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The previously existing world power structure is all but over. The world resulting from the Pax Americana of 1944 and expressed in the G7 group of countries now has to confront the fact that it no longer controls most of the world’s GDP and that by 2016 it will be in a minority position in terms of total GDP.
This means that Europe as a whole will have to redefine its global role and the United States will no longer be able to act unilaterally on economic fronts.
Asia has a new role to play in helping to ensure international economic and financial stability in face of mature economies that need to devalue their currencies in order to import less and export more.
The beggar-thy neighbor-policy again being deployed these days was what led the 1930s crisis into a depression with deflation. Both then and now it was meant to try and keep weakening economic powers on top of their economic game. That failed and ended in the creation of the economic stabilization fund sponsored by the Roosevelt government and designed by Harry White, later creator of the International Monetary Fund (IMF).
The end of the beggar-thy-neighbor policy meant the consolidation of the U.S. dollar as a reserve currency at a fixed parity of $35.70 to an ounce of gold. There is no such item in the current discussion of the G20 meeting.
The three main issues are the framework for strong and stable growth, governance of international financial institutions (IFI) and the global financial regulations. On the first issue there is a conflict between European pro-cyclical policies and U.S. counter-cyclical policies. This came out in Toronto and produced a non-declaration.
The issue is if highly indebted rich countries can afford to keep counter-cyclical policies and who will pay for them? Can the emerging nations afford to finance fiscal deficits without placing any conditions?
This issue is more complicated when we consider that future economic growth as estimated by the IMF and projected to 2020 show that there is a very tenuous relationship between the growth rates of mature economies and those of the emerging economies. It is so tenuous that by 2017 the top three world economies will be China, the U.S. and India, in that order. Great Britain left the G7 list of large economies in 2010 and was replaced by Brazil.
IFI governance is an issue where there cannot be agreement either. With the power structure changed, voting rights even adjusted as they have been recently do not reflect the shift in the world power structure.
IFI design needs to go back to the drawing board in order to reconsider among other things the matter of reserve currencies, the role of basket of currencies as reserve currencies and more importantly, the regionalization of the international financial architecture, so it becomes more responsive to immediate problems and less subject to the whims of the U.S. Treasury.
It considers a 12-percent-GDP fiscal deficit good for itself but wrong for all others and blames its economic troubles on the evident strengths of others.
Last but not least the matter of financial regulation. The currency war deployed from the United States against the leading world currencies when it announced that it will inject a further $600 billion into the market over the next year, warns us of booms and busts in commodity and stock markets.
This will have an impact on emerging country stock markets as those funds that have near zero percent cost are invested around the world. It will produce a new boom in commodity prices with a new food and oil crisis as foodstuffs and oil prices soar.
Worse, there will be appreciation of currencies in all countries with stock markets as short-term capital flows in. The reverse will occur when U.S. monetary policy stiffens and the money returns home, leading to sharp devaluations thus slowing down economic growth and curtailing consumption the world over.
This outlook requires consideration of short-term capital controls in the three known varieties: taxes, minimum cash requirements, and terms.
The U.S. Fed has forced its trump card by announcing the injection of additional liquidity into the market. It is making use of the “seigniorage” the U.S. dollar holds, while trying to export its crisis to the rest of the world. This must not happen for the economic sake of all. The consequence in any event is the further weakening of the reserve currency.
Oscar Ugarteche is a senior research fellow at the Instituto de Investigaciones Economicas in Mexico.
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