On Thursday and Friday of this week, the leaders of the G20 will meet in Cannes to discuss the numerous problems that the world economy is currently experiencing. The big question on everyone’s mind is whether they will be able to restore some kind of confidence in financial markets as well as with consumers and businesses. The hope is that a repeat of the April 2009 London meeting can take place, at which the leaders agreed to a significant boost to the IMF’s financial firepower.
Leaders of the world’s most important economies must come together at the end of this week and offer coordinated solutions that will effectively help restore some degree of confidence in world financial markets. Otherwise, a new global financial crisis and ensuing world recession may become a self-fulfilling prophecy of global investors.
Confidence is key if we want to avoid another meltdown, which would be worse than the one of 2008-2009, because central banks and governments have much less macroeconomic margin of maneuver now than they did back then. Given the economic turmoil that is taking place right now, especially in the context of a Greek political crisis, only the G20 has the capacity to calm things down. (That’s why it was created, after all!) To do so, however, it must act decisively and in unison, just like it did at its meeting in London at the beginning of April 2009.
But what should the G20 leaders achieve this week? The first thing that they should do is increase the IMF’s firepower, just like it did in April 2009. Back then, the IMF’s capacity to act was increased to US$750 billion. This time, it should be increased to at least US$1.5 trillion but preferably US$2 trillion. In combination with the European Financial Stability Facility’s (EFSF) newly increased intervention capacity, to over US$1 billion, such IMF lending power would probably be able to contain the catastrophic contagion scenario whereby Italy and Spain are no longer able to finance their government debts with private investors in financial markets. Otherwise, there will be massive defaults in Europe, with a complete collapse of the European and, probably, global, financial system. It would lead to the 21st century’s Great Depression, which the G20 members did so well to avoid in 2008-2009.
But where would the money come from? The main financial contributors to the IMF’s increased firepower would be China, Japan and the United States, especially because eurozone countries would have already put their contributions in the EFSF. This would forcibly lead to a decrease in Europe’s voting rights in the IMF, but it would be the price to pay to keep the euro, and the EU, alive. Finally, the eurozone, if not the EU itself, could be pushed to consolidate their seats into a unified one on the IMF’s Executive Board, and China would get a seat of a size more in line with its GDP.
In exchange for preparing the IMF to backstop Italy and Spain, the G20 should push the eurozone members to commit themselves to creating some form of fiscal union in the near future. The French and the Germans, in particular, should make this requirement explicit at the meeting. Such a fiscal union is something that sovereign bond investors have been advocating in order to give the European common currency some kind of fiscal equivalent. After all, taken as a whole, the euro area’s fiscal situation is better than that of the United States.
As part of the economic confidence-building measures that they must agree to, G20 leaders will also have to address the issue of how to support economic growth through fiscal policy in the short term, while ensuring debt sustainability in the medium and long term. This is a very delicate balance to achieve. On the one hand, too much fiscal stimulus will make government debts unsustainable in many countries, thereby making financial markets even more nervous. On the other hand, too little will fail to boost growth and to give consumers, businesses and market investors a bit of confidence that things are going to get better rather than worse (which is when consumption and business investment is postponed, thereby pulling down the economy even further.) The last thing that is needed right now is even more fiscal austerity, though some countries like Greece, Italy, Portugal and Spain have no choice but to continue getting their finances and economies in order. (Their reforms were postponed for too long, which is why investors do not want to buy these countries’ sovereign bonds any more.)
What should Canada’s contribution be at the G20 meeting? To begin, the government should stop acting like a peacock in front of our partners; now is no longer the time to keep telling them how good we are because we have had no banking crisis and our fiscal situation is in such good shape, at least at the federal level. Telling them to follow the good Canadian example is not what our American and European colleagues want to hear. They all wish they were in our shoes, but they are not! So we must be proactive and consensual by putting feasible solutions on the table, along the lines discussed above, so that a fruitful exchange can take place in Cannes.
Our main goals should be (1) to convince the Americans that they need to provide more financial support to the IMF, and (2) to convince the Europeans to accept more help from the IMF until their fiscal union is up and running in a few years from now, and, in exchange, to agree to the creation of a euro area seat at the IMF. (The UK will surely refuse to give up its seat in favour of an EU one.)
The Cannes meeting is another decisive moment for G20 leaders. Will they be up to the challenge? Let’s hope so! Otherwise, we are in for another world economic recession, if not a depression.