Markets: G20 summit
John Walsh looks at the differences emerging from the G20 summit and possible reforms to bridge the gap and get the global economy back on track.
Markets have been in disarray over the past month on the basis that the coherency and unity with which the world's major industrialised economies were tackling the global downturn was unravelling.
The G20 Summit in Canada (pictured above) held over the weekend of June 26-27th appears to have restored an element of calmness to the markets. But whether stability remains over the medium and longer term remains to be seen.
Equity markets looked like a one-way bet for most of the noughties. US consumers were soaking up two thirds of global exports. Needless to say, this credit binge was enabled by a low interest rate environment combined with a banking system doling out unhealthy levels of credit which, in turn, precipitated one of the biggest property bubbles across OECD countries.
When the words subprime entered market lexicon in August 2007, even the most seasoned commentators failed to predict the devastating consequences it would have for the global financial system and the real economy.
After all, for a number of years leading up to the credit crunch equity markets lived in almost splendid isolation from the real economy. Not anymore.
When the credit crisis showed its full teeth, there were fears that the downturn could turn into a full blown depression similar to what happened in the 1930s. What prevented such a scenario from panning out was the unprecedented global co-ordination among G20 countries in an effort to save the banking system. In terms of its initial objective, this has been achieved. But the world economy is still very fragile and there is less unanimity on how to tackle remaining and potential hazardous challenges threatening the recovery.
The bull market run which lasted from the early part of the noughties to 2007 was predicated on private-sector debt spiralling on an annual basis. Governments ramped up public-sector debt in an effort to stave off a perfect storm as the private sector retrenched and banks stopped lending. What to do with that public debt is now the almost trillion dollar question.
The EU has embarked on an austerity drive sparked by fears of a sovereign-debt crisis spreading throughout the EU triggered initially by Greece but with mounting pressure on the public finances of Spain and Italy. All euro zone member states have pledged to bring their deficits back within the 3% agreed limit by 2014.
Germany recently enacted legislation to made budget deficits unconstitutional by 2016. Then in mid-June, it announced an €80bn fiscal-consolidation package starting in 2011. The Obama administration argues that the EU threatens a double-dip recession on the grounds that a fiscal retrenchment could derail what is a very fragile recovery.
The EU's position is motivated by fears that if there is a debt default among a member state, then that could lead to a second round of bank losses across the region. That would have disastrous consequences for the real economy. These seemingly implacably opposed positions was the backdrop to the G20 summit.
"This misalignment in policy objectives was causing a huge amount of uncertainty and if there is one thing markets do not like, that is uncertainty," says Kevin McConnell, head of research at Bloxham Stockbrokers. There were other issues up for consideration. Most major economies have been looking for consensus on the level of capital buffers that banks should carry. The higher the capital requirements, the less capital available to transmit to the corporate sector.
In the event, the G20 was high on backslapping and smiles for the camera but achieved very little on a detailed agreement on how to plot the next phase of the recovery. There was a pledge to halve fiscal deficits by 2013 and stabilise debt-to-GDP by 2016. But this was the policy objectives of most countries anyway. Moreover, there was no firm agreement on capital requirements for banks.
"The two sides [US and EU] are both right and wrong," said Mohammed El-Erian, chief executive of the asset management firm Pimco in a recent article.
"Their impasse will persist until both understand that the debate is incomplete. In particular their discussion takes too narrow an historical perspective, looking excessively to the past experience of industrial countries as opposed to also reflecting that of emerging economies.
As a general rule, industrial countries need to adopt both fiscal adjustment and higher medium-term growth as twin policy goals. The balance between the two will vary. Some, like Greece, need immediate fiscal retrenchment. Others, like Germany, the US and Japan, have more room for manoeuvre. But no one should pursue just one of these objectives."
To begin to achieve both, countries must quickly implement what were once known in the emerging market speak as "second generation structural reforms".
"Basically, these involve enhancing the longer-term responsiveness of western economies that have had their comparative advantages eroded, and now see their populations stranded on the wrong side of significant global changes. Squaring the circle of growth and fiscal stability needs policies that focus on long-term productivity gains and immediate help for those left behind," explains El-Erian.
He argues that the political will to enact many of the needed policy changes is not there. But unless these reforms are implemented, then the future will be punctuated by low growth and periodic bouts of sovereign debt crises.
