COMMENT: Risks of race to the bottom

By SAM FLEMING FOR MAILONLINE
Updated: 16:56 EST, 25 June 2010

In a few short days Britain has tried to turn itself from a pin up for Western profligacy to the standard-bearer of austerity.

Having announced the harshest public spending clampdown in UK postwar history, David Cameron flew to the G20 trumpeting the country's newly-found fiscal temperance with the enthusiasm of a born-again teetotaler.

The Prime Minister told readers of Canada's Globe and Mail: 'In Britain this week, we showed how we will start to live within our means again.'

From the heart: David Cameron has been forced to do some tough talking recently

Alongside this outbreak of prudence, however, comes a new mood of introversion that is untypical of British governments. Leaders shouldn't be making lofty promises at G20 meetings, the PM went on, but rather stick to their domestic knitting.

Global priority one, he said, was for each nation to bring its own public finances under control. Bilateral trade deals, rather than grand global bargains, should be the focus. Crucially, each country must retain the 'flexibility' to act in accordance with its 'own national circumstances.'

The contrast with the swaggering foreign policy approach of Tony Blair and Gordon Brown could hardly be more obvious. Compare Cameron's muted ambitions with the sweeping deal for global reflation Brown struck at the London summit in 2009.

This partly reflects the Tories' rediscovered antipathy for the meddling of big government. But the PM's scepticism about the fruits of multilateralism bodes ill if it is replicated with too much gusto among the other major economies. And there are reasons to fear it will be.

Britain has since 2008 quietly pursued a unilateral devaluation of its currency that has been pivotal to the government's attempts to adjust to (and indeed survive) the credit crunch. Sterling has been Britain's flexible friend.

We are far from alone  -  Switzerland has been explicitly intervening in the currency markets. Beijing has been actively suppressing the yuan for years. Last weekend China said it would modestly loosen its grip, but it remains to be seen how genuine this move will prove.

Senior market players now fear this self-serving spate of currency-tampering could spread. America's Democrats are approaching midterm Congressional elections with a stalling recovery, poor poll ratings and a titanic oil slick sitting off the Gulf coast.

They have also promised to somehow double America's exports in five years. Unfortunately America's partners all want exactly the same thing  -  stronger exports. As Britain has proved, the quickest and dirtiest way of achieving this is through a slide in the currency.

There remains a real risk of an unseemly race to the bottom, as countries with flagging domestic demand pursue competitive devaluations. If this trend spreads it would quickly sour international relations and derail fragile confidence in the economy.

It would make an orderly ' rebalancing' of the world economy between overly-indebted Western economies and surplus countries such as China that much more tricky.

Cameron is right that global conclaves such as the G20 are unwieldy mechanisms that struggle to match words with action. But they are also a necessary evil  -  now more than ever.

A long, winding road

The need for a 'rebalancing' of the world economy will dominate the G20 talks, but it looks as distant a prospect as ever. In particular, the US is going into the summit facing economic headwinds that are getting more, rather than less, daunting.

As yesterday's US gross domestic product figures showed, momentum-in the world's biggest economy is already fading. American housing market data are heading south again after the expiry of tax incentives.

Obama may be banging the drum for fiscal stimulus abroad, but his country will, after Britain, have the largest structural deficit in the OECD this year.

As Societe Generale uber-bear Albert Edwards pointed out in a note this week, the process of 'deleveraging', or paying down debts, is only just beginning in America's horribly over-extended economy.

Indeed, stripping out the financial sector, deleveraging hasn't even started, with debt hovering at the highest share of GDP since the Great Depression.

A similar picture can be found over here. Bank of England figures yesterday showed Britons borrowed more from their banks than they deposited every year between 1988 and 2008.

Last year that finally changed, as we saved a net £ 4bn in our accounts.

It was a tiny step back towards financial sanity. But there is a long journey ahead.