Solving a global crisis

IMFRestarting the global economy through a widening of the US external deficit is not the best way forward.
The world saw a crisis coming. Just not this one. The widening US external deficit and the growing surpluses in China, Japan and other countries reflected major global imbalances that would eventually wreak havoc on the world. Some analysts predicted that the world would grow tired of funding the US deficit, causing the dollar to plunge, long-term rates on treasurys to skyrocket, and the US to go into a tailspin, bringing down the world.
A crisis did finally occur, but neither the dollar nor US treasurys tanked, yet things got really nasty anyway. The initial response to the crisis saw an unprecedented injection of liquidity by the Federal Reserve that was designed to normalize credit markets, but which others feared would cause inflation. Neither took place. Instead, things got worse.
So, what seems to be the problem? The best interpretation is that the 2008 aggravation of the crisis was triggered by major equity losses in key financial intermediaries, associated with a moderate correction in asset prices. These losses caused a rise in counter-party risk, triggering a major disintermediation process as investors fled towards safer assets. In the process, financial links were broken and spending collapsed precipitously.
During the previous boom years, the financial industry had become more concentrated (in terms of the number of players), more leveraged, and more globally diversified (in terms of assets), so that problems in the main players would be systemically large and have global impact.
So, what seems to be the game plan for dealing with the crisis? The investors’ flight to quality means that those issuing the safe assets are left as the sole remaining super-borrowers. These super-borrowers—the US and Japan, mainly—are the only ones left to re-establish financial links and rewire the system. Up to now, this has had two legs: propping up aggregate demand directly through fiscal reflation, and recapitalizing the banking system.
In the US, the recapitalization and reflation is planned mainly for the domestic economy. But the solution, to be effective, should also have a global character. Restarting the global economy through a widening of the US external deficit is not the best way forward.
A more sustainable alternative is to use the super-borrower capacity to reflate the global economy and to re-establish financial links globally. This can be done in several ways. First, multilateral development banks should be recapitalized—by issuing guarantees in the form of callable capital—allowing them to raise funds in global capital markets to lend to the developing world.
This would allow developing countries to compensate for the lost access to private markets. Loans should be disbursed quickly and conditional only on an ex- ante assessment of the soundness of their macro stance. They should be made in an amount sufficient to prevent the inefficient, pro-cyclical contractionary fiscal adjustment that is being caused by the lack of access to finance. Part of the capital raised could be invested in a diversified portfolio of private emerging market assets to provide for this asset class—what Ben Bernanke is doing to the US variety.
With this strategy, a global fiscal reflation can take place by preventing inefficient cutbacks in the countries shut out of finance because of the global crisis instead of relying solely on expansion in the structurally weak US fiscal position. Second, IMF should also be recapitalized so as to make sure that it has more than enough funds to help reconnect countries to finance.
The goal should be to convince countries that are currently hoarding large amounts of international reserves as insurance against future crisis that they need not sit on so much liquidity because they will have ample access to contingent funds if needed. This will allow countries to adopt policies that are more supportive of a global reflation effort.
If capital markets are impaired, the global and regional international institutions need to step up to a much bigger plate than is currently being envisioned.
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Globalization 2.0 in peril

Statements by world leaders strongly advocating open trade every once in a while is perhaps proof they are worried that countries could close their borders in a moment of panic.
Several Italian towns ban the sale of kebabs and other foreign food in an attempt to make Italians eat Italian. British workers at their country’s third largest oil refinery go on strike because foreign labour is being used for new construction at the refinery site. Spain is promising to pay immigrants to pack up and head home.
And then there is the more well-known case of the US, where the new economic stimulus package announced by the Barack Obama administration has controversial provisions to buy and employ American.
The war of words between the US and China on how the latter manages its currency, the use of higher tariffs by many countries to protect powerful industries such as steel, bailouts of select companies, the rise in trade disputes—all point to the disturbing fact that protectionist pressures are welling up in many parts of a recession-stricken world.
Note that most of these cases are from the rich countries rather than the poor. Some 25 years after the US and its allies pulled most countries into the global trading system and brought in the second golden era of globalization—the first ended with World War I—it is the original proponents of Globalization 2.0 who are busy trying to protect domestic interests.
It is reassuring that most world leaders continue to swear by open trade. The finance ministers of the Group of Seven (G-7) nations met earlier this month and promised to fight the growing threat from economic nationalism. The larger group of 20 (G-20)—which includes India—made similar promises when it met in the middle of November.
However, that the world’s leaders see the need to make such statements every once in a while is perhaps proof they are worried that countries could close their borders in a moment of panic. Declining capital flows and the withdrawal of shaky global banks back to their home bases are other warning signs.
The theoretical case against protectionism is clear: Free trade allows countries to specialize in activities where they have a comparative advantage. For all their famed disagreements, most economists concur that open borders for the movements of goods and services are far better than tariff walls that protect inefficient producers.
If the US, for example, insists on the use of expensive American rather than cheap Chinese steel to build a bridge, it is short-changing one set of citizens to help another.
The empirical case is clear as well: Countries with open borders usually grow faster than those that build barriers to trade. Also, it is widely accepted that the protectionism of the 1930s worsened the Great Depression. It is unlikely that the old mistakes will be repeated, though we may see milder forms of the protectionist affliction in the coming months.
The problem now is slightly complicated. Say, country A decides to spend hundreds of billions of dollars to support a weak economy. A large part of this money will naturally go into the coffers of the companies and individuals who get this money. They spend part of it and that gets the economy rolling again—or at least that is what the fiscal stimulus crowd fervently hopes.
But not all the money that a government pours in stays in the country. Some of it leaks out when domestic companies and consumers import stuff from country B. So, the fiscal stimulus in country A partly helps prop up export demand in country B. It is also likely that the fiscal stimulus in the latter helps the former.
What if country B decides not to spend too much money, either out of conviction or because it already has high levels of deficits and public debt? It benefits from what the government of country A is spending, but does not return the favour.
It is in such cases that country A may be tempted to slip in trade-destroying policies that insist on local buying and employing.
Avoiding these traps will require international coordination, where countries agree to keep borders open and spend in unison.
But that will be easier said than done. Recession, unemployment and bankruptcies will almost inevitably make voters put pressure on politicians to protect domestic interests. Some of it could manifest in ugly xenophobia—do not eat kebabs, do not employ Indian techies. This is going to be a tug-of-war worth watching.
What about India? We have undoubtedly benefited from globalization. Growth picked up after the 1991 reforms and poverty levels have declined. The fear of the outside world has subsided as national confidence has grown. For all their posing while in opposition, no major political formation in India has tried to roll back economic reforms.
Yet, let us not be surprised if the old swadeshi warriors polish their armour and step into the battle with renewed vigour this election season.
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Forbes thinks Tata can be India's Obama

Who could be India's Obama who could unite the country and march the nation forward at a traumatic time?
US business magazine Forbes feels it is industry captain Ratan Tata.
"While it (India) has the sympathy of the world (after the recent attacks), India could have an Obama moment -- one in which a leader, whose personal history epitomises the country's principles, marches forward to unite the country during its very moment of trauma. India has a chance now to get it right, but it needs a strong, credible leader to step up," Forbes said in a report.
"As an American, I don't get a vote in India, but if I did, mine would go to Ratan Tata," added the report written by Forbes magazine' Senior Editor (Asia) Robyn Meredith.
"He is not a politician, but he is the country's most respected business leader. His Tata Group owns the Taj hotel that was just attacked, but his family is just as connected to India's proud history as its shell-shocked present," Meredith wrote in a weekly column published online.
Posing the question whether should there be not a way to involve Tata at the highest level in the government, the report noted that "a fractured India" would immensely benefit from his acumen and constructive patriotism.
Meredith pointed out, "Should there not be a way to involve him in government at the highest level? A fractured India would benefit immeasurably from his acumen, his managerial skills, and his very obvious--but always constructive--patriotism."
Wondering what if the nation leapfrogged America's approach, the magazine pointed out that the political leap could be as successful as the country's technology jump.
"In a few short years, technology allowed India to go from a land with a 10-year-wait for a telephone to one where even farmers carry cell phones. India could make a political leap that is as successful as its technology jump," Forbes said.
Taj Hotel, the prime target of Mumbai terror attacks was the dream realised by Jamsetji Tata. It came up on the city's water front, after a British-owned hotel denied Jamsetji Tata entry, just because "he was not white".
Writing on the hotel, which was built much before the 'Gateway of India' came into existence, the report said, "It opened just over a century ago and was the first Indian-owned luxury hotel. That is why the attack on that hotel resonates so strongly: The Taj hotel was a symbol of all that post-colonial India could become -- successful, honourable, dignified, strong and admired the world over."
Noting that India is at the crossroads, the magazine said that the nation can "turn to past enemies, to yesterday's memories, or it can look to the future and new hopes that could unite the nation's Hindus and Muslims."

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What the world's big guns say about the meltdown

The financial crisis -- that has ravaged global markets, bankrupted many investment banks, brought about a tectonic shift in world economies, turned many a topcat into a homeless tramp and caused thousands to lose their livelihood -- is said to be the most horrific fiscal calamity ever to have visited mankind.
Worse, the full impact of this onrushing tsunami has not even been felt yet: experts promise more pain in the coming months and years. Pain that will take years to fade away.
And here's what the world's top leaders and economic brains have to say about the global meltdown. Read on. . .
We are right now teetering on the verge of panic: George Soros, billionaire investor, head of Soros Fund Management
The government's intervention is not intended to take over the free market, but to preserve it: George W Bush, president, US .
It's wrong to ask teachers, farmers and small-business owners to fill the gas tanks of the helicopters of Wall Street tycoons: John McCain, Republican presidential hopeful .
Washington has to recognise that economic recovery requires that we act not just to address the crisis on Wall Street, but also the crisis on Main Street and around kitchen tables across America: Barack Obama, Democrat presidential hopeful .
The Masters of the Universe have bitten the dust, the same dust that is now in the mouths of the rest of us. The impact on the developing world would be profound. Projects are already stopping because of the lack of liquidity and financing. The debt crisis would become worse. The decline in commodity prices and exports would hurt the developing world: Nirupam Sen, India's permanent representative at the UN .

I can say with certainty that if investment banks were still private partnerships, where the partners have all their personal capital at risk, the financial meltdown would never happen. They would not let another Lloyds of London capital call happen, ever: Mark Cuban, US billionaire.
The financial tsunami we now face is a global crisis. Its destructive force is much stronger and more widespread than the Asian financial turmoil in 1997. The recovery will take longer, be more difficult and certainly cannot be taken lightly: Donald Tsang, chief executive, Hong Kong .
What is the nature of the crisis? The details can be insanely complex, but the basics are fairly simple. The bursting of the housing bubble has led to large losses for anyone who bought assets backed by mortgage payments; these losses have left many financial institutions with too much debt and too little capital to provide the credit the economy needs; troubled financial institutions have tried to meet their debts and increase their capital by selling assets, but this has driven asset prices down, reducing their capital even further: Economic Nobel laureate Paul Krugman.
What we needed and didn't have two or three weeks ago was a good diagnostic of the problem: It was not a liquidity problem; it was a solvency problem. And once you start from that position, the British solution is the only way forward: Philippe Martin, professor of economics, the Sorbonne, Paris
I'm a strong believer in free enterprise, so my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business. Under normal circumstances, I would have followed this course, but these are not normal circumstances: George W Bush, President, US .

For the poor, the costs of the crisis could be lifelong. The poorest and most vulnerable groups risk the most serious -- and in some cases permanent -- damage. 100 million people have already been driven into poverty this year and that number will grow: Robert Zoellick, president, World Bank
Wall Street had it coming. . . The nature of America's financial crisis is the failure of Wall Street's business model in and of itself: Japanese columnist Hideo Tamura .
We live in an interdependent world and the fate of all countries is related to the international financial system. Our value markets are opened to the world and, if they are affected, this will affect our capacity to finance our development. If the financial crisis causes a recession in the main economies, this will compromise our exports: Manmohan Singh, Prime Minister, India
The age of Reaganism is over. The no-regulation, low-taxes philosophy has broken the back of our economy: Former Harvard University economist Jeffrey Sachs, now special adviser to the UN Secretary-General Ban Ki-moon
Where was the IMF? This is the sort of crisis that should be at the heart of what the IMF was set up to do, but no one in the U.S. or in other G-7 countries seems to turn to the IMF for advice: Mohamed El-Erian, co-CEO, investment firm PIMCO, and a former IMF economist who was in the running to head the fund four years ago.

Seeing big American banks saved by privatisations, one almost wants to scream, 'Marx, come back, they've gone crazy!' We're seeing, in renewed form, the most debatable aspects of Anglo-Saxon capitalism called into question: Arnaud Lagardere, general partner and CEO, Lagardere Group
I know too well how disastrous these slumps can be. During the 1991 recession I was basically bankrupt -- it all happens very quickly. So what's the use in finger-pointing? I don't want to see the Americans go down the pan. Everyone knows that we'll follow: Stephen Brown, British citizen
The financial world still has a number of serious problems. However, time and money will eventually heal them: Barton Biggs, Wall Street strategist
Although a great many policy actions have since been taken, they have been neither comprehensive nor global. Indeed, the approaches taken have been so varied and inconsistent, especially with regard to deposit guarantees, that they are intensifying problems for other countries: Dominique Strauss-Kahn, head, IMF
The situation is going to get better when you feel good about buying Citigroup stock. Right now, nobody feels good about buying it: John Catsimatidis, supermarket billionaire and New York mayoral hopeful .

It's a good warning for the Chinese economy, but I believe China will make the exact same mistake in future: Kelly Yu, Chinese citizen
You can't just blame the banks, you also can blame the people that took out mortgages... We were brought up that you first had to put some savings together and then enjoy. But this whole society has gotten to the fact that we're a 'now, give it to me today' kind of society. I think regulation has not been adequate. There's no one person to blame other than all of us: Mike Bloomberg, mayor, New York, former Wall Streeter, founder, financial services company Bloomberg
My own view right now is that cash is king; liquidity is king: Don Marron, US billionaire
The Wall Street crisis has been caused by the years of excesses and the fee-based economy where the only goal is to make fees at any cost without any benefit to the economy: Carl E Berg, US billionaire
We have counted on emerging economies, which collectively account for half of global GDP, to hold up. However, with the credit crisis reaching shores of emerging market countries, their growth is now likely to fall well below trend by the end of the year: Moody's Economy.com

Economic Policy: Obama vs. McCain

Denver, 25 Aug. The tightly-contested presidential race between Barack Obama and John McCain may ultimately boil down to one issue: Economic policy. The subprime mortgage crisis and the increasing cost of gasoline have contributed to the widespread escalating economic worry and fears of recession. How does each candidate address the most pressing economic issues? Each candidate is approaching the economy differently. Obama made a strong entry into the race largely due to his Iraq policy, and is only now gathering steam with economic issues. On 22 August, 2008, CNN reported that Obama needed to become an “economic populist” if he wanted to win the race. Whether this is true or not remains to be seen, but with McCain trailing by only one point, Obama will have to do something to garner more support. McCain’s entry to the race was also based on overseas policy – but now with domestic concerns on the rise, he is being forced to address economics at home. “The issue of economics is not something I’ve understood as well as I should,” the Arizona senator once admitted. It’s no secret that McCain is uncomfortable discussing the economy – he’s more adept at defending his war or immigration policy. So if Obama continues to embrace an economic agenda, he may well overshadow McCain as the candidate that can best create change for the country.More