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When it comes to G7 what you see is what you get

 As much as I try I find myself unable to shed my G7 goggles…the goggles that make G7 a powerful and meaningful institution that markets ignore at their own peril.  I can’t remember a major turning point in the dollar that did not involve coordinated currency intervention.  But G7 is nothing like what it once was and apart from not intervening in FX markets since September of 2000 (bought euros), there are a number of factors making this institution an irrelevant relic. 

 

To begin with the global capital market has growth much in the last 8 years and daily turnover in FX markets, based on BIS surveys, has doubled to around $3trln a day.  The market is so much bigger than G7’s ability to influence currency or asset prices; it makes sense that officials take a hands-off approach to financial markets (the dollar). 

 

Then there is the emergence of reserve managers as major players in the FX market who have on balance mopped up a large share of the supply of dollars through fixed currency regimes and exports of raw materials (at ever higher prices) and finished goods.  Why do what others are ever more willing to do – funding the US current account deficit and indefinitely putting off the need for the US economy to adjust to a lower consumption rate or conversely higher savings rate.  Why complain much if exporting finished goods to the US consumption giant is not causing a run on the dollar (capital losses on all those reinvested assets held by surplus nations)?     

 

Additionally G7 is only as relevant as the US makes it…goes with having the reserve currency.  The Bush administration has ideological shackles on international economic policy coordination – markets are best left to set FX levels not governments.  Moreover, the Bush administration has not had the coziest of relations with its European counterparts outside of the UK.  Even relations with Canada have been the most strained in my lifetime.   Sure Japan remains a loyal friend and ally at the G7 level. 

 

Finally necessity is the mother of invention and in the last 7 plus years there has not been a currency or growth crisis necessitating policy coordination.  Clearly since last summer due to the credit crisis this condition has changed and arguably makes policy coordination (reducing systemic capital market risks) argues for more not less policy coordination.  But the credit crisis so far has been mainly a US problem from a policy perspective with possibly the exception of the UK (Northern Rock).  Sure the ECB has been active in adding liquidity to the banking system, but what has it done for growth lately?  The most we can say is the ECB has not hiked rates in light of record high inflation (what about the free Bernanke growth put the ECB enjoys?). 

 

Still not even the credit crisis has jolted G7 into a cooperative spirit.  European, Canadian and Japanese concerns over the weak dollar (risk of a disorderly decline) have to date failed to prompt any new US agreed-to initiative to support the greenback.  Because US exports are benefiting from the decline in the dollar – Bernanke noted this last week – there is not a snowball’s chance in hell that the US Treasury will agree to any joint currency intervention operation or stepped up rhetoric in light of the serious US economic slowdown now underway.  Indeed the only way the Treasury gets to the intervention table is in the event of a disorderly dollar decline and any chart of the dollar will show that the decline while multi-year in length and historic in depth has been anything but disorderly. 

 

The reality of G7 is that it is a blame game – Europe blames the US for all ill that befalls the global economy and financial markets and yet thrives on the very imbalances that the US economy supports (Euro Zone exports). 

 

Things have to get much worse to get G7 to look and act like the G7 of old, no matter my personal nostalgia for a bygone era. 

 

So no new FX language at G7 Friday in Washington and no elevated risk of currency intervention with my G7 goggles off. 

 

But if I put on my rose colored goggles and ask what could G7 do to make a difference in the event financial markets relapse into disorder and a run on the dollar?  Sell gold – G7 footprint in this market would be significant and in light of the tight inverse correlation with the dollar and gold, the US currency would shoot up.  But at the end of the day, this bygone solution is only partly complete without a strong signal from the ECB that rate cuts are on the table and the chance of this happening are about as likely as the Bush administration being convinced by Euro Zone officials mainly that the dollar demands increased US support.

 

David Gilmore

 

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