Self-interested G7 leaders unlikely to save the world from the next economic crisis
There’s a Group of Seven summit this weekend in Biarritz, France. If you want to test your optimism, take a second to study the family portrait. You will be looking at most of the generals who will lead the response to the next international economic crisis, should we have one in the next few months.
Now, how do you feel?
On Oct. 10, 2008, finance ministers from G7 countries eased the panic that followed the bankruptcy of Lehman Brothers Holdings Inc. by issuing a statement that promised “urgent and exceptional action.” Their bosses quickly agreed to set rivalries aside and assemble with the leaders of China, Russia, Brazil and other emerging powers under the auspices of the Group of 20 a month later. They stopped a depression.
It’s hard to imagine the G7 reprising its heroics today. This year’s assembly includes too many saboteurs to be taken seriously as rescue team.
Germany is on the brink of recession. It has a huge trade surplus that implies it could be a bigger source of global demand, and it borrows for essentially nothing. Yet it still refuses to cut taxes or attempt any other form of fiscal stimulus out of fear of running a budget deficit.
Boris Johnson, Britain’s prime minister, is bent on quitting the European Union on Oct. 31, come what may. Italy’s most powerful politician, Matteo Salvini, leader of the populist League party, chose this moment to trigger a political crisis, even though the International Monetary Fund reckons his country is teetering on the edge of its own downturn.
And of course, the G7 has done nothing to contain the biggest threat to the global economy, even though he has attended the meetings annually since being elected president of the United States in 2016. Stocks dropped (again) on Friday after Donald Trump tweeted that “we don’t need China” and the U.S. would be “better off without them.” He was commenting on the publication of the American imports that China will punish if the White House goes ahead with new duties on Chinese goods.
Trump’s trade wars have sucked the life out of the global economy, and America’s allies have proven powerless to do anything about it. Prime Minister Justin Trudeau said in Montreal this week that he would tell the G7 that, “we need to build a future where everyone can benefit from economic growth and where we invest to help the middle class,” a nice thought that will change nothing, since Angela Merkel, Johnson, Salvini and Trump all think their self-centred approaches to economic policy will achieve the same thing.
This is troubling because the politicians won’t be able to hide behind their central bankers when the next economic crisis hits.
In the aftermath of Lehman Brothers, the G7 finance ministers blew the battle horn, and the G20 implemented a co-ordinated round of fiscal stimulus. But it was the central banks that did the real work. They slashed benchmark interest rates across the board, and some of the biggest banks created trillions of dollars to buy bonds and other financial assets. They made mistakes, but if the mission was to avoid a repeat of the Great Depression, the effort was a clear success.
Central banks won’t be able to respond to the next downturn with the same degree of force. The U.S. Federal Reserve’s benchmark rate was around five per cent on the eve of the financial crisis; it’s 2.25 per cent now. Benchmark rates in Europe are near zero or even negative in some cases. The firepower just isn’t there.
So fiscal policy will need to play a greater role, and that’s a problem. Some of the bigger economies are carrying a lot of debt, which could tie the hands of a few important finance ministries.
The bigger issue is the state of politics in so many countries. Central banks are first up in a crisis because they can deploy so much faster. Fiscal policy must go through a design stage and approvals before the money is spent and begins rippling through the economy. Months would pass before the money hit the economy — under the best-case scenarios.
… those simply hoping for a better form of soft co-ordination will probably be disappointed.
BlackRock Investment Institute report
“There was room for a better policy mix with less reliance on monetary policy and more emphasis on fiscal policy” after the financial crisis, a team of heavyweights at the BlackRock Investment Institute, including Stanley Fischer, the former Fed vice-chairman who also led the Bank of Israel, and Jean Boivin, a former Bank of Canada deputy governor, say in a report published earlier this month.
“Yet there are reasons why that better policy mix was not achieved — chiefly that it is practically and politically easier to resort to monetary policy,” the report continues. “These forces are likely to keep prevailing in the future and those simply hoping for a better form of soft co-ordination will probably be disappointed.”
The BlackRock group, which also includes Elga Barch, head of macro research, and Philipp Hildebrand, the former head of the Swiss central bank who is now BlackRock’s vice-chairman, proposed an interesting solution. The paper proposes a “standing emergency fiscal facility” that central banks could trigger when interest-rate cuts fail to reverse deflationary forces. Central bankers would use a price-level target as a guide and aim to make up whatever ground was lost in a downturn.
An elegant technocratic fix for an ugly populist age. Yeah, I know. I just wanted to report that solutions exist, even if we’re too far gone to want any.