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Busch: Audacity of Redesign?

Ahead of next weekends meeting, the G20 group of advanced and big emerging economies issued a communiqué indicating the direction and scope of their interests. From stabilizing the financial markets to supporting global growth to minimizing the “negative social impact” of the crisis, their goals are lofty and their ambition extraordinary.

But it’s in the area of financial structure that is most likely to be the area where they can have the biggest impact. Federal Reserve Governor Kevin Warsh said, “. In my view, the speed and success of a new financial architecture is likely to be more consequential to economic growth than the design and implementation of well-intended housing policies alone. The establishment of a new financial architecture, thus, is the essential policy response to the greatest economic challenge of our time.”

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Warsh believes that the housing collapsed revealed broader failings that manifested the current credit crisis. These failings include inadequate market discipline, excessive reliance on credit ratings, and poor credit and liquidity risk-management practices by many financial firms.

In the G20 communiqué, they give strong indications over what they think will be appropriate to change. Here are the key points:

“G20 says all sectors of the financial industry, "as appropriate," should be regulated or subjected to oversight, including ratings agencies. Countries with weak currencies and suffering inflation pressures may need careful monitoring by monetary authorities in order to take appropriate action.”

“The International Monetary Fund and the World Bank "must be comprehensively reformed" to reflect greater weight of emerging nations. G20 is ready to increase funding to help the IMF, the World Bank and other multilateral agencies, if needed, to assist countries affected by the global financial crisis.”

This is where things getting interesting. On Sunday, the Chinese announced a massive stimulus plan of 4 trillion yuan or around $586 billion. The amount of the stimulus is equivalent to a fifth of their GDP. This has been universally praised. Since China accounted for 27% of global economic growth last year, no one wants to see their economy slow down for long. It sets them up to be a major player in the talks to restructure global finance. If they want to have a larger role, many want the Chinese to bankroll IMF new lending programs.

However, the Chinese are skeptical of a G20 inspired global regulator doling out rules for all financial institutions in all countries. Clearly, they don’t like the idea of a technocrat in Brussels deciding what is proper in Beijing. Whether it’s Bush or Obama, I doubt Washington likes the prospect, either. Therefore, the United States and China will likely delay and prolong the discussions to avoid policies that intrude on their sovereignty.

Unfortunately, next weekend will begin the process for the redesign of the global financial architecture not come to a conclusion of on the blueprints. This means that the credit crisis may ease, but won’t be ended until an agreement can be made.

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Andrew Busch

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Andrew B. Busch here