|THE TRADITIONAL strategy of cutting interest rates to cope with a financial
crisis hasn't worked this time because the core capitalist countries no
longer dominate the global economy as they once did. The devalued USD
coupled with rapid economic growth in in China and other newly emergent
economies whose currencies are pegged to the dollar have sent food, energy,
and other commodity prices soaring. Central bankers have "awoken to an
uncomfortable reality that focusing on a regional financial shock (has) led
them to ignore a global commodity shock", says Jean Pisani-Ferry in
Even if a global downturn temporarily brings down commodity prices, "a
lingering scarcity of fossil energy and agricultural commodities is likely
to remain", requiring greater international coordination of monetary and
fiscal as well as trade policy. "Success, however, will only be possible if
the G7 countries admit that the days when they were running the show are
over", Pisani says. He could have added that today's interwoven class and
national conflicts stem from the contradiction between this need and that of
a declining US empire desperate to maintain its hegemony in a unipolar
world. The article can also be read as a faithful reflection of the views of
European policymakers, and a source of their tactical disagreements with the
Bush administration. (MG)
* * *
Policy is a matter for the world, not just a rich club
By Jean Pisani-Ferry
August 12 2008
As the collapse of the trade talks in Geneva in July made clear, there is no
longer any meaningful trade negotiation without the main nations from the
emerging world. The year 2008 may go down in history as the one in which
rich countries discovered that this applies to macroeconomic policies, too.
In January it looked as if the opposite lessons could be drawn from events.
For a while, Ben Bernanke at the US Federal Reserve and Jean-Claude Trichet
at the European Central Bank seemed to be the only relevant policymakers in
the world – and they were, as far as liquidity strains were concerned, if
only because the US and Europe account for about two-thirds of the global
supply of financial assets.
But as months went by, it became clear that countries affected by the shock
represented merely a half of world gross domestic product, two-fifths of
global energy demand and not even a third of world cereal consumption.
Furthermore, rich countries have significantly less weight at the margin:
their contribution to world growth is about half their share of world GDP,
so one-quarter of the total, and the same rule of thumb applies even more to
the demand for oil and foodstuffs. So in the market for scarce commodities,
the effects of the slowdown in the US and Europe were offset by domestic
booms in the emerging world.
By the end of spring, policymakers in the Group of Seven leading nations had
awoken to an uncomfortable reality that focusing on a regional financial
shock had led them to ignore a global commodity shock. Worse, thanks to the
fact that most emerging and developing countries in Asia and the Gulf were
part of a de facto dollar zone, actions taken by the Fed to address
financial stress in fact compounded runaway domestic demand in those
countries and fuelled global hunger for commodities. In spite of rising
inflation, real interest rates in the main emerging countries are still
inappropriately low or even negative.
Stagflation is not here to stay. East Asia is unlikely to remain immune from
current near-zero growth in Europe (to where it exports about 5 per cent of
its GDP) or, even more, from forthcoming deterioration in the US (to where
it exports almost 7 per cent of its GDP). Commodity prices have started to
decline. However, the underlying issue will not go away, for two reasons.
First, lingering scarcity of fossil energy and agricultural commodities is
likely to remain and to change the macroeconomic scene significantly. For
about two decades, since the start of the current wave of globalisation, it
seemed that there were no real speed limits to global growth.
Disinflationary forces coming from the increase in the global labour force
and the weakening of organised labour were powerful enough to ensure an
environment of low prices worldwide. This Goldilocks era has ended and the
world economy is likely, over and again, to test the speed limit stemming
from constraints on the supply of commodities.
Second, in the same way German unification revealed the fault lines in the
European monetary arrangements of the 1980s, the current episode has exposed
the fault lines in the so-called “Bretton Woods 2” arrangement, whereby a
large part of the emerging world pegs to the US dollar. But for the
direction of the shock (a boom then, a slump now), what is happening now is
in many way a repetition of what happened then to the European exchange rate
mechanism: here, a shock to the anchor country that desynchronises it from
its monetary bedfellows.
So the question is: what do we need to manage interdependence better? A
straightforward solution would be for the main countries or groupings to
target domestic inflation independently in the context of flexible exchange
rates. The proviso is that for such a solution to work participants would
have to target total, not core, inflation (this may seem obvious but it has
apparently escaped some policymakers, who claim that there is nothing they
can do about inflation because it is not home-made). This is more or less
the arrangement industrialised countries came to a decade or so after the
collapse of Bretton Woods. It involves minimal co-ordination and can
accommodate differences in preferences. In the European case, it has proved
compatible with tighter regional agreements – including a single currency.
The problem is that a large part of the emerging world, starting with China,
is not ready for independent floating. There are genuine obstacles to it,
such as incomplete financial liberalisation and resistance stemming from the
fear of uncontrolled appreciation. However, there is no reason why a
preference for managing exchange rates should imply the status quo remains.
Adjustments are needed and the current de facto dollar pegs are often at
odds with the countries’ foreign trade. From basket pegs involving
currencies other than the dollar, especially the euro, to innovative
solutions such as the commodity peg advocated by Jeffrey Frankel of Harvard,
there is a large menu of options to choose from for reformers looking to
strengthen domestic and world stability.
But with managed exchange rates comes closer policy interdependence. If they
are to remain prevalent in one form or another, there will need to be more
co-operation in setting reference rates and monitoring aggregate demand.
This implies multilateral discussions on exchange rate arrangements as well
as on domestic demand policies and domestic subsidies to oil and food
consumption. From an institutional standpoint, this also implies going
beyond the existing loose arrangements or mere lunch invitations such as the
last G8 summit in Hokkaido. The G7/G8 is not the appropriate forum for
macro-financial matters any more. A frank policy dialogue between emerging
and developed countries requires an appropriate venue.
The one option that is not advisable is to ignore the lessons from this
year. For some time now, globalisation has been increasingly difficult to
sustain politically, in spite of having brought income gains and low prices
to the citizens of the advanced economies. It will already be much harder to
convince the same sceptical citizens that they must accept it despite the
fact that it brings higher commodity prices and lower incomes. It would
simply be impossible to make the case for it if, in addition, it were to be
perceived as a source of enduring instability.
Exchange rate arrangements and their implications for global macroeconomic
management should thus be a priority topic for the international community
and especially the International Monetary Fund. The Fund is looking for a
renewed purpose; here is one that belongs to its core mission and where it
has no substitute. Success, however, will only be possible if the G7
countries admit that the days when they were running the show are over.
The writer is director of Bruegel, the European think-tank