G-20 in depth
By mid-March 2009, worldwide financial system losses from the credit crisis totalled over $1.2 trillion, exceeding total new capital raised by over $200 billion1. This puts the $1.1 trillion of measures agreed by the leaders of the world’s biggest economies at April’s G-20 summit into stark perspective. The G-20 pledged to “do whatever is necessary” to “restore confidence and growth” and “repair the financial system.” But how will some of the moves announced by the G-20 affect markets?
International Monetary Fund (IMF)
The G-20 confirmed plans to triple the IMF’s lending resources to $750 billion and effectively create an additional $250 billion in “special drawing rights.” It also backed $100 billion in lending to low-income countries from Multilateral Development Banks. By boosting confidence that help is available for troubled economies, these moves should help to lift investor sentiment, especially towards emerging countries, where the risk of sovereign bond defaults should decrease significantly. For our part, we have always believed that assets in regions such as Asia and emerging markets, which have been victims of — rather than catalysts for — today’s systemic problems, would outperform in the long term.
Financial regulation
The G-20 provided another lift to confidence by agreeing to establish a new Financial
Stability Board, or FSB, to succeed the Financial Stability Forum, a group of major national financial authorities founded in 1999. The FSB will work with the IMF to give early warning of economic and financial risks. The G-20 said all financial institutions, instruments and markets should be regulated, and critically for investors, this includes hedge funds and credit rating agencies. The group, which pledged to improve the quality of capital in the banking system, also agreed to urge accounting bodies to work towards better valuation methods and loan loss provisioning and a single set of global accounting standards. This initiative is to be welcomed, particularly by those investors who compare assets globally. However, the G-20 was not detailed on how troubled assets should be valued, or how such assets should be removed from bank balance sheets; the assumption is that governments will continue to deal with this latter central issue individually. More details from the G-20 on these two issues might have gone further towards raising confidence, although on the day of the G-20 summit, U.S. accounting standard-setters unveiled changes that should ease the impact of mark-to-market rules, which require companies to value their assets at current market prices. Such policies had a severely detrimental effect on banks’ financial results and confidence within credit markets, so this may be an important step towards fixing the credit transmission mechanism.
Global trade
Global trade has suffered badly in the past months. The G-20 also announced its intention to make at least $250 billion available over the next two years to support trade finance — a pledge that should go some way to helping confidence in a global trade recovery. The group also promised to promote worldwide capital flows via the World Trade Organization and to resist protectionism. While it remains to be seen whether individual countries can hold to an anti-protectionist pledge, such an initiative on the part of the G-20 is praiseworthy. For recovery to gain momentum, market mechanisms must to be allowed to work. Given the relatively underleveraged nature of Asian economies, companies and consumers in comparison to those of the West, we believe that free trade will certainly mean allowing the balance of global economic power to continue its shift towards the East. Ultimately this should encourage the West to learn the lessons of the current crisis — as did the East in 1997 — and emerge stronger at the country and company level.
Fiscal stimulus
The G-20 also highlighted the “concerted fiscal expansion” the group is undertaking “that will, by the end of next year, amount to $5 trillion [and] raise output by 4 percent…” The fact that the group did not announce any new fiscal stimulus is unsurprising, given that in countries such as the U.S., UK and Japan, massive, budget-busting fiscal expansion has already been deployed, and authorities in some countries are turning to measures such as quantitative easing. However, the G-20’s statement reinforced individual countries’ commitments to fiscal expansion — a necessary complement to the monetary easing we have seen worldwide. Attention will now focus on the extent to which fiscal stimulus feeds through to economic activity and eventual recovery.
The final analysis
The G-20’s initiatives will not provide an instant fix for the world’s economic problems, but in our view, the cooperation of world leaders on such a grand scale to try to solve the crisis and avoid a repeat performance has to be positive. By pledging to increase the resources available for troubled economies, strengthen global financial oversight, encourage better accounting standards and transparency, and promote global trade, the G-20 has bolstered confidence. Investors are now waiting for the effects of fiscal stimulus to support growth, but for an upturn to gain momentum, credit market gridlock must also be eased. Confidence in and among banks has to be restored before this can happen, the key to which lies in the stability of bank balance sheets. To this end, we believe that a housing market recovery — and the efforts of the U.S. and UK governments in particular to support housing markets — will be vital. Meanwhile, we feel that financial markets will remain volatile, giving careful investors the opportunity to identify undervalued assets that will outperform in the long term.
Some Good News
1.Source: Bloomberg, March 11, 2009.
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