Medley On The Real Dollar Story

Submitted by hedgeyourmind

G7: The Real Dollar Story

Forget Robert Fisk's latest anti-American fantasy about a "secret" deal to end dollar-priced oil in a loss-making British newspaper. For once, truth is more interesting than fiction. Behind the scenes at recent G20, G7 and IMF ministerial gatherings, a genuine and, until now, untold story of high politics and the US dollar has been taking shape.

Not since 2004 has European Central Bank President Jean-Claude Trichet been so relentlessly vocal in his calls for a "strong dollar," even intriguingly elaborating for the first time that global rebalancing via exchange rates should "not imply a change in the bilateral position of the dollar and the euro."

The Europeans are getting worried. As the euro flirts with the $1.50 level not seen since mid-2008, the Eurozone's economic and monetary authorities are mulling their first unequivocal verbal protest against the currency's appreciation in five years.

Why now? Because Eurozone officials have lost trust in the commitment of US President Barack Obama's administration to the "strong dollar" policy. This loss of trust has reached a point where some even suspect the US has reached an accommodation with the Chinese whereby Beijing turns a blind eye to dollar depreciation in return for a moratorium on Washington's public calls for renminbi appreciation.

A doubt is born

Underlying these suspicions are two factors: the illogic of recent currency trends, and the increasingly obvious signs of a burgeoning office romance between the US and China. The Eurozone followed the US into recession and their central banks respectively forecast zero and nearly 3% growth in their GDP next year. The Eurozone policy response also lagged, yet, since mid-June when huge demand for the ECB's first 12-month liquidity tender probably took rates to their cycle low, the trade-weighted euro has appreciated by nearly 5%. Over the same period, the renminbi has fallen 6% against the euro while pegged against the dollar.

Coincidentally, since US Treasury Secretary Tim Geithner's June visit to Chinese President Hu Jintao, Premier Wen Jiabao and Vice Premier Wang Qishan in Beijing, Europeans have detected a marked change in tone between the Americans and Chinese over a range of issues. Following further high-level bilateral meetings in July and September and Obama's decision to postpone a meeting  with the Dalai Lama, Europeans say they have never before seen such levels of Sino-US détente at the IMF meetings in Istanbul.

Even Geithner's three-time public commitments to a "strong dollar" since the Pittsburgh G20 September 24–25 have failed to win over suspicious Europeans. In their view, his firmer comments, in which he recognized how the dollar's "role in the system conveys special burdens and responsibilities on the US,"only came after much public prodding from Trichet and Eurogroup Chairman Jean-Claude Juncker.

Trend depreciation

What would justify this behavior, they ask? One explanation is a tacit Sino-American currency deal. In Europe, policymakers have long accepted the Americans won't be willing or politically able to shrink their twin deficits to sustainable levels only through boosting saving.

They have always believed the dollar would need to go through a trend depreciation. However, this should not happen disproportionately at the expense of Eurozone exporters, nor should it be a substitute for US structural adjustment.

As they grow increasingly skeptical about the political will to make these structural changes, Europeans are starting to conclude the administration—or at least parts of it—are trying to manage the dollar lower and have accepted the renminbi will go with it at least in the short term.

Indications from Beijing and Washington are that the Europeans are reading too much into their improved relationship. Not only has Geithner recommitted publicly to the "strong dollar" and renminbi appreciation over time, they say, but the Istanbul G7 communiqué notes China's "continued commitment to move to a more flexible exchange rate, which should lead to continued appreciation of the Renminbi in effective terms." The Chinese say they haven't changed their fundamental concerns about a US fiscal turnaround.

So far, the Europeans are not pacified. They want to be convinced of paranoia rather than justification, which is the reason they have not already gone beyond Trichet's careful reminders of the public commitments of Obama and Geithner to a "strong dollar" and calls on Asian authorities to share the dollar-adjustment burden with the Eurozone.

But both Washington and Beijing are running out of time if they want to avoid the emergence onto the world stage of yet another central bank with an exchange-rate objective.