RGE Monitor – The G20’s Crowded Agenda

This week we review the critical issues G20 leaders will focus on when they meet this week in Pittsburgh.

The coordinated and unilateral policy actions taken by these countries and others—including aggressive fiscal and monetary stimulus, increased funding to the IMF, and backstopping financial systems globally—helped stop the economic freefall. The economic outlook has improved since their last meeting in April, but the challenge of navigating towards sustainable growth is equally difficult, and the coming period brings the risk of policy missteps as countries begin to plan their exit strategies. On the eve of the G20 meeting, there remain significant divides over the timing and scope of exit strategies from monetary accommodation, the path towards fiscal consolidation, and the drive for financial regulatory reform.

As RGE highlighted recently, financial regulation will continue to be a key part of the leaders’ debate. New capital requirements seem more likely, in the vein of suggestions raised by the Bank of International Settlements (BIS) and the Financial Stability Board. The recent meeting of the G20 finance ministers and central bank governors supported such moves. The meeting broke, however, without an agreement on compensation reforms to avoid a procyclical focus on short-term returns, a policy championed by the European Union. The issue of banks’ balance sheets still being impaired also needs to be addressed.

All G20 countries have pledged to maintain fiscal and monetary accommodation for as long as is required to ensure a stable recovery. That implies that countries and central banks might begin exiting at different paces. Some countries have already begun to remove some of the excess monetary accommodation (Israel and China are perhaps the most noticeable), and others are likely to follow through rate hikes or other measures later this year and in 2010. The record growth in national debt will force some countries towards fiscal consolidation in the not-so-distant future, though tax hikes could weaken a recovery of private demand.

While G20 leaders are likely to repeat their pledge to support the Doha round of multilateral trade talks, real movement on removing trade barriers is unlikely in the coming months, given that trade remains weak. Some countries, like Canada, have unilaterally removed barriers in sectors that benefit domestic investment, but overall, more sluggish trade will raise the incentive for trade barriers. In fact, trade disputes are on the rise, particularly between the U.S. and China . In September, the U.S. raised tariffs on Chinese tires, a move that was countered by Chinese investigation of U.S. trade practices. These disputes may not escalate and spread and given the importance of the bilateral trade relationship, action on trade seems unlikely.

The U.S. wants to put a focus on reducing global imbalances and promoting the sort of structural reforms that would increase domestic demand in export-focused economies like China. Imbalances have narrowed since the onset of the financial crisis, with the U.S. current account deficit falling to US$98 billion in Q2 2009, but it remains to be seen if this narrowing will be sustainable once consumption begins to grow again. The Chinese fiscal stimulus and those of other export-oriented countries have supported domestic consumption, yet consumption in these countries is not yet a major growth driver, neither for the countries themselves nor for the world. In fact, Chinese consumption may continue to lag overall growth in 2009 and 2010. Many economists worry that the crisis and financial shocks might increase emerging market countries’ propensity to self-insure through collecting reserves, which could exacerbate imbalances. Meanwhile, some economists continue to debate the role of global savings and investment ratios played in financial instabilities.

Even if global imbalances are a problem, it remains unclear whether the G20 is the best forum through which to address them. It is perhaps too large and too diverse a group to tackle the issues of imbalances and sustainable demand in an effective manner. As RGE has noted, the U.S. and China agree that the U.S. needs to save more and China needs to consume more, but they differ on the timing of such a shift and how to bring it about. Boosting China’s consumption would require reallocations of capital between the corporate and the household sector as well as patching holes in the social safety net to reduce the propensity to save for health, education and retirement.

G20 leaders will probably avoid making specific reference to individual currencies, and particularly avoid reference to the U.S. dollar. A new plaza accord to support the dollar seems unlikely. The most vocal U.S. creditors like Russia and China are likely to make only very muted calls for new reserve assets and fiscal consolidation in the U.S. The voicing of dollar solvency concerns in June only added to pressure on the U.S. dollar and increased these countries’ (dollar-dominated) reserve accumulation. The increase in use of the IMF’s special drawing right (SDR) through IMF bonds is one step. Yet for now, all plausible alternatives to the U.S. dollar lack liquidity and in some cases convertibility. As recently detailed RGE, China and Japan in particular have continued to purchase U.S. government debt, lest their currencies appreciate. But should U.S. fiscal consolidation be delayed, these creditors might not be as willing to provide financing.

Despite the fact that almost all the major countries are making significant steps i
n promoting renewable energy—in part because of job creation hopes—countries remain divided over the timing and scope of emissions cuts. Most of the G20 leaders attended the UN climate summit yesterday, sponsored by UN Secretary General Ban Ki-Moon, which attempted to ease the roadblocks on the way to the December 2009 Copenhagen summit. While countries agree on long-term emissions-cutting goals, they doubt the sincerity or ability of their counterparts to make the near- and medium-term sacrifices. In particular, emerging markets and developing economies are reluctant to agree to any emissions caps that might cool their growth, and European leaders have grown weary of delays in the passage of the U.S. climate change bill. However, the reduction of global emissions in 2008 from lower consumption and industrial output might bring some breathing space. Even if an overarching grand bargain seems hard to achieve, domestic policies are changing—even in the U.S. and China, the largest emitters.