Economics: Self-interest rules as G7 drifts apart
Sunday 28 February 1993
The meetings of finance ministers go on, as they did yesterday in London. They do no harm. But there is little sense of the shared endeavour with which their predecessors drove down the dollar after the Plaza agreement of 1985, or indeed stabilised the US currency after their Louvre meeting in 1987.
Since 1989, the G7 nations have drifted apart, pursuing domestic objectives. The movement of their currencies has reflected those priorities. In the US, low interest rates were designed to haul the economy out of its Eighties debt trap. They had the side-effect of a declining dollar.
Japan, too, has had its own agenda. It would no doubt like a G7 consensus to encourage the recent rise of the dollar because this would help to stop the yen's surge. The Japanese currency is up by a fifth over the year - a painful shift for Japan's trading sectors, especially since the domestic economy is suffering from the falling asset prices and high debt familiar in Britain.
But there is no corresponding willingness among other G7 members to cap the Japanese currency. The yen's appreciation is the least damaging way of reducing Japan's monstrous dollars 117bn current account surplus last year, since the alternative is probably US protectionism. Japan's economic salvation lies in another and more enthusiastic fiscal package to stimulate public works.
Within Europe, the country that matters most to Japan and the US is Germany. The Germans, too, have pursued their own domestic agenda as they have tried to control the inflationary implications of reunification. The Bundesbank has liked a lower dollar because it reduces German import prices and inflationary pressures. A strongly rising dollar would make the Bundesbank more reluctant to embark on rapid cuts in interest rates.
Nor does President Clinton have any interest in a strong rebound in the US currency, since his first priority is jobs at home. The rise in the dollar eases the way into the US market for foreign producers, and will tend to redistribute some US growth and jobs to its trading partners. So any rise in the dollar will not be a matter of international agreement so much as an incidental consequence of higher US interest rates as the recovery gets under way.
France, like Britain, is no longer a key player but French interests are also split: capital flows from the German mark to the dollar weaken the mark, and make it easier to fix the franc against the German currency without a large gap in interest rates. But a weak mark may mean German interest rates are higher than they would otherwise be. The real question about France is not one for the G7, but for the European Community: will the Germans - and this means the Bundesbank, not Bonn - fight off another speculative attack on the franc?
There appears to be a touching faith in Paris and Frankfurt that this will not happen. A leading continental industrialist recently dined with senior Bundesbank council members in Frankfurt and asked how confident they were that the franc could be defended ahead of the National Assembly elections on 21 and 28 March. The reply was that they had talked to George Soros (the brilliant speculator who is said to have made more than dollars 1bn betting against the pound in September) and he had promised not to sell the franc short.
In reality, the Bundesbank can defend the link if it wants to, for the simple reason that it can print enough marks to meet any demand. But one consequence would be that German interest rates could fall sharply, at least temporarily. And the Bundesbank has not yet shown any sign that it is prepared to make such sacrifices of its domestic objectives for its international ones. There must, therefore, be a real chance that the franc-mark link will be broken.
The danger is particularly acute when the markets have a clear date on which there is a risk of a realignment, as they did in September at the time of the French referendum on Maastricht. Imagine that there is a one in 10 chance of a devaluation of 10 per cent at some point over the next year or even beyond. In other words, anybody holding that currency could lose a tenth of their capital. Investors may insist that interest rates are one percentage point higher than German mark rates - 10 per cent of 10 per cent - to compensate for the risk of a capital loss.
But if the devaluation may happen on one specific day - after the French referendum or elections - an interest rate accelerator begins to operate. A year away, one percentage point on annual interest rates is enough to offset the risk. Half a year away, the annual interest rate premium has to be double the size to offset the same risk. The day before the day arrives, the interest rate premium has to be one per cent a day - an annual rate of hundreds of per cent.
The problem for the French is that they have once again set a date beyond which there is a real risk of a franc devaluation, whatever the right-wing parties now say. The front-runner for the Finance Ministry if the centre-right parties win is Edouard Balladur. Yet it is the same Mr Balladur who promised before becoming Finance Minister in 1986 that there would be no devaluation, and who devalued soon after taking office.
Any renewed turbulence in the exchange rate mechanism may well hit the pound. Sterling appears to be in the invidious position where almost any major ruffle in the foreign exchanges is an excuse to sell. The pound will not shake off its persecutors until there is incontrovertible evidence of a recovery, and we are still in a period of mixed signals.
Last week's crop was generally encouraging. The CBI survey was the first since just after the election to show the sort of optimism about output that has traditionally signalled an upturn. The growth of cash in the economy is running ahead of the Government's target ceiling. The Central Statistical Office also slipped out an analysis in Economic Trends which admits that it has underestimated growth. The CSO says it is getting better, and it will not happen again. But I doubt it.
The bias has not been large: the CSO owns up to an average revision upwards of half a percentage point in the annual growth rate over the 10 years to 1988. This appears to come about because the CSO compares its first estimate of national output with a figure for national output a year earlier which has already been revised upwards to take account of new information. The result is to reduce measured growth.
The latest GDP figures, for example, say that output dropped by 0.1 per cent over the year to the fourth quarter. But this compares a new figure for the fourth quarter of 1992 with a figure for the fourth quarter of 1991 which has been revised upwards from 113.1 (1985=100) to 113.4. If we compare first estimate with first estimate - like with like - the economy is seen to have grown by 0.2 per cent. It is not much, but after the last few years perhaps we should be thankful for small mercies.
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