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.
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.
The G20 was a proven success at the height of the global financial crisis. Its future during the aftermath is far more uncertain and it risks becoming just another talking shop instead of maintaining its role as a global defense committee against massive economic shocks.
How can the G20 get its mojo back?
To maintain its sense of mission, the G20 should adhere to three key guiding principles.
First, keep to high-level, but narrow, international economic coordination issues, particularly international financial institution funding and direction, reforms to the international financial system architecture and economic crisis management.
Second, gently coax and provide support for G20 members on domestic economic reform initiatives that have international ramifications (such as competitiveness-related initiatives and bank recapitalization). Political leaders often want to make bold reforms, but domestic politics frequently holds them back. The G20 can provide much needed endorsement and encouragement.
Third, avoid formal or informal concentration on politically charged issues (such as territorial disputes or domestic stimulus packages) that cannot be resolved through the G20 process and derail the core of its mission.
The next year will be an especially challenging time for emerging markets – this is the issue on which the G20 must now relentlessly focus.
Emerging market outflows could turn into something much worse in a politically charged election atmosphere. G20 members Argentina, Brazil, South Africa, Turkey, India and Indonesia all go to the polls over the next 12 months. This brings several systemic dangers.
Political parties may promise wasteful public spending, which can prompt capital flight and, if implemented, will cause much economic damage. Elections can be a gift to populism and risk a rise in trade barriers and economic nationalism. Moreover, emerging markets have a history of political violence during election contests, which takes time to subside, particularly during economic downturns, further frightening foreign investors.
If the U.S. actually initiates tapering and Japan intensifies its stimulus over the next year, this risks inflicting additional economic shocks on emerging markets and damaging pro-business political candidates supporting free markets and free trade.
In a crisis climate, emerging market election campaigns may be a breeding ground for intensified hostility to developed countries in general and the U.S. in particular. The U.S. may be blamed for a monetary policy that increases its economic growth at the expense of the developing world. This has the potential to cause political difficulties within the G20 as well as damage to multiple bilateral relationships.
The writing is on the wall. Two of the largest Asia-Pacific emerging markets, Indonesia and India are entering an especially dangerous period.
To put recent events in context, during the 1998 Asian financial crisis (1998), Indonesia’s equity market declined 5% in local currency terms and the rupiah (IDR) collapsed by 35%. During the 2008 global financial crisis Indonesian equities were down 50% and the IDR declined by 18%. Since May 2013, when QE tapering was first mentioned, Indonesian equities are down 25% and the IDR is down nearly 18%. This is deeply concerning and it may well get much worse: Jakarta’s current account deficit, slowing growth and inflation fears plus the large proportion of debt held by foreigners are all potential mutually reinforcing catalysts for a further deterioration.
In India, while the equity market has held up at around 3% for the year to date, the rupee has slipped 15% since May. The country suffers from twin deficits – budget and current account—which were the result of the massive stimulus during the global financial crisis and the lack of much-needed structural reforms. Stagflation is a worry for investors and the picture in India may swiftly become grim.
Clearly then, the incoming G20 chair for 2014 has a fiendishly difficult task. Yet, Australia, which will assume this role, is particularly well-positioned. In contrast to Russia’s prickly relations with many G20 members, Australia is well-liked and has no overwhelming bilateral disputes that will significantly cloud its chairmanship.
The program of the recently elected Australian Liberal-National Coalition government largely matches the stated economic objectives of the G20, including efficient financial markets architecture, domestic competitiveness reform, free trade and disciplined orthodox economic management. This is backed by the Coalition’s strong record of economic and financial markets reform during its last term in power from 1996-2007, as well as its commitment to restore economic diplomacy as a priority of Australian foreign policy.
Finally, Australia is centered at the crossroads of the diverse competing economic and political interests of G20 members. This makes it an ideal facilitator, given its very strong relations with the U.S. and Europe, an Asia-Pacific economic focus, and its founding membership of the Cairns Group of agricultural exporters including Argentina, Brazil and South Africa.
In light of ongoing monetary decisions, the challenges faced by the G20 are immense. The health of the international economy depends on its ability to coordinate a high-level political and policy response to prevent a full-blown emerging markets crisis.
Andre Stein and Miro Vassilev are principals of Cryptos Global Investments, a New York-based global macro fund. Both hold advanced degrees in international political economy from Harvard University. Stein served as a Senior Advisor on sovereign risk issues to a global professional services company. Vassilev managed European investments for a US special-situations hedge fund, worked at Goldman Sachs’ European macro desk, and also holds an MBA in Finance from Wharton. Stein is a New York Fellow at the Foreign Policy Initiative, and Vassilev is a Fellow at the Truman National Security Project.