The G7 is Not Permanent Manna from Heaven!
March 18, 2011
David R. Kotok
“We need to be sure to note in any comments that the G7 move was decided by the finance ministers, not the central banks. Foreign exchange intervention decisions are the responsibility of finance ministries. Central banks then carry out the intervention. The Fed actually does not hold much yen to sell. The ECB has more, and the Japanese have an unlimited amount. I expect the intervention will target the price of 80, countering speculative moves for a higher yen, and eventually fundamental forces will likely bring the yen lower.” Source: Bill Witherell, Cumberland’s Chief Global Economist, Friday morning, March 18, 2011, and following the Thursday night announcement of the G7 “secret” agreement.
I have excerpted the above from our internal Cumberland exchanges this morning. Bill summarized it well, so there is no reason for me to paraphrase it. Readers may not know that Bill Witherell spent many years at the OECD in Paris and headed the Finance Directorate there. In his previous role, he participated in many of these “secret” or closed meetings. Last night and this morning we had dialogue as we dissected the G7 action.
In this morning’s news, we have heard several erroneous statements coming from anchors who were not reading a teleprompter, or from TV guests. Let’s try to add clarity.
The Group of Seven countries are Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. They each have a national central bank and a finance ministry. In the US, we have the Federal Reserve (Bernanke) and the US Treasury (Geithner). France, Germany and Italy each have a national central bank. They are also in the Eurozone and coordinate their monetary polices at the European Central Bank (Trichet).
Central bankers usually participate in these types of discussions because they are the ones who have to execute them. In the US, the execution will be carried out at the Federal Reserve Bank of New York; it will represent the US Federal Reserve. The NY Fed does not make the intervention policy; they are the administrative arm of the US. For the US, the decision is made by the Treasury Secretary, with the approval of the President.
This intervention means selling yen in order to weaken the yen in the foreign exchange markets. In order for one of the nations involved to sell yen, they have to hold it. They hold some for commercial trade purposes and they hold some as reserves. As Bill notes, some of those holdings are relatively small. If they do not hold enough yen, they may borrow it from the Bank of Japan and then sell it. This is an indirect form of the Bank of Japan selling it themselves. The borrowed yen is likely to be paid back at a later date when the markets have calmed and are stable.
A key issue is whether the intervention will be sterilized. Sterilization means offsetting transactions. In this case, the intervention will be unsterilized, according to the Bank of Japan. That is the only way it can achieve any success.
The G7 have not said what their targets are; however, they may be easily surmised. Bill emailed me that he concurs with the analysis that was on CNBC this morning. He notes, “David Kan just gave a great analysis of the yen situation on CNBC. It may shortly be available on their web site. He argued the G7 intention is to bring the yen back to where it was before the quake and stabilize the market. Then yen is likely to ease thereafter from market forces.”
Bill Witherell is on his way to Chicago. I’m now going to the office. Next week, we can ask Bill to elaborate. All errors in this morning’s commentary are mine.
A final note: this intervention will certainly be added to the discussion in Rome at the GIC conference on April 6-7-8. Any last minute registration may be accomplished at www.interdependence.org.
David R. Kotok, Chairman and Chief Investment Officer