The G-20 Makes Progress but Currency Volatility Continues October 27, 2010, Bill Witherell, Chief Global Economist
The G-20, now the primary forum for managing the global economy, met last weekend in Korea. The meeting was at the level of finance ministers and central bank governors and will be followed in three weeks by a G-20 meeting of heads of state (a “Summit”) on November 11-12. Market expectations for significant results from the Korea meeting were very limited and, therefore, the modest progress that was achieved was a positive surprise. Nevertheless, the US dollar resumed its downward course when markets opened Monday, bouncing back several days later as currency markets reacted to changing expectations about next week’s Fed meeting and future quantitative easing (QE) and its effects.
The G-20 made significant progress in two areas last weekend. First, they reached agreement on a framework for addressing the imbalances in current accounts and avoiding widespread competitive devaluation of currencies. Second, they agreed to a significant shifting of power in the International Monetary Fund (IMF) and to a doubling of the Fund’s quotas, that is, the financial resources that the Fund can draw upon to meet future crises.
The agreed “framework” incorporates the idea pushed by the US and South Korea to focus on underlying factors affecting exchange rates, in particular, a nation’s current account balance, the broadest measure of a nation’s trade and investment balances. The other countries in the G-20 were not ready, however, to agree to a definite external-balance target, despite US pressure for acceptance of the idea that current account balances (deficits or surpluses) should remain within 4% of GDP. Reportedly, Germany, Japan, and Brazil opposed setting a specific target.
The G-20 did agree to examine current account balances against a still to be developed set of indicative guidelines and called upon the IMF to have a supervisory role, assessing “progress towards external sustainability.” This clearly is a work in progress, which the November G-20 Summit may be able to advance further. Reports today out of China suggest that the US and China are close to reaching an agreement on targets. The communiqué included commitments to “move towards market-determined exchange-rate systems that reflect market fundamentals and refrain form competitive devaluation of currencies.” While this statement and the framework might be dismissed as “just words,” they represent an important shared understanding on the principles which should provide the basis for further progress. In the end any agreements in the G-20 are unlikely to be binding, but the effectiveness of peer pressure within the Group, backed by the IMF, should not be discounted.
The progress reached on reform of the IMF was more unexpected and more substantial. Emerging-market countries are to be given more weight on the 24-member governing board of the IMF, gaining 2 seats that are to be given up by Europe. This will result in China becoming the third biggest member, with a 3.65% voting share, compared with second-ranked Japan at 6.01%. The US, with a 17.67% share, maintains its veto power for key IMF decisions. The shift in global power is evident in the fact that after the changes take effect, the funds ten largest shareholders will include all the “BRICs”– Brazil, Russia, India, and China. This will largely correct the current underrepresentation of these countries in the institution. As noted above, a further important result was agreement to double the resources of the fund.
The implications for investors of these developments are important. The threat of a real “currency war,” with competitive devaluations, widespread trade protectionism, and a freezing of international capital flows has receded. The constructive spirit of cooperation that is developing between the US and China, in particular, lessens the likelihood that the US will feel it necessary to brand China as a “currency manipulator” (a move that would almost surely have been counterproductive) and should reduce pressure in the US Congress for protectionist trade moves.
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