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What the G20 should do at Los Cabos

RP’s Diary

“The global recovery has stalled again as confidence in policy makers’ ability to provide conditions for growth has slipped away” writes Chris Giles of the Financial Times, in his report from Los Cabos on the opening day of the G20 meeting there. According to the latest FT/Brookings Institution Tiger Index, world economic growth is stalling after its initial recovery from the 2008-09 economic crisis. Growth in the US is slowing, much of Europe is in recession, China’s growth outlook has weakened, the reform processes in India have stalled and other large emerging economies have slowed dramatically.

Giles’s phrase encapsulates the argument of “The Money Trap”. Governments must create conditions for growth. Until they do so, the world economy will remain weak, irrespective of what happens in the eurozone. A solution of the eurozone crisis would not get us out of the trap. It would solve one problem only to reveal others. Indeed, success in Europe could precipitate another global recession. Why? because it would produce a rapid rise in the euro against the dollar and other leading currencies, undermining Germany’s export boom and putting still further pressure on weak euro economies and government finances. Unless coordinated action were taken to stabilise leading exchange rates, recession could spread round the world from Europe.

There are two ways in which governments can attempt to provide “conditions for growth”. One is by spending more themselves; this is the Keynesian pump priming route practiced by the G20 in 2009 and recommended again by former UK prime minister Gordon Brown and by the economic commentators of the New York Times and Financial Times, such as Paul Krugman, Martin Wolf and Sir Samuel Brittan.

But financial markets have shown the terrible punishments they can inflict on countries that have lost their confidence – governments that are not doing enough to bring their national debts under control. Despite the low yields on government bonds in the US, UK and Japan, in the judgment of many leading governments, and of the IMF, the room for such pump-priming is very limited in most G20 countries; priority has to be given to stabilising public finances. The argument between those who say “end this austerity now!” and those who say “clean up your state finances!” raises hopes that one or the other of these policy prescriptions can lead us out of the money trap. They are both false.

As argued in “The Money Trap”, the only way in which governments can unlock the trap is to provide confidence to companies and households that it is safe to spend more. Governments should not try to replace lack of private spending by more public spending; households, companies and banks can see through such tricks. If governments are failing to control state liabilities, as they are almost everywhere, households will keep their purses shut, banks will hoard cash and capital, companies will not increase investment.

Private spending is hostage to policy uncertainty. Governments must create an international policy framework strong enough to control and channel the forces of private finance, capital flows and investment into productive uses. And in a globalised world economy, that means nothing less than a global order for banking, finance, and money. It must be so robust that no amount of speculation or industry lobbying can overthrow it. Eventually, it must mean a world currency standard, but it also means uniform, agreed international procedures for bank supervision and resolution. Heads of state and government should give regulators a deadline of the end of 2012 or be shot.