The nations' actions speak louder, and they don't show a real commitment to global economic stability
After a two-day freefall, the U.S. stock market appeared to stabilize on Friday. We can debate about what's got the market resting a little easier, as we always do. Maybe investors have come to decide that the Federal Reserve's new action will help. Maybe they think the situation in Europe isn't as dire as they did yesterday. Or maybe they're just covering their short positions. But one reason they shouldn't feel some relief is the G-20 communiqué: it's just words with no clear indication that action will actually follow.
In the communiqué (.pdf), the twenty member nations pledged their commitment to global financial stability and economic recovery. But the measures actually referred to provide little assurance of real follow through.
Euro Zone Stability
The communiqué starts things off with euro zone nations pledging that they will work together to ensure that fiscal problems don't bring down the troubled countries in the region. It notes the recent July 21st agreement meant to stabilize the region. But one of the most important nations to provide aid through that pact, Germany, doesn't appear to be so committed.
Earlier today, the Wall Street Journal reported that German Finance Minister Wolfgang Schäuble said that the terms of the Greek rescue may need to be revised for the nation to obtain additional aid. Of course, this fueled speculation that the Mediterranean nation won't escape default.
The big fear then becomes contagion. If Greece defaults, will this put other struggling euro zone nations like Portugal and Italy in more serious danger of bankruptcy? Germany can't save everyone, and it might have problems of its own if the European banking system enters a financial crisis.
But perhaps the most laughable part of the communiqué was the following sentence:
The US has put forward a significant package to strengthen growth and employment through public investments, tax incentives, and targeted jobs measures, combined with fiscal reforms designed to restore fiscal sustainability over the medium term.
Right, but that package has approximately zero chance of becoming law. If the G-20 nations followed American politics, then they would know that the proposed stimulus was little more than a political ploy on the part of the Obama administration to jumpstart the president's 2012 campaign. His decision to propose aggressive new taxes on the wealthy as his means to pay for the stimulus makes this clear: Republicans would never agree to this, and he knows it.
Next, it refers to Japan's fiscal spending to recover from its devastating earthquake. Is the G-20 really pinning its hopes for a global economic recovery on spending meant to put one nation in the position it was in before a natural disaster? To be sure, these measures will help Japan to recover, but they don't amount to significant supplemental stimulus that will help to solve the problems plaguing the broader global markets.
The communiqué reiterates the nation's commitment to work towards the new Basel III capital standards. But in what way is this meant to help financial stability in the near-term? If anything, this will put additional stress on banks. They'll be forced to acquire additional capital at a time when credit is tight and assets are devalued.
In the long-term higher capital requirements will provide additional financial stability. In the short-term, however, compliance will just make the situation more difficult for already fragile banks.
Finally, it says central banks are ready to provide liquidity. "Monetary policies will maintain price stability and continue to support economic recovery," it adds. The question, however, is whether monetary policy can really do that much more to encourage economic activity. If we're in a situation where global consumers and firms are feeling too pessimistic to spend or invest more, then all the cheap credit in the world won't enhance economic output.
Indeed, we might have seen the market express this worry this week, as it shrugged off the latest Federal Reserve action. One of two things must be the case: either the market didn't think the central bank was doing enough or it was unconvinced that additional monetary stimulus would help. Each possibility is equally damning. Whether central banks are unwilling or unable to help, we can't rely on them to provide much relief to the ailing global economy.
So if something has the market feeling a little bit better today, then that's great. But it shouldn't be the G-20's commitment to global stability. It provides little reassurance that governments can fix the problem. Increasingly, it looks like the private sector will have to nurse its own wounds.