The G7 did speak on major exchange rates, over the weekend, as expected. But they only spoke about the yen’s “recent excessive volatility.” This was about the least they could say under the circumstances, and it is not clear that it will do anything – other than encourage further flows into the dollar.
Why did they not mention the dollar, the euro, and the British pound? One possibility is that they are happy with the appreciation of the dollar and the depreciation (falling value) of the euro and the pound. This would be a bit strange, given that dollar depreciation – from 2002 through the summer – was considered by the G7 to be a reasonable component of the global adjustment process that would put current accounts onto a more sustainable path (yes, notwithstanding “strong dollar” statements from the US.) The dollar was getting close to what the G7 (and the IMF, who do a lot of the technical work in this regard) saw as a plausible “medium-term” value, at least as measured against a broad basket of currencies. Now the dollar has taken off (i.e., rising in value against almost all currencies). How does that help with anything?
It could be the case that the Europeans like the depreciation of their currencies, as this will help cushion the recession. The falling value of the euro makes interest rates cuts in the eurozone less likely, because the European Central Bank (ECB) will see the depreciation of the euro as helping the real economy and also increasing (their) fears about inflation. But given the ECB’s obsession, even today, with inflation – and thus its unwillingness to cut interest rates, come what may – it might be that depreciation is the eurozone’s best short term hope (as well as its likely medium term future, as sovereign risks materialize for smaller countries).
Still, it would be odd if no one at the G7 table isn’t already raising the dangers of deflation (falling prices), particularly in the US – I’m looking at the representative of the Federal Reserve at this point. Commodity prices are falling worldwide and now the price of imports into the US will decline sharply. If this feeds into low prices (i.e., a lower price level, not just slower inflation) then short-term, of course, US consumers benefit. But if lower prices lead to lower wages, then just think what that does to anyone’s ability to pay their mortgage or any other debt – these are almost always fixed nominal amounts.
When people talk about avoiding the mistakes of the Great Depression, they mean in large part not allowing prices and wages to fall. And the faster and further that the dollar appreciates, the more likely we are to worry about deflation.
What then are the internal G7 dynamics? Based on what we saw, and didn’t see, this weekend, I would guess that recriminations and nonconvergent policy views prevail. The spirit of cooperation we saw around bank recapitalizations, just two weeks ago, must have evaporated. We may not want to rely on the G7 to lead the way. Can I interest anyone in a G20 summit?