This would have changed the politics in a beneficial way. Default would have damaged French and German bank balance sheets, but the taxpayers of those countries would have been more ready to support their banks than to assist the feckless Greeks. In Athens, without the ability to borrow, the government would have had to run a balanced budget. Pensioners and public servants would have been demonstrating on the streets, but rather than criticising the IMF, they would have been demanding that taxes should be collected so that they in turn could receive their salaries and pensions.

This opportunity was lost and the private creditors (who made the mistake of investing in Greek debt in the first place and who should have lost all their money) have largely managed to unload their assets, albeit with some haircut.

The problem remains: unless the debt slate is wiped clean, the future of the Greek economy is dismal. Why would any young well-educated Greek stay home, facing a lifetime of high taxes and penny pinching government services? Those who can emigrate will do so.

Why would any investor (Greek or foreign) put their money in Greece, knowing that a permanent tax squeeze will be in place? Why would any foreign portfolio manager buy newly-issued Greek debt, knowing that this new debt was adding to an existing debt mountain? Without strong growth, government debt is patently unsustainable.

In short, Greece can't get onto a sustainable debt profile unless the existing debt slate is wiped clean (or something pretty close to clean). This is what Iceland did by defaulting in 2009. Foreign investors, far from being deterred by the country reneging on its debt, realised that new debt would be repaid because the old debt had not been. Iceland successfully issued new debt.

Behind closed doors, the European policy makers and the IMF both now recognise this reality. They are inching their way towards a solution, but face an insurmountable problem. The various European funding possibilities (European Financial Stability Fund, European Stability Mechanism, European Central Bank) can't tolerate a simple unambiguous default.

Their resources could be used the reduce the actual burden of Greek debt (through much longer maturity and much lower interest rates) provided that it is called a 'voluntary rescheduling', not a 'default'. It doesn't matter that the longer maturity and low interest rate dramatically reduce the true value of the debt (and if proper accounting were to be applied, the debt would have to be dramatically written down on balance sheets, including the ECB).

But if this semantic sleight-of-hand is needed for the European legal and political system, different semantics would be needed to convince Greece's smart younger people to stay home to get the Greek economy going, and investors to give them the capital to do so. Both these groups need to be assured that tax rates will be much the same as other countries and that the budget will be able to provide normal levels of support. Without an unambiguous debt write-off, their growth-enhancing entrepreneurship will go elsewhere.

The policy dialogue is changing, becoming more realistic. Just about everyone now accepts that strong austerity is bad for growth. The IMF is warning that the multipliers involved in fiscal tightening seem to be uncomfortably large (see Box 1 in the current IMF World Economic Outlook).

Just about everyone has lost faith in the confidence fairy: the unlikely notion that tough fiscal policy would raise confidence and thus boost growth. The UK looks as though its 'courageous' (in Sir Humphrey's use of the term) budget austerity will be softened.

The European authorities have the EFSF and ESM to help funding pressures and the ECB is ready to do Outright Monetary Transactions to help bond markets. There are moves towards 'more Europe': bank supervision by a single European supervisor and fiscal union.

All this is moving in the right direction and financial markets are reacting positively. But 'more Europe' will take a generation to put in place and in the meantime no-one has yet reconciled Europe's need to avoid Greek default with Greece's need to wipe the debt slate clean.

 Photo by Flickr user joannova, aka foodalogue.

When the IMF met six months ago, growth was forecast to slow further this year but pick up next year. In the Fund's newly-revised forecasts, almost all countries have had their forecasts trimmed for this year and next: a powerful message that the malaise in the advanced countries is infecting the whole world.

Even this feeble outlook assumes that a recovery is in sight, with world growth returning to 4 per cent over the course of 2013. This assumes that Europe will keep the show on the road and that the US will maintain its current rate of growth of around 2 per cent, in a year in which it has to resolve the 'fiscal cliff' and keep market confidence under control as the political battle on the budget plays out.

As in the past four years, the emerging countries are providing just about all the rise in per capita growth. Even with sluggish growth in international trade, China is still seen as growing at 7-8 per cent, India around 5 per cent and ASEAN around 5-6 per cent.

There is plenty of room to be pessimistic about the prospects of achieving even this lacklustre performance. At this stage of the cycle, with contagion sapping confidence just about everywhere, there is a tendency for country forecasters (who have quite a bit of input into the IMF forecasts) to resist the idea of a persistent under-performance. They accept the irrefutable evidence of current weakness, but argue for a quick bounce back. Why make things worse by talking the economy down?

Running parallel to this gloomy short-term outlook are arguments that structural longer-term growth rates will be lower in the future. Some of these apply to particular countries: the arguments that China's structural changes require a very much lower growth rate; arguments that emerging countries are in danger of running into the middle-income trap; and Gordon's arguments that the US (and other advanced countries) are exhausting the lifeblood of rising living standards: productivity.

If the short-term growth outlook has elements of 'whistling in the dark' to keep up confidence and therefore has substantial downside risk, the longer term pessimism seems overstated. The short-term forecasts overwhelmingly represent the outcome of policy failures in the advanced countries, rather than any intrinsic weakness in the dynamic of growth. When policy makers learn to do better, growth will be stronger.

The US is still labouring under the malign influence of the 2008 financial crisis, with the recovery hindered by seriously dysfunctional politics. Europe's mess is, similarly, a reflection of political failure. The current futile attempt to fix excessive debt through austerity will eventually be seen to be a failure and alternatives found, involving the write-off of excessive debt.

China's task is restructuring its demand to favour consumption rather than investment. This will take time, but there seems no pressing urgency for radical restructuring. Encouraging the public to consume more still seems an easier task than the more ubiquitous problem elsewhere of restraining consumption in order to fix the debt overhang.

As for the danger of the middle-income trap, there are enough examples of countries which have made this transition to assure us that it's not inevitable that countries will get stuck half-way along the journey to high living standards.

The most interesting growth pessimism is Gordon's concern that the engine of productivity will stall. You only get a once-off rise in living standards from electricity, improved hygiene, education, computers, women joining the workforce and falling infant mortality. Each one gives society a leg up, but is once-off. You have to keep inventing new things for the next leg up, and maybe all the best ideas have already been discovered and exploited.

Gordon worries that the productivity increases associated with electricity were more profound than more recent technology, no matter how awesome the technology of the information age. Certainly the measured productivity from recent innovation is lower, but this may reflect the way productivity is measured more than the slowing in improvement. When productivity was just a matter of producing more widgets with fewer workers, it was easier to measure. But the benefits of extended shopping hours, the ATM and day surgery are all understated as enhancements to living standards.

Some of the examples Gordon gives are to demonstrate that when you have arrived at a good outcome, you should rest on your laurels. When infant mortality is effectively zero we should regard that as success, not a reason for despair that we can't get any better. Even advanced America has many opportunities for further improvement: getting the unemployed back to work would be one example. Reducing income disparities, managerial improvements and protecting the environment all seem eminently achievable, and with those in place the advanced countries might be well pleased to grow more slowly, even perhaps work less and have more leisure.

Meanwhile, intentionally outside Gordon's purview, the rest of the world can benefit from the journey to the technological frontier, reaping massive productivity gains by applying already-existing technology. You can think of many things that might go wrong with this: for a start, it might put intolerable strain on global resources or the climate. Wars (or even business cycles) might cut living standards profoundly. But it seems unlikely that we are running out of worthwhile problems to solve, or the ability to so. 

Photo by Flickr user Pondspider.

All this took place in the fraught atmosphere of the GFC. 'Lifeboat camaraderie' allowed petty jealousies to be put aside. The existing G20 finance ministers group was taken, without too much questioning, as an appropriate basis on which to bring the world leaders together, replacing the unrepresentative G7/8.

This group worked well under the pressure of the crisis, where the priorities were well-defined and the urgent circumstances allowed no place for prevarication. But what does a crisis-resolution group do when the nature of the problem changes? As the immediate crisis receded, G20 members were reminded of their domestic priorities. Non-G20 members began to ask why their views were excluded. The lifeboat camaraderie faded.

There's no shortage of challenging international issues. Even leaving aside security issues, economics provides ample unfinished business. The Doha Trade Round is on life support. Concerns about food security have encouraged countries to take selfish export restrictions. Copenhagen demonstrated the difficulty of getting agreement on climate change. Tom Friedman's Golden Straitjacket   might suit some, but is not always equitable or even efficient. Agreements on international trade, standards, intellectual property rights and legal infrastructure are ad hoc, inadequate and uncertain.

No-one is suggesting that G20 alone can do all the detailed rule development that effective globalisation requires; but it could be a top-level steering committee or 'ginger group' to sit over (and whip along) the various specialised agencies which attempt to formulate internationally-acceptable rules. The interminable trade negotiations, the pathetically tardy addressing of governance issues in the UN specialised agencies, together with conflicting standards all attest to the need for such a spur to energise the global rule-making process.

But there is little hope that the present G20 format can successfully address this task. It has no formal linkage into the United Nations hierarchy and will tread on toes if it tries too hard to tell them what to do. G20 is constantly fighting to contain participation bloat. Membership quickly degenerated from the initial 19 countries (already pushing the limits of a feasible face-to-face meeting) into 35 participants with the addition of UN agencies, regional groupings and another half-dozen countries which have managed to get invited. By the third meeting, there were 55 people around the table.

With these larger numbers, the intimacy and like-mindedness of the old G7/8 group was lost. The earlier group may be been unrepresentative, but it had an informality that could sort things out over dinner. Contrast this photo of the smaller group watching football (below) with the formality of the G20 meeting (top).

Mission creep presents a further obstacle. Without the urgent focus of the 2008 crisis, the array of topics rapidly gets out of hand. Development, trade and climate are all failed discussions at other forums, with interminable talk and no resolution. G20 presents an opportunity to transfer this failure to the G20 group. The futile hope is that a collection of political leaders, whose main priority will inevitably be the interests of their disparate domestic constituencies, will somehow be able to solve issues that years of expert discussion have not been able to resolve.

Weighed down by these obstacles, the main G20 meeting has been reduced to little more than a photo opportunity and chance for the leaders to get to know each other. Any real business will be done in smaller groups, spun off from the main meeting. Issues such as IMF governance will be decided by a sub-set of countries which have common mindsets and enough votes to impose their view when the vote is taken. This format has its value, but will this be enough to keep the leaders meeting year after year, waiting for the day when a crisis forces some collective action?

Perhaps this is all that the international system can handle at present. Ian Bremmer argues the wider case that the diminished role of the US in world affairs has removed the possibility of effective economic cooperation, leaving a G-Zero world. Rule-making will be done via groups such as the Trans Pacific Partnership, where America can still dominate the agenda and build on the Golden Straitjacket, which reflects its interests in intellectual property and international capital flows.

It's clear that the answer is not to be found in widening G20 membership to make it more representative. We already have international bodies using this universal model, bogged down in the futile search for consensus. There is no point in repeating their shortcomings.

 Perhaps the answer is to re-think the format, confining participation to the original member countries plus the regional groupings which have formed around the world. At present these are at different stages of development, but if we take the European Union as the model, they have the potential, within their various and frequent internal meetings, to build up refined positions which go beyond the interests of individual countries, with these brought together in the G20 to arrive at consensus which cannot be achieved in the current format.

Photos by Flickr user G20Mexico and Wikipedia user The White House.

China represented 4% of Taiwan's exports ten years ago: the share is now 30%, accounting for 20% of GDP. China's share of Korea's exports went from 12% to 25% over the past decade, now accounting for 12% of GDP. Both Korea and Taiwan are growing slowly and would be highly vulnerable to a sharp slowing in China. The IMF estimates that a 1% fall in China's investment would reduce Taiwan's GDP by nearly 1%. Hong Kong is so closely linked that a sharp slowing on the mainland would produce a recession in Hong Kong.

The links with commodity suppliers such as Indonesia and Australia are of the traditional type, but will be important too. Ten years ago, Australia's exports to China were 12% of total exports; the figure is now 30%.

China accounts for around 40% of world consumption of steel, aluminium and copper and consumes half the world's coal production, though until quite recently it was net self-sufficient in coal. Even now, it accounts for well under 20% of internationally-traded coal. Thus if demand for coal in China slows, the impact might be mainly felt by domestic producers (often high-cost underground mines) rather than foreigners, predominantly cheaper open-cut mining. That said, whatever the cost comparisons, the Chinese authorities may arrange things so that the effect of slower growth falls largely on the foreigners.

On top of the effect on trade volumes, there is the impact on commodity prices. China's huge stimulus in 2009 prevented the 2008 Great Recession from undermining commodity prices at that time. China kept commodity demand growing while the financial chaos postponed the supply-side response which in normal circumstances would have mitigated the commodity price increase. Now the delayed supply response is coming on stream.

Whatever China's growth rate, in time commodity prices will reflect the supply side: the cost of production of the marginal producer. Again, the impact of the changing demand/supply balance will not fall solely on foreigners. If the Chinese authorities accept the logic of using the cheapest supplier, then well-located low-cost suppliers (like Indonesia and Australia) should maintain good volumes, albeit at much lower prices.

The debate about China's growth isn't just about its pace: it's also about the composition. The rebalancing involves less reliance on overseas demand (running an export surplus). As well, domestic demand has to be switched from investment to consumption. Much of the external rebalancing has already occurred, with the current account surplus falling from over 10% of GDP five years ago to less than 3% now. The switch from investment to consumption is likely to be slower, simply because it can't be done quickly while maintaining full employment, which is a paramount political priority. Thus commodity-heavy investment is likely to go on growing, albeit more slowly.

Faster consumption growth might produce a domestic supply response but, just as accelerated demand for coal led to substantial growth in imports, accelerated consumption growth is more likely to spill over into imports. Other Asian agricultural suppliers (Thailand, New Zealand) might do well out of the rebalance towards consumption. Indonesia will lose in terms of slower growth in coal demand, but its two other big exports to China – palm oil and natural rubber – should do well, with China cooking and driving more. And in any case, faster consumption growth will raise the demand for electricity, predominantly generated from coal. A sudden switch from investment to consumption would be unhelpful for Australia's two big exports – metallurgical coal and iron ore – although the switch is likely to be gradual.

The Pettis forecast of 3% growth for China is still an outlier: most conventional forecasters are closer to the official figure of 7.5%. The most compelling case for such a number is that this is what is required to keep unemployment from rising, so the authorities will do what is necessary, in terms of stimulus, to achieve it.

Of course they could make a misjudgment or be distracted by politics. Let's hope not. With Europe still deeply mired, the US facing its fiscal cliff and longer-term budget issues, and Japan performing at its usual lethargic pace, there is not much else to keep world growth going.

The demographic bonus still has many years to run (no one-child policy in Indonesia to slow workforce growth) and both agriculture and the huge small-scale service industries have plenty of scope to release labour to do more productive things. Indonesian growth is largely driven by domestic demand and has been mainly unaffected by stagnation in Europe, the US and Japan.

Comparing the China growth debate with that in Indonesia shows some differences. In China, slower growth is seen as inevitable because they cannot go on investing 50% of GDP (or, nearly the same argument, they must be wasting a lot of investment by building fast trains to nowhere) and they can't raise consumption or net exports fast enough to compensate for a substantial reduction in investment.

In contrast, the optimism that Indonesia can sustain and even speed up its rate of growth comes from identifying myriad glaring possibilities to do better. Creating an excess supply of fast trains (or any other infrastructure, for that matter) is not a concern in Indonesia.

On the supply side, Indonesia could produce much more from the existing resources. The star performer in the agricultural sector, palm oil, has average yields only one quarter of best practice. Good infrastructure would slash the costs of getting domestic agriculture and fisheries to market. It's cheaper to import fresh fruit than to supply domestically.

On the demand side, McKinsey sees another 90 million people shifting into the 'consuming class' by 2030. Let's by-pass the debate about exactly what the 'consuming class' is and focus in the things that people buy when they get some discretionary income. There is no shortage of demand for airline travel, telecommunications, entertainment, health and education. Indonesians buy a million cars a year and eight million motor bikes. Unmet demand for public goods demonstrates the potential. One study says that only 17% of the population has piped water. The World Bank ranks Indonesia 161 out of 183 countries in ease of getting reliable electricity, behind the Congo.

Optimists look at these figures and see the potential for huge improvement in productivity and growth. Pessimists look at the same figures and wonder what has gone wrong to produce this yawning gap between actual and potential.

Some of the answer is found in the international surveys of governance, corruption and ease of doing business. Indonesia invariably rates poorly. McKinsey puts the challenge clearly enough, but doesn't say much about why Indonesia scores badly and how it might be changed.

The McKinsey report is very much of the 'glass half full' variety, but it does lay down the challenge: productivity will have to increase by 60% in order to reach the 7% growth objective.

It is an economic truism that productivity improvements are almost all that matters for higher living standards, but a lot of detail is lost in this truism. As McKinsey notes, the productivity achieved so far has not been a result of the once-off structural transfer from overcrowded agriculture to higher-productivity manufacturing. Only a little over half of the population is urbanised, so those gains are still waiting to be reaped. In fact, the share of manufacturing is lower now than at the time of the Asian crisis, accounting for around 25% of output, compared with 40% in Vietnam.

Put differently, Indonesia is still to make the big structural jump that Clifford Geertz talked about 50 years ago, when he worried that Indonesia would experience 'agricultural involution' (more intensive use of land, increasing output but not output per head) and miss the structural shift that had taken Japan from being a low-productivity agriculture-based country to a manufacturing powerhouse. Things haven't turned out exactly as Geertz foresaw and the service sector can be a bigger part of the structural change than Geertz envisaged. But the strongest gains of productivity are in manufacturing and services tend to be low productivity. McKinsey doesn't tell us why manufacturing expansion, stopped in its tracks by the 1997 crisis, has failed to revive.

This report sees lots of opportunities, but doesn't say much about why these haven't been seized so far. Why has the effort to fix corruption not been more successful? Why can't Indonesia get its act together on infrastructure? Why are they slipping the wrong way on protection? Economics is only a part of the story and the politics is missing here.

 Photo by Flickr user Bert van Dijk.

Thus we need to look elsewhere for the impact. The bond sellers found themselves with increased deposits, which might have encouraged them to repay bank loans, with little or no effect on economic activity. Or they might have bought other assets, bidding up these prices. Each QE operation has raised equity prices, which might reflect this effect. Just as likely, it might reflect the general boost to confidence which comes from the Fed's signal that 'it cares' and that it will go on working hard to try to get the economy moving faster.

Even though the QE operations didn't have much effect on the public's currency holdings, they did sharply raise banks' excess deposits at the Fed. As a result of these large holdings of low-return assets, it's possible that banks might have tried harder to find borrowers. But banks were already meeting the borrowing demands of bankable customers, and with interest rates already very low, there was no demand for new loans.

The latest version of QE has a couple of twists that might help. In QE1, the Fed bought not only government bonds but also privately-issued mortgage-backed securities (MBSs). At the time (early 2009) this market had frozen because of lack of confidence in these assets, and the Fed's action was probably beneficial in getting this market going again. This time round, they will resume buying MBSs rather than the government bonds that they bought in QE2. But the MBS market is no longer frozen so the effect, while probably still beneficial in putting downward pressure on mortgage interest rates, is likely to be less powerful than in 2009. In any case, there are more micro-factors which are holding back housing.

Some commentators are making much of the fact that the Fed's promise is 'open ended', continuing until the economy is in a healthier state, with lower unemployment. But it would take nearly four years of QE3 operations at the planned rate for this episode to match the volume done in the first two QEs, so this doesn't seem a big story.

This promise to continue operations should push down medium-term interest rates, not just the short-term rates that the Fed's actions normally target. But the Fed had already made a promise to keep interest rates very low until at least the end of 2014 (and this promise has now been pushed out to mid-2015). Again, there doesn't seem a big extra effect from QE3.

QE announcements have consistently lowered the US dollar exchange rate a little, and this should boost net exports. But of course this is at the expense of foreign competitors, so it risks reigniting the 'currency wars'.

What should we make of all this? Bernanke has always talked as if QE is a powerful instrument. He quotes studies confirming this: past QEs might have added 3% to growth and 2 million to employment. But these studies are done by the 'official family' and it's not in anyone's interests to say that the magic doesn't work. Bernanke did, however, say that other instruments of policy also had to be mobilised to get the economy going. 'Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces.'

But if QE is such as powerful instrument, why hasn't it been used more? It's not, as some argue, that all this 'money printing' will suddenly spring back to cause inflation. But there is not much doubt that the Fed, like all central banks, is uncomfortable treading the fine line between fiscal and monetary policy and dislikes long periods of very low interest rates, which distort investment signals, undermine pension plans and hurt those who rely in investment income. 

There may not be a serious technical problem in unwinding QE when the time comes, but there is always a political issue when interest rates have to be raised. When this happens, those holding bonds (including the Fed) will experience significant capital losses. Those who believe QE is a powerful instrument argue that the benefits outweigh the costs. But those who remain unconvinced by the purported channels of operation, and who think it has mainly worked by boosting confidence through incantation, don't want to see the monetary magic performed too often for fear that the audience will see that it is largely a matter of smoke and mirrors.

Then there is the politics. If this helps the economy, then it helps Obama. Romney can't oppose action which fosters a sustained economic recovery, but he can (and does) claim that this is politically-motivated 'sugar-high', lasting just long enough to get Obama over the line.

Photo by Flickr user I like.

The current G20 membership reflects its origins in the group of finance ministers and central bank governors who formed the initial 1999 G20 group in the aftermath of the emerging-country crises during the 1990s. At the time, there were heated debates about modifying this membership. Some wanted to add more participants (principally those Europeans who had been in the old G10 arrangements and who now found themselves excluded). Others wanted to make the pre-eminent forum a more exclusive club, building on the old G7 grouping, genuflecting to the changing world power by adding Russia, China, Brazil, India and perhaps South Africa. Others thought the future lay with an even-more-exclusive group: a G3 or even G2 (US and China).

When the 2008 financial crisis hit, the G20 finance group was elevated to leaders level. As the urgency of the crisis receded, membership gripes re-emerged. It was left to the successive rotating G20 hosts to respond. The result was rampant ad-hocery as each host country endeavoured to placate the diverse complainants.

Canada (host in 2009 and an important activist within the G20 throughout) invited a couple of Europeans who had missed the cut in 1999 and four other countries, on the grounds of geographical balance. Singapore participated, representing a disparate group of countries whose only commonality was that they were excluded. To broaden involvement and reflect geography, regional bodies such as ASEAN, the African Union, MERCOSUR, the Gulf Cooperation Council and the Economic Cooperation Organisation were invited. The UN also found a place, with the Secretary-General and the heads of various specialised agencies also invited.

As a result, sensible discussion around a single table becomes difficult. The real action spins off into bilateral meetings and specialised sub-groups.

This is not the only thing that has gone wrong at the G20. We'll leave the problems of agenda-creep to another day. But participation and governance needs fixing. Australia can't do it alone, but it might be able to improve on the limp attempts made so far. Rather than leave participation issue to the vagaries of rotating hosts (whose main interest is to get through the current meeting with everyone smiling, whatever the longer-term impairment done through participation-bloat), a more permanent and impersonal decision process is needed, perhaps from a standing governance committee.

The starting point might be to cease inviting individual countries as guests. Spain and Holland will be upset, but Europe has been over-represented in international economic governance since World War II (and remains so in the IMF). Europe is already double-counted by having the EU participate, as well as individual European countries.

With the decks cleared, the next task would be to enhance regional representation. Over time, the link between the regional groupings and the G20 might become important enough so that the regional bodies will devote significant time and resources to developing effective regional lobby and consensus positions (as Europe has traditionally done in promoting its interests at international institutions such as the IMF and World Bank). Australia could make it a priority of its 2014 hosting to encourage Asian countries to take a more active role in this sort of international diplomacy, not just through ASEAN, but through the East Asia Summit (whose initial core membership includes six G20 countries, nearly one-third of G20's country membership).

As the G20 meeting is at head-of-state level, these regional organisations inevitably play a different role from country representative, but they can be given an important place without over-crowding the discussion. The UN and its various economic institutions also need to be found a place in the room, although not at the top table; they have other opportunities to have their voices heard.

These are vexed issues. The nub is that there is an intrinsic conflict between effectiveness and inclusiveness. The more successful G20 is, the louder the clamour to join.

Australia has a choice. Do we want to make G20 a more focused institution at the risk of offending a few countries in the process? Or will the Brisbane meeting be like a children's birthday party, where the main objective is to make sure that no one feels excluded, every participant wins a prize, and everyone goes home happy?

Photo by Flickr user David Maddison.

If competition is the spur to invention, this monopoly reduces the pressure to stay ahead through further innovation. Arguing that this will make Samsung work harder to find a different way of doing the same thing is advocating for the re-invention of the wheel.

For how long should a monopoly remain valid? The 'Mickey Mouse Protection Act', which lengthened copyright to 70 years after the death of the author, reflected the lobbying strength of Hollywood rather than economic logic. The incentive provided for innovation by the promise of income so far into the future is worth little to an innovator and its promise would not have produced a better Mickey Mouse. This retrospective protection is just a dead-weight cost on today's users.

Getting the right balance between the owners and the users of intellectual property is hard enough within the domestic jurisdiction. There, at least, a political process is at work to balance interests and competing lobby groups (in the Disney case, Hollywood versus Silicon Valley). The difficulties, however, increase in the global domain.

For countries like Australia, why not just ignore the US ruling and allow Samsung to sell its infringing devices here, competing with Apple to keep prices down? Through the Berne Convention, WTO and our various trade agreements (for example the Australia-US Free Trade Agreement) we agree to enforce foreign property rights. The agreements are often incorporated into wider trade arrangements, the current example being the Trans Pacific Partnership; we sign up to a package of arrangements going well beyond trade. 

It's generally in our national interest to sign up to multi-member trade agreements which lower trade barriers. But other topics covered in the TPP, such as intellectual property rights, are not so straightforward. We should not presume that US laws, as interpreted by a California jury in a dispute between an American company and Korean one, will result on a decision that serves Australia's interests.

We do have some bargaining power. If intellectual property is to be enforced in Australia, our administrative apparatus will be needed. When our police and customs are asked to defend the intellectual property rights of foreign designers against unauthorised imitations (thus diminishing the choice of Australians who might value the opportunity to purchase the cheaper copies), this cooperation should be contingent on achieving a sensible balance between the benefits to users and owners of intellectual property.

Mickey Mouse and Amazon's patent over '1-click' purchases may be trivial examples of excessive protection. But these are not trivial issues. We benefit hugely from the availability of generic medicines based on expired patents. It is in our interests to have a continuing flow of pharmaceutical innovation, so such innovation needs to be rewarded. But it is also in our interests that the duration of the monopoly should be short.

Tom Friedman saw the inevitability (and indeed the desirability) of the Golden Straitjacket: uniform universal rules which evolve to govern international economic relations. The detail of these rules is being written day-by-day in negotiations such as the TPP. These negotiations can develop their own political momentum (as happened with the Australia-US FTA). If this occurs, the benefits of globalisation risk being inequitably shared.

Photo by Flickr user Express Monorail.

To answer this, look at the nature of the growth spurt. When China was growing at over 10%, an investment/GDP ratio of around 50% was needed just to keep the capital/output ratio around its usual level and allow for the capital deepening ('more and more expensive equipment with a lesser corresponding rise in wage expenses') that is part-and-parcel of the development process.

China's capital per worker is still only 8% of America's and 17% of South Korea's. If growth has now slowed to around 7.5%, this  still requires investment to be almost 30% of GDP just to maintain a steady capital/output ratio, and quite a bit more to allow for capital deepening.

Of course, at some time in the not-too-distant future, China needs to shift consumption up from its current 35% of GDP to a more conventional number, at least half of GDP. Compared with the task faced by most of Europe and by America (cutting consumption and raising taxes to fix the budget, while maintaining growth), China's task is the easier one, but it does require a major change in thinking. So far China is fumbling the job.

Pettis' growth pessimism goes beyond simply arguing that the current high levels of investment will inevitably contain some white elephants. He thinks the policy instruments available to the authorities won't work because they're caught in a Catch-22: it is hard to alter the long-standing policies which restrain consumption, so the authorities maintain growth by retarding the rebalancing: artificially boosting investment, with the risk of bad debts from excessive credit expansion and unproductive investment projects.

This seems to under-rate the policies available to a hands-on interventionist government which gives high priority to employment. It may also seriously underestimate the growth potential of an economy which still has many useful investment opportunities, achieving the necessary rebalancing over a longer period.

If Pettis wins his bet with The Economist, the world economy will indeed be a dismal place for the medium term. But so far he has had to tweak his forecasts to keep them consistent with the unfolding actual record of higher growth ('forecast early and forecast often'). Earlier this year Pettis said 'average growth in this decade will barely break three per cent'. Given the growth already achieved in the first few years of the decade, this would have implied almost no growth at all for the rest of the decade. In a more recent blog post he talks about China's growth slowing 'even to 3%, as I expect it will within the next few years...'. So he's no longer talking about the whole decade.

Even when Pettis talks more positively about the prospects of China rebalancing, he sees this being bad news for Australia, as the rebalancing will hurt commodity prices. The 'glass half-full' interpretation of that problem was offered by the Reserve Bank Governor:

That presents some challenges of economic analysis and management. But even so, it may be better to be exposed to a Chinese economy with a high average, even if variable, growth rate, than, say, to a Europe with a very low average growth rate that is apparently also still rather variable.

Photo by Flickr user Major Clanger.

Of course Ryan is candidate for vice-presidency, not the presidency. Romney has already had to make clear that he, Romney, is in charge. But Ryan is the budget expert: he is Chair of the House Budget Committee, and has offered a series of detailed budget proposals over the past couple of years. He was also a member of the 2010 bipartisan Bowles-Simpson Commission that proposed a mix of revenue increases and expenditure cuts (his dissent from the Commission's revenue proposals helped to torpedo the initiative). His ideas will have to be the basis for any Republican budget plan.

His over-riding aim is to get the top tax rate down from 35% to 25%. He says this can be done by widening the base – reducing the multitude of exemptions and deductions, closing loopholes and achieving better enforcement. Paradoxically, with Romney now acknowledging that his own tax rate is not much more than 13%, there is hard evidence that getting the rich to pay the proposed reduced rate would, in fact, be positive for revenue.

But it's one thing to have 'outed' the tax rate of one rich individual; it is another to provide specifics on the base-widening. And for good reason: each one of the exemptions and loopholes has its own vigorous defenders. Not only do they vote, they also make political contributions. This political reality is inconsistent with Ryan's forecast that his measures will raise revenue by 4% of GDP by 2028.

That said, there is ample opportunity to enhance revenue. The Tea Party's bleatings might give the impression that Americans are heavily taxed. Judged by international comparisons, however, this is far from true. America has no Federal VAT/GST. Given the huge redistribution of income to the very rich over the last couple of decades, a concerted effort to tax the rich, even at an effective rate of 25%, would go a long way to fix the US budget problems.

Thus the most radical element of the Ryan proposals is not on the revenue side. But his proposals do imply a revolutionary slimming of the government role, at a time when most countries are shifting inexorably in the other direction: government services are a 'superior good' which people want more as they get richer (and older).

The Ryan proposal to transform Medicare (which looks after those over 65) into a voucher-based scheme is not, in economic terms, all that radical: similar schemes operate successfully in a number of countries. Medicaid expenditure (for poor under-65-year-olds) would be halved. These are tough measures, but toughness is needed to rein in both overall health costs (the US spends around 5% of GDP more on health than similar countries) and the proportion met by the budget.

That leaves the truly radical elements in 'discretionary' expenditure, outside health, social security, debt interests and defence; according to Jeffrey Sachs, this includes areas such as education, job skills, infrastructure, science and technology, space, environmental protection, alternative energy and climate change adaptation. These other expenditures would fall from 12% of GDP to 6% by 2020, and halve again by 2050. With defence off limits for cuts by Republicans, this leaves nothing for all other discretionary expenditures.

It is possible that the Ryan proposals are just camouflage for a repeat of the Bush sequence, where tax rates for the rich are cut but the revenue offsets never eventuate, leaving the budget deficit unresolved. David Stockman, the Republican-appointed former director of the Office of Management and Budget, says Ryan's proposals are 'devoid of credible math or hard policy choices'.

But at least on the election hustings, Obama can use the proposals as a debating target to correct his own budget inadequacies. He can toughen up his budget stance while giving it specific content and credibility. He could borrow Ryan's revenue base-widening ideas (while retaining his own tax rate), and rein in health costs more vigorously. He can do this knowing that the Republican alternative, taken at face value, promises to give America a third-world government sector.

Photo by Flickr user monkeyz_uncle.

This will not be enough, says the IMF. Structural improvements (productivity and 'product market flexibility'; code for more flexible labour markets) must come next. As these corrections take place, exchange rates will adjust further, with China appreciating by 5-10% and the US depreciating by around 10%. This correction sounds particularly dismal for Europe:

An orderly adjustment process within the Euro area is likely to be prolonged and costly for output given the absence of an exchange rate channel for adjustment.

Some Asian countries might be puzzled by the suggested adjustments. Indonesia, currently running a small current account deficit, is seen as needing the same exchange rate appreciation as Singapore, running a current account surplus equal to 20% of its GDP. Singapore's current account imbalance is calculated to be smaller than Malaysia or Germany, because the IMF's 'norm' for Singapore is a continuing surplus equal to 20% of GDP.

For China, the proposed structural improvement is to provide 'social protection' (health and pensions) which it is argued will lower household savings (in fact, China's saving is largely done by state corporations).

As usual, this analysis is the vehicle for an IMF morality tale. And as usual, the broad thrust of the tale is hard to dispute: budgets must be repaired, debt reduced and productivity enhanced. But again as usual, no one knows how to get onto the virtuous path. Even if they do, they prefer to put off the political pain until another day.

Other recent IMF analysis has evolved to acknowledge a role for policy in addressing the often-fickle and disruptive nature of international capital flows. The current paper is a relapse into the old mind-set. The Fund still has faith that if countries get their fundamental policies right, capital flows will be appropriate and exchange rates will find the right level.

As usual in Fund documents, there is something for everyone. It is acknowledged that the GFC made capital flows to emerging countries volatile and potentially damaging to nascent financial markets (given the huge risk-on/risk-off surges and reversals since 2007, it would be hard to ignore this characteristic of capital flows). The Fund also notes that capital is 'flowing uphill' from the fast-growing emerging economies to the mature economies. Yet the IMF sees only a minor supporting role for capital flow management and exchange rate intervention. The old mantra is repeated: 'restrictions should not be seen as a substitute for policy adjustment'.

It is surprising, then, that one seasoned observer sees this study as evidence that the Fund has belatedly adopted the approach advocated by John Williamson for the past couple of decades. Williamson's calculations of fundamental equilibrium exchange rate (FEER) may be analogous to the Fund's current calculation of sustainable exchange rates. The Williamson approach, however, envisages that countries will use the full range of active policies (including intervention and capital controls) to keep their exchange rates inside a band around the FEER: the 'band-basket-crawl' (BBC) approach. The Fund still has more faith in the magic of the market than Williamson.

And what about Australia? The study sees the Australian dollar as overvalued by around 10% and the sustainable current account deficit as around 3% of GDP, about where we are at present.

Photo by Flickr user alexwardphoto.

G20 seems to be a bystander in all this. The problems are seen as domestic, off-limits for international efforts. In the face of a clear need to develop uniform rules to guide greatly increased international interactions (an element of Tom Friedman's Golden Straitjacket), countries have resorted to their own approaches on financial structures (with the US, the UK and Europe all tackling 'too-big-to-fail' banks in different ways).

Europe is torn in two directions, wanting on the one hand to control the fate of the euro and on the other to get others to help in the gargantuan rescue costs ahead. Europe missed the chance to cauterise the Greek problems early on and the possible responses have now become so politically charged that outside advice is irrelevant.

Earlier groupings (notably the G7) have ceded policy space only reluctantly. As well, there are constant attempts by those excluded from G20 to join, threatening to overburden the numbers. In any case, the big countries have never been very ready to devolve much power to international fora, or even accept advice.

In response to these intrinsic problems, each subsequent G20 host (UK, US, Canada, Korea, France, Mexico) has searched for alternative initiatives to ensure that its meeting can be seen as a success, with 'announcables' and even the hope of some 'deliverables'. Mission creep is exacerbated by the host of ideas waiting to be brought before the 'pre-eminent forum for international cooperation': poverty, food security, climate change. Each new initiative leaves a residue of distracting unfinished business.

By the time we get to 2014, the world outlook is still likely to look bleak. Europe's mess is so comprehensive that it will probably still weigh the continent down. The US will still be wrestling with its fiscal problems. Japan will still be staring at its public debt mountain, with action constrained by its demographics.

In this fragile and introspective world, the unfinished business of the first G20 will be even more vital. There will be a need for internationally consistent rules covering sustainable external balances, international capital flows, financial sector stability and international trade. It was never envisaged that G20 would do the detail of all this. But its over-arching authority is needed to oppose the inertia, beggar-thy-neighbour policies, parochial self-interest and petty jealousies that prevail. Its job is to cajole, entice and embolden those at the next level down in the hierarchy of international institutions (the IMF, FSB, WTO) to ensure that international institutions are effective in fostering the benefits of globalisation. G20 participants should be sufficiently vocal to influence the domestic debate on these issues.

Australia might do well to announce its agenda for 2014: to return the G20 to the core issues identified in 2008 and keep pounding away at them, rather than introduce the distraction of new initiatives.

Photo by Flickr user The Prime Minister's Office.

Back in the real-world policy debate, reform prospects are far less dramatic, despite new evidence that big conglomerate banks can't be effectively managed. JPMorgan Chase's 'London whale' trading loss has now risen to nearly $6 billion. Barclay's chief executive has fallen on his sword over the Libor interest rate fixing. But the key managerial failings exposed in the Libor scandal have been confounded in a welter of mutual recriminations involving both the Bank of England and the US Federal Reserve.

Thus none of this has had much impact on efforts to make financial institutions small enough to manage. Fed governor Susan Raskin has reported that she was outvoted in her efforts to toughen up restrictions on banks. It looks like the Volcker Rule, the modest efforts to limit banks' ability to take risks via proprietary trading, effectively will be buried under a mountain of red tape and exceptions (known as 'carve outs'), as Wall Street manoeuvers to preserve the status quo. If the JPMorgan Chase trading losses had any influence on this debate, it was only to confirm the difficulty of distinguishing between risky proprietary trading and risk-reducing hedging.

At the international level, the Bank for International Settlements has engineered new rules requiring banks to hold more capital. These, however, don't come into full force until 2017 and there is so little faith in the arcane calculations of risk-weighted capital (with its abundant opportunities for gaming) that an additional overall leverage ratio will be imposed. This crude and distortionary belt-and-braces approach is a reminder of how difficult it is to make global rules.

The current BIS effort is focused on identifying systemically important financial institutions whose failure might threaten the global financial system. But crises (including 2008) have been triggered by problems in rather modest-sized institutions. The danger lies not so much in an individual institution being 'systemically important'. Rather, the financial system as a whole develops ways of doing business which make it collectively vulnerable, so the demise of even a modest-sized institution triggers system-wide contagion.

Other problems remain unaddressed. Despite the traumatic experience of unraveling the worldwide tangle of Lehman Brothers' collapsing balance sheet in 2008, no global plans are in place for handling the much larger possibilities (Citi, for example, is about three times as big as Lehmans and JPMorgan Chase is much larger still).

Every effort to improve the resilience of the financial structure is met by the argument that this particular problem didn't cause the 2008 crisis. So many different factors contributed in the years leading up to 2008 that this argument is hard to refute. Even when a key weakness is identified, it is then argued that whatever measures are taken will not be enough (for example, more capital wouldn't have saved the institutions that got into trouble).

A resilient financial sector will be very different from the structure of 2007, with its excessive trading, over-leverage and the sloshing back and forth of vast international capital flows. The financial sector will have to reverse at least some of its pre-crisis expansion, which doubled the sector as a per cent of gross domestic product in the US and the UK. This process has hardly begun. Trading is still where the sector hopes to earn a good part of its livelihood, playing a zero-sum game in which these profits come at the expense of non-financial businesses and households.

High-speed transactions and 'dark pools' of trading have no benefit in price discovery or market liquidity, but are attracting new capital. US regulators are still no match for the political power of Wall Street. The credit rating agencies, having totally failed to identify problems before the crisis, now make a living out of walking the battlefield, stabbing the wounded. Salary incentives are still unreformed and those who headed the failed institutions have walked away from the wreckage, well remunerated. Banks, already too big to fail and too big to manage before the crisis, have merged to become bigger still.

There is still much unfinished business here.

Photo by Flickr user mikebaird.

The TPP encompasses intellectual property rights, labour standards, competition policy, investment rules, the environment and the role of state-owned enterprises. These issues might have some trade-related aspects but are quite different from trade liberalisation in that there is no consensus on the optimal standards.

Let's start with intellectual property rights. Of course ideas are valuable and their creators should be rewarded. But how much and in what form? Patents and copyright require a balancing of the creator's monopoly weighed against the loss to society through not having full use of the idea. For example, economists have decried the extension of US copyright to the author's life plus 70 years, a move widely seen as a response to lobbying to keep Mickey Mouse still earning, long after Walt Disney had passed on. 

Even within a single country there will be strongly conflicting interests (for example, between Hollywood and Silicon Valley on protection of digital material). Similarly, international standards for child labour are well justified, but to impose advanced-country labour standards on emerging countries, in the guise of protecting workers, undermines the natural comparative advantage that emerging countries have through cheaper wages.

In short, the 'add-ons' to the trade liberalisation agenda are intrinsically different in character. Is TPP the best forum and are these the right set of issues? The TPP seems an ad hoc and accidental forum into which the US has inserted its own priorities.

Will the mix of issues in the TPP suit Australia's interests? It may (after all, Australians generate intellectual property too, although we pay out much more than we receive), if they coincide with America's. But we need to go into these negotiations recognising that our bargaining power to influence the rules is minimal and pointing to America's many instances of protection will do us no good.

Moreover, we have already had one experience of getting into a negotiation from which there was no retreat. The US-Australia Free Trade Agreement predominantly benefited America but failure to reach agreement was not an option as it would have undermined Prime Minister Howard's claim to be America's best friend.

There are other strategies in play, such as the ASEAN-based idea for a free trade area based on the ASEAN+6 (the East Asia Summit, which could include the US) countries. On past experience, this is a slow track, but at least it focuses on trade issues and in particular the rules needed to foster multi-country supply chains.

There is another worrying aspect of the TPP negotiations. It is widely accepted that China will be unable and unwilling to accept the rules on intellectual property rights and state-owned enterprises. The US discussion downplays this issue, seeing it as just a matter of time before China will change in ways that enable it to meet the TPP's 'platinum standard'. But with China initially excluded, it would be easy to interpret TPP as an element of a China containment strategy, especially as Vietnam (which would seem to have the same issues on intellectual property and state-owned enterprises) has been accepted as an inaugural member.

The China aspect needs urgent clarification. Unless a way can be found to signal that there is a realistic prospect of China joining and that China would be welcome to do so, we need to recognise that this will be seen by China as containment. Is this our intent?

Photo by Flickr user femme run.

To put this problem in perspective, outstanding Spanish government debt is €800 billion while Italy has a €2 trillion debt. Of course these figures don't represent the likely losses. But while it remains unclear how any losses will be absorbed, government debt-holders will be concerned that they are the fallback absorption option.

Thus the ESM decision, in itself, doesn't change much. But by shifting some of the responsibility for Spanish banks towards Europe and requiring a new banking union with a unified banking supervisor, the European Central Bank (ECB) may have become more involved.

This holds out some hope. The ECB's balance sheet is the only ready source big enough to match the enormity of the sums involved. Unified supervision might make the ECB more ready to act as lender-of-last-resort to troubled banks. But this is not, of course, costless or unlimited. While the ECB has very great capacity to provide short- or medium-term funding, it has almost no capacity to absorb losses: its capital is €5 billion. Thus losses go back, sooner or later, to the constituent governments. The deeper involvement of the ECB will buy time, but won't solve the underlying issues.

If Europe is going to pick up some of the losses, it will certainly want a greater say on how the Spanish banks are run. Europe would want to ensure, for instance, that the first line of defence for Spanish banks would be the shareholders and probably the bond-holders as well. Beyond this, Europe is sure to want to get more closely involved in the ongoing detailed prudential supervision of Spanish banks (and, given the precedent that this sets, of all euro area banks).

This is politically sensitive and much harder to achieve. No sovereign government is going to readily cede the detailed supervision of its banks. Europe's banking is so heavily cross-border that overall European supervision makes a lot of sense. But this is the sort of change negotiated over years rather than months and preferably in good times when countries can agree without feeling the gun pressed to their head.

This predicament is typical of the current fraught climate. Proposals which give a bigger role to Europe, at the expense of member sovereignty, are being put forward as solutions to the pressing problems of the immediate crisis.

It is possible that greater banking centralisation (and greater fiscal centralisation) might be further steps along the path the continent has been on for 50 years: towards a unified Europe. But unification objectives are usually achieved at an evolutionary pace. Financial markets, mainly concerned about the exigent issue of how they will be repaid, are looking for some early assurance that losses will fall elsewhere. On this, the summit offered little comfort.

Photo by Flickr user Greg Gladman.

In the US, Bernanke got this one right: he not only lowered interest rates but committed to keeping them low, and this is what matters if you want to encourage longer-term borrowing. He also implemented 'Operation Twist' to lower longer-term interest rates.

With interest rates close to zero and monetary policy in the classic 'liquidity trap', central banks in the US, UK and Europe explored the new territory of quantitative easing. This had been tried a decade earlier in Japan in an attempt to break out of the 'lost decade' of the 1990s, with little or no effect. Bernanke was prepared to go further in 2009, buying up private-sector debt to revive this paralysed market.

Whether the subsequent QE exercise had much effect on interest rates is debatable, but there is no doubt that financial markets liked this demonstration that the central bank cared. They responded by strengthening equity prices. Late last year the ECB carried out huge QE-style operations in response to the parlous state of the bond markets of the southern Europeans.

Given these policy initiatives, the absence of a strong recovery is being taken by some as evidence of policy failure. But the better conclusion is that the instruments are not capable of fixing the problems. This is the main thrust of the BIS defence.

It would be absurd to expect monetary policy to fix the problems of the debt-ridden southern Europeans. The ECB has already loaded its balance sheet with worthless Greek paper; the inevitable write-offs will leave the ECB in need of recapitalisation. In the UK the BoE has bought up 30% of the total stock of government debt in an attempt to stimulate the economy. Nevertheless, total bank credit has fallen for the past two years, and lending to business is lower than three years ago. The response to increased base money has not been to expand lending, but to repay debt. The BoE is now looking for more direct ways to encourage lending, but this takes it onto tricky political territory.

In the US, QE seems to be losing its power; it is, after all, largely a psychological instrument. What is needed is a credible fiscal policy, with short-term stimulus combined with medium-term consolidation. Just because the political system is incapable of providing this doesn't mean monetary policy can be a substitute.

Perhaps the greatest problem with the critical commentary is the ignorance it demonstrates of how monetary policy actually works. The Economist, Wolf and Krugman all carry the legacy of Milton Friedman's misleading message in which monetary policy works by increasing base money, expanded by the banking system through a credit multiplier. But extra base money doesn't encourage banks to expand their lending; they are already lending to all the bankable customers who want to borrow at the going interest rate. The extra base money just accumulates in the banks' balance sheets in the form of deposits with the central bank, with little or no effect.

Perhaps the most curious lesson The Economist draws is that central bankers need more democratic oversight (ie. less independence). A glance at its own readers' correspondence would demonstrate that the monetary policy debate contains a good share of nutters and cranks, as well as those who, like themselves, just don't understand how it works.

Photo by Flickr user m.p.3.

To reap the full benefits from this sort of unbundling, there needs to be not just a dismantling of 'behind-the-border' restrictions but also a consistency of rules, standards, methods of operation and physical infrastructure to smooth the complexity of this production chain. This is much more subtle than the conceptually straightforward task of lowering tariffs. (Free trade is also a universally-accepted principle; just about everyone accepts that lower tariffs are a good idea, even if it's not easy to implement this in practice.)

There will be much disagreement about these rules. Some differentiation in standards is the basis of comparative advantage: different labour, safety or environmental standards may in fact be appropriate. With intellectual property rights, there has to be a balance between the rights of those who thought up the ideas and the rights of users to copy: handing out monopolies to patent-holders never made good economic sense. Simple technical standards should be the same universally, but whose standards will prevail (whose electric plugs will become the international norm)?

The key issue is that a set of rules to foster the 'second unbundling' can't be established and enforced in the same way free trade is enforced within a forum like the WTO. Even less appropriate will be the 'platinum standards' the US is pushing for in the Trans Pacific Partnership, which demand stronger intellectual property rights, stronger labour and environmental standards and regulatory discipline of state-owned enterprises.

Hence the two radical ideas currently under discussion. First, that there is way forward from the noodle-bowl of overlapping and conflicting preferential trade agreements. Whatever damage these PTAs do to the multilateral system, some of them are potentially valuable as the framework for negotiating 'second unbundling' issues. 

Second, that the ASEAN framework, lumbering along under the need for consensus and often held back by the lowest common denominator, may actually be a better approach to the sensitive issues of the 'second unbundling'. Connectivity (smoothing the physical infrastructure connecting the production units) is the sort of issue where progress is made in ASEAN.

What seems pretty clear is that the platinum standard envisaged in the Trans Pacific Partnership, which imposes self-interested US intellectual property objectives and which sees abnormality in state-owned enterprises, is not going to get Chinese participation. Any set of international rule making which excludes the Chinese will not be a relevant basis for the 'second unbundling'.

Photo by Flickr user geographyalltheway.com.

Given the embarrassment to Dimon (who is being very publicly urged to resign from his prestigious position on the Board of the New York Fed), this event does seem to represent not so much a lapse of risk management but rather a demonstration that the job is too complex to be done adequately.

If this is true, then these sorts of institutions are also too big for regulators to understand, and certainly too big for any realistic degree of market discipline via transparency.

Yet we are unlikely to see this issue addressed effectively. The financial sector has not been able to stop the efforts at regulation, but it has managed to make them so convoluted that they may well be unworkable. The US has already passed the Dodd-Frank Act. Congress managed to squeeze the broad principles of regulation into 2300 pages of legislation. By the time the implementing regulations are written, it will have deserved its informal title of Financial Lawyers' Full Employment Act.

And this is only the start. The Volcker Rule (attempting to prevent banks trading in financial markets on their own account) takes up nearly 300 pages of Dodd-Frank, and won't come into force for another two years. In response to Wall St pleading, US bond trading has been exempted. This immediately led to protests from Canada and Japan: if US bonds were exempt, then so should their own government bonds.

Volcker himself, faced by this concerted obfuscation, would be happy to wind back the clock to pre-1999, going back to the Glass-Steagall solution of separating stolid conventional banking from the go-go business of investment banks, with its fundamentally different risk characteristics (and thus need for different style of management). This worked for over sixty years and was only 37 pages long (including appendices). But it's not possible to go backwards; only forwards into the morass of greater complexity.

Photo by Flickr user Chris Blakely.

...Deutsche Bank identified as Glencore's "key drivers" of growth: copper in the Democratic Republic of the Congo, coal in Colombia, oil and natural gas in Equatorial Guinea, and gold in Kazakhstan. All are places with a heady, dangerous mix of extraordinary natural wealth and various degrees of instability, violence and strongman leaders. Glencore's experience and adeptness operating in these "frontier regions" and "challenging political jurisdictions" - Deutsche Bank's delicate euphemisms for countries known for corruption, autocracy, and human rights abuses - is central, the investment firm wrote, to Glencore's "significant growth potential."

Given that mining industry pressure succeeded in emasculating Rudd's proposed resources tax, leaving it with meager revenue prospects, Glasenberg's reported reference to 'Australia wanting to nationalise 30 per cent of their mines' seems a bit over the top. As well, the carbon tax makes Australia 'another country where you've got to make sure the rules aren't going to change on you'.

There are (at least) two policy issues here. First, is it in Australia's interests to have world commodity markets dominated by large players like Glencore? Second, is this sort of absurd language an acceptable form of dialogue in the debate between foreign investors and host governments?

Commodity prices

First, commodity prices. The former Swiss ambassador to Australia raised the need for international scrutiny of commodity price-setting recently in The Interpreter. If Glencore has doubts about investing in Australia, perhaps, in turn, we should have reciprocal doubts about Glencore. After all, Marc Rich did try to corner the world zinc market in 1992.

Glencore handles one-quarter of world commodity flows, controls half of internationally traded zinc and copper, one-third of seaborne coal, and accounts for 9% of the global wheat market. They are not end users of these commodities. Rather, they control the trade, hold strategic inventories and do the deals with the end-users.

If a foreign end-user sought this degree of control of an Australian mining enterprise, we would be reluctant to approve such investment, not for xenophobic reasons, but because it opens the possibility of distorted pricing contracts, transfer pricing and minimisation of royalty payments in Australia.

While the possibility of manipulation of world commodity prices is real, the merger of Glencore and Xstrata doesn't seem to undergo any scrutiny (as BHP and Rio would have undergone, if their joint venture on iron ore had gone ahead). Where are the European competition authorities and the Australian Foreign Investment Review Board in all this?

Tax and royalties

What about the second issue: taxation and royalties? Of course it's not just the Glencore chief executive who has raised the spectre of foreigners moving their investment to more profitable (and exciting) locales. Last year Tom Albanese, head of Rio Tinto, was reported as saying that Australia was his main sovereign risk concern: 'From my own perspective, this is my No. 1 sovereign risk issue on a global basis.' Yet as that Fairfax report went on to note:

Rio continues to operate in some of the most unstable economies in the world. Its Simandou iron ore project is progressing in Guinea, a country the CIA World Factbook says is in the grip of ''rampant corruption''. Mongolia, home to Rio Tinto's $5 billion Oyu Tolgoi copper-gold project, received a $236 million stand-by agreement last year from the International Monetary Fund to provide some financial stability. 

Mistakes can be made in either direction: the golden goose can be strangled, or our birthright can be sold for a mess of pottage. Over time, the balance may shift and require tax changes, just as there are changes in other forms of taxes such as income tax or the GST. Australia has turned out pretty well for Glencore, Xstrata and Rio. It's now about time to get the debate on mining taxes and royalties onto a more positive, objective and constructive level.

Australian governments, custodians of our mineral wealth, have a duty to negotiate the best deal for Australians. This means striking a sensible balance in dividing up the benefits of minerals between us as owners and them (mainly foreigners) as miners. This balance is not easy to strike, especially in a world where the uncertainties are great and the gestation and life of projects are long.

Photo by Flickr user stephenjohnbryde.

But for most central banks the single-objective version of inflation targeting was a convenient heat-shield to protect them from popular pressures for overly-accommodative policies. It was convenient for central banks to talk of 'doing whatever it takes', but they knew that their newly won independence could be taken away as easily as it was given. They might talk tough, but they weren’t going to be foolishly doctrinaire.

For most inflation-targeting central banks, there was always room for some flexibility to respond to cyclical fluctuations, supply-side price shocks and exchange-rate irregularities.

In particular, there was no obvious conflict with financial stability, which had always been part of the central bank remit. In many countries the day-to-day micro job of prudential supervision had been given to a specialised agency. Once every generation, some financial institution would get into trouble and would have to be 'resolved' by a bailout or a forced merger. Central banks still had the powerful instrument of the 'lender of last resort'. All this could be held in readiness to be used in the rare times when it was needed. None of this conflicted with the inflation targeting framework.

Financial sector not properly supervised

There is no dispute that the 2008 global financial crisis was a major shock to the complacency that had developed during the two decades of the 'Great Moderation', when inflation was low and growth was good. That said, what went wrong was not that inflation targeting prevented central banks from addressing the needs of financial stability, but that some of them (including the US, which has no formal inflation target) gave a low priority to the mundane task of ensuring that the financial sector was competently supervised.

The authorities mis-assessed how pro-cyclical the financial system can be, overestimated its self-righting properties and had too much faith in the 'magic of the market'.

But these mistakes were not forced on central bankers by the mono-dimensional inflation targeting framework. Fixing these deficiencies doesn't require winding up inflation targeting. It requires, instead, the creation of a competent supervisory structure in those countries where it didn't exist; higher capital requirements; some liquidity requirements; and limiting the degree to which banks can participate in high-risk market trading.

Macro-prudential instruments (cyclically varying capital requirements; loan/valuation limits) can be used as well. None of this requires abandoning inflation targeting.

Intentionally boost inflation?

And it should be acknowledged that an obsession with price stability may have led some policy-makers astray. Two members of the Bank of England policy board clung too fixedly to the rhetoric of inflation targeting, advocating tighter policies in July 2011 to deal with temporary inflation, just as the UK was sinking deeper into recession. Fortunately, their appalling judgment was overridden by the rest of the policy committee. Across the channel, the European Central Bank pushed up interest rates as recently as July last year.

These mistakes were, however, errors of judgment rather than principle: in each case, the policy stance remained accommodative. The more fundamental problem is an old one: when interest rates are close to zero, monetary policy cannot be made still more accommodative.

In the US, UK and even in Europe, the interest rate instrument is up against the 'zero bound'. Thus the substantive debate is about whether 'unconventional policies' – quantitative easing, for example – should be taken further. This seems, at best, an uncertain policy tool.

Attacking from another direction, there are advocates of a higher inflation target (not only to get real interest rates lower and to speed balance-sheet adjustment by eroding the real value of debt, but also to provide Greece with the opportunity to improve its competitiveness).

Of course the thought of intentionally creating higher inflation is shocking to some. But the real problem here is that no central bank has a policy instrument which can reliably boost inflation in a depressed economy. The Bank of Japan has been pushing on a string for decades. Not much point in blaming inflation targeting for the intrinsic nature of monetary policy.

Photo by Flickr user herefordcat.

But the moment has passed when this crisis can be resolved by a resolute display of austerity on the part of the troubled country combined with solemn pledges by the European authorities that they stand ready to back the country when it comes under market attack. That approach either works quickly to restore confidence, or it fails definitively. For Greece it has failed definitively.

For the past six months its prime minister has been a former central bank governor, well-known and trusted by his European colleagues and able to do enough (and promise enough) to keep the crisis at bay. He also had the unambiguous objective of keeping Greece in the EU even if this meant years of austerity. Last month's inconclusive election saw 70% of Greeks vote for parties which promise to abandon austerity, a deal-breaker for the European assistance package. If this remains the case in the mid-June elections, it's hard to see how the policy chasm between the new Greek authorities and the Germans can be bridged.

The prolonged agony of this crisis must tarnish the IMF's reputation. When the crisis first broke in May 2010, European politics constrained sensible responses and diverted the debate into unattainable solutions such as fiscal union.

The Fund alone was in a position to take a clear-sighted stance and require debt rescheduling (de facto default). Taken in a timely way before financial markets had time to work themselves into a frenzy of self-interested concern about contagion, the outcome might well have resembled Iceland in 2009 or Korea in 1998: a painful cut in living standards for the troubled country, but quick resumption of growth and access to foreign capital markets. Once this opportunity was lost, it was hard for the Fund to avoid pouring good money after bad. There is a real chance that some of the Fund's newly-gathered US$400 billion (including Australia's contribution) will be tipped into this bottomless well.

Did the time bought make a departure from the euro any less traumatic? It allowed private sector creditors to unload more of their potentially-worthless Greek assets onto European governments, and some financial institutions may have been able to strengthen their balance sheets.

But the mechanics of departure will still be traumatic. One central problem is the decision-making process: the official sector can't make any preparations for departure without precipitating the event. They can't, for example, put in an order for printing New Drachma. And resolution would certainly involve closing all the banks and opening them again as state-owned or state-backed entities, dealing in a new, greatly depreciated, currency.

It is the chaotic nature of any departure which has encouraged the authorities in both Europe and Greece to keep the show on the road. But they are no longer in control. Greece and its collateral damage have hobbled world growth for the past two years. The cost of default is now much greater. In addition to the ELA, the ECB holds perhaps €50 billion of Greek Government paper, Greece is in deficit with the euro payments system for more than €100 billion and the official support package is well over €200 billion. Most of this will have to be written off.

As usual in political economy, nothing is certain and Greece could still battle on as part of the euro area (which an overwhelming majority of Greeks say they want to do). After all, Edgar Allan Poe's character did extricate himself from the maelstrom.

But this is no longer a matter of incremental modification to policy: it would take an extraordinarily bold shift in policy mindsets, especially in Germany. There would have to be agreement on a softening of austerity, a recognition that Greece’s huge foreign debts are essentially worthless, and easier euro monetary policy (including higher German inflation which might help restore Greek competitiveness). It now seems more likely that Greece will be sucked under.

Photo by Flickr user Ignacio Sanz.

He can't use the conventional instrument – interest rates – because that's already effectively set at zero. He could do a third round of QE. QE was supposed to work by lowering longer-term bond yields. When the Fed was buying private-sector sub-prime securitized assets in 2009, there is not much doubt that this helped restore a market which had seized up through extreme risk aversion. Whether the more recent QE activity of buying government bonds did much to lower their yields is much less clear: the biggest falls in yields occurred in periods when the Fed was not doing QE operations.

That said, financial market believe in QE (many misleadingly think it is 'printing money' and are awaiting a burst of inflation) and as a result QE has probably worked by strengthening the stock market and weakening the US dollar (making exports more competitive). But how often does the magician want to repeat a successful trick? Sooner or later the audience sees through the smoke and mirrors and the magic is gone.

Bernanke's second unconventional instrument has been to explicitly tell the market what the Fed intended to do with future policy settings. The Fed has promised to leave interest rates at essentially zero 'at least through late 2014'. This lowers the whole yield curve (which depends to a large degree on what the market thinks future policy settings will be) and assures borrowers that they won't be caught short by an unexpected interest rate increase any time soon, making them more confident to borrow.

But short of making an irrevocable promise never to raise interest rates, the Fed has done about all it can do here.

What of Krugman's higher-inflation strategy? If the public believes the Fed will succeed in raising inflation to, say, 4%, they will realise that the real (inflation-adjusted) rate of interest is substantially negative. This will encourage borrowing and spending.

Bernanke's counter-argument is two-fold. Although he advocated this policy for Japan, he argues that Japan was in deflation while the US is not. Second, he argues that although Krugman's inflation strategy might buy a small reduction in unemployment, this would be at the cost of damage to the Fed's hard-won anti-inflation reputation. He might also use the same argument that the Bank of Japan used in resisting this suggestion in 1999: that the central bank doesn't have an instrument for promoting this sort of generalised higher inflation other than the interest rate, which is already 'flat to the floor'.

No-one is advocating the unconventional policy that Bernanke himself included in his list of possibilities back in 2002: the 'helicopter drop' of money. It's not that this is impossible or wouldn't work. Australia's 'cash splash' in 2009 was exactly that, although the money arrived by mail rather than out of a helicopter. It's just that this kind of give-away is clearly fiscal policy, not monetary policy. It's not an operation on the central bank's balance sheet and it needs proper congressional approval. Given the state of the US budget, it's not on the agenda.

What's Bernanke's best answer? Perhaps it is to say that he has already pushed the limits of what a central bank can do, and it's now up to other elements of economic policy to get the economy moving faster.

Photo by Flickr user free2beesmees.

The outlook is sufficiently grim to motivate Fund members to pledge US$430 billion to supplement the Fund's resources. This backs up Europe's own €700 billion 'firewall', designed to assure Spanish and Italian bond-holders that their money is safe. Australia is offering US$7 billion. America is not contributing, seeing this as a European problem.

The commentary from the meeting wove a similarly subtle path through the policy morass that faces Europe, emphasising how the extra money would help. The Chairman of the Fund's policy-making body accepted that the pledged funds and the firewall are just palliatives which might buy time and might sustain market confidence but which don't address the basic problems of budget deficits, excessive government debt and loss of international competitiveness. 

The main emphasis must remain on fiscal and structural reforms to put economies on a firmer footing. While getting budgets and debt under control was important, it was equally important to spur growth and get it back to normal levels within 2–3 years. Without growth, fiscal sustainability was not possible.

Easy enough to say, but hard – perhaps impossible -- to achieve. Fixing the government debt problem requires austerity, and austerity is inimical to growth. Low growth makes the budget problem worse. Membership of the euro makes external competitiveness hard to restore. Leaving the euro would be chaotic. The IMF commentary offered no solutions to these conundrums.

Photo by Flickr user thetejon.