October 10th G-7 Statement Unlike Any Precedent

October 14, 2008

Finance Ministers and Central Bank Governors met last Friday under unprecedented global risks to growth and released a statement that was shorter in length, different in format, lacking in detail, but resolute in laying out five principles of agreement for the need to recapitalize financial institutions, better protect depositors, and re-liquify financial markets.  Taxpayers are to be protected, and actions by one government that hurt other countries are to be avoided. 

Last Friday’s statement said nothing about currency developments or shared Forex policy.  Since the Group statement was released, the euro and dollar have advanced 3.4% and 1.9% against the yen, and the euro has recovered 1.6% against the dollar.  A weakening yen is one litmus test of a less panicked market.  Another is that gold prices, down 1.2% since Friday’s close, remain contained.  Gold was about the only investment to perform well in the depression.  Oil prices are 2.6% firmer. 

Unlike Japanese officials in the 1990’s, the architects of various announced measures since the G-7 statement are trying to act with minimal procrastination.  Even so, investors are only hopeful and not really confident that officials have forged a workable solution.  Success will be measured by how bank willingness to lend adjusts.  To draw an analogy, suppose three doctors arrive to treat three isolated patients.  When the doctors are told that one of the patients is so ill that any contact would mean certain death without identifying that patient’s identity, each doctor refuses to enter the room even though an epidemic is likely if the other two patients do not get medical help.  The role of government  is to change risk/reward incentives such that the doctors will again be willing to step forward.  Banks need to be enticed to lend anew but to do so to parties that will have the means to service the loans.



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