Stephen’s Posterous

Finance ministers and central bank governors are gathering in Washington for their annual spring meetings. The outlook is challenging, but we have not been idle.

The global economy is projected to shrink this year for the first time in more than six decades. The collapse of world trade is expected to be the largest since the end of the second world war. A global process of deleveraging is adversely affecting the availability of financing domestically and internationally. Job losses in the US have topped 5m since our recession began.

Earlier this month in London, leaders of the Group of 20 nations adopted a common strategy to restart global growth and secure international financial stability for the future. Our task in Washington is to keep at this process of repair and reform.

First, the G20 nations must follow through on their commitment to deliver the fiscal, monetary and financial policies necessary to restore growth. In the US we have passed our largest recovery programme in the postwar period. We are moving aggressively to stabilise and repair our financial system and to restore credit flows on which businesses and consumers depend. Most other countries have initiated similar forceful measures.

The collective fiscal response by the G20 for 2008-2010 is estimated by the International Monetary Fund at $5,000bn . We are acting to limit the effects of dislocations in financial markets on the financing of global trade in goods and services. Our task now is to ensure the effective implementation of these programmes and to narrow the growth shortfall. The IMF must be proactive in holding our feet to the fire of our good intentions.

Second, a strengthened and more responsive IMF is at the core of our agreed strategy for promoting recovery. The objective is not only to mitigate the effects of the global recession and the drying up of international capital flows but also to support sustained growth. This weekend we will make progress on the major IMF-related components of the London package.

Putting in place $250bn in immediate, additional, temporary financial resources to support IMF lending is substantially completed. We are also making good progress in reshaping the New Arrangements to Borrow (NAB) and facilitating its expansion by up to $500bn, incorporating into the NAB the $250bn in immediate financing.

The actual and potential availability of IMF resources on this scale has encouraged Mexico, Poland and Colombia to apply for almost $80bn in precautionary financial assistance from the IMF’s new Flexible Credit Line facility. This will boost confidence within these countries and is also an insurance policy against further global weakness.

The IMF has also taken the first steps towards implementing the London agreement to support the general allocation of $250bn in Special Drawing Rights. Emerging and developing economies would receive $100bn of this liquidity to help meet their foreign exchange obligations as necessary.

President Barack Obama wrote last week to Congressional leaders to request their endorsement of speedy US action on these measures. He stressed their critical importance to restoring the health of the global economy and therefore our own.

Third, the G20 meeting in London transformed the framework of global economic and financial co-operation. In addition to measures to boost the global economy and support the international financial institutions, leaders agreed that the Financial Stability Forum, renamed the Financial Stability Board (FSB) and expanded to include all of the G20 nations, should be given greater responsibility for the stability of the international financial system.

The US is initiating a comprehensive reform of our own system of financial regulation as part of our determined effort to lead a race to the top in regulatory and supervisory standards. That effort will not be wholly successful, however, without parallel action in other national financial systems. The FSB will play a critical role in this international co-operation.

In recent weeks, there have been some encouraging signs that the global economic downturn may be slackening. Conditions in some financial markets have improved and the decline in world trade may be abating.

However, real progress requires time, and significant risks and challenges remain. Thus, it is critical that we continue to act together to strengthen the basis for global recovery. We have an agreed strategy and a common imperative to implement our strategy with energy and dedication to our shared objectives.

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From Roger Altman, Chairman and CEO of Evercore Partners and former Deputy Secretary in the Clinton Administration

The rare nature of this recession precludes a cyclically normal US recovery. Instead, we are consigned to a slow, painful climb-out, as are nations such as Japan and Mexico that depend on US demand. The implications for US policy include a likely second round of stimulus, much more federal capital for the banking system and stunning budget deficits that will slow key initiatives for President Barack Obama, such as healthcare and energy reform.

What is unusual is that this is a balance-sheet driven recession, centred on the damaged financial condition of both households and banks. These weaknesses mandate sub-normal levels of consumer spending and overall lending for about three years.

In contrast, most postwar recessions had a different sequence – rising inflationary pressures, a monetary tightening to counter them and, then, a slowdown in response to higher interest rates. This was the pattern of the sharp 1980-81 slowdown.

None of that happened here. Instead, we saw a housing and credit market collapse that caused enormous losses among households and banks. The result was a steep drop in discretionary consumer spending and a halt to lending. To see why recovery will be slow, we can look at the balance sheet damage.

For households, net worth peaked in mid-2007 at $64,400bn (€47,750, £43,449bn) but fell to $51,500bn at the end of 2008, a swift 20 per cent fall. With average family income at $50,000, and falling in real terms since 2000, a 20 per cent drop in net worth is big – especially when household debt reached 130 per cent of income in 2008.

This debt derived from Americans spending more than their income, reflecting the positive wealth effect. Households felt wealthier, despite pressure on incomes, because home and financial asset values were rising. Now that wealth effect has reversed with a vengeance.

The crisis and unemployment have frightened households into raising savings rates for the first time in years. They had been stagnant at 1-2 per cent of income but have surged to nearly 5 per cent. With reduced incomes, only cutting discretionary spending can produce higher savings. This explains why personal consumption expenditures fell at record rates at the end of 2008.

Consumer spending, however, has approximated 70 per cent of US gross domestic product for the past decade and dominates our economy. But household balance sheets will not be rebuilt soon.

Home values will keep falling through mid-2010 and there is no precedent for equity markets, still down 45 per cent from their peak, to make those losses up in just two years. It is illogical, therefore, to expect a full snap-back in the consumer sector in 2010 or 2011. This alone mandates a drawn-out, weak recovery.

The second key sector is the financial one. According to the International Monetary Fund, western financial institutions, mostly in the US, have realised $1,000bn of losses on US-originated assets since the crisis began. The IMF has estimated that unrealised losses may amount to another $1,000bn.

With residential and commercial real estate steadily declining, this is possible. This is why the banking sector cannot make new loans. These losses are eating into banks’ capital and shrinking their capacity to add assets. Funds from the Troubled Asset Relief Program are only replacing lost capital, not increasing it.

When might they end? With key categories of toxic assets still losing value, the answer is: not soon. The scale of lending needed to support a normal cyclical recovery will not materialise.

A third constraint on recovery may involve the federal balance sheet. The fiscal and monetary engines are currently on full throttle. But, within two years, concerns over budget deficits and inflation may revive, compelling the Federal Reserve to raise interest rates and Congress to adopt deficit reduction steps. These actions, contractionary by definition, could occur before a full recovery has asserted itself. On that basis, the federal balance sheet would also limit a full recovery.

This weak outlook is likely to force a second injection of spending rises and tax cuts in 2010 to prod demand. Despite public opposition, substantially more federal capital will be required for banks.

The deficit outlook will worsen, perhaps to $1,000bn annually over 10 years. That will force a slowing of Mr Obama’s investment plans. That is a shame, because those investments are needed, but this balance sheet recession will be too deep.

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There have been many pseudo reserve currencies through the ages. Now, the governor of the People’s Bank of China has called for a new global currency “disconnected from individual nations”.

Russia, too, wants to move away from a world dominated by the dollar. Kazakh president Nursultan Nazarbayev suggests such a currency could be called the acmetal, an amalgam of “acme” and “capital”.

But is there a case for one? In theory, yes. Although no one was banging the table for change when emerging growth rates were still being powered by deliberately undervalued domestic currencies. The reserve currency status of the dollar helped to create nasty global imbalances, one of the main culprits of the current downturn.

As China, for example, recycled export earnings back into dollar-denominated assets, the US could happily run profligate trade deficits with impunity. That helped push up the price of US assets, particularly house prices.

Now surplus countries are stuck. They cannot diversify fast enough and a rapid sell down of US assets would destroy their portfolios. Not only that, global central banks holding about two thirds of their reserves in dollars are hostage to the Obama administration.

Unsurprisingly, huge budget deficits and the Federal Reserve’s leap into quantitative easing have foreigners fretting over the longer term health of the dollar.

Theory is one thing, however. In reality, currencies live and breathe more than just short-term economic air. The two other life forces for a reserve currency are sovereign credibility and power.

China, Russia and India simply do not have long enough economic track records to justify backing a reserve currency. Find a single investor in this crisis that has panicked out of dollars into roubles. Of course, if China one day emerges as the dominant economic and military power, the status quo will change. Until then, investors cannot be rushed.

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From George Soros, Chairman of Soros Fund Management and Founder of the Open Society Institute

The forthcoming Group of 20 meeting is a make-or-break event. Unless it comes up with practical measures to support the less developed countries, which are even more vulnerable than the developed ones, markets are going to suffer another sinking spell just as they did last month when Tim Geithner, Treasury secretary, failed to produce practical measures to recapitalise the US banking system.

This crisis is different from all the others since the end of the second world war. Previously, the authorities got their act together and prevented the financial system from collapsing. This time, after the failure of Lehman Brothers last September 2008, the system broke down and was put on artificial life support. Among other measures, both Europe and the US in effect guaranteed that no other important financial institution would be allowed to fail.

This necessary step had unintended adverse consequences: many other countries, from eastern Europe to Latin America, Africa and south-east Asia, could not offer similar guarantees. As a result, capital fled from the periphery to the centre. The flight was abetted by national financial authorities at the centre who encouraged banks to repatriate their capital.

In the periphery countries, currencies fell, interest rates rose and credit default swap rates soared. When history is written, it will be recorded that in contrast to the Great Depression protectionism first prevailed in finance rather than trade.

Institutions such as the International Monetary Fund face a novel task: to protect the periphery countries from a storm created in the developed world. Global institutions are used to dealing with governments; now they must deal with the collapse of the private sector.

If they fail to do so, the periphery economies will suffer even more than those at the centre, because they are poorer and more dependent on commodities than the developed world. They also face $1,440bn (€1,060bn, £994bn) of bank loans coming due in 2009. These loans cannot be rolled over without international aid.

Gordon Brown, the UK prime minister, recognised the problem and designated the G20 meeting to address it. Yet profound attitudinal differences have surfaced, particularly between the US and Germany. The US has recognised that the collapse of credit in the private sector can be reversed only by using the credit of the state to the full.

Germany, traumatised by the memory of hyperinflation in the 1920s, is reluctant to sow the seeds of future inflation by incurring too much debt. Both positions are firmly held. The controversy threatens to disrupt the meeting.

Yet it should be possible to find common ground. Instead of setting a universal target of 2 per cent of gross domestic product for stimulus packages, it is enough to agree that the periphery countries need aid to protect their financial systems. This is in the common interest. If the periphery economies are allowed to collapse, the developed countries will also be hurt.

As things stand, the G20 meeting will produce some concrete results: the resources of the IMF are likely to be doubled, mainly by using the mechanism of the “new arrangements to borrow”, which can be activated without resolving the vexed question of reapportioning voting rights.

This will be sufficient to enable the IMF to help specific countries at risk but it will not provide a systemic solution for the less developed countries. Such a solution is readily available in the form of special drawing rights. SDRs are complex but they boil down to the international creation of money. Countries that can create their own money do not need them but periphery countries do. The rich countries should therefore lend their allocations to the nations in need.

Recipient countries would pay the IMF interest at a very low rate, equivalent to the composite average treasury bill rate of all convertible currencies. They would have free use of their own allocations but would be supervised in how the borrowed allocations were used to ensure they were well spent.

In addition to the one-time increase in the IMF’s resources, there ought to be a big annual issue of SDRs, of say $250bn, as long as the recession lasts. It is too late to use the April 2 G20 meeting to agree this, but if it were raised by President Barack Obama and endorsed by others, this would be sufficient to give heart to the markets and turn the meeting into a resounding success.

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It has been a great week for commodities. But has the price rally got ahead of itself? Although demand has improved relative to the dismal conditions of late last year, analysts and traders warn that conditions have yet to perk up sufficiently to warrant an across the board price rally beyond current levels.

“The market is ignoring near-term bearish fundamentals,” says Adam Robinson, director of commodities at Armored Wolf, a California hedge fund. The poor prospects have not discouraged investors, fearful that the Federal Reserve’s action to buy US government debt will stoke growth at the cost of higher inflation.

Some banks are also beginning to see value in the asset class. Goldman Sachs, Wall Street’s largest commodities dealer, on Friday increased its recommended allocation for commodities to “neutral” from “underweight”.

The benchmark S&P GSCI index rose 8 per cent this week. Some commodities gained more than 10 per cent. That strong performance has brought talk among investors about a revival of the asset class, after the carnage of last year. Money flows, particularly exchange traded funds, have picked up. Most analysts are less enthusiastic than investors.

James Steel, a commodities analyst at HSBC in New York, says given that the genesis of the wider commodity rally appears to be the shift in policy by the Federal Reserve and not a sudden change in underlying supply and demand balances, “it is unclear whether higher commodity prices can be sustained.”

Barclays Capital says that a fall in freight costs, a steep decline in Chinese domestic steel prices, both good indicators of industrial activity and commodities demand, and the steady increase in inventories in some raw materials “all suggest fundamental conditions in several markets are still very weak and price recoveries [would] likely prove fragile.”

Goldman warns that it would need to “see demand stabilise before going overweight” in commodities.

Some analysts, such as Daniel P. Ahn, director of macroeconomic research at Louis Capital Markets in New York, question how much central bank quantitative easing, in which central banks inject large amounts of cash into the system in an attempt to bring down long-term interest rates, by itself will help stimulate demand.

“Japan’s example in the 1990s, though not a perfect analogy, shows how massive quantitative easing can co-exist with continued deflation in the absence of structural reforms and proper fiscal stimuli,” Mr Ahn says.

Even if the world’s central banks are successful in quick-starting the economy, it will be months, probably a year, before a pick-up in activity lifts demand for commodities and drags inventories down.

There are some bright spots. Commodities producers’ output cuts, such as by Opec in the oil market, have been in place for long enough and represent a sufficient amount of production to begin to offset demand destruction. This is supporting prices. Merrill Lynch and JPMorgan on Friday raised their oil forecasts for the second half of the year.

“Against our initial expectations, Opec production cutbacks have been very significant,” says Francisco Blanch, commodities strategist at Merrill Lynch.

Other supportive factors for commodities are the Chinese and US fiscal stimulus programmes, which involve large outlays on infrastructure. There are limiting factors. Oddly the pick up in prices is the critical one. Higher prices could lure some producers, from Opec countries to miners, to bring back output capacity even if final demand has yet to recover, opening the door for oversupply and lower prices.

The cycle of higher prices leading to more output and eventually to lower prices is exactly what has happened in the steel sector in China, where a rebound in prices in January, due to traders stockpiling, prompted steel makers to bring back production capacity. As soon as the stockpiling ended, it became clear that final demand was not there and prices fell sharply again.

The influence of speculative money is also likely to be smaller than last year, potentially capping the rally. Hedge funds, for example, have far less firepower than last year as the credit crunch has reduced their capacity to leverage. Regulators appear ready to intervene in the commodities market if they perceive that speculators are driving raw materials prices higher, particularly if oil and food prices are being pushed up.

One way to avoid getting caught out, say analysts, is to pick commodities with supportive fundamentals such as sugar and corn and avoid those with poor ones, base metals and natural gas are typically blacklisted, while also avoiding baskets of raw materials that mix good and bad picks together. The market is divided about the prospects for oil.

Some commodity hedge funds are betting on relative value strategies, gambling that the price of forward contracts, such as for delivery in 2010 and later, will increase relative to spot prices.

The question for investors is whether the economy is strong enough in the short-term to justify the gains. The International Monetary Fund, which forecast that economic growth would fall this year for the first time in 60 years, has a clear view. “Commodity prices are unlikely to recover while global activity is slowing,” it says.

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From Alan Greenspan, former chairman of the Federal Reserve and president of Greenspan Associates LLC.

We are in the midst of a global crisis that will unquestionably rank as the most virulent since the 1930s. It will eventually subside and pass into history. But how the interacting and reinforcing causes and effects of this severe contraction are interpreted will shape the reconfiguration of our currently disabled global financial system.

There are at least two broad and competing explanations of the origins of this crisis. The first is that the "easy money" policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess.

The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages. Between 2002 and 2005, home mortgage rates led U.S. home price change by 11 months. This correlation between home prices and mortgage rates was highly significant, and a far better indicator of rising home prices than the fed-funds rate.

This should not come as a surprise. After all, the prices of long-lived assets have always been determined by discounting the flow of income (or imputed services) by interest rates of the same maturities as the life of the asset. No one, to my knowledge, employs overnight interest rates, such as the fed-funds rate, to determine the capitalization rate of real estate, whether it be an office building or a single-family residence.

The Federal Reserve became acutely aware of the disconnect between monetary policy and mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004. Moreover, the data show that home mortgage rates had become gradually decoupled from monetary policy even earlier, in the wake of the emergence, beginning around the turn of this century, of a well arbitraged global market for long-term debt instruments.

U.S. mortgage rates' linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.

As I noted on this page [Opinion, Wall Street Journal] in December 2007, the presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition.

The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.

That decline in long-term interest rates across a wide spectrum of countries statistically explains, and is the most likely major cause of, real-estate capitalization rates that declined and converged across the globe, resulting in the global housing price bubble.

The U.S. price bubble was at, or below, the median according to the International Monetary Fund. By 2006, long-term interest rates and the home mortgage rates driven by them, for all developed and the main developing economies, had declined to single digits, I believe for the first time ever. I would have thought that the weight of such evidence would lead to wide support for this as a global explanation of the current crisis.

However, starting in mid-2007, history began to be rewritten, in large part by my good friend and former colleague, Stanford University Professor John Taylor, with whom I have rarely disagreed. Yet writing in these pages last month, Mr. Taylor unequivocally claimed that had the Federal Reserve from 2003-2005 kept short-term interest rates at the levels implied by his "Taylor Rule," "it would have prevented this housing boom and bust. " This notion has been cited and repeated so often that it has taken on the aura of conventional wisdom.

Aside from the inappropriate use of short-term rates to explain the value of long-term assets, his statistical indictment of Federal Reserve policy in the period 2003-2005 fails to address the aforementioned extraordinary structural developments in the global economy. His statistical analysis carries empirical relationships of earlier decades into the most recent period where they no longer apply.

Moreover, while I believe the "Taylor Rule" is a useful first approximation to the path of monetary policy, its parameters and predictions derive from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have prevented the housing bubble. All things considered, I personally prefer Milton Friedman's performance appraisal of the Federal Reserve.

In evaluating the period of 1987 to 2005, he wrote on this page [Opinion, Wall Street Journal] in early 2006: "There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind."

How much does it matter whether the bubble was caused by inappropriate monetary policy, over which policy makers have control, or broader global forces over which their control is limited? A great deal. If it is monetary policy that is at fault, then that can be corrected in the future, at least in principle. If, however, we are dealing with global forces beyond the control of domestic monetary policy makers, as I strongly suspect is the case, then we are facing a broader issue.

Global market competition and integration in goods, services and finance have brought unprecedented gains in material well being. But the growth path of highly competitive markets is cyclical. And on rare occasions it can break down, with consequences such as those we are currently experiencing.

It is now very clear that the levels of complexity to which market practitioners at the height of their euphoria tried to push risk-management techniques and products were too much for even the most sophisticated market players to handle properly and prudently.

However, the appropriate policy response is not to bridle financial intermediation with heavy regulation. That would stifle important advances in finance that enhance standards of living. Remember, prior to the crisis, the U.S. economy exhibited an impressive degree of productivity advance. To achieve that with a modest level of combined domestic and borrowed foreign savings, our current account deficit, was a measure of our financial system's precrisis success.

The solutions for the financial-market failures revealed by the crisis are higher capital requirements and a wider prosecution of fraud, not increased micromanagement by government entities.

Any new regulations should improve the ability of financial institutions to effectively direct a nation's savings into the most productive capital investments. Much regulation fails that test, and is often costly and counterproductive. Adequate capital and collateral requirements can address the weaknesses that the crisis has unearthed. Such requirements will not be overly intrusive, and thus will not interfere unduly in private-sector business decisions.

If we are to retain a dynamic world economy capable of producing prosperity and future sustainable growth, we cannot rely on governments to intermediate saving and investment flows.

Our challenge in the months ahead will be to install a regulatory regime that will ensure responsible risk management on the part of financial institutions, while encouraging them to continue taking the risks necessary and inherent in any successful market economy.

Mr. Greenspan is the author of The Age of Turbulence: Adventures in a New World.

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Following is the full text of a communique drawn up by G7 finance ministers and central bank governors who met in Rome on Friday and Saturday, February 13-14, 2009.

The G7, also known as the Group of Seven, is the meeting of Finance Ministers from a group of seven industrialized nations. It was formed in 1976, when Canada joined the Group of Six: France, Germany, Italy, Japan, United Kingdom, and the United States. The finance ministers of these countries meet several times a year to discuss economic policies. Their work is supported by regular, functional meetings of officials, including the G7 Finance Deputies

We, the G7 Finance Ministers and Central Bank Governors met today amid an ongoing and severe global economic downturn and financial turmoil. The stabilisation of the global economy and financial markets remains our highest priority. We have collectively taken exceptional measures to address these challenges and we reaffirm our commitment to act together using the full range of policy tools to support growth and employment and strengthen the financial sector.

The financial measures taken by each of us are helping to stabilise extremely volatile financial markets.

These actions aimed at restoring normal credit flows to the economy follow three approaches as needed 1) enhanced liquidity and funding through traditional and newly created instruments and facilities 2) strengthen the capital base according to the competent authority's assessment of individual financial institutions and 3) facilitate the orderly resolution of impaired assets. The G7 commit to take any further action that may prove necessary to re-establish full confidence in the global financial system.

We will continue to work together and to cooperate to avoid undesirable spillovers and distortions.

What started as financial turmoil has now gripped the real economy and spread throughout the world. The severe downturn has already resulted in significant job losses and is expected to persist through most of 2009.

The policy response by the G7 has been prompt and vigorous, its full effects will build over time. Policy interest rates have been reduced to very low levels and unconventional monetary policy actions are being taken as appropriate. Budgetary action has been resolute. In addition to the full functioning of automatic stabilisers, substantial further fiscal stimulus packages are being implemented. By taking action together the effects of our individual actions will be boosted. Our fiscal policy measures adhere to principles that will increase their effectiveness.

* be frontloaded and quickly executed
* include the appropriate mix of spending and tax measures to stimulate domestic demand and job creation and support the most vulnerable.
* increase longer term growth prospects, addressing structural weaknesses through targeted investments.
* be consistent with medium-term fiscal sustainability and mostly rely on temporary measures.

We also welcome and appreciate the prompt macro-economic response from others throughout the world. In particular, we welcome China's fiscal measures and continued commitment to move to a more flexible exchange rate, which should lead to continued appreciation of the Renminbi in effective terms and help promote more balanced growth in China and in the world economy.

We reaffirm our shared interest in a strong and stable international financial system. Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate.

An open system of global trade and investment is indispensable for global prosperity. The G7 remains committed to avoiding protectionist measures, which would only exacerbate the downturn, to refraining from raising new barriers and to working towards a quick and ambitious conclusion of the Doha round. The G7 also stresses the need to support emerging and developing countries' access to credit and trade financing and resume private capital flows, and is committed to explore urgently ways, including through multilateral development banks, to enhance this support.

This crisis has highlighted fundamental weaknesses in the international financial system and that urgent reforms are needed. We agree that a reformed IMF, endowed with additional resources, is crucial to respond effectively and flexibly to the current crisis. In this respect, we welcome the Japanese government's lending agreement with the IMF. Increased collaboration between the IMF and the expanded Financial Stability Forum (FSF) will be particularly important to develop a timely and reliable assessment of macro-financial risks. We also welcome the contribution of the World Bank and regional Development Banks to providing finance to emerging and developing countries affected by the crisis, using their resources effectively.

The G7 finance ministers have asked their deputies to prepare, in consultation with other partners, a progress report in four months on developing an agreed set of common principles and standards on propriety, integrity and transparency of international economic and financial activity.

The G7 is committed to continue working with partners in international fora to accelerate reforms of the regulatory framework including limiting procyclicality, the scope of regulation, compensation practices, market integrity and risk management.

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Demand for oil will fall this year at the fastest rate since 1982, the International Energy Agency has forecast.

The rich countries’ energy think-tank has again cut sharply its prediction for world oil demand this year, and now expects it to average 84.7 million barrels per day, down 1 million barrels per day (b/d) from last year, because of the steep downturn in the world economy. This year is expected to mark two successive years of falling demand for the first time since 1982-83.

Fuel demand has plummeted in the US and is falling in many other countries, the IEA said. Even in China, one of the countries that powered the global growth in oil demand up to 2007, the rise in consumption is expected to slow sharply.

However, the IEA also warned that sharp production cuts from Opec, the oil producers’ cartel, would mean that by the end of the year there would need to be a substantial draw-down in oil stocks, unless demand weakens even further, or supply from non-Opec countries turns out to be stronger than expected.

Opec cut its agreed production levels by 4.2 million barrels per day in the second half of last year, and could well cut production again at its next meeting on March 15, 2009, in a bid to raise oil prices from this week’s levels below $40. The IEA’s forecast for oil demand this year is 570,000 b/d lower than it predicted in January 2009, reflecting the sharp deterioration in the assessment of the world economic outlook from the International Monetary Fund.

Forecasts for oil demand in the US are unchanged, as the IEA already expected a second year of decline in 2009 following a drop of more than 5 per cent to 19.5 million b/d last year. The sharpest revisions come to forecasts of demand in the European Union and Japan. Demand is particularly weak in the industrial sector; consumption of naptha, used as a feedstock for manufacturing plastics and synthetic fibres, ”virtually collapsed” in Germany at the end of last year, and has fallen ”off a cliff” in Japan.

In China, total oil demand is still growing, but the rate of increase has slowed very sharply. As demand for oil drops, the IEA warns that its estimates of oil supply capacity are also falling, as the financial crisis and the plunge in oil prices from the summer’s peak of over $147 per barrel force companies to delay or cancel planned investment in increasing or sustaining production.

That reduction in investment is already likely to have some effect on oil supply this year, the IEA thinks, but the greatest impact will not be felt for a few years. In its next medium-term analysis of the oil market, due out in the summer, the IEA will analyse the effect of project delays on the outlook for supply over the next five years, looking ahead to the hoped-for recovery in the world economy.

When economic growth picks up, under-investment could lead to supply shortages and send prices soaring again. As the IEA puts it: ”Ultimately, low prices sow the seeds of their own destruction.”

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The International Monetary Fund said advanced economies are already in a "depression" and the financial crisis may deteriorate unless problems with the banking system are addressed. IMF Managing director Dominique Strauss-Kahn also said the European Central Bank, which held rates steady at 2% last week, has room to lower rates, but questioned the tool's effectiveness.

Late last month, the IMF slashed its 2009 estimate for global growth to 0.5%, the weakest expansion since World War II, from 2.2% two months ago.

"We are already in depression ... at least for advanced economies," Mr. Strauss-Kahn said Saturday, February 7, 2009. He said there is still downside risk to global economic growth forecasts and the "worst cannot be ruled out."

Separately, the IMF said Sunday, February 8, that the economies of the Middle East, North Africa, Afghanistan and Pakistan are set to grow at 3.6% in 2009 compared with about 5.9% in 2008. However, the extent of the slowdown depends on the fiscal response by the region's oil-exporting countries and on the depth of recession in the U.S. and Europe, said Masood Ahmed, director of the IMF's Middle East and Central Asia Department.

Mr. Ahmed flagged the possibility the IMF will again revise down its 2009 outlook if indicators such as oil prices or growth in major economies such as China fall. Mr. Strauss-Kahn said the U.S. stimulus package is the correct size and has the right mix of spending allocations, but it needs to be implemented at the same time as restructuring of the banking sector.

On the European Union, Mr. Strauss-Kahn said its officials were more concerned about inflation. He said measures such as providing liquidity and restructuring the banking sector could be a more effective tool there than reducing interest rates.

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Emerging economies are usually the first to drop when international capital flows dry up. This year, they will be lucky to attract $165bn, the Institute for International Finance estimates,one fifth of the level in 2007. Yet no generalised collapse has yet happened – not even in Latin America, the region traditionally most dependent on external capital. At first glance this looks odd.

Take Brazil and India, the globe’s ninth and 12th biggest economies, according to the International Monetary Fund’s latest estimates. While the developed world is expected to shrink by 2 per cent this year, the IMF reckons Brazil will grow by 2 per cent, and India by 5 per cent. Why? One answer is that they have stable banks, relatively closed economies, and large internal markets. This has insulated them from much of the global turmoil.

The contrast with East Asia is stark. Singapore’s economy shrank at an annualised 17 per cent rate at the end of last year, South Korea by some 20 per cent. Yet this is not for lack of capital. Asian economies, after all, are global creditors. Their economies have shrunk instead because they are heavily oriented towards collapsing international trade. Meanwhile, their local markets are undeveloped and weak. Asia’s challenge is how to best deploy its accumulated surpluses to boost domestic demand.

The biggest sufferer from falling capital flows, though, has been emerging Europe. The region alone accounted for almost 50 per cent of the emerging world’s foreign capital demand in 2007. Worse, almost half of that was from western banks, which now have problems of their own. That alone suggests the region will struggle to attract the $117bn it needs this year. Much of the region had embraced globalisation with gusto. Now it is experiencing how fickle international capital flows can be. It is a cold welcome to the emerging debtors’ club.

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