The emergency meeting of the Group of 20 this Saturday, November 15, was called because the world’s financial system is broken. The crisis is shredding financial markets around the globe:
- It is driving currency markets into turmoil: currency devaluations are threatening all currency markets. Note the table below on the effects on the currencies of both developed and emerging markets:
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Capital markets are plunging into record declines. Just when they need foreign reserves to defend their currencies, Russia and Brazil, just to name two, are seeing massive outflows of capital. The graph below shows the stock markets for Brazil (EWZ), Mexico (EWM), Turkey (TUR) and Russia (TRF) over the last three months:
- Banks around the world are reeling from taking record write-downs of their loan portfolios. This has the effect of freezing lending to the business and consumer sectors.
- A world-wide recession is spreading and threatening to turn into a deflationary depression.
We urgently need the system fixed. The currency markets need to be stabilized; capital markets need confidence that their economies can be mended; banks need stabilizing regulation and recapitalization, and most economies need a massive dose of fiscal stimulation. It’s a tall order, and too much to expect from a single meeting, especially one led by a lame duck president with no idea of how we got where we are.
Even with this grim an outlook, however, I am optimistic that the coming meeting will be successful in beginning the process of recovery. It is too important to allow failure, and I believe that most of those in attendance know this. At the worst case, I look for this meeting to lead to another meeting next year, after our new President takes office.
Background of the G20
The G20 nations consist of 19 of the world's largest national economies, plus the European Union. These 20 economies are among the world's most strategically important. Collectively they comprise 90% of global gross national product, 80% of world trade and two-thirds of the world's population.
At a preliminary meeting last week in Brazil, the G-20 members met to discuss the upcoming conference in Washington. From the tone of that meeting, we can expect a different atmosphere than greeted the 44 nations that met in Bretton Woods, NH, in 1944—the last time economic circumstances demanded this kind of action. At the New Hampshire meeting all the attendees ultimately agreed with the plan offered by John Maynard Keynes, the great British economist and currency trader. His plan provided the structure of what would become the Bretton Woods Agreement. This landmark agreement provided for the Charters of the IMF and the World Bank, and it laid out a framework for international currency standards. The U.S. dollar was defined in gold, and all other currencies would be pegged to the dollar. The agreement is widely seen as facilitating the rebirth of world trade after the great depression and WWII.
We shouldn’t expect this kind of sweeping deference to the U.S. or any of the G7 members this time around. The emerging markets are no longer comfortable playing lap-dog to their richer neighbors. Mr. Bush tried to limit the solutions by trotting out all the old bromides about preserving “free market forces,” as if he has learned nothing from the current financial crisis. Mr. Luiz da Silva, President of Brazil, answered this with a statement of his own:
We need a new, more open and participative governance. This is not the moment for narrow-minded nationalism or of individual solutions.
There are two caveats that must be asserted in making any prediction about the ultimate outcome of this conference. The first is that little will be decided at the initial meeting. Mr. Bush, as the host, is the lamest of ducks on the American side, and it is not his time to be exerting leadership on an issue such as this. Furthermore, Mr. Obama, as President Elect, is not attending and will not meet with any of the foreign leaders during their stay. Mr. Obama did, however, announce late on Wednesday, that the former Secretary of State, Madeleine Albright and Mr. Jim Leach, a former Republican Congressman from Iowa, will be available to meet with foreign leaders on his behalf.
This is an awkward time in American politics, and Mr. Obama is probably correct in staying out of it in the first round. When the second meeting occurs he will have had time to consider the issues more thoroughly and will have the full force of his office behind him.
The second caveat is that neither this meeting, nor the second one, will likely directly address banking regulation. There will be fierce resistance by the American financial community to international regulations, so this issue is most likely to be left again to each nation to address. I hope that at the least there will be some consensus about minimum standards of protection of depositors, reserve requirements and full transparency of financial statements.
The main focus of the first meeting will be on getting the currency markets stabilized. The list of nations experiencing destabilizing currency movements is long. The approach up to now has been to take each country as a unique case. Russia, Poland and Hungary will probably be loaned massive amounts by the IMF to defend their currencies. Turkey is being pressed to borrow to support their lira, but they are resisting, trying to go it alone. Iceland has already received billions in aid from its Nordic neighbors, and more will come from the IMF. But these are all piecemeal solutions that beg for a more cohesive approach.
Currency issues will probably dominate much of the conversation of the first and second meetings. It will be a significant challenge to Mr. Obama to craft a solution from among these diverse nations. The old days of the United States dictating to everyone else are probably over; it will have to be a collaborative effort, supposedly something Mr. Obama is good at orchestrating.
Other items on the agenda have already been discussed by some of the participants. Europe has signed off on a proposal to increase the role of the IMF. They would give it increased powers to curb financial crises with more money to aid troubled economies. But this probably will not be sufficient to satisfy Brazil and other emerging markets. Brazil has long complained their representation in the IMF and World Bank is insufficient, and Mr. da Silva on Saturday said the G-20 is better positioned to forge new international financial regulations, because it more broadly represents both rich and developing countries. Expanding IMF membership may, therefore, become an important issue.
The last item on the agenda will be something of a coordinated fiscal stimulus to shock the economies out of their current doldrums. China has already announced a huge public works package, and the U.S., Britain and Germany are also considering spending measures that will help bring their economies to positive growth once again. A coordinated approach would strengthen investor confidence and go a long way in beginning the healing process. The amounts needed are huge. 2% to 3% of GDP are estimated to be required for the U.S. alone. Whatever they come up with will be shocking.
There will probably be some members who will suggest we return to the Bretton Woods Agreement. As a nostalgic idea, it has strong appeal. In my view, however, we should not look for a repetition of Bretton Woods. It served well in its time, but it would be insane to implement the same kind of specie arrangement today that was used until 1973. We abandoned the gold standard for good reasons, and we should stay off of it for the same ones. We cannot tie the world’s economies to the production of gold, platinum or any other commodity. There is much more to international monetary stability than any commodity can furnish. World prices tied to the luck of the mining industry are arbitrary and inadequate. Also, without the global respect that John Maynard Keynes commanded when he came to New Hampshire, the members will have to cobble an arrangement together that includes the needs of all participants, and that does not look to be easy.
The G-20 meeting is vitally important to the future of world trade, and I hope it will be successful in facilitating the financial recovery of all nations. If so, it could usher in another century of sound economic expansion. If not, we will be in for a long, slow recovery, and many of the emerging markets could be a generation away from recovering.
For currency traders, the situation presents a huge opportunity if they guess right, and a similar magnitude of punishment if they guess wrong. I am guessing on the eventual up-side for emerging market currencies, but I am skeptical about any immediate recovery. The wheel is in spin but when or where it will stop is far from certain.
