The Financial Tsunami ( FT ) - The Way Forward ( 17 ) - Golden Gifts for the G20 Global Summit

I must start with an apology for the lapse of 2 weeks before resuming my blogging. As advised in earlier blogs I was working on my proposals for the G20 Economic Summit to be held in London on 2nd April to decide on the joint international efforts that should be made to rescue the world from falling in to a deep recession akin to or possibly worse than the Great Depression of the 1930s.

Today's blog contains a summary of the more detailed proposals that are set out in a separate article written on the same important subject to be linked to this blog in the next few days. I have attempted to categorize my proposals under different headings for easy reference. Important advantages and disadvantages to each proposal are also briefly set out together with the relevant economic principle or rationale behind them. It is highly recommended that the reader should study my more detailed discussions in the linked article referred to at the beginning of this paragraph in due course.

Link to my economic essay :- 2008 Economic & Financial Tsunami - An Overview for the Lay Person

https://docs.google.com/viewer?a=v&pid=sites&srcid=ZGVmYXVsdGRvbWFpbnxqa2hjbGlmZXN0eWxlfGd4OjY4MWY3YTM5ZDFmY2NmZTU


( A ) Urgent Measures to be taken :-

( 1 ) Restore public confidence in the financial system.

Specific measure recommended : - Reconfirm existing government guarantee on all personal bank deposits and extend it to all countries. Those governments not in a strong financial position to do so must be supported by the IMF to which all leading and developed countries must contribute to a special FT emergency fund (IMF-SEF ) set up ASAP for this purpose. The existing contributions to IMF by member countries in the form of credit facilities are called Special Drawing Rights ( SDR ) to be allocated to all countries in need. Thus, IMF is,in fact, acting as the international lender of last resort just as the central bank is to the banking system of each individual country.

Advantage :- Consumer confidence in the financial system in every corner of the world is immediately propped up. The FT was started by the failure of just a few large US merchant banks. Any further failures in even some smaller countries may trigger another FT.

The fact that there will be no weakest link ensures that there will not be any need to utilize the special drawing rights relating to this proposed IMF-SEF.

Disadvantage : - At a time of great upheaval in every financial market and in most countries the leading nations may be reluctant to increase their contribution to IMF.

( 2 ) Keep the credit flowing

The drastic lowering of interest rates by all leading countries has not succeeded in the resumption of commercial credit flow. The reasons are two fold. Firstly, monetary policy relating to the interest rate mechanism is by nature passive. By lowering interest rate it is hoped that consumers and businesses will take advantage of the lower costs for capital thus leading to higher spending in both sectors. In reality consumer confidence is so low that business investment decisions are also adversely impacted. Secondly, even with partial government guarantee on a large range of consumer and small business loans by some government banks are still reluctant to extend credit because even a 90% guarantee by government may lead to a 10 % loss if the business or consumer loans under 90% government guarantee go bad. Thus, credit flow has been stagnant so far despite drastic reduction in the lending and deposit rates.

Specific measure recommended : - a drastic proposal to guarantee 100% by government on loans extended by banks of up to say, US$ 1,000,000.

Advantages :- This will definitely cause credit flow to smaller businesses to restart. More business activities in all sectors will create a positive atmosphere which is a great help to consumer confidence. At present the government such as USA are favouring collapsing giant corporations like those in the motor industry and the banking sector to the detriment of the small businesses. Understandably governments are under more public pressure to rescue large firms where many more jobs are at stake. The congregation of job losses under one roof ( or corporation ) attracts a lot of political attention while smaller individual groups of job losses over a wide cross section of small businesses could make an even bigger total number of job losses. The only difference is that the latter case though equally tragic does not attract as much political attention and pressure as those in the well known giant corporations.

Disadvantages : - Politicians are less inclined to give priority to small businesses which have less political bargaining power.

( 3 ) Overhaul the financial regulatory system

Specific measure recommended : - Disallow multiple roles with potential conflict of interests. For example, the same CPA firm cannot act as act both as independent auditors and financial advisers and account keeping for the same client corporation. Fund mangers & merchant bankers cannot become financial commentators and credit rating agencies at the same time. They can only do one or the other. Directors cannot vote on their own remuneration package. It must be approved by shareholders in AGM.

Set up an international monitoring and regulatory body ( possibly a branch of IMF ) to review existing and the reformed financial system in all countries especially the major financial markets and to investigate complaints on irregularities.

Put a cap on the remuneration package that can be paid to top executives. Disallow any incentive scheme that favours high risks investment activities.

Disallow multiple and inter-related derivative financial products that can be traced to tax heaven as the ultimate ownership control. For example, hedge funds based on multiple linkage of derivatives that make their true and fair market values quite impossible to be ascertained.

Dubious financial products like CDO should be banned altogether.

Advantage : - restore confidence of the general public in the financial system and prevent future recurrence of FT.

Disadvantage : - It could be a long and arduous process with heavy resistance from all interested parties.

( 4 ) Investigate and annul unreasonable remuneration packages already paid out to CEO & Top Executives

Specific measure recommended : - Investigate all excessive remuneration packages with a view to seeking a refund and annul any unreasonable remuneration contracts concluded under dubious circumstances including collusion between board of directors and top executives under corrupt corporate cultures.

Advantage : - raise the morale of the depressed general public and deter future rip off by top executives. This is also an important part of the overhaul of the whole financial system.

Disadvantage : - With the help of their cunning legal advisers these black sheep of the financial world will definitely make use of the gray areas in the law to try and get themselves off the hook. In such a likely scenario a lot of time consuming and legal efforts are required to successfully punish these criminals but it is worth our while to do so.

( 5 ) Boost public spending on the rescue package wisely

Massive spending by all leading countries has been underway since the beginning of 2009 but it has been a trial and error process unfortunately. For example, US rescue of the car industry has been a poor show of throwing good money after bad. Only now has the Obama administration just started to impose strict conditions on any further funding by requiring the resignation of incompetent CEOs and compulsory amalgamation with foreign but more efficient operators like FIAT in the case of Chrysler.

Specific measure recommended : - Try to divert part of the rescue package to directly making interest free loans to consumers on some useful items such as upgrading home computer equipment, environmentally friendly cars, etc. This is a more direct boost to consumer spending. China is making this smart move to subsidize Chinese citizens in purchasing home appliances thus raising the living standard of the village population.

Advantage : - This is a direct stimulus to consumer spending unlike indirect boost through the passive reduction of interest rates working through the banking system which is very sluggish for reasons given above. Furthermore, direct consumer spending can generate jobs and confidence through the positive multiplier effect.

Disadvantage : - It could be difficult and tedious to assess who is in need of what unless some kind of across the board cash subsidy like what the Australian government have done twice so far. Then, there is the possibility that people will just hoard the cash because of failing confidence about the future economic outlook. This can, however, be remedied by issuing spending coupons like the step taken by Taiwan but with related administrative costs.

( 6 ) Raise the rescue funds wisely

So far, the US government has relied mainly on money printing ( which it has unwisely publisied on a high profile basis to apparently reassure the financial circle of enough liquidity in the system ) and issuing more treasury bonds in the normal commercial way. The bonds are usually auctioned off in lots. As they are fixed interest instruments, the fall in their prices would mean a higher indicative interest rate which is bad for economic recovery. To a certain extent the fall in bond prices ( implying the undesirable rise in indicative interest rates ) are inevitable with more of them being supplied to the financial market to raise much needed rescue funds.

Regarding the above two rescue funds raising measures I would humbly recommend a lower profile and less reliance on money printing which simply means Uncle Sam robbing the pockets of every US Dollar holder. This is a morally questionable move. It is also a fast track to becoming a 5th class nation ( just look at Zimbabwe ). As for the increase in the issue of treasury bonds which could lead to the undesirable effect of raising the indicative interest rate their issue can be supplemented again by the issue of fixed interest rate FT RESCUE BONDS not subject to auction but promoted to fight this financial war just as Uncle Sam had done in WWII.

Specific measure recommended : - This measure of which we have plenty of experience and with existing governing laws and readily available mechanism to save much time in implementation can provide the urgently needed rescue funds for the rescue package. Besides, it is the scared duty of every citizen to defend his or her country in time of war. Heavy propaganda must be carried out to provide an atmosphere of patriotic duty to pressure the rich to channel their still abundant savings into rescue funds for rejuvenating the economy to everyone's benefit including their ( the wealthy sector of society ) own. Why have I never hear about this simple and ancient idea discussed during the whole of the FT , I wonder ? It should be done on a global basis.

Advantage : - This is a controversy free measure with existing legal, philosophical and historical basis for its immediate implementation. It also provides a beautiful opportunity on educating the public and our younger generation as regards our social responsibility.

Disadvantage : - With the interest paid on these FT RESCUE BONDS all going to the rich but ultimately financed by taxation on everyone this measure is not conducive to a fair distribution of income but this shortcoming has to be accepted in times of emergency like the present crisis.

( B ) Longer term measures

( 1 ) Fight protectionism

This is public enemy no. 1 for the growth of world economy. Historically, it has led to devastating wars and extreme poverty for all as in the Great Depression of the 1930s. It is a recipe for certain world economic disaster. Unfortunately, very few politicians can stand up to the political pressure from their electorate. Already there are signs of its raising its ugly head again in the aftermath of the FT. France protecting its motor industry, US Congress pushing for the " buy American " clause in legislation to approve rescue funds to large US firms are just a few unfortunate examples of the petty politicians at work flying in the face of the public interest of the world at large.

Specific measure recommended : - strengthening the functions of international trade organizations such as WTO and forming an impartial and effective panel to mediate trade complaints between nations. The decision of the panel must be binding and the process must work quickly before the disputes spill over to the whole world.

Advantage : - This is an ideal vehicle to set trade dispute and for the prevention of protectionism. In theory, this must be done and soon.

Disadvantage : - The rich nations have an undue weight on all trade and, in deed, world issues. Perhaps the abolition of the right of veto is a first step to remedy this less than desirable situation in international affairs.

( 2 ) Set up a separate body under WTO to organize frequent multilateral discussing and monitoring of trade unbalance

Meetings should be held say, every 6 months before the situation like the China -USA unbalance that has been dragging on for over a decade ( why is trade balance important - please read my article on 2oo8 Economic & Financial Tsunami - An Overview for the Lay Person by clicking on the title of this blog to reach my website ) runs of of control.

Advantage : - Prevention is better than cure.

Disadvantage : - Same as in ( 1 ).

( 3 ) Refrain from accusations and counter accusations

Pointing the finger and passing the buck do not solve any problems especially in the midst of this devastating aftermath of the FT. It serves everyone better to for get about differences and embrace co-operation. Nowadays, the global village is so intricately intertwined that no single country can isolate herself fro the madding crowd. Let us face the crisis with pragmatism, a sense of fairness and wisdom.

Specific measure recommended : - Put any accusations or complaints up for arbitration by an international panel set up along the line as set out above. Meanwhile, the G20 summit should carry on with discussions with a view to reaching consensus on the urgent measures required to arrest the downward spiraling world economy. global unity and consensus is the key to the success of this very important economic summit.

Advantage :- Hopefully, this no accusation policy will hasten the reaching of consensus.

Disadvantage : - Same as (B ) ( 1 ) & ( 2 ) above.

( 4 ) Don't overlook the positive multiplier effects of public spending

Everyone knows that with her over 2 trillion in reserve China will play a major role in the rescue efforts. As a matter of fact, 50% of China's reserve is tied up in US treasury bonds. This again proves the intricate relation in the world economy. There is a negative feeling and tendency toward China probably because of the Chinese government's ( mind you, not the Chinese people ) less than democratic system. I for one hates Communism ( which is actually no more ! ) or any repressive regimes. That is the sole reason for my emigration to Australia after the infamous June 4, 1989 Tiananmen Massacre of the students & workers demanding democracy and an end to corruption in the Chinese Communist Party.

As I have just said this is no time for politics or ideology. Although the GDP of China is only roughly 10% of USA according to IMF data China's positive moves such as putting forward infrastructure projects and subsidizing domestic purchases of the village population are very helpful to the world economy in terms of boosting consumer confidence and providing a positive economic outlook for the world. The multiplier effect on China's spending will be a deciding factor in the success or failure of the FT rescue. When it comes to finance and economics the multilateral interaction between individual economic units plus contingency decision making ( more popularly known as the Flock of Sheep Psychology ) imply a more than one-to-one relationship. It is not an exact science so that one plus one can be far more than two.

Advantage : - The Multiplier effect ensures the more than proportional result form any given amount of spending. Hopefully, China's contribution can ( not on her own though ) save the day.

Disadvantage : - It could give China more political leverage which can give a misleading impression of the success of a less than democratic regime.

( 5 ) Promote an enlightened form of capitalism

Capitalism is still the lesser of two evils compared to a totally planned economy in terms of economic efficiency and incentive to personal efforts but it is the latter goal that has been far too excessively overdone in Wall Street. So much so that greed has become the sole driving force hence the FT. This coupled with an almost criminal negligence in failing to regulate the US financial market and letting its corrupt corporate culture run wild are the ultimate origins of the FT. A more balanced and less materialistic but higher moral standard based incentive system should be put in place if the FT is to be avoided in future. An enlightened form of market or capitalistic system where human beings are treated as such is urgently needed. Our future survival totally depends on that !

Advantage :- An enlightened capitalistic system is the only way to save us from our present predicaments for good.

Disadvantage : - It will take a long, long time, perhaps a few generations to achieve this noble goal. Every long journey starts with the first step. We will never get there if we hesitate to take the first step.

( 6 ) Don't delay environmental protection measures under the excuse of expedience

For the long term welfare of mankind none of the existing proposals on environmental protection should be delayed because of the FT. For one thing some damages to Mother Earth are irreversible. Secondly, do not forget that environmental measures can generate economic benefits and employment as well. Kill off a few black sheep of the financial world and we are home free.

I sincerely hope and pray that some decisive and positive measures can come out of the G20 summit in London later today and that common sense will prevail for the good of the entire global village.


JKHC.