Ministers face up to market realities

Despite a modest rally by the dollar against the yen in London trading, the score stands at 40-15 to the financial markets. The finance ministers of the Group of Seven leading industrial countries announced in Washington this week that an "orderly reversal" of this year's dramatic swings in exchange rates would be desirable - but they could not produce the aces they would need to deliver it.

The ministers' communiqu stressed the measures the seven men could agree on; it is in the nature of such documents to pick out the lowest common denominator. In briefings, officials were at pains to point out that there had been more agreement than disagreement. The Chancellor, Kenneth Clarke, referring to the weeks of public bickering between G7 countries over ways to handle currency-market turbulence, said this week's meeting "didn't live up to its billing".

This financial love-in might have delivered a strategy for reversing the dollar's fall and the yen's rise, but there are no new tactics. The ministers share the same analysis of the dramatic currency swings but could not agree what to do in the short term. If the markets continue to "overreact" and sell the dollar lower still - well, so be it.

The G7 analysis is that exchange rates have gone beyond the levels that are justified by underlying economic conditions. But some currency realignment was justified. As Mr Clarke put it in his statement to the IMF's policy- making Interim Committee yesterday, volatility in the financial markets has "provided a reminder of how costly it can be to allow economic imbalances to persist until markets finally force the necessary adjustments".

These imbalances are the big fiscal and trade deficits in countries with weak currencies. Other G7 members see the United States as the biggest culprit. Its current account deficit was a record $156bn in 1994 - almost an exact mirror of Japan's $129bn current account surplus. The US government's budget deficit is another whopper. It reached $203bn last year.

These tides of US red ink are not the world's biggest as a proportion of GDP, but they are the biggest in absolute numbers of dollars needed to finance them.

Even so, the US administration is touchy about being instructed to cut back by countries with bigger budget deficits relative to the size of their economies. Japan's budget deficit is equivalent to 3 per cent of GDP, Germany's to 2.5 per cent. Last year Britain's public sector borrowing requirement was 6.9 per cent of GDP, but at least Mr Clarke has had the grace not to lecture Robert Rubin, his American counterpart, on how to run his budget.

Mr Rubin agreed that the US deficit needs to be reduced. Unfortunately, budget-cutting - the best combination of cuts in spending and taxes alike - is the political football of choice on Capitol Hill. The IMF's assessment earlier this week of the likely progress was not optimistic.

The administration's February budget proposal would not produce a significant reduction this year and foresees a rising deficit in future years. The IMF concluded: "Even assuming that effective measures to curtail healthcare costs and other entitlements are adopted, it would be difficult to achieve the necessary further improvement in the fiscal balance in the medium term."

Delivering a lower deficit will not be easy for the US. It will not be easy anywhere. Mr Clarke described it as "grasping the nettle of fiscal consolidation". Ouch. The G7 strategy involves long-term, painful structural measures. It is no quick fix.

The trouble is, the long-term approach is the only shot the industrial countries can agree they have left. The French and Japanese could not persuade the other five that target zones for exchange rates or taxes on currency trades were viable.

French finance minister Edmond Alphandery emerged grumpily from the G7 meeting saying it would have been better if the US had made a "significant gesture" on the deficit front.

All the G7 can do is pursue sound policies, given that there was no consensus on more active measures. The harmonious communiqu admitted the realities of the new game in global financial markets.