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What Will New World Order Look Like? - WSJ.



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Updated June 18, 2012, 8:20 a.m. ET

What Will New World Order Look Like?


Leaders of the world's largest economies are gathering in Mexico for the latest G-20 meeting. WSJ's Simon Nixon expects little from them unless they consider a new world order that can tackle the financial crisis. Photo: Getty Images

Los Cabos in Mexico is by all accounts a delightful place: Chic hotels, excellent beaches and fine weather at this time of year. World leaders descending on the resort for this week's Group of 20 summit should make the most of what it has to offer. Nothing they discuss is likely to make any difference to the crisis raging in the global economy. The world is now a different place to 2009 when, at summits in London and Pittsburgh, the leaders of the world's largest economies believed they had "saved the world"as then-U.K. Prime Minister Gordon Brown put itwith a massive fiscal and monetary stimulus and a comprehensive agenda to reform the financial system. At the time, the G-20's response was hailed as the start of a new world order. It may turn out to have been the last gasp of an old world order. That old world order began in 1944 at Bretton Woods in response to the Great Depression and the horrors that followed. One of its main architects was John Maynard Keynes, and his ideas have guided much of the current crisis response. The central challenge in the post-Bretton Woods era has been how to manage economies in the absence of the gold standard. The gold standard had many flaws, but the chief virtue of fixing the exchange rate and constraining the supply of credit was to stop politicians succumbing to the inevitable pressure to respond to crises by debauching the currency, resulting in long-term harm to the livelihoods and living standards of their citizens.

Zuma Press

Chinese President Hu Jintao, left, arrives at Los

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What Will New World Order Look Like? - WSJ.com


Cabos airport in Mexico on Saturday for the seventh G-20 summit.

Previous experiments in paper money had ended in disaster, most spectacularly in France in 1720.

What the current crisis is testing is how far modern democracies are capable of submitting to the discipline needed to maintain faith in their currencies. Post-War economic history is the story of the quest to find new ways to bind the hands of politicians. To prevent a repeat of 1930s beggar-thy-neighbor protectionism, governments yielded significant powers over trade policy to supranational bodies such at the World Trade Organization (previously the General Agreement on Tariffs and Trade) and the European Union. In response to the inflation shocks of the 1970s and 1980s, governments ceded powers over interest rates to central banks. More recently, politicians have had to accept debt brakes and other devices to limit borrowing and many have submitted to external surveillance by independent monitors such as the U.K.'s Office for Budget Responsibility or, under the euro zone's Fiscal Pact, by the European Commission. That hasn't stopped politicians continuing to look for easy solutions. Although trillions of dollars of stimulus failed to deliver the expected recovery, diehard Keynesians insist the answer is more of the same. But stimulus alone can only provide a bridge while governments address the causes of economic weakness, typically low productivity and weak competitiveness. In too many countries, inefficient companies are shielded from market pressures, wages are too high, basic infrastructure is lacking. Employment rules and trade-union pressure frustrate efforts to change working practices or cut costs. Broken banking systems can't provide working capital or finance viable projects. Poor education systems and rigid immigration rules hold back the supply of skilled labor. Wasteful and corrupt bureaucracies act as a disincentive to investment. Few G-20 countries have used the time bought by past stimulus to make the vital supply-side reforms to boost productivity and competitiveness. That is as true of the U.S., the U.K. and particularly Japan, as it is of most of the euro zone. Indeed, in one crucial respect, the G-20 has made the problem worse. Financial-sector reform was essential, but the G-20 went too far: In seeking perfection, policy makers have delivered a profoundly pro-cyclical shock, resulting in a deflationary credit squeeze. On this score, reality is dawning on policy makers: Last week, Bank of England Governor Mervyn King, the high priest of the global regulatory onslaught, called for a rethink of the Basel liquidity rules that have led banks to hoard cash in ultra-low-yielding central bank reserves and government bonds. Restoring sanity to liquidity rules could free up hundreds of billions of dollars for "socially useful" activities, enabling banks to generate capitaland ultimately to lend. But the G-20 leaders needs to do far more. Far from complaining about their lack of economic levers, politicians need to recognize the importance of the supply-side powers they do possess: The true role of politicians lies in the micro, not the macro. Only they can decide on the proper balance between social protections, welfare spending, infrastructure investment, regulations and the appropriate burden of taxation. It is their responsibility to ensure economies are competitive, productive and not vulnerable to financial shocks via excessive debts, deficits or balance of payment crises. Yet politicians find this difficult to accept. In the post-gold-standard world, voters have been conditioned to believe pain-free solutions are always available. France, Italy and Spain clearly believe it will be easier to persuade Germany to underwrite their broken economic models with euro-zone bonds than to persuade their electorates to accept change. U.K. politicians privately ask whether a Greek euro exit might provide an opportunity to push through reforms they don't have the courage to risk now. All politicians know the moment they drive an unpopular reform, a financially illiterate populist such as Greek radical-left leader Alexis Tsipras is waiting in the wings, vowing to defy economic and political reality. Regardless of what happens in Los Cabos or in post-election Greece, the world is now at a crossroads. The old order ended with the London and Pittsburgh G-20 summits. All that stimulus has provided a bridge to nowhere. Maybe fresh market turmoil this week will lead to more monetary easing. But the question for world leaders now is what the new world order will look like. Will they commit to the reforms needed to make their economies more competitive? Or will they try to cast off the shackles imposed over the past

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What Will New World Order Look Like? - WSJ.com


70 years and try to engineer their own solutions? Neither path is easy, but the latter surely leads to chaosand a world in which no one will ever trust the promises of politicians again. Write to Simon Nixon at simon.nixon@wsj.com
SmartMoney Glossary: exchange rate, gold standard, credit squeeze, working capital, central bank

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