from Follow the Money

Stephen Jen knows currencies, not communiqués

May 3, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Stephen – the dollar will go down, but “ the US will not adopt a weak dollar policy … and the sky will not fall on the dollar” – Jen has gotten the course of a the dollar/ euro roughly right for the past few years.  Jen was bearish on the dollar when US rates were low, turned bullish in 2004, was vindicated in 2005 and is now bearish, though as he takes pains to point out, he bearishness is cyclical, not structural. 

Jen takes far more relish explaining why he does is not a dollar perma-bear (and that imbalances are a natural product of globalization) than he does explaining his cyclical call for more dollar weakness.  Indeed, is already arguing that the structural perma-bears will push the dollar down too far, setting the stage for Jen to make another triumphant long dollar call, proving the perma-dollar bears wrong …

He may well be right.   He was before.

But he almost certainly is wrong to argue that some members of the G-7 didn’t read the annex carefully.   He writes in his most recent client note:

“The wording of the annex may not have been vigorously discussed by all the members of the G7, like the communiqué itself had.    Therefore it may not have the full endorsement of all the G-7 members.   One important difference between the Communique itself and the annex is that the former refers to greater AXJ (Asia ex Japan) currency flexibility while the latter calls for more appreciation.   These two parts o the G7 statement were probably drafted by different people, and went through different editing processes.   This is why the G7 statement appeared so confusing to investors, in my view.   Some members of the G7 felt an Annex was necessary because the IMF had just hosted a conference on global imbalances and the G7 wanted to make sure that it, rather than the G7, took ownership/ leadership on this matter.”

I cannot rule out the possibility that someone – say the Japanese – regrets not insisting that the word “appreciation” be taken out of the annex, even if everyone knows that flexibility means appreciation.  But I am pretty confident that the different parts of the communiqué were not drafted by fundamentally different people, and that they did not go through a fundamentally different vetting processes.

I am at best an amateur currency strategist.   But I am a semi-pro at communiqué drafting. 

I wrote a bit of draft communiqué language back in my days at the Treasury.  I worked in the G7 office for a while, and that office is responsible for communiqué related intra-G-7 communication.

So let me tell you a few things about how the communique process.

The US hosted this G7.  That means the US had the “pen’ and circulated the initial draft of the communiqué, probably a week of two before the communiqué was released.    And that Washington crafted the initial draft of both the communiqué and the annex.   I suspect a couple of my former colleagues (and my former boss) wrote it – and if Adams didn’t help write the language, I am sure Adams personally signed off on it.  This was his statement. 

And since the language originated in the Treasury I would bet that “large oil exporting countries” meant the large oil countries on in the Treasury’s white paper on petrodollars.  That means Saudi Arabia as well as Russia.  Sorry Stephen.  

After the US circulated a draft, everyone in the G-7 would then have exchanged letters and redlines proposing a series of edits to the initial language the US proposed.  That exchange would narrow down the differences. 

Before the ministers formally met, the G-7 Deputies would have met to hammer out the communiqué language.  This is when the hard parts of the communiqué – the fx language, the oil language, anything else that is hard – is usually  negotiated.

Sometimes a few issues are left to the ministers, but their job really isn’t to draft communiqué language – or to know when the G-7 is making small deviations from earlier language.   That is the job of the deputies and their staff.

There are a couple of constants of the communiqué drafting process.  Central banks vet any language that hints at monetary policy.   Back when the communiqué went over developments in every major region, each country/ region generally got to describe how to characterize its own economy.    Language that has been accepted previously is – generally speaking – still acceptable.  Finally, any new language tends to be discussed extensively. 

So I would guess that the language in the annex was discussed vigorously.  

That doesn’t mean that the annex language and the communique language will always be totally consistent.   The US may have kept flexibility in the main communiqué because it is already agreed language, and put appreciation in the annex.    Or the US may have put appreciation in both drafts and the Japanese—or someone else – may have objected to appreciation in the main communiqué but not the annex.  Or the price the Japanese paid for avoiding a general call for appreciation in all economies with large current account surpluses may have been accepting the explicit call for appreciation in emerging Asia.  Remember, Japan has a current account surplus and the yen is very weak in real terms.  Toyota’s success has translated into a stronger yen. Or maybe the ministers personally negotiated the exchange rate language in the main communiqué but not the language in the annex.

I wouldn’t rule out any of these possibilities.  Or the possibility that there was just a bit more room to spell out what the G-7 meant in the annex.

But I find the argument that no one paid careful attention to the annex rather implausible. The annex contained the most innovative language of the communiqué.  I suspect that implies it required a fair amount of discussion – maybe not as much discussion at the exchange rate language in the communiqué, but still lots.

Moreover, the April communiqué language wasn’t a bit break from past language, and the annex language isn’t a huge break from the communiqué language. 

The April communiqué noted: “Greater exchange rate flexibility is desirable in emerging economies with large current account surpluses, especially China, for necessary adjustments to occur.”

The September communiqué welcomed “the recent decision by the Chinese authorities to pursue greater flexibility in their exchange rate regime.” 

The December communiqué  noted “further flexible implementation of China's currency system would improve the functioning and stability of the global economy and the international monetary system.”

I am sure that the G-7 would have liked to note that China was proceeding with its move toward greater flexibility, but it couldn’t really.   And I read the April communiqué as calling for more exchange rate flexibility in the oil exporters with big current account surpluses, not just China.  That is fully consistent with the Annex’s call for “enhanced exchange rate flexibility” in some oil-producing countries. 

There was a bit more room in the annex to spell out what the G-7 wants the rest of the world to do. The annex said “In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations.”

But in my view, the G-7 didn’t drop the call for flexibility so much as spell out that flexibility doesn’t include – at least in their eyes – something like a true basket peg that implies RMB depreciation against the dollar when the dollar rises v. the euro.    “Necessary appreciations” was an innovation, but it is hardly a shock to discover the G-7 wants to see the RMB to appreciate, not depreciate. 

I also suspect that the rest of the G-7 recognized that the US – and Under Secretary Tim Adams personally – needed to show that something was happening on the “imbalances” issue.   Business as usual was unacceptable, if not the US Treasury, then to the US Congress.   The US Treasury needs a bit of cover – and some signs of progress – to avoid labeling China a currency manipulator.  And since it didn’t get anything out of China directly, it needed something from the G-7. 

I don’t think the Europeans really want the US to label China a manipulator.  China might dig in its heels, and all the pressure would fall on the euro/$.  That is the last thing the Europeans want.  They are happier with 1.20 than 1.30 – or 1.35 -- euro. 

That probably meant that the rest of the G-7 let the U.S. get a bit more of its preferred communiqué language than they normally would. 

The G-7 deputies are certainly capable of vigorously discussing two pages of communiqué language, not just the language in the main communique.  Back in the verbose Clinton Administration days, the G-7 deputies would go through 6, 7, 8 or even more pages of communique language.   Annexes were developed because Paul O’Neil insisted that the main communiqué be limited to one page.   He often cared more about limiting the communiqué to a page than about what the communiqué said.  And the deputies soon discovered that they sometimes had more than one page worth of things to say.

That said, I do think the deputies were a bit surprised by the vigorous market reaction to their communiqué.  Recently, communiqués have been non-events.   Previous annexes hardly moved markets.    

And I agree with Jen on one point – “the US (G7) did not mean to convey the notion that this was a mini-Plaza.”   Bernanke and Trichet have both said as much.  The US has articulated a strong yuan policy.  But not (at least not yet) a weak dollar policy.

And, more importantly, today’s version of the Plaza would need to include a bunch of countries that aren’t in the G-7.   The deal, if there is one, involves trading a serious US commitment to reduce its fiscal deficit (which, to be credible, needs some efforts to raise revenues, not just fake commitments on the spending side) for a series of step revaluations in those currencies that have been tightly pegged to the dollar.   And probably some signal that the yen should appreciate.   At a minimum, that means China has to be part of the deal.   And with oil at $75, I think the Saudis (really the GCC) and Russians have to be part of the deal too.  Or at least part of a side deal. 

The G-7 issued instructions to the dollar block, telling them that they recommend that they consider breaking away from the dollar.  But it didn’t do a deal with them.

That is my critique of the April communiqué.  It reads like a G-7 demarche to the rest of the world.  It is very thin on the commitments from the countries that actually sat around the table. 

One piece of evidence that there was no mini-Plaza (and that the US got most of what it wanted) is the language describing the needed US contribution to reducing global imbalances in the annex. 

The overview spoke of the need for the medium-term evolution of private savings and investment – not public savings.  That is a mini-victory for the US position that fiscal deficits don’t matter.   The more specific language referred to increasing national savings in US by “continuing fiscal consolidation, addressing entitlements and raising private savings” – in other words, nothing new.   “Continuing fiscal consolidation” means stay the Administration’s fiscal course, entitlement reform is a political non-starter and would have no impact on the deficit in the near term either (unless current benefits, not future benefits, were cut) and steps to increase private savings could include budget-busting tax breaks.   Nothing hinted at the need for more revenues. I doubt this was an accident.   Tim Adams has a mandate to push for Asian appreciation, but not to undo the Bush administration’s tax cuts.

I doubt that any Plaza is possible unless the US is willing to give a bit more.  If China is going to move by more than it wants too, the US needs to show that it is willing to take some difficult steps.   

Enough communiqué-ology.

One note: I am making inferences based on my experience, nothing more.  I have not discussed the communique with my former Treasury colleagues.


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