Dateline 25th, June 2010,Â Â Fake Lake, Ontario, Canada
Eat your heart out South Africa!! You might have the FIFA Word Cup to celebrate, but Canada has the â€œMax Carbon Footprint Lollapalooza Rolling Caravan and Econo Extravaganzaâ€ in town; otherwise known as the G8/G20 Meetings. Featuring a cast of tens of thousands; a security budget of $1 Billion; and your favourite World Leaders; never before has Toronto the Good hosted an event which promises to generate so much hot air. Apart from the security lockdown, the cost, and the fumes; what does it all mean?
Weâ€™ll get to that later in this piece.Â In the meantime we turn our attention to a related matter that appears to us to be of more pressing importance, namely, the unfolding Sovereign Debt crisis.
The markets have hailed the UKâ€™s post-election budget and similar moves on the ContinentÂ as evidence that the Sovereign Debt crisis is receding and the appropriate solutions have been identified and are being applied. Simple Simon. The reality is that these types of financial reform operations have a very poor track record of success, as we have discussed at length elsewhere. There are only a handful of success stories among the more than 140 attempts at fiscal consolidation in the last few decades. Importantly, there has never been a successful effort mountedÂ in a situation where numerous countries are attempting to achieve the same thing in the aftermath of a Global Financial Crisis (GFC). [For more detail on this topic you can view a BNN G8/G20 Special Panel discussion on Sovereign Debt in our Newsroom section.)
What the authorities will never acknowledge and what the MainstreamÂ Media has either ignored or failed to understand, is that the Sovereign Debt crisis is itself the result of Policy Failure and years of Government cronyism, inefficiency and waste that took root and spread throughout a number of economies. ThisÂ made theÂ authoritiesÂ in those places very reluctant to upset the balance of political and economic interests that hold sway; and encouraged policymakers to apply fixes that protect those interests at the expense of more appropriate, durable andÂ cost effective solutions (but those happened to be options that promised to do financial damage to their supporters and paymasters).
Â Thus, the reality is that the second-order effects of the Fed-mandated QE include significant erosion of market confidence in a number of economies who participated in the program of aggressive fiscal expansion to support activity. Many Governments it now turns outÂ did not possess finances and institutions robust enough to sustain the policy – it should never have been followed by those countries in other words.
Hence we witness that within 18 months, the Euro-zone and other economies are largely abandoning what will ultimately be recognized as a massive failed experiment based on the idea of Keynesian pump-priming, and have moved instead to exercise restraint and austerity in an attempt to rein in ballooning deficits and deteriorating finances. Only the US and to some extent Canada, are continuing to advocate further fiscal expansion, unwilling to admit that this policy move, while having stopped a potentially deeper recession, has brought with it an array of more serious problems to deal with; including the risk of sovereign default(s), geopolitical instability and a renewed downturn in the key economies.
Â Apart from the political dimension, this policy failure is also related to the fact that key government agencies around the globe, most importantly the Fed and Treasury, did not recognize that what was and is occurring is a Solvency Crisis and not a Liquidity Crisis. The distinction is important. In the first instance, this means that you cannot solve this problem with either monetary or fiscal policy. There must be a reckoning and write-down of bad debts.Â This is the only cure.
However, as a consequence of the policy-driven efforts to prop up the many and various zombies, not only has there been a massive risk transfer to national balance sheets (leaving taxpayers on the hook); the needed liquidation of bad debts has been pushed into the future causing solvent banks to shy away from lending, creditworthy borrowers to restrain their activity and savers to hoard as opposed to investing. This promises to stretch out the period of adjustment until the needed liquidation has run its course. If Japan’sÂ experience since the early 1990’s Â is any guide, and the authorities remain slaves to mis-guided Keynesian policy prescriptions, then this adjustment will likely take many decades; assuming that we do not experience a worse crash, extreme social dislocation, and/or geopolitical conflictÂ in the interim.
Â For these and other reasons we believe that the G8/G20 roadshow is unlikely to produce any major policy agreements and will instead serve to highlight key policy differences between countries participating in this shindig. Outside of the many potential areas of disagreement, we listÂ five key issues that will fail to find resolution at these meetings:
Â The key area of policy difference was alluded to above. The US and Canada are clearly advocates of continued pump priming while the key euro-zone countries are embracing fiscal restraint. Inscrutable as always, Japan is sitting on the fence while hinting at wanting to rein in its deficit but taking no steps to do so.
Â The second most important area of disagreement concerns the Chinese exchange rate. As we know there is significant potential here for tensions to flare up despite the soothing announcements by Chinese policy authorities ahead of the meetings, suggesting that they were relaxing the Yuan/US peg. We are more likely going to see the Chinese continue to keep their options open while seeking to extract more concessions in return for agreement to the Western demands that the Yuan should appreciate.
The third bone of contention is the relevance of the G8 itself and whether this forum should continue. The attack on the hegemony of the large Western Economies is rooted in regional differences and the failure of the G8Â to deliverÂ on commitments it has made at its previous meetings.
Fourth is the issue of Global Warming which, quite apart from the science which remains unsettled, cuts straight across North South Divide as regards the apportionment of the fiscal burden.
Finally, the bank tax and supervisory reform is another area of friction where Canada has led the charge against a bank levy, and is supported by the Japanese and others whose banking systems held up during the crisis; while the countries in theÂ euro-zone and the US are in favour of new taxes on banks and more stringent supervision.
Â G8, G20 it doesnâ€™t matter. In an environment of instability and financial stress, the policy flips of the past 18 months and the growing rifts between various countriesÂ in key areas of economic management are extremely worrying. In our view therefore, the best and safest thing to hope for coming out of these meetings is that our fearless leaders do not make things yet worse.