The US, the EU and China at the G20 summit

The differing concerns and priorities of the US, the EU and China in confronting the current financial crisis were reflected in their main proposals and recommendations to the G20 summit. T Rajamoorthy considers these and analyses their significance.

THREE significant issues associated with three different players at the recent G20 summit merit some comment.

One issue was the US drive for a huge stimulus package to kickstart the global economy. Despite attempts by US President Barack Obama to put a positive spin on the outcome of this issue at the summit, it is clear that the US failed to achieve its goal.

Here it's important to be clear about the nature of the fiscal package originally envisaged by the US. This was enunciated clearly by the International Monetary Fund (IMF), which had been behind this whole push for a global fiscal stimulus.

At a press briefing in Washington on 15 November 2008, IMF Managing Director Dominique Strauss-Kahn had put the case for such a stimulus in blunt terms: 'If there has ever been a time in modern economic history when fiscal policy and a fiscal stimulus should be used, it's now.' The figure the IMF had proposed was 2% of the world gross domestic product (GDP). More important than the actual percentage was the need for a coordinated effort in fiscal expansion. He argued that to be truly effective, the action had to be taken in unison, not separately and individually. As he explained in the press briefing:

'So our calculations are that the multiplier is one. What does that mean? It means that if you have a coordinated action with 1% of GDP of increases as a fiscal stimulus, either an increase in spending or a decrease in taxes, then the result will be 1% of additional increase in growth. One per cent is one percent. That's the multiplier. That's a lot. It's often argued that when you have a fiscal expansion of 1% the result on growth is less than 1% which is true when this action takes place only in one country. But when you're considering a coordinated action plan, then the result may be much higher and that's why we here in the IMF are arguing for weeks that it was time for coordination.' (emphasis added)

As for the countries expected to lead this effort, it was clear that the Organisation for Economic Cooperation and Development (OECD) and China were to constitute the vanguard. Hence, when US officials spoke before the summit about a unified plan of action for an economic stimulus, they had in mind a huge coordinated stimulus by the world's economically powerful nations.

Viewed in this context, it is clear that the fiscal package announced by British Prime Minister Gordon Brown at the summit is a caricature of what had been mooted. In fact, it is even doubtful whether a concrete fiscal package along the lines advocated by the IMF was actually adopted by the summit. In a section on 'Restoring growth and jobs' in the summit communique, there is a claim that the G20 leaders are 'undertaking an unprecedented and concerted fiscal expansion . that will, by the end of next year, amount to $5 trillion'. No particulars or breakdown of figures are provided. Curiously enough, the annex to the communique (Declaration on Delivering Resources) which was supposed to spell out the actual resources to make good the pledges made does not even mention the $5 trillion figure! The only conclusion that can be drawn is that no new resources are to be made available for a fiscal stimulus.

However, the summit did decide to make available additional resources to the IMF ($500 billion) and multilateral development banks ($100 billion). In addition, the summit decided on an increased allocation of Special Drawing Rights (SDRs) ($250 billion) and a $250 billion allocation to support trade finance. In a bid to cover up the failure to secure a proper stimulus package, an attempt was made to pass off this cumulative figure of $1.1 trillion as part of the stimulus package. While the size of the package is questionable (since the pledged sums may not materialise), the point is that it is nothing like the coordinated stimulus package which the US had originally proposed.

A sizeable portion of the $1.1 trillion package is in the form of loans to the IMF to be disbursed to developing and Eastern European countries in distress. While money properly disbursed to poor countries during a recession may afford palpable relief and may even help stimulate their lagging economies (since the poor will spend the money for basic needs, rather than hoard it), it is open to question whether disbursing the money through the agency of the IMF will have the desired result. IMF structural adjustment programmes have traditionally been designed to cut public spending (there is little evidence this has changed in recent years - see the article 'Development-blind G20 outcome empowers an unreformed IMF' in this issue) and hence may result in further shrinking of contracting economies. But aside from the pro-cyclical bias of IMF programmes, any such stimulus administered in individual isolated countries in the periphery cannot have more than a ripple effect on the world economy or generate the sort of massive multiplier effect the US had in mind.

Obama thus failed to get his stimulus package and the reason for this failure is clear. From the beginning, the European Union (EU), especially Germany and France, had opposed a huge stimulus and proposed instead a tightening of international financial regulations.

Financial market regulation

This brings us to French President Nicolas Sarkozy's claim that the 'Franco-German Axis' succeeded not only in deflating the US stimulus plan, but also in pressuring the G20 summit to agree 'to radically reform the international financial system'.

The summit's decision to 'reform the regulation of the financial sector' is anything but radical, however. On the critical issue of 'vulnerabilities affecting the [international] financial system', e.g., where existing banks and financial institutions take excessive risks thereby endangering the whole financial sector, the summit has tasked an existing body of regulators, given an enhanced mandate and broader membership (the Financial Stability Board), with monitoring, assessing and identifying any threat to the financial system before it erupts into a full-blown crisis. However, the Board has only the power to alert national governments to such an impending threat for action to be taken. It is thus a toothless body with no real powers to take any effective action on its own.

Much the same pattern can be observed on the issue of regulating financial institutions, markets and instruments. The summit merely agreed that 'all systemically important financial institutions, markets and instruments' should be subject to an 'appropriate' degree of regulation. But the question of what is 'appropriate' is left to national authorities! It is true that hedge funds have now to be registered and it could be argued that registration is better than no registration. But here too it is left to national authorities to determine what the 'appropriate' information is which they should be forced to disclose.

It is not difficult to see why leaving the actual regulation of financial markets to national authorities will defeat the whole aim of (using Sarkozy's dramatic phrase) 'ending the madness of this time of total deregulation'. The US has been resisting, even in the face of the current crisis, any serious move to regulate Wall Street. There are good reasons for this and an article by Bloomberg's Heidi Przybyla1 has explained why. For one, Obama is beholden to Wall Street financiers as during his presidential campaign, he received a record sum of $12.7 million in contributions, larger even than the $8 million received by Republican rival John McCain. He has surrounded himself with cabinet members and advisers (Timothy Geithner, Robert Rubin, Lawrence Summers) who made their fame, fortune and career by pushing through the deregulation of the US financial markets. Specifically, Summers and Rubin played a critical role in securing the passage of the 1999 Gramm-Leach-Bliley Act. The law repealed the 1933 Glass-Steagall Act, which had prohibited commercial banks from offering investment and insurance services. According to Przybyla: 'Summers helped craft the legislation, and Rubin urged Congress to pass it and [then President Bill] Clinton to sign it.'

Both Rubin and Summers also played a leading role in stymieing attempts by the US Commodity Futures Trading Commission (CFTC) to regulate over-the-counter derivatives on the ground that they posed 'grave dangers' to the US economy. While Rubin (along with Alan Greenspan) challenged the power of the Commission to impose regulation, Summers in effect intimidated Brooksley Born, the then chairperson of the CFTC, into retreating from this course by warning her that the banking community strongly felt that such a move would provoke an economic crisis. Ironically, it turned out that it was the very failure to regulate these 'explosive' financial instruments that contributed to the current crisis.

When Rubin left the US Treasury Department in 1999, he became an adviser to Citigroup and continued in that role throughout the period when the bank, as the second largest seller of collateralised debt obligations (CDOs), helped to ignite the current financial crisis. He made a tidy sum of $150 million at the bank.

Rubin was, as is well known, the mentor of the current Treasury Secretary Geithner. In a recent piece entitled 'Geithner, member and overseer of finance club'2, two New York Times journalists have highlighted his close links to Wall Street. They point out that in his five years as President of the New York Federal Reserve - 'an era of unbridled and ultimately  disastrous risk-taking by the financial industry' - Geithner 'forged unusually close relationships with executives of Wall Street's giant financial institutions' and that his plans to tackle the financial crisis have always been 'overly generous to the financial industry at taxpayer expense.' Already last June at a brainstorming session on emergency measures to stem the gathering financial tsunami, he had proposed that the administration 'should guarantee all the debts in the banking system'. His continuing concern for the welfare of Wall Street is reflected in the Obama administration's 'toxic purchase plan' to bail out the big US banks in distress.

Denounced by Nobel laureate economist Paul Krugman as a 'cash for trash' scheme, the plan will result in the transfer of hundreds of billions of US taxpayers' money to ailing commercial banks. In abandoning the alternative of public investment ('nationalisation'), it would appear that Obama has again given in to his Wall Street cabinet members and advisers.

But even apart from the US administration and the baleful influence of Wall Street, it is questionable how serious the EU itself is about the regulation of financial markets. It is telling that when Sarkozy was challenged at his press conference on how far the G20 had gone on 'the road to the radical reform of capitalism' which he had been calling for, he beat a hasty retreat by declaring that ' .we, Mrs Merkel [German Chancellor Angela Merkel] and I, don't want us to move from an absence of rules to an excess of rules. I want that to be clear.'

Clearly what is envisaged is 'regulation with a light touch' and this is reflected in a number of issues highlighted by the G20 summit outcome. On the issue of securitisation, what was agreed was that by 2010, the Basel Committee on Banking Supervision and national authorities will work towards agreement on 'quantitative retention requirements'. As Sarkozy explained, the proposed regulation will require banks involved in securitisation of assets to keep on their balance sheet only 'a percentage of the risk'. If his claim is true that in the debate on the actual percentage, the leaders could not agree on a figure of even 5%, it shows how minimal the proposed regulation will be.

On the important issue of regulations for the derivatives market, the G20 merely agreed to 'promote the standardisation and resilience of credit derivatives markets' through the establishment of central clearing counterparties subject to effective regulation and supervision. Most astonishing of all, the summit outcome then calls on the derivatives industry 'to develop an action plan on standardization'! In short, the action plan to tackle the problem of credit derivatives, which contributed so much to the crisis, is to be drawn up by the very industry that created the problem in the first place.

Chinese concerns

The third significant issue at the G20 summit was Chinese President Hu Jintao's call on the IMF to 'strengthen and improve its oversight of the macroeconomic policies of major reserve currency issuing economies ., with a special focus on their currency issuing policies'.

In essence, this was an articulation of China's increasing concern - as the largest holder of US debt - over the fate of the US dollar. This open and public expression of China's concern on this issue marks a decisive break with its policy of discreet silence which it had hitherto maintained. Perhaps what was particularly striking was the way this concern was pointedly expressed in the run-up to the summit.

In March Chinese premier Wen Jiabao voiced concern about 'the huge amount of money lent to the United States'. Confessing that he was 'a little bit worried', he expressed the hope that the US would 'maintain its good credit, honour its promises and guarantee the safety of China's assets'.

While this statement elicited a humilating assurance by Washington that the debts and assets were safe and secure, an article by Zhou Xiaochuan3, the governor of the People's Bank of China, on the eve of the G20 summit proved even more explosive. Dramatic Western media reports that he had called for the 'ouster of the US dollar as the international reserve currency' made the markets nervous. Beijing, some commentators claimed, was 'flexing its muscles' and indulging in 'sabre-rattling'.

A close reading of the article, however, reveals a sober proposal to overcome the problems posed by an ailing and depreciating dollar as the world's reserve currency. According to the governor, since the dollar is the national currency of the US, its use as the international reserve currency was bound to give rise to financial crises and problems. This was because of the inevitable conflict of interests between achieving domestic monetary policy goals and the international community's demands and need for a reserve currency. The way out, in the view of Zhou, is to create an international reserve currency 'that is disconnected from individual nations'.

Recalling that in the 1940s John Maynard Keynes, the great economist who led the British delegation to the Bretton Woods Conference, had proposed such an international currency (he had called the currency unit 'the Bancor'), Zhou expresses regret that the proposal was not accepted. 'The creation of an international currency unit based on the Keynesian proposal is a bold initiative that requires extraordinary political vision and courage.' The re-establishment of such a currency will also require, he is at pains to stress, 'a long time'.

In Zhou's view, the key role in the transition to a fully fledged super-sovereign currency could be played by the SDR, the unit of account used by IMF member states to settle any outstanding amount between themselves. In the words of the governor, the SDR 'serves as the light in the tunnel for the reform of the international monetary system'.

What he advocates is the greatly expanded use of SDRs until they in effect make the US dollar redundant as a reserve currency. To this end, he makes two concrete proposals.

Firstly, a greater role must be given to the SDR in the international financial system. While hitherto only governments have used SDRs, their role should be expanded to include their use as payment for international trade and financial transactions. In addition, financial assets and securities denominated in SDRs could also be created to popularise and expand their use.

Secondly (and crucially), a part of member countries' reserves should be entrusted to the central management of the IMF which should then set up 'an open-ended SDR-denominated fund' with facilities for exchange of dollar reserves for SDRs.

In this way the groundwork will be laid for increasing SDR allocations to replace existing reserve currencies.

It is clear from the above that Zhou sees the IMF as the key institution in carrying out the transition to a fully fledged super-sovereign currency. Presumably, once the transition is over, it will continue to manage the SDR as the world's reserve currency. It is also important to note that Zhou views the SDR fund not purely as an end in itself but also as a means to effect the transition.

However, the idea of such a fund located at the IMF with facilities to convert dollar reserves has attracted support from some US circles who see in it a mechanism to save the dollar. They conceive of such a fund as a 'substitution account' which can be established to enable official dollar holders, concerned about the falling value of the dollar, to  deposit and exchange dollars for SDRs. Such a move, unlike exchanges in the open market, will not depress the dollar. Thus Fred Bergsten, who was assistant secretary for international affairs at the US Treasury Department under President Carter, and who worked to develop such a facility in the 1980s when the dollar was experiencing a crisis, has come out in support of Zhou's idea.4

It must be noted that despite Bergsten's claim that Zhou's idea of an open-ended SDR fund is substantially his idea of a 'substitution account', there is a fundamental difference between the two. The object of the 'substitution account' is to salvage the dollar as a reserve currency to ensure its continued dominance, while Zhou's proposal for an open-ended SDR fund is designed to end it.

China's idea of a super-sovereign currency to replace the greenback has however elicited support (notably from Russia and, according to some reports, even Brazil and India) and chimes with the recommendations of a UN commission of experts on reform of the international monetary and financial system. The commission's recommendation, as part of its call for 'a new global reserve system', is for a 'greatly expanded SDR, with regular or cyclically adjusted emissions calibrated to the size of reserve accumulations'.

However, despite such support, China clearly has to tread warily as she is caught in a 'debt trap'. The more vigorously she pushes for an alternative to the US dollar, the more the value of the dollar will plummet and cause losses to her huge reserves. In fact, when the US Treasury Secretary responded to governor Zhou's proposal by merely saying that the US was 'open to the idea' of reducing reliance on the dollar, the dollar took a nosedive. A 'clarification' was necessary to arrest the descent.

Moreover, a sagging dollar will also adversely impact on developing countries among which China has the greatest influence. She therefore has to take steps to ensure that she does not alienate them.

Perhaps it was because of such fears that China did not specifically raise the whole issue of an alternative currency at the G20 summit. Instead, the issue was obliquely raised by President Hu when he called for greater oversight of the macroeconomic policies of major reserve currency issuing countries and developing a more 'diverse' and rational international monetary system.

However, with an eye on the summit, Zhou in his article had specifically proposed that:

'Efforts should be made to push forward [an] SDR allocation ... Specifically, the Fourth Amendment to the [IMF's] Articles of Agreement and relevant resolution on SDR allocation proposed in 1997 should be approved as soon as possible so that members [which] joined the Fund after 1981 could also share the benefits of the SDR. On the basis of this, considerations could be given to further increase SDR allocation.'

The London summit substantially accepted this proposal as clause 19 of the G20 communique reads:

'We have agreed to support a general SDR allocation which will inject $250 billion into the world economy and increase global liquidity, and urgent ratification of the Fourth Amendment.'

It may perhaps be premature to suggest (as some writers have done) that this decision on SDR allocation brings the world closer to a new global currency. A single allocation of SDRs is not going to reshape the existing order. It is clearly going to take many, many such allocations before there is even the prospect of a new international reserve currency on the horizon. It is going to be not only a long road but, in view of US and Western hostility to the very idea, a rocky one. And as each assault on the dollar results in a financial loss for her, China (especially if her export dependency continues) may well decide that the risks of a complete switchover may be too great and settle for the compromise of the SDR fund as a 'substitution account'.

However, that is all for the future. What is clear for now is that at the G20 summit, China served notice that she is no longer prepared to remain a silent observer of international financial developments. She has evinced an unambiguous intention to play a full role in shaping the new international financial architecture - a role which has clearly been greatly facilitated by her $40 billion contribution to the IMF's coffers and the proposed revision of voting quotas in this key institution.                                        

T Rajamoorthy, a senior member of the Malaysian Bar, is an Editor of Third World Resurgence.

Endnotes

1.         Heidi Przybyla, 'Why Obama won't bash Wall Street', Bloomberg Markets, January 2009.

2.         Jo Becker and Gretchen Morgenson, 'Geithner, member and overseer of finance club', New York Times, 27 April 2009.

3.         Zhou Xiaochuan, 'Reform the international monetary system', People's Bank of China website, www.pbc.gov.cn/english/detail.asp?col=6500&id=178.

4.         Fred Bergsten, 'We should listen to Beijing's currency idea', Financial Times, 8 April 2009.

*Third World Resurgence No. 224, April 2009, pp 10-13