It was never going to be simple to redesign the global financial system.
The good news from the 22 February gathering of European leaders in Berlin, hosted by German Chancellor Angela Merkel, is that agreement was reached on seven proposals to present to US President Barack Obama and Group of Twenty (G-20) officials on 2 April.
The bad news is that the meeting, which was attended by French President Nicolas Sarkozy, UK Prime Minister Gordon Brown and Italian Prime Minister Silvio Berlusconi, was more wasted political theatre than substance. It didn’t do much to address the current financial crisis.
“We should strictly differentiate between fighting the fire and drafting fire-protection legislation,” Czech President Vaclav Klaus wrote in the Financial Times last month.
The Europeans called for doubling the resources of the International Monetary Fund (IMF) to $500 billion (Rs25.9 trillion). That was in addition to proposals calling for an international early-warning system and a boost in bank capital requirements to create a cushion that increases in good times and that banks can access in bad spells.
The Europeans know that the additional cash will probably have to come from China, which has almost $2 trillion in foreign exchange reserves. They also know that, in exchange for its largesse, China will rightly demand increased voting rights at IMF that would come at the expense of Europe’s quota.
The European leaders also proposed sanctions against uncooperative jurisdictions. “We want to put a stop to tax havens,” Sarkozy said. “We want results on this, with a list of tax havens and a series of consequences.” At the April G-20 summit in London, “Europe wants to see an overhaul of the system,” he said. “A new system without sanctions would not have any meaning.”
Cracking down on tax havens may be a good idea. But to blame them for the global financial crisis is bogus. What’s more, the Organization for Economic Co-operation and Development already polices tax havens and currently labels just three—Liechtenstein, Andorra and Monaco—as uncooperative.
The Europeans also want to regulate hedge funds. Again, not a bad idea. But they didn’t cause the crisis any more than the tax havens did. The G-20 summit in November also had a dose of political theatre. It was billed as the precursor to a new Bretton Woods. Attendees pledged to agree on successfully concluding the seven-year Doha Round of world trade talks by year’s end, and vowed to forgo new protectionist measures for 12 months.
Three criticisms: The original Bretton Woods Conference in 1944 lasted three weeks and was preceded by at least two years of technical groundwork. Two, the Doha Round is effectively dead until global growth picks up. Three, one G-20 member after another began adopting protectionist measures within a month of the November meeting.
Regardless of these shortfalls, world leaders must not abandon the search for a better mousetrap. Today’s crisis makes it clear that the current system of financial oversight, with its foundation in the principle of self-regulation, is outdated.
Since the 1970s, the world has witnessed explosive growth in cross-border capital flows, the evolution of multinational corporations and the expansion of financial institutions internationally in pursuit of that money and those corporate clients. Ideally, there should be a global regulator or at least a structure where the biggest institutions are policed by a single international entity.
The political reality is that governments are reluctant to surrender supervision of their financial institutions to an international body, nor are they ready to establish a global lender of last resort.
Probably the best that can be hoped for at this time is what Brown calls a “college of supervisors”.
When all is said and done, the quality of any redesign of the world’s financial architecture will depend on the nitty-gritty details. Obama, Merkel, Brown and Sarkozy alone can’t be expected to negotiate the minutiae.
It is imperative that they and their Japanese, Chinese and Brazilian counterparts keep sight of some key principles:
• Free markets must be shielded from the temptation to embrace statist solutions. Although existing regulation has proved wanting, overly regulated markets aren’t the answer. The collapse of the Soviet Union clearly illustrated the flaws of the central planning model.
• The current market and banking crises aren’t the consequences of a failure of capitalism but of regulation.
• Financial market innovation needs to be harnessed, as the growth of credit default swaps and other derivatives shows. It shouldn’t be stifled.
• Each country must set aside parochial interests for the common good.
• The allure of protectionism must be resisted.
When they meet in four weeks, G-20 leaders must get their priorities straight. Move quickly and forcefully to reinvigorate global demand and with it world growth, while taking time to carefully peruse the menu of moderate regulatory options.
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