An imbalanced summit

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An imbalanced summit
By Oscar Ugarteche



A group of seven highly indebted rich countries (HIRC) of the world have organized a meeting of 20 nations in London next month to discuss the future of the world's finances. They have called to the table some creditor developing countries, such as Brazil, Argentina, Mexico, some Arab countries, China and India, but have left aside all the world's other surplus countries, creditors to the US and Europe.

After all, the accumulation of export surpluses over a 20-year period is what has allowed deficit countries to overborrow to the



tune of about 200% of average gross domestic product, and growing fast. For good measure, British Prime Minister Gordon Brown, feeling a bit weak, invited two more European nations into the talks.

A few things come to mind. First, "He who pays the piper calls the tune"; and certainly now those who pay the piper are from outside Europe and the US. Secondly, the world order we have known since 1944 and the institution of the Bretton Woods financial framework have finished and the new world order will have to take a new Group of Seven into account.

This means China, India, Brazil and Russia are in and some European countries are out. Whatever discussions are held by the 20 countries plus 2 (the European Union also has its say) will be irrelevant, as this needs to be a global discussion, given who the new creditors and debtors are.

Third, the significant new role of Asia as a whole in both international trade and international finance calls for a reconsideration of the International Monetary Fund/World Bank Board reflecting this major change and diminishing the European and US role.

Fourth, this leads to the elimination of US veto power in these institutions established in 1944 and of the mechanism by which each institution has a director from Europe and the United States, respectively. This is hardly relevant these days, aside from being undemocratic, opaque and does not reflect current economic and financial realities.

Finally, a system where economic policy leads to massive surpluses that help finance massive deficits created by the model itself cannot work forever, as this crisis has come to show.

What has emerged is a group of leading nations that are now the major world debtors. These are highly indebted rich countries that have sustained trade and fiscal deficits for more than a decade and have accumulated major debts, thereby draining credits to developing nations.

These are countries that have over-consumed systematically and in some cases have done so with very lax domestic credit policy. The argument was that the consumer in the West was better off with cheaply manufactured goods from Asia, Central America and Africa. The fact that no nation can borrow indefinitely for consumption did not come to mind.

Initially surplus countries bought US Treasury bills and kept their reserves partly in those instruments; then this was extended to British and European government bonds. It was not clear that buying government bonds in large quantities was going to lead to overborrowing on the other side. The table shows the picture of the present Group of Seven countries (the US, Japan, Germany, the UK, France, Italy and Canada), which hold roughly one third the reserves of the new leading emerging nations.

If Japan is removed, the group of leading nations holds one sixth the reserves of the seven largest emerging nations, most of which are in Asia. The external debtor position, both private and public in other currencies, is very high for the UK, France and Germany, in the 150%-450% of GDP range, followed by the US, which is in the 90-100% of GDP range.

Public debt, in local currency, is highest for Japan, Italy and the US. The very high level of Japan's public debt - at about 170% of GDP - is a result of the banking crisis of the 1990s. Taken together, the sum is in the range of over 200%. The growth perspectives of those countries is negative for all.

Is it reasonable for lenders to continue lending to contracting economies? What happens to debt payments when the economies that have overborrowed stop growing? Will they enter a depressive cycle because they have to adjust consumption downward in order to live within their means? Is it reasonable or fair that developing nations finance rich nations openly?

The role of the IMF was to be a watchdog for all countries and to be a whistleblower. It was designed to this end, but it lost its track and ended up looking at emerging nations instead of looking at its constituency. The Financial Stability Reports (FSR) are a case in point.

The present financial crisis began to unfold after October 2007 in the US, but the FSR looked elsewhere. The first support programs between the US Federal Reserve and the European Central Bank happened in late 2007 and the IMF kept very silent. It did not blow the whistle and hence did nothing to prevent the crisis from unfolding.

True, it no longer has the capacity to do so, as the value of derivatives is now 12 times the world GDP. No one can prevent a major crisis unless we all agree to new rules that forbid some financial instruments from being used and that returns reserves to banks and foregoes hedging risk.

In this context, then, faced with Asia's major leading role in the international finance and a new enhanced role for Latin America and the Middle East, Russia and its neighbors in world financial and economic affairs, it seems odd that Brown wants to lead the discussions on the changes. Debtors are in no position to set the rules of the game, as debtor nations learnt in the 1980s.

It may well be that the export-led model needs to be buried and a new model put forward at the same time that we end floating currency exchange rates. We went through this same problem in the 1930s and agreed then to have fixed exchange rates and industrialization policies together with welfare policies. This was the background to the Bretton Woods system. This had both a fiscal and external angle supervised by the then newly created IMF. It seems these days the IMF does not look into HIRC accounts, or does not care about them, or HIRC don't care much about IMF opinion.

All of this must come to an end and be addressed by all UN member countries, as no country should be outside the scope of international supervision and no new lending should go to shrinking overborrowed economies, however developed they may be, unless they reorganize their economies and bring financial order to their nations. At the World Social Forum in Belem do Para this January, we agreed that this means much more than changing IMF governance. A new world order is possible.

Dr Oscar Ugarteche, a Peruvian national, is a senior research fellow at the Instituto de Investigaciones Economicas, UNAM, Mexico; a member of the Mexican Research System; and president of ALAI, the Latin American Information Agency based in Quito. His Genealogy of the International Financial Architecture 1850-2000, is to be published in Mexico next year. Dr Ogarteche last year cosponsored with Yoko Kitazawa from Pacific Asia Resource Center, Tokyo, and Paul Dembinsky, Observatoire de la Finance, Geneva, the conference "Beyond Bretton Woods. The transnational economy in search of new institutions" in Mexico City.

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