G20 summit: New world order?

Some G20 nations hope the weekend summit on financial reform will be a modern Bretton Woods, but can it make big decisions without Barack Obama? By Stephen Foley in New York

November 12, 2008

For the Prime Minister, Gordon Brown, it is a "new Bretton Woods", as important as the 1944 convention that established the modern financial world order. For Nicolas Sarkozy, President of France, it is a once-in-a-lifetime chance to remake the global financial architecture and usher in an era of "regulated capitalism". But beware the headlines that these leaders try to manufacture when they assemble for their credit crisis summit in Washington this weekend.

What we have is a summit without an agenda, on a crisis without an agreed cause, in a country without a functioning government. The US – whose outgoing President agreed to hold the meeting under French pressure, and whose President-elect, keen to stress that the US has "only one president at a time", won't even be there – has already bristled at European talk of a creating new supra-national regulators and international rules.

So little wonder everyone else is scrambling to downplay expectations for what might emerge, and to lengthen the timetable for achieving results. As one person from the UK delegation put it, "Bretton Woods took two years".

Bretton Woods created the International Monetary Fund, which endures as the one international body powerful enough to prop up governments and economies that run into trouble. It also created a system of fixed exchange rates that failed to endure into the Seventies. Today, despite a financial crisis that is agreed to be the worst since the Great Depression, little yet under academic discussion rises to the level of ambition on display in the New Hampshire mountains in 1944. Certainly, nothing likely to be on the table on Friday and Saturday rises to that level.

Sebastian Mallaby, director of the Centre for Geoeconomic Studies at the Council on Foreign Relations in Washington, is cynical about the summit's origins and its chances of triggering major reform.

"The truth is that national regulators failed, but national politicians don't want to be blamed, and so they blame a lack of international co-ordination and respond by calling an international summit. Lo and behold, we have a G20 summit without an agenda."

Behind the scenes, work on an official communique is already under way, but people with knowledge of the discussions say it is currently broad-brush to the point of bland, and will promise a lot more work still to be done.

The problem is that there is little agreement yet on the necessary counter-factual: what type of financial architecture, if it had been in place, would have prevented a housing downturn in the US from becoming a credit crisis that engulfed the world?

Discussions last week between the countries of the European Union, as it agreed its position before the meeting, were notable by even their lack of agreement about the extent of international regulation that might be desirable. Specific plans, such as a "college of supervisors" bringing together different national regulators to oversee the activities of multinational finance firms, could take flight, but even the EU appears reluctant to let go of national powers, and the US has never previously shown an inclination to do so. The White House has already played down talk it could accede to demands to curb speculation and to regulate hedge funds on an international basis.

Mr Brown, meanwhile, has talked about setting up an early warning system for international crises, but it remains unclear how to get people to listen to it. He has also called for emerging economic powers such as China and those in the Middle East to contribute more to the IMF, and for bolstering that organisation's powers. Meanwhile, China and other countries in the G20 – which, unlike the G7, encompasses emerging powers such as Brazil, Russia and India – are pushing for a greater say in the IMF as a quid pro quo.

Cash for chairs, Simon Johnson, professor of entrepreneurship at MIT and a former chief economist at the IMF, calls it – and this might be the most productive bit of the weekend's discussions. "The Americans and the emerging economies have more interests in common than people suppose. Everyone in the world except the small European countries think that the small European countries are over-represented at the IMF."

Reform of the IMF would have the advantage of bringing in the new powerhouse economies of the world more firmly into the club of leading nations, but there is little agreement on what bargains might then be desirable to strike.

Economists identify big capital flows and leverage as two major contributors to the credit crisis, the first for pumping giant surpluses from China into the US and inflating a housing market bubble that went pop, the second for allowing banks to make bets many times the size of their underlying assets.

Mr Johnson says the discussion of what to do about international capital flows could emerge as an important philosophical discussion in the administration of Barack Obama. Washington insiders and economists are already searching for clues among his economic advisors as to whether they will lean towards the continental European inclination to regulate these flows, or to the British view of laissez-faire – and what sort of accommodations can be struck with a Chinese government that firmly controls capital flows and has kept its currency stubbornly low to stimulate its export-driven economy.

"Capital flows are really large and unstable compared to the bucket of money that can be used to lean against the wind," Mr Johnson says. "The default is to do nothing, and just to muddle through, but there have been moments in the past few months when everybody was very scared, and I don't think that those scary things have gone away."

These are longer-term issues that might rise to the level of a Bretton Woods, and they will get little airing this weekend. They may get more if the Europeans succeed in getting agreement on a second summit in 100 days, when President Obama will be in place and his administration's world view will have begun to emerge.

As for the other issues likely to be aired in Washington, a survey released yesterday by the law firm Allen & Overy, of 700 of its global business clients, showed executives split down the middle on the desirability of a supra-national regulator to oversee global financial institutions (continental European business leaders were the only ones to unequivocally support it).

Wim Dejonghe, managing partner at Allen & Overy, said: "Businesses are still reeling from the impact of recent events. They are yet to focus on how better to regulate the markets. We fear that, in the absence of an informed debate that fully engages market participants, we could face a knee-jerk political reaction that is focused on punishing the markets instead of helping them to function efficiently and securely."

It seemed, before the meeting, that these issues of international regulatory co-operation and the desirability of developing international standards will be finessed for the time being.