Sunday, April 19, 2009

The G20 Analysis

On April 2 2009, leaders of the world’s top 20 economies met in London — they collectively represent 80% of the world’s trade—to explore ways on how to deal with the global economic turmoil. Since the last G20 meeting held in Washington in November 2008, the world economy has plummeted to a record low. Consumers have cut back spending. Companies have reduced production, postponed investment and slashed millions of jobs.

The financial system remains dysfunctional. Trade flows are shrinking at the fastest rates since the Second World War, felling export-dependent economies from Germany to Japan. Private capital flows are collapsing, devastating those emerging economies, especially in Eastern Europe, that rely on foreign borrowing. In its latest forecast, the OECD (Organisation for Economic Co-operation and Development) said this week that it expected the world economy to shrink by 2.7% in 2009. It thinks that its mainly rich member countries will see their output decline by more than 4%. That would be by far the deepest synchronised downturn since the 1930s. But despite these dismal facts, the leaders at the G20 summit gave an upbeat assessment about the remedies they had agreed upon.

Speaking at the conclusion of the G20 summit the UK Prime Minister Gordon Brown said, “This is the day that the world came together to fight back against the global recession. Not with words but with a plan for global recovery and reform.”

US President Obama said,”By any measure the London summit was historic. It was historic because of the size and the scope of the challenges that we face and because of the timeliness and magnitude of our response.”

Nicolas Sarkozy said, “I'm very happy with the result...Honestly, we never thought we would we have such an agreement. Even our Anglo-Saxon friends are now convinced that we must have reasonable rules.”

The leader of Germany Angela Merkel said, “I think I can say that in an important conference we have found a very good, almost historic compromise in a unique crisis.”

Below is a summary of some of the key measures agreed by the G20:-

IMF Resources
The centrepiece of the announcement was a substantial increase in the funding available to the International Monetary Fund (IMF). The IMF currently has about $250 billion at its disposal to lend to countries facing financial difficulty. Under the G20 agreement, funding for the IMF will be increased by $500 billion to $750 billion. Japan agreed to provide $100 billion of the extra funding, the European Union $100 billion and China about $40 billion. The IMF will also sell off some of its gold reserves to establish a new $50 billion fund to help the developing world. Emerging economies such as China are also expected to be given a greater say in the running of the IMF as part of the package.

Bankers' pay
The world leaders agreed to curb pay and bonuses for bankers. A new international set of rules will prohibit banks from paying traders and executives multi-million pound cash bonuses if they are making risky decisions. Regulators will assess how much risk traders are taking and those deemed to be making more risky decisions will only be paid in shares which cannot be sold for several years.

Global "quantitative easing"
At the behest of the world leaders, the IMF will increase the amount each country has in so-called Special Drawing Rights (SDR) by $250bn. This is effectively global quantitative easing – comparable to the unprecedented measures the Bank of England carried out last month when it committed to pumping £75bn into the British economy. This is a form of printing money. Under the IMF scheme, each country has an allocation of a shadow IMF currency – known as SDRs. This currency can be converted into useable currencies such as dollars, euros or sterling. The amount of SDRs was dramatically increased by more than ten-fold yesterday. The scheme is best regarded as a safety valve for struggling economies, and rich countries are likely to donate some of their SDR allocation to those most in need.

Fiscal Stimulus
This was supposed to be the big centre-piece of the G20 summit - a global agreement on how much countries around the world would spend on measures to support their economies and fight unemployment. However, the French and German governments ruled out an explicit commitment. All leaders could agree to announce was how much had already been pledged - $5 trillion.

Offshore tax havens
Countries who refuse to pass information to foreign tax authorities to help catch potential tax evaders will face sanctions in future. A preliminary list of such offshore tax havens is to be published. The G20 communique proclaimed: "The era of banking secrecy is over". Gordon Brown said that it was "the beginning of the end" for widespread tax avoidance. However, it is yet to be seen what sanctions will be deployed against the tax havens despite lobbying from the French Government.

Toxic Assets
Most economists agree that until the world's leading nations cleanse the balance sheets of their stricken banks the credit crunch will persist and there will be no return to normal lending conditions. The G20 communiqué recognises this issue and pledges that each country will dispose of the assets, either by setting up a so-called bad bank or by insuring the assets against default (as the UK has done). The commitment is slightly stronger than in previous international statements. But it does not go as far as many economists had hoped by pledging to set up new, healthy "good banks" which could provide fresh lending for households in the future.

Protectionism
The G20 member countries committed to a 12-month freeze on introducing any new trade barriers. In other words, they will not increase tariffs or quotas on goods imported from overseas. If followed to the letter, this would be a significant move. It was an increase in protectionism during the 1930s that lengthened and deepened the Great Depression, and ultimately fed the forces that caused the Second World War. However, there is scepticism that this commitment will be met.

Strengthen international financial regulators
The summit agreed to turn the existing Financial Stability Forum (an international group of regulators) into a more pro-active global banking watchdog. It will be renamed the Financial Stability Board and its membership will be broadened to developing nations including China, Brazil and India. Its job will be to monitor whether banks and financial houses are taking excessive risks, and to tell their national regulators to police them more stringently. However, critically, the new FSB will lack explicit powers to clamp down on companies which overextend themselves. There remains a major question mark over how much difference a relatively toothless regulator will make.

Trade finance
One of the major problems facing the global economy is the sharp drop in trade across the world – the first reduction in trading in a generation. Exporters in the developing world have been unable to obtain credit in the wake of the global financial crisis. Global leaders agreed to provide $250 billion in new trade credit guarantees. The guarantees – to be offered by the World Bank and other international institutions – should allow exporters to obtain credit once again. Mr Brown heavily pushed the scheme during his recent trip to South America.

However, despite the show of unity amongst the G20 leaders there are still a number of issues where differences run deep.

1. The most contentious issue is the type of capitalism practiced by the US and Britain—known as the Anglo-Saxon model. The Europeans abhor this form of capitalism and want to see it reigned in through extensive regulation. The Europeans want the regulation to cover the operations of hedge funds, banks, tax havens and credit rating agencies.
Furthermore, the Europeans want an international organisation such as the FSB to effectively monitor the compliance of countries and their financial institutions to this new form of regulation. In the run up to the G20 summit the Europeans made their intentions clear and aggressively attacked the Anglo-Saxon model.

Czech Prime Minister Mirek Topolanek deemed Obama’s economic policies too dangerous. He said, “...all of these steps, these combinations and permanency is the way to hell. We need to read the history books and the lessons of history and the biggest success of the (EU) is the refusal to go this way”.

The French president has insisted that “radical reform” of capitalism is more important than tax cutting. In fact at a cabinet meeting Sarkozy vented his frustration at Brown. He said, "If things don't go forward in London, there will be 'la chaise vide' (empty chair). I'll get up and walk out!." The US on the other hand despises European intrusion into America’s form of capitalism and has strongly resisted Europe’s attempts supervise its financial institutions. The lack of consensus about the powers of the FSB to regulate capitalism is a manifestation of schisms between America and Europe over the type of capitalism the world should follow. It appears that these differences will increase in the coming months, as America continues to press ahead with its form of capitalism.

2. The other notable difference amongst the G20 leaders was over the size of the fiscal stimulus pledged by each nation for its economy. Originally Gordon Brown was looking for pledges of 2% of GDP by other nations at the G20. But this was soon abandoned, after Angela Merkel led the assault with a statement that Germany would not be dictated to by other countries over fiscal stimulus. “I will not let anyone tell me that we must spend more money,” she said.

Merkel was shortly followed by Spanish Finance Minister Pedro Sorbes: “In these conditions I and the rest of my colleagues from the eurozone believe there is no room for new fiscal stimulus plans.”

There are two main reasons for Europe’s reluctance to follow America and Britain down the path of greater fiscal stimulus. First, for historic reasons a country like Germany and others dislike public debt as a means of bailing out the economy at the time of economic turbulence. Second the Europeans fear that America and Britain want the European economy to become heavily strapped with debt and weaker like the Anglo-Saxon economies. The Europeans worry that this will diminish Europe’s ability to present a strong challenge to Britain and America when the recovery finally arrives.

3. Another source of disunity amongst the G20 is their hollow pledges towards reducing protectionism. A similar promise was made last November; since then the World Bank has found that 17 member countries raised trade barriers. This is clearly evident in the way that America and Europe have bailed out banks, insurance companies, car companies and other industries in direct violation of this pledge. It is expected that such contraventions will only increase in 2009.

4. One of the most dangerous developments at the summit is the new role given to the IMF which includes new funds to lend to the developed world. The plan is to use the IMF to debase all the currencies of the world, which in relative terms will ensure the superiority of the developed world over the rest of the world. So as the Federal reserve and the Bank of England increase their money supply through quantitative thereby debasing the dollar and the pound respectively, the IMF through emergency loans and SDRs facilities will debase the currency of recipient countries. This policy is most likely to cause hyper-inflation across the world, but is dependent to a great deal on China. If China is not granted a greater say in the IMF or if China senses that the dollar reserves it holds are worthless then this policy will fail, as China will be forced to dump the dollar.

Lastly, the very fact that countries have to resort to bilateral economic solutions as opposed to multi-lateral solutions exposes the fallacy of those who claim that capitalism is a force for globalisation. Indeed capitalism has failed at the national and international level. It is unfit to be the engine for globalisation or a universal ideology for mankind. We pray that Allah (swt) honours this ummah with the return of the Khilafah, so that Islam takes its rightful place in the world and lifts mankind from the darkness to the light.

April 4 2009

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