The Group of Seven leading industrialised nations will on Friday attempt to impose
a coherent international framework on the unco-ordinated emergency measures taken in recent weeks in an effort to contain the spiralling credit crisis.
The aim is to maximise the impact of moves taken by individual nations and minimise the scope for negative spillovers – for instance, the risk that blanket deposit guarantees in one country destabilises banks in others.
On this, there is much agreement in the G7, at least in the words of policymakers. In a speech this week, Hank Paulson, US Treasury secretary, insisted on the right of individual governments to take unilateral steps. But he added: “We must also take care to ensure that our actions are closely co-ordinated and communicated, so that the action of one country does not come at the expense of others or the stability of the system as a whole.”
The European Union’s 27 finance ministers signed up to a similar set of conditions, allowing each country to take individual steps while agreeing not to allow their policies to spill over to others. Such sentiments are understandable since financial systems in G7 countries differ radically, in particular the US has a large non-bank financial sector, unlike European countries.
The G7 statement is expected to refer specifically to action taken on liquidity, capital, market stability and deposit guarantees, as well as the G7’s longer-term approach to regulation.
But in their deeds, the G7 has not been so harmonious. Countries have acted when a domestic crisis has forced their hands, showing little regard for the interests of others.
Stephen King, chief economist of HSBC says: “Piecemeal actions by different governments have undermined the credibility of other actions.” He said that if one country insists its policies are the best – as most G7 countries are saying to a domestic audience – it immediately casts doubts on what others are doing.
In recent weeks there has been considerable policy convergence as governments have reached into the same set of tools to shore up their financial systems and reduce the risk of a severe recession. These include strengthened depositor guarantees (in many cases implicit blanket guarantees) and interest rate cuts in addition to supercharged liquidity operations.
But the US and the UK stand out. The US is implementing a $700bn (€513bn, £407bn) asset purchase plan – a public good from which all banks globally will benefit and other nations therefore do not need to replicate. Moreover, it has cut rates much further than any other G7 nation and has ventured into unsecured lending with a commercial paper purchase programme.
Meanwhile, as UK bank share prices dived, London has unveiled a comprehensive rescue plan, with government-led recapitalisation of banks, enhanced ultra-long-term liquidity support and a government guarantee on all new medium term
borrowing by banks. The condition for the government support is that banks restart lending to households and companies. The number one issue for every country is ending the crisis of confidence in the banks.
There are two nuclear options available. A senior former US policymaker says the question is whether everyone is now heading towards the Irish model, which adopted an explicit blanket guarantee of all bank liabilities.
That, in effect, turns bank debt into government debt. The UK scheme goes quite far down this route.
The second is to bypass the banks completely and start government lending to the non-financial sector.
The US lending against commercial paper is a half-step down this route.
This debate serves to highlight how difficult it will be to achieve any single crisis-solving plan, given the differences in the size, market concentration and structure of each G7 financial sector.