Cablegate: Embassy London

DE RUEHLO #2860/01 3191137
P 141137Z NOV 08

C O N F I D E N T I A L SECTION 01 OF 03 LONDON 002860



E.O. 12958: DECL: 11/14/2018

1. (C/NF) Summary: Coordinated stimulus measures to jump-start economies should be a main outcome of the G20 meeting, several prominent economists told the Ambassador during a November 12th luncheon roundtable. While measures do not have to be exact across-the-board, their timing should be in sync. Economies need to be stabilized before radical reform measures are taken. Leaders also need to agree to strengthen immediately the Financial Stability Forum, and give it the mandate for early warning and improved coordination. If the Summit is not deemed a success, the markets will be harsh in their judgment. While many parties were to blame for the global crisis, attention has not been drawn sufficiently to the role of China, which contributed to the easy credit by providing cheap money. One unintended outcome of the Summit will be the G20's expectations to be seated at the table at all future, high-level economic meetings, and the greater importance of China in global economic decision-making. The root cause of the crisis was the rapid expansion of credit in the U.S. and Europe, and the inadequate policy responses, the economists agreed. End Summary.

2. (SBU) On November 12th, the Ambassador hosted an off-the-record luncheon with several of the UK's top economists and economic observers: Roger Bootle, CEO, Capital Economics, and formerly one of then Chancellor of the Exchequer Gordon Brown's panel of economic forecasters, the "Wise Men"; Sir Samuel Brittan, economic commentator for The Financial Times; David Green, Advisor, Financial Reporting Council, and former head of international policy coordination for the Financial Services Authority; Anatole Kaletsky, principal economic commentator, The Times; Martin Weale, Director, National Institute of Economic and Social Research.

What the Summit Needs to Achieve --------------------------------

3. (C/NF) Consumer markets are paralyzed; spending has stalled. The immediate response must be to re-inflate economies by providing direct credit and debt forgiveness, and by increasing the money supply. Emergency fiscal stimulus measures are needed, and such measures need to be coordinated among the major economies, the participants said. This must be one of the primary outcomes of the November 15th Summit. China's $586 billion stimulus package was a necessary measure to help its stalling economy, remarked Green, but without similar coordinated re-inflationary measures, the effect on global markets would be minimal. While each country could pursue separate policy instruments, there must be agreement among the G20 leaders to reduce interest rates, even if they fall to record lows, to allow foreign exchange rates to be as flexible as possible, and if need be, to write-off some consumer debt, argued Kaletsky. Coordinated fiscal stimulus measures might be the only way to stave off a global deflationary recession. If the Summit does not produce such a coordinated response, it will be deemed a failure, and the markets will react, he stated.

4. (C/NF) The Summit should also lay the foundation for more radical reforms, they said. While the participants disagreed whether new institutions or a new financial architecture - a Bretton Woods II - should be created, they all agreed that existing mechanisms were inadequate. Regulators of the markets and the financial sector need to understand what is happening in the broader economy and should be charged specifically with ensuring market stability. Internationally, the proper organization to take on this mandate would be the Financial Stability Forum (FSF), said Green, and this mandate needs to be given to the FSF immediately. In the UK, The Bank of England's mandate should include not only inflation-targeting but also economic stability. Regulators of the Financial Services Authority also should ensure that financial instruments offered by banks contribute, and not undermine, macro-economic growth and stability, said Bootle.

The Causes ----------

5. (C/NF) The rapid expansion of the credit market of the past decade - in the form of mortgages, consumer credit, etc - was the primary cause of today's economic crisis. The credit expansion was a transformational event, said Kaletsky, LONDON 00002860 002 OF 003 and led to record growth in emerging markets, record levels of home ownership in the U.S., UK, Europe, record levels of consumption. All of this was positive. The problem was the financial sector wanted to continue credit expansion beyond levels already reached and adopted financial instruments of dubious quality - and the regulators failed to notice or to react. The perceived failure of Federal Reserve Chairman Greenspan to monitor and regulate these instruments and to keep watch on the rising asset prices was particularly criticized by the luncheon participants. Another problem is that economists have no understanding of the markets, and market experts have no understanding of the macro-economy, Brittan stated. They speak a different language, and that presented a vacuum of understanding and failure in oversight.

6. (C/NF) While a slowdown was inevitable, a meltdown might not have been, said Green. However, the decision to not bail-out Lehman Bros accelerated uncontrollably the de-leveraging process, which accounted for the free fall of stock prices. Lehman's problems also highlighted to investors how little oversight there had been of investment firms. Lehman gambled in hedge funds and other financial instruments, and no one was watching, he argued.

China - The Power Broker ------------------------

7. (C/NF) Another contributing factor that has not garnered much attention is the role played by China. Its use of its surplus helped drive the global consumer boom by providing banks low-cost capital. Chinese leaders were also swayed by the high and quick returns of their investments, and did not seek out quality, but longer-term and lower-return investments, said Weale. (Note: On this point, the economists argued about why there were so few quality capital investment projects, especially given the aging infrastructure of the U.S., UK, Europe.) Chinese complicity helped spur on the consumer-driven growth of the past decade. If more money had been spent internally or even on overseas infrastructure projects, Europe and the U.S. would have likely entered into a recession sooner, contended Kaletsky. When the Chinese abruptly decided to pull back on their investments in mortgage bonds, that is when the floor collapsed, he said, spurring on the ever-widening gap between mortgage and treasury bonds, and helping to plunge our economies into recession.

8. (C/NF) China also holds a key to economic recovery. It can use its nearly $2 trillion in reserves to stimulate its economy (as in its fiscal stimulus package of $586 billion), to bolster the resources of the IMF and other international bodies to help shore up emerging economies, and to invest in infrastructure projects, said Kaletsky. Other economists at the table did not predict that China will exert such leadership. The Chinese will not change their investment behavior, said Brittan, and therefore, China should be treated as exogenous in any global recovery plan. However, if the Chinese were to take an active role in helping solve this crisis, western political leaders must understand that conditions might be placed by the Chinese on their investments. They might demand indexed, package securities, or equity holdings, Brittan commented, setting the stage for disagreements between the creditor and borrower nations. Kaletsky also agreed that there could be a real confrontation in financial diplomacy.

9. (C/NF) The Chinese are not the only ones who will demand a greater say in new financial rules and architecture. The November 15th Summit will set a precedent, and from now on, G20 countries will expect to participate in all major economic forums. They will question the legitimacy of the G7 mechanism, said Kaletsky, and as a result, western leaders need to be prepared to be more inconclusive.

Comment -------

10. (C/NF) The economists were universally multi-lateral in their beliefs, and argued quite convincingly that no government can solve the problem independently. They were not as quick as others in the U.K, including Prime Minister Brown, to proclaim that the U.S. was cause of the problem, although they did point to Federal Reserve Governor Greenspan's cheap credit policies as one of the contributing LONDON 00002860 003 OF 003 factors. They seemed to agree that democratic governments find it politically difficult to counteract market trends that provide consumers with short-term benefits - even when they can foresee eventual negative consequences. Perhaps most importantly, they thought the current crisis was severe enough to override any concerns about deficits or inflation -- governments should "flood their economies with money." End Comment. Visit London's Classified Website: XXXXXXXXXXXX

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