Outlook: Forex markets struggle to make sense out of Snow in Dubai

Few G7 communiques rise above the anodyne, if only because they are dictated by what everyone can agree on, which is rarely any more than motherhood and apple pie. Not so the one agreed by finance ministers in Dubai over the weekend, which produced a remarkable effect in currency markets yesterday, with the yen and dollar bouncing all over the place.

Few G7 communiques rise above the anodyne, if only because they are dictated by what everyone can agree on, which is rarely any more than motherhood and apple pie. Not so the one agreed by finance ministers in Dubai over the weekend, which produced a remarkable effect in currency markets yesterday, with the yen and dollar bouncing all over the place.

The key paragraph was the call for "more flexibility" to allow markets to determine exchange rates. To the casual observer, this might not seem like a statement of any more than the obviously desirable, a view apparently shared by the British Treasury delegation, which was keen to down play its significance. There hasn't been any change at all, said one senior Treasury official, whom I won't embarrass by naming. But for John Snow, the US Treasury Secretary, it was "a milestone change".

The two currencies Mr Snow most has in mind are the Japanese yen and the Chinese renminbi, neither of which are wholly subject to market forces as things stand. The Chinese currency is pegged at a relatively low level against the US dollar, to the disadvantage of US and European manufacturers alike. Meanwhile, the Bank of Japan has until recently been selling yen at record levels in an attempt to keep the Japanese currency depressed against the dollar and underpin Japan's still fragile economic recovery.

Market forces would dictate that both currencies should be a good deal higher against the dollar than they are, yet in both cases Government policy dictates that they are kept artificially low. The effect has been to create some truly awesome trade imbalances, between the US and China and Japan on the one hand, and between China and Japan on the other.

The US runs a massive and growing trade deficit with China and Japan. Meanwhile, China has overtaken the US as Japan's biggest export market, particularly for capital goods. Another way of looking at the problem is that most of China's growing export success story goes to America but most of its imports of capital equipment to support that growth come from Japan. To keep the dynamic of the process going, both the yen and the renminbi have to be kept low against the dollar. Europe is caught in the crossfire. The biggest competitor to Japan in capital goods is Germany, which with the euro now relatively strong against the dollar, finds itself outpriced in the growth markets of Asia.

So how is this situation going to resolve itself? For reasons of ideology, Mr Snow favours a free floating exchange rate system, with the capital markets wholly dictating the strength or otherwise of currencies. Yet he speaks with forked tongue. Having heralded the G7 statement as a "milestone change", he yesterday seemed to perform a 180 degree about turn, by saying there was no change in the "strong dollar policy".

On one level, this was just a white lie for public consumption. But there was more to it than that. The strong dollar is not all downside. In keeping their currencies depressed, both China and Japan are forced to buy dollar assets, thus helping to support the burgeoning US budget deficit. The effect is also to keep US inflation and interest rates low and consumption high. Far from damaging the US economy through the loss of manufacturing jobs to China, there is a respectable case for arguing that a strong dollar continues to be a boon to both regions.

Eventually China will allow the renminbi to revalue against the dollar. I'd bet on a small revaluation later this year or early next with the promise of greater currency liberalisation further down the line. With the yen, there hasn't been any intervention for some months now, but with the currency strengthening to a level in recent weeks which might endanger the export led recovery, the Bank of Japan must again be raring to go. Curiously, it only tends to intervene if the US agrees. Japan was, of course, a party to the G7 communique, so does this mean it has agreed to let the yen appreciate? We'll see.

Alstom aid

When is illegal state aid not illegal state aid? When, apparently, it is injected in the form of debt and not equity. So it was that Brussels yesterday gave its blessing to the French government's bail-out of the engineering conglomerate Alstom, even though it involves an even bigger bung from the French taxpayer than was originally envisaged.

The initial plan would have seen the French state paying €600m for a one-third stake in the manufacturer of the TGV and luxury cruise liners. It was all too much for the Competition Commissioner, Mario Monti, who pronounced a firm non and told the government, the banks and the company to go away and think up something that was less blatantly interventionist.

The new deal involves the government stumping up €800m for a variety of esoteric bonds, a portion of which are convertible into shares some-time-never, but has nevertheless passed the Commission's Good Housekeeping test of what constitutes acceptable state support.

After the bail-out of France Telecom, there was a weary inevitability that the rescue of Alstom would somehow overcome the competition concerns of Brussels. Had this been Britain, it would have been left to the insolvency practitioners to see what capital could be rescued from the wreckage of Alstom, leaving employees to their fate. But since it is France, jobs have been saved instead.

There is, however, a silver lining for the UK. Though you would not guess it from the name or the composition of the board, Alstom is part British - a product of Lord Weinstock's merger of part of his GEC empire with Alcatel of France back in the 1980s. And although Alstom's UK presence is much diminished, some of those French euros will be helping to preserve British jobs.

The Commission's approval of the Alstom deal should also make it hard for Brussels to object to the UK government's rescue of the nuclear generator British Energy - a deal which involves the taxpayer shouldering all the company's decommissioning liabilities. However, in British Energy's case there is at least the purpose of keeping the lights on and cleaning up the mess. No such justification exists with Alstom.

Baltimore Tech

Strange but true. Baltimore Technologies, which yesterday reduced itself to a small cash shell by selling off its remaining business in internet security software for just £5m, was once worth nearly £7bn. For a brief few months, it was even a member of the FTSE 100. Yet its fame and fortune proved scarcely less transitory than that of Will what's-his-name from Pop Idol. The moral of the story is never invest in something you cannot understand.

At the height of the technology boom, investment wisdom of this sort counted for nothing. Baltimore was in something to do with internet security, and that was enough. Eventually all business transactions would be performed online, it was widely assumed, so this had to be a growth business.

Never mind that it was hard enough even to understand how Baltimore's public key infrastructure technology worked, let alone how it might be sold and marketed, and who might profit from it. Nevermind too that whatever it was that Baltimore did was alive with competitors. It was something to do with the internet, it was quoted, and, er, it was the future, wasn't it? Apparently not.

Baltimore was the result of a merger between the business interests of a nerdy mathematics professor, Henry Beker, and a fast talking Irishman, Fran Rooney. It should have been a perfect match of opposites but in fact they never gelled. About the only thing they could ever agree on was when to sell their shares, which, fortunately for them, they managed largely to offload when the price was still relatively buoyant. So there's the other lesson. Pay attention to the directors' share dealings.

jeremy.warner@independent.co.uk