoric, for three reasons.

  1. Such an approach has been tried before, mostly recently in the Multilateral Consultation, run by the IMF.  This achieved little, as the WSJ article points out.
  2. This approach will always be fruitless unless and until you can put pressure on surplus countries to appreciate their exchange rates.  But the IMF, with US connivance, just punted on this exact point – letting China off the hook.  Tell me exactly, in detail, how the administration’s proposal would change this, particularly with Mr. Geithner and Ms. Clinton so keen to be deferential to Chinese official buyers of US government securities.
  3. Where is the evidence that this kind of “imbalance” had even a tangential effect on the build up of vulnerabilities that led to the global financial crisis of 2008-09?  I understand the theoretical argument that current account imbalances could play a role in a US-based/dollar crisis, but remember: interest rates were low 2002-2006 because of Alan Greenspan (who controlled short-term dollar interest rates); the international capital flows that sought out crazy investments came from Western Europe, which was not a significant net exporter of capital (i.e., a balanced current account is consistent with destabilizing gross flows of capital); and the crisis, when it came, was associated with appreciation – not depreciation – of the dollar.

The main argument for the revolving Wall Street-Washington door is that this lets an administration bring in top minds from the financial sector, with the practical experience necessary to tackle our most pressing problems.  It is hard to understand the prioritization here, unless the goal is to create a smokescreen that will both postpone real policy action (“because correcting imbalances takes time”) while also covering up for the crimes and misdemeanours of the Greenspan era (“it was all about imbalances, which were out of our control”).

Granted, big current account imbalances are not a good thing and should be on some list of problems to address.  But are they really on the top ten list of pressing issues for this G20 summit, which should include: much tougher financial regulation, substantially raising capital standards,  workable cross-border rules for handling failed banks, a timetable for downsizing our biggest banks, how credit rating agencies are paid, and reforming – top to bottom – financial sector compensation?

By Simon Johnson

17 responses to “You Cannot Be Serious: US Strategy for the G20

  1. The question is moot, since neither of the two frameworks (The US administration’s or Professor Johnson’s) will be enacted anyway.

  2. “big current account imbalances are not a good thing and should be on some list of problems to address. But are they really on the top ten list of pressing issues for this G20 summit?”

    Well, actually, yes… The trade imbalance is that important, and should be included IF there was a chance of getting meaningful movement from the G20 on this issue. But in practice, anything meaningful is going to come from quiet bilateral negotiation, so the G20 is not a good forum for this.

    The reason to focus on financial regulation (as SJ suggests) is that there’s a chance something might be done, and the public stage and high-publicity commitments help the politicians defend against the inevitable assault from finance. Here’s a taste at what’s at stake:

    http://www.bloomberg.com/apps/news?pid=20601087&sid=awwmvvMGIIXU

    “The crackdown could lower profitability by a third at Goldman, Barclays and Deutsche Bank AG’s investment bank, JPMorgan Chase & Co. analysts led by Kian Abouhossein said in a Sept. 9 report.”

    That’s right… a third. IMHO, it’s a good start. :) And that ripples through right to bonuses and return on equity (e.g., stock price). This issue NEEDS the public stage to even have a chance of surviving.

    Remember that to sustain their current level of credit activity, they’re going to need to acquire a lot more equity… This has a lot of implications.

  3. Now we know they aren’t even trying.

  4. The administration’s top priority is to return Wall Street to its way operating before the financial crisis.

    The attempt to “reform health care” is nothing but a noisy political contrivance which has successfully but only temporarily focused the public’s attention elsewhere.

    After health care reform fails (by pretty much every serious definition), the administration will need a new distraction to confuse us.

    I predict we’ll hear a whole lot more about the war in Afghanistan in the Fall season. And there’s always the old battle horse known as “global warming.” Or, with a little luck, hurricane season could get really exciting this year.

    Anything but denying bonuses from the big bank executives ….

  5. I have it on good authority that Obama will give the Chinese The Glare soon, which will make them behave better.

  6. This will be fruitless for the even more obvious reason that not only is the US not willing to pressure China to adjust its exchange rate, the US is not willing to save more itself.

    This applies to public finance – no one is proposing, say, gas taxes to offset the deficits – and private finance, where the government has been adamant that consumers SHOULD be buying more cars and houses instead of paying down debt and fixing personal balance sheets.

    That said, I don’t understand your criticism of the revolving door; do you believe that the government would be better served with people who did NOT understand the topic at hand? That’s a bit like saying that to avoid lawyers and politicians dominating a constitutional convention, you should just grab fifty people off the street.

    If you are the kind of person who understands finance and enjoys working with it, odds are you are going to work on Wall Street. Unless the government is going to start paying folks in the Treasury millions of dollars a year – and I can only try to imagine what the performance metrics would be – no one worth listening to is going to want to join the government if by doing so he gives up a quarter of his earning years in non-compete. I would rather have my economic policy made by Bob Rubin than Rahm Emanuel.

  7. How bout we develop at topic at hand that is understandable. Would your world be unbearable? What happens when you have a group of people doing things most people don’t understand is that they take advantage of everyone else. Do you prefer to see this continue? If Mr. & Mrs. Wall Street have a need to express their intelligence, let them go cure cancer, and figure out if we contribute significantly to global warming or not, not create and nurture financial cancers.

  8. Re #3, “interest rates were low 2002-2006 because of Alan Greenspan (who controlled short-term dollar interest rates)”: Brad DeLong seems to disagree with you (at least as to ultimate causes; proximately, of course you’re right). He wrote in :

    “Wicksell gave economists and central bankers: … a way to judge the central bank: it was doing its job of setting the market to the natural rate if there was neither unanticipated inflation–which would mean the market rate was too low–or unanticipated deflation–which would mean the market rate was too high. … That was what Alan Greenspan was trying to do in the first half of the 2000s: to set the market rate of interest equal to the natural rate. And he succeeded: there was neither unexpected inflation nor unexpected deflation.”

    That is, something pushed the natural interest rate below where it “should” have been, and the most obvious culprit is current account imbalances. That it was Western Europe rather than China that directly invested in the crazy investments doesn’t disprove this: if China eliminated the returns from safe investments, my Econ 101 understanding says that’ll push other investors into progressively crazier investments.

    That said, I’m certainly not competent to correct either you or DeLong. I’d like to understand why you seem to disagree.

  9. He can glare? Oh yeah…we saw Hillary reflect back one of his glares during the campaign debates, didn’t we…

  10. Excellent post, Simon.

  11. It would be marvelous if someone would comment on the contribution of theoretical inconsistencies on this whole matter… Why should any nation follow one or another policy when the theoretical ideas are not really understandable?
    In this blog I believe think there has been widespread agreement on the need for clarity in the language explaining financial instruments. Surely the same applies when discussing balance of payments theory.

    In basic international economics, theory demanded that flows of trade in physical goods be equal to the flows of capital in and out of a nation. I also recall the importance of only looking at an instantaneous stock of capital. Has the language in explaining balance of payments theory become more obscure? Does this maybe help sustain the disconnect between the nature of imports and exports of goods and services and the financial flows that make their way in and out of nations? Are students still taught to believe that these flows are supposed to be equal to one another? Or, have some mythical explanations evolved around this phenomena?

    Can anyone clarify in the above article; “…the international capital flows that sought out crazy investments came from Western Europe, which was not a significant net exporter of capital (i.e., a balanced current account is consistent with destabilizing gross flows of capital)”?

    Is someone working on this stuff?
    “The IMF definition: “Balance of Payments is a statistical statement that summarizes transactions between residents and nonresidents during a period.”[1] The balance of payments comprises the current account, the capital account, and the financial account. “Together, these accounts balance in the sense that the sum of the entries is conceptually zero.”[1]” http://en.wikipedia.org/wiki/Balance_of_payments

    thanks!

  12. Isuspect Chinese exchange rates will rise once the Chinese gov’t decides/realizes that they wont be able to grow by increasing exports to the US and their only hope of achieving the kind of growth they need to maintain the legitimacy of their gov’t is through increased domestic demand.

  13. Though I would not like to sound as dismissive about imbalances, especially when placed in the perspective of the growing public debt, I agree in principle, but NOT as to the substance:

    For instance I would not waste a second on “how credit rating agencies are paid” (as I would reduce much their importance, see next point) and if we are going for attack issues such as “financial sector compensation” I would much rather favor a broad approach, not limited to the financial sector, looking to restitute the powers of shareholders.

    With respect to “much tougher financial regulation, substantially raising capital standards,” I would just start by announcing a timetable to get all banks assets back on equal footing, 8% capital requirements. It will take time to work-out all the 1.6% or less in the system and we do not want to stop any recovery in its tracks before it has started. By the way this 8% requirement goes for government debt too. That would help the banks get back to the business of being banks.

    “workable cross-border rules for handling failed banks” Absolutely… Good luck!

    As to “a timetable for downsizing our biggest banks” No, most of the pressures for that will result in a natural way from equalizing the capital requirements and if that would not prove to be enough then, as I recommended in the World Bank in 2003, place an extra little insurance premium on size based on the bigger they are the more it hurts when they fall on top of you.

  14. “That said, I don’t understand your criticism of the revolving door; do you believe that the government would be better served with people who did NOT understand the topic at hand?” – Taunter

    Taunter,

    Do you actually believe the Wall Street participants understand what they have created? They are the fools that created this mess because they believed that recent trends could be forever extrapolated into the future. They are back to their old ways in bidding up the current market. Go read some of Taleb’s works and develope and understanding of the narrow self delusion that pervades Wall Street. Bernanke, Geithner and their minions actually seem to believe that all we need to do is get credit growth going again.

    The underlying issue is that credit growth has this by product…called accumulated debt. For the last 20 years, ever incremental dollar in net deb growth has resulted in less economic growth. This is becauase the debt has been used for consumption…which is increasingly offshore. So to maintain some semblance of steady growth…we have taken debt parabolic.

    How can credit growth be re-started again when we are over indebted. It can not….and nationalizing the mortgage credit segment is a perfect example of this. Mortgage credit in the US is almost all Gov backed now. Theses fools (with the ideas put in their heads by Wall Street) actually believed that they could prime the pump with Gov intervention…then step back. Wrong. Nothing is starting.

    The Wall Street mindset that led to this recent bidding up in equity prices is nothing more than the following:
    1. We are in a recession
    2. Recessions usually last X long.
    3. We are about that point
    4. Hey look…there is some less terrible data…thus the reccession will be over soon…BUY STOCKS!

    That is it. That is the mindless curve fitting that qualifies as wisdom on Wall Street.

    A good analogy for most in the financial sector (even at the highest, most rigorouse analytical levels) is that of an engine tuner. They know what happens when you change the mixture. They know what happens when you cange the timing. They know how to tweak all the settings. BUT THEY DO NOT ACTUALLY KNOW HOW THE ENGINE WORKS. When something is broken in the engine…they sit their tweaking all the settings because they can not recognize that something is broken…and the only way to fix it is to shut it down, and rebuild it.

  15. One more comment. For a healthy economy, the financial sector fullfils a support function. It enables value added industries, the true engine of growth, to function.

    A finance centered economy is a temporary abberation brought about by an environmnt of strong (usually unsustainably strong) credit expansion. Examples are the 1920s…and 1990 till 2008. The FIRE (finance, insurance, real estate) is dead. The financial elite just don’t realize it yet. They have pulled out all the stops to save it…and they think they have, but the impossibility of financing all the new public debt has not become apparent yet.

    We have reached debt saturation, where new debt service can not be paid for, so debt growth must stop. Defaults can not be papered over, or shifted to the public sector. There is no other optoins except failure. The conventional wisdom that the policies in the 30’s were failed, and cause the problem has led many to conclude that the problems were avoidable. They were not. The problem was not the 30’s…it was the 20’s. Same this time around….except the irrationl credit growth started in 1900…and lasted almost 70% longer than in then 20’s.

    One curious parallel. Income distribution. The previous modern example of skewed income distribution towards the top in the US was the 20’s. When finance takes over the economy in an irresponsible credit expansion phase, those in the financial sector are always positioned to siphon off huge profits. The same thing occured 1990-2008. The period following the GD was called the great compression by economic historians, and incomes equalized dramatically. This is what Wall Street is fighting tooth and nail to prevent now. They will fail…but it will take time. The longer it takes, the more corruption will be institutionalized, and the US will be damaged. The financial elite will take the ship down with them…if they can.

  16. I would be happy to make fundamental changes in Wall Street practices:
    http://tauntermedia.com/2009/09/08/reform-week-finance-industry/

    For what it’s worth, I disagree (and disagreed) with the bailouts, and believe firms that were unable to roll their financing should have been left to go through bankruptcy.

    All that being said, would you trust an auto repair shop that you knew (a) paid a tenth of other auto repair shops; (b) required its mechanics to sign five year non-competes?

    There are people on Wall Street who believe in charts. There are doctors who smoke. However, the overwhelming majority of people who DO understand finance are employed in the industry or were employed in the industry or will be employed in the industry within five years. Not all Americans are Kansans, but all Kansans are Americans…

    The Rubin proteges may have the entitled sense that failures in their accepted business model constitute force majeure as opposed to normal corporate events. But I would much rather place our economic fate with them than with, say, Maxine Waters, who sits on House Financial Services and has absolutely no idea what she is talking about.