President Bush has called a global summit meeting, to be held in late November, for the leaders of the "G-20" -- a collection of the world's most advanced economies along with a dozen or so aspirants to that exclusive club. Let's hope he invites along whoever is elected the next President of the United States, eight days from now, because the world's problems are certainly not going to be solved before Inauguration Day.
Indeed, the disaster faced by the new President could be considerably worse than what we are looking at right now. Think of the housing bust as a locomotive pulling a long train of freight cars laden with volatile commodities. The locomotive derails, and the cars behind it start to slam into each other, buckling every-which-way, exploding into flames, sending shock waves in every direction. It might take some time, relatively speaking, for the disaster to get all the way back to the caboose, but all the while the scale of the calamity just keeps growing.
While focusing largely on the plight of the U.S. economy and the political implications thereof, I've been noticing, out of the corner of my blogosphere-watching eye, an increasing number of economists sounding alarms over the next stage in the meltdown, a currency crisis in emerging markets. The rich nations have had their fun, now it's time for the rest of the world to join the party. As Paul Krugman notes, what we're about to witness makes the Asian financial crisis of 1997 look like "a day at the beach."
The rich nations of the world may have, for now, stabilized their credit markets, in large part because the Federal Reserve and U.S. Treasury stepped in to bail out banks. The Fed has even allowed a select group of advanced European nations essentially unlimited access to credit. The result: the lines lines that once separated Europe, Japan, and the U.S. from the rest of of the world -- boundaries that had had become blurred with the recent emergence of such economic adolescents as Brazil, Russian, China, and India -- are being redrawn.
Now that advanced countries have bailed out and guaranteed vast portions of their financial systems, there is a much greater demarcation between "safe" and "risky" assets, with emerging markets in the second category. The flight to safety is already taking a huge toll on them. And the worst is likely to come when domestic residents join en masse in the capital flight.
By "flight to safety" Rodrik is referring to the exodus of capital -- so-called "hot money" -- from the emerging economies back to the advanced nations, where bank deposits are guaranteed and governments are taking huge equity stakes in financial institutions. The consequence of hot money flight is drastic pressure on national currencies. Which in turn, could lead to the kind of competitive devaluations and relapse into protectionism that the world experienced during the Great Depression.
All of this means that governments in these economies will be under pressure to mimic the public guarantees and bailouts that we have seen in the U.S. and the E.U. But there is a big difference. Emerging markets for the most part have weak and fragile fiscal systems, and the magnitude of the potential run is huge relative even to the large mountains of reserves that many of them have built up. Socialization of private liabilities may enhance confidence in the rich countries; it will likely magnify the run in emerging markets. So we are talking about economic collapses that could be significantly bigger than what the rich countries will experience. And this time developing countries can legitimately say: it wasn't our fault!
To ameliorate the crisis, Dani Rodrik, economist Brad Setser and others argue that the IMF must play an analogous role, with respect to emerging nations, to what the Fed and Treasury have done for Wall Street, et al. The IMF must extend credit and capital to all comers. But this time, the mistakes of the Washington Consensus-era IMF, which penalized debtor nations with crippling "conditions," should not be repeated. If Citigroup and Morgan Stanley can get infusions of billions of dollars with essentially no questions asked, then why not Hungary, Iceland, Poland, or Kazakhstan? (There is some evidence that the IMF is already moving in such a direction.)
A natural question: Where would the IMF get the money? The IMF has only around 200-250 billion at its disposal, which could be considered chickenfeed compared to what it will take to stabilize all the national economies that are at risk. But the U.S. and E.U. are already stretching their own resources to the limit.
One suggestion is that China should part with some its vast, nearly $2 trillion reserves, and other Asian nations could follow suit. The irony would be immense. Many Asian nations now boast huge reserves of foreign currency because the lesson they learned from the Asian financial crisis was that they never again wanted to be in the position of having to beg from the IMF. How sweet to now be in the position of bankrolling the IMF's attempts to save emerging economies from the maelstrom born on Wall Street? There's also the matter of self-interest. Export-depending East Asian economies are at serious risk from a collapse in global trade.
But if China ponies up, won't China want something in return? Like, for example, a bigger role in the governance of international financial institutions such as the IMF and the World Bank? Just as the failure of Wall Street to mind its own store is smashing the authority of decades of deregulatory ideology, the vulnerability of the entire global economy to U.S. and European financial market failure may prefigures a realignment of of the global financial order.
Which brings us back to the big G-20 summit meeting in November. Clearly, the topics on the table won't just be strategies on how to better regulate Wall Street. A readjustment of who calls the shots on the global economy may well be at stake.
Best perhaps, that George Bush should stay out of it? Figuring out how to structure the new, new world order ought to go on the new guy's to-do list, no?