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Wednesday April 19, 2006 - 15:11:19 GMT
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Forex: IMF WEO Calls For Lower Dollar, Should We Care?

Absolutely. No doubt the IMF is not a policy making body per se, and markets would pay a lot more attention to a call for a broad dollar decline far more literally if it came from a senior US Treasury or G7 official. But this is not your father's IMF. If Tim Adams, US Treasury Under Secretary, and G7 generally, has anything to say about it, the new and enhanced IMF will be to global currency disputes and misalignment as the WTO is to global trade disputes and imbalances. Adams and G7 want to empower the IMF. The IMF can do what G7 believes but fears for an orderly dollar decline. Could the IMF thinking on global imbalances be that fundamentally different than G7 thinking? After all it is an organization largely controlled by G7 (largest donors). Surely Adams is first and foremost concerned with China's currency policy and its unsustainability. However, any call for an orderly adjustment in global imbalances assumes that in the face of record US external deficit (7% of GDP), a lower dollar is inevitable. Yes even those at the Fed and Treasury believe this orthodox economic conclusion. No dark matter here. No global savings glut can save the dollar indefinitely from a significant decline.

So the question the IMF and G7 is facing ahead of and at coming meetings in Washington is how best to make the adjustment orderly?

G7 and the IMF have been calling for policy steps for years that would reduce imbalances - high US savings (gvt and private sector) and policies aimed at boosting domestic demand in Europe, Japan and now China (mostly involving structural reforms). But as the IMF report noted today the longer governments fail to adjust policies to fix imbalances, the larger the FX adjustment may be need to correct imbalances. That is the equation...nothing has happened of significance (China reval Jul21 and crawling peg since are marginally helpful) from a policy standpoint to aid adjustment. So the one avenue for adjustment is the dollar and yet the market is not concerned with imbalances, just rate differentials. Well if you give low odds to government policy steps to address imbalances, then do as the IMF would do...sell dollars and the sooner it starts the less chance of a disorderly move later behind the "don't worry be happy" view of US current account deficit.

Can G7 or US Treasury risk calling, as the IMF has, for an orderly, "significant", dollar decline (over the medium-term)? Not only could it but it must. Markets at times need direction. No one can think that Japan's imbalance with the US has any chance of adjusting with dollar/yen at 118 or with Euro Zone at 145. But G7 is a cautious lot and getting European
finance ministers to accept a higher euro/dollar much more MoF accepting a lower dollar/yen is no easy achievement. And then the risk aversion in the Bush admin argues that no one wants to risk pushing the dollar off a precipice and undermining foreign capital inflows that would result in higher Treasury yields and lower stock prices...the disorderly outcome. Then there is the evidence that markets may already be doing what nearly everyone (central bankers too) off the record wants...selling dollars in an orderly manner.

So my expectations of a meaningful explicit call for a lower dollar at G7 are low. The focus in FX will remain primarily on the yuan. But I can't help but think that it would be helpful if G7 went from calling for policy measures to bring about an orderly adjustment in global imbalances to more generally calling for an orderly adjustment in global imbalances which would imply a role for the markets to gradually sell dollars.

David Gilmore


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