Ignore The Backslapping

The look on the faces of the world leaders above says it all: "Thank God we made it through this thing without a complete blowup." That's not good.

There's good reason for the looks of relief. Earlier this week, I was pretty sure that the G20 was going to end in serious disappointment, if not disaster. Czech Prime Minister Mirek Topolanek had set the stage by declaring the Obama administration's recent stimulus efforts "the road to hell," not exactly paving the way for transatlantic undertakings around the financial crisis. French President Nicolas Sarkozy followed up Thursday at the summit itself by baiting and badgering Chinese President Hu Jintao on the relatively minor issue of tax havens (and emblem, he said, of disfunctional "Anglo-Saxon" capitalism). He didn't go quite so far as to blame it all on "white, blue-eyed bankers" as Brazilian president Luiz Ignácio Lula de Silva had, but all the rawness and venom still threatened to derail any real cooperation around the big-tent issue—how to pull the global economy out of its death spiral. (Article continued below...)

In fact, there were a number of agreements made, and President Obama was in the middle of most of them. Obama got the tax issue out of the way by doing some front-room brokering with Hu and Sarkozy, very smartly pulling them aside in full view of the plenary to cut a deal for more tax disclosure. He also scored big with the developing world leaders by proclaiming that the U.S. exercises its leadership best "when we listen … and show humility."

The big headline, of course, was world leaders' pledge to put together a $1.1 trillion package of measures to boost the global economy, including more cash and a new pool of drawing rights for the International Monetary Fund, more support for trade finance, and a lot more development aid to poor nations. British Prime Minister Gordon Brown, clearly thrilled and relieved that things didn't fall into complete chaos on his watch, declared the advent of a "new world order." Not quite.

The good news: that is a lot better than a trade war sparked by protectionism leading to the Great Depression, which is what happened the last time world leaders got together to powwow over an economic crisis of this magnitude. The bad news: all the good will and stimulus in the world is not going to save us.

Let's put aside the first issue, which is that only a fraction of the $1.1 trillion is actually new money. And let us also discount the global market rally following the announcement of the G20 plan—markets will always rally when governments throw money around with very few strings attached. The truth is that despite all the promises to ban tax havens, stop protectionism and hold those greedy bankers accountable, world leaders are still missing the boat. The only issue that matters—and the only one on which they made absolutely no progress—is rebalancing the global economy. Until Americans stop spending so much, and China and Germany and all the rest of the surplus countries start spending more, we're still in a sinking ship.

Who cares how many millions or even billions people are stashing in offshore bank accounts in Hong Kong and Macao? Whatever the figure, it's a drop in the bucket compared with the $2 trillion in reserve cash that's sitting underground somewhere in China. I suspect that Sarkozy was only banging on about tax havens because it was a way to signal his annoyance with the Chinese, without really having to do the hard work of fixing chronic imbalances in the global economy that led us all into this mess to begin with. Tax havens are just a symptom of the problem; the real issue is the bulimic global economy.

What I'm talking about here is the fact that the entire Bretton Woods system of global finance set up after World War II is no longer working. The way things are now, the U.S. gets to take advantage of the dollar's position as the world's de facto reserve currency to run up enormous deficits. Meanwhile, the East Asian economies, China in particular, run large account surpluses, which allows them to keep their currencies depressed (and their goods cheap). The whole cycle has a snowball effect, which gets worse and worse over time, and it is the underlying factor in the financial tsunami through which we are all living. For an excellent, albeit lengthy, explanation of all this, check out this paper on global financial imbalances by the Council on Foreign Relations.

Americans now know that they've been living beyond their means, and that they need to save more. Most of us are slowly and painfully grasping that we're entering a world in which our dollar probably won't ever buy as much as it did in the past. But what's ironic is that while the Chinese, with their vast pools of savings, seem to have the upper hand now, they may ultimately suffer more if they can't rebalance their own economy, and cut their reliance on exports. Historically, it's always been the surplus countries, rather than the deficit countries, that suffer most in recessions/depressions. For more on that, check out these two very smart pieces from NEWSWEEK's own Stefan Theil, and Peking University professor of finance Michael Pettis.

What's to be done? Changing the reserve currency system to move it, at least in part, away from the dollar would be a great start. Various folks, from Nobel laureate Joseph Stiglitz, to the People's Bank of China governor Zhou Xiaochuan, have some ideas about how to do that. The export countries also need to retool their economies to boost domestic consumption; it's encouraging that China's recent domestic stimulus package has some key provisions to encourage this. The fact that Beijing is now proposing to give 90 percent of the population medical insurance by 2011 will also help get money out from under some of those 1.3 billion mattresses.

But there's a lot more to do. The huge amounts of cash being thrown around by governments at the moment is camouflaging the fact that when all the stimulus settles, nothing will really have fundamentally changed. As Martin Wolf recently pointed out in the Financial Times, "encouraging a relatively small number of countries to spend themselves into bankruptcy" is not a way to solve the global economic crisis. We need a new world order for sure. Despite all the backslapping, leaders at the G20 aren't there yet.