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November 10, 2010
The G20 meets in Seoul, South Korea, this month. The continuing agenda is global recovery, rebalancing growth, financial regulatory reform and governance reform at the International Monetary Fund—plus the two new issues added by the Korean hosts: financial safety nets and closing the development gap. The agenda is whether a new international order can be created that would move from the framework established after World War II in which the Group of Seven advanced economies managed the world economy.
The reality is that the G20 is a self-appointed body that has little legitimacy, has achieved precious little since it started holding two yearly summits two years ago, and it provides a better forum for the powerful to pursue their own agenda.
The conflicts over achieving a strong, balanced and sustained world recovery will surface at the G20 in the form of the "currency wars":
The background is multilayered:
(1) The political background is visceral public anger towards banks, the activities of which severely damaged the real economy to the extent that full recovery will take years.
(2) The US is juggling the agenda to support US economic growth and job creation through US dollar depreciation at the expense of East Asian economies and oil and commodity exporters.
(3) The economic background is that the core of the world’s financial system has become unstable, and reckless risk-taking will once again lead to great collateral damage.
(4) The secular decline in economic growth rates and the long-run increase of financial fragility and instability.
(5) Financialization, or the shift in the center of gravity of the capitalist economy from production to finance, is a compensatory mechanism to a long term decline in growth that has helped to lift the economic system under these circumstances, but at the expense of increased fragility.
(6) a rapidly growing industrial base in emerging markets is being hard-wired to intensive use of coal. This, coupled with the reliance on cheap local coal in the US and Australia, will make it exceedingly difficult to reverse the trend in the future.
My view is that the US's trajectory of slow growth means that it will be forced to curtail its international commitments. This will create space for rising powers like China, but it will also expose the world to a period of heightened geopolitical uncertainty.
The trajectory is one of decline for the US because its political elite is failing to develop a coherent policy response to the global financial crisis as it is being forced to choose between job creation, which requires a more competitive exchange rate, and cheap financing of its external and fiscal deficits.
This is a political failure in that its political parties, rather than working together to address pressing economic problems, remained at each other’s throats. The country is turning inward, and its politics is becoming more fractious, its policies more erratic, and its finances increasingly unstable.
Update
Martin Wolfe at the Financial Times says that the Federal Reserve's attempts to reflate the American economy through low interest rates and pumping more money into the economy will encourage capital to flow into countries with less expansionary monetary policies (such as Switzerland) or higher returns (such as emerging economies or Australia). He adds:
Recipients of the capital inflow, be they advanced or emerging countries, face uncomfortable choices: let the exchange rate appreciate, so impairing external competitiveness; intervene in currency markets, so accumulating unwanted dollars, threatening domestic monetary stability and impairing external competitiveness; or curb the capital inflow, via taxes and controls. Historically, governments have chosen combinations of all three. That will be the case this time, too.
The US, one way or the other: it will either inflate the rest of the world or force their nominal exchange rates up against the dollar.
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Intersting the above comments. Elsewhere it's been proposed that the US is likely to become more bellicose, as the republican populists gear up for a shot at thepresidency in a couple of years. Then, we are told exponentially worse to follow, as the hard right gears up for a new Bush era, this time on steroids.