Thu, Oct 21, 2010 - Page 9 News List

On the brink of a world crisis

By Will Hutton  /  The Guardian, LONDON

Illustration: Mountain People

Those who run the IMF are supreme financial diplomats. They talk the opaque language of financial final communiques, the honed compromises between the great economic powers.

So when IMF managing director Dominique Strauss-Kahn acknowledged that the language of a recent IMF summit communique was “ineffective,” that the time for “real action” had come and that he feared “a race to the bottom” as the major countries began to outdo each other in beggar-my-neighbor currency wars, you should sit up and listen.

The problem is that we can talk and talk and talk, he said, but in the end something has to happen — and it has not. If countries chose not to co-operate in unravelling the problems facing the world economy, we all faced disaster.

Washington blames Beijing for the impasse, saying it was manipulating its currency to export unemployment to the stagnation-stricken US. Beijing blames Washington for flooding the world with dollars and taking no responsibility as the hegemonic power for the fiscal and monetary discipline necessary to underpin the world’s key currency. Fears are growing that next month’s G20 meeting in South Korea will reveal the lack of cooperation.

It was the collapse of collaboration at the London summit in 1931 that launched the trade and currency policies that prolonged depression. Will history repeat itself?

The US is preparing to declare unilateral economic war on China by further swelling the flood of dollars when it adopts a US form of quantitative easing next month to boost anemic levels of bank lending. China will be swamped by yet more dollars displaced from the US, but is determined, as Bank of China Governor Zhou Xiaochuan (周小川) repeated, to move with extreme gradualism on its currency, if it moves at all.

Both, as in the early 1930s, imagine they can get better results by going it alone. And if they square up to each other, the rest of the world has no option but to protect itself, the dynamic that caused the competitive devaluations and trade protection of the 1930s.

This is the background to this week’s statement by British Chancellor of the Exchequer George Osborne, in which he will announce the fastest, deepest cuts in public spending ever mounted by any leading government in modern times.

Given the risks, the right policy would have been to embed flexibility in Britain’s spending, taxing and borrowing plans so the government could move fast to adjust to whatever happens. It is not what will be announced.

There was no need for such haste. Just as we took a decade to solve our problems after the crises of the mid-1970s and early 1990s, so we could have done the same today — aggressively cutting the deficit only when it became clear that there is an international bargain to better manage the world economy and when recovery is more assured.

After all, it has never been easier to sell government debt. Equally, if more of the burden of deficit reduction had been shouldered by planned tax increases, they could have been quickly deferred or abandoned to boost the economy if world economic prospects darkened. The haste to cut so blindly and so crudely, unless we are very lucky, will be seen by future historians as one of the great acts of economic folly.

Optimists insist China and the US will draw back from economic war and that the risks are manageable. The Chinese have let the yuan go up by 2 percent over the last two months, a concession noticed in Washington, and have pledged to lower their trade surplus. After all, with foreign exchange reserves of US$2.6 trillion, the highest of any country in history, the only way China can carry on acquiring reserves on this scale without risking massive inflation is through even more draconian controls on its banking and monetary system.

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