The G-7 Geopolitics, Politics and the
Monday, 13 October 2008
The G-7 - Geopolitics,
Politics and the Financial Crisis
The finance ministers of the G-7 countries are meeting
in Washington. The first announcements on the meetings
will come this weekend. It is
not too extreme to say that the outcome of these
meetings could redefine how the financial markets work,
certainly for months and perhaps for a generation. The
Americans are arguing that the regime of intervention
and bailouts be allowed to continue.
Others, like the British, are arguing for what in effect
would be the nationalization of financial markets on a
global scale. It is not clear
what will be decided, but it is clear that this meeting
The meetings will extend through the weekend to include
members of the G-20 countries, which together account
for about 90 percent of the
This meeting was called because previous steps have not
freed up lending between financial institutions, and the
financial problem has
increasingly become an economic one, affecting
production and consumption in the global economy. The
political leadership of these
countries is under extreme pressure from the public to
do something to solve or at least alleviate the problem.
Underlying this political pressure is a sense that the
financial class, people who run global financial
institutions, have failed to behave
responsibly and effectively, and have therefore lost
reasonable or not, is that the political system will now
supplant these managers and impose at least a temporary
The finance ministers therefore have a political
mandate, almost global in scope, to act decisively. The
question is what they will do?
That question then divides further into two parts. The
first is whether they will try to craft a single,
global, integrated solution.
The second is the degree to which they will take control
of the financial system; and inter-financial institution
lending in particular. (A primary reason for the credit
crunch is that banks are currently afraid to lend even
to each other.) Thus far, attempts at solutions on the
whole have been national rather than international. In
addition, they have been built around incentivizing
certain action and increasing the available money in the
So far, this hasn't worked. The first problem is that
financial institutions have not increased interbank
lending significantly because they are concerned about
the unknowns in the borrowers balance sheet, and about
the borrowers ability to repay the loans. With even
large institutions failing, the fear is that other
institutions will fail, but since the identity of the
ones that will fail is unknown, lending on any terms
with or without government money is imprudent.
There is more lending to non-financial corporations than
to financial ones because fewer unknowns are involved.
Therefore, in the United States, infusions and promises
of infusion of funds have not solved the basic problem:
the uncertain solvency of the borrower.
The second problem is the international character of the
crisis. An example from the Icelandic meltdown is
relevant. The government of
Iceland promised to repay Icelandic depositors in the
island country's failed banks. They did not extend the
guarantee to non-Icelandic
Partly they simply didn't have the cash, but partly the
view has been that taking care of ones own takes
priority. Countries do not want to
bail out foreigners, and different governments do not
want to assume the liabilities of other nations. The
nature of political solutions is
always that politicians respond to their own
constituencies, not to people who cant vote for them.
This weekend some basic decisions have to be made. The
first is whether to give the bailouts time to work, to
increase the packages or to accept that they have failed
and move to the next step. The next step is for
governments and central banks to take over decision
financial institutions, and cause them to lend.
This can be done in one of two ways. The first is to
guarantee the loans made between financial institutions
so that solvency is not an issue and
risk is eliminated. The second is to directly take over
the lending process, with the state dictating how much
is lent to whom. In a real sense, the distinction
between the two is not as significant as it appears.
The market is abolished and wealth is distributed
through mechanisms created by the state, with risk
eliminated from the system, or more
precisely, transferred from the lender to the taxing
authority of the state.
The more complex issue is how to manage this on an
international scale. For example, American banks lend to
European banks. If the United States comes up with a
plan which guarantees loans to U.S. banks but not
European banks, and Europeans lend to Europe and not the
United States, the integration of the global economy
will very quickly shatter, leading to significant
limitations on international trade, currency
convertibility and so on. You will nationalize economies
that cant stand being purely national.
At the same time, there is no global mechanism for
managing radical solutions. In taking over lending or
guarantees, the administrative
structure is everything. Managing the
interbank-lending of the global economy is something for
which there is no institution.
And even with coordination, finance ministries and
central banks would find it difficult to bear the
burden; not to mention managing the
systems Herculean size and labyrinthine complexity. But
if the G-7 in effect nationalize global financial
systems and do it without
international understandings and coordination, the
consequences will be immediate and serious.
The G-7 is looking hard for a solution that will not
require this level of intrusion, both because they don't
want to abolish markets even
temporarily, and more important, because they have no
idea how to manage this on a global scale. They very
much want to have the problem solved with liquidity
injections and bailouts. Their inclination is to give
the current regime some more time. The problem is that
the global equity
markets are destroying value at extremely high rates and
declines are approaching historic levels.
In other words, a crisis in the financial system is
becoming an economic problem and that means public
pressure will surge, not decline.
Therefore, it is plausible that they might choose to ask
for what FDR did in 1933, a bank holiday, which in this
case would be the suspension
of trading on equity markets globally for several days
while administrative solutions are reached.
We have no information whatsoever that they are thinking
of this, but in starting to grapple with a problem of
this magnitude and searching for solutions on this scale
it is totally understandable that they might like to buy
It is not clear what they will decide. Fundamental
issues to watch for are whether they move from
manipulating markets through government
intrusions that leave the markets fundamentally free, or
do they abandon free markets at least temporarily.
Another such issue is whether they can find a way to do
this globally or whether it will be done nationally. If
they do go international and
suspending markets, the question is how they will unwind
this situation. It will be easier to start this than to
end it and state-controlled
markets are usually not very attractive in the long run.
But then again, neither is where we are now.
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