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The Hourglass of Our Life

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In early April the leaders of 29 nations and international institutions met in London to formulate a united plan of action for addressing the global economic crisis.  The outcome of this meeting of the so-called ‘G-20’ will have bearing on what action steps we take here in the U.S. to bring our economy out of its current slump.  This was a meeting of the heads of state that comprise approximately 85% of the world’s economy.  We would do well to link these actions with the strategic steps that we take to improve our own economy during these tough economic times.

Entering into the meeting, the Obama Administration had hoped to get agreement on additional stimulus packages from other members of the G-20. But, both Germany’s Chancellor Angela Merkel and France’s President Nicolas Sarkozy were dead set against it.  For Merkel, the memory of the hyper-inflation for Germany after WWI was too strong. It was under these conditions that the fascism that led, ultimately to WWII took hold.  For Sarkozy, the official argument was that the French social safety net was deemed to protect many of those hit by the crisis.  Both the US and Britain have aggressively moved to implement economic stimulus packages, while others are taking a wait-and-see approach, much to the Obama Administration’s chagrin.  Even China was, surprisingly, closer to the US and the U.K. camp than were Germany and France on this issue.

What the leaders could agree on were a series of provisions related to:

  • The need for greater financial supervision and regulation of capital markets and banking regimes;
  • The need to put additional pressure on jurisdictions deemed as ‘tax havens’ for increasing transparency and inter-jurisdictional cooperation;
  • The need to provide an line of credit of $250 billion to jump-start international trade once again;
  • The need to increase the funds available to the International Monetary Fund (IMF) for emergency loans to developing countries.

Some other discussions centered on:

  • The possibility of establishing an alternate to the US dollar as the de facto currency for central bank reserve accounts;
  • Techniques for strengthening the global financial institutions such as the IMF and the World Bank; and
  • The possibility of regulating hedge funds.

These high-level discussions were, granted, a long way from the humble settings of our local city council meeting halls and chambers of commerce.  And, the jargon of macroeconomics and politics at the global level might seem obtuse, but the decisions that were made in London will have a trajectory that will quickly reach us here in the towns and cities of the U.S.  It serves us well to be informed about these decisions.   I will comment on each of the bulleted items, listed above, and point out why we need to watch how each provision evolves.

First, the financial supervision objective will be administered by a new Financial Stability Board (FSB).  This FSB will serve as the first line of attack on addressing the issue of credit restrictions for companies today.  The criterion used by credit rating agencies is just one of the areas that the new FSB will be looking at on a global basis.  The kind of criterion that is to be applied, consistently, across all agencies, as specified by the FSB, will certainly affect the outcome of future ratings. This will affect both the multinational corporations operating in Hong Kong and Dubai and the Mom and Pop shops operating in Sedona.  This is because credit rating scores affect banks, public agencies and private entities, alike.  All of us are important stakeholders in today’s functioning economies.

Second, the practice of tax evasion, so pervasive in today’s world, will become more and more difficult as more of the offshore banking centers yield to the pressure from the world community to engage in bilateral tax treaties and other transparency measures.  This will lead to greater consistency in cross-border reporting.  This will free up some of the cash that has been sequestered away in these offshore accounts; cash badly needed to circulate through the global economy.

Third, the agreement the G-20 came to with respect to the fallacy of policies aimed at trade protectionism is a big step towards opening up world markets to trade.  International trade is the engine that fuels the fire of the economy; protectionist measures act like a bucket of water poured on that fire.  The addition of $250 billion for export credit agencies of G-20 member nations will help to reignite that engine, but, only for those companies that take advantage of these facilities.  Companies in the U.S. that are ‘export ready’ should begin to look more seriously at taking advantage of some of these provisions which, for us, will be through the US Export-Import Bank (ExIm).  Even if a company is not ‘export ready’ it might be to its strategic advantage to begin to prepare for such a contingency.  This commitment from the G-20 is good for a period of 2 years.

Furthermore, the round of trade negotiations the world community is currently engaged in, the so-called Doha Round has been dedicated to establishing a regime that worked to ensure fair trade treatment for developing countries.  But, over the past year, talks have broken down, largely over such issues as agricultural subsidies by the US and several European nations.  It is ironic that the G-20 would in this forum, once again reaffirm the goals of the Doha Round and the much more esoteric United Nations Millennium Development Goals (MDGs) aimed at reducing world poverty.  The issue of world poverty is beginning to take a front and center place on many of the agendas of world governments because of the linkages between illegal migration and the resulting crime communities that emerge from these phenomena.

Forth, the infusion of capital to developing world countries can help, to some extent, to ameliorate the hardships that stem from extreme poverty for millions of people.  With extreme poverty comes discontent, and with discontent comes political strife.  And, after the trauma of 9/11, we all know that political strife can, ultimately, lead to terrorism.   By reducing pressure on the Mexican government, for example, to provide social programs for their growing populations living under the poverty line is one way to address the illegal migration issue. There is an economic answer to terrorism, as was so aptly described by Hernando De Soto in his groundbreaking book The Other Path about the Shining Path terrorists in Peru.  Many other countries throughout Latin America and the world would do well to seek this ‘other path’ by strengthening their legal institutions to reduce the administrative burden of operating legal businesses within their own countries.

This infusion of capital by the G-20 will target countries most in need of emergency relief.  The increases in crime and violence, so evident in some major cities in the U.S., are showing early symptoms of this potential for social discontent.  Strategies by our Federal, State and local governments to stem this tide of violence can only help to fortify civil society.

Now let’s turn to the more amorphous implications of the three points I mentioned above under ‘Other Discussions’ the G-20 leaders focused on.

In the world today the US dollar is the gold standard.  It is the currency that is held as the reserve currency to prop up the central banks of more than 75% of the world’s economies.  This is true even though the US only accounts for approximately one-fifth of the world’s gross domestic product (GDP).  This is, in part, an historical artifact stemming from our relative strength coming out of WWII.  In the past, it was also from our vigorous economy and our status as the world’s largest consumer market.  But, as we all now recognize, this was largely a societal delusion fostered by the lax credit policies of our banks, the use of syndication to bundle risk assets together, and the lack of meaningful prudential oversight of these practices.  Now we see that the Emperor has no clothes.  So does the rest of the world.

Prior to the G-20 meetings China’s central bank officials made public statements calling for a new ‘basket’ of world currencies, or, alternatively, the IMF’s Special Drawing Rights (SDRs) vehicle to be used as the de facto world currency, rather than the US dollar. Some have argued that this was a retaliatory statement because the US had been putting pressure on China to reduce its tight oversight and management of the Yuan Rimini.  We were pushing for them to let their currency float freely, as our does.  They, on the other hand, are now letting us know that, because we have let our currency float freely, we have almost brought down the rest of the world with our lax practices.  China was telling us that the Emperor has no clothes.

The implications for us, locally, if the world shifts to a ‘basket’ or the SDR as the currency reserve is that the world will suddenly be flush with dollars as countries seek to cash out of the US dollar.  This would cause an over-supply, which could lead to a precipitous drop in the value of the dollar.  No one at the G-20 wanted to press this issue because it suddenly became apparent that this type of loss of confidence in the US dollar would cause the global economy to go into an even more accelerated tail spin.

On the issue of strengthening the IMF and World Bank we must cast back to Bretton Woods for an understanding of this action.  At Bretton Woods, New Hampshire in July, 1944, the leaders of 44 nations met to establish institutions to address the many reconstruction issues of the post WWII era.  Upon the onset of globalization in the 1990s some have questioned the relevance of these post-WWII institutions.  Importantly, during this crisis, the infrastructure of these institutions (i.e., the IMF and the World Bank) has been crucial to the stabilization of countries most impacted by the crisis.  As a result, there is a renewed spirit of cooperation to continue to jointly fund these institutions; albeit with a revised balance of power that more accurately reflects the relative strength of the member nations in today’s world.  Importantly, China and India will likely have more sway in the governing bodies of these institutions.  All of the G-20 nations agreed to support the World Bank’s new Vulnerability Framework and the Infrastructure Crisis Facility and the Rapid Social Response Fund.

So what are the implications for the businesses and local governments of the US?  As other economies aided by the IMF and World Bank programs begin to grow and as they develop more robust consumer markets we will have greater export potential.  Companies can more aggressively sell their products to consumers in these markets and governments can form sister-city and sister-county relationships to further bilateral trade agendas.

Finally, we turn to the issue of hedge fund regulation.  Within the US hedge funds have traditionally been organized around the principal of short selling, which is an investment strategy that bets on the attempt to profit from an expected decline in the price of a financial instrument.  Because they have limited numbers of investors and they are typically, highly leveraged, the collective effect of these hedge funds had a devastating effect on the global economy once the markets started going down.  The G-20 member nations have agreed that this betting on the down side has inherent macro-economic risks and that they want national governments to register their hedge funds, monitor their leverage levels, and set limits for single counterparty exposures.  This will, in effect, bring hedge funds into the overall framework of prudential regulatory management.  In the US there is also talk of reducing their capital gains tax privileges, and limiting the pay of hedge fund managers. How this will shake out is still a mystery.  Only time will tell.

At the same time all of this is happening, hedge fund managers are also being courted by the Obama Administration to encourage them to buy up some of the toxic assets from the mortgage lending crisis under terms established by Treasury Secretary Timothy Geithner’s toxic asset management plan.  How this mixed message will play out in the markets is a question in the minds of many on Wall Street.

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We would do well, to recognize the quote from Niccolo Machiavelli (b. 1469 – d. 1527) “The more sand that has escaped from the hourglass of our life, the clearer we should see through it.”

  • JDO

    This is a very thorough review of the G-20 Summit, and the writing is excellent!!!
    My concern is whether the talk and high-level proclamations will result in change on the ground. The financial meltdown was caused by a long-term, systemic lack of regulatory oversight on an industry defined by one mantra: make more money.
    Until we change that mantra to, for example, ‘enough is good enough’ societies and governments will be doomed to repeat.

    I also struggle with the true intentions of institutions like the World Bank, IMF, or Central Banks for that matter. Since they have the “permission” to create money electronically, a data entry with limitless zeroes, and earn interest on it, I’m not sure they have the best interest of the needy in mind.

    On a slightly different note, I for one look forward to the day when I can protect personal and company earnings from taxes. Unless I have a say in how my tax dollars are spent, I prefer not to give it to governments that spend in military terms, rather than humanitarian.
    My hopes are eternal…and thanks to the author of this blog post. I enjoyed the read.