G-7 Risks ‘Muddled Middle’ With Plan to Spend Now, Save Later
Group of Seven finance ministers promised to spend now and save later as they try to spur the global economic rebound without incurring the wrath of investors increasingly focused on mounting debt.
“The position for most countries is to support the economies now and get the budget deficit down as the economy recovers,” U.K. Chancellor of the Exchequer Alistair Darling said in an interview in Iqaluit, Canada, where G-7 finance ministers and central bankers concluded talks on Feb. 6.
Governments face a dilemma as they try to sustain the rebound from last year’s recession at a time when rising sovereign debt burdens are being punished by investors and threaten to hobble future expansion. Adding urgency to the situation, the MSCI World Index of stocks fell to its lowest since October last week amid concern Greece and some other European nations may default on their debt.
Policy makers want to “address the twin challenges of high unemployment and rapidly worsening public finances,” said Mohamed El-Erian, chief executive officer at Pacific Investment Management Co., which runs the world’s biggest mutual fund. “The risk is that major G-7 economies will remain in the muddled middle, achieving insufficient progress in meeting either and both objectives.”
Insurance Levy
Apart from immediate economic pressures, G-7 ministers moved closer to requiring banks to pay more of the cost of future financial turmoil after government rescues of financial companies from Citigroup Inc. to Royal Bank of Scotland Group Plc saddled taxpayers with trillions of dollars in liabilities.
One initiative winning support is having banks pay an insurance levy to create reserves that could be tapped if a bank or financial system ran into trouble, a U.K. official said on condition he not be named. Sweden already has such a program.
Policy makers will await an International Monetary Fund report in April before making a decision and each country would need to adopt the plan for it to be a success, the official said. One downside of the proposal is banks may take on more risk knowing that money existed to save them in the case of failure, a German official said.
“We agreed to work together to make sure financial institutions bear the costs of their contribution to those crises,” Canadian Finance Minister Jim Flaherty said.
Officials also pledged to complete work on forcing banks to raise the quality and quantity of capital they hold. Papering over recent differences, ministers said governments still have room to pursue individual policies such as U.S. President Barack Obama’s proposal to limit the size and proprietary risk-taking of large banks.
‘Strong Reforms’
“What you saw was not a divergence of approach, but a strong commitment together to try to make sure we are putting in place the strong reforms that would permit these kinds of crises from happening again,” U.S. Treasury Secretary Timothy F. Geithner said.
With credit-default swaps on Greek debt surging to a record last week, European officials sought to bolster investor confidence in Greece’s ability to cut the EU’s largest budget deficit by endorsing the country’s austerity plan.
“The European members of the G-7 will make sure it is managed,” French Finance Minister Christine Lagarde told reporters in Iqaluit. European Central Bank President Jean- Claude Trichet said the bank is “confident” the nation will pare its deficit below the EU’s limit of 3 percent of gross domestic product in 2012 from 12.7 percent now.
‘Dress Rehearsal’
“No measure of official reassurance would be enough unless the nations in question retain credibility in financial markets, which remains to be seen,” said Geoffrey Yu, a currency strategist at UBS AG in London. “We expect foreign exchange markets to continue trading on a risk-averse tone.”
Deutsche Bank AG is warning that the increase in the cost of insuring against debt defaults by Greece and other European economies such as Spain and Portugal may be a “dress rehearsal” for the U.S. and U.K., which are now running deficits above 10 percent of GDP.
As the IMF calculates debt in the advanced Group of 20 economies will reach 118 percent of GDP in 2014, up from about 80 percent before the crisis, some G-7 nations are attracting the ire of investors and credit rating companies.
‘Horrible’ Math
Standard & Poor’s last month cut the outlook for its sovereign credit rating of Japan, whose debt burden is the biggest in the industrialized world and nearing twice the size of its economy. Moody’s Investors Service Inc. said on Feb. 2 that the U.S.’s Aaa bond rating will come under pressure unless additional measures are taken to reduce deficits. Pimco calls U.K. government bonds “a must to avoid.”
“The contagion is going to spread,” Harvard University Professor Niall Ferguson said in a Bloomberg Television interview. “The math is horrible for the United States.”
Geithner told ABC News yesterday that the U.S. will “absolutely not” lose its Aaa debt rating even after the administration predicted a $1.6 trillion budget deficit in 2010.
Still, in an acknowledgement of the looming fiscal risks, G-7 members were told in a document drawn up by Canadian officials that they should set “clear, credible and consistent” plans to strengthen their budgets.
Delay in doing so would lead markets to “begin to question our commitment to sound medium-term policy frameworks, with the result that interest rates would rise,” said the report obtained by Bloomberg News.
The G-7 officials met 195 miles south of the Arctic Circle in a former whaling and fur-trading outpost that is now the capital of Canada’s northernmost territory, Nunavut.
Bank of England Governor Mervyn King was among the delegates to try dog-sledding, while Flaherty’s personal exit- strategy backfired as he damaged the doorway of an igloo when his duck-down parka got snagged on its arch. European officials found themselves dodging press questions about whether the trip made them more supportive of seal hunting.
“It was an adventure for people, which I think took them out of their normal office mode,” said Flaherty.
Filed under: money by Wolf