Stephen King: Creditor nations may be looking to pick up some corporate silverware

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In one sense, next Saturday's G20 meeting in Washington comes too early. George Bush is still in the White House, even though he no longer sets America's economic agenda. Barack Obama, the man who will set the agenda, won't really be able to do much of substance until 20 January and, according to reports, has no intention of being anywhere other than Chicago next weekend. Nevertheless, the world's financial system is in crisis. Even if the US administration is impotent, it is better to establish some form of international dialogue. Or we could find ourselves hurtling towards protectionism.

The G20 is an informal gathering of the world's biggest and most influential industrial and emerging nations. It includes the G7 nations (plus the European Union if the EU Presidency is held by a country other than the UK, Germany, France or Italy). It also embraces China, India, Saudi Arabia, Turkey, Russia, Brazil and Mexico, among others.

The chances of 20 leaders agreeing on anything are remote, but the meeting in Washington DC on 15 November will at least involve the right countries. On too many occasions, the G7 members sit down for a cosy cup of tea forgetting the world economy has changed a lot over the last 20 years. The G20 reflects that change.

Broadly, three groups of countries will be represented at the G20: the world's biggest debtor nations (the US is miles ahead of everyone else, but the UK has also borrowed a lot from other countries); the world's most important creditor nations (China, Saudi Arabia and Russia); and the world's most important commodity producers (Russia and Saudi Arabia again, but also Brazil and South Africa). All will play a role in shaping a new global financial architecture.

When it comes to modern global finance, no country is an island. Once the assumption of financial independence is dropped, it becomes easier to piece together the causes of today's financial crisis. Take China. Although capital spending in China has been booming, China still manages to save more than it invests, reflected in a large current account surplus. The excess savings are invested abroad. Their cautious approach means they're happy to buy lots of safe assets, notably US Treasuries. Chinese demand for Treasuries leaves yields on Treasuries rather low. That creates a problem for global investors, who discover that returns on Treasuries are not high enough to meet their investment objectives. They demand other assets which offer higher yields.

Turn the clock back a few years, and the assets which became fashionable were mortgage-backed securities, effectively bundles of mortgage loans sold by banks to investors who needed higher yield. So long as the ratings agencies were prepared to give these securities high ratings, investors didn't need to worry: they could enjoy higher yields, apparently with no additional risk. The problem was the rising demand for mortgage-backed securities made it easier for banks to increase their lending in the housing market. House prices rose rapidly, creating the conditions for even more lending. A housing bubble was the inevitable result. I'm not suggesting China is responsible for the current financial crisis. I'm pointing out that economic interdependency has become greater. It is not enough to worry about the size of America's current account deficit. It is as important to contemplate the effects of large current account surpluses elsewhere in the world.

The success of economic policies today must take this interdependency into account. The US and the UK are beginning to believe that monetary policy, on its own, is not going to be sufficient to solve the current crisis, notwithstanding the bold interest rate cuts over the last few days. With the rapid rehabilitation of John Maynard Keynes, fiscal policy will also play a role. The reason is simple. Following the collapse in demand for mortgage-backed securities and the increase in mistrust between the banks, the banks' sources of funds dried up. Loans are too high relative to deposits. Even if the price of loans comes down, the quantity of loans supplied will shrink. This is what a credit crunch is all about.

Rate cuts alone cannot guarantee levels of demand which will pull economies quickly out of recession. Governments have a fiscal role to play, creating demand in areas inaccessible to monetary policy. They can do this by borrowing more.

But from whom? Around half of all the Treasuries that exist are held outside the US. Big creditors include the central banks of China, Russia and the various oil-rich countries of the Middle East. If the US and the UK are going to spend their way out of recession, it is to these countries that they will need to turn if they are going to raise fiscal funds through conventional means. The creditors may not be so enthusiastic. For them, an increase in the supply of Treasuries or gilts will feel a bit like an equity rights issue but without the voting rights.

The creditors may decide to play hardball. Rather than lending to Western governments who then decide how the money is best spent, perhaps China and others will instead demand to own Western companies outright, requiring a sale of the West's family silver. Would the incoming US administration sanction such a move? Is it likely that American banks, car companies and industrial conglomerates would be allowed to fall into Chinese or Saudi hands?

Perhaps not. Nevertheless, until now, the role of the creditor nations had received scant attention in the Western press. Moreover, Western policymakers have, doubtless unintentionally, created anxiety within the emerging world as a result of the various banking bailouts. Understandably, Western taxpayers want to see some benefits from the cash injections into the financial system. Governments, in response, have asked banks to protect certain kinds of domestic lending, notably to households and to small and medium-size enterprises. If, though, there's a shortage of funds to support lending, ring fencing lending in some areas must lead to greatly reduced lending elsewhere. Emerging economies are directly in the firing line.

The West desperately needs funding to support its broken financial system. The emerging markets desperately need Western demand to enable their own economies to generate the income gains which will drag people out of poverty. If, though, there's a failure to recognise the important roles being played by both creditor and debtor nations, we could end up in a world of cross-border capital and exchange controls as countries seek protect their "national interest". This would be a disaster. Our countries are more closely interconnected than ever before. Given America's temporary impotence, the G20 meeting may, on its own, achieve very little. At least, though, it forces the interested parties to talk to each other. With no dialogue, there can only be despair.

Stephen King is managing director of economics at HSBC