While the world’s focus has been on the UN General Assembly and the APEC leaders meeting, the recent dysfunctional G20 summit in St. Petersburg seems to have been quickly forgotten despite a looming emerging markets crisis.
The U.S. Federal Reserve’s projected reduction or “tapering” of its Quantitative Easing (QE) program cast an ominous shadow over the G20. QE sought to stimulate the U.S. economy by lowering long-term domestic interest rates, which caused international investors to seek higher yields elsewhere. As a result, foreign capital poured into emerging market bonds and equities as the expected returns were significantly higher and economic growth prospects seemed bright. Now that the Fed has signaled it will slow and eventually eliminate QE, leading to a rise in US interest rates, this capital flood has quickly reversed, threatening severe economic instability in the developing world.
Yet in St. Petersburg, the extraneous political issues of Syria, Snowden and the Senkaku/Diaoyu Islands led to diplomatic standoffs overshadowing critical economic coordination.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
Ironically, G20 leaders’ failure to confront decisively the challenging issue of Fed tapering and a potential emerging markets crisis risks worsening existing bilateral and geopolitical tensions. This may create a vicious circle of reduced cooperation and increased hostility between G20 developed and emerging market members.
It was not always this way.
During the early years of the global financial crisis, G20 meetings successfully coordinated high-level political, monetary and fiscal responses to the imminent collapse of the global financial system. This was remarkable given G20 countries’ diverse political systems.
Three factors were the key to the successes of the early G20 leaders’ summits.
First, there was an overwhelming, shared sense of urgency. The global economic boat was sinking fast and all the main passengers’ representatives needed to work together to refloat the vessel.
Second, all G20 economies faced similar shocks to their economic and business cycles. Difficult domestic political decisions had to be made, notably by G20 emerging market governments, including resisting economic protectionism. Subsequent political fallout was contained by capital inflows from developed markets to emerging markets which reinforced low borrowing costs and buoyant stock markets. This largely placated emerging markets’ populations, moderated domestic politics and greased the wheels of G20 cooperation.
Third, G20 leaders tended to put extraneous and divisive political matters to one side (such as the 2008 Georgia-Russia crisis) and concentrated on the critical economic issues at hand.
The mechanics of the G20 in acting as a crisis management committee worked well on a number of levels.
Politics: Leaders were able to come to agreements on domestic political responses to the crisis, such as preventing increased trade barriers.
Monetary policy: Meetings between central bank chiefs provided a forum for coordination and dialogue which contributed to decisions to keep interest rates low across G20 economies.
Fiscal and financial system policy: G20 developed markets’ finance ministers led the way in a unified manner by stabilizing the global banking system, creating conditions for household deleveraging and using the government’s balance sheet to offset private sector indebtedness, via financial institution bailouts and mortgage relief programs.
Those three key factors have since unraveled. There is no longer a deep sense of unified urgency on the global economy that binds G20 leaders together. Rather, the perception that the worst of the global financial crisis has been averted has removed the discipline that comes with financial terror.
G20 members’ economic cycles and monetary policy objectives are no longer synchronized. Major importers (i.e. deficit countries) such as France, the U.K. and the U.S. have opposing views on how global economic imbalances must be tackled, compared to large exporters such as Germany and China that enjoy significant current account surpluses.
There are widely differing approaches on how to resolve the global financial crisis’ ongoing effects. Some, like the Eurozone, have opted for varying degrees of austerity. Others, such as Japan, the U.S. and U.K. have now chosen stimulus.
Diverging monetary policies are slowing international political cooperation as central bank actions are increasingly seen as a zero-sum game. The U.S. tightening of monetary policy is hurting emerging markets. Japan’s huge monetary easing and subsequent drop in the yen’s value are damaging its neighbors’ export competitiveness.
Finally, as the St Petersburg summit clearly demonstrated, international political posturing and second-order squabbles, which were put on hold during the global financial crisis, are back with a vengeance.