A better G-20 agenda (Part 4)

By Philip Zelikow

The next part of a better agenda for the G-20 summit is keeping this in mind:

The proposal for global stimulus spending of 2 percent of GDP (with IMF monitoring) is not so good.

Last week, Geithner drew on a new IMF report for support in his call for the world to spend 2 percent of its collective GDP on fiscal stimulus. True in general, and the IMF wants countries "with fiscal room" to plan to keep the fires burning on into 2010.

But the IMF also re-emphasized two other points: 1) Hold on to money that governments will need for "upfront" financial sector support, and these needs will be large; 2) "Reinforcing fiscal credibility is paramount. Thus, fiscal support needs to be anchored by a sustainable medium-term fiscal framework." 

The Great Depression was aggravated, if not caused, by ideological commitment to monetary stringency. But this crisis has very different structural origins, almost the exact opposite. Yet, in responding to this generation’s Great Recession, Geithner and the administration seem to be exhibiting a reflexive ideology of their own, assuming that already highly leveraged economies can borrow/spend their way out — relying on what World Bank president Robert Zoellick recently called "a sugar high."

As a historian, an interesting pattern one sees is how often governments rarely make the same mistake twice. Instead they are damn sure they "won’t make that mistake again." And they don’t. They slavishly act to avoid the last mistake. Which becomes their new mistake.

Two other recent comments help place these global stimulus proposals into a proper global perspective, one from a historian and one from an economist. Yale historian Paul Kennedy recently tried to imagine what Keynes would think of the current debate. Kennedy thought Keynes "would be uneasy at parts of Mr. Obama’s deficit-spending scheme." Not only the domestic part, but also unease with:

… a Washington spending spree that seems uncoordinated with those of Britain, Japan, China and the rest; and, most unsettling of all, at the fact that no one is asking who will purchase the $1,750bn of US Treasuries to be offered to the market this year – will it be the east Asian quartet, China, Japan, Taiwan and South Korea (all with their own catastrophic collapses in production), the uneasy Arab states (yes, but to perhaps one-tenth of what is needed), or the near-bankrupt European and South American states? Good luck! If that colossal amount of paper is bought this year, who will have ready funds to purchase the Treasury flotations of 2010, then 2011, as the US plunges into levels of indebtedness that could make Philip II of Spain’s record seem austere by comparison?

For those who don’t remember Kennedy’s book on The Rise and Fall of the Great Powers, Philip II of Spain was the exemplar of "Fall."

If Kennedy’s worries seem a bit hyperbolic, there are more nuanced cautions from Simon Johnson’s recent congressional testimony.

First, Johnson pointed out that America’s own stimulus plans are predicated on economic forecasts (for a recovery later this year) that he regards as too rosy. Thus, "In the United States, the budget deficit is approaching a trajectory that is sustainable only if rapid growth returns in 2010."

Second, commenting on Geithner’s 2 percent proposal, Johnson (aside from noting its "fuzzy" math) observed:

Very few countries now have room for a fiscal stimulus; debt levels are too high and fiscal capacity is hard pressed by contingent liabilities in the banking system, particularly with an increasing probability of quasi-nationalization. As a result, the idea of a 2 percent of GDP global fiscal stimulus seems quite far fetched at this point.

Contingent liabilities in the banking system: Has anyone noticed that, while some Republicans are worrying aloud that Obama wants to turn the United States into a big-spending and high-taxing version of Western Europe, the actual governments in Western Europe (e.g. France) think the United States is focusing too much on fiscal stimulus!?

What is going on? Did Friedman and Hayek just get translated into French? No, but the French are indeed a bit worried about "contingent liabilities in the banking system." They wish the Americans would focus more on that. Meanwhile, the AIG bonus blowup is going to make that problem even harder for the Obama administration to tackle.