Brazil was now experiencing the same dilemma as China, having to choose between inflation and revaluation. When the United States is printing dollars and another country is trying to peg its currency to the dollar, that country ends up printing local currency to maintain the peg, which causes local inflation. As a consequence, investors chasing high returns around the world, the so-called hot money, poured into Brazil from the United States. The situation had deteriorated to the point that a Nomura Global Economics research report in early 2011 declared Brazil the biggest loser in the currency wars. This was true up to a point, based on the appreciation of the real. By April 2011, Brazil was “waving the white flag in the currency war,” in the words of a Wall Street Journal analysis. Brazil appeared resigned to a higher value for the real after currency controls, taxes on foreign investments and other measures had failed to stop its appreciation.
Lacking the reserves and surpluses of the Chinese, Brazil was unable to maintain a peg against the dollar by simply buying all the dollars that arrived on its doorstep. Brazil was stuck between the rock of currency appreciation and the hard place of inflation. As was the case with the United States and the Europeans, albeit for different reasons, Brazil increasingly looked to the G20 for help in the currency wars.
Brazil is an important case because of its geographic, demographic and economic scale, but it is by no means the only country caught in the cross fire of a currency war among the dollar, euro and yuan. Other countries implementing or considering capital controls to stem inflows of hot money, especially dollars, include India, Indonesia, South Korea, Malaysia, Singapore, South Africa, Taiwan and Thailand. In every case, the fear is that their currencies will become overvalued and their exports will suffer as the result of the Fed’s easy money policies and the resulting flood of dollars sloshing around the world in search of high yields and more rapid growth.
These capital controls took various forms depending on the preferences of the central banks and finance ministries imposing them. In 2010, Indonesia and Taiwan curtailed the issuance of short-term investment paper, which forced hot money investors to invest for longer periods of time. South Korea and Thailand imposed withholding taxes on interest paid on government debt to foreign investors as a way to discourage such investment and to reduce upward pressure on their currencies. The case of Thailand was ironic because Thailand was the country where the 1997–1998 financial panic began. In that panic, investors were trying to get their money out of Thailand and the country was trying to prop up its currency. In 2011 investors were trying to get their money into Thailand and the country was trying to hold down its currency. There could be no clearer example of the shift in financial power between emerging markets such as Thailand and developed markets such as the United States over the past ten years.
None of these peripheral, mostly Asian, countries trying to hold down the value of their currencies is the issuer of a widely accepted reserve currency, and none has the sheer economic scale of the United States, China or the eurozone when it comes to the ability to fight a currency war by direct market intervention. These countries too would need a multilateral forum within which to resolve the stresses caused by Currency War III. While the IMF has traditionally provided such a forum, increasingly all of the large trading economies, whether G20 members or not, are looking to the G20 for guidance or new rules of the game to keep the currency wars from escalating and causing irreparable harm to themselves and the world.
CHAPTER 7
The G20 Solution
“Let me put it simply . . . there may be a contradiction between the interests of the financial world and the interests of the political world.... We cannot keep constantly explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people who have earned a lot of money from taking those risks.”
Angela Merkel,
Chancellor of Germany, at the G20 Summit,
November 2010
The Group of Twenty, known as G20, is an unaccountable and very powerful organization that arose from the need to resolve global issues in the absence of true world government. The name G20 refers to its twenty member entities. They are a mixture of what were once the world’s seven largest economies, grouped as the G7, consisting of the United States, Canada, France, Germany, the United Kingdom, Italy and Japan, and some fast-growing, newly emerging economies such as Brazil, China, South Korea, Mexico, India and Indonesia. Others were included more for their natural resources or for reasons of geopolitics rather than the dynamism of their economies; examples are Russia and Saudi Arabia. Still others were added for geographic balance, including Australia, South Africa, Turkey and Argentina. The European Union was invited for good measure, even though it is not a country, because its central bank issues one of the world’s reserve currencies. Some economic heavyweights such as Spain, the Netherlands and Norway were officially left out, but they are sometimes invited to attend the G20 meetings anyway because of their economic importance. G20 and Friends might be a more apt appellation.
The G20 operates at multiple levels. Several times each year the finance ministers and central bank heads meet to discuss technical issues and try to reach consensus on specific goals and their implementation. The most important meetings, however, are the leaders’ summits, attended by presidents, prime ministers and kings, which meet periodically to discuss global financial issues, with emphasis on the structure of the international monetary system and the need to contain currency wars. It is at these leaders’ summits, both in the formal sessions and informally in the suites, that the actual deals shaping the global financial system are made. Interspersed among the presidents and prime ministers at these meetings is that unique breed of international bureaucrat known as the sherpa. The sherpas are technical experts in international finance who assist the leaders with agendas, research and drafting of the opaque communiqués that follow each confab. All roads toward the resolution of the looming currency wars point in the direction of G20 as the principal forum.
The G20 is well suited to be inclusive of Chinese participation. China often resists compromise in bilateral meetings, viewing requests for concessions as bullying and their assent as a loss of face. This is less of a problem in G20, where multiple agendas are implemented at once. Smaller participants enjoy the chance to have their voices heard in G20 because they lack the leverage to move markets on their own. The United States benefits from having its allies in the room and avoids charges of acting unilaterally. So the advantages of G20 to all parties are apparent.
President George W. Bush and President Nicolas Sarkozy of France were instrumental in changing the G20 from merely a finance ministers’ meeting, which it had been since its beginning in 1999, to a leaders’ meeting, which it has been since 2008. In the immediate aftermath of the Lehman Brothers and AIG collapses in September 2008, attention turned to a previously scheduled G20 meeting of finance ministers in November. The Panic of 2008 was one of the greatest financial catastrophes in history and the role of China as one of the largest investors in the world and a potential source of rescue capital was undeniable. At the time, the G7 was the leading forum for economic coordination, but China was not in the G7. In effect, Sarkozy and Bush reenacted the scene in Jaws where Roy Scheider, after seeing the shark for the first time, says to Robert Shaw, “We’re gonna’ need a bigger boat.” Politically and financially, G20 is a much bigger boat than G7.
In November 2008, President Bush convened the G20 Leaders’ Summit on Financial Markets and the World Economy, at which every president, prime minister, chancellor or king of a member country was present. Instantly the G20 morphed from a finance ministers’ technical session to a gathering of the most powerful leaders in the world. Unlike various regional summits, every corner of the globe had its representatives and, unlike the UN General Assembly, everyone was in the room at the same time.
Based on the urgency of the financial crisis and the ambitious agenda laid down by the G20 in Novembe
r 2008, the leaders’ summits continued through four more meetings over the course of 2009 and 2010. For 2011, the G20 leaders decided to hold a single meeting in Cannes, France, in November. This sequence of summits was the closest thing the world had ever seen to a global board of directors, and it seemed here to stay.
The G20 is perfectly suited to U.S. Treasury secretary Timothy Geithner’s modus operandi, which he calls “convening power.” Author David Rothkopf brought this concept to light in a highly revealing interview he conducted with Geithner for his book Superclass, about the mores of the global power elite. When he was president of the New York Fed in 2006, Geithner told Rothkopf:We have a convening power here that is separate from the formal authority of our institution.... I think the premise going forward is that you have to have a borderless, collaborative process. It does not mean it has to be universal.... It just needs a critical mass of the right players. It is a much more concentrated world. If you focus on the limited number of the ten to twenty large institutions that have some global reach, then you can do a lot.
Geithner’s notion of convening power states that, in a crisis, an ad hoc assembly of the right players could come together on short notice to address the problem. They set an agenda, assign tasks, utilize staff and reassemble after a suitable interval, which could be a day or month, depending on the urgency of the situation. Progress is reported and new goals are set, all without the normal accoutrements of established bureaucracies or rigid governance.
This process was something Geithner learned in the depths of the Asian financial crisis in 1997. He saw it again when it was deployed successfully in the bailout of Long-Term Capital Management in 1998. In that crisis, the heads of the “fourteen families,” the major banks at the time, came together with no template, except possibly the Panic of 1907, and in seventy-two hours put together a $3.6 billion all-cash bailout to save capital markets from collapse. In 2008, Geithner, then president of the New York Fed, revived the use of convening power as the U.S. government employed ad hoc remedies to resolve the failures of Bear Stearns, Fannie Mae and Freddie Mac from March to July of that year. When the Panic of 2008 hit with full force in September, the principal players were well practiced in the use of convening power. The first G20 leaders’ meeting, in November 2008, can be understood as Geithner’s convening power on steroids.
It was in the G20 that the United States chose to advance its vision for a kind of global grand bargain, which Geithner has promoted under the name “rebalancing.” To understand rebalancing and why this has been critical to growth in the U.S. economy, one need only recall the components of gross domestic product. For the United States, GDP grew to roughly $14.9 trillion in early 2011. The components broke down as follows: consumption, 71 percent; investment, 12 percent; government spending, 20 percent; and net exports, minus 3 percent. This was barely above the level the U.S. economy had reached before the recession of 2007. The economy was not growing nearly fast enough to reduce unemployment significantly from the very high levels reached in early 2009.
The traditional cure for a weak economy in the United States has always been the consumer. Government spending and business investment might play a role, but the American consumer, at 70 percent or more of GDP, has always been the key to recovery. Some combination of low interest rates, easier mortgage terms, wealth effects from a rising stock market and credit card debt has always been enough to get the consumer out of her funk and get the economy moving again.
Now the standard economic playbook was not working. The consumer was overleveraged and overextended. Home equity had evaporated; indeed many Americans owed more on their mortgages than their houses were worth. The consumer was stretched, with unemployment high, retirement looming and kids’ college bills coming due. And it seemed the consumer would stay stretched for years.
In theory, business investment could expand on its own, but it made no sense to invest in plant and equipment beyond a certain point if the consumer was not there to buy the resulting goods and services. Besides, high U.S. corporate tax rates led many corporations to keep their earnings offshore so that much of their new investment took place outside the United States and did not contribute to U.S. GDP. Investment remained in the doldrums and would stay there as long as the consumer was in hibernation.
With the consumer out of action and investment weak, the Keynesians in the Bush and Obama administrations next turned to government spending to stimulate the economy. However, after four stimulus plans from 2008 to 2010 failed to create net new jobs, a revulsion to more spending emerged. This revulsion was fanned by a Tea Party movement, threats from ratings agencies to downgrade U.S. creditworthiness and a Republican tidal wave of victories in the 2010 midterm elections. It became clear that the American people wanted someone to put the lid back on Uncle Sam’s cookie jar. It remained to be seen how much in the way of spending cuts could be enacted, but it was apparent that greatly increased government spending was off the table.
So a process of elimination led the Obama administration to see that if consumption, investment and government spending were out of play, the only way to get the economy moving was through net exports—there was nothing else left. In the State of the Union address on January 27, 2010, President Obama announced the National Export Initiative, intended to double U.S. exports in five years. Achieving this could have profound effects. A doubling of exports could add 1.3 percent to U.S. GDP, moving growth from an anemic 2.6 percent to a much more robust 3.9 percent or higher, which might be enough to accelerate the downward trajectory of unemployment. Doubling exports was a desirable goal if it could be achieved. But could it? If so, at what cost to our trading partners and the delicate balance of growth around the world?
At this point U.S. economic policy crashed headlong into the currency wars. The traditional and fastest way to increase exports had always been to cheapen the currency, exactly what Montagu Norman did in England in 1931 and what Richard Nixon did in the United States in 1971. America and the world had been there before and the global results had been catastrophic. Once again a cheap dollar was the preferred policy and once again the world saw a catastrophe in the making.
China’s GDP composition was in some ways the mirror image of the United States. Instead of the towering 70 percent level of the United States, consumption was only 38 percent of the Chinese economy. Conversely, net exports, which produced a negative 3 percent drag on the U.S. economy, actually added 3.6 percent to the Chinese total. China’s growth was heavily driven by investment, which totaled 48 percent of GDP versus only 12 percent for the United States. Given these mirror image economies, a simple rebalancing seemed in order. If China could increase consumption, in part by buying goods and services from the United States, including software, video games and Hollywood films, then both countries could grow. All that needed to change was the consumption and export mix. China would dial up consumption and dial down net exports, while the United States did the opposite. Those new export sales to China would create jobs in the United States for good measure. This could not be done through exchange rates alone; however, Geithner said repeatedly that upward revaluation of the yuan was an important part of the overall policy approach.
One reason the Chinese did not consume more was that their social safety net was weak, so individuals saved excessively to pay for their own retirement and health care. Another factor working against Chinese consumption was a millennia-old Confucian culture that discouraged ostentatious displays of wealth. Yet U.S. policy makers were not looking for a prospending cultural revolution; something more modest would suffice. Just a few percentage points of increase in consumption by China in favor of U.S. exports could allow the United States to ignite a self-sustaining recovery.
This was to be a strange kind of rebalancing: the increased Chinese consumption and increased U.S. net exports would come entirely at China’s expense. China would have to make all of the adjustments, with regard to their currency, their social safety net and twenty-five hundr
ed years of Confucian culture, while the United States would do nothing and reap the benefits of increased net exports to a fast-growing internal Chinese market. This was a particularly soft option for the United States. It required no tangible effort by the United States to improve its business climate by reducing corporate taxes and regulation, providing for sound money or promoting savings and investment. Some of what the United States wanted may have been in China’s best interests, but China could not be blamed for believing it was being bullied on behalf of a U.S. plan that above all suited the United States. In the parlance of the G20, “rebalancing” became code for doing what the United States wanted.
The international financial cognoscenti did not have to wait for the January 2010 State of the Union to see where the United States was going with its rebalancing plan. The idea for increased U.S. exports and the associated revaluation of the yuan had already been vetted in September 2009 at the Pittsburgh G20 summit. The first two G20 summits, in Washington and London, had been devoted to an immediate response to the Panic of 2008 and the need to create new liquidity sources through the IMF. These early G20 summits had also been preoccupied with plans to rein in the banks and their greed-based compensation structures, which provided grotesque rewards for short-term gains but caused the long-term destruction of trillions of dollars of global wealth. By the Pittsburgh summit in late 2009, the leaders felt that while vulnerabilities remained, enough stability had returned that they could look past the immediate crisis and begin to think about ways to get the global economy moving again. Pittsburgh would be the last G20 summit before the 2010 State of the Union. If the United States was going to get buy-in for its export-driven rebalancing plan, this was the time.
Currency Wars: The Making of the Next Global Crisis Page 15