The Golden Goose Rule (or, why the G7 is irrelevant)

In a transforming moment, the foreign exchange market is reconsidering what its driving forces should be. The analysis emerging over the next few weeks is going to color the entire year, and perhaps beyond.

In early February, the Group of Seven (G7) is going to hold one of its two yearly meetings. The G7 host this time, Great Britain, has invited China to attend. Most commentators expect the G7 to put pressure on China to revalue the renmimbi, which would have a small effect on reducing the U.S. trade deficit with China, but a bigger effect if other Asian countries followed suit. But most commentators also expect China will politely refuse, on the perfectly true grounds that its financial system is not yet big or mature enough to handle free market interest rates and exchange rates.

If the G7 were being held while the dollar was still falling, before January 3, China’s refusal would have been dollar-negative. After all, the high and rising U.S. trade deficit with China is a key reason the dollar has fallen over the past year.

But this time it will be different, because our understanding of the U.S. economic situation is undergoing a transformation from seeing the glass as half-empty to seeing it as half-full even a little more than half-full.