G7 Leaders Summit and the Dollar

May 28, 2017

Three matters attracted keen attention at the two-day summit of Group of Seven leaders in Taormina, Sicily: international terrorism, trade, and climate change. The first priority enjoyed the most agreement going into the meeting, and a considerable portion of the six-page communique is devoted to coordinating efforts to defeating terrorism in Syria, Libya, Iraq, North Korea, Ukraine, and cyber space.

Climate change, which much of the world population view as the single greatest threat to the planet, was covered in two short paragraphs, the first of which was really about energy development. The short section on climate bluntly states that the “United States of America is in the process of reviewing its policies on climate change and on the Paris Agreement and thus is not in a position to join in the consensus on these topics.” With or without America’s participation, the second sentence adds, everybody at the summit “reaffirms their strong commitment to swiftly implement the Paris Agreement.”

Much of the press commentary on the discussion regarding international trade has observed some conciliation from President Trump on the very hardline and confrontational stands that he espoused as a campaigner for the office and in the early months of his presidency. This accentuation of the positive may also rest on the fact that China was not called a currency manipulator in the Treasury Department’s recent review of foreign exchange.

My interpretation of the statement’s passages on trade is different from this consensus. Two sentences seems especially pertinent.

  1. We acknowledge that trade has not always worked to the benefit of everyone.
  2. We push for the removal of all trade-distorting practices — including dumping, discriminatory non-tariff barriers, forced technology transfers, subsidies, and other support by governments and related institutions that distort markets — so as to foster a truly level playing field.

Trump claims to be a free trader, so long as the rules of commerce are fair, and fairness is in the eyes of the holder. No doubt at the U.S. insistence, the jointly express “commitment to keep our markets open and to fight protectionism” is immediately counterbalanced with “while standing firm against all unfair trade practices.” You can’t have one without the other.

This potential back door exit from a promise not to engage in protectionism is reinforced in a section of the communique entitled “Global Economy.” The first part of this section reads identically to text from the May 13 G7 Finance Ministers and Central Bank Governors Communique. However, when the statement comes to broad foreign exchange policy, it merely reaffirms “our existing G7 exchange rate commitments as agreed upon by”finance ministers and central bank governors at that meeting in Bari. When governments or central banks wish to underscore no change in a protocol that’s been long observed, they ordinarily repeat the identical language verbatim so as to remove any confusion. For the record, the G7 creed on foreign exchange policy includes the following elements:

  • Exchange rates should reflect economic fundamentals.
  • Policymakers in the G7 will consult closely in regard to actions in forex markets.
  • Fiscal and monetary policies will remain oriented toward meeting respective domestic objectives using domestic instruments and will not target exchange rates for competitive purposes.
  • It is important that all countries refrain from competitive devaluation.
  • G7 governments agree that excess volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability.

All this is not explicitly stated in the G7 Leaders┬ástatement, and then a key sentence is deleted that had followed in both the finance ministers communique as well as an earlier statement in March from the Group of Twenty finance ministers and central bank governors. It read, “we are working to strengthen the contribution of trade to our economies.” Inserted instead is a different sentence that commits the group’s nations to “tackling all forms of corruption and tax evasion, as a means of reinforcing public trust in governments and fostering sustainable global growth.”

The changes on trade and currency policy are ones mostly of omission and a rearranging of thoughts. In the case of Donald Trump, who’s broken promises such as a pledge not to cut Medicaid, the modifications to the leaders statement for me at least raise more than a shadow of a doubt about the depth of his commitment not to engage in forms of protectionism including actions intended to depreciate the dollar.

So far, the dollar’s actually moved in the wrong way. Using monthly averages of the trade-weighted dollar compiled by the Federal Reserve against a collection of other major currencies that circulate widely outside the country of issue, the dollar posted on-year declines in eight of the eleven months leading up to January, the month Trump took office. These on-year declines were very modest, with none exceeding 2.0%. In February, March and April, in contrast, the dollar posted on-year appreciation of 1.1%, 3.4% and 5.3%. Last Friday, May 19th, the trade-weighted dollar was still above its year-earlier value but by just 2.0%.

Such movements are too small to make any meaningful difference in the price competitiveness of exports and import-competing U.S. goods. Moreover, the recent moves in the trade-weighted dollar pale in magnitude to historical swings seen since the dollar first floated in March 1973. Each decade since that end to fixed rates, in fact, has seen a meaningful downswing of the dollar.

  • Again using monthly averages, the trade-weighted dollar lost 14.4% from March 1977 to October 1978.
  • In the mid-1980s, the greenback tumbled 38.9% from March 1985 to April 1988.
  • From September 1989 to April 1995, the dollar dropped 17.3%.
  • The dollar slumped 36.9% from February 2002 to July 2008.
  • And more recently, the U.S. currency lost 12.7% trade-weighted from June 2010 to August 2011.

Economic fundamentals are in fact becoming less supportive. Forecasts of U.S. growth in 2017 are getting scaled back, while greater optimism about Europe can be seen in such forward-looking data as the purchasing manager surveys. The Fed is normalizing U.S. monetary policy very slowly, and the Fed funds target remains very low. Fed tightening is no guarantee that the dollar will appreciate, moreover. When the fed funds rate was doubled from 3% to 6% in the space of a year during 1994-95, for instance, the dollar actually declined pretty sharply.

Another reason to be guarded in one’s confidence toward the dollar emerges from the argument that asserts that the external value of one’s currency embodies the present value of how economic and political stability are likely to evolve in the future. Viewed as such, the dollar strengthens or weakens depending on the balance of hope and worry. From that standpoint, a headline in Saturday’s Financial Times captures an assessment shared by the people and their leaders around the world that seems to spell possible trouble for the dollar. The main headline proclaims, “Trump’s grand tour leaves trail of confusion,” and it is followed in the line below by this: President proclaims White House roadshow a success but causes bemusement and outrage from Saudi Arabia to Sicily.”

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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