The G7 was originally conceived as a form of steering committee for the world economy (antecedents).  Existing formal governance mechanisms, around the IMF and the UN, seemed too cumbersome (and too inclusive) during the 1970s, with the breakdown of fixed exchange rates, assorted oil shocks, and the broader shift of economic initiative towards Western Europe and Japan.

And the G7 had some significant moments, particularly with regard to moving exchange rates in the 1980s.  More broadly, behind the scenes, it served as a communication mechanism between the world’s largest economies (“coordination” is a dirty word in G7 policymaking circles).  And it was probably a good thing in the 1990s that Russia wanted to join the G7 – hence the G8 once a year, although many of the most important technical meetings are just the G7.

But today, honestly, what’s the point?

The L’Aquila summit seems likely to achieve nothing, i.e., nothing that could not have been agreed upon in a conference call among deputy ministers.  Just because there’s a communiqué does not mean it has any real content.  Does this kind of expensive pageant make politicians today look important or frivolous? 

More broadly, three longer-run shifts mean the G7/G8 is increasingly anachronistic.

First, emerging markets have obviously risen in both respectable clout and ability to make trouble.  China’s exchange rate policy is a leading example, but think also about Mexico, Brazil, or India.  Having a global economic discussion (e.g., on climate change or aid to Africa) without these players fully at the table does not really make sense – particularly as the G20 now operates effectively at the heads of government level.  And inviting these countries to a dinner or other event on the fringes of the main meeting just adds insult to injury.

Second, the Europeans are now organized into a loose political union and all of the major economies – except the UK – are in a currency union.  What is the point of sitting down with Italy, Germany, France, and the UK separately?  It is much more effective when they – and other Europeans – work out common positions and bring those to the table collectively.  The European Union belongs to the G20 but not the G7. 

Third, the idea that the US and its allies “lead” by any kind of economic policy example is plainly in disarray.  The recent crisis focuses our attention, but we’ve seen two or three decades with irresponsible credit and throwing fiscal caution to the winds across these countries.  These countries traditionally position themselves as “G7 models” worth emulating; this message needs to be toned down.

President Obama obviously has a talent for diplomacy (e.g., at the April G20 summit).  He should use the Pittsburgh G20 summit in September to transition away from the dated emphasis on the importance of a G7/G8 heads of government meeting (e.g., reduce the excessive display of nothingness, lower the hype, have it feed into the G20 more explicitly).  Canada, chair of the G7 next year and usually very sensible on these kinds of issues, can help.

The G7 is still a useful forum for senior staff meetings on some technical issues, but it would be much more appropriate and effective for the high profile pinnacle organization to be the G20, not the G7. 

By Simon Johnson

If you’d like to attend the G8 Ministers of Finance meeting this weekend, the Italian Ministry of Finance has put out a handy travel guide.

Alternatively, take a look at my preview on The New Republic’s website.  Our leadership appears to be resting on its laurels after the April G20 summit – or perhaps they think the next G20 summit in September is the place for real discussion.  Regulatory reform still needs (a) to happen in a meaningful sense for the financial sectors in all industrial countries, and (b) to be closely coordinated across countries – if your bank is too big to fail in my country, whose problem is that and whose taxpayers are on the hook?  But gone completely from the G7/G8 ministerial level is any sense of urgency; all we’ll hear is self-congratulation.

And in terms of macroeconomic policy, discussed in a piece with Peter Boone on the NYT’s Economix this morning, current global early warning signs (higher oil and other commodity prices; rising long-term yields) are being interpreted by policymakers as indicators of success and return to “normalcy”.  It reminds me of official discussions in early 2007 – no matter what weakness you could point out in US housing and European banking, leading G7 policymakers were completely in denial, with articulate arguments about why they were right. 

Incrementalism is the preferred policymaking culture of G7 ministries of finance and central banks, and they are very much back in that mode.  But if you put incrementalism together with refusing to really change the rules for banks and huge, unconditional support for credit that is hard to withdraw, what do you get?

By Simon Johnson

The global crisis approaches another major twist in its downward spiral.  A key barometer of financial and fiscal pressure – the credit default swap (CDS) spread – has widened sharply for Irish government debt over the past few days; the markets think that the risk of a sovereign default is rising sharply.  Immediate action is needed to forestall a dramatic deterioration of growth prospects across Europe and around the world.

The G7 ministers of finance and central bank governors met today in Rome.  It was a great opportunity for this group of leading industrial countries to reassert its leadership in the global economy, taking strong preemptive action to prevent a recurrence of the calamitous days and near total financial collapse of September/October 2008.

Instead, all we received officially is a communique that blandly restates what these documents always say: we are opposed to instability and we are working on it, honestly.  When an official has nothing to say, he or she talks about “principles” – and this was a pure principles communique (e.g., see their 3rd and 6th paragraphs).  Nothing new or even vaguely reassuring.

Unofficially, it appears the situation is even worse.  The G7 is signalling a lack of support for various key countries that are in the line of financial market fire.  This is irresponsible, short-sighted, and bound to lead us all into great danger. 

G7 effectiveness is at a low point.  Why?  The Europeans are in denial, particularly regarding the way their banks and their broader economic and political elite contributed to the global financial fiasco.  The Americans are distracted, to put it mildly, while they search for a policies that make sense.  There is a great deal of unproductive finger pointing within the G7.

But the real issue is that no one is yet ready to take on the deeper underlying problem – the political power structure of modern finance.  While this structure is a particular problem – and particularly obvious right now – in the US, all industrialized countries today share some version of the same problem.  We supersized our banking systems, allowed them to load up on risk that could threaten the macroeconomy, and gave them a mindboggling put option – in other words, the taxpayer is on the hook for a vast amount of downside.  Across the industrialized (and coming soon to the industrializing world), the message from bankers is the same: give us the bailout money, or your economy will suffer.

Coming to terms with this reality and doing something about it will take leadership – the skills, popularity, and vision needed to really take on bankers (and preferably, win).  That leadership is unlikely to come from Europe, Japan, or Canada.  It’s also unlikely to come from the G20 (which is basically the G7 plus large emerging markets), whose next heads of government meeting is on April 2nd.

Everyone and everything, in some sense, waits for the US and for President Obama.  How long will it be before he is able to fully and personally take charge of sorting out banking at home – and help those trying to do the same abroad?

If you see any other – even slight – glimmer of hope in this situation, post it as a comment here.

The G7 did speak on major exchange rates, over the weekend, as expected. But they only spoke about the yen’s “recent excessive volatility.”  This was about the least they could say under the circumstances, and it is not clear that it will do anything – other than encourage further flows into the dollar.

Why did they not mention the dollar, the euro, and the British pound? One possibility is that they are happy with the appreciation of the dollar and the depreciation (falling value) of the euro and the pound. This would be a bit strange, given that dollar depreciation – from 2002 through the summer – was considered by the G7 to be a reasonable component of the global adjustment process that would put current accounts onto a more sustainable path (yes, notwithstanding “strong dollar” statements from the US.)  The dollar was getting close to what the G7 (and the IMF, who do a lot of the technical work in this regard) saw as a plausible “medium-term” value, at least as measured against a broad basket of currencies.  Now the dollar has taken off (i.e., rising in value against almost all currencies). How does that help with anything?

It could be the case that the Europeans like the depreciation of their currencies, as this will help cushion the recession.  The falling value of the euro makes interest rates cuts in the eurozone less likely, because the European Central Bank (ECB) will see the depreciation of the euro as helping the real economy and also increasing (their) fears about inflation.  But given the ECB’s obsession, even today, with inflation – and thus its unwillingness to cut interest rates, come what may – it might be that depreciation is the eurozone’s best short term hope (as well as its likely medium term future, as sovereign risks materialize for smaller countries).

Still, it would be odd if no one at the G7 table isn’t already raising the dangers of deflation (falling prices), particularly in the US – I’m looking at the representative of the Federal Reserve at this point.  Commodity prices are falling worldwide and now the price of imports into the US will decline sharply.  If this feeds into low prices (i.e., a lower price level, not just slower inflation) then short-term, of course, US consumers benefit.  But if lower prices lead to lower wages, then just think what that does to anyone’s ability to pay their mortgage or any other debt – these are almost always fixed nominal amounts.

When people talk about avoiding the mistakes of the Great Depression, they mean in large part not allowing prices and wages to fall.  And the faster and further that the dollar appreciates, the more likely we are to worry about deflation.

What then are the internal G7 dynamics?  Based on what we saw, and didn’t see, this weekend, I would guess that recriminations and nonconvergent policy views prevail. The spirit of cooperation we saw around bank recapitalizations, just two weeks ago, must have evaporated.  We may not want to rely on the G7 to lead the way.  Can I interest anyone in a G20 summit?

Saturday, October 11, 10pm.

The world’s finance ministers sat for several tests this weekend, and it’s not yet clear how they did.  If we set the bar low enough (i.e., no public criticism of each other), they did OK.  The Italian finance minister did threaten not to sign the communique on Friday afternoon, but this was not particularly meaningful (think about it: if Italy walked out of the G7, how would the markets view Italian risks on Monday morning?)  Everyone else was reasonably polite.

But if we were hoping for specific steps to be announced, then Friday’s list of principles from the G7, and the ensuing vague statements of support from other sets of finance ministers on Saturday have really not taken us very far.

Still, there is time for a make-up test (or two) on Sunday.  The US Treasury is undoubtedly working on some detailed measures to shore up parts or, hopefully, all of the banking system.  Eurozone member countries will be meeting in France on Sunday afternoon, presumably to see how far along they can bring the Germans – particularly with regard to systematic bank recapitalization.  It remains unclear whether anyone in the eurozone will suport the British ideas of blanket bank guarantees at this point.  And it is far from clear if the British will introduce the kind of overall package that in our view could turn the corner, even in a local sense.

The goal, as you know, is to get a clear strategy in place and well communicated by the time the stock market in Tokyo opens at 8pm (US East Coast time) on Sunday.  Let’s see how they do.

As we’ve discussed previously, this weekend’s meetings of the G7 and the IMF are crucial to halting the financial crisis. This weekend, we’ll be updating you on events as they happen.

Update (Friday evening): The G7 statement is pretty much a general set of principles with which it would be hard to disagree, with very little by way of specifics and really nothing that we hadn’t seen before.  Mr. Paulson’s statement today was similarly vague, although Treasury continues to signal that it will launch some sort of recapitalization program.  I know they want to exude calm and confidence, but the sense of urgency that had building in the last couple of days seems to be slipping away from them.

Update (Saturday morning): Reaction from around the world is mostly disbelief.  Could it really be the case that the G7 does not understand that trade credit is under pressure everywhere, that financing for new projects is drying up, and that Iceland’s experience sends a dangerous signal to investors?  Our piece in the Washington Post Outlook section lays out the very real dangers.  Unless the G7, separately and jointly, act more decisively by the end of Sunday (yes, tomorrow), I’m afraid that next week could be quite difficult.

Update (Sunday morning): Reliable sources indicate that the eurozone member countries, who are due to meet today at the invitation of President Sarkozy, may well be able to announce agreement on some sort of parallel bank recapitalization scheme(s).  It is also hard to imagine that the US will let the day go by without a major announcement.  But it will take a great deal of detail in order to be credible at this point.  And the question of who is and is not given a place on the Great Ark for Bankers will be much on our minds.

We already know that at least some people in major European countries (Peer Steinbrueck, this means you) are mad at the U.S. for “causing” the global financial crisis. But while many of the rest of the G7 are at least complicit – European banks were buying large piles of the same mortgage-backed securities that set of the crisis in the U.S. – many of the world’s less-developed countries may be even madder at the U.S. Henry Paulson has called a meeting of the G-20, which includes some of the larger economies outside the G-7, for this weekend. The hope is that it will help dampen strife between rich and less rich countries, all of whom are being affected by the crisis.

For the reasons I laid out last weekend, the G7 meeting of finance ministers today could be pivotal.  The G7 and their close allies are the epicenter of the global crisis, and they most definitely have the financial resources and combined brainpower needed to turn things around, starting with bold, decisive action today.

They cannot do it with a Business-as-Usual approach, and there are already signs that some of them (US, UK) are inching in a more dramatic and even coordinated direction.  It would be unreasonable to expect them to make one gigantic leap today to a complete solution.  Even if major players now think this is the only sensible way to go, such a sudden move would be inconsistent with how G7 governments operate internally or interact with each other.  Nevertheless, there will be unmistakable signs today, in their communique and related communications, regarding how long we will have to wait for decisive action.

Here are three things to look for:

1. The extent of recriminations.  These are obviously unproductive at this stage.  If the German finance minister (Peer Steinbrueck) can refrain from saying negative things about the United States, that would be encouraging.

2. Statement of the problem.  Jointly and separately the language used to describe the severity of the situation is important.  In the Business-as-Usual approach, officials hate to use negative language about the direction of the economy, for fear it would be self-fulfilling.

3. Detail on next steps.  Ideally, there will be a road map, with a timetable on when different countries will adopt various kinds of measures.  If all they can agree on is a vacuous statement of principles, we are in trouble.

Update (by James): PRI’s The World led off Friday’s show with a discussion of the G7 and IMF meetings, including an interview with Simon.