G7 at Bat

All eyes turn to Washington this week for the annual meetings of the International Monetary Fund (and World Bank), which will include the finance ministers of the world (up to 185 of them, plus entourages).

Naturally, before these events there is another meeting that – arguably – is where the real decisions are taken. This is the meeting of the G7 finance ministers, which by tradition takes place in the US Treasury on Friday (with the broader meetings being Saturday through Monday).  To remind you, the G7 is the club of the largest industrialized countries: the US, Canada, Japan, France, Germany, Italy, and the UK.

Some people regard the G7 as the group that is really in charge of the world.  But as you probably noticed by now, no one is really in charge.  Still, the G7’s voice carries considerable weight on many issues.

This is a particularly important week for the G7 for three reasons.  First, the world economy is in worse shape and heading in a more dangerous direction than at any time in the recent past.  Old hands cast their minds back to 1982 for anything comparable in terms of global circumstances.  But 1982 was the beginning of an emerging market crisis, involving default and devaluation in Latin America, Eastern Europe and various other middle and low-income countries scattered around the world.  Now we have a crisis in the core of the system, clearly in the US and Europe and quite possibly more widely.

The second reason to look to the G7 is that, this time, they really can do something.  Their main policy tool is the communique, which is a joint statement that you should look for late on Friday.  This will tell you what they think is going on, and what should be done and by whom.  Of course, the language will be fairly indirect, but at least in this instance it should not be too hard to interpret.  The statement is not binding on anyone, but it will give us an indication of whether they are on the same page.

The third point is that prominent members of the G7 seem already to be on different pages.  The four European members had an unusual pre-meeting today in Paris, and their messages seem to be about the need for more regulation, looser accounting rules, and a change in the compensation system for executives so they take less risks. We’ll see what is the US position by the time we reach Friday; we guess there will be less than full convergence.

At least on one point, there is already a large gap in views opening up.  The Europeans still want to rescue banks on a case-by-case basis, whereas the US has definitively switched to a systemic approach of some kind. Given the gravity of the situation, we prefer the US position at this point, and none of the current European proposals seem to bolster confidence: the problem in Europe was not lack of regulation, but rather failure to enforce existing regulation (fact: European banks bought a lot more collateralized debt obligations than anyone realized); looser accounting rules would open up a massive can of nontransparent worms (a lack of transparency helped get us into this mess, and it’s not clear how less transparency will get us out), and executives in all kinds of incentive systems took on, in retrospect, way too much risk recently.

The G7 could, speaking together, help to decisively break the crisis of confidence that still – at the end of last week – gripped financial markets.  The indications at this moment, however, are that this unfortunately will not be the case.