All together now

The meeting of the G20 leaders in London this April is ominously being compared to the failed London conference of 1933. Then, a newly elected president, Franklin Roosevelt, (probably rightly) refused to accept the policies agreed in London. The prospects for success today are not much brighter, especially if those gathered fail to agree a global reflation plan and lack the courage to reform the IMF.

In 1933 America, as now, was the leading player in the world economy. Once again, we have a new US president anxious to preserve domestic support for a radical reform programme. He will be nervous of appearing to sacrifice US interests to foreigners. And there is little consensus among other delegates about what should be done about the crisis. Some governments have acted boldly but others have trailed behind events with a succession of ad hoc, sticking-plaster responses, surprised at every turn that things were worse than they had expected.



Today's crisis is at an earlier stage; in 1933 the depression was already three years old. Contraction in industrial production in many countries over the past six months, however, has been comparable. Alarmed policymakers have responded variously by nationalising banks, slashing interest rates, expanding the money supply through cutting taxes, buying up debt and running unprecedented deficits. The deficit in the US is forecast to reach 12 per cent of GDP and in Britain could exceed 9 per cent in the next two years. Many other countries are in a similar situation.

Such policies are unavoidable, but they cause concern nonetheless. One fear is that public spending and investment decisions are replacing private ones. This will be hard to reverse, and taxes will have to rise to prevent government debt exploding. Another worry is that governments will be unable to recognise when their economies have started to improve, and will fail to reverse monetary policy in time to prevent severe inflation. Indeed, some take the more jaundiced view that governments will find inflation the most convenient way to reduce the burden of accumulated debt.

Ultimately, these concerns are beside the point. Debt deflation will not be resolved for many years. The first objective of the G20 meeting must be to boost and maintain demand in the world economy. Swift action is needed, and the surest method is for governments to cut taxes and raise expenditure, while "monetising" the resulting deficit. (This is where a government prints new money to buy back its own debt, so more money circulates in the economy as a whole.)

The British government started this in February, calling it "quantitative easing." But not every government can do this: some are limited by large budget deficits, which, if they get worse, could result in a loss of market confidence in their bonds and currency. Coordinated international action is the only way to avoid new runs on currencies and all countries must accept their part in a general reflation.

This is where the G20 face a tough choice, because the burden should relate not to who is most at fault for the crisis, but instead be proportional to a country's ability to carry it. This means that countries with current account surpluses—like Germany, China or Japan—must push proportionately bigger fiscal expansions than deficit countries, like Britain or America. If not, a set of unbalanced reflations will make pre-crisis trade imbalances worse, and weaken confidence.

Agreeing to a firm timetable for action must be the first step. But countries may fail to deliver, so reform of global economic institutions is also essential. The IMF is too obviously controlled by the US and "old" European countries. To make it a credible monitor, it must concede larger quotas and voting rights to the big emerging economies, as well as some surplus countries. A grand bargain must be struck: in exchange for taking responsibility for fiscal reflation, the surplus countries and other Asian economies will gain influence. A useful symbolic gesture would be to move the IMF headquarters out of Washington. Its own rules state that it must be sited in its largest member state and the US congress is unlikely to repeal this. But if the eurozone agreed to act as a single member, it would become the largest participant. The fund could then relocate somewhere more neutral, like Bratislava.

Such a reformed IMF would need new authority to police a reflation plan over the next two or three years. To give itself teeth, it should revive the moribund scarce currency clause of article VII of its constitution. Any country backsliding from commitments it has made by running a persistent and excessive surplus would have its currency formally declared "scarce." This would permit other countries to discriminate against it in trade. Of course, few countries would accept such a limitation on their sovereignty and others will object to any infraction of the sacred doctrine of free trade—but the scarce currency clause is like a nuclear bomb. Its utility lies in its deterrent value, not in its use. Moreover, a failure of reflation and a depression will spell the end of free trade anyway.

The fund should also be able to provide support to poorer countries caught in the backwash of global recession. With a large increase in borrowing arrangements as well as in subscriptions and quotas, which are the means whereby members provide resources to the fund, it could help to plug the gaps created by dwindling short-term banking flows to developing countries, providing much-needed finance for world trade. If the fund's resources were to bear the same relationship to world trade as was intended when it was created in 1944, they would have to be increased fourfold. To meet the designs of the larger IMF that Keynes originally imagined, they might need to be increased 16 fold.

The IMF was designed for an era of international policy coordination, but that time is long passed. During the period of liberalisation from 1980 onwards, private finance expanded to take on many of the IMF's functions, like lending between rich and poor countries. But with private finance in crisis and international policy co-operation urgently needed, these institutions must now be revamped.

Politically, this will be difficult. The original IMF was the result of US hegemony. Now it can only be reformed by international agreement involving a dozen or so substantial players. Some hitherto dominant countries, like Britain, will have to sacrifice their leading roles. Politicians will be tempted to retreat into displacement activities, like attacking tax havens or hedge funds. Yet we must hope that, against all likelihood and in defiance of historical precedents, the leadership of today's G20 rises to the occasion and meets the imperious needs of the times.