The Los Cabos “G20 Leaders Declaration” and Los Cabos Growth and Jobs Action Plan have some encouraging elements for those concerned about the prospects for the global economy. Three key risks came to prominence in the weeks leading to the summit:
- most pressing, obviously, is the continuing crisis in the euro zone and the uncertainty it creates for Europe and the rest of the world;
- the threat of a fiscal shock in the United States as tax cuts expire undermining growth, just as a threatened repeat of the debt-ceiling drama unfolds; and
- slowing growth in the key dynamic emerging economies that have powered global growth since 2008.
These risks remain. The declaration is a statement of intent, not a plan of action. Yet, the Los Cabos declaration reveals that these risks were front and centre in the intense, exhausting (and typically all-night) drafting sessions of senior officials that preceded the formal meeting of leaders. Those negotiations, which often hinge on the placement of a comma, or long, drawn-out debates about the appropriate adjective, undoubtedly featured a number of heated exchanges. The declaration is welcomed, notwithstanding the possible tensions involved in its drafting, because it signals that G20 members intend to address these risks.
Most important, is the commitment by the euro-area members to "take all necessary policy measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks." The problem in Europe has been a yawning gap between the nearly perfect degree of capital market integration within the euro zone, and the institutional arrangements (or governance) that is required to support that integration. This cleavage accounts for the outflow of deposits from periphery-country banks to German banks, resulting in the loss of liquidity in the former, and a surfeit of liquidity and lower interest rates in the latter.
Containing the euro crisis is critical. But the Los Cabos declaration also includes language on the need for the United States to "...calibrate the pace of its fiscal consolidation by ensuring that its public finances are placed on a sustainable long-run path so that a sharp fiscal contraction in 2013 is avoided." This would prevent the much-feared fiscal shock that might undermine growth before a strong, self-sustaining dynamic of employment growth leading to higher incomes and the higher consumption that sustains growth, is established.
Moreover, the Los Cabos declaration welcomes the "commitment by China to allow market forces to play a larger role in determining movements in the renminbi (RMB), continue to reform its exchange rate regime, and to increase the transparency of its exchange rate policy." This is potentially significant. As noted in CIGI's pre-summit commentaries (Perspectives on the G20: The Los Cabos Summit and Beyond), key dynamic emerging economies are conflicted between their need to prevent inflation, which if unchecked could fuel growing asset price bubbles and foster financial instability, and their desire to limit the appreciation of their currencies in order to preserve current account surpluses. Attempts to achieve both could guarantee success in neither. A commitment to allow greater flexibility of the RMB combined, presumably, with clear targets for inflation, would signal China's determination to accept the obligations that go with global leadership.
Each of these commitments is encouraging. To some extent, however, making commitments is the easy part. The real test will come when the leaders and their entourages return to their capitals and begin the more difficult task of implementing their commitments. And, on this score, there are considerable grounds for caution.
Most significantly, the wording of the euro-area G20 members' commitment is very weak. They "support the intention to consider concrete steps towards a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance." In other words, they are not committing to concrete steps — merely their intention to consider such measures. I suspect that, while this may buy a little time with markets, its half-life can be measured in days, if not hours. To be fair, that is probably the best that could be hoped for, since a small subset of euro-zone members cannot bind the others in a summit at which they are not present.
Similarly, while President Barack Obama can undertake to calibrate US fiscal consolidation to avoid premature and disruptive fiscal tightening, the simple truth is that the US president does not unilaterally control fiscal policy. He can draw on his extraordinary powers of oratory to mobilize public opinion, but fiscal policy is a two-player game. If Congress does not cooperate, it is not clear how that commitment can be honoured.
And, finally, China's commitment to greater exchange rate flexibility (which echoes earlier commitments) could be tested in the coming weeks. A year or more ago, there were widespread concerns of a new currency war as the US Federal Reserve Board and other advanced-country central banks adopted so-called quantitative easing to promote recovery. The use of these measures was necessary to offset the effects of ongoing financial de-leveraging, as banks struggling with weakened balance sheets restrained their lending activities. But one effect of these measures was increased capital flows to emerging market economies and the appreciation of their currencies. These effects were the channels through which the policy of quantitative easing could stimulate growth.
Looking ahead, it is possible that continuing turmoil in Europe, which weakens global growth, or an unwanted US fiscal tightening, could trigger additional quantitative easing. If that is the case, China's commitment to the Los Cabos Action Plan will be tested. In this respect, while it is clear that G20 leaders appreciate the urgency of addressing the key risks in the global economy, it is unclear that the commitments made in Los Cabos will be implemented.
The message has been received. Will it be heeded?