A Plan for Economic Recovery

We are facing the prospect of global deflation and depression. But I believe the situation could be turned around by adopting a bold and comprehensive program. Unfortunately, Treasury Secretary Geithner has not presented a convincing case.
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We are facing the prospect of global deflation and depression,

similar to but potentially worse than the 1930s. That said,

I believe the situation could be turned around by adopting

a bold and comprehensive program. Unfortunately,

Treasury Secretary Geithner did not present a convincing case.

I outline the basic elements of such a program in my forthcoming

Book, The Crash of 2008 and What it Means. I am

providing an excerpt here in the hopes that it will

stimulate discussion and help generate the necessary

political will for bold action.

The bursting of bubbles causes credit contraction, forced

liquidation of assets, deflation, and wealth destruction that

may reach catastrophic proportions. In a deflationary environment,

the weight of accumulated debt can sink the banking

system and push the economy into depression. That is

what needs to be prevented at all costs.

It can be done by creating money to offset the contraction

of credit, recapitalizing the banking system, and writing

off or down the accumulated debt in an orderly manner.

For best results, the three processes should be combined.

This requires radical and unorthodox policy measures. If

these measures were successful and credit started to expand,

deflationary pressures would be replaced by the specter of inflation,

and the authorities would have to drain the excess

money supply from the economy almost as fast as they

pumped it in. Of the two operations, the second is likely to

prove both technically and politically even more difficult

than the first, but the alternative--global depression and

world disorder--is unacceptable. There is no way to escape

from a far-from-equilibrium situation--global deflation and

depression--except by first inducing its opposite and then

reducing it.

The size of the problem is even larger than it was in the 1930s. This can be

seen from a simple calculation. Total credit outstanding was

160 percent of GDP in 1929, and it rose to 260 percent in

1932 due to the accumulation of debt and the decline of

GDP. We entered into the Crash of 2008 at 365 percent,

which is bound to rise to 500 percent or more by the time

the full effect is felt. And this calculation does not take into

account the pervasive use of derivatives, which was absent in

the 1930s but immensely complicates the current situation.

The situation has been further

aggravated by the haphazard and arbitrary way in which

it was handled by the Bush administration. The public

and the business community suffered a shock in the aftermath

of the Lehman Brothers default, and the economy

has fallen off a cliff. The next two quarters will show rapid


To prevent the economy from sliding into a depression,

President Obama must embark on a radical and comprehensive

policy package that has five major components:

1. A fiscal stimulus package

2. A thorough overhaul of the mortgage system

3. Recapitalization of the banking system

4. An innovative energy policy

5. Reform of the international financial system

I shall briefly discuss each of these elements.

1. A Fiscal Stimulus Package

This is conventional wisdom, and I have nothing original

to contribute. The fiscal stimulus package is already well

advanced, and it will be the first out of the gate, but it will

take time to implement and will serve merely to moderate

the downturn. In my view the next two items are indispensable.

To turn the economy around, the mortgage and

banking systems need to be thoroughly reorganized and


2. A Thorough Overhaul of the Mortgage System

The collapse of the financial system started with the

bursting of the U.S. housing bubble. There is a real danger

now that house prices will overshoot on the downside and

put further pressure on the banks' balance sheets. To prevent

this, foreclosures must be reduced to a minimum and house

ownership facilitated both for new buyers and current owners.

But we ought to go even further than that. With the

mortgage financing industry in shambles, we ought to subject

it to a thorough overhaul and introduce a new system

that is free of the deficiencies that are responsible for our

current difficulties. It is rare that a systemic change is necessary

or even possible; the present is such an occasion.

I advocate adopting, with suitable modifications, the Danish

system, which has proven its worth since it was first introduced

after the Great Fire of Copenhagen in 1795. Our current system

has broken down because the originators of mortgages

have not retained any part of the credit risk. They are motivated

to maximize their fee income. As agents, their interests

are not identical with the interests of the ultimate owners. In

the Danish system, the service companies retain the credit

risk--they have to replace the mortgages that are in default.

In contrast to our reliance on government sponsored

enterprises (GSEs)--namely Fannie Mae and Freddie Mac--

the Danish is an open system in which all mortgage originators

participate on equal terms, and it operates without government

guarantees. Yet Danish mortgage bonds are traditionally very

highly rated; often they yield less than government bonds.

This could not be replicated in the United States at present

because of the demoralized state of the market, but it may be

achieved later.

Danish mortgage bonds are highly standardized, and their

distinguishing feature is that they are identical to and interchangeable

with the underlying mortgages. House owners

can redeem their mortgages at any time by purchasing the

equivalent mortgage bond in the market and exchanging it

for the mortgage. Since bond prices and house prices normally

move in the same direction, this feature--called the

principle of balance--reduces the chances of householders

having negative equity in their houses. The mortgage originators

are strictly regulated, and their interests are closely

aligned with those of the bondholders. They pass on only the

interest rate risk to bondholders, retaining the credit risk.

That is why the bonds are so highly rated.

When Mexico wanted to securitize mortgages in order to

promote house ownership, it opted, with my assistance, for the

Danish system. My proposal was supported by the U.S. Treasury,

which was then under the leadership of Paul O'Neill.

The Danish model is clearly superior to the GSE model.

The question is, how can you get there from here?

Originally, I proposed a grand scheme in which all mortgages

that are under water (i.e., whose principal amount exceeds

the current market value of the house) would be

replaced by a new mortgage, incorporating the Danish principle

of balance but being insured by a government agency.

This would have had the advantage of removing the incentive

to default in order to obtain the benefits of loan modification,

but it would have run into insuperable political and

even constitutional difficulties. The slicing and dicing of

CDOs has created such conflicts of interest amongst the

holders of various tranches that neither a voluntary nor a

compulsory scheme of reorganization is possible.

Abandoning the search for an optimal solution, I have

come to realize that a second best solution is readily available.

The GSEs have become effectively government owned, but

the government is not exercising its powers of control. They

are in limbo, torn between the interests of their shareholders

and the public. The prospect of the shareholders emerging

with a positive value is imaginary; nevertheless, the GSEs are

trying to make a profit from their quasi-monopolistic position,

charging heavy fees and imposing restrictive conditions

on both refinancing applications and new ones. This is aggravating

the housing problem, but it could easily be changed by a

newly established regulator asserting its authority and using

the GSEs as an instrument of public policy.

The GSEs could then introduce a new type of mortgage

contract based on the Danish model. It would be transparent

and uniform, and it would incorporate the principle of balance.

The GSEs would reduce their fees, extend the limit on

the size of mortgages they are willing to guarantee, and introduce

a new line of guarantees--up to 90 percent of appraised

value at a higher premium--effectively replacing the private

mortgage insurance companies that have become inactive.

They would then introduce a streamlined and cheap refinancing

process for existing mortgages. That would greatly

reduce the cost of conforming mortgages and create a powerful

incentive to convert nonconforming mortgages into conforming ones.

Owners of defaulting mortgages could avail

themselves of the provisions of the Help for Homeowners Act

and realize 85 percent of the appraised value. In most cases this

would be preferable to going through a costly foreclosure process.

If owners failed to choose that route, it could be imposed

on them by a judge in a simplified bankruptcy process. One way

or another, the number of foreclosures would be greatly reduced,

and with mortgages more freely available at lower cost,

house prices would stabilize at a higher level than would otherwise

be the case. Financial institutions would recover some of

their losses on residential mortgages and securities.

It is ironic that the GSEs, which are at the root of the

problem, should provide a route to the solution. In the long

run the GSEs should be phased out and their portfolios run

off. They would become a government agency in charge of

mortgage guarantees issued by the government. Eventually,

when the modified Danish model becomes firmly established,

even that function could be phased out. Under the

new system, mortgage origination companies would remain

responsible for the first 10 percent of any losses arising out of

default. They would be allowed to charge a fee that would be

determined by competition. As the system matures, service

companies may find it advantageous to accept the entire

credit risk and not pay a fee for government guarantees. The

system would then come to reflect the Danish model more


The sequence of the GSEs first becoming more important

and then fading away resembles the sequence that characterizes

the entire process--to escape deflation you first induce

inflation and then reduce it. In implementing it we should

never forget what went wrong with communism: the state

did not fade away. The fading away should be part of the plan

from inception.*

The whole process could be accomplished by using the

GSEs and the new bankruptcy law currently under consideration

by Congress. The government already controls the

GSEs; all it has to do is to exercise its powers. The cramdown

provisions of the proposed new bankruptcy law face

active opposition from many financial institutions holding

mortgages; it should be possible to persuade them that most

of them would benefit from the mortgage reorganization

scheme outlined here. The costs to the taxpayers would

manifest themselves through the eventual losses incurred by

the GSEs, but, considering the impact on house prices and

the economy, the net effect is likely to be positive.

3. Recapitalization of the Banking System

I cannot present as clear a picture of what a reformed

banking system would look like as I can for the mortgage system

because there are no suitable models to invoke. The

Spanish banking system has weathered a bigger boom in

house construction better than the U.S. banking system, and it

has some desirable features, but Spain is even more adversely

affected by the Crash of 2008 than the United States. What

happened to the U.S. banking system after the Great Depression

certainly does not present a desirable model. Banks

were put into a straightjacket whose constraints began to be

loosened only in the 1970s. We are in uncharted territory.

I summed up the main lessons to be learned from the

current financial crisis in the previous edition of this book:

Financial markets do not tend toward equilibrium, and deviations

are not random. Credit creation and contraction

are reflexive and tend to occur in initially self-reinforcing

but eventually self-defeating boom-bust sequences. Therefore

it is not enough to regulate the money supply; it is also

necessary to regulate credit conditions. This involves reactivating

policy tools that have fallen into disuse: variable

margin and minimum capital requirements, and central

bank directives on bank lending to particular sectors. Not

only banks but all institutions involved in credit creation must

be subject to regulation. The objective is to maintain stability

and prevent mispricing and other excesses from becoming

self- reinforcing. The same applies to financial instruments:

They need to be licensed and supervised to ensure that they

are uniform and transparent and do not destabilize markets.
Leverage must be used cautiously: It is not enough to allow

for quantifiable risks; one must impose an additional safety

margin for the uncertainties inherent in reflexivity. Financial

engineering, structured finance, and other innovations are of

dubious value; insofar as they circumvent regulations or render

them ineffective, they can be harmful.

It is clear, in the light of these observations, that the financial

sector became far too big and profitable. In the future it

will have to shrink and remain within the control of the

authorities. While financial markets became global, the authorities

remained national. Since global markets are beneficial,

the authorities must also become more international

and the international financial institutions must serve the

interests of all their members more equitably.

Since the publication of the previous edition of this

book, financial markets have completely collapsed and had

to be put on artificial life support. Keeping them alive and

preventing the world economy from sliding into depression

has to take precedence over all other considerations. As we

have seen, the economy can be turned around only in two

steps. The first is to offset the collapse of credit by creating

money, writing off bad debt, and recapitalizing the banks.

Then, if and when that succeeds, the excess money supply

will have to be drained as fast as credit begins to flow. That

means the initial policy measures will take us in exactly the

opposite direction from our eventual destination. Nevertheless,

the ultimate destination ought to inform the design

of the initial step. Unfortunately, Treasury Secretary Henry

Paulson reacted in a haphazard and capricious manner.

That is how the situation spun out of control. After the

bankruptcy of Lehman Brothers, he forced through Congress

a $700 billion rescue package without any clear idea

how it should be used to adequately recapitalize the banks. I

explained how it should be done in an article published by

the Financial Times online on October 1, 2008, at the height

of the Congressional debate. This is what I proposed:

The Treasury secretary would give bank examiners clear guidelines

for how assets should be valued. For instance, it would be postulated

that commercial real estate will on average lose 30 percent of

its value. He would then ask the examiners to establish how much

additional equity capital each bank needs in order to be properly capitalized

according to existing capital requirements. If managements

could not raise equity from the private sector, they could turn to the

Treasury. The Treasury would offer to underwrite an issue of

convertible preference shares. The preference shares would carry a

low coupon (say 5 percent) so that banks would find it profitable to

continue lending, but shareholders would be heavily diluted by the

convertibility feature. They would be given the right, however, to

subscribe on the Treasury's terms, and if they exercised their rights,

they would avoid dilution. The rights would be tradeable, and the

Treasury would seek to set the terms so that the rights would have a

positive value. Private investors, including me, may be interested in

buying the shares of some banks on the same terms as the Treasury.

After recapitalization, minimum capital requirements would be

lowered to, say, 6 percent. This would encourage banks to lend because

they could suffer a further 25 percent depreciation of assets

without violating statutory limits. They would be eager to take advantage

of the rich margins currently prevailing. The economy

would be reactivated. With everyone sitting on a lot of liquidity and

suddenly eager to put it to work, there would be a sudden rush into

less liquid assets. Deflation would be replaced by the specter of inflation,

and liquidity would have to be drained as fast as it had been

pumped in. Minimum capital requirements would then be raised

first to 8 percent, then higher. In this way, the leverage of the banking

system would be reduced, which is a desirable long-term objective.

If TARP (the Troubled Asset Relief Program) had been

implemented in this way originally, the banking system

could have been recapitalized with $700 billion, or perhaps

even less. Unfortunately, half that money has already been

spent, and most of the second half of TARP will also be

needed to plug the holes that have already developed. What

would have been possible then is no longer realistic. That is a

distinguishing feature of financial crises and other far-from-equilibrium

conditions: What is appropriate at one point in

time is no longer valid at the next one.

Adequate recapitalization of the banking system now faces

two seemingly insuperable obstacles. One is that Treasury

Secretary Henry Paulson has poisoned the well by the arbitrary

and ill-considered way he forced through and implemented

the $700 billion TARP program. The Obama

administration feels that it cannot ask Congress for more

money. The other is that the hole in the banks' balance

sheets has become much bigger since TARP was introduced.

The assets of the banks--real estate, securities, and consumer

and commercial loans--have continued to deteriorate, and

the market value of banks' stocks has continued to decline.

It is estimated that something in the neighborhood of an

additional trillion-and-a-half dollars would be required to

adequately recapitalize the banks. Since their total market

capitalization has fallen to about a trillion dollars, this raises

the specter of nationalization, which is politically--and even


Consequently, the administration is constrained to do

what is possible even if it falls short of what is necessary. It

plans to carve out up to $100 billion from the second tranche

of TARP in order to set up an aggregator bank that would acquire

toxic assets from the banks' balance sheets. By obtaining

10:1 leverage from the balance sheet of the Federal

Reserve, the aggregator bank could have a trillion dollars at

its disposal. That is not sufficient to cleanse the balance

sheets of the banks and restart lending, but it would bring

some welcome relief. The aggregator bank could serve as a

useful interim measure except for the fact that it is liable to

make it more difficult to obtain funding necessary for a

proper recapitalization in the future. It will encounter all

kinds of difficulties in valuing toxic securities and even if

these could be overcome it will still end up as a covert subsidy

to the banks by bidding up the price of their toxic assets.

There will be tremendous political resistance to any further

expenditure to bail out the banks. This will make it much

more difficult to mobilize additional funds in the future. It

would be a pity to take the aggregator bank route, especially

when there is a way to adequately recapitalize the banks with

the currently available resources.

Let me spell out how it could be done. The trick is not

to remove the toxic assets from the balance sheets of the

banks but to put them into a "side pocket" or "sidecar" as

hedge funds are now doing with their illiquid assets. The

appropriate amount of capital--equity and subordinated

debt--would be sequestered in the side pocket. This would

cleanse the balance sheets and create good banks, but leave

them undercapitalized. The same trillion dollars that is currently

destined to fund the aggregator bank could then be

used to infuse capital into the good banks. Although the hole is

bigger, a trillion dollars would be more than sufficient because

it would be possible to mobilize significant amounts

from the private sector.

In the current environment a good bank would enjoy

exceptionally good margins. Margins would narrow as a result

of competition but by then the banking system would

be revitalized and nationalization avoided. The situation is

analogous to a devastating hurricane depleting the capital

of property insurance companies, raising insurance premiums,

and attracting additional capital into the industry.

The scheme I am proposing would minimize valuation

problems and avoid providing a hidden subsidy to the banks.

Exactly for that reason it is likely to encounter strong resistance

from vested interests. Losses would first accrue to

shareholders and debenture holders; only if they exceed a

bank's capital would the FDIC be liable for the deficiency, as

it is already. Shareholders would be severely diluted, but they

would be given tradable rights to subscribe to the good bank,

and if there is a positive residue in the side pocket, it would

also revert to the good bank as of the date of the new issue,

giving shareholders the benefit of any subsequent appreciation.

The fact that debenture holders may lose money will

make it more difficult to sell bank debentures in the future.

But that is as it should be: Banks should not be as highly

leveraged as they have recently been. Pension funds would

suffer heavy losses; but that is preferable to taxpayers taking

over those losses.

In addition to restarting bank lending, my scheme would

resolve the moral hazard issue for a long time to come. The

banking industry is accustomed to turning to the state in a

crisis and effectively demanding a bailout on the grounds

that financial capital has to be protected to ensure the proper

functioning of the economy. Given the aversion to state

ownership of banks, the blackmail has always worked. That is

how the bubble grew so large. The Obama administration

ought to resist the blackmail and adopt the scheme outlined

here as a prelude to building a better financial system. Our

future depends on it.

4. An Innovative Energy Policy

Energy policy could play a much more innovative role in

counteracting both recession and deflation. The American

consumer can no longer act as the motor of the global economy.

A new motor is needed. Alternative energies and energy

savings could serve as that motor, but only if the price of conventional

fuels is kept high enough to justify investing in

them. That might also help to moderate price deflation. A

high price on conventional fuels would be beneficial on both

counts, but it would be hard to sell to the public. Until now,

no politician dared to do so.

President Obama would need great courage and great skill

to do the right thing. This would involve putting a floor under

the price of fossil fuels by

a) imposing a price on carbon emissions by (a) a carbon

tax or (b) auctioning pollution licenses (the former would

be more efficient, the latter is politically more acceptable)


b) imposing import duties on oil to keep the domestic

price above, say, $70 per barrel.

The anticipated income from carbon emissions should

then be distributed to households in full and in advance.

This would compensate them for the higher cost of energy

and hopefully make the scheme politically acceptable. It

would also act as a temporary fiscal stimulus at a time when

it is most needed, although most of it can be expected to be

saved rather than spent. Gradually the price of carbon

emissions would have to be raised to a level where it would

pay to remove carbon from coal. This is indispensable for

bringing climate change under control because there is no

adequate substitute for coal-fired power plants except

clean coal.

It is essential to convince the public that the cost of energy

will remain high for some time in order to encourage investment

in alternative energy and energy-saving devices. Eventually

the cost of energy may decline as new technologies

travel down the learning curve. We cannot depend on the

price mechanism alone to ensure the development of new

technologies. Tax concessions, subsidies, vehicle emissions

standards, and building codes are also needed. Even so, neither

energy security nor the control of global warming can

be achieved without putting a price on carbon emissions.

The United States cannot do it alone, but it cannot be done

without the United States taking the lead.

5. Reform of the International Financial System

The fate of the United States is intimately interconnected

with the rest of the world. The international financial system as

it has evolved since the 1980s has been dominated by the

United States and the Washington consensus. Far from providing

a level playing field, it has favored the United States,

to the detriment of the countries at the periphery. The

United States exercises veto rights over the international

financial institutions (IFIs)--the International Monetary

Fund (IMF) and the World Bank. The periphery countries

are subject to the market discipline dictated by the Washington

consensus, but the United States is exempt from it. This has

exposed the periphery countries to a series of financial

crises and forced them to follow pro-cyclical fiscal policies,

and it has allowed the United States to suck up the savings

of the rest of the world and maintain an ever-increasing

current account deficit. This trend might have continued

indefinitely because the willingness of the United States to

run a chronic current account deficit was matched by the

willingness of other countries to run current account surpluses.

It was brought to an end by the bursting of the

housing bubble, which exposed the overindebtedness of the

household sector.

The current financial crisis has revealed how unfair the system

is because it originated in the United States, but it is doing

more damage to the periphery than to the center. This damage

to the periphery is a recent development, following the bankruptcy

of Lehman Brothers, and its significance has not yet

been fully recognized. The countries at the center have effectively

guaranteed their bank deposits, but the periphery countries

cannot offer similarly convincing guarantees. As a result,

capital is fleeing the periphery, and it is difficult to roll over

maturing loans. Exports suffer for the lack of trade finance.

The IFIs are now faced with a novel task: to protect the

countries of the periphery from a storm that has emanated

from the center, namely the United States. The IFIs' future

depends on how well they cope with that task. Unless they

can provide significant assistance, they may become largely

irrelevant. Global, multilateral arrangements are in danger

of breaking down, turning the financial crisis into global disorder

and depression.

Assistance is needed to

  • protect the financial systems of periphery countries,

including trade finance, and

  • enable periphery governments to engage in countercyclical
  • fiscal policies.

    The former requires large contingency funds available at

    short notice for relatively short periods of time. The latter

    requires long-term financing.

    When the adverse side effects of the Lehman bankruptcy

    on the periphery countries became evident, the IMF introduced

    a new short-term liquidity (STL) facility that allows

    countries that are otherwise in sound financial condition to

    borrow five times their quota for three months without any

    conditionality. But the size of the STL is too small to be of

    much use, especially while a potential stigma associated with

    the use of IMF funds lingers. Even if it worked, any help for

    the top-tier countries would merely aggravate the situation

    of the lower-tier countries. International assistance to enable

    periphery countries to engage in countercyclical policies has

    not even been considered.

    The fact is that the IMF simply does not have enough

    money to offer meaningful relief. It has about $200 billion

    in uncommitted funds at its disposal, and the potential

    needs are much greater. What is to be done? The simplest

    solution is to create more money. The mechanism for issuing

    Special Drawing Rights (SDRs) already exists. All it

    takes to activate it is the approval of 85 percent of the membership.

    In the past the United States has been the holdout

    opposing it. Creating additional money supply is the right

    response to the collapse of credit. That is what the United

    States is doing domestically. Why not do it internationally?

    Ironically, SDR would not be of much use in providing

    short-term liquidity, but it would be very helpful in enabling

    periphery countries to engage in countercyclical policies.

    This would be done by rich countries lending or, preferably,

    donating their allocations to poor countries. The scheme has

    the merit that the IFIs would retain control over the disbursement

    of the lent or donated funds and ensure that they

    are spent in accordance with the poverty reduction programs

    that have already been prepared at the behest of the World

    Bank. This would especially benefit poorer countries that are

    liable to be hardest hit by the worldwide recession.

    If it were implemented on a large scale--say $1 trillion--the

    SDR scheme could make a major contribution to both fighting

    the global recession and fulfilling the United Nations' Millennium

    Development Goals. This seemingly selfless act by rich

    countries would actually serve their enlightened self-interests

    because it would not only help turn around the global economy

    but also reinforce the market for their export industries.

    Since the SDR scheme is not of much use in providing

    short-term liquidity to periphery countries, that task would

    have to be accomplished by other means, notably the following three:

    a) Chronic surplus countries could contribute to a trust

    fund that supplements the new STL facility. This would

    greatly enhance the value of that facility by removing the

    five-times-quota limitation. For instance, under STL Brazil

    can draw only $23.4 billion, while its own reserves are over

    $200 billion. A more flexible supplemental fund would give

    the STL facility more heft. Japan held out the promise of

    $100 billion. Other chronic surplus countries probably

    would not contribute unless the quota issue was reopened.

    Holding out the prospect of higher quotas could serve as an

    inducement to put together a supplemental fund that would

    be large enough to be convincing.

    b) The central banks of the developed world should extend

    additional swap lines to developing countries, and they

    should accept assets denominated in local currencies to make

    them more effective. The IMF could play a role by guaranteeing

    the value of assets denominated in local currencies.

    c) In the longer term, international banking regulations

    should facilitate credit flows to periphery countries. In the

    short term, the central banks of the developed countries

    should exert pressure on commercial banks under their

    aegis to roll over credit lines. This could be perhaps coordinated

    by the Bank for International Settlements.

    With regard to enabling periphery countries to engage in

    countercyclical policies:

    1. The major developed countries should, in addition to

    donating their SDR allocations, jointly guarantee, within

    agreed limits, longer-term government bond issues of periphery

    countries. Regional arrangements should be encouraged,

    provided they are within an international framework. For instance,

    the European Investment Bank and the European

    Bank for Reconstruction and Development should finance

    public works in Ukraine in conjunction with the IMF package.

    China's interest in Africa and other raw material-producing

    areas should be encouraged, provided China observes the

    Extractive Industries Transparency Initiative and other international


    2. The chronic surplus countries could be induced, by offering

    them additional voting rights, to invest a portion of

    their currency reserves or sovereign wealth funds in longerterm

    government bonds of less developed countries. This

    could be connected with the proposed trust fund supplementing

    the STL facility.

    None of these measures is possible without opening up

    the vexed question of quota redistribution. This would be in

    the enlightened self-interest of both the United States and

    the European countries that would give up some of their voting

    rights, because in its absence the newly rich countries

    would have no interest in cooperating with the IMF. They

    would turn to bilateral or regional arrangements, and the

    IMF would become largely irrelevant. The question probably

    cannot be avoided anyhow, but it will take a long time to

    settle. The best course would be to obtain support for a

    large-scale SDR scheme by agreeing to open negotiations.

    President Obama would be fulfilling the world's expectations

    by championing this course. The main opposition is likely to

    come from Germany, but with U.S. leadership and broad

    international support it could be overcome.

    In addition, many other international arrangements are


    • Banking regulations need to be internationally coordinated.

    This would be the task of a Basel Three accord.

    (Basel Two has been discredited by the financial crisis.)

  • Market regulations also need to be global.
  • National governments need to coordinate their macroeconomic
  • policies in order to avoid wide currency swings

    and other disruptions.

  • Commodity stabilization schemes ought to be considered.
  • They could be particularly helpful for commodity dependent

    periphery countries and in counteracting the

    prevailing worldwide deflationary tendencies.

    This is a condensed, almost shorthand, account of what

    needs to be done to turn the global economy around. It

    should give a sense of how difficult a task it is. It remains to be

    seen whether any of ideas laid out here are adopted as policy.

    "The Crash of 2008 and What It Means " will be available in paperback on March 30th.

    The eBook edition is available now at this link and wherever eBooks are sold.

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