The media coverage of the G20 finance ministers meeting this weekend was dominated by the apparent battle between those who support more fiscal stimulus and those who want to impose more regulations on the financial system.

    This, we are led to believe, is the big debate facing the full G20 heads of government summit early next month: the US is pushing for a bigger global fiscal stimulus (2 percent extra government spending from everyone, to be monitored by the IMF), while the continental Europeans are holding out for greater regulation. Gordon Brown is trying hard to cast himself as the broker for any apparent deal.

    However, don't be fooled by all this sound and fury. The rival agendas of fiscal stimulus and regulation are both red herrings at this point in time.

    The reality is much less promising, for three reasons.

    First, co-ordinated fiscal expansion made sense early in 2008, when it was first proposed by the IMF. But the severe downturn that followed the onset of financial panic last September means that very few countries can now afford to spend more or tax less.

    And while the hard-headed redesign of regulation should be a top priority going forward, the G20 regulation agenda is weak.

    Who really believes that establishing an international "college of supervisors" would achieve anything in terms of reigning in the power of major banks? Always a good principle to keep in mind when evaluating international reform proposals: anything that sounds meaningless is meaningless.

    Second, while the conventional official reluctance to discuss unpleasant truths is always awkward, during a major global crisis it's downright dangerous. Across the industrialised world, the financial sector has become too large and too politically powerful.

    How do we break this power and move resources into something more productive and less inherently unstable? How do we deal with the failures of risk management, CEO leadership, and corporate governance in our still-massive banks? Can we break them up before they break our economies?

    There is not even an inkling of these major issues on the G20 agenda.

    Third, politicians keep repeating something along the lines of "we face a global problem that needs a global solution" - this was Gordon Brown's refrain in Washington recently. But the most pressing problems in 2009 are not so much global as European.

    Back in the 1990s, much of east central Europe put itself on a high risk debt-fuelled growth path, egged on by Brussels. European Union accession countries were told that they could afford to import far more than they export - and that this difference would be financed by capital coming in from Western Europe. This was true, for a while, but now the crash in Eastern Europe threatens to bring down banks in Austria, Greece, Italy and other places that bet big on Hungary and its neighbours getting rich quick.

    As Eastern Europe has plummeted into crisis, the West European response has been further bad advice. Countries with fixed exchange rates, such as Latvia, are told to cut wages and prices by 20-30 percent, rather than devalue their currency.

    Never mind that this is political suicide and bad economics. Brussels considers it better for the West European banks with capital at risk. Almost all of Eastern Europe is in trouble and will need to borrow from the IMF; the massive over-representation of Western Europe on the IMF's board suggests that this will end badly.

    And that's not all. The crash of real estate in Ireland, Spain, and the UK worsens bank balance sheets that are already damaged from losses incurred in the crazy casino that was the American mortgage market.

    The financial sector globally is shrinking, and this will lead to significant job losses in countries like the UK and Switzerland.

    It gets worse. The US has banks that can plausibly claim they are Too Big To Fail, and this is bad enough - because it lets them get big bailouts. But Europe has banks that may be Too Big To Rescue - ask Iceland or, more recently, Ireland.

    Far from being able to afford government expansion, European economies with big banks see the prospect of budget cutbacks - to persuade the financial markets that their governments are still good credit risks.

    European countries face two types of future. On the one hand, countries that still control their own currencies can engage in creative monetary measures, pushing down the exchange rate and raising inflation; the Bank of England leads the way in this regard. Inflation will reduce debt burdens but of course comes with other costs. Think of it as the worst of all possible policy choices, apart from the alternatives.

    And those most unpleasant alternatives are faced by Eurozone countries. Their economies are slowing dramatically, their banks are impaired, their budgets are constrained, and their monetary policy is in the hands of the European Central Bank (ECB).

    These countries face the prospect of falling wages and prices. Most central bankers would recoil in horror as this deflation threatens further defaults and a deeper recession, but Jean-Claude Trichet, head of the ECB, is actually welcoming this development in Ireland and elsewhere.

    The real agenda of the G20 should be helping save Europe from itself, forexample by encouraging the creation of a €2-trillion European emergency economic stabilisation fund, funded primarily by richer Eurozone countries, and a major relaxation of Eurozone monetary policy.

    Without such measures, we are likely on the path to a bigger slowdown in global growth and a more difficult recovery.

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    Simon Johnson, former chief economist of the International Monetary Fund, is a professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. He co-founded and contributes to an economics blog, the Baseline Scenario.

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