Falling dollar should force G7 to find a new role

Just as the clocks change twice a year, so finance ministers of the Group of Seven (G7) wealthy nations troop off to Washington for their biannual meetings. The latest one takes place this weekend (19/20 Oct). Yet again the issue at the top of the agenda will be the fall in the dollar.

Finance ministers – at least those outsider the dollar bloc – are worried for two reasons, one altruistic and one selfish.
The altruistic reason is a worry it could turn into a full-blown slump that triggers a spike in inflation, forcing the Federal Reserve to raise interest rates that in turn delivers a consumer recession.

The selfish reason is that they are concerned that the appreciation in their currencies, most notably the euro, is harming their export sectors. They say that villain in the piece is China which keeps its exchange rate artificially low against the dollar, forcing the euro to take the brunt of the pain. This is true enough. Since Beijing revalued the renminbi in July 2005, the dollar has fallen 9% against the Chinese currency but 18% against the euro.

Ministers will doubtless issue the same sort of statement they have for some years. Emerging economies with large current account surpluses “especially China” must let their effective exchange rates move, they will say. These statements rarely move currencies as the markets have decided the G7 has little relevance in a world where Italy and Canada are members but China is not. The first step towards using finance ministers as a conduit for discussing currencies would be to include the BRICs – Brazil, Russia, India and China.

The problem is that would imply a single European Union seat at the table, a move opposed by the four EU members – France, Germany, Italy and the UK. The real reason for the increasing irrelevance of the G7 is it assumes the dollar is the world’s reserve currency. Overseas investors do not see life that way. They are shunning US equities in favour of other markets and may do the same to US credit in the wake of the crisis on Wall Street.

In terms of currency transactions, the dollar has lost 2.4% of global share over the last three years while emerging market currencies have gained 4.6%. Several countries have reduced the importance of the dollar in their currency baskets while others mull pricing oil in euros not dollars.

The challenge for the US is to accept the solution to the imbalances in the financial system may involve a less pivotal role for the dollar. In a perfect world the G7 communiqué would acknowledge that the future will be less dollar-centric. Sadly just as millions of households prepare to turn their clocks back for winter, finance ministers will try to do the same for the financial markets.

This article first appeared in The Business (www.thebusiness.co.uk) on 18 October 2007