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Wednesday October 20, 2010 - 23:51:22 GMT
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US Dollar Policy - A Work in Progress

It may well be a function of G20 approaching and the need to find common ground with major countries at G20 in S Korea Friday and Saturday (c bankers are attending as well) that US Treasury Secretary has been drawn into discussing the US dollar’s decline.   Geithner’s comments in California Monday evening found here  Geithner California transcript  were aimed at assuring markets and allies that the US is not deliberately devaluing the dollar and is working to maintain confidence in the currency.  I would interpret this to be pushback on the benign neglect dollar policy in place all through the September decline.  So the US Treasury is saying we hear you (EZ, CA, JP, GB, BR, KR…) we are not insensitive to USD declines versus major currencies.  However, the policy key from Geithner’s perspective to unlock the currency volatility dilemma is in the hands of China and emerging nations that are intervening to prevent or slow the appreciation of their currencies.  This “manipulation” is forcing the adjustment burden onto currencies that float against the USD which in the main are developed economies’ currencies.   And I think most EM states see the Fed QE at the root of local FX appreciation pressures and see QE as a form of US FX manipulation.


However, the US Treasury is aware of the fact that the fate of the dollar near-term is largely in the hands of the Fed which is an independent institution.  The Fed is going to embark on QE2 for domestic reasons and not adjust QE2, short of a run on the dollar, for some exchange rate objective like stabilizing the dollar (surely part of the grand bargain BOE Gov King had in mind Tuesday…along with greater flexibility in EM FX regimes…plus very deliberate efforts at turning high savings nations into low savings, high consumption nations).  Even King implied this goal was not within grasp short of a revolution in thinking.  I simply can’t see the Fed promising less QE2 for more Asian FX flexibility this weekend.  Furthermore I doubt either Geithner or Bernanke is unhappy with the stock market gains since late August and the kicker a weak dollar has provided for stocks. 


So what is Geithner trying to do now by sounding off on the USD decline?  I call it the parachute…slowing the rate of descent…with jawboning.  I do not see an additional parachute of currency intervention being deployed in the advance of Fed QE2 nor after…that option will be reserved for the worst case scenario and well after QE2 is underway. 


The US Treasury today met with the press today as is normal ahead of G20 and according to Bloomberg said this ..."Currencies and trade flows will be at the center of talks among finance ministers from the Group of 20 nations...Some big emerging-market nations are resisting market forces and keeping their currencies undervalued, creating a competitive dynamic of resisting market forces, the official said, speaking on condition of anonymity. The U.S. wants foreign exchange rates to reflect market forces and economic fundamentals, the aide said."    


I don’t believe this message means there will be a grand bargain to stabilize the USD and allow EM FX to appreciate more.  Again I can’t see the Fed making QE2 conditional upon USD levels.  Moreover, I can’t see Asia (China) agreeing to a faster rate (than September) of appreciation without some concession from the West like the Fed scaling back QE2 or US State Department and White House authorizing the sale of high tech defense systems to the Chinese (this would surely not bring any easing of FX regimes elsewhere in Asia). 


Geithner’s views on FX and adjustment were recently outlined in a speech at Brookings Institution earlier this month where he said the following:


“That brings me to the second policy challenge: we believe it is very important to see more progress by the major emerging economies to more flexible, more market-oriented exchange rate systems.  This is particularly important for those countries whose currencies are significantly undervalued. 


This is a problem because when large economies with undervalued exchange rates act to keep the currency from appreciating, that encourages other countries to do the same. 


This sets off a damaging dynamic, described first by my former colleague Ted Truman, as "competitive non appreciation." Over time, more and more countries face stronger pressure to lean against the market forces pushing up the value of their currencies. The collective impact of this behavior risks either causing inflation and asset bubbles in emerging economies, or else depressing consumption growth and intensifying short-term distortions in favor of exports. 


This is a multilateral problem.  It is unfair to countries that were already running more flexible regimes and let their currencies appreciate.  And it requires a cooperative approach to solve, because emerging economies individually will be less likely to move, unless they are confident other countries would move with them. 


This problem exposes once again the need for an effective multilateral mechanism to encourage economies running current account surpluses to abandon export-oriented policies, let their currencies appreciate, and strengthen domestic demand.  This is a necessary complement to the adjustments being undertaken by countries running current account deficits.  A cooperative rebalancing of policy in this direction would be better for overall growth.


This issue was well-known to the group of economists who gathered in Bretton Woods, New Hampshire, to refashion the war-ravaged global financial system in 1944.  The Articles of Agreement of the IMF, drafted at that conference, contain a now-obscure paragraph calling on the Fund to issue reports on countries with "scarce currencies"--what today we would call countries running persistent surpluses--"setting forth the causes of the scarcity and containing recommendations designed to bring it to an end."  That clause now reads like a relic of a bygone monetary era.  But the problem it was drafted to address--the threat to global financial stability posed by persistent, large surpluses--is as salient today as it was then.”


Lastly I would see the absence of the strong dollar mantra in US Treasury public statements not as an embrace of a weak dollar policy or even benign neglect (though this was the de facto policy in September) but instead that the Treasury has deliberately retired the phrase….it is not useful anymore and is too confining.  I am not ruling out Geithner chanting the mantra at some point ahead.  But its virtual absence from the vernacular of the Treasury Secretary is deliberate. 


I see QE2 full steam ahead and the USD a victim…markets can discount QE2 only to a point, but when it is expressly open ended I can’t see how markets can claim QE2 is fully priced….maybe the first iteration for November 03, but beyond?  Hence the dollar should continue to slide on an open-ended QE2 and a longer-term low rate commitments. Throw in German ECB’ers calling for higher rate (discussion) and phasing out of unconventional (Weber called for end of EZ bond purchases, though Trichet rejected this call), and we are nowhere near the top in EURUSD. 


Here is Draft G20 Communiqué story from DJN earlier today…will be the basis for Saturday’s communiqué…officials can make changes before final draft is released, though often the changes are at the margin. 


 10:54 20Oct10 DJN-UPDATE: G-20 To Avoid FX 'Competitive Undervaluation'-Draft Communiqué

UPDATE: G-20 To Avoid FX 'Competitive Undervaluation'-Draft Communiqué


    (Adds detail from statement, context.) 




    The Group of 20 nations vow to "refrain from competitive undervaluation" of 

their currencies, according to an early draft of a statement by finance ministers 

and central bankers from the world's biggest economies, suggesting the group may   take a clear stand against what has been called a global "currency war." 


    The G-20 will "move towards (a) more market-determined exchange-rate system,"   says the draft seen by Dow Jones Newswires, reflecting an often-used U.S.   expression meant to discourage countries from intervening in currency markets. 


    But, perhaps reflecting concerns of Asian and other export-reliant economies 

about rapid rises in their currencies, the draft also says the G-20 will minimize 

"adverse effects of excess volatility and disorderly movements in exchange 



    The statement could change substantially, as debate on it is just beginning. 

G-20 vice finance ministers meet Thursday in Gyeongju, South Korea, with 

ministers and central bank governors following them Friday and Saturday. The 

Gyeongju meetings are meant to prepare for the G-20 summit in Seoul Nov. 11-12. 


    Market participants have been keenly watching whether the G-20 can take a 

unified stance on the bouts of aggressive currency interventions by some member   countries that have divided global policy makers after a period of remarkable   solidarity in pulling out of the global financial crisis and recession.


    As the dollar slides broadly on a murky U.S. economic outlook and 

expectations that the Federal Reserve will expand its monetary easing, 

export-reliant economies in Asia--the world's fastest growing region--have seen 

their currencies soar and potentially destabilizing floods of foreign capital 

pour in. The U.S. has pressured China to let the yuan rise faster to help 

"rebalance" economic growth away from a reliance on U.S. consumption of Asian   products. 


    Beijing has let the yuan rise more than 2.5% against the dollar since early 

September--fast for the Chinese currency but less than the sharp gains of many 

currencies of China's competitors in Asia and other emerging economies. Many of   them, notably G-20 members Brazil, Japan, South Korea and Indonesia, have sold   their own currencies to slow their rallies. 


    Accusations have flown, with U.S. policy makers accusing China of using an 

undervalued currency for unfair trade advantage, while China has called the U.S.   irresponsible for pursuing such a loose monetary policy, to the detriment of the   world's key reserve currency. 


    The G-20 has become the focus for hopes that big economies can manage the   global economy more harmoniously.  


    "Our cooperation is essential," the draft G-20 communique says, for 

maintaining a global recovery that is "moving ahead, albeit in a fragile and 

uneven way. Recent financial market strains have receded, in part due to our 

timely and concerted policy efforts. However, many downside risks remain." 


    The G-20 members vow in the document to play their part "in sustaining 

ongoing growth and reducing global imbalances in a collaborative way." 


    In addition to exchange rates, the draft communique says the group will "work 

to manage more effectively rapid and volatile capital inflows into emerging 

countries." The G-20 pledges structural reforms, swift "financial repair" and 

regulatory reform. 


    The group is walking a tightrope on how fast to withdraw the interest-rate 

cuts and government stimulus spending implemented during the global downturn.   Asian economies have been tightening monetary policy aggressively, with China   raising rates Tuesday for the first time in nearly three years, while the U.S.  looks set to loosen further. The U.K. is cutting government spending while many   countries are keeping the fiscal throttles open. 


    The draft says the G-20 will "continue with monetary policy which is 

appropriate to achieve price stability." The G-20 will "articulate credible and 

growth-friendly medium-term fiscal consolidation plans while being mindful of the   effects of synchronized adjustment on the global recovery." 


I also believe that US-China relations are very strained…perhaps worse now than even a few weeks ago and this is no better seen in reports that China has stopped exporting rare earth minerals to the US (stopped exporting them to Japan after the fishing boat captain was jailed…since released) and the sudden halt to an appreciating yuan even before the surprise rate hike Tuesday.  I also know that the Treasury decision to delay the report to Congress on FX practices of major trading partners (Chinese yuan policy) was very last minute and reflected sensitive relations with China…see NYT’s by clicking here China stops rare earth exports to US …and this sensitivity was seen in the Treasury’s statement explaining the decision to delay the report here: US Treasury statement on cancelling FX report   


Things are going badly with China and expecting US to get backing from other G20 nations (Brazil’s Mantega is not even going for yet unstated reasons) bringing multilateral pressures to bear on China and getting China to cave on yuan appreciation is wishful thinking.


David Gilmore





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