Thoughts on the G7 Statement from Washington

April 12, 2008

New language used by G7 finance ministers and central bank heads to more firmly protest recent foreign exchange movements closely resembles the group’s joint statement a day after the last round of concerted intervention. About six billion euros of central bank purchases were done on September 22, 2000 collectively by the Fed, Bundesbank, Bank of Italy, Bank of France, Bank of England and Bank of Canada. The intervention was administered mostly in two waves and at a level around $0.8730, 45% weaker than the euro’s present value against the dollar. Over the ensuing 7-1/2 years the euro has appreciated at an average annual rate of 8.2% against the dollar. The intervention in September 2000 was the first joint intervention since 1995, underscoring how seldom this policy tool is utilized.

The G7’s statement one day after its September 2000 intervention declared, “We discussed developments in our exchange and financial markets. We have a shared interest in a strong and stable international monetary system. At the initiative of the ECB, the monetary authorities of the U.S., Japan, U.K., and Canada joined the ECB on Friday, September 22nd in concerted intervention in the exchange markets, because of shared concern of finance ministers and governors about the potential implications of recent movements in the euro for the world economy. In light of recent developments, we will continue to monitor developments closely and to cooperate in exchange markets as appropriate.” Resurrecting phraseology from the italicized portion, this past Friday’s statement announced, “we reaffirm our shared interest in a strong and stable international financial system. Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate.” So that the similar expressions of concern might be connected, a top official from the French Finance Ministry observed this “was the first time in about seven years and seven months that concern over the impact of major currency moves was expressed in the communiqué.”

For the record, the euro’s average value since it was launched at the start of 1999 has been $1.1317, which means the euro is about 10% further away from its center of gravity now than it was the last time currency levels became a big issue for officials. The yen was only 7.7% away from its post-1998 mean in September 2000 but now shows a deviation of 14%. Those discrepancies are not large enough to elicit common G7 purpose in this matter. It is the behavior of the dollar against the euro that persuaded all officials to take a stand then and now. But there is a huge difference in the two episodes, which is that the currency adjustment – a sinking euro then and a strengthening euro now – has greater fundamental justification this time. Comparisons of growth, monetary policy, interest rates, and current accounts suggest that the dollar should depreciate.

It is interesting too that a phrase found in most G7 declarations about currency values was deleted from the statements of September 2000 and April 2008, namely that exchange rates “should reflect fundamentals.” By doing that now, officials avoid the inconsistency of protesting a market trend that from a directional standpoint makes some sense. The most obvious difference in the two situations is that in 2000, central banks intervened jointly and issued a statement explaining that operation a day later. This time, so far at least, there’s been only a bark but no bite. Nor is there any indication that central banks will modify their monetary policies in order to complement this call for stability. The Fed will ease again at its next meeting, and that will not be the last rate cut, either. When asked if the ECB would cut rates, the bank’s president Jean-Claude Trichet replied, “certainly not.” Maybe not Monday, maybe not Tuesday, but soon markets will test if this emperor has any clothes, and we’ll just have to see if G7 nations intervene to support the dollar. It will have to include U.S. participation to be credible. A top Republican Party economist and trusted advisor to former President Reagan, Marty Feldstein, has been outspoken with columns in the Financial Times and Wall Street Journal arguing against the use of intervention and the need for dollar depreciation to proceed. The U.S. has never intervened under President George W. Bush. He is the only president since Nixon for which that can be said. My belief is the U.S. will break precedent and intervene this late in his presidency.

There is another reason that I do not expect serious action to backstop the G7 tougher talk. In September 2000, the group’s statement had advice for individual members, some of which remains as pertinent now as then – for example urging the United States to take steps to raise its savings rate, requesting that the euro zone implement structural reforms to lift investment and the region’s potential rate of non-inflationary growth, and telling Japan to follow macroeconomic policies to ensure a self-sustaining, domestic demand-led recovery. The new G7 statement assigns no such homework. It rather states the obvious outlook for weakening growth faced by everybody and identifies three blame-worthy factors: the weakening U.S. residential housing market, stressed-out global financial markets, and commodity price-charged inflation. The main thrust of the statement is the endorsement of all the Financial Stability Forum’s recommended reforms and a timetable of some actions to be completed within 100 days and others by the end of 2008. The focus is on the ill-health of financial institutions and the markets in which they operate. No question, this area needs attending, but so do the festering economic imbalances and mis-specified macroeconomic policies that created the present situation.

G7 officials admit there is a problem, which is always a good sign. But they are not yet ‘fessing up to correcting all the issues that fed this beast. Until that is done, neither markets nor the economies they support will return to normal.



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