Global Currency Dance Continues

Global Financial Officials Meet, But the Currency Dance Continues October 13, 2010, Bill Witherell, Chief Global Economist

Last weekend finance ministers and central bank governors from around the globe gathered in Washington for the annual meetings of the International Monetary Fund (IMF) and World Bank, with a side meeting of the G7. Recall that in former years it was the IMF and G7 that played the central role in managing global currency markets. The meetings were held at a time of high volatility of currencies, including sharp falls in the international value of the US dollar, an unstoppable advance in the Japanese yen, warnings of “currency wars” as a growing number of countries take various kinds of action to dampen export-damaging appreciation of their currencies, and the growing threat of trade protectionism. David Kotok described the situation in his recent note, “Global Musical Chairs.”

No one expected these meetings to produce an agreement on global foreign-exchange coordination or even first steps in developing a substantive action plan to address the situation. But the meetings fell short of even these limited expectations. The meetings were in effect hijacked by the mounting hostility between the US and China over China’s resistance to a more rapid appreciation of their currency, on the one hand, and the very loose monetary policy and near-zero interest rates in the US and elsewhere in the advanced world, on the other. Other countries’ positions fell somewhere in the middle on these two issues. The undervalued Chinese yuan is affecting their exports, and exceptionally low interest rates in the US are putting upward pressure on their currencies as very large capital flows seek more attractive yields. The meetings ended with no resolution of differences between the world’s largest economies.

The contrast with the spirit of international cooperation that characterized the response to the financial crisis several years ago is striking. That cooperation was possible because there was a common analysis of the dangers then confronting the global economy and agreement on what needed to be done: a massive coordinated fiscal stimulus and a flood of liquidity to free up frozen credit markets. It worked; a global depression was avoided and a global economic recovery is well underway. Today, however, there is not a shared analysis as what are the most important risks to the global recovery and the required policy responses. The IMF is seeking to play the role of broker between the major economies, with a new mechanism under which simultaneous analyses of the major economies and their policies would reveal the effects of national policies on other countries. There was no agreement on this either.

Attention has now turned to the November summit meeting in Seoul of the G20 group of leading economies, which has become the primary forum for international economic coordination. The risks are considerable that the G20 meeting also will be overshadowed by the currency disputes. While we do not anticipate major agreements to come out of this meeting, we do hope that there is at least a return to a more cooperative and constructive tone and evidence of “global thinking” by our leaders.

It is likely that over the month leading up to the G20, the already high volatility in the currency markets will increase, interventions in these markets will also increase, and the “global musical chairs” process will continue. In addition to the G20 summit, November will bring the mid-term elections in the US and the next meeting of the Federal Reserve Open Market Committee. The latter is expected to reveal the timing and dimensions of a new and substantial round of quantitative easing (Federal Reserve purchasing of securities). Any surprises from the Fed meeting or the elections would have global market effects.

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