Where the finance ministers can fix it
Monday 05 October 1998
Robert Rubin, the US Treasury Secretary, described the meeting of the G7 finance ministers as "energised" or "energetic" half a dozen times. I'm not sure that the world really needs energetic finance ministers and central bankers. It needs calm and competent ones.
To say this is not to be dismissive of Mr Rubin, the G7's most important player, or Gordon Brown, who as UK Chancellor is currently the G7 chairman. Both are playing a weak hand with some style. Both sought to portray the G7 as active and in charge. But if you look at the ability to deliver there is a great vacuum.
Thus, the Japanese promise to rescue their banks and promote growth. Er, yes, without knowing how to do so? The US Administration promises to pay its dues at the IMF. Yes, but that is a Congress decision, not one for the Administration. Gordon Brown promises to promote sustainable growth in the UK. Yes, great idea, but already the Treasury predictions for growth next year look seriously over-optimistic.
So in this context, all these longer-term plans for changing the world money system are interesting but irrelevant. Everyone has to have A Plan for reforming some bit of the system. We have one; the Americans have one; the French have one; the Germans have one; the Japanese have one; the Canadians have one. The only G7 member that doesn't is Italy, and since the Banca d'Italia is in the central bankers' doghouse for investing in LTCM, the hedge fund that went belly up, maybe that is no bad thing.
So in the short-term there is likely to be disappointment. I suspect some of that will manifest itself in the markets this week, but unless there is blind panic, that short-term test is less important than the longer-term one.
Two things have happened in the last few days which have scared the more thoughtful participants at the G7 meeting. One is the clear sign that the Asian crisis is hitting the real economy in the US. Individual US companies had been warning of cuts in profits and in jobs for some months, but on Friday came figures showing a sharp fall in manufacturing jobs and only a small rise in employment overall. This was the first general evidence of a slowdown in the world's main engine of economic growth.
The other is the increasing evidence of a "credit crunch". This cute expression describes the situation where banks refuse to lend even to good risks because they have lost so much to bad ones. No-one can borrow, and economic activity declines as a result.
I spoke with one top banker who I have known for a long time. I have never seen him so worried. He felt that there had really been a change in the fragility of the world banking system. It wasn't just Asia. Russia had been the major shock, for here was a part-time member of the G7 (it became for a while the G8) defaulting on its debts. Add in the collapse of LTCM, plus the bizarre fact that even a G7 central bank had invested in it, and the sense of shock was all the greater.
As a result we had reached a new stage of the crisis, the outcome of which had become impossible to predict. One measure, however, of the financial world's desperate search for assets it could trust was the fall in bond yields of trusted governments, like the UK. People were terrified of everything else. What is the right policy response to all this? You have to segment the question, because there are lots of different problems, all of which require different reactions.
There are some obvious immediate problems that can be fixed and have to be fixed fast. Among these are shoring up the Japanese banking system. That is a mammoth job, with estimates of bad debts costing up to 30 per cent of Japan's GDP. If that is right, the Japanese are not going to experience much of an increase in their living standards for a generation, because they are going to have to pay somehow, either in higher taxation or in lost deposits, for their bankers' folly. You can see why this is such a divisive political issue in Japan now.
There are other "can be fixed" problems. Most of these are finding funds to tide over countries that have perfectly sound policies but are caught up in the general contagion. There is a long-term structural weakness here that will have to be tackled. But in the meantime we are just going to have to find ways of patching the existing system, grabbing each casualty and giving first aid as they come along.
Then there are some "can't be fixed" problems, like Russian debt. Here the bankers and other players have to accept that there are casualties in the fog of war, and that the important thing is not to allow the "can't be fixed" problems to undermine the "need to be fixed" ones.
Finally, there will be one or two "absolutely have to be fixed or the world economy is in very serious trouble" problems. We simply cannot see these coming now. We do know that these become more manageable under a climate of lower global interest rates. But cuts in rates only buy time - they are not a solution in themselves. And if they are not credible to the markets, they may fail in their intent. Meanwhile, the G7 finance ministers will have to lift their game.
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