Deja vu all over again

Political considerations seemed to argue against a new G7 policy initiative. The governments in Germany, Italy, and Canada are new. Japanese Prime Minister Junichiro Koizumi is expected to step down in the fall and there will likely be a new finance minister as well. Many people suspect UK Prime Minister Tony Blair may also step down before the end of the year. The French government is unpopular and there istalk President Jacques Chirac may reshuffle his government to bolster the party’s chances for next year’s election.

In the U.S., there continued to be speculation that Treasury Secretary Snow may be replaced shortly. One rumored potential successor is Harvard’s Martin Feldstein, who incidentally has published at least two essays calling for a substantial dollar decline. Even though Feldstein is unlikely to get the appointment, his comments did not do the dollar any favors.

Rather than prevent a new initiative, the political weakness of the individual G7 countries led to the acceptance of the U.S. offensive, which was a reversion to an earlier and politically-expedient strategy: the reliance on exchange rates to adjust global imbalances. The U.S. has abandoned the strong-dollar policy first articulated by former Treasury Secretary Robert Rubin to signal a break from the devaluationist thrust of his predecessor, Lloyd Bentsen.

Many observers have portrayed the G7 and IMF stance as multilateral. This is deceiving. There were two other significant meetings of international monetary officials this spring (ASEAN+3 got together in early May, while the Asian and European finance ministers met in late April), and their resulting statements did not reflect the sense of urgency of the G7-IMF meeting communiqué. The key difference was the absence of the U.S.

Remember, too, that after the 1997 - 1998 Asian financial crisis, insofar as it essentially pushed for the implementations of the Washington consensus, the IMF is hardly perceived as an independent actor. U.S. foreign economic policy is a subset of U.S. foreign policy, and in this sense the IMF is another “coalition of the willing.”

In addition, while there is official recognition that the IMF’s voting system no longer reflects economic reality and reforms are likely to be announced in September, it did not prevent the old IMF (in which developing countries such as China, India, South Korea, Brazil, and Russia were not fairly represented) from taking on a new foreign-exchange mandate.

We have been down this road before. The pattern is for European and Japanese officials to “cry uncle” before the U.S. and long before the dollar has fallen to a level the conventional view says is required to correct global imbalances. In mid-May, with the U.S. Congress approving the renewal of some the Bush Administration tax cuts, the signal being sent is the U.S. is not serious about boosting savings and will rely on currency depreciation. As the euro approaches its historical highs, the dollar sags below 110 yen, and global equity and bond markets become more volatile, it will not take long for domestic pressure to build in Europe and Japan and resistance to dollar depreciation to grow.