from Follow the Money

G-7 punts on the yen, as expected

February 10, 2007

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The G-7 punted on the yen, more or less.  They didn't highlight yen weakness in their closely watched paragraph on exchange rates.  Though, as Morgan Stanley points out, the language on Japan ("Japan’s recovery is on track and is expected to continue. We are confident that the implications of these developments will be recognized by market participants") presumably was meant to send something of a signal. 

I wonder if the markets will pick up on the "recovery is on track" language,  or will take the absence of stronger language on the yen as an "all clear" sign to make even bigger bets on yen weakness.  

The G-7 did talk explicitly about the RMB.  That isn't a surprise, but Chinese presumably still don't  like being singled out.  China isn't a part of the G-7, and its currency was called out.  Japan is a part of the G-7, and its currency wasn't mentioned.  Yet by some measures the yen is now as undervalued as the RMB.   That sort of thing rankles the Chinese -- even though it would be a far bigger deal for the G-7 to talk about the yen than the yuan precisely because Japan is a part of the G-7.

Intellectually, though, the language on the renminbi makes sense.   The G-7 called for an appreciation of the RMB in real effective terms

In emerging economies with large and growing current account surpluses, especially China, it is desirable that their effective exchange rates move so that necessary adjustments will occur

That is right.   China's current account surplus looks set to increase even further from its already enormous (8-9% of GDP) 2006 levels on the back of strong export growth and stable or falling commodity prices.  The RMB appreciated against the dollar (modestly) last year, but since the dollar slid v the euro by far more than the RMB rose v. the dollar, the RMB didn't move much in real effective terms.   The RMB/ euro matters, not just the RMB/ dollar.   Remember, China now trades as much with Europe as with the US. 

The Chinese are not the only Asian economy that won't like the communique.  Korea will be disappointed that the G-7 didn't agree to do something about yen weakness.  

The yen/ won probably has a bigger impact on Korea's economy than the won/ dollar -- and right now, the Koreans are very worried about the won's strength against the yen.   Probably even more worried than the Germans. 

The G-7 doesn't agree on hedge funds, not really.  The Germans want to do something, the US and the UK aren't convinced there is a need to do much, and certainly not as much as the Germans would like.  So they agreed to a study.  Fair enough.   Call it papering over a disagreement.  But if the Financial Stability Forum's report is done well, it should provide a lot of information about the evolution of financial markets since 2000. Among other things, I'll be interested to see if the FSF believes that hedge funds are still less leveraged than they were in 1998, taking into account the embedded leverage of many derivative contracts. 

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