Think small, for a real global recovery!

The head of the International Monetary Fund (IMF), one Dominique Strauss-Kahn announced last week that we are now seeing the light at the end of the tunnel as far as the global economic downturn in concerned.

These were his words of wisdom to the G20 finance ministers at their meeting ahead of the big G20 summit in Pittsburgh, where global leaders can actually make decisions.

Now I am inclined to agree with Mr Strauss-Kahn's current analysis, but I am less than enamoured with the IMF's performance over the past two years.

One of the IMF's roles traditionally, other than pushing small economies into austerity in return for loans, was meant to be keeping an eye on the global economy.

But a year past April, when the fact that we were all facing gloom and doom was blatantly apparent to even some of the slowest analysts in the game, the IMF was still forecasting only a mild slowdown.

I get the impression that if the big man from the IMF is now convinced that we are coming to the end of the recession in financial markets, it is because he has been reading the newspapers rather than anything to do with any economic model being used by his organisation.

The finance ministers at the meeting in London also seem to be getting the wrong end of the stick as far as I can see.

These, remember, are also the policy-makers who did not see anything coming and were by and large a bit surprised just over a year ago, when the financial system went into meltdown.

But now, possibly something to do with up coming elections for some of them next year, they are painting a fairly rosy picture, talking about a swift 'V-shaped' recovery, and making it quite clear that they are going to clamp down on big bonuses for bankers.

I have serious problems with this sudden outbreak of optimism.

I have long argued, simply because politicians could not afford a return to a 1930s-type recession, that we would see a fairly swift recovery after the downturn had bottomed out.

There are certainly signs that we are seeing that in the financial sector, with markets moving ahead, commodity prices looking healthy and the fall in house prices coming to an end as speculators and investors see considerable potential, particularly in the prime global commercial property markets.

We are also already seeing the financial industry beginning to salivate at the prospects of bonuses by the end of this year.

But most economists and analysts that I read are still looking towards a slow recovery rather than a sudden bounce back.

And if we are to see a swifter recovery that most of these experts imagine, then it will take political will and decisions rather than a faith in market economics correcting the correction.

Globally policy-makers were pretty slow to react to the slowdown and it was only when we were hitting a full blown credit crisis that they really began to act.

Before that they concentrated on the old policy of trying to stimulate demand by cutting interest rates.

That works when everything in the garden is more or less rosy and when people are prepared to borrow cheap money and spend, to boost the economy.

What happened over a year ago, when interest rates were falling, is that credit, far from becoming cheaper, got more expensive as banks panicked about their liquidity levels as they came to terms with balance sheets weighed down with bad, or highly doubtful, debt at historic highs.

The sudden conversion to Keynesian economics, which saw even George W Bush's administration and Gordon Brown's New Labour cohorts pour billions into the banking system, was clearly driven more by panic than economic strategy.

In the course of a year-and-a-half we have seen a situation develop where the UK banking system and to a lesser extent the US financial markets, have become state-owned entities.

The finance ministers last week were already starting to discuss how they would unwind this position as the economy recovers and let the finance system stand on its own feet again.

I would suggest that the upcoming G20 summit is an ideal forum for the politicians to debate not how this can be done, but how it can be done without going back to the system that brought us to the brink.

And all the regulation and all the risk management in the world is not going to prevent the financial system steaming ahead to reassert itself as the leading light of an economy based on greed.

It's all very well to talk of limiting the pay and bonuses of financial executives.

It is even something that can be enforced while governments are major shareholders in financial institutions.

But as these institutions return to private hands it is incongruous that the state can play a role in remuneration.

And while an income policy for the fat cats may be quite appealing to most of us, economic history would suggest that incomes policies and wage controls do not work.

There are those who would argue that leading financial institutions and other heights of the economy should remain in state hands.

But you normally hear that argument from people who spend their Saturday afternoons selling Marxist Leninist publications on street corners.

And with all the failings of capitalist system, it has proved far more successful than the left-wing alternative.

Perhaps we should look to the most successful economy in the world, the one that got us into the mess, for the answer.

Just over 100 years ago US president Theodore Roosevelt, a Republican and the man who followed him into the White House, fellow Republican William Howard Taft, got a bit concerned about the amount of control over the US economy exercised by a relatively few industrialists.

Now 100 years on, I am a little concerned about the amount of control over the global economy held by a relatively small number of giant financial institutions.

And Roosevelt and Taft became trust busters, trying to break up the giant corporations that had too much influence over the business of America.

There is surely a case to be made that our financial institutions are far too big, far too global and need breaking up.

Even in my own lifetime there was a law, later repealed, that prevented US banks operating in more than one state.

Bring that back and we would immediately have a more diversified set up across the pond.

The law would also have prevented small Scottish banks like the Royal Bank of Scotland buying up US banks and becoming an overseas colossus in the US system.

It strikes me that if the G20 really want to reform the financial system then it has to be done by mutual agreement to change structures, rather than introduce executive incomes policies.

Why not break up the bank assurance conglomerates.

Let's create a global economy where companies, preferably mutuals, who provide home loans do just that and no more.

Let's have assurance and insurance companies stand alone.

Let's have retail banks that keep their noses out of investment banking.

And investment banks that invest, rather than speculate.

When I was a lad there was a local savings bank on every corner, building societies required you to save with them for at least a few years before that would grant you a mortgage you could afford and clearing bank managers used to phone you up about cheques cashed on licensed premises.

I believe the future of the financial system has got to take the view that small is good and should put in place incentives for smaller institutions that could let them compete with national and international players.

I do not know what the manager of my account at the end of the 1960s at the Glasgow Savings Bank earned. But he lived just round the corner from me, so you could bet he would have fallen outside any restraints of a G20 executive incomes policy.

- Arthur Macdonald

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