Thursday, April 2, 2009

"Nasty, brutish and short" or "Where's your Leviathan my G20 friends?"

In response to a comment I feel the need to publish this in order to give people a better understanding of what exactly we can expect from the G20 meeting.

Basically the G20 today released a communique about the outcome of its meetings. Much of it was a statement of an intention to do everything possible to restore the world economy to health and propserity both as individual nations and collectively. There was some reference to actions that have already been taken by governments. There were several items of interest those are:

1.) A commitment to increase the funding for the IMF by $750 billion. The IMF will also liquidate its gold reserves in order to improve its liquidity. Along with this they pledged to support multi-lateral development banks and trade finance.

2.) They agreed to reform banking regulation within thier own countries and to promote cooperation between thier various regulators in order to prevent "regulatory arbitrage."

3.) They pledged to refrain from increased protectionism and called on the WTO to monitor their adherence to this pledge.

Personally I think the only thing that has real meaning is item 1.) We don't know what horse trading went on behind the scenes and to what extent China's wishes for more influence over the IMF were granted and we won't know for a while. While it is helpful to know that the firemen at the IMF will now have plenty of water when needed it doesn't say too much about the fire itself. Countries which recieve IMF funds often nonetheless have wrenching adjustments to make even if they are smoothed over with IMF funding.

The other two points I think are mostly just for show. Recently there have been calls for a global regulator. On the subject of tax havens there was wide agreement that banking secrecy should come to an end and they seemed willing to threaten tax havens with sanctions. But with regard to banking regulaton the G20 stopped well short of global regulation and instead asked for their individual regulators to "cooperate."

Personally I think that cooperation is likely to be short lived. London made serious inroads against New York as the global hub for finance after the US passed the Sarbanes Oxley act and moved the international IPO business from the NYSE to the AIM. Most other budding financial centers learned the lesson of that and I think that there will be no shortage of would-be Londons from Dubai to Shanghai willing to take on the mantle of the easiest place to do business.

I think the trade issue is the same story. Almost immiediately after the last G20 meeting Russia placed tariffs on foreign cars. It is true that the world is made better off by free trade and it is true that the Smoot-Haley tarrif act in the 1930s made the depression deeper than it needed to be. But there is a fundamental problem with international cooperation under duress that the G20 is not designed to address.

The reason for this was best explained by Thomas Hobbes in his classic work Leviathan.

The premise of the book is that human beings live in a "state of nature" which is characterized by a war of all against all. Every man for himself and the devil take the hindmost. In order for civilization to flourish you need a "Leviathan" or a person with more power than any individual or most concievable collections of individuals in order to establish the rule of law. For this Hobbes had in mind the King of England because well, he worked for the King.

The international system is essentially a state of nature. There is no single state, not even the United States with the power to enforce rules on the whole system and the G20 certainly cannot do it. The real problem is that the governments are not responsible to one another, they are responsible to a domestic audience. An international financial regulator need the cooperation of all the domestic regulators in all the states because only they have the power to enforce the law within their states.

There will come a time when the interests of indidividual states conflict with those of the international regulators and in those cases the states will go their own way. Take for example the subprime lending crisis. Imagine that an international banking regulator had determined that subprime lending combined with securitization posed a systemic risk to the world financial system and as a result lower income Amercans should continue renting and be shut out of the American dream. Something tells me America would have sent the international regulator packing.

It's the same thing with trade. It's all well and good to put something down on paper about how trade is the best thing for everyone and we are not going to raise trade barriers. This neglects some basic facts. Right now international trade is somewhat one sided with America being responsible for the plurality of world imports and a number of mercantilist countries generating huge trade surpluses against the US and using them to run their countries and keep their currencies cheap to keep the game going.

Trouble is, the American consumer and soon the American government have taken in too much foreign capital and to pay it back we need to reverse the balance of payements. How do we do that? We need to export more and import less. But the rest of the world wants to do the same thing at the same time. It is easy to say that we don't want to embark on a protectionist spiral but what will the mood in the country be when we have 9% unemployment and are still shipping $500 billion a year abroad to pay for imports? How about 10%. 11% The voices of free trade are going to get quieter and quieter and the voices of protectionism are going to get louder and louder. And what will the G20 do to silence them? It will use all its enforcement powers....

....which is to say... nothing.

No comments: