Global imbalances require a global fiscal system in place

Governor Meryvn King's dictum that we have global banking in life, but national in death characterizes large complex financial institutions that are larger than sovereign nations, ineffectively regulated in compartments at national levels, with no global laws.

Their demise means that national governments have to pay for the global banks' mistakes, but ultimately the whole world pays in the form of higher inflation, taxation and lost jobs.

This Westphalian system of national sovereignty voluntary cooperation in a highly inter-connected and interdependent world is cracking at the seams.

The Group of 20 (G-20) has improved the legitimacy of global governance, but the What to Do is confused by turf battles over Who bears the Loss and Who to Control.

It will be useful to be reminded that the present fiscal trend of rising expenditure increases and tax cuts to rebuild excess consumption funded by excess leverage, despite limited global resources, is just a race to another crisis.

The world is caught in a collective action trap. The gaming nature of nation-states and private sector behavior are such that there is the tendency of a race to the bottom. No country is able to tighten monetary policy alone for fear of inviting hot money that negates that policy. No country is able to tighten financial regulation for fear of business migrating to other financial centers.

No country is able to raise taxation for fear of massive tax arbitrage.

In hindsight, global imbalances were caused by the violation of the Triffin Dilemma writ large.

The Triffin Dilemma states that the reserve currency central bank faces the dilemma of running monetary policy that is inconsistent with domestic needs.

When the reserve currency country has excess consumption, its central bank should be running tighter monetary policy, but in a world of free capital flows, the efficacy of monetary policy is weakened.

The trouble is that when all four reserve currency central banks are faced with rising fiscal deficits and massive financial engineering that pumped hidden leverage into the system, the systemically important countries collectively generated a global credit bubble that can only be financed by lower and lower interest rates.

The reality is that we now have a global economy without global monetary policy, global financial regulation and global fiscal system.

In other words, excess consumption that ultimately feeds into Global Warming can only be controlled by hard budget constraints - current taxation, not future taxation.

We are reminded of the effects of Global Climate change by recent typhoons, floods, earthquakes and droughts, as well as the estimate that Biodiversity Loss could cause as much as US$2-5 trillion annually when the total cost of the current financial crisis is less than US$4 trillion.

Advocates of global governance reform suggest that the current problems can be solved through a global currency or a global financial regulator.

They forgot that the pre-condition for global government action is a global fiscal system.

The Euro-currency system has demonstrated unequivocally that a single currency cannot function without some form of fiscal compensation for those who suffer regionally from the consequences of monetary policy that may not suit local conditions.

We cannot agree on a global fiscal system because so far all taxation is local.

But Lord Adair Turner of the UK Financial Services Authority has shown the way.

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