G7 Speaks Out Against the Yen

October 27, 2008

I do not recall the last time, if ever, that G7 finance ministers and central bankers, the designated body for coordinating currency market policy, issued a statement concerning a particular currency that did not follow one of the group’s three scheduled annual meetings. The G7 has not been in the habit of making idle threats. If the yen does not retreat soon, chances are very strong that today’s threat will be followed by intervention sales of yen.

The statement is modeled after the April 11th statement, which tweaked and escalated joint concern about harm that could be caused by exchange rate volatility. To wit, the April statement “reaffirmed our shared interest in a strong and stable international financial system.” Officials then noted that “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.” The first sentence of today’s warning repeats the thought from the first sentence of the April 11th communique: “We reaffirm our shared interest in a strong and stable international financial system.” Officials then particularized the second sentence of the April 11th statement to the yen: “we are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability.” The third sentence today reiterates the third sentence from April 11th.

A general promise to “cooperate as appropriate” has become part of the G7’s lexicon and carries no threat of action. However, it is very rare for officials to single out a particular member currency, and when that happens, intervention does usually follow and reasonably quickly. The problem here is that yen strength is part and parcel of the deleveraging process. Requesting a stronger yen is tantamount to requesting a drop in three month interest premiums or a rise in stock prices or commanding banks to start trusting one another again. Intervention may not work, but officials will never know for sure unless they try it. The G7 is now backed into a corner. Having issued a special statement protesting yen strength, officials have put their credibility on the line to do something, namely sell yen, if words alone do not resolve the problem.

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