G7 has no answer to currency woes
Markets, not governments, will decide the yen's fate, writes Paul Wallace
Thursday 20 April 1995
The "something must be done" school is led by the French and the Japanese. Edmond Alphandery, the French Finance Minister, called 10 days ago for a new system of target zones for currencies, backed up by intervention agreements. The Japanese Finance Minister, Masayoshi Takemura, has also called for policy co-ordination and joint intervention. He has taken the debate one stage further by urging a rethink of the current exchange rate system.
These calls for action seem certain to get a loud diplomatic raspberry from the Americans. From their perspective, the dollar is just fine. On a trade-weighted basis, it hasn't gone into free-fall. The problem, they will argue, is not the weakness of the dollar but the strength of the yen.
Any American tears over the surging yen will be crocodile tears. The private view in the Clinton administration is that the superyen has handed the US just the crowbar it needs to lever open the protected domestic markets of Japan. The Americans and the Japanese are currently at loggerheads over the issue of opening up the Japanese car market. The US Trade Representative, Mickey Kantor, would be unlikely to thank Treasury Secretary Robert Rubin if he lets the Japanese off the hook of an over-priced yen.
The Americans are not alone in making the link between trade and currencies. Earlier this week the French Prime Minister, Edouard Balladur, said that currency instability could undermine the Gatt world trade accord signed in Morocco last year. The French were willing to reopen that most laboriously negotiated of agreements, he intimated, if "sharp currency swings disrupt international trade".
The French position would carry more weight if it commanded the backing of Germany. But the last thing the Germans want to do is to return to the days of "international co-operation". Their experience of stabilising the dollar is that they do all the co-operating. Joint intervention turns out to be one-way intervention. The result is that they pile up unwanted foreign exchange reserves of dollars, as in 1987 under the Louvre Agreement, which then impede their ability to control the money supply and maintain price stability.
The British are no more than bit players now in the great game of currencies. The days when sterling was a reserve currency are long gone. But the Americans can rely on support from the British, who have themselves become neuralgic about currency stabilisation. Policy-makers remain scarred by the exchange rate mechanism debacle - and ever-conscious of the power of the Euro-sceptics, for whom any form of exchange-rate targeting is a step on the path of perdition and ultimate damnation in the form of European monetary union.
Set against this "do nothing" alliance, it is easy to see why little concrete is expected to emerge from the G7 meeting. Yet the pressures leading to calls for reform will not go away.
This latest battle in the currency wars has been different on several counts. For one thing, the speed and scale of the appreciation of the yen - up more than 20 per cent against the dollar since the start of the year - has been extraordinary, putting enormous pressure on anyone who has to meet debts in yen from earnings in dollars. For another, currency strategists agree that the market has not been driven in recent weeks by speculators.
But most important of all, amid all the smoke and gunshot of the day- to-day skirmishes in the world's dealing rooms, can be seen emerging the potential for a fundamental shift away from the dollar as the key reserve currency. For all its travails, the dollar remains the principal currency of world trade and finance. Oil and other commodities are all invoiced and paid for in dollars, generating a huge rollover demand for dollars. The greenback represents 55-60 per cent of global foreign exchange reserves held by the world's central banks.
However, the view is gaining ground that the world's investors are serving notice on this dollar hegemony. What will replace it is a world of three reserve currencies, with the dollar sharing equal billing with the mark and the yen. In this new international order, each of these three currencies would correspond to a regional bloc.
One of the most striking manifestations of this was the US response to the crisis in Mexico. The loan package announced in February is estimated to be the largest international aid programme since the Marshall Plan, tying up a quarter of the US foreign reserves. Contrast that with the policy of benign neglect towards the dollar's weakness against the hard currencies. Maybe poor Mexico - so close to the US and so far from God - has something to give thanks for after all.
Equally, the creation of an embryonic yen bloc can be discerned in the attempts of East Asian central banks to diversify out of dollars into yen. With yen-denominated borrowing over a third of total debt, countries like Malaysia and the Philippines have taken a hit from the rise of the yen.
The pain of losses in international trade and financing are pushing towards an erosion of the use of the dollar. But the problem remains: Japan, and to a lesser extent Germany, are either unwilling to take up the baton or are incapable of doing so. If Japan is to become a reserve currency it must export capital, not hoard it. If Germany is to extend its use of the mark, it must be willing to give up control of the money supply, a price that the Bundesbank has not been willing to pay in the past.
What seems clear, however, is that change, if it comes, will come through the pressure of the currency markets and the remedy they are prescribing - not through inter-governmental fiat.
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