G20 Summit Adjourns

As world trade shriveled and currencies collapsed, few harbored hope of miracles

News | Jessica Spiegel | May 2009

The flags representing the G20 nations; can the group create a new world order? (Photo: Rick Smith)

By the end of the G20 Summit on Apr. 2 in London, leaders came away with quite a respectable list of agreements – and more than skeptics had expected.

Until now, the world’s 20 largest economies had taken a backseat to the G8, the group of primarily Western countries belonging to an ‘old boys club’ of the post-WWII world order.

This time, the stakes were particularly high: Finance ministers, central bankers and heads of state of both developed and emerging nations – controlling nearly 90% or world economic output – were hoping to halt the global economy on its downward spiral. With world trade shriveling, unemployment swelling, and currencies collapsing, the task was daunting, and few harbored hope in G20 miracles.

In the week leading up to the meeting, the Organization for Economic Cooperation and Development (OECD) had published yet more dismal forecasts, predicting the world economy would shrink by 2.7% in 2009, enough to make unemployment rise to double digits in many developed countries. And the world’s love affair with Barack Obama didn’t stop protesters from taking to the streets during the new president’s début on the world scene. One protestor died at the hands of British police forces, signifying a clash of energies in a very anxious world.

The G8 is clearly outdated, and some believe that even respected organizations like NATO may be losing clout. Formally established in 1999, the G20 more accurately reflects today’s globalized economic landscape and seems better equipped to tackle the current crisis, including the developing powerhouse economies of China, India and Russia, as well as strategically significant countries like Saudi Arabia and Turkey. With the reemergence of a multi-polar world, this expansion is essential; these economies are vital organs of any meaningful world financial body.

A number of initiatives were announced at the summit, the results of months of preparation by government insiders and staff of the World Bank and International Monetary Fund (IMF). One trillion dollars in new appropriations would be made available to the IMF, up from the $150 billion previously at its disposal. Short-term lending through the IMF, already announced in October, along with a new Flexible Credit Line would assist affected developing economies with fewer conditions.

In addition, an up-graded regulatory regime within the IMF, the Financial Stability Board, has been authorized to repair the faulty rating system and tighten regulation of hedge funds, tax havens and instruments of non-bank financial intermediaries – all understood to have played major roles in triggering the crisis to begin with.

But despite bold pledges, the far-reaching fiscal stimulus plan the American’s had pushed for failed to emerge. Obama’s calls for increased government spending, for example, were rebuffed by the Franco-German led European Union. And further easing of monetary policy did not surface either, which many financial experts believe vital to combating deflation.

The meeting was hailed by some as the new Bretton Woods – the congregation of world leaders in 1944 that created the World Bank, IMF and the predecessor to the World Trade Organization. And while those present at the G20 summit may have failed to reinstate a new world order, decisive action, it seemed, had been taken. But there was also skepticism following the meeting. "There was lots of hoopla," wrote The Economist in early April, "but there were no new, substantial remedies for the global slump." The magazine claimed that world leaders had resorted to an old trick: "bandying around big but squishy numbers and blathering about the importance of international institutions."

In an interview with The Vienna Review, former World Bank employee Robert Graffam, currently Senior Managing Director of private equity firm Darby Investments, disagreed with the pessimists.

"I would argue that this is a mini new Bretton Woods," Graffam said in his office on the Ringstraße across from the University of Vienna, referring to the massive overhaul of the IMF announced at the meeting. "A year ago people were saying the IMF should be shut down; it had no role; it was actually in severe financial jeopardy. Today, governments all over the world are tripping over each other to provide the IMF with more capital."

Countries such as Poland, Colombia and Mexico, though not all in a crisis situation, were suffering from their close ties with the U.S. and other economies reeling from the downturn. In recent months, they have all been provided with standby lines of credit through the IMF – given more as a reward for good economic behavior than as a bailout – suggesting that the institution has been able to evolve and stay relevant to the current crisis.

Viewed as a lender of last resort for developing countries during the last half of the 20th century, the IMF has been criticized for its one-size-fits-all approach, which often inflicted pain on citizens by forcing struggling economies to balance budgets, reduce public spending and raise interest rates. The credit line for Mexico, the first to take advantage of a new tailor-made IMF instrument and announced just days before the launch of the summit, has few string s attached.

Some economies – such as Ukraine, which is currently running a massive deficit partially due to a political crisis – still need to restore a semblance of economic order, Graffam explained. But there is a danger in clumping all emerging economies together. This recognition is reflected in the IMF’s unique policy towards countries like Poland, who have performed relatively well despite the downturn.

"Poland’s terms of trade have deteriorated, through no fault of its own, and is facing a liquidity crisis," Graffam said, convinced that the new developments announced at the summit would lead to more effective results in tackling the current financial crisis. "Now we can give these countries a standby facility, which empowers them to protect their currencies, knowing they have access to fall-back financing."

A favorite criticism of the cynics was that the restructuring of the IMF could help in a future crisis, but would do little to get us out of this one. But Graffam, who worked inside the Infrastructure Crisis Facility department of the World Bank for more than a decade, believed that the changes are already helping, particularly in Central and Eastern Europe (CEE).

"They have already provided facilities to three leading economies of Eastern Europe: Hungary, Ukraine and Poland," Graffam explained. For Poland the financing was in reserve, for the other two, it was urgent. And others in Eastern Europe may still come knocking at the IMF’s door. CEE countries, like Ukraine and the Baltic states, have experienced declines in GDP growth by as much as 8 to 10 per cent. And with currencies down as much as 30 to 35 per cent since highs in September of 2008, people who took out loans in euros or Swiss francs are suffering damaging currency mismatches that increase the cost of repayment. It is these trends that are causing massive disruptions in CEE economies and commentators to raise the alarm for Western banks. [See "Stating the Obvious," pg. 3.]

Yet, another example is the recent situation in Serbia, where the government relaxed bank reserve requirements, thereby freeing up approximately €500 million for lending. But instead of using that money to stimulate the economy, it was used to pay down loans from Western banks.

"Rather than these banks serving as a conduit for money going in," Graffam said in reference to the CEE’s troubles, "in the past six months they have been serving as a conduit for it going out."  According to this argument, more lenient credit lines from the IMF could help restore confidence and prevent damaging outflows from already-stressed economies.

As for the other financial ills the G20 hoped to combat, the remedies seemed less clear to experts like Graffam. Confronting tax havens and coordinating banking regulation to prevent a resurgence of unregulated ‘innovative’ banking instruments was, according to Graffam, "a huge conundrum." This was something that would not be resolved in his professional lifetime, he claimed.

But for now, struggling economies are getting help: After Mexico, Poland sought a precautionary credit line of $20.5 billion; IMF officials are in discussion with Ukrainian authorities; and the Fund has agreed to a $15.7 billion loan to bolster Hungary’s troubled finances, whose foreign-denominated debt threatens to spiral out of control.

How credit assistance will affect these countries remains to be seen, but IMF interventions may be positioned to help lift Eastern Europe out of the current crisis, and may indirectly protect heavily leveraged interests in countries like Austria.

A final question is the structure of the G20 itself. At the moment, the Group excludes countries tactically important to global cooperation, such as Iran, and most of Eastern Europe. But if the G20 manages to help disentangle the current economic calamity, the Group – along with an empowered IMF – could accomplish what many had hoped for from a new Bretton Woods.

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