Having met only two weeks ago in Abu Dhabi, followed by Istanbul, finance ministers and central bank governors from the Gulf are now congregating in Muscat, setting the agenda for the Gulf rulers’ summit in Kuwait next month.

The meeting is set to focus on the monetary union — facing challenges after the UAE followed Oman in withdrawing from the plan for the euro-style single currency bloc.

Most of the participants –  who also include  number of key Gulf commercial bank chiefs and Dominic Strauss-Kahn, head of the IMF — are here for less than 24 hours though. They are meeting for dinner tonight in the luxury seaside hotel set in a bay surrounded by rugged mountains, once a paradise for treasure smugglers. 

(Photo: the royal palace in Muscat)

Reuters correspondent Emily Kaiser analyzes the G-20 draft communique.

The International Monetary Fund has been warning for years about the risk of global imbalances — namely huge U.S. current account deficits and surpluses in China. Today its chief economist offered a grim view of how the economy might suffer if the rebalancing act fails.

Olivier Blanchard says unless the United States can refocus its economy more toward exports and China more toward imports, the U.S. recovery will probably be anemic because American consumers aren’t going to quickly revert back to their pre-crisis free-spending ways.

And if the recovery is anemic, there will no doubt be intense political pressure for more stimulus, particular in 2010 when most members of Congress face re-election.

“Were that to happen, one can imagine various scenarios: political pressure may be resisted, the fiscal stimulus phased out, and the U.S. recovery would then be very slow. Or fiscal deficits might be maintained for too long, leading to issues of debt sustainability, worries about U.S. government bonds and the dollar, and causing large capital flows from the United States. Dollar depreciation may take place, but in a disorderly fashion, leading to another episode of instability and high uncertainty, which could itself derail the recovery,” Blanchard wrote in an article released by the IMF.

Blanchard builds a case for rebalancing being in everyone’s best interest, including China’s. What’s your take? Will China and the United States get this right?

Hiroshi Watanabe, president of the Japan Bank for International Cooperation, saw his share of dollar buying intervention during decades at the nation's finance ministry.  But the market veteran says despite prevalent talk recently, a shift away from the greenback as the world's reserve currency may be great in theory, but like the language of Esperanto short on daily practitioners.

"Esperanto is a very good language, but no community uses it in its daily life, " Watanabe told the Reuters Japan Investment Summit.

"That's the same situation that applies to the currency... I don't see any other currency that can take the position to replace the key U.S. dollar."

China, Russia and Brazil intend to push at this week's Group of Eight summit for a new global reserve currency as an alternative to the dollar.

G8 sources say they do not expect serious debate by world leaders on the issue, which potentially could affect the value of trillions in dollar-denominated assets held by world nations, including China and Japan.

The euro, a basket of currencies like the IMF's Special Drawing Rights (SDRs), or even the not-fully convertible yuan have been touted as future replacements.

Watanabe says this will not happen any time soon, although he notes a loss of dollar sheen. 

"The dollar should remain the key currency for the time being, but we have to admit that the dollar is over its peak," he said.

"SDRs can be used for book-keeping the liability of an asset by the IMF of World Bank... but in the case of settlement, it is not so easy to use that kind of hypothetical unit."

 Photo credit: REUTERS/Toru Hanai

Central bankers have not had much reason to be happy over the last two years, as the financial crisis has lurched from bad to worse.

But the European Central Bank at least is now finding comfort in the fruits of its injection of close to half a trillion euros in 12-month funds last week, which has pushed money market interest rates to new record lows. 

“We are very happy, we see clearly that we decreased the risk premia,” ECB President Jean-Claude Trichet said on Thursday, after the ECB kept its benchmark rate on hold at 1 percent.

Still, the ECB’s generosity in filling bank coffers with cheap cash could paradoxically help financial institutions defer the day of reckoning when they will have to write down bad loans and toxic assets on their books, and adjust their balance sheets. Flush with ECB cash, banks could be encouraged to think they can hang on to past investment mistakes, rather than writing them down now. 

The Swiss-based Bank for International Settlements, a forum for the world’s central banks, says this painful process is a prerequisite for financial and economic recovery, and the International Monetary Fund  says the euro zone is lagging the United States in writedowns.

Maybe the ECB is not helping.

The International Monetary Fund’s bumbled calculations on the financing needs of some eastern European countries revealed last week were met in Austria with disbelief, ridicule but also a quiet smile.

The IMF said it had overstated external financing needs of some countries in its Global Financial Stability Report, released on April 21, largely because of double-counting errors. The corrections have trickled in.

Worrying reports earlier this year indicating west European banks had lent $1.7 trillion to IMF-bailed-out states like Ukraine and Hungary worsened a steep selloff in the region’s assets. Policymakers lashed back at the time, saying the fear was blown out of proportion.

The IMF mistakes were front page news in many newspapers – especially in Austria, where the exposure of its banks to the emerging Europe region has been a topic of fierce debate.

Austrian banks have lent the equivalent of 70 percent of the country’s gross domestic product to emerging Europe and the exposure has driven market concerns that they could need a massive government bailout. The worries have driven up the price of Austrian government debt and prompted some, like U.S.economist Paul Krugman, to speculate that Austria could be on the brink of default.

This has made the Austrian central bank pretty angry, not to mention rankling politicians, bankers and the media. This one in The Telegraph really got them going.

Even before the IMF correction, many in Austria blamed an Anglo-American conspiracy trying to divert attention away from their own banking troubles by painting a bleak picture of Austria’s stake in emerging Europe.

“Would we be better off if we were active in the United States, in Great Britain or in Germany?,” Herbert Stepic, the chief executive of emerging Europe’s No.2 bank Raiffeisen International asked last month. ”I can only say: categorically no.”

So the financial stability of the emerging Europe region, a motor of Austrian growth in recent years, is close to the Alpine republic’s heart and the IMF mess-up gave room for a touch of Schadenfreude.

“An embarassing calculation mistake — (Finance Minister) Proell sees himself justified,” on state broadcaster ORF, “Not the first mistake” popular daily Kurier and Die Presse  said, pointing out a previous IMF miscalculation and emphasising Austria’s battle against the negative flow of news from the region. 

“There is a serious risk that policymakers will now use this in order to avoid addressing the issues that have been there all the time,” said Lars Christensen, Emerging Markets Chief Analyst at Danske Bank.

Austria likes to point out that ratings agencies have confirmed its triple-A debt rating and have dismissed concerns of a downgrade like that of fellow eurozone member Ireland — let alone the prospect of an Iceland-style default.

When the IMF got its figures on Eastern Europe wrong, Central Bank Governor Ewald Nowotny also told Die Presse newspaper that he felt his position strengthened.

“We just couldn’t believe it,” he is quoted as saying in reference to the original figures. He does add that the IMF is a reputable institute and that the exposure problem should not be dismissed “We have to be realistic and say there are big problems in the region, one of them being the proportion of credit in foreign currencies as a proportion of total credit,” he said.

Nowotny has been keen to make clear the distinction between different countries in the region and stresses over and over again that Austrian banks are stable, invested mainly in EU member states, that Austria has a banking package and will not pull out of the region.

“It’s highly embarrassing that the IMF made this slip-up and it has led some to question whether Central and Eastern Europe was in such bad shape. But the numbers have been blown out of proportion in both directions.” Christensen from Dankse Bank said.

Worries about the region cannot be based or dismissed using just these figures, he says. Concerns are based on more than one set of data. “But the revised IMF figures are still pretty terrifying.”

It is sure to be a topic when IMF Managing Director Dominique Strauss-Kahn visits Vienna later this week. 

International Monetary Fund Managing Director Dominique Strauss-Kahn, Washington, April 26, 2009. REUTERS/Yuri Gripas

Austrian Vice Chancellor and Finance Minister Josef Proell, Vienna, May 12, 2009. REUTERS/Leonhard Foeger

Austrian central bank (OeNB) Governor Ewald Nowotny, Vienna, December 9, 2008. REUTERS/Heinz-Peter Bader

It took some time, and a lot of downward corrections to IMF GDP forecasts, before the current global economic downturn won the title of ‘worst since the Great Depression’.

Why settle for second worst though?

This one is in at least three ways just as bad if not even worse than 1929-30, economists Barry Eichengreen (University of California, Berkeley) and Kevin O’Rourke (Trinity College,
Dublin) argue. 

Look at global industrial output, world stock markets, and global trade volumes. Map the nine months after April 2008 against the period following June 1929 and the story you see is the following:

* the decline in industrial production is at least as severe  * stock markets sank faster this time * trade volumes are falling much faster now

Eichengreen and O’Rourke say the reason people tend to say that this one is second to the Great Depression is because the comparisons tend to be between the United States now and back then — not the world now and back then.

Which begs the question — if this one is every bit as bad as the Great Depression, it’s the worst since when?

Analysts are starting to wonder if the International Monetary Fund will issue bonds denominated in its currency, Special Drawing Rights (SDRs), to boost the international lender’s capital. 

G20 leaders meeting today are said to be ready to agree a tripling of the IMF’s resources, to $750 billion. One source at the summit said the IMF might also tap international capital markets. 

BNP Paribas analysts like the idea of SDR bonds that could be bought by central banks reallocating portfolios away from the dollar. “Increased IMF firepower and the IMF likely to issue SDR-denominated bonds later this year will allow equities to move significantly higher,” they say in a client note.

Youssef Boutros-Ghali, Egyptian finance minister and head of the IMF’s policy committee, the IMFC, also likes the idea. 

“It’s an efficient means of financing the IMF,” he told Global Investing this week, adding that a bond tradeable by central bank members of the IMF would enable even smaller members like Egypt to contribute a billion here or there to IMF coffers. 

(Reuters photo: Bogdan Cristel)

All this talk about ditching the dollar as world reserve currency may be irrelevant — central banks are already walking away.  The latest International Monetary Fund figures show dollar share of world FX reserves falling to 64.0 percent in last year’s fourth quarter from 64.4 percent the previous quarter. Doesn’t sound much, but at that pace dollar is less than half of world reserves in less than a decade. years. It was the same for once mighty sterling. The pound’s share dropped to 4 percent from 4.5 percent. The euro rose 1 percentage point to 26.5 percent.

Marc Chandler of  Brown Brothers Harriman says not too much should be made of this though. ”The reserve figures are heavily influenced by valuation swings,” he says.

Still, given the debate about SDRs. . .

(Reuters photo: Kai Pfaffenbach)

Stopping off in New York during a marathon, 18,000-mile diplomatic offensive before next week’s G20 summit in London next week, British Prime Minister Gordon Brown recalled a conference held in eerily similar circumstances in London 76 years ago.

Sixty-six nations gathered for the June 1933 London Monetary and Economic Conference which was aimed at lifting the world’s economy out of the Depression.

But amid American opposition to European plans to return to a system of fixed exchange rates, the conference collapsed and the world put up trade barriers, jobless ranks swelled and the rise of Fascism took the world into war.

“There was no further progress other than a resort to protectionism for the rest of that decade,” Brown told a business audience during a five-day pre-summit tour that has taken him to the European Parliament in Strasbourg, New York, Brazil and Chile.

Brown must be hoping desperately that history will not repeat itself when he hosts a meeting of leading industrial and developing economies in London on April 2 to try to chart a way out of the worst global financial crisis since the 1930s.

Again there have been signs of transatlantic division in advance of the summit, with many Europeans resisting U.S. pressure for more fiscal stimulus to boost the economy, while the Europeans put the emphasis on tightening regulation of the financial sector.

Mirek Topolanek, prime minister of the Czech Republic which holds the current European Union presidency, was quoted this week as saying U.S. President Barack Obama’s huge economic stimulus plan was “the road to hell”.

Many countries are suspicious that their neighbours are resorting to protectionist policies to try to safeguard jobs at home.

Currency questions have caused friction between the United States and China, whose economies are now closely inter-dependent. Paul Volcker, a senior Obama adviser, gave short shrift to China’s proposal for a new world currency when asked about it at a New York roundtable with Brown this week.

Volcker said he understood restiveness about the “lopsided nature” of the current international monetary system but he said pointedly that the Chinese “didn’t have to buy those dollars in the first place”. A new international monetary system which suddenly devalued the dollar’s role was not practical, he said.

As Brown jetted around the world to bolster support for concerted action to lift the economy, he came up with a variety of ambitious and expensive proposals to revive trade and get the economy going again.

But he runs the risk of setting expectations for the London meeting too high, perhaps bringing crushing disappointment in its wake.

“If the G20 becomes a meeting just to set another meeting, we’ll be discredited and the crisis can deepen,” Brazilian President Luiz Inacio Lula da Silva said at a press conference with Brown in Brasilia.

Brown’s G20 envoy, Mark Malloch-Brown, voiced similar fears earlier this month. "If indeed we get anodyne committee conclusions where all substance has been taken out of them, the markets on April 3 will be something of a disaster zone, I have no doubt," he said.

Brown has called for a doubling of IMF resources to $500 billion and for a $100 billion trade financing facility to help reverse a slide in exports. He has also called for an insurance policy for countries with big foreign currency reserves, such as China, so that they will feel able to use some of their reserves to boost the economy without fearing a run on their currencies.

U.N. Secretary General Ban Ki-moon, who Brown met in New York, urged the G20 to support a $1 trillion stimulus plan for developing countries.

With so many other demands on their cash, it is doubtful that even the powerful G20 economies will be able to find the vast sums needed for all of these programmes.

The huge media focus on the gathering of Obama and other world leaders in London, and the big protests that are expected to accompany it, will only heighten the anticipation.

British officials are trying to dampen expectations that a big new fiscal stimulus package will be approved at the G20 summit, saying they do not expect countries to put their national budgets on the table next week and suggesting that the results of the summit will be seen over the next year, rather than on the day of the summit.

Harsh economic reality may also force Brown to rein in his own wish to pump more resources into the British economy.

While he was away cheerleading for the G20, events back home kept intruding.

First -- in a move one opposition lawmaker described as a “coup” -- Bank of England Governor Mervyn King warned the government on Tuesday that its soaring budget deficit meant it would have to be cautious about any new stimulus for the British economy.

On Wednesday a sale of British government bonds failed for the first time since 2002, sending a warning to Brown that the markets may balk at financing ever higher British government deficits.

Then on Friday, Brown was given a lesson in economic management by Chilean President Michelle Bachelet who described how the money Chile had put aside in good economic times had enabled it to pump more cash into the economy during the downturn.

Brown’s Conservatives opponents at home say this is exactly what he failed to do during the years of prosperity – reduce the budget deficit so he had more financial firepower to help people through a recession.

As his ambitions clash with harsh reality, Brown may have to lower his sights both for the G20 summit and for the British economy.

[Photo: Prime Minister Gordon Brown (L) listens to Brazil's President Luiz Inacio Lula da Silva during a news conference at the Alvorada Palace in Brasilia March 26, 2009. REUTERS/Roberto Jayme]