On Thursday evening and all day Friday, heads of government from countries belonging to the G20 will meet in Pittsburgh. On paper, this looks important – 90 percent of world economic output and 67 percent of world population will be at the table: the G7 (US, Canada, Japan, UK, Germany, France, and Italy), plus the European Union, the largest emerging market countries (including China, India, Brazil, Mexico, and South Africa) and a few others. And unlike the G7, which is really a club for rich industrialized countries, every continent and almost all income levels are represented in the G20.
The last time this group met – in London at the beginning of April – they had one of the most productive summits in living memory, agreeing to triple the resources of the International Monetary Fund (IMF) so that it could help troubled countries, while also projecting an image of determination to “do whatever it takes” to avoid a Second Great Depression.
There could still be dramatic moments at or around the summit. There will be some street protests, mavericks could rock the boat (President Sarkozy of France is always threatening to do this), and there is always scope for mini-drama and quirky photos when so many heads of government rub shoulders.
But in terms of the economic agenda – and this meeting is supposed to be about the global economy – the likely deliverables look thin. Three issues are up for discussion.
First, whether the countries can agree on “rebalancing” global growth, which means – in its current iteration — that the US would commit to save more and China would commit to save less. But “commit” will not mean that the countries agree to any penalties if they fail to comply. The US may well save more as it struggles along the road to recovery – after all, households have been saving very little for over a decade – but this won’t be much or at all affected by any agreement at Pittsburgh.
Second, whether lower income countries can have more representation at the International Monetary Fund. This is a long-standing issue, which should eventually help the IMF rebuild the legitimacy that was sorely damaged by its handling of the Asian Financial Crisis in the late 1990s. Unfortunately, real progress on this issue is blocked by some rich West European countries, who are overrepresented at the IMF for historical reasons and who would lose out in any reshuffle; they will not be in Pittsburgh and there is no sign of any new concessions from this side.
Third, to what degree and precisely how financial regulation will be tightened around the world. Here there is scope for a deal, with the US pushing for higher capital requirements for banks, while the Europeans (and Mr. Sarkozy in particular) are demanding changes in how bankers are compensated. These are crucial question, but here we face our greatest potential disappointment.
The open secret is that even the US is not pushing for significantly higher capital requirements – the US Treasury view is that our largest banks currently “have enough capital,” even though Citi and JP Morgan have roughly only about as much of an equity cushion against losses as did Lehman Brothers the day before it failed. So the US proposal is largely meaningless – which does not prevent the continental Europeans from opposing it; many of their banks are very thinly capitalized but their governments don’t want to draw attention to this fact.
The Europeans want, instead, to focus on how bankers are paid. Compensation systems in big banks encourage reckless risk-taking, but more this is more of a symptom than a cause. Unless the underlying causes are tackled – the excessive size of our biggest banks, their thin level of capital, and the revolving door that has top Wall Street people running bailout strategy in Washington – changing compensation rules would just increase the effort that smart lawyers and accountants put into figuring out new ways to pay people.
If the G20 fails to deliver, is it really possible that we are doomed to repeat the same mistakes with regard to building up vulnerabilities in our financial system? Amazingly, the answer is: a definite yes. How can this happen, with so many smart people in government? Unfortunately, it is not about having clever individuals on the job; it is about their incentives, their world view, and whether or not they really face pressure for change.
During World War I on the Western Front, well-educated British generals with great practical experience insisted on repeating the same mistakes again and again, at great cost. Democratic oversight, in that context, was worth little. If you delegate to “experts” and they fall into dangerous groupthink – and are allowed to construct sophisticated sequential cover-ups – expect the worst.
By Simon Johnson
This is a slightly edited version of a post that first appeared on the NYT’s Economix. If you would like to reproduce the entire post, please contact the NYT for permission.
The Baseline Scenario 
So the executive summary is, “No” ?
…
Re: #1. Whether the U.S. saves more largely depends on whether China continues our “vendor financing” relationship. Any evidence on this one, either way? (Sometimes I really miss Setser’s blog.)
No!
I think that sitting in our ‘virtual peanut gallery’ it is far easy to be critical of the intention of the G20. When we think about the events of the past year and the desperate policies to save the financial system from doom through massive injections of liquidity – everything is happening far too quickly for the necessary systemic changes to make any headway.
The huge injections of liquidity are bound to cause a continuation of volatility in world financial markets. (What happens if a drunken alcoholic wakes up from a hang-over to find a new 26 ounce bottle of booze?) The increased liquidity in financial markets is bound to generate a proliferation of machinations based on instantaneous reactions to
possible contact with money. Anyone not reacting as such – as in the example of Morgan Stanley in the link above to the NYT blog “Taking a Chance on Risk” – misses out on the action.
In general real innovation and investment take thought, time and effort (like the regulatory changes needed in finance) – none of which fits into the schematic or the “force field” that has harnessed the liquidity injections of the past year.
In spite of all this, the G20 matters. It may have utterly inadequate capacity to make the sort of regulatory and structural change that is needed. However, it remains an important symbol of effort to share political power on the international stage. The next question is; when the intellectual and theoretical change that is needed to re-store sanity to markets finally takes hold, (why not hope this is possible?) will bodies like the G20 still be around to help keep the idea democracy alive on the international stage?
Yes – we should care.
I applaud your comment. It’s so easy, with much justification, to become angry, cynical, and deeply negative about what’s happening. But that way, en masse, leads to social unrest with all the terrible implications thereof.
I believe it was Churchill who was quoted as saying, “It has been said that democracy is the worst form of government except all the others that have been tried.”
“If you delegate to “experts” and they fall into dangerous groupthink – and are allowed to construct sophisticated sequential cover-ups – expect the worst.”
That to me is a perfect description of the Basel Committee and their buddies
More than applauding your comment, it has prompted a Post on Learning from Dogs that will be published on Sunday – thanks for the inspiration.
Yes, we should, but not for any of the official reasons.
http://dailyreckoning.com/the-real-and-untold-g-20-story/
The big development most likely will be china unloading discounted T-bills to the IMF in exchange for about $14 billion gold bullion.
Outside of national elections to call ourselves a democracy is myopic since corporations and their interest lobbyists who control Congress and the oligarchs effectively rule USA.
Some comments:
1) Even if the US merely legislates capital requirements that match current levels, that’s still better than where we were. It may feel worthless now(and therefore be easier to pass Congress), but the effect will be felt as the economy (hopefully) improves and banks are prevented from returning to the worst of their ways. Ideally, we will phase in stricter capital requirements over time, too. I’m not saying mandating current levels is good, but it isn’t completely worthless. I still struggle with the Lehman failure since they _appeared_ to be “well capitalized” and clearly their executives did, in fact, suffer huge personal wealth losses from Lehman’s failure… This suggests we need to look at one of the competing explanations – like black swan events or animal spirits. Neither satisfying since both are hard to fix.
2) Just to clarify from previous comments, restoring balance to global currency/consumption/exports is important (even though the G20 is not the right forum for pursuing this goal) because it is strongly related to finance regulation and monetary policy. This is because Fed policy is highly constrained by international currency flows and expectations. I have argued before that the threat to the dollar helped push the Fed’s attack on the commodity bubble in July/August/Sept. 08, and kept the Fed committed to an anti-inflationary policy line all the way through March of 09, which very much helped accelerate an unnecessary asset price collapse. Some would argue (especially after seeing the spectacle of Geithner and Clinton flying to Beijing to beg for continuing commitments to buy US debt) that an implicit threat from foreign central banks to withdraw support from US debt auctions prevented the Fed from moving earlier.
The Fed is discovering just how much monetary policy, like fiscal policy, is constrained by international flows (trade and capital) when there is lack of coordination. We already know that asymmetric fiscal stimulus “bleeds” into other economies through imports. Asymmetric monetary stimulus also bleeds, it seems, though conventional macroeconomists don’t seem to be getting this yet. The bleed occurs through asset price inflation induced by expectations of devaluation. In other words, the fed can run Monetary stimulus, which decreases investor willingness to hold dollars. In a closed economy, this forces investors into other assets – including investment assets. Investment/consumption spending surges, restoring the investment/savings equillibrium (which was broken by a spike in perceived default risk) as holding cash or reserves becomes unattractive and higher demand decreases default risk.
In an OPEN economy, however, this can simply force investors into non-dollar assets, including foreign investments and investment in commodities and exporting firms. In other words, capital flight. Note the recent trends in the markets… The extreme of this is an anti-dollar carry trade in which investors borrow at low US dollar rates and buy foreign government securities. This depresses the dollar, and accelerates devaluation – which might normally be stimulative, unless it results in commodity driven price inflation. But even commodity inflation might be OK (it finally got us to seriously think about our oil addiction).
But devaluation is politically difficult because China vigorously opposes this (for fear of devaluing its currency reserves) and at the same time does not want to allow the dollar to depreciate for (apparently) fear that it will lose its export advantage and go the way of Japan in the lost decade. China, in short, wants to have its cake and eat it to… They want to maintain a huge export surplus to a country whose currency does not depreciate, and the only way this can happen is if that country (the US) keeps borrowing ever larger sums.
All of these imbalances are playing havoc with monetary policy. So how does this relate to financial regulation?
Because if we institute financial regulation (like higher capitalization requirements) we NEED to inject cash liquidity into the system to compensate for the lower velocity of money. Otherwise, overall money supply drops rapidly, and we risk deflation. This means the Fed needs to keep printing money, yet these visible efforts drive expectations of inflation/devaluation which are much worse because we continue to accumulate greater debt to forieign countries due to trade flows.
The trio of issues – capital asset ratios, financial regulation, and trade flows – are all linked through the value of the dollar and Fed policy. But G20 is a bad place to discuss a massive deal on trade flows. Most likely, we’ll get nothing more than Geithner’s vacuous “emerging consensus”.
But if we don’t fix the structural problems, then the Fed’s ability to regulate the economy through monetary policy is impaired.
Worth reading:
http://delong.typepad.com/sdj/2009/09/second-best-punchbowlism.html
http://www.washingtonpost.com/wp-dyn/content/article/2009/09/22/AR2009092203737_pf.html
http://curiouscapitalist.blogs.time.com/2009/09/23/why-china-should-stop-piling-up-dollars-and-why-it-wont/
I read in today’s FT that the US is again arguing with Europeans reluctant to give up seats on the IMF board, to make room for India and China.
That is a great and necessary move…but why is the US pushing this, rather than the Chinese and Indians themselves? Is the US getting anything in return? Is FX re-valuation (INR and CNY) the basic objective?
StatsGuy writes: I still struggle with the Lehman failure since they _appeared_ to be “well capitalized”
Yes appears is the code word… because if you reduce the assets exposure by applying risk weights of only 20% or less… anything can appear to be well capitalized”
A 1.000 billion exposure to AAAs is only reflected as 200 billion.
If you then have 16 billion in capital and you look at 200 billion investments you see an 8 percent equity a 12.5 leverage and you will say “it appears to be well capitalized”
but the hard and cruel reality, the way you have been misled by Basel is that it could be 16 billion for a 1.000 billion exposure only 1.6 percent in capital and a leverage of 62.5 to 1 …does not appear reasonable any longer!!!
So, Simon, help me understand why the April G-20 meeting was “one of the most productive summits in living memory.”
As I understand it the G-20 elites voted to give money from the G-7 treasuries to the IMF. The IMF would inturn, make loans to Iceland and Eastern Euro countries so that they could go in hock bailing out the the G-7 banks who made bogus real estate loans to the locals.
So, the IMF was simply a conduit for the G-7 to further bailout their own banking elites.
This is productive?
Is it “groupthink” or the failure of economics? Is it not more likely a more toxic combination of both? The struggle of relying on inadequate out-dated theory has fueled increasingly unsuccessful meetings of experts over the years. If theory had capacity to be more comprehensive or reflective of our reality there would be a greater liklihood of agreement amongst economists. It is not at all surprising that economists are increasingly splintered in thought. Maybe ‘delegating a group of experts’ to come up with solutions reflects the level of desperation of intellectual leadership to deal with the scope of economic crisis…
Yes you have a point but let me tell you why first and foremost I believe it is “a groupthink failure” and as I was a frontline witness of it though not belonging to the club.
When you have an group of regulators in a room and hear them coming up with what they believe are fancy and sophisticated ways of living out their bedroom fantasies of a world without any bank crisis; and these regulators device a system of capital requirements for banks based on risk assessments made by credit rating agencies; which allows among other that a bank can leverage its equity 62.5 to 1 times as long as there is an AAA rating involved…and there is not one single hand allowed to go up and pose the simple question of: “what if the credit rating agencies are captured by other interests or as humans are just fallible? Well then my friend, you just know you find yourself within a quite dangerous incestuous groupthink group.
As an Executive Director in the World Bank I saw it happening right in front of me, which is why, in a letter that the Financial Times published in November 2004, before FT censored me, I wrote:
“We also wonder how many Basel propositions it will take before they start realizing the damage they are doing …. Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters trying to avoid bank crisis at any cost – even at the cost of growth.”
What an interesting experience… It must have been pretty frustrating to be witness such incestuous groupthink at such a high level. I can imagine how dismayed you must have felt – especially if you entered into the gathering with a sense of hope.
I think though that unfortunately the groupthink happens again and again at many different levels, starting from the base levels of academia. As a result, the head games replicate themselves as a cultural phenomena and the exercise of actually questioning anything is routinely censored (from the bottom up). However I think this still boils down to the intellectual insecurity that surfaces when there is failure of theory… If little lies and unreasonable assumptions underlie everything (and can not be questioned) – then any quest for knowledge can be turned into a head game – and at any level of social or political rank.
There is a substantial argument that much of the currency problem in eastern europe was really (truly) a liquidity problem (unlike many US banks which had a solvency problem). They had short term debt obligations during a credit contraction, which was causing currencies to plummet, yet short term exports had dropped and they could not buy enough foreign currency to hold steady. Many of the Eastern European governments were not fundamentally insolvent. Iceland was another matter entirely.
Yes it was extremely frustrating, as I was extremely hopeful. But “groupthink” comes in many way and forms when small-spirited organizations clam up in self-defense and so one has to learn to ignore it and keep ones own spirit high… (which is also why I keep on sending letters placing them in bottles on the internet ocean, and hoping someone somewhere will in the future open and read them with interest)
Put our feeble leaders on a diet high in moral fiber. It not only raises the energy level but also results in a 30 – 50% increase in political longevity – the last obviously being what it is all about for this bunch.
Pittsburgh’s G-20 story: Take an expressway from town and disappear into desolate ‘hoods and encounter the civilization of menace. Pittsburgh, a dual city! The glass wonder of PPG Place and/or the G-20 Summit is a faded memory. Here in the ‘hood lives lie abandoned as far as the eye can see.
That is: For the most part, African-American Pittsburgh seems to be invisible, not only to the public relations hucksters who tout Pittsburgh’s successes, but we are equally invisible to the protesters.
Certainly, black Pittsburgh is as proud as anybody in that the black President we worked so hard to elect has selected Pittsburgh as the host of the G-20 Summit. We even enjoy the re-invention of Pittsburgh from a dirty, smoky steel-churning history to the bright, clean, green financial success that the business leaders and politicians boast about so loudly. Nobody is more proud of the Super Bowl winning African-American coach of the Pittsburgh Steelers, Mike Tomlin. But none of that feel-good stuff erases the pain of the stubbornly high unemployment among African American young adults and the staggering dropout rate for young black males from the public school system.