By all appearances it was a happy ending to London’s G20 summit.
British PM Gordon Brown hailed it as "the day that the world came together to fight back against the global recession". Echoing his host, US President Barack Obama called it "a turning point in our pursuit of global economic recovery". Even French President Nicolas Sarkozy, who earlier in the week had threatened to walk out of the summit if his demands for stricter financial regulation were not met, said "a page has been turned".
There was never any doubt that the summit would be a putative success. No G20 leader could afford to leave London without some semblance of coordinated global action.
In this case, the headline figures from the London summit are certainly large: US$1.1 trillion will be injected into the global economy. Leaders of the G20 countries said in their communiqué that the deal would boost global growth by 4 per cent this year.
Yesterday afternoon the markets surged with approval: the index of top European shares were up 5 per cent, the Dow Jones rose 3 per cent, and the Nikkei gained 4 per cent.
Has the world economy been saved? Have we seen the emergence of a new economic global order? And will we now all live happily ever after?
If only things were so simple.
To be sure, the summit sees significant and necessary action in strengthening the International Monetary Fund. In addition to a US$500 billion increase in funding to the emergency lender, US$250 billion will be allocated to emergency currency reserves to be made accessible to developing countries. Trade finance will receive a US$250 billion boost. In a sign that "light-touch" neoliberal capitalism has come to an end, G20 leaders have also agreed on stronger tax and financial regulation — with a crackdown on tax havens and with hedge funds being brought under regulatory oversight for the first time.
These are all substantial steps to a global recovery. Yet there are two glaring omissions.
First, the G20 leaders have failed to offer a plan for resuscitating banks and restoring credit flows to the banking sector. There remains no agreement about how governments will flush "toxic" assets from the financial system. Markets still have little confidence about how to price distressed assets.
Second, the summit delivered no new fiscal stimulus — despite calls from the United States and the IMF for a coordinated boost in government spending. Last month, US treasury secretary Tim Geithner urged G20 leaders to push fiscal stimulus towards the equivalent of 2 per cent of GDP in their respective countries. As things stand, the Organisation for Economic Cooperation and Development estimates that the average discretionary stimulus measures taken by governments will boost GDP by a mere 0.5 per cent in 2009–10.
Without convincing responses on these two fronts, significant economic improvement will not happen any time soon.
In the first place, the banking sector (especially in the US and Europe) remains in deep strife. Zombie banks threaten to drain the life of more than one economy. This was, of course, the situation during the so-called lost decade in Japan during the 1990s. Unless governments move decisively to recapitalise troubled banks, a prolonged period of stagnant growth, if not recession, remains a possibility.
However, there is no consensus between governments about how to restore health to bank balance sheets. Opinion remains divided about whether governments should be encouraging banks to sell their "bad" assets, or be insuring banks against losses instead. The US has been pursuing the former approach with its public-private partnership investment program announced last month; the UK has opted for the latter.
The trouble is that dealing with toxic assets and recapitalising banks will cost a lot, and a lot more than it already has. In places like the UK and the US, there is little public appetite for more taxpayer money to be spent on bailing out banks, especially when bank executives have shown so little remorse about their egregious failures. Bankers have become a prime target of public anger.
As for stimulus, there remains stubborn resistance from some quarters to any coordinated global public spending. Most notably, German Chancellor Angela Merkel and her finance minister Peer Steinbruck have consistently argued against higher levels of public expenditure. Even in the UK, there is a growing recognition that public spending has now reached its limits. Last week the Bank of England governor gave an unprecedented warning about the sustainability of public finances. More worryingly, a recent UK Treasury bond auction failed to receive sufficient bids for the first time in more than a decade.
But for the Germans, at least, the point cannot be as simple as prudence. As a country that runs consistent trade surpluses (along with other exporting countries like Japan and China), it relies on trade deficit countries (like the US, UK and Australia) to purchase its excess supply. To insist now that it cannot afford to stimulate its domestic economy is effectively a beggar-thy-neighbour policy. Unless surplus countries do their part to inflate demand, any return to business as usual will be painfully delayed.
Still, the German Government remains more interested in financial regulation than in macroeconomic balance. They see the current crisis as a reflection of Anglo-American laissez-faire excess. They have been joined by the French: a jubilant Sarkozy crowed at the conclusion of yesterday’s summit that "Anglo-Saxon" capitalism was now dead.
Any such triumphalism is likely to be overshadowed quickly by economic reality. Growth across the OECD is forecast to be negative by 4 per cent this year, with advanced economies improving only to a standstill in 2010. The immediate priority must be to guard against a deep recession. Governments will have to clean up their banks as well as boost demand. With a rock-solid banking sector, Australia need only worry about the latter.
For now, though, the G20 leaders can claim the London summit to be a success. That it did not end in abject failure was, in itself, something of an achievement. But it reflects the seriousness of the recession we are now in that even a $1.1 trillion injection can only be considered one of the first steps to recovery. It is going to be a long road.