G20 Meeting A Positive Surprise

The Group of 20 nations (G20), a forum representing the world’s largest economies, to which the United States and other participants have given the leading role in guiding the global economy, met Friday and Saturday in Moscow at the level of finance ministers and central bank presidents. While some recent G20 meetings have been judged non-events by observers, that cannot be said about this week’s gathering.  After all-night negotiations, the G20 nations were able to agree on a statement that represents a significant step towards common global guidelines for exchange-rate policies. The objective of defusing global tensions and talk of a currency war was deemed of such importance that countries were able to overcome various differences on currency policy issues for the first time. They did this while avoiding singling out Japan, whose recent actions had contributed to the higher tensions.

The G20 countries stated, “We will refrain from competitive devaluation. We will not target our exchange rates for competitive purposes.… We reiterate our commitments to move more rapidly toward more market-determined exchange rate systems and exchange rate flexibility to reflect underlying fundamentals, and avoid persistent exchange rate misalignments, and in this regard, work more closely with one another so we can grow together.” This agreement that exchange rates should be market-determined is a breakthrough, as is the promised cooperation and trust among these important economies.

It is accepted that the major developed countries should continue their monetary-policy stimulus to encourage growth in their economies, which is important for global growth. It is also accepted that developing countries may use measures to moderate destabilizing short-term capital flows. On both sides is understood that such policies are acceptable if not pushed to extremes.

Following this agreement, Japan is expected to refrain from again specifically referring to any exchange-rate target. It will be free to pursue monetary and fiscal policies that are directed at domestic economic objectives such as promoting growth and reversing deflationary trends, even though these policies will likely result in further yen depreciation.

Of course, currency market participants are well aware of the Abe government’s desire to see the yen weaken further and that its policies will likely have that effect. The central bank under new leadership to be appointed by Abe within a month is expected to undertake an expanded program of quantitative easing through buying longer-dated Japanese government bonds, pumping substantial additional liquidity into the economy. This asset purchase program will likely become open-ended before year-end. Furthermore, after the G-20 meeting Abe confirmed that the option of Japan buying foreign bonds remains on the table. The Bank of Japan has already in January raised its inflation target to 2%.

The currency market responded this morning with the US$/Japanese yen weakening, moving back to 93.9. Market participants appear to believe the yen’s decline will continue. The equity market also was re-assured, with the Nikkei index rising 2.1%.
More generally, there appears to be a broad agreement that the global economic recovery is weak and fragile. Accordingly, ambitious fiscal targets for debt reduction (set in 2010 to assure bond markets) have not been restated. The austerity involved has proven to be too severe. The governments pledged instead to develop “credible medium-term fiscal consolidation plans … taking into account near-term economic conditions and fiscal space where available.” The objective of promoting global economic recovery is now paramount.

Investors should welcome these results, which are likely to reduce the incidence of political flare-ups over currency developments and improve economic prospects. The ability of the globe’s leading economies to come together in a cooperative approach to a difficult issue, despite significant differences in their levels of development, is encouraging. There appears to be an increased willingness to understand each other’s positions and work towards shared objectives. The G20 governments committed to examine how countries can best deal with the external effects of each other’s actions. The contrast with the continued inability of our politicians in Washington to compromise and reach sensible agreements is striking.

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