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Liam Halligan: No reform, just a patch for a discredited regime

Section: Daily Dispatches

By Liam Halligan
The Telegraph, London
Saturday, Septemer 26, 2009

"The ultimate result of shielding men from the effects of folly," said the Victorian philosopher Herbert Spencer, "is to fill the world with fools."

These words sprang to mind as I watched last week's G20 Pittsburgh summit.

The world's leading nations have agreed "tough new regulations" to prevent another global financial crisis, declared Barack Obama, as the two-day meeting drew to a close. The G20 has "taken bold and concerted action to forge a new framework for strong, sustainable and balanced growth."

Obama's oratory was typically impressive. The trouble is, it wasn't true. No specific rules on banks' capital reserves were announced at this summit. No leverage caps were agreed. Nothing "bold" was done to lessen systemic dangers or overhaul the global regulatory regime.

Pittsburgh produced nothing more than the usual photo calls and drab theatre. The lack of questioning of the status quo was spectacular. The world needs to learn from what we've just been through and implement financial reform, cutting the chances of a repeat performance.

What our "leaders" produced instead was a rhetorical patch for the existing flawed regime. Worse still, they did everything possible to protect the financial vested interests -- above all, the big investment banks -- from the damage caused by their deeply irresponsible use of derivatives and debt, while preserving the system that allowed such excess.

These paltry G20 measures will reassure yet another generation of financial denizens they can gamble recklessly, generating massive systemic risk and when it all blows up -- as it always does -- their government friends will bail them out. The moral hazard is simply enormous.

In Pittsburgh, yet again, our limp-wristed politicians "shielded men from the effects of their folly". Now, a whole new batch of financial "fools" will find new and ever more opaque ways to take huge taxpayer-backed risks. But the real chumps are the rest of us – who get none of the upside, only the bill to clean up the mess.

"We will avoid any premature withdrawal of the stimulus," said the G20 communique. With such faux-scientific words, we learnt that the Anglo-Saxon world will continue to print money and borrow like crazy. Our leaders declared "a success" the wildly expansionary policies which, by the back door, have shoved the costs of bank irresponsibility onto Western taxpayers, their children and grandchildren.

Until recently, we were told such unprecedented measures were needed to "tackle deflation." Now that myth has been disproved, the investment banks' pet economists talk about "the output gap." Pittsburgh was full of well-paid eggheads explaining that, because there is "so much spare capacity in the economy," the likes of the US and UK can print money "without fear of stoking inflation."

This is utter tosh -- yet another intellectual deceit to justify policies that rescue reckless bankers while fleecing the rest of us. There is no huge reservoir of excess capacity. The sub-prime crisis, by starving firms of credit, has destroyed vast swathes of supply.

The money we've printed, once the banks start to use it, will generate serious inflation. The Bank of England now understands this, which is why the latest minutes admit that the Monetary Policy Committee "may have misjudged the amount of slack in the economy."

"Where reckless behaviour and a lack of responsibility led to crisis, we will not allow a return to banking as usual," pledged the Pittsburgh communique. So where was the debate on a new Glass-Steagall -- the Depression-era firewall between retail and commercial banking? Until we get that, our large banks will remain replete with systemic risk. Yet again, the politicians didn't dare face down the vested interests.

"We will adopt policies needed to lay the foundation for strong, sustained, and balanced global growth," our leaders claimed, but there wasn't even a statement of firm intent on concluding the Doha "round" of trade liberalisation, now stalled after eight years of talks.

The communique called for "global architecture that meets the needs of the 21st century," yet the Western powers couldn't bring themselves to formally replace the old G8 with the much broader G20, let alone reform the all-important voting shares within the International Monetary Fund.

So France will retain almost twice as much IMF power as China and America will keep its veto over the rest of the world -- even though the large emerging markets now have economies almost as big as the EU and US.

"We've brought the global economy back from the brink," Obama declared at Pittsburgh. No, Mr President. Incrementally, you've pushed it back to the edge.

As the G20 communique was released, the US dollar lost more ground. Reading that "economic stimulus measures" would remain in place "for some time," the markets concluded that US interest rates will not rise any time soon.

As a result, the greenback fell below 90 yen on Friday, an eight-month low. Against a basket of currencies, the trade-weighted dollar has now fallen 15 percent since March.

Fears are growing that Uncle Sam's endless money printing and borrowing will ultimately debase the US currency -- which, of course, is true.

After the September 2008 collapse of Lehman Brothers, global investors reached for the security of the dollar. The world has since realised that America, far from being a "safe haven," is actually the epicentre of financial instability. As other investment locations have begun to look more attractive -- not least the emerging markets -- demand for dollars has fallen.

"Carry-trade" pressures are also important. Investors are taking out cheap US loans then converting them into higher-yielding currencies -- so flooding the world with dollars.

Above all, the markets know the White House will do nothing to prevent the dollar from falling. A weaker currency makes the US more competitive and lowers the value of its massive external debt. "Benign neglect" toward the dollar is at the heart of America's recovery strategy.

The danger comes if the "rope slips and burns" and, rather than depreciating gradually, the dollar tips into free fall. That would send US inflation soaring while sparking a whole new wave of global panic. But dollar free fall is unlikely -- not least because so many reserve-rich countries such as China and Japan would move to protect their dollar assets.

Last week, sterling also dropped to its weakest level in six months -- hitting 92.14p against the euro and 62.71p to the dollar. Taking his cue from the US, Chancellor Alistair Darling said Britain has "no policy in place" to control the level of the pound.

America can pull off this trick because it is America -- with a currency that's too big to fail. Just as Wall Street has the White House over a barrel, so the White House knows the rest of the world has too much to lose to allow the dollar to tank.

The same is not true of sterling. Given the UK's unmatched money printing and horrifying debt service costs, the currency markets are smelling blood -- with many now arguing the pound should be "cut loose."

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