Hamish McRae: The downturn will go on, but this should restore confidence

See the summit as a bandage over a wound that will take time to heal itself
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The Independent Online

So this is not a new Bretton Woods, the agreement in 1944 that shaped the post-war monetary system of fixed exchange rates and led to the founding of the International Monetary Fund and World Bank. But nor is it the Smithsonian agreement of 1971, which was supposed to shore up the fixed exchange rate system but collapsed in six months.

The world moved to its present system of floating exchange rates in a messy and disorganised way during the following years, generating huge inflation as a result. Those were the years of a quadrupling of the oil price, the strikes and all the human misery associated with that. The legacy was two decades of high interest rates and high unemployment.

The world is now in the middle of another period of financial and economic turbulence and inflation has again been rampant. But it is a different sort of inflation. Then the problem was a failure to control current inflation – the price of goods and services. This time the problem has been asset inflation – principally the price of property but also other assets including shares.

Correcting the 1970s' excesses was a long slog involving the world's main central banks, the IMF and the main national governments. Curbing the excesses of the 2000s will require much of the same. We have had the immediate market correction in the sense that asset prices have plunged. Neither the US nor UK house prices are back to their normal relationship with earnings but both are getting towards a more reasonable level. Share prices around the world look reasonably cheap.

This correction has however been brutal. Something like 40 per cent of the world's wealth has been destroyed. World trade has plunged. That is why the world is facing as serious a recession as those of the 1970s and 1980s, maybe a more serious one.

So see the London summit as a bandage over a wound that will eventually heal itself but will take some time to do so. The principal new element – a lot more money for the IMF – puts the fund back into the position it used to hold as the main multinational focal point for helping countries that have got into a mess to get out of that mess without having to bring in emergency measures that would damage world trade.

Most of the other elements – the regulation of banks and hedge funds, the Financial Stability Board, the stuff about tax havens – were all going to happen anyway. All that is changed is that there may be better co-ordination.

Meanwhile the main policy for pumping up global demand, the bigger budget deficits that all countries are having to run, have to be done by the countries themselves. There is nothing new in the summit about this. It is true that countries are giving the largest fiscal boost the world has ever known, though at a cost of increased borrowings that will take a decade or more to be repaid.

So the agreement does not of itself restart the world economy. In all probability global output will decline for some months yet. There is a real danger that even when growth resumes it will not be sustained and it would be unwise to expect the recovery to be secure until 2010, maybe well into 2010.

But the summit looks as though it will help in three main ways. First it will boost confidence, as the markets already recognised. Insofar as greater confidence helps asset values and investment recover, that will reduce the still enormous overhang of bad debts and help companies look beyond the recession.

Next, the fact that 20 heads of government and finance ministers have survived the meeting in good temper means that as the inevitable squabbles over protectionism and other economic issues occur in the months ahead, at least the chances are diminished of countries introducing really destructive policies.

The idea that countries that bring in protectionist measures should be "named and shamed" may not sound a powerful sanction, for politicians can always greet it with the traditional hand gesture, but if it helps tip the world just a little towards freer trade then it is worth having.

And finally the meeting gives the leadership of the world's largest economy and what will this year become the world's second largest to sniff each other out. If the US and China can maintain a reasonable trading and investment relationship then the world economy can recover. If not, then there will be trouble indeed.

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