The Dollar: A Modest Re-alignment

Back to Kevin's blowing sunshine argument about the absence of a currency policy instrument. I still think the key point here is not the presence or absence of direct intervention. The US intervenes in currency markets by means of 'expectations'. Since the US Treasury is potentially the strongest player in the game, market participants try to read the tea leaves and anticipate official policy. If they do this successfully, then, in the best of circumstances there, is no need for the intervention. Of course, when we get to the 'worst of circumstances' all this changes. The US attitude to dollar policy is changing, and, if we take Bernanke seriously, we should expect more changes to come. The real push-comes-to-shove moment will come when Brussels and the ECB finally reach the conclusion that the euro is way too high, it's then that we'll see whether intervention is a thing of the past or not, especially if interest rates start rubbing against the zero limit and conventional monetary policy loses the little capacity it has left.

The dollar is expected to come under renewed pressure on the foreign exchange markets on Monday after John Snow, US Treasury secretary, suggested the long-standing strong dollar policy did not imply any view about the exchange rate. He also played down the dollar's recent fall as "a modest realignment."...........

Since the mid-1990s, the strong dollar policy has relied on rhetoric to support the exchange rate, rather than intervention or interest rate changes. The rhetoric provides reassurance that the US would not intentionally attempt to drive the dollar lower and might at some point be prepared to support it. Mr Snow has undermined that reassurance.His comments came after data showing signs of flagging growth and falling inflation heightened fears of deflation in the US.
Source: Financial Times
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Deflation: Now the IMF Warns

As if to confirm my impression that the 'new management' at the IMF are in fact reasonably in touch with reality (more so at least than their OECD counterparts), Rogoff serves us up a Deflation Index replete with a clear and direct warning on Germany. Note the additional mention of Hong Kong and Taiwan. For my money they are still too complacent on the US situation, and are simply wrong about Germany being the only EU country in danger. But then I suspect Edward Hugh is the only observer waving the flag right now on Italy, let's see if I'm still alone twelve months from now, shall we? Until we understand the causes we're never going to be able to treat the consequences.

The International Monetary Fund warned on Sunday that Germany was at high risk of deflation and that Japan might suffer further price declines. Hong Kong and Taiwan were also facing serious deflationary pressures.However, the IMF said other eurozone countries and the US remained at low risk of deflation despite equity market declines, high unemployment, weak output and geopolitical upheaval."Deflationary pressures are not strong enough to lead to generalised global deflation,” the IMF said. But those “pressures have risen in several countries."The IMF appointed a special task force to study deflation risks in the world's 35 largest economies and a special task force in December amid rising concerns about global price declines.The findings, approved by IMF chief economist Kenneth Rogoff on April 30 and published to the organisation's website on Sunday, may ease fears in some "low-risk" countries, such as the US and the UK. But they are likely to stoke them in countries now in the IMF's "high-risk" category.

The likelihood of Germany suffering a "mild deflation" over the next year was "considerable," the IMF said. The country had already seen inflation fall below 1 per cent, economic growth was expected to be only 0.5 per cent this year, and policy options were limited. Switzerland and a handful of other European countries were at moderate risk, the IMF noted, but their governments were seen to have more room for manoeuvre.In Japan, where the core consumer price index had declined for a consecutive 41 months, deflationary pressures showed few signs of easing. Hong Kong and Taiwan were also listed as "high risk" by the IMF.
Source: Financial Times
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An Opportunity Missed

I suppose it really was naive of me to hold out even a candle of hope for some movement towards cooperation and understanding at the G7 meeting, but even the tiniest 'soupcon' of expectation appears to have been dashed by the reality of the show. It seems that the finance ministers have chosen to remain in the realm of unreality, and hope in this way to avoid the storm. Apparently the currency issue was part of the general discussion, but not mentioned in the communique. I say apparently because that's what is said and that is all we are going to know. Even if the discusion was more wide ranging, the decision seems to have been to leave matters as they stand, for if things had been otherwise, then presumably part of the effect of any change would have been achieved by trying to use the decision to shape market participant expectations. In addition, since, for the time being, the US seem happy with the dollar decline, and the Europeans, less aware of the deflation menace, seem happy to accept the rising euro, and since the Japanese are too diplomatic to ask for something they know they won't get, then probably things are pretty much as the public version has it. I still want to know what's going to happen when the main players wake up to the fact that this won't work. On the unreality of it all, Francis Mer sums it up: 'the worst is now behind us'. I would hope that he is right, but I find it difficult.

Bereft of a quick fix to ward off recession, the world's leading finance ministers on Saturday voiced confidence in stronger growth and committed to deep-seated reforms for rich and poor regions as the remedy. Meeting for the first time since the end of the war in Iraq, ministers from the Group of Seven powers and Russia discussed but broke little ground on debt relief, terror funds, financial stability and links with the developing world, in preparation for a summit of heads of state in two weeks time in Evian. Despite fears of imminent recession in many G7 countries, concerns about Japanese-style deflation spreading across the globe and the recent slide in the U.S. dollar, ministers said that many downside risks had receded. "We're optimistic more than anything else," French Finance Minister and G7 host Francis Mer told a news conference. But U.S. Secretary John Snow was eager that all G7 nations do more to revive global growth. "Growth in the major economies is simply not what it could be," he said. "We need to do more to ensure a robust recovery." "I made clear that the United States expects others to take bold actions themselves -- including fundamental structural reforms where necessary -- to spur growth, create jobs and contribute to global prosperity," Snow said. Currency markets -- where the dollar has fallen to near four-year lows against the euro and two-year lows against the yen -- were not mentioned in the communique and this is expected to be noted by markets wary of G7 displeasure over recent moves. The meeting, which did not include central bank governors, did not dwell on exchange rate levels, but ministers took note of recent market volatility and the fall in the dollar. "It was acknowledged that an adjustment in the dollar exchange rate had been anticipated," Canada's finance minister, John Manley said, adding that recent moves in the dollar were more rapid than anticipated. Mer said currencies were part of the general discussion and there was a standing agreement to closely monitor and cooperate if foreign exchange rates moved out of line with fundamental economic trends -- a phrase often used by G7.

The statement at the end of the two-day gathering on Saturday provided a "to do" list of ongoing reforms for each country to pursue in order to create a better environment for the private sector to lead economic recovery. The G7 said there was optimism economies would improve soon without the need for any emergency action and officials told reporters there was some hope business and consumer confidence would improve following the end of the war in Iraq. Mer said recent dire first-quarter growth figures from at least three of the G7 focussed too much on the past."The indicators which are in the red tell you only about the past. You don't drive a car solely looking in the rear mirror." Mer, who said earlier in the week the ECB had room to cut interest rates, said the G7 agreed inflation was largely behind them -- a comment only a week after the U.S. Federal Reserve said it was worried about an "unwelcome substantial fall in inflation," raising concern that deflation could threaten. The G7 countries -- the United States, Canada, Japan, Italy, Britain, Germany and host France -- said dangers to global growth and prosperity were receding but challenges remained. The statement said: "We are strengthening our commitments to structural reforms and sound macroeconomic policies." Britain's finance minister, Gordon Brown, struck a more positive note and said he saw more grounds for optimism in stabilising oil prices, rising stock prices and governments' commitments to reform."This was the strongest statement yet at a G7 on the need for reform," added Brown, drawing encouragement from European economic plans as he returns home to a critical cabinet debate on whether the UK should join the euro. "Europe is facing up to the need for reform."
Source: Forbes
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Japanese Bank Bailout

The decision to inject an estimated $17.7 billion into Japans fifth largest bank has set-off all manner of questions about the future of the 'reform' process, including questions about the survival of key economics minister Heizo Takenaka whose attempts to accurately reclassify the book value of bad debts are thought to have provoked the capital adequacy problem. On the back of the latest GDP deflation figures, the pressure certainly seems to be building up.

Anxiety about the state of Japan's banks, rekindled by the government's weekend decision to bail out the nation's fifth-biggest banking group, has turned up pressure on the administration to kill profit-destroying deflation. The rescue of Resona Holdings also reignited calls to oust Financial Services Minister Heizo Takenaka, an academic closely identified with Prime Minister Junichiro Koizumi's reform agenda and a target of old guard discontent. "Prime Minister Junichiro Koizumi...must do his utmost to prevent the crisis from spreading," the Yomiuri Shimbun newspaper, Japan's biggest, said in an editorial on Sunday. "At the same time, we should not forget Resona's case has been influenced by the hard-line financial reconstruction policy championed by Heizo Takenaka...which has gone astray," the conservative newspaper added. The government said on Saturday it would rescue Resona with a huge injection of funds after tougher accounting rules pushed its capital adequacy ratio below limits needed to do business. Media reports said the infusion of public funds could be as much as two trillion yen ($17.17 billion). Ruling politicians on Sunday generally endorsed the decision. But Taro Aso, policy chief of the ruling Liberal Democratic Party, and others called on the government to address the persistent decline in prices that is likely to get worse as the nation's banks struggle to dispose of an estimated 40 trillion yen ($345 billion) of problem loans now on their books. Aso attributed Japanese banks' dismal situation to declines in the value of real estate, which was used as collateral for many loans in during the late 1980s "bubble economy" and is now a major cause for soured loans, as well as falling stock prices."Asset deflation is the biggest problem," he said.

Aso sidestepped the issue of whether Koizumi -- whose central policy pillar is fiscal reform -- should adopt an extra budget to fund public works as suggested by some LDP heavyweights and their partners in the three-way ruling bloc. "When you are suffering from both diabetes and consumption, you have to treat the consumption first," was all he would say. Koizumi, who meets President Bush later this week for a bilateral summit, also faces international pressure to tackle a four-year slide in core consumer prices. Japan pledged at a weekend meeting of Group of Seven finance ministers in France to step up efforts to fight deflation. But Finance Minister Masajuro Shiokawa offered few clues as to how Japan, burdened by massive public debt, could do so.

Shiokawa said Japan would ensure ample liquidity in financial markets and diversify the way it provided liquidity, although the Bank of Japan (BOJ) already pins interest rates at near zero and floods the money market with far more liquidity than it needs. The central bank is set to hold a policy-setting meeting on Monday and Tuesday. The maverick Koizumi sprang to power in April 2001 on a wave of public support for his agenda of painful reform, including reining in the nation's ballooning fiscal deficit and lifting the heavy hand of government from Japan's long-stagnant economy. Criticism of his policies from within the LDP has been harsh, but some on Sunday urged him not to cave in. Calling for a "comprehensive policy" focusing on deregulation and tax reforms to nurture new business and create fresh demand, the liberal Asahi Shimbun newspaper said the massive stimulus policy adopted after a 1997 financial crisis had inflated government debt without fixing the financial system. "We cannot walk that same path again," the newspaper said. Still backed by about half the nation's voters despite plummeting stock prices and a stagnant economy, Koizumi vowed on Saturday to carry on with his reform agenda. "There is absolutely no change in our reform stance," he said after the government held its first emergency financial crisis council meeting to approve public funds for Resona. "We took measures so that a financial crisis will not occur."

Koizumi, who must be re-elected as LDP president in September to keep his premier's job, stood by his controversial minister. "I have no intention of changing him," he said, when asked about calls for Takenaka's resignation. "He is doing a good job." Resona's call for help underscored longstanding suspicions that Japanese banks have overstated their capital by taking advantage of accounting loopholes. Auditors had declined to sign off on the group's earnings estimates, which were deemed to be far too optimistic. Stock market investors can expect a volatile day on Monday in reaction to the rescue deal if it's perceived that Resona's problems are just the tip of iceberg, analysts said. If bank shares get slugged, the Nikkei average could drop toward the 20-year lows it reached last month -- putting even more pressure on the banks, which have huge shareholdings.
Source: Reuters News
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