IMF and G-7 at Cross Purposes on the Dollar?

In an odd happenstance of timing, the IMF published a report on Wednesday that declared the dollar to be overvalued. As we have noted before, this isn’t the first time they’ve come to this conclusion (they issued a similar finding at the beginning of August). That view, by the way, isn’t one that has made our Treasury Department very happy, since they’d rather have the yuan deemed to be undervalued so the US could pressure China to let their currency float more freely. Declaring the dollar’s value to be the issue makes it harder to argue that other countries should be doing things differently.

The Financial Times provided a recap:

Currency traders were given a green light to continue selling the US dollar on Wednesday, as the International Monetary Fund said the greenback “remains overvalued” and rejected claims the euro had risen too far….

Even with slower growth forecast for the US and a weaker dollar, the IMF sees little improvement in the world’s huge trade imbalances, embodied in the US trade deficit and corresponding surpluses in Asia and in oil exporters.

The Fund thinks that the US current account deficit will remain close to 1.5 per cent of world output until 2012, raising the likelihood of a disorderly plunge in the dollar and protectionism growing over the next few years

However, the IMF’s report was almost certain to have been prepared without the benefit of considering the US Treasury’s August Treasury International Capital report, which showed a stunning and unprecedented $69.3 billion outflow of financial assets. While the dollar indeed may be overvalued, this is not the most propitious moment to encourage further repudiation of dollar assets.

Both the Wall Street Journal and the Financial Times, via John Authers’ “Short View” column, discuss how the G-7 nations would like to halt or even reverse the dollar’s slide, but are unlikely to provide concrete support. From the Journal:

When finance ministers and central bankers from the Group of Seven leading nations gather tomorrow, the financial landscape will be starkly different than when they last met five months ago in Germany.

The dollar has fallen to historic lows against the euro….

But while tensions may be greater at this meeting than in the recent past, the gathering is unlikely to result in any substantive action, say government officials and outside observers. The official G-7 communique, which outlines the issues and areas of focus going forward, is expected to be tweaked slightly.

Most expect the communique to continue reflecting concerns about “risks” to the global economy, to reiterate calls for exchange rates to reflect “economic fundamentals” — and specifically to say that China should allow movement in its exchange rate….

But that’s unlikely to end debate about global currencies. Europeans, in particular, are agitating for some type of Washington response to the recent depreciation of the dollar, which has fallen against the euro and British pound, and is on par with the Canadian loonie.

That decline is hurting European exporters, who must either raise prices for products sold in the U.S. or accept a lower value for their goods. Exacerbating the problem is that many Asian currencies, including the Chinese yuan, are pegged to the dollar, depressing prices on Europe’s exports to other countries as well.

But the U.S. is unlikely to do anything more than continue to reiterate support for a strong dollar — and most observers say the Europeans don’t actually expect, and may not even want, anything tougher. While the falling dollar is hurting European exports, it is helping the U.S. trade gap, which Europeans see as a source of instability in the global economy.

“Wise leaders in business and in government understand that a depreciation of the real value of the dollar is necessary to get a rebalancing of global demand and output,” said Matthew Slaughter, an economist with Dartmouth College’s Tuck School of Business.

By contrast, Authers at the FT argued that the truly terrible Treasury International Capital report for August might spur the G-7 into uncharacteristic action:

Can the Group of Seven’s finance ministers provide a catalyst for the dollar to recover when they meet this weekend? G7 meetings regularly generate speculation ahead of time that fails to affect the market.

But there is room to hope it will be different this time. This is the first time the leaders of the world’s biggest economies have met since the credit crisis.

The fallout of that crisis for the dollar, and for global capital flows, is only now becoming fully apparent. Tuesday’s official data on US capital flows for August were truly astonishing. The net sales of $69.3bn of US securities during the month were more than triple the previous record monthly outflow, set in August 1990.

That prompted reasonable speculation that the point might soon come when the US feels forced to do something tangible to support its currency. Add to that the rhetoric coming from politicians in France, where exporters are worried by the strong euro, and maybe the G7 will do more than talk.

Cynics point out that the US has to say it wants a strong dollar, whatever the reality, and that European pressure comes from politicians, not from those charged with monetary policy.

They also claim that the most important players will not even be at the G7. China’s renminbi has depreciated against the euro this year, as its exports to the eurozone have increased. That could be a bigger issue for Europe than the weak dollar.

And there was a reminder on Wednesday from India that the weak dollar has consequences far beyond the G7. India’s BSE Sensex stock index dropped 8 per cent in early trading before the market was closed and order partially restored. The selling was prompted by news that the country’s regulators wanted, understandably, to limit the flows of capital into the market.

A strengthening dollar would also serve to limit what look like excessive flows into emerging markets. So, even the cynics will be watching the G7 with more interest than usual.

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