Jeremy Warner: G20 is leaving main cause of the crisis largely unaddressed

Despite sporadic outbreaks of pointless violence, yesterday's protests seemed barely worthy of the name. Had the demonstrators been City bankers, they would not remotely have qualified for the annual bonus, so poor was their showing. This was not so much a riot as a little bit of rough and tumble at a garden tea party.

In Mumbai a couple of years ago, I was caught in the middle of a riot that stemmed from the hanging of a necklace of slippers around the neck of a Hindu icon. Trains were set alight, there were running battles in the streets, several people were killed, and the city was brought to a standstill. That's what I call a riot.

Britons are not noted for violent unrest, but even by the unremarkable standards of the British tradition of mass protest, yesterday's rally was close to a non-event. I've seen worse chaos caused by signalling problems on the Jubilee line. Here's hoping the degree of disruption is similarly confined to a minimum for today's grand finale to the G20 summit.

I say grand finale, but the underwhelming nature at the time of writing of the demonstrations is matched only by that of the summit itself. This lost all possibility of suspense when early drafts of the already largely agreed final communiqué were leaked to the media. Despite the theatrics of Nicolas Sarkozy, and the determination of the press to find division and argument in all aspects of the debate, it remains likely that everyone will be able to sign up to some version of this somewhat anodyne statement of basic principles. Disunity is not really an option. The situation is so dire economically that the G20 has to put on a common front. Nobody is going to forgive the country that sticks a spanner in the works.

M. Sarkozy would no doubt go through with his threat to storm out over reforms to regulation if it was only the British he was negotiating with, but he won't want to upset the new US President, so it's reasonable to bet that some way of papering over the cracks will be found. Regulating the naughty Anglo-Saxon financiers is really the least of our worries right now, even if the French and the Germans seem determined to elevate this element of the agenda to one of life-and-death importance.

Regulation, protectionism, arms control and the degree to which participant nations are doing their bit through fiscal stimulus to pull us all out of recession are really only so much flotsam and jetsam floating on top of the main issue. Regrettably, this is the issue that dares not speak its name, for any attempt to tackle it head on would make the current international jousting over regulation look trivial by comparison.

The problem I refer to is the one identified as a key potential cause of macroeconomic instability by the British economist John Maynard Keynes as far back as the Bretton Woods agreements of 1944. In any system of international trade, there are going to be surplus and deficit nations. If rules and sanctions are established to make deficit nations behave themselves, there have to be equal obligations imposed on surplus countries.

In recent years, these trade and capital imbalances have been allowed to grow unchecked. Rapid, export-led development in China has magnified the problem into one of the major causes of financial instability. It's a funny old world that has some of the poorest nations in terms of per-capita income financing the consumption of some of the richest, but this in essence is what has been happening. The Chinese have been lending the Americans the money with which to buy their exports. The resulting flood of cheap money was one of the major underlying causes of the credit crunch.

Economists have been warning about the dangers posed by these imbalances for years, but everyone had too much of a vested interest in the status quo to want to do anything about them. Even today, there is an unwillingness among the surplus nations to recognise the nature of the problem. These surplus nations are by no means confined to the developing world and the oil-rich regions of the Middle East. They also include Germany and Japan, whose economies are equally reliant on vibrant export markets. As a consequence, some have found themselves even more hard hit by the economic crisis than the deficit nations. Most forecasters expect output in Germany and Japan this year to contract even more sharply than the US and the UK. The apparently thrifty and responsible are being punished alongside the profligate.

The Germans have sneered at Britain's credit-fuelled, free-spending ways and rightly predicted that they would end badly, but who did they think were buying their BMWs and Miele vacuum cleaners? The tooth fairy?

Any long-term solution to the problems that confront the world economy has to include dealing with these imbalances, yet the Europeans, and to some extent the Chinese too, seem more intent on blaming the investment bankers of Wall Street and the City. If only their antics could be curbed through the imposition of a presumably Paris-based global regulator, they imply, then all our problems would be over. Would that it were so simple. Bankers make easy scapegoats, but the greed of financial markets was always more a symptom than a cause of our troubles.

Unfortunately, correcting these imbalances by imposing corrective action on surplus nations alongside deficit ones is easier said than done. By their very nature, big exporters tend not to be big spenders. To the contrary, surplus nations are by definition substantial net savers. In developing nations, this is easily explained. Most people cannot afford the goods they are manufacturing. Instead, they have to sell to those who supposedly can. The surpluses thereby generated are saved, for there are no social safety nets to fall back on in hard times.

For the time being, China believes it cannot afford to change this dynamic. Moreover, it won't allow the degree of currency depreciation which would correct the imbalances by market means because that would mean crippling portfolio losses on the American debt it has been forced to buy in this bizarre money-go-round.

In already rich, industrialised surplus nations, the phenomenon is a bit more complicated. In Japan, it may have something to do with deflation and an ageing population. If you already own three overcoats and you are 80 years old, you are pretty unlikely to want to buy another, however rich you are. So you save the money instead, and the surplus output is exported.

Some of the same mentality is now afflicting the once-profligate deficit nations. Growing job insecurity and an absence of credit are forcing people to start saving again. Figures released by the Bank of England yesterday show that, after years of equity withdrawal, British householders have gone sharply into reverse and begun to pay down their mortgages.

The once negligible savings rate has also begun to rise sharply. What Keynes famously called the "paradox of thrift" has kicked in with a vengeance. Thrift is rightly thought a virtue, but it is just what you don't need when an economy is nosediving. More saving equals less spending equals less demand.

The surplus nations seem to want the world to return to the way it was, only with bankers reined in by regulation so they cannot create another credit crisis. And maybe that's the way it will be. As private consumption and credit creation slumps, governments in the deficit nations have moved into the breach to borrow and spend more, thus acting as a substitute for the absence of private demand. As a consequence, fiscal deficits are ballooning in the US and the UK alongside already swollen current account deficits.

That same thrifty mentality as rules in the general population instructs the German government's aversion to the further fiscal stimulus demanded by Gordon Brown and Barack Obama. It's impossible to generalise too far, for Japan, with its recent history of deflation, is not at all averse to running big budget deficits and urges all other nations to do the same in an effort to reflate the world economy.

Even so, the overriding wish seems to be for a return to business as usual, with US consumption pulling China up by the bootstraps, and consequent Chinese development feeding demand for German and Japanese machine tools, earth-moving equipment, turbines and so on. Is this really the way forward, or are we not just recreating a fundamentally unsustainable world order? Mervyn King, Governor of the Bank of England, has identified these issues as the biggest challenge facing the reform agenda. Regrettably, the G20 in London shows little sign of wanting to confront them.