Monday, October 27, 2008

Curious G7 comments of concern without action

The G7 voiced "concern" about the appreciation of the yen. They also stated that they would "monitor the markets closely and cooperate as appropriate." This jawboning was supposed to have the effect of slowing the ascent of the yen. No such luck. Without clear action to stop the delevering flows, there is no reason to see a change in the yen direction. It is usual to see the G7 be so specific about a currency but there is a significant bias with the Europeans given the size of the move in eur/yen.

The Japanese have the most to lose from an appreciation given their strong export business and the current slowdown. Given the size of the delevering, there is little reason for Japan to intervene and stop the move. They will have to wait for an extreme when their intervention money will have some impact.

The G7 has lost control of global capital flows and there does not seem to be a financial mechanism to gain control of the situation. The problem is twofold. There are countries which are seeing their currencies depreciate. In this case, raising interest rates will hurt internal growth. Using foreign reserves may not be effective if the size of delevering is greater than the available reserves. The second problem is currency appreciation which is the case of the yen. Here there may be the belief that flooding the market with yen may work, but if world interest rates converge there is less room for a rate impact. The G7 belief is that Japan could be pressured to reflate and cut the yen rally.

All trends will continue in this environment. Policies in place will not end the flight to home currencies and the cut in leverage.

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