This weekend saw the Finance Ministers of the G-20 nations meet at Gyeongju in South Korea and there can be little doubt about the main item on the agenda which was what the Brazilian Finance Minister had recently called “currency wars.” The location was also symbolic as South Korea is looking at imposing currency controls herself in an attempt to avoid the effects of a falling US dollar on her own economy. The South Korean Won had risen some 7.6% in 3 months and it is likely that once the G-20 bandwagon has moved on that the host nation will impose a withholding tax on foreign investors’ bond holdings, and impose further limits on currency forward trading.
The economic problem
At this time there are 2 main competing world influences. One is represented by China who has maintained an exchange-rate for some time which is undervalued which has helped it to build a balance of trade surplus and large foreign exchange reserves. The other camp is represented by the United States which in spite of recently having been in a severe recession has very quickly returned to a level of large trade deficits. The fundamental nature of the problem here is that both camps feel that the other needs to change. For example the US Trade Secretary came into this meeting with a plan that involved the surplus countries which for example would include Germany, Japan and Saudi Arabia with China adjusting their policy. Quite how he thought they were going to agree to this I do not know as the move was a quite transparent effort to avoid any blame for his home country the United States.
US economic policy
If one moves on from Mr. Geithner’s hyperbole which may well be primarily aimed at the midterm US elections and looks at what the United States is actually doing then we see something which in reality is the reverse of the “strong dollar” he talked about. I cannot help but wonder how the other delegates kept a straight face as he talked of a strong dollar! The German Economy Minister Rainer Bruederle offered a much more realistic assessment of recent US policy.
Excessive, permanent money creation in my opinion is an indirect manipulation of an exchange rate.
Indeed if we read between the lines Herr Bruederle was in fact very critical of US economic policy as he went on to say that adding more liquidity was the wrong way to solve economic problems. As the United States looks likely to start a new version of Quantitative Easing possibly as soon as next week this is in fact a direct criticism of the US Federal Reserve and US economic policy. So in truth a rapprochement between Germany and the US on this subject was never very likely and that is before we get to the problem which is China and her undervalued Yuan.
What did the meeting claim it achieved?
If one was looking for a sign the meeting had achieved little one got in from this claim in the communique.
We have reached agreement on an ambitious set of proposals to reform the IMF’s quota and governance that will help deliver a more effective, credible and legitimate IMF.
Also many might wonder why some eighteen months ago they gave some much extra money to an organisation which needs reform, many might consider it wise to reform first and increase funds later. But then we are talking about a group of people who have this in their communique.
continue with monetary policy which is appropriate to achieve price stability and thereby contributes to the recovery.
If you read many of the recent speeches I have quoted from that relate to discussion by members of the US Federal Reserve they are often discussing doing precisely the reverse of this…
If we look at what they claim to have achieved.
move towards more market determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies…….continue to resist all forms of protectionist measures and seek to make significant progress to further reduce barriers to trade……strengthen multilateral cooperation to promote external sustainability and pursue the full range of policies conducive to reducing excessive imbalances and maintaining current account imbalances at sustainable levels.
So even a crew prone to flannel and hyperbole cannot claim much from this meeting although I did smile at the section “continue to resist all forms of protectionist measures” which if you look at recent events reminds me of Oscar Wilde’s “I can resist anything except temptation!” The Financial Times recently made a list of the countries it felt had manipulated their currencies in some form recently and it came to 25 and the list is lengthening.
Market Response after the meeting
The main signal in these times is that value of the US dollar index which is its effective or trade-weighted exchange-rate. This peaked back on the 7th June at 88.71 and this morning has fallen by nearly three-quarters of one percent to 76.9. If we consider Mr. Geithner’s “strong dollar” it appears to involve a fall of 13.3% in less than five months. Perhaps he has been taking language and consistency lessons from Wayne Rooney.
Where this renewed US dollar weakness has really hit home has been in the land of the rising sun this morning as we have seen a new dollar low/ Japanese Yen high and the exchange rate is at 80.50 as I type. This exchange rate has moved by more than 1% over the weekend in its own summary of developments at the G-20 summit. In an even more disappointing development for Tokyo the Yen has also strengthened against the Euro and has risen by 0.6% against it to 112.96.
If I may be permitted a reference to the situation in my home country it would appear that talk of more Quantitative Easing in the UK has begun to affect our exchange rate adversely. The recent Monetary Policy Committee minutes showed that Adam Posen, in perhaps a show of American central banker solidarity, had voted for an extra £50 billion of QE. However if we look at the pounds performance the last time the Euro went above 1.40 versus the dollar we went above 1.60, yet today we are just above 1.57. The Pound reached 1.22 versus the Euro in mid and late August but now is at 1.12 representing a fall of just over 8%. So rumours of possible more QE in the UK appear to be having an influence on our exchange rate too. I discussed this possibility in my critique of a speech by Adam Posen on the 29th September.
Sadly a lot of the pressure is being created by central bank moves, in my opinion, and here Mr.Posen and I completely disagree as he asserts that QE does not affect exchange rates.
Perhaps he will let us know his opinion on why the countries most likely to introduce QE have falling exchange rates.
It seems to me that even those who attended this seminar could not manage much enthusiasm for it and I wonder as to whether there were rows at the end of it. Unfortunately my view of the world’s politician’s is now so low I wonder if they are flying to next to a symposium on telling everybody else about the dangers of global warming. At best one can conclude that they are a group of people who are not very self-aware.
The UK Government Bond or Gilt market
I thought that I would address this area as I have noticed quite a few articles on this subject over the past few days and sadly many of them have shown a lack of understanding of the position. The opening salvo was fired by the Financial Times which pointed out correctly that up to the five-year maturity UK gilt yields are below those of Germany’s equivalent government bonds.
However to get a true picture of the situation you need to take a look at the overall market and if we move up the maturity spectrum we find the following. The ten-year yield is considerably above that of Germany as we yield 2.96% and they yield 2.45%, for twenty years the figures are 3.93% and 2.98% respectively and for thirty-years 4.09% and 2.96%. Indeed our longer-dated yields have risen recently rather than fallen.
So I cannot report that there has been a re-evaluation of the relative economic performances of the UK and Germany as these gaps remain wide. What I can report is a view on likely policy of the Monetary Policy Committee. The gilt market appears to be expecting them to buy short-dated gilts.
An Immediate contradiction
Unfortunately problems immediately flow from this.
1. On whatever inflation index you use then inflation is and looks likely to remain higher and in many cases much higher than the yields on offer from these bonds. So buyers are buying for an expected loss in real terms. Either they are expecting the UK economy to collapse or expected QE is horribly distorting our interest-rates.
2. Let us say they are right and the Bank of England does purchase these bonds. Exactly how will the economy improve by lowering interest rates the highest of which is at 1.57%? I wrote recently on the dangers of us being in a liquidity-trap for such interest rates on the 12th October and am reminded of one of my first articles on this site back on the 14th December 2009 about official and unofficial interest rates in the UK. According to the Bank of England the official overdraft rate is according to its latest figures some 19.08% and no this is not a misprint.
If we look at officialdom and central bankers at this time I am reminded of some of the lyrics from a song by the US duo, Hall and Oates.I doubt whether they were writing about a 17.5% difference in interest-rates but they might as well have been.
Out of touch
Out of touch.
You’re out of touch
I’m out of time.
Let us hope they were wrong about the out of time bit.