The G20 Parachute

The G20 Summit, which concluded last week, leaves open three great questions. Can China give enough support to prop up the US economy and the dollar? Can Asia, especially China, India and Indonesia, summon enough demand and trade finance to help lead world recovery? Where and when do we see the structural changes which Asia wants in world economic institutions to reflect the new balance of economic power?

These questions are not yet fully answered. The G20 has started to address the global financial meltdown and collapse in world demand, but the underlying causes of the collapse of Western housing and equity markets are not yet adequately addressed. Changes in power structures and policies in international economic institutions are not yet addressed. There is still a huge question mark over the US and UK bailouts, as to whether they will work, and what will happen to the dollar and sterling? Asian countries clearly still have doubts in the future of the dollar and do not wish to over-depend on it.

Asian countries cannot make use of IMF facilities until they overcome distrust going back to the 1998 Asian banking crisis. Asia wants the IMF restructured for a new approach, not refinanced for the old one.

But Asian countries would be interested in a new role for a restructured IMF leading to the transformation of Special Drawing Rights (SDRs) into a fully-fledged international trade support currency. So when are IMF structural and policy changes going to take place? Or did the G20 simply give new money to second-hand Rose wearing second-hand clothes?

The G20 agreed to pump $5 trillion into stimulus packages and trade boosting measures and act against tax havens, control corporate rewards, push a global trade deal and set up a Financial Stability Board (FSB). Of course the G20 could not restructure the International Monetary Fund, the World Trade Organization and the World Bank in a weekend. But is there a real commitment to these changes or will a G7 clique still cling to world economic power?

British Prime Minister Gordon Brown said the G20 means a new world order is emerging, but so far the G20 has simply stitched together a new kind of parachute for a financial system in free fall, and now we are going to find out if it works. After this we still have to learn how not to fall down again.

Roman Frydman and Michael Goldberg argue that the near collapse of the financial system exposed structural weaknesses but the US Financial Stability Forum (FSF) is missing the point by focusing mainly on transparency, leveraging, tax havens, crazy incentives and conflicts of interest. The point is that massive downswings in housing and equity markets, reflecting previous upswings way above sensible benchmarks, mean there is a still a risk of further excessive downswings. We are not yet addressing risks related to underlying asset values and do not have financial buffers in place to deal with this.

This reflects market failure in a system that was supposed to be market-led and self-righting.

The full impact of the US recession, bailout and stimulus package are yet to be felt. The huge scale of Western toxic assets and financial scams is still coming to light. The liquidity problem is not solved. The financial markets are still not working properly. Global demand is still collapsing.

Chinese Premier Wen Jiabao sees China already holding $740 billion of US debts and President Obama increasing US debt by another US$2.5 trillion to finance the bailout, compared to maybe US$1.6 trillion now held by Saudi Arabia and the Gulf States from high oil prices in the first half of 2008.

China is helping bail out the US and supporting the IMF, but holding back to some extent. Of the 50 million people who will lose jobs in this crisis, 20 million will be Chinese. China has to bail itself out too.

The country is not quite ready to declare itself a financial super power, and must position well in case the US (and UK) take a second nose-dive, despite the best efforts of President Barak Obama and Prime Minister Gordon Brown. If that happens the rest of the EU may nose-dive with them unless they keep very cool heads.

Then the US dollar could take a real hit and the UK might have to drop sterling and go into the euro. China cannot afford to take a major drop if these events happen. Asia still has to lead a global trade recovery, backed by Middle Eastern liquidity. Asian leaders are therefore no longer sure of the US dollar, nor of its financial system or its banks, nor of the true value of its underlying assets. Time for Asia to stand on its own feet.

Terry Lacey is a development economist who writes from Jakarta on modernization in the Muslim world, investment and trade relations with the EU and Islamic banking.