An article in Bloomberg notes that despite the dollar bounce against the euro (the move against the yen can be characterized as noise), the Group of Seven will probably need to take “concrete steps” to support the currency. And those aren’t coming any time soon.
As the piece notes, the ECB is still concerned about inflation and thus not eager to lower rates. Our Japanese sources with top-level government connections tell us the island nation didn’t see the rise in the yen above 96 to the dollar as reason to consider intervention, which suggests they may sit on their hands until the dollar is below 90 yen, perhaps even approaching 80 yen.
But there is another element that the article does not follow up on: currency volatility. While rates are seldom stable, rapid movements in FX prices undermine international trade. They make pricing, procurement, and investment difficult and unreliable. While the G7 may eventually make a credible move to put a floor under the dollar, there isn’t as obvious a remedy for well founded skittishness.
Note that we doubt that intervention could do more than slow the dollar’s slide. While currencies often appear immune to fundamental forces for quite a long time, the US current account deficit is so large as a percent of GDP as to exert continued pressure on the currency. The US needs to get its savings rate up if it wants to salvage the greenback.
Note that while Bloomberg implied that this communique might be a prelude to intervention similar to that to bolster the euro in 2000, the Financial Times argues that the G7 ministers are deeply worried:
The Group of Seven industrialised nations has signalled shared concern over the danger of a disorderly slide in the dollar and sterling, following bouts of extreme weakness in the two currencies in recent months.
The warning came in a new sentence of the G7 communiqué, which said “there have been at times sharp movements in major currencies, and we are concerned about their possible implications for economic and financial stability”.
The G7 pledged as before to “monitor exchange markets closely and co-operate as appropriate”.
From Bloomberg:
Group of Seven officials, signaling concern over a sliding dollar for the first time in 13 years, may have to match talk with action before the currency stages a sustained rebound.
U.S. Treasury Secretary Henry Paulson, European Central Bank President Jean-Claude Trichet and G-7 counterparts warned after talks in Washington on April 11 that recent “sharp fluctuations” in exchange rates risk hurting the global economy.
Sounding the alarm over the weakest dollar since the 1970s may still fail to buoy it so long as the ECB refuses to follow the Federal Reserve in cutting interest rates. Wariness of backing rhetoric with intervention may also limit the new language’s effectiveness.
“Officials are clearly more concerned about the dollar, but are not yet ready to openly threaten the market because they know they would not be credible with the ECB’s reluctance to lower interest rates,” said Stephen Jen, head of currency research at Morgan Stanley in London.
The dollar rose to $1.5722 per euro at 12:08 p.m. in Tokyo, from $1.5808 late in New York on April 11. It earlier reached $1.56 a euro, the strongest level since April 3. The currency strengthened to 101.15 yen from 100.95….
The change represented a victory for European governments increasingly concerned that the dollar’s slide threatens their exports. “I hope this concerted wording on currencies will help,” French Finance Minister Christine Lagarde said in an interview with Bloomberg Television…..
While the G-7’s currency warning may help temper the dollar’s descent, central banks would have to realign their monetary policies to reverse its direction, analysts said….
Diverging economic interests mean the G-7 will also be wary of trying to buck the $3.2 trillion-a-day currency market by buying dollars, said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. “The statement reflects an attentive G-7, but not a G-7 that either carries a bigger stick or is prepared to use it,” Ruskin said.
Though traders may be wary of selling the dollar as aggressively as they have been, they may “test” the G-7’s appetite to defend it by pushing the currency toward $1.60 per euro, said Goldman’s O’Neill, who correctly predicted the G-7 would toughen its language. The dollar closed at $1.5808 per euro on April 11.
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Global inflation linked to oil is impacting imports and exports, which along with the instability of global currency volatility will result in a global liquidity trap — much like attempting to build a dam on The Amazon River before XMAS…
The following was posted this morning and IMHO this line of thought in regard to the dollar, the deficit and instability provides fuel for thought::
“Funabashi in fact calls the Plaza Accord “an instrument by which the deficit
country…would be able to push the adjustment burden on the surplus countries.” The burden of excessive economic stimulus in Japan and Germany ended up being a source of domestic economic problems in each nation and a source of instability for external relations among the G7.30
30
Funabashi, Managing the Dollar, pp. 5,6. In fact, attempts to redistribute burdens of
adjustment have been a pervasive characteristic of economic diplomacy from the time of the summit at Puerto Rico in 1976. See Putnam and Bayne, Hanging Together, p. 43.”
http://www.g7.utoronto.ca/ govern…larotti_g8g.pdf
Link of interest:
The determination of exchange rates (Chapter 11)
http://www.forexhound.com/article.cfm?articleID=74243
3. OFFICIAL ACTIONS TO INFLUENCE EXCHANGE RATES
… The expectations, or signaling, channel holds that sterilized intervention may cause
private agents to change their expectations of the future path of the exchange rate. Thus,
intervention could signal information about the future course of monetary or other economic policies, signal information about, or analysis of, economic fundamentals or
market trends, or influence expectations by affecting technical conditions such as bubbles and bandwagons.
A considerable number of studies have found no quantitatively important effects of sterilized intervention through the portfolio balance channel. Some studies have found expectations or signaling effects of varying degrees of significance.Others conclude that the effectiveness depends very much on market conditions and intervention strategy….
We will either have a controlled devaluation of the $ (with sterling following) or an uncontrolled devaluation; those are the choices. If the G7 had made a co-ordinated effort to re-valuate at $1.30 to the Euro (or the basket equivalent), they might have been able to construct a mid-term defensible perimeter; now, who knows? It is very interesting the Japan is pricing in the $ at -90 yen, if what you suggest is true, Yves. They were the one party outside the US who might be prepared to lay down on the tracks to keep a high $; that they are not doing so suggests they accept the _inevitability_ of a change.
In yesterday’s post on “1929 Again?,” the commentator cited put in an oar in on the ‘inflation or deflation’ brangle. This debate seems to have been going on for well before I’ve paid attention to it; it’s tiresome, and needs to be redefined. Sure, if we face one problem or the other, and chose the ‘wrong’ policy interventions that would bark some knuckles. The issue to me is that we in the US, and rather differently in the international community, face _multiple macroeconomic vector changes_ with different inputs, different impacts, and unfortunately different optimal policy interventions.
These separate vectors interact and mutually modulate, but they cannot be ‘solved’ by a single-variable intervention—i.e. lower rates. Thinking needs to be multi-variable for solutions, but to this point policy discussions are centered around limiting losses to existing wealth holders, the equivalent of poking powerful heads into well-crafted and airconditioned holes in the middle of the highway.
At a minimum, we have a massive asset price deflation, specifically in the US but in other markets also (housing in ESP, UK, IRE, etc., but equities in China, for example). We have a major decline in the dollar which in view of the asset deflation _cannot_ be reversed to pre-2005 levels. And we have a permanent increase in demand for essential commodities which global recession will temporarily debate but in no way reverse through the mid-term and long-term. The floor here moved up, it will stay up, and keep rising after a pause.
We need to see a controlled devaluation of the $ to a defendable level. Given what is coming in the US, we will _not_ be able to save more anytime in the mid-term, so the $ needs to come well down. Japan seems to accept it; China seems to be buying into the idea, anyone think the EU—read Germand and France—can hold the line alone? I don’t. Once we get our legs under us again in the US, we can work with others to get it back up to a better long term rate. Mid-term, I’d be amazed if we can defend $1.50 to the euro or mid-90s to the yen, problems in other people’s houses notwithstanding. This problem is rather like crashlanding a plane to save the passengers; the alternative is to keep flying around in circles until we run out of gas, stall the jumbo liner, and corkscrew in nose first.
We need to save the banking system in the US not the asset prices, the equivalent of carrying the children and seed corn out of the burning house rather than continuing to try to put the fire out. The longer we wait, the more we lose in getting out the door into tomorrow.
Regarding permanent high commodities, we’ll have to take the belt in a notch on our big, fat bellies to begin with. The days of the US consuming over a quarter of the world’s production are over. Policy can mitigate some impacts on food prices, and a sane energy policy can have a major impact on our costs (we waste vast amounts ‘because we’re rich,’ er, _were_ rich).
Etc., etc. the point being a _multi-vector_ interventionary strategy is needed. Bernanke won’t think like that, and Paulson can’t think like that, so it’s going to be up to the next crew. Let’s hope they’re plotting their positions on the back of an envelope now. ‘Cause things will be far worse by the time other hands take over in ten months.
Richard,
Great post! Also of note is the speculative money flowing into China in search of fast rewards. Instead of global liquidity flooding everywhere and available to anyone, we seem to have pirate-like pockets of speculation that are parasitic and able to quickly morph from one hot market to the next. Speculation has always influenced rouge trading, but the size of these pirate funds have increased to a point where they can impact international policies which are used to nudge currency values, or commodities. An example is wheat speculation, where rouge speculation has resulted in fueling inflation which raises the global cost of living, thus, if hot money is flowing back into China, one should wonder what long term global impact that will have. It is possible, a lot of that free-flowing money will be trapped there and that China will make a mistake of ramping up supply for a world that has less cash and thus less demand.
“The change represented a victory for European governments increasingly concerned that the dollar’s slide threatens their exports.”
The days of the world feeding frenzy on the middle class American wealth are ending, either by free functioning trade or by calamity (maybe both). In a perfect world, the dollar decline is the mechanism of stabilization, US exports up, imports down. However, the biggest delusion is that world trade patterns are “free trade”. NO other country, including the EU, will open up their markets to predatory mercantilism like the US has.
As long as slack in the credit markets was available to fuel the credit bubble, the feast continued. The increasing dollar flow sopped up and propped up the dollar for five years. The slack is gone and there are too many dollars. America can no longer borrow to unilaterally, buy foreign goods.
The world is failing miserably at free trade. Let’s manipulate FX a little more.
So doc,
I wouldn’t say that I have any strong sense of hot money flows in and out of national markets. This is something that takes long and close personal examination to take its pulse, so I tend to lean on area experts such as Brad Setser for that, or generalists such as Yves who keep a running scrutiny of the issues. That said, I’m less sure of the impact of hot money _into_ China than perhaps you seem to be suggesting. Speculative hot money buying of commodities seems to very much a fact, and hence a factor in price spikes. The caution, though, is that after the fact analysis often tends to suggest that such hot point pushes are less impactive than they seem at the time. It may be more a case that prices are rising, and the bandwagon speculators just push a rolling cart. I tend to shy away from strong position statements such as ‘Hot money is _causing_ . . .” not that I’m suggesting you are leaning that far.
My general perspective is on the order that national scale policy actions ‘shape the environment’ [in the military sense if you wish] while hot money flows and institutional plays than exploit the environment. The impact of public policy is not necessarily in the mass and main of its direction but perhaps more in that such policies define _parameters_ for state spaces of interaction. But to have maximum effect, one needs to have multiple parameters reinforce each other to harden the event-space. Right now, we are tending to have policy actions in the US that effect only single parameters, and then often in counterproductive ways for other parameters; e.g. lower rates, but in consequence downward pressure on the $ _and_ vanishing profits for banks from actual lending at lower rates if they themselves were to accept them (they’re not). The US is doing a piss poor job of shaping the event space to the extent that it can. Conversely, China to the extent that I have a perspective is doing s superior job of aligning multiple parameters for maximum outcome.