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G20 means G7 no longer only game in town on forex

September 30th, 2009

G7G20Group of 20 leaders say they want to rebalance the world economy but getting them to accept a weaker U.S. dollar in the process could prove a lot to ask.

That’s especially true now that the Group of 20, which includes emerging markets like China and India, has supplanted the Group of Seven rich countries as the forum for managing the global economy.

In fact, coordinating currency policy of any kind may get a lot harder if it requires getting 20 countries, with disparate interests and priorities, to pull in the same direction.

“It’s tough to reach consensus on currencies in the best of times, but with more people at the table and more interests to pursue, it could make coordinated intervention more difficult to achieve,” said David Gilmore, partner at FX Analytics in Essex, Connecticut.

Take the case of rebalancing the world economy. That’s viewed as a polite way of calling for a weaker U.S. dollar, since it would require debtor countries such as the United States to save more and exporters like China or Japan to spend more.

But that would involve major social and economic changes for countries like China, which has relied on a weak currency and exports to drive its phenomenal rate of growth. In other words, it’s hardly something China would want to rush into.

The G7 — the United States, Britain, France, Japan, Canada, Germany and Italy — say they will still meet periodically, starting this weekend on the sidelines of an annual International Monetary Fund meeting in Istanbul.

But their ability to act quickly and decisively within the larger G20 may be diminished, particularly if China, with its war chest of $2 trillion in currency reserves, is not on board for any proposed changes.

Last weekend’s G20 summit, with its rebalancing pledge, is a case in point. While exchange rates may have been discussed behind closed doors, there was no official mention of currencies, much less any coordinated action.

It was a far cry, for instance, from the 1985 Plaza Accord, named after the New York hotel where officials from the United States, Germany, Japan, Britain and France met and agreed to weaken the dollar against the Deutschemark and yen.

Barclays Capital strategist Steven Englander said that with so many different interests represented in the G20, references to currencies will be rare, “even if some of what they say has clear implications for exchange rates.”

But agreement on policy objectives will carry more weight, he said, now that developing countries, which hold the biggest share of currency reserves and are having a growing impact on the world economy, are represented at the table.


Still, some worry that a lack of coordination at the top will tempt countries to act unilaterally on exchange rates.

Indeed, many countries have not been shy about weakening their own currencies to protect their fragile economies.

The U.S. dollar has barely budged this year against China’s yuan, thanks to active Chinese intervention, even though the greenback has shed 5.0 percent against a major currencies .DXY

Switzerland has been selling francs aggressively while Bank of England Governor Mervyn King extolled the virtues of a weak pound last week, saying it would help British exports.

And while Japan has not intervened since 2004, the yen is approaching levels beneath 90 per dollar that have in the past raised serious worries about undermining Japanese exports

Other members of the G20, including South Korea and Brazil, intervene often in markets to soak up incoming dollars and keep their own currencies from getting too strong.

“There’s a risk that locking arms to maintain the status quo may change into competitive devaluation,” said T.J. Marta, chief strategist at Marta on the Markets in Scotch Plains, New Jersey.


None of this means the old G7 is entirely powerless.

Marc Chandler, a strategist at Brown Brothers Harriman in New York, said cross-currency swap lines between the Federal Reserve and other G7 central banks have been particularly effective at getting dollars to overseas markets while keeping a lid on foreign currency appreciation.

So far, officials have not had to resort to coordinated currency intervention of the sort seen with the Plaza Accord in 1985 or in 2000 when countries got together to boost the euro.

But Chandler said there’s nothing to stop countries from acting. “You could see shifting coalitions of the willing.”

Mark Weisbrot, co-director of the Center for Economic and Policy Research in Washington, called the G20 supplanting the G7 a “symbolic change,” adding that the institutions with economic enforcement powers such as the International Monetary Fund and World Bank, are still dominated by rich countries.

But rival blocs within the G20 will certainly exercise more power, particularly since countries such as China, Brazil, Russia and India hold massive amounts of currency reserves and have growing clout in global financial markets.

In fact, these four, known as the BRIC countries, have already started having informal get-togethers at meetings of G20 finance ministers.

“There was once a lot of pressure on China from the U.S. and Europe to revalue the currency, but these days, the U.S. no longer mentions it,” said Zheng Wang, an assistant professor at Seton Hall’s Whitehead School of Diplomacy.

China’s enhanced role in global decision-making should make it easier for Washington and Beijing to cooperate on the many common issues they face, he said.

Englander extended the same logic to the broader G20 but admitted that diplomacy and decision-making will be tougher.

“The good news is that it makes anything that’s agreed on more enforceable,” he said, “but the risk is that it makes it harder to agree on policies because the various interests around the table are very diverse.”

By Steven C. Johnson – Analysis

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