Sunday, February 7, 2010

Will the Davos formula work?

Strictly speaking, no binding resolutions came out of the 40 meetings at the World Economic Forum in Davos. In the world of economics, discussion, the exchange of opinion and identifying the problem areas of the global economy are considered the most important objectives for such forums. At Davos, around 2,500 leading businesspeople and politicians held more than 200 meetings to discuss reviving the global economy after the financial crisis.

As far as the problem areas of the global economy, the current crisis has brought to light one issue, as I see it the main sore spot that was the root cause of all the other problems - the incompatibility of the existing global financial system with the real global economy. Many economists believe that the finance system has become virtual and detached from real economic processes, and the value of derivatives and other types of derivative securities have exceeded the real value of business assets and other material assets many times over. Many cite this as one aspect of the crisis, emphasizing that total debt is many times greater than the total U.S. mortgage defaults, which really marked the start of the crisis. Furthermore, the flow of capital around the world has become detached from national economies so much so that it has become impossible not only for corporations, but also entire nations, to determine to whom they owe money.

The belated attack on the banking community, which did not abate for the entire week in Davos, offered no solutions. Bankers were offended that they were lumped into the same category as terrorists, and politicians recognized the need to change the financial structure, but delicately avoided discussing details and the appearance of new regional currencies. Representatives of the scientific community called for recognizing the crisis of the globalization era, with its new, as of yet undefined, problems.

Nevertheless, Davos helped governments and businesses express their fears and hopes for the future reform of the financial system. Specific examples of these fears and hopes could, in the best-case scenario, be discussed at the G20 meeting, although disagreements are appearing already. If representatives from a majority of countries are ready to tighten the screws of banking legislation even further, then, according to Russian Finance Minister Alexei Kudrin, "Regulating currencies on a global level will help developing economies overcome the crisis more than instituting control over the flow of capital."

Hearkening back to the 1998 default, Kudrin noted that that financial crisis "dramatically illustrated that limiting the flow of capital is ineffective in times of crisis. A black market forms, and the outflow of capital continues."

Therefore, one can hardly expect Russia to place limits on its banks' activities, and the rigid parameters proposed by Barack Obama and European leaders will not be applied to Russian bankers. Nor will any sundry new taxes on financial and banking transactions be levied. And even though a system for determining bonuses for top management is being developed in order to stimulate the financial sector, bonuses will nonetheless be limited.

As the forum came to a close, delegates noted that the global economy has begun to recover and that the recession is ending, but that growth is still too anemic to allow for optimistic predictions. For government finances, these conclusions will serve as the basis for economic policy for the next few years. Preliminary anti-crisis measures famously consisted of "pumping" government money into the banking sector and propping up corporations. Is it time to curtail or completely stop this assistance? Individual countries will decide their own course of action on this issue. Kudrin said that Russia could come out of the crisis by late 2012, but he also said that there would be budget deficits until 2015; therefore,Russia intends to phase out its anti-crisis measures gradually until 2015.

How will Russia's economy grow if domestic demand remains frozen and foreign demand for oil, gas and other commodities is difficult to predict? Investments not only and not so much from the Reserve Fund should provide the impetus. In Davos, Kudrin confirmed that Russia would resume foreign borrowing and had set a ceiling of $17.8 billion for 2010. With this sort of investment, the Russian economy will probably grow by 5% to 6% in 2010. The need for foreign loans has given rise to a discussion among Russian economists that, given current oil prices, Russia could do without such investment. According to Finance Ministry estimates, basing policy solely on oil prices would be irresponsible, and a real alternative could be domestic lending. Even last year during the crisis, personal savings in Russia grew by around 50% and now stand at more than seven trillion rubles, i.e. more than the value of the Reserve Fund at its peak. But in order to turn these funds into investments, a whole system of measures is needed to encourage the citizens to entrust their money to the government for longer than one or two years. In order to do this, at the very least Russia needs to lower inflation and establish a stable financial system. Some of the recommendations from Davos could be used to achieve the latter goal.

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