By Simon Johnson
The April 2009 London summit of the G20 is widely regarded as having been a great success. The world’s largest economies agreed on an immediate coordinated approach to the global financial crisis then raging and promised to work together on banking reforms that would support growth. At the time, President Obama got high marks for his constructive engagement.
The G20 heads of government have met twice a year since London and in Cannes this week they meet again (November 3-4). Could this summit also help stabilize the world economy? And can President Obama again play a leading role? The answer to both questions is likely the same: No.
In 2009, the primary problem was slumping economies in the United States and Western Europe. It was in the perceived individual interest of those economies to engage in some fiscal stimulus – and they were happy to present this as a joint approach. China was also willing to stimulate its economy, as its policymakers feared slowing global trade would lower Chinese exports. President Obama’s appeal for fiscal stimulus around the world was pushing on an open door.
Now the issue is quite different. We have a sovereign debt crisis within the eurozone, in which countries that have borrowed heavily are facing the prospect of restructuring their debts. The eurozone summit last week established that Greek debt will fall by about half (relative to face value), although this does not clearly put Greece onto a sustainable debt path. The surprise referendum in Greece, announced this week, could build political support for the needed reforms. Or it could lead Greece to exit the euro and to default on its debts in a “disorderly” manner – meaning without any kind of international framework or outside financial support.
But the real issue is Italy, as it has been at least since the summer. The Europeans are only beginning to get to grips with the centrality of Italy in the European debt web – glance at Bill Marsh’s recent graphic to get the point. Italy has over 1.9 trillion euros in debt outstanding; this is the third largest bond market in the world. In the aftermath of the Greek referendum announcement, the yield on Italian debt rose above 6.1 percent – the standard view is that if this reaches 6.5 percent, Italy will need to seek assistance in the form of a back-stop fund, to guarantee that there will be no default.
But the International Monetary Fund does not have enough resources available and the existing European Financial Stability Facility is also likely too small. Informed observers talk of the need for more than 2 trillion euros in a “stabilization fund” and while there is a lot of fuzzy math involved in contemporary international financial rescues, the IMF and EFSF combined would be hard pressed to provide more than a third of that.
This might seem like a good time for a summit – so the hat can be passed around world leaders. And some people do hope that China could provide an enormous loan, either directly or working with the IMF. China, after all, has more than 2 trillion euros worth of reserves (not all in euros, of course; much of this is in dollars).
But it’s not clear China wants to take the credit risk of lending directly – the Europeans might not pay back, after all. And the US is not keen to have China funnel such a large amount through the IMF; this would undermine the traditional US predominance there. In today’s budgetary environment, there is no way that the US can come up with anything like matching funding at a level that would make a difference – would you like to ask the House of Representatives for $100 billion right now, to help keep Mr. Berlusconi in power?
And the heart of the problem is really European, not global. Specifically, the eurozone needs to address its underlying fiscal structure, which has become severely dysfunctional. They need a proper fiscal union, with the right to tax and to issue debt – backed ultimately by the European Central Bank. And the ability of member governments to issue new debt must be severely curtailed.
The US faced a similar problem, long ago. The original Articles of Confederation proved inadequate, largely because there was no centralized fiscal authority. The Constitutional Convention convened in 1787 in large part because the US had defaulted on its debts – incurred during the war of independence – and there was no way forward without a new agreement among the original 13 states and greater fiscal powers (and more) for the federal government.
Europe needs the equivalent of a constitutional convention. But today’s financial markets move so much faster than 200 years ago and the delay to date in Europe has already been excessive. The Europeans need to move fast. Will the Cannes summit speed them up?
An edited version of this post appeared on the NYT.com Economix blog today; it is used here with permission. If you would like to reproduce the entire post, please contact New York Times.