Red Alert: The G-7 -- Geopolitics, Politics and the Financial Crisis
The finance ministers of the G-7 countries are meeting in
Washington. The first announcements on the meetings will come this
weekend. It is not too extreme to say that the outcome of these
meetings could redefine how the financial markets work, certainly for
months and perhaps for a generation. The Americans are arguing that the
regime of intervention and bailouts be allowed to continue. Others,
like the British, are arguing for what in effect would be the
nationalization of financial markets on a global scale. It is not clear
what will be decided, but it is clear that this meeting matters.
The meetings will extend through the weekend to include members of
the G-20 countries, which together account for about 90 percent of the
global economy. This meeting was called because previous steps have not
freed up lending between financial institutions, and the financial
problem has increasingly become an economic one, affecting production
and consumption in the global economy. The political leadership of
these countries is under extreme pressure from the public to do
something to solve — or at least alleviate — the problem.
Underlying this political pressure is a sense that the financial
class, people who run global financial institutions, have failed to
behave responsibly and effectively, and have therefore lost their
legitimacy. The expectation, reasonable or not, is that the political
system will now supplant these managers and impose at least a temporary
solution. The finance ministers therefore have a political mandate,
almost global in scope, to act decisively. The question is what they
will do?
That question then divides further into two parts. The first is
whether they will try to craft a single, global, integrated solution.
The second is the degree to which they will take control of the
financial system — and inter-financial institution lending in
particular. (A primary reason for the credit crunch is that banks are
currently afraid to lend — even to each other.) Thus far, attempts at
solutions on the whole have been national rather than international. In
addition, they have been built around incentivizing certain action and
increasing the available money in the system.
So far, this hasn’t worked. The first problem is that financial
institutions have not increased interbank lending significantly because
they are concerned about the unknowns in the borrower’s balance sheet,
and about the borrowers’ ability to repay the loans. With even large
institutions failing, the fear is that other institutions will fail,
but since the identity of the ones that will fail is unknown, lending
on any terms — with or without government money — is imprudent. There
is more lending to non-financial corporations than to financial ones
because fewer unknowns are involved. Therefore, in the United States,
infusions and promises of infusion of funds have not solved the basic
problem: the uncertain solvency of the borrower.
The second problem is the international character of the crisis. An
example from the Icelandic meltdown is relevant. The government of
Iceland promised to repay Icelandic depositors in the island country’s
failed banks. They did not extend the guarantee to non-Icelandic
depositors. Partly they simply didn’t have the cash, but partly the
view has been that taking care of one’s own takes priority. Countries
do not want to bail out foreigners, and different governments do not
want to assume the liabilities of other nations. The nature of
political solutions is always that politicians respond to their own
constituencies, not to people who can’t vote for them.
This weekend some basic decisions have to be made. The first is
whether to give the bailouts time to work, to increase the packages or
to accept that they have failed and move to the next step. The next
step is for governments and central banks to take over decision making
from financial institutions, and cause them to lend. This can be done
in one of two ways. The first is to guarantee the loans made between
financial institutions so that solvency is not an issue and risk is
eliminated. The second is to directly take over the lending process,
with the state dictating how much is lent to whom. In a real sense, the
distinction between the two is not as significant as it appears. The
market is abolished and wealth is distributed through mechanisms
created by the state, with risk eliminated from the system, or more
precisely, transferred from the lender to the taxing authority of the
state.
The more complex issue is how to manage this on an international
scale. For example, American banks lend to European banks. If the
United States comes up with a plan which guarantees loans to U.S. banks
but not European banks, and Europeans lend to Europe and not the United
States, the integration of the global economy will very quickly
shatter, leading to significant limitations on international trade,
currency convertibility and so on. You will nationalize economies that
can’t stand being purely national.
At the same time, there is no global mechanism for managing radical
solutions. In taking over lending or guarantees, the administrative
structure is everything. Managing the interbank-lending of the global
economy is something for which there is no institution. And even with
coordination, finance ministries and central banks would find it
difficult to bear the burden — not to mention managing the system’s
Herculean size and labyrinthine complexity. But if the G-7 in effect
nationalize global financial systems and do it without international
understandings and coordination, the consequences will be immediate and
serious.
The G-7 is looking hard for a solution that will not require this
level of intrusion, both because they don’t want to abolish markets
even temporarily, and more important, because they have no idea how to
manage this on a global scale. They very much want to have the problem
solved with liquidity injections and bailouts. Their inclination is to
give the current regime some more time. The problem is that the global
equity markets are destroying value at extremely high rates and
declines are approaching historic levels.
In other words, a crisis in the financial system is becoming an
economic problem — and that means public pressure will surge, not
decline. Therefore, it is plausible that they might choose to ask for
what FDR did in 1933, a bank holiday, which in this case would be the
suspension of trading on equity markets globally for several days while
administrative solutions are reached. We have no information whatsoever
that they are thinking of this, but in starting to grapple with a
problem of this magnitude — and searching for solutions on this scale —
it is totally understandable that they might like to buy some time.
It is not clear what they will decide. Fundamental issues to watch
for are whether they move from manipulating markets through government
intrusions that leave the markets fundamentally free, or do they
abandon free markets at least temporarily.
Another such issue is whether they can find a way to do this
globally or whether it will be done nationally. If they do go
international and suspending markets, the question is how they will
unwind this situation. It will be easier to start this than to end it
and state-controlled markets are usually not very attractive in the
long run. But then again, neither is where we are now.
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