Clout of G-7 Validated as Yen Selloff Bolsters Its Relevance Against G-20
The Group of Seven may have been counted out too soon.
Almost two years after ceding control of international economic policy making to the G-20, the club of seven rich nations yesterday reminded financial markets of its power. By throwing what analyst Ashraf Laidi called a “no buy zone” around the surging yen, the G-7 triggered the Japanese currency’s biggest drop in more than two years.
The response to the group’s first intervention in foreign exchange markets since 2000 proves it still carries clout with investors at a time when the ability of the G-20 to find common ground on policies is being questioned.
“The action shows the commitment to cooperation and coordinated action that has been the hallmark of the G-7 in times of great stress or volatility,” said Daniel Price, a former G-20 adviser to President George W. Bush and now a partner at law firm Sidley Austin LLP in Washington. “It also underscores the continued vitality of the G-7 and the crucial role it plays even as many important global economic policy issues are taken up by the G-20.”
The G-7 comprises the U.S., Japan, Germany, the U.K., France, Canada and Italy. Each sold yen yesterday when their markets opened in a bid to reverse its surge to a post-war record against the dollar, which threatened Japan’s efforts to revive its economy after last week’s earthquake and tsunami.
The nations acted after their finance chiefs spoke for about an hour via conference call from about 7 a.m. Tokyo time yesterday, Japan’s Vice Finance Minister Fumihiko Igarashi said in an interview. They made their decision known in a statement that promised to “provide any needed cooperation” with Japan, which is also tackling a stricken nuclear power plant.
Officials from Japan’s Ministry of Finance initially contemplated asking the G-7 to warn against market volatility before Finance Minister Yoshihiko Noda decided to seek joint intervention, Igarashi said. Noda told reporters he had won prior approval from Prime Minister Naoto Kan to make the decision on what to do.
In the hours leading up to the call, U.S. Treasury Secretary Timothy Geithner spoke with Federal Reserve Chairman Ben S. Bernanke, French Finance Minister Christine Lagarde and European Central Bank President Jean-Claude Trichet to discuss how they wanted to show their support for Japan. Geithner also spoke with Noda and briefed President Barack Obama.
The yen, which had climbed for five days on speculation insurance companies and investors will repatriate assets to pay for damages, traded as low as 81.99 per dollar yesterday, compared with the high of 76.25 the previous day.
“If there’s ever a time for coordinated G-7 intervention, it’s now,” said Laidi, an independent currency strategist in London.
Yesterday’s action shows the G-7 still has relevance after a September 2009 decision to have the G-20 serve as the main forum for international economic coordination, said Jim O’Neill, London-based chairman of Goldman Sachs Asset Management, which oversees about $840 billion.
“The G-20 just can’t act as decisively and quickly as the G-7 has just done,” said O’Neill. “In a strange way this has all given the G-7 a rationale for existence for the first time in years.”
While G-7 leaders and their finance chiefs still gather for informal talks, it is the G-20 summits at which common policies are now agreed and communiqués released. The G-20 showed early success by uniting to fight the credit crisis and subsequent recession with bank bailouts, tax cuts and lower interest rates.
Since then, divisions have appeared, most recently at a November summit of leaders in Seoul, which was marked by clashes over trade imbalances, China’s management of the yuan and the U.S.’s easy monetary policy.
Other splits have opened up over how soon governments should reverse record stimulus, whether to tax financial speculation and how to re-write the rules governing global banks.
Any success stemming from the G-7’s latest move may give impetus to a proposal from French President Nicolas Sarkozy to establish a smaller forum within the G-20 to address currency issues because he views the larger body as too unwieldy. Sarkozy is convening a seminar on March 31 in Beijing to discuss the monetary system.
Julian Jessop, chief international economist at Capital Economics Ltd. in London, said the need to solve disparities in international trade and investment means the G-7 will remain junior to the G-20.
“The big problem facing the world is global imbalances and it has to be solved by the G-20 because that includes emerging markets,” said Jessop, a former U.K. Treasury official.
The practice of key economies meeting to set economic policy began in 1975 following the end to the Bretton Woods currency system, when French President Valery Giscard d’Estaing invited the leaders of West Germany, Italy, Japan, the U.K. and the U.S. to a summit in Rambouillet, France.
The smaller group’s influence reached its zenith in the mid-1980s when it agreed the Plaza Accord to weaken the dollar in 1985 and the Louvre Accord to buoy it two years later. A 2008 study by ECB economist Marcel Fratzcher found the G-7 was successful in moving currencies within a year on 80 percent of the 29 occasions it tried since 1974.
This week’s intervention was the G-7’s first since September 2000’s effort to boost the euro after it slumped in only its second year of existence.
In the past decade the group has shied away from attempting to directly move currencies, choosing instead to use so-called verbal intervention. At a 2003 meeting in Dubai, the G-7 started saying that exchange rates “should reflect economic fundamentals.”
The G-20 began echoing the G-7’s stance when finance ministers and central bankers said after October talks in South Korea that they would “move towards more market determined exchange rate systems that reflect underlying economic fundamentals.”
Continued intervention from the G-7 may be limited given it could “raise some eyebrows” in China, which is under pressure from the U.S. to allow the yuan to appreciate more, UBS AG currency strategists including Geoffrey Yu wrote in a report.
“The earthquake has triggered the latest round of yen strength, so China will probably let it rest for now,” the UBS strategists said. “But if G-7 action is sustained, tension could rise.”
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