The great meltdown

When the G20 meet in Washington on November 15, there will be a spectre in the wings. The incumbent President is a dead duck and his successor will be ever-present in people8217;s minds but not physically there.

When the G20 meet in Washington on November 15, there will be a spectre in the wings. The incumbent President is a dead duck and his successor will be ever-present in people8217;s minds but not physically there. So whatever the G20 decide, there will have to be a renewal of all commitments three months later.

But more than that, there is another imponderable the meeting will face. Is this global crisis one of the many periodic crises Capitalism has faced8212;in 1971, 1981, 1987, 19978212;or is it something of a once-in-a-lifetime event? The Great Depression was one such event. It was the deepest crisis of Capitalism, but at the end the system came out of it reformed and stronger. But it was also the signal of the end of British and European dominance and the rise of America. It was America which had begun the stock market crash and indeed the incompetence of the Federal Reserve which prolonged and deepened the cycle. Yet, it was Europe which lost out and America which became the dominant power.

This time around once again we have a meltdown. It started in America with the subprime mortgages, but the entire financial system of the world is caught in it. There are several causes8212;excessive risk taking by banks, new financial instruments which were little understood but much used by hedge funds and others, rapid movements of markets thanks to IT and 24215;7 news coverage which spread panic fast. But underlying all those things were global financial imbalances. China and many Asian countries had accumulated large reserves of foreign exchanges which had resulted from America and Europe overconsuming. They put these reserves into US Treasury bills, which meant lending the money back to the US at low interest rates, creating excess liquidity in world financial markets. China8217;s manufacturing exports and India8217;s service exports kept global inflation low, and everyone had a bonanza since despite an explosion in global money supply, prices remained reasonably low.

When the global financial system was redesigned in Bretton Woods in the 1940s, it was the US which had the strong hand. Britain had Keynes but his schemes had to be modified to satisfy American desires. This time around, when redesigning the system, the lead is still being taken by the US and Europe but they are bankrupt. The financial strength is with China and the rest of Asia, plus the oil-rich countries of the Middle East. Most of these countries have a low voting quota in IMF, which badly needs their money to recapitalise the broken banks of Europe.

Thus the money is with the rest of the world. But where are the ideas? As of now, I have seen very little serious work on the issues. There is a lot of posturing. Europe wants to regulate the markets much more and the Anglo-Saxons are not so sure. Everyone takes Keynes8217;s name in vain, but we can hardly repeat his 1940s recipes for the 21st century. If power is going to shift to Asia, where are Asia8217;s terms for the reforms?

The easiest thing to be done should be a recasting of the governance structure of IMF and World Bank. Its heads should be selected from a much more open process than what happens now, with Europe running IMF and US the World Bank. Quotas have to be reallocated and there is no reason why those who have deficits and need capital injection should have the same large votes. Indeed, one should examine the reason for unequal quotas. A system of one-country-one-vote, as happens in WTO, would be much better.

IMF has to be capable of holding the excess reserves of Asia and the Middle Eastern countries. There should be some asset that the IMF can issue across a basket of currencies, which will be suitable for holding excess reserves. This will eliminate the current bias in favour of dollar-denominated US Treasury bills. This will wean the US from the addiction to other people8217;s money and make it start saving. It would also rebalance the world8217;s financial system. Maybe this will be the first fruits of the meltdown for Global Governance.