PhillyDeals: G-20 split reflects classic struggle between emerging and established economies

What's worse - the disease or the cure?

The G-20, the group of Western and growing Third World nations that united to spend their way out of the 2008 financial-markets paralysis, split in Toronto last week trying to figure out a common policy on what to do next.

The group's 25-page closing statement divided "deficit countries" like the United States, which need to "boost national savings" and "enhance export" by borrowing and spending less, from "surplus economies" like China, which should "reduce their reliance on external demand" by letting their currencies rise and encouraging citizens to buy more and save less.

Policy "will need to be tailored to individual country circumstances." That means no one's in charge.

That, plus governments' deepening involvement in energy, finance, and health care, and the realization that Western nations won't be able to spend their

way out of debt for a long time, has spooked private investors and slowed economic recovery, warns Mike Ryan, head of research at Union Bank of Switzerland's American wealth-management arm.

David Strasser, retail analyst at Janney Capital Markets in Philadelphia, last week cut profit estimates for Wal-Mart, Best Buy, Lowe's, Costco, and other big U.S. retailers. "Sales of big-ticket discretionary items have slowed [since] unemployment remains stubbornly high," banks aren't lending, and new-home sales are down again, Strasser told clients.

The U.S. House of Representatives is expected to pass its final version of what will be known as the Dodd-Frank Law Tuesday. It's named for architects Sen. Chris Dodd (D., Conn.) and Rep. Barney Frank (D., Mass.).

We keep hearing that this is the biggest bank-law reform since the Great Depression. It would force banks to raise more money before making loans and investments, restrict risky investment trading, and curb consumer-lending fees and ripoffs.

This should make for less-volatile banks. But will that help or slow economic recovery?

Banks that survived the onslaught of the Depression "were arguably safer and sounder than at any time in the nation's history," with plenty of capital set aside in the wake of the national collapse, writes bank analyst Richard X. Bove of Connecticut-based Rochdale Securities L.L.C.

Yet those banks sat on their money, and borrowers were scarce. As a result, "they were unable to reverse the direction of the Depression."

So don't count on bank reform to restart the economy, Bove says. It's the wrong solution: "The financial crisis was not caused by crooks on 'Wall Street,' " but by the impact of too many Federal Reserve-created dollars flooding the financial economy and chasing "too few solid investment opportunities."

Bove says the G-20 split reflects the U.S. role on the wrong side of the "classic" struggle between rising new economies and the "so-called wealthy industrialized nations." We lost our historic advantages as producers of goods and services, but retain expensive tastes to buy stuff we can't afford except with borrowed money.

What happens when you live beyond your means? Eventually "the debtors cannot pay, and failures and crises develop," Bove said. The fraud that blew up Bernie Madoff's clients and the subprime-mortgage market was a symptom of Western economic bloat, not the cause, Bove concludes.

The cure, to old-fashioned dollar-watchers like Bove, is less reliance on debt and consumer finance, and, eventually, a more healthy and diversified U.S. economy that can afford to again make products the world needs and wants to buy.

That's a painful process that implies a lower standard of living for many of us. No wonder President Obama and his advisers don't consider that an attractive future, and Treasury Secretary Timothy Geithner tried to push the G-20 to help accommodate America before offering to tighten our belts further.

You can see why the government under both parties and the Federal Reserve under Alan Greenspan tried to put this off for so long, inflating stocks and housing until the markets froze.