Storm, The (25 page)

The world of international finance is characterized by what Richard O’Brien called ‘the end of geography’: a high level of
interconnectedness and rapid cross-border flows of money and data. The ‘end’ is, in practice, rather less definitive, because
many less developed, emerging economies are not fully integrated financially with the rest of
the world and, in all countries, there are numerous financial transactions that depend upon proximity and personal relationships.
There is, nonetheless, a tension between the globalized world of financial and wider economic integration and the world of
national political decision-making.

To a degree, tensions can be eased through agreed global rules. Long before this crisis, it was understood that the benefits
of trade in goods and services and cross-border investment could not be realized without a rules-based global regime that
embedded some common standards. There are, already, quite explicit Bank for International Settlements global rules governing
bank capital requirements and, arguably, without these, banks would have become even more highly leveraged than they have
been in pursuit of competitive advantage. There are the (less developed and self-regulatory) rules under the International
Organization of Securities Commissions (IOSCO) governing global markets in securities, or the attempts being made to create
common accounting rules. And the WTO not only liberalizes trade but also seeks to create rules for the fair – that is to say,
equal – treatment of companies investing overseas and governing the use of subsidies. These transnational rules – some intergovernmental,
some private sector – are fundamental to making globalization work.

There is some recognition, too, that one country’s economic policies spill over on to others’ through the activities of the
International Monetary Fund – though, apart from emergency and politically onerous balance of payments assistance, mainly
to small, poor countries, the IMF’s formerly central role in easing countries’ temporary payments crises has become peripheral.
Instead of collaborating to provide a pool of funds to finance emergency lending, nervous governments have taken to insuring
themselves by piling up large foreign exchange reserves: a wasteful alterantive which has added to global instability. The
one major international structure to take account of cross-border policy impacts is the European Monetary Union and its accompanying
fiscal rules (and also its important competition
policy and state-aid rules). These limited and inadequate activities collectively represent the cooperative infrastructure,
the flood defences, that have to withstand the stresses and strains of the massive storm currently hitting the global economy.

As we noted above, there are strong political and institutional pressures to act in a nationalistic, not a competitive, manner,
and an emerging ‘state capitalism’ that puts state actors at odds with international rules. So far, however, the main governments
have broadly acted on the principle that unless they hang together, and cooperate, they will hang separately. The European
Union, the Group of 8 developed countries (and Russia), and the Group of 20 developed and major emerging countries have all
been pressed into service, as never before, to produce agreed positions and action. In October 2008 the European Union narrowly
avoided a beggar-my-neighbour competitive scramble for bank deposits, when Ireland and Greece offered unlimited depositor
protection and other countries looked set to follow, before a common approach was agreed. The US Paulson plan and the British
bank recapitalization plan were endorsed by each of the main countries affected by the banking crisis, and a version of the
British plan was widely adopted.

There has also been a degree of commonality in the approach to macroeconomic policy. At the height of the banking panic in
October, there was an agreed 1 per cent cut in interest rates, partly to maximize the impact on business and consumer confidence,
and partly to stop unilateral action triggering a currency crisis as markets targeted relative weakness. But Britain’s more
aggressive approach to interest rate cuts – and the perception that Britain is exceptionally vulnerable because of the size
of its banking sector and the scale of its housing bubble – contributed to a serious weakening of sterling (though the subsequent
devaluation has, in the short run at least, helped the UK escape the worst of recession). Fiscal policy is more difficult
to coordinate because it is difficult to compare the impact of different combinations of tax cuts and current and capital
spending increases, and because measurements
are only roughly consistent. Nonetheless, a loosely coordinated package was agreed in December 2008, which involves the USA
providing a stimulus of around 4 per cent of GDP, mainly in public works. The EU was to contribute around 1–2 per cent of
GDP – despite big differences between member states and a strong reluctance to participate on the part of Germany. Other stimulus
packages, from China and Japan, were ambitious but not entirely believable. And, so far, the main countries have mostly resisted
the temptation to indulge in protectionist trade policies and competitive industrial intervention, despite some slippage in
US trade policy, in EU support for the car industry, and in China. The refusal of the US Senate to countenance a comprehensive
bail-out for the car industry was a welcome act of self-discipline, though the US government took a big share in General Motors
and there are large subsidies for the industry.

So far, mainly so good. There is, however, one set of issues that is being addressed only tentatively and that has the capacity
to derail any kind of cooperative response and to generate serious conflict. It concerns the shift in the centre of gravity
of the world economy to the east, particularly to China, and the imbalances that have grown up, with China (and other surplus
savings economies) providing large flows of capital to the USA (and the UK). As described in
Chapter 5
, the continued growth
of the USA, based on imported savings and cheap finance, lay at the heart of the banking (and associated housing) crisis.
And this growth was only possible, in turn, because of a system of ‘vendor finance’ provided by China to the rest of the world
in order to enable Chinese exports to grow rapidly, fuelling Chinese economic growth.

By agreeing to participate in a common approach to fiscal stimulus, the Chinese are signalling a recognition that they can
only continue to coexist peacefully (in economic and, perhaps, military terms) if their model of economic growth shifts towards
domestic demand rather than export. Ominously, however, the Chinese authorities responded to a serious slowdown in growth
and export demand by pushing their undervalued exchange rate
lower, rather than higher. And the Chinese official reading of the crisis has been in terms of Western – specifically US –
economic weakness and lack of financial discipline, rather than a recognition of shared responsibility and mutual weaknesses.
As the crisis deepened in 2009, some American and European politicians were spoiling for a fight with China: an economic war
characterized by trade restrictions and a search for ‘economic security’ through bilateral deals and attempts to pre-empt
supplies of energy and food. That would be a route to disaster.

There is an alternative: a new multilateralism that recognizes the changing balance in the world economy and has Asia at the
heart, not at the edge of it. The references by many commentators to a New Bretton Woods agreement correctly emphasize multilateralism,
but with it comes nostalgia for an Anglo-Saxon-led world with its intellectual capital somewhere on the civilized east coast
of the USA. The New Bretton Woods, if it were to happen, would be better hosted in Singapore. The key participants would be
the USA, China, Japan, the eurozone and India. The membership of the two G20 meetings in 2009 already reflects this new reality.

The key issues to be addressed, and resolved, are well-enough recognized and have already been the subject of innumerable
conferences and speeches. This is not the place to rehearse all the complex issues involved, some of which have been dealt
with above. But unless the key players can demonstrate a capacity to make serious headway on them, the existing structures
could swiftly unravel, to be replaced by confrontation and conflict.

The first of the issues is the left-over business from the old Bretton Woods – exchange rates, economic imbalances, and macroeconomic
stability – which has a new dimension in the surpluses of China (and other Asian and oil-exporting countries) vis-à-vis the
deficits of the USA (and others). The IMF was to have been at the centre of the adjustment process. In practice, adjustment
has been privatized, disastrously, and the international banking system has collapsed under the weight of it. The IMF, with
quotas and voting weights radically changed to reflect the
new economic reality, will have to have a much bigger role again, monitoring trends and coaxing governments with serious indebtedness,
providing balance of payments finance that is adequate and timely, and overseeing the stronger regulatory regime for global
finance that will emerge from the crisis.

Second, there is man-made climate change. Little progress can be made without fundamental agreement on the principle of ‘contraction
and convergence’, as between the high-income countries, which have generated the lion’s share of the stock of carbon in the
atmosphere, and the big low-income countries, which will contribute the greatest future emissions. Without China or India
as full and equal partners in the process, it will fail. In the run-up to the Copenhagen Conference to strengthen the earlier
climate change agreement at Kyoto, these two countries were in no mood to accept any constraints on their economic growth.

Third, there is revival of the stalled talks on world trade, which have ground to a halt, in substantial part because of lack
of agreement on the most fundamental of traded goods: basic foodstuffs. The necessary opening of markets and the removal of
damaging subsidies – as for biofuels – also has to reflect a legitimate concern in poor countries that there will be ‘food
security’, and recognition that a large part of the world’s population – the poorest – are peasant farmers engaged in subsistence
farming or producing small marketable surpluses.

Last but not least, the development agenda – to eliminate hunger, poverty and disease – for which the World Bank is the lead
agency, has to remain central, for both economic and moral reasons. Looking back on the events of the last few months, what
is striking is the alacrity with which the USA and the EU have managed to mobilize $3 trillion (and rising) in capital and
guarantees for failed banks, having failed to mobilize $300 million to help fight hunger in the midst of a food supply crisis
earlier in the year. Such narcissistic self-absorption and twisted priorities do not bode well; but a structure of global
governance in which the main emerging economies have parity would do something to redress the balance.

I have described above the global linkages which transformed a banking crisis centered on the US and UK into a global recession.
But there is a particular significance for Britain. After the sense of defeatism and national decline of the 1970s, the painful
transformation under Mrs Thatcher and then the decade of growth under a New Labour government had produced a new sense of
national confidence, a confidence derived above all from having an economy that seemed to work well. Britain (at least in
its own eyes) was elevated from the ‘sick man of Europe’ to an exemplar of good economic management, stability and contentment.
No more ‘boom and bust’. No more sterling crises. No more bloody-minded unions, decrepit factories or lagging growth rates.
Even as the crisis has unfolded, the government has stuck uncompromisingly to the line that any problems are ‘global’, that
the British economy is sound.

When we look at the foundations of this confidence it rested, essentially, on three main elements: the success of the global
financial services industry, centred on London but of which Northern Rock was a provincial outpost; an openness to overseas
investors as a source of technology, management and capital; and a sense of personal prosperity and well-being deriving from
appreciating property prices for home owners and consumption, financed by borrowing. Yet, until the current crisis, these
foundations had not been seriously tested.

In a big storm, even the finest-looking trees come down if they have shallow, insecure roots or an excessive weight of leaves.
So the British economic miracle of recent years has been exposed as structurally unsound, however superficially impressive
the foliage might have appeared. The effects on politics and national morale will be profound and long-lasting. Each of the
key elements in the British ‘success story’ needs to be re-examined afresh. Starting with the last, the great housing bubble
has provided an illusion of wealth and fed a lie: that housing equity is a safe form of saving, a pension, a one-way-bet.
Many have been complicit in that lie: politicians, bankers, financial advisers and journalists. There are strong pressures
to perpetuate the lie, to reflate property values through state-generated mortgage loans and other protections. And it may
be that there will be some vindication for property investors, since the collapse of the house-building industry is destroying
potential supply and helping to ensure that event ually, once demand recovers, prices will escalate because of supply bottlenecks.
But the housing bubble, and associated personal (mortgage) debt, has exposed a serious failure in economic policy: the inability
of a much-vaunted independent central bank to manage asset inflation and deflation. The deeper challenge is to demystify property
ownership and owner-occupation and to ensure that in future first-time buyers enter the market when prices are at more realistic
levels and on the basis of a substantial deposit, and for government and local planners to aim for a much better mix of social,
privately rented and owner-occupied property, as in Germany or Switzerland.